Should You Prepare For A Lost Decade?

We spend a lot of time here trying to study and learn about how to make portfolios more robust to various types of risks including market risk (bear markets) and event risk (usually resulting in fast declines). One market risk might be a so called lost decade. A report from Gorman, Keel and Randazzo went into depth on lost decades. 

I added the green rectangle because that doesn't look very lost to me, but the red rectangle would seem to fit the bill. If you were around for the lost decade of the 2000's you know first hand that even in a lost decade, there will be pockets of the market that will do at least ok, if not better than ok. 

In the 2000's, dialing up foreign exposure was pretty important for example. Someone who builds a portfolio that includes individual stocks would reasonably have at least a couple that would do just fine if we have another lost decade. There are now more ways to build a portfolio that includes all weather types of funds or tools that would allow investors to build their own all weather portfolio to succeed in a lost decade. 

Ares tried to make an argument for (private) infrastructure to play a role in a lost decade (my interpretation) because they say it tends to go down less, has fundamental tailwinds behind it and doesn't necessarily rely on a favorable economic cycle. It's not that infrastructure is reliably countercyclical but money can still be spent on infrastructure development and various forms of tolls can still be collected. 

Maybe private infrastructure can offer crisis alpha or maybe it's just volatility laundering but I wouldn't count on getting crisis alpha from infrastructure stocks or ETFs. I use PAVE for clients with part of the thesis being, we need to invest a lot into our infrastructure, I believe the money is going to be spent no matter what is going on, even if it happens in fits and starts. I've talked frequently about my belief that publicly traded financial financial markets are also part of the infrastructure theme as toll takers. I use CBOE in this context which also benefits from VIX trading volume despite getting kicked very hard over the last couple of weeks or so. In 2022, PAVE and CBOE were only down 7.18% and 2.17% respectively but I am saying I would not rely on that to repeat....great if it does. 

The Ares paper explores leveraging up with a sort of portable alpha strategy to add 20% in infrastructure to a 60/40 portfolio. Here's how I built their idea out.

Compared to plain vanilla 60/40 comprised of SPY and AGG.

It does outperform but with more volatility and the max drawdown was much higher. The infrastructure portfolio went down less in 2022 but down more in every other significant drawdown available to look at. 

According to Copilot, the main driver of the outperformance is the leverage, then avoiding duration with FLOT and MERFX (both client holdings), we always avoid duration in these exercises, with the infrastructure exposure being the least important driver. While I believe in infrastructure, I am skeptical that it can do the sort of long term heavy lifting implied in the Ares paper. 

Kind of funny, on the flip side of a lost decade for equities, Robert Pozen made the case for 90% equities instead of 60%. We can get a sense of what 90/10 would look like versus 60/40 from the last two previous lost decades cited above. I'll use the IEI ETF for the fixed income allocation, testfol.io can't go back as far as we need with AGG.

If there is a lost decade anytime soon, I wouldn't want to rely on bonds helping as much as they did in the last two lost decades. In the most recent lost decade, the SocGen Trend Index compounded at 13.43%. The index was not around in the 70's but Gemini theorized that managed futures trend would have done better than 13.43 from 1968-1974.

Having some managed futures seems like a good idea to help with a lost decade and I would consider more than one fund to build out this part of the portfolio and maybe a higher volatility managed futures fund should be considered. 

Gemini thinks that global macro, equity market neutral, merger arb, commodities and reinsurance would also work in a lost decade. 

Selling volatility doesn't seem like a great idea but Gemini said that covered calls might be a strategy that could work. 

There isn't a great sample size to study on that point but I certainly wouldn't go heavy if at all into crazy higher yielders. 

It makes sense to think about what you'd do if equities start to sputter. Getting the timing exactly right seems like a low probability outcome so I wouldn't make dramatic changes. Dialing down equities a little and dialing up diversifiers a little can work to improve results in a lost decade without being completely left behind in case it's just a lost month. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Is The Options Market Giving Away Money?

A reader left an interesting comment on this week's Striking Price column in Barron's. The article was about SpaceX. The reader said he sold deep in the money calls against the stock, really deep at $110, he didn't say where the common was when he put the trade on. Despite being that deep in the money, there was a ton of time premium in the price of the option.

Usually when there are calls that are that far deep in the money, there isn't much time premium (time premium is where changes in volatility are reflected) because the odds of the stock cutting in half or whatever are very remote. 

With markets closed it is easy to take a look at where the stock and a couple of options are pricing without it being completely different 10 minutes from now. On Friday at 4pm, SPCX common closed at $185.00. The January 100 call was bid at $90.90 so the time premium was $5.90. With something like this you could compare $5.90 to how much interest you might get on the $9410 you'd need to put this on as a buywrite. That annualizes out to a "yield" of almost 11%.

The trade runs into problems if the common drops below $94.10 ($100 minus the time premium taken in). If SpaceX drops to $110 or $120, the buywrite would still intact and be profitable when the option expires, the call sold gives up everything that happens above the strike price. You might be sweating it, if the common was at $110 or $120 next month, you'd still have a long time to go. The reader called his strategy "conservative." He believes he is avoiding the volatility in the stock prices but is benefitting from the options volatility. 

Obviously, there is no way to know what will happen to SpaceX' price between now and the January expiration but to the title of this post, the options market doesn't give money away. I take the time premium in our example to mean that the market thinks the stock could go below $100 between now and January. 

If it works out, then the reader did a great job of exploiting SpaceX' volatility but either way it's a fascinating trade. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Steep Hill To Climb

We had a very challenging wildfire yesterday. Walker Fire trucks are red and the Forest Service are green.

It was very close to the road which made it easy for us to find but it was down an insanely steep hill. I've never done any sort of fire activity on such a steep hill.

We got there just a couple of minutes before PNF 633, it was on federal land so they had command of the incident which was probably a good thing, no obvious obstacles to ordering up air support. 

Now, on to today's post. Alpha Architect has put out a lot of content and information lately promoting its High Inflation And Deflation ETF (HIDE) as a substitute for managed futures. There is some amount of trend following in the HIDE process and part of the pitch is HIDE can be a way to avoid the fallout when managed futures struggle or otherwise do poorly. The most recent incidence of this was the few months going into the Tariff Panic in early 2025. 

You can see from the drawdown chart that when DBMF and QMHIX get colds, HIDE barely gets the hiccups. 

The tradeoff is that in 2022, HIDE might have been down based on replicating it. A reasonable expectation for managed futures is that it will hopefully go up when markets have longer, slower declines. HIDE seems like it is setting a different expectation. 

Here's a fun idea.

The funds will take any dividends earned by the underlying equity portfolio and use them to buy Bitcoin. Or you could just buy Simplify US Equity PLUS Bitcoin Strategy ETF (SPBC). Or you could just buy a Bitcoin ETF. 

What will be the yield of the equity portfolio? A little over 1%? Maybe? I don't know why this would be someone's best choice to add Bitcoin. 

A couple of weeks ago, we looked at a portfolio from Finomial that they called Leveraged Equity + Diversifiers Portfolio. Today I got an email about their review of Leveraged Equity + Diversifiers Portfolio II. The differences between the two is slight.

Version 1 has pulled away the last couple of years, I think the difference can be attributed to the position in FEGIX which includes mining stocks. Gold miners tend to have bigger moves in both directions than just plain gold. 

The results are compelling. The Finomial portfolios have had quite a bit more growth with about the same volatility as putting 100% in the S&P 500 often with smaller drawdowns. The Finomial portfolios are 100% equities with alts on top. 

There's never been any sort of hideous path for SSO versus the S&P 500 but it's not impossible going forward, 50% in SSO could be difficult at times. That said there a couple of concepts here that I think are useful and overlap with what we talk about and do here. One is the willingness to include traditional mutual funds in the mix. ETFs are generally the better wrapper but not in every instance. I don't think it is logical that one wrapper must always be best and I don't think ETF-only models make the most of what is out there. In building or managing your own portfolio, if a mutual fund is the best way to capture some exposure, use the mutual fund. 

The other thing is that I'm learning from a project I am working on for the Del E. Webb Foundation is that these are "institutional caliber" portfolios. That doesn't guarantee results and that doesn't mean portfolios like this can't be poorly assembled but these sorts of things really are sophisticated concepts that are accessible for individual in their brokerage accounts.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Style Is Tricky

Sorry I haven't posted in a few days. It's been very busy (good busy) and I haven't seen a whole lot that would spur a blog post. Here's a quick something though. 

The weighting is microscopic but still, what's the deal? Dave Nadig weighed in. It's a long article so the TLDR is "SpaceX was added to the Schwab U.S. Large‑Cap Value ETF (SCHV) not because it looks cheap, but because the Dow Jones style methodology couldn’t classify it as growth—so it defaulted into value by process of elimination."

That comes on the heels of our conversation the other day about the VLUE ETF having 22% in Micron. If Dave is right, it's value because it's not growth, then to the point we made the other day, there's not much utility to the growth or value labels. 

That may not matter as much with an actively managed stock picking fund. To buy that sort of fund is to buy the manager. The SpaceX weighting is so small in SCHV that if the company went out of business tomorrow, it probably would not be detectable in the NAV but for anyone trying to build a style oriented portfolio, it is tricky, maybe trickier than it should be. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.  

Are Index Funds Too Big?

First a follow up to an idea from a couple of months ago about creating some sort of fund that would make constant bets on Kalshi or Polymarket. The idea was not so much hold bets through to the conclusion but to use an algorithm to scale in and out as prices change. The hope would be some sort of uncorrelated, absolute return outcome that maybe did a little better than T-bills.

The NY Times wrote about something not that close but sort of close. The article was about arbitraging between two markets when they price outcomes differently. If between the two markets the yes and the no outcome add up to less than a dollar, then a combo bet could be placed to capture the pricing discrepancy, very much hitting singles. The article profiled a mathematician who the Times reports has made over $1 million in the last three years. 

The arb isn't betting on outcomes it is exploiting inefficiencies and discrepancies. 

Torsten Slok is concerned about the enormous size of the three largest index ETFs; VOO, SPY and IVV.

Two different AIs corroborated that index funds (ETFs and mutual funds) comprise 20-30% of the US market. Jack Bogle thought it would be problematic if it ever got above 50%. 

I think it is important to understand that indexes have flaws and drawbacks and it is prudent to know when to deviate from tracking too close to the index. With 50% in tech plus communications, I believe this is one of those times. I have no idea if anything bad will happen but the concentration of risk in those two sectors seems obvious. 

And we'll close out with a fire department buddy who is my age but retired. Part of his post-retirement routine is that he picks up shifts at his church as an EMT during Sunday Services which is not uncommon for larger churches. I believe he has done similar work at the arena in Prescott Valley that has concerts and is the home field for our indoor football team. 

Another former fire department colleague used to get event gigs for EMS down in Phoenix, mostly concerts and festivals. The last time we had a serious fire here was the Crooks Fire in 2022. The community was evacuated and our station house hosted one of the divisions working on the fire as well as the structure protection group. 

As part of this contingent working from our firehouse, there were two EMTs and an ambulance. The EMTs sat in front of our station house on their phones or tablets just hanging out waiting for someone to need help. They were doing nothing wrong, their job was to be on standby and wait in case someone got hurt. There are also teaching/training opportunities for people with EMS credentials.

The point here is there can be plenty of ways to pull together a useful income in an area that might be as relevant to you if needed as EMS is to me. None of these EMS opportunities strike me as punching clock on a regular basis. Taking shifts with the ambulance company would feel like giving up some independence. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Value Funds That Load Up On Tech

Barron's had an interesting writeup about value funds having done well this year including the iShares MSCI USA Value Factor ETF (VLUE). It is up a whopping 44% this year versus 7% for the iShares S&P 500 Value ETF (IVE). 

When you see that sort of dispersion, I think the first question to ask is what the hell is causing that sort of outperformance (or lag as the case may be)? In the case of VLUE, it owns Micron (MU) at a current 22% weighting. MU is up 243% YTD so at 22% of the fund, it has not been rebalanced yet. Barron's neglected to make the point about Micron but several reader comments made the same observation I am making. The number two stock is Cisco (CSCO) with just under 5% of the fund.

A big point being made was that the line between value and growth appears to be blurring as more and more tech is showing up in value funds. The tech sector comprises 42% of VLUE, for IVE it is only 22% which seems kind of high. Apple is the largest holding in IVE at almost 8%, tech adjacent Amazon is second at 4%. The DFA US Large Cap Value Fund (DFLVX) has only 14% in tech for context. 

iShares has several large cap growth ETFs. BGRO and ILGC both have 52% in technology. If both growth and value are heavy in tech and tech adjacent, the odds of doubling up on the same stocks are pretty high as well as having just a ton of tech. Apple and Amazon are both top four holdings in growth funds BGRO and ILGC along with value fund IVE but don't appear to be in VLUE.

I've never done anything with funds that target growth or value. I think managing sector weightings is very important and if the lines are blurring between growth and value then managing sector weightings becomes harder to do. If someone buys VLUE today thinking they're going to get X% of their tech from the fund, whenever MU gets rebalanced down it will change the tech exposure of the portfolio. VLUE is 42% tech with half of it being one stock. 

It's a lot simpler to use sector funds and some thematic funds for any portfolio that doesn't use individual stocks. Utilities are always going to be utilities and a defense contractor themed ETF is usually going to be a mix of industrials with a little bit of specialized tech thrown in unless the name indicates otherwise. 

Quick pivot to the behavioral challenge of spending down from a retirement account. When you build up some sort of account balance, retirement or otherwise, it creates a sense of security. Pulling from that account combined with seeing it shrink doesn't sound easy to me. Over the last many years, chances are someone taking a reasonable amount out has seen their account balance still grow because of how well markets have done. Taking 4-5% out is very unlikely to result in running out of money early but with a decade like 2000-2009, taking 4-5% out could have easily cause the balance to decline. 

Looking back in hindsight, yes just staying the course was the obvious thing but maybe not so easy to actually stick to at the low in 2008 or early 2009. 

This is something I've long recognized in myself. I think it will be emotionally challenging to pull money out whenever the time comes but my thinking on this has evolved a little, maybe someone will find this helpful or useful.

More than just generally spending down if the market sequence is not great causing discomfort, I think when the time comes, there will be some number in my account that would be difficult to go below. Right here, right now there is number that makes me feel comfortable and the dollars above that are gravy. I'd be ok spending the extra, spending the gravy. If I can continue to work to RMD age, 75 in my case, that's still quite aways from here so I have no idea what my comfort number would be by then between price inflation and hopefully account growth (price appreciation and any contributions I might make) or obviously what my gravy number will be but this is a useful tweak to my thought process. 

You can't take out $15,000/mo from a $1.8 million account and expect it to last but if you have that much money when you retire, it would be nice to take your $80.000-$90.000/yr without being constantly stressed out about it. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Prioritizing Peace Of Mind

A few days ago we looked at an article about whether or not to end up as the richest person in graveyard. Basically, dying with too much leftover could lead to regret for people when they get to a very old age. The article from William Bernstein and Edward McQuarrie gave permission to have a lot of unspent money at the end because going through with that sort of safety net, even if unspent, has utility, it has value. They validated the idea of moving financial security further up the priority list. 

This week, the WSJ reported on Fidelity moving toward allowing target date funds to partially convert into immediate annuities. I am not a fan of annuities, I've never sold one and I am not licensed to sell annuities. Anything bad you can say about them, I am likely to agree.

That said, there are positives to annuitizing a portion of a retirement portfolio. I think this will come at some point without getting tied up with a complex insurance contract. One point that I made ages ago, more anecdotal actually, was that people I knew who had annuities love them. 

Someone living a $6000/mo lifestyle, getting $3500 from Social Security, maybe they can peel off a chunk of their IRA into an immediate annuity to generate a $1000/mo income stream while having most of their retirement money still in their brokerage account where they maintain control of the assets. The lifestyle in this example might be $6000 but if SS plus the $1000 annuity stream covers the fixed expenses, then that might reasonably create utility, value, for the end user in the form of peace of mind. 

So if you want an annuity, go buy an annuity if the trade offs would be worth the peace of mind. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Income Engines

StateStreet has filed for the SPDR NASDAQ MyPaycheck ETF. It will be a fund of funds and while there is surprisingly little information on the underlying index for now, Copilot thinks it will target about a 6% yield. Great name, it overlaps one of the things we talk about here for bridge strategies and it reminds me of the StrategyShares NASDAQ 7Handle Index ETF (HNDL) which started trading in 2018 and targets a 7% distribution that can be comprised of yield, capital gains and return of capital.

It was a lot harder to cobble together 7% in 2018, I remember the fund having a lot more exposure to MLPs and funds like SDIV.

The chart is price only. Right now, the distributions are a shade under 7%. 

SDIV has been paying out closer to 9% with much more volatility and obviously compounding very negatively for anyone taking out the distributions. When I first wrote about HNDL, that URL doesn't exist anymore, I expressed concern that the fund would deplete which it clearly has not done. Thinking back to 2018, "the fund will yield 7% and the price will trade sideways" would have been thought to be very good result, I do think it is a good result. 

Lately, HNDL has been paying more ROC. One third of the fund is in various aggregate bond funds that yield more like in the fours, it might actually be more than 1/3 because another 28% appears to be in swaps that replicate the fund. 

I took a stab at making a paycheck strategy as follows;

BKLN and BSJS are in my ownership universe. 

If all the income is taken out then it would deplete after 27 years per Copilot. That seems a little too optimistic but as a bridge to some financial milestone it could last a decently long time. The withdrawals could be managed to avoid the negative compounding (take less out).

HNDL and our idea held up well this past March when the Iran war started but they both got hit hard during the Tariff Panic, dropping about 15%. 

Although not precise terminology, this idea plays off the concept of carry, creating an income "engine" from a portfolio balance that doesn't move around that much.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

The Social Security Problem Appears To Be Getting Worse

By now, you've probably seen they nudged up the timetable to 2032 for when Social Security would presumably need to start cutting payouts by what the Washington Post says would be 22%. Here's the Barron's report on this story. 

There are plenty of ideas floating out there including raising the full retirement age, lifting the income cap (for 2026, once income gets to $184,000 there is no more payroll tax due), reducing the annual COLA bump, means testing (cutting/reducing it for "rich" people) and even investing it in the stock market.

As a legal matter, they simply cannot pull the money from somewhere else to plug the hole. Apparently the last time they made changes in 1983 they did so just in the nick of time which argues that sitting here in 2026 is too soon to worry about it. To adopt that position is to give Congress the benefit of the doubt and while I am sure they will do something, I don't know about giving them the benefit of the doubt on anything. My point being that waiting until the last minute increases the odds that whatever they do is "unfair" to more people than it would otherwise need to be. 

There's a cliche about a negotiation being good when no one thinks they got a great deal, they got something they wanted but not everything. I would suggest being mentally prepared for feeling a little worse than that when this all shakes out. 

Related, this year's Social Security COLA is now estimated to be 4.7% after this morning's inflation data. Someone planning to take Social Security in 2031 and thinking they will get $4000 in today dollars would get $4866 in 2031. If they have to take a 22% haircut from $4866, they'd be down to $3795. Put yourself in that position with your numbers. As it stands right now, would that much of a drop be a problem? I'm not being critical at all. If that drop is a problem, you've got time to figure something out. Then, all the better if they somehow fix it. 

And a quick follow up, with the recent leg down in Bitcoin, I wanted to check in on the Vistashares Bitbonds 5 Years Enhanced Weekly Distribution ETF (BTYB). The basic idea is that fund seeks to pay out twice whatever the five treasury is paying by harnessing Bitcoin volatility via a synthetic covered call. 

UFIV tracks the five year treasury and YBTC is a Bitcoin covered call fund. In the period charted, BTYB has paid out a total of $0.187 so add 75 basis points back into the decline of 5.5% as of Tuesday's close.

BTYB is down less than I would have expected in the face of how much Bitcoin has fallen. What has probably gone on is that as the price of Bitcoin has fallen, the volatility has gone up which results in the option combo that creates the synthetic covered call going down slower than underlying Bitcoin. The fancy term is gamma. BTYB benefitted from positive gamma. If Bitcoin had gone down in such a way that volatility compressed then BTYB would have probably fared worse.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Permanent Adjacent?

Meb Faber Tweeted out an article he wrote in 2020 about a "stay rich portfolio" which he called the Global Asset Allocation. Presumably, the article was in support of the Cambria Global Asset Allocation ETF (GAA) which allocates 45% to equities, 45% to fixed income and 10% into alternatives. 

We've looked at GAA before. The allocation is interesting and results need to be looked at closely to understand them.

The overall numbers aren't so hot. The 67%/33% blend is in there because it was mentioned in the article as being good middle ground between all GAA or all T-bills. The DIY version I built as follows;

Gold is mentioned favorably in Meb's article and I know he thinks managed futures is an excellent diversifier. I chose QMHIX for this to start playing with higher volatility managed futures. MERFX and BKLN are client holdings. 

When we look at the Cambria funds, the volatility stats usually aren't that good, they seem high for GAA given it only has 45% in equities. I wouldn't expect 45% equities to keep up with 60% equities but it would be nice for the volatility to be lower than it is for GAA, inline with the DIY version maybe. 

Where the results get interesting beyond the obvious that the  GAA ETF has been doing very well for the last year and half is that it does appear to be differentiated from VBAIX. Differentiation can be good. 

Pivot to a new fund that might blow your mind. It is blowing my mind, not being sarcastic. It's the Porter & Company Porter Index Fund (PPCP) it is a quadrant style fund that is modeled after the Permanent Portfolio but the asset mix is different. It allocates 25% each to... are you ready... property and casual insurers, capital efficient equities, hard assets and short term fixed income. What?

This one is easy to backtest thanks to the iShares US Insurance ETF (IAK).

Which one is which? That's a 20 year run and the lack of dispersion is remarkable. 

Copilot has thoughts. First it says that PRPFX hasn't been true to the Permanent Portfolio in terms of long term bonds. The equity allocation in PRPFX has generally tilted toward quality, not simpler market cap weighting. Gold is gold of course and cash is cash. Copilot thinks "insurers are unusually resilient, capital-efficient, low-volatility compounders that behave well across many macro regimes."

I don't know about that. The drawdowns look pretty rough for IAK. It then told me that IAK isn't the best proxy even though it gave me the ticker in the first place.

At that I point I threw in the towel. Seeing how PCPP trades might shed some light or maybe IAK is a proxy for something else that Copilot isn't teasing out. What's going on then? Leave your thoughts in the comments.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Tools, Not Return Engines

We've got a lot different things to tie together related to portfolio construction and diversification. 

Cliff Asness wrote a long Tweet in support of a paper from AQR that said bonds don't diversify equities, they dilute equities which I think is a fascinating way to phrase it. There's been commentary from various sources that bonds no longer diversify equities they way they used to (I have said that repeatedly) but Cliff believes "bonds never mattered all that much in 60/40" because as the AQR paper goes on to explore, there are other diversifiers can do the job that people think bonds can do. 

I disagree a little bit, bonds mattered for a long time. They were reliably negatively correlated in a way that doesn't exist anymore. Compensation stopped being adequate for duration long before the top in late 2021 but they did help...until they didn't. 

The actual paper starts off talking about the mistake of replacing bonds with things that actually have more equity-like risk than bonds. They cite "most buffered funds" as one example, they cite private credit as having a 0.63 correlation to equities with equity beta of 0.70. They also noted that some believe Bitcoin can function as an equity diversifier but they are very dismissive of that idea. Per the paper they favor long/short equity with a market neutral bias and managed futures. 

Many of the blog posts boil down to me trying to refine my approach on how to build the 40 in a 60/40 construct. There's value in backtesting but there needs to be a grain of salt added to the process of backtesting per a paper from Long Tail Alpha. Done incorrectly, the process can lead to building around hindsight bias that relies too much on the past repeating. 

How often do we backtest a heavy dose of managed futures and then contrast that to the actual experience of owning managed futures? Too much allocated to any diversifier creates risks to the portfolio regardless of whether there's ever a consequence for that risk. Managed futures always backtests beautifully but since the resurgence in popularity of managed futures starting in late 2021, there have been two very rough stretches, one in early 2023 and then going into the Tariff Panic. I've seen a couple of different sources say how bad early 2025 was but I actually recall early 2023 being worse. Managed futures are great for slower, longer declines but really a flip of the coin for fast declines. 

This is a great quote from the Long Tail Alpha paper.

we’re keenly aware of the historical bleed of a typical left tail hedge, whose value does not come from a strong CAGR, but rather from smoothing out left tail events in a larger portfolio

Or, diversify your diversifiers. You can smooth out the left tail events, meaning reduce a portfolio's sensitivity to outlying, downside market events by owning several different strategies that each have their own unique risks. This approach makes the portfolio more robust in case the next long, slow decline is the one where managed futures doesn't work. Thanks to liquid alts, there's no logistical barrier to having many different diversifiers. 

This chart is from Man. The way to read it is that the green combos provide better diversification than the pink combos.

The take away is not to allocate this way, I think the way to take it is as a reminder that during a draw down, a portfolio that goes narrower than broad based indexes will have things that go up. As we noted the other day, during Friday's puke down, healthcare, financials, REITs and staples generally went up. Whenever the next real bear market comes along, there will be stocks and maybe even a couple sectors that go up. If a couple of alts work as well as a couple of plain vanilla holdings go up or are even just flat, then a the portfolio has a good chance of weathering something more serious than a bad week or month.

Hedgeco.net provides rationale for using alts that aligns with my beliefs.

Investors have become more aware that the classic 60/40 portfolio can fail when stocks and bonds fall together. Inflation shocks, rate volatility, geopolitical events, and liquidity stress have all exposed the limits of relying solely on long-only equity and core bonds.

They go on to talk about alts not as "return engines" but as tools that can fill portfolio gaps. The gap in the context for today's post is how to build the 40 or whatever percentage not allocated to plain vanilla equities. There's even a shoutout to litigation finance (we've looked at this a couple of times) which at this point doesn't exist in a wrapper with daily liquidity. "Liquid alts are most useful when they are mapped to a specific portfolio role." How often do we talk about this point? A lot, because it should be an obvious conclusion. 

Adam Grossman weighed in at Morningstar about his concerns for a coming lost decade. A key to success from 2000-2009 was knowing where else to look. I have no idea if we are going to have another lost decade but the process of planning in case we do should have started a long time ago.

A final note, in Friday's recap, I should have included how the autocallable funds did. We've talked about them some so it makes sense to check in when the market does poorly.

ACYN is from First Trust and pretty new. ACYN targets an 11% "yield" which is lower than the others, Copilot says that ACYN should have less sensitivity to equity declines. That panned out of Friday anyway. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Hola San Felipe!

On Saturday night I went down a fun rabbit hole of retiring as an expat to San Felipe, BC Mexico. The catalyst for my rabbit holing was a video on Instagram from a couple selling something to help people figure out how to retire to places in Italy that are just as pretty as the tourist spots but off the beaten path with no tourists. So they said, I obviously have no idea. 

A couple of months ago a dog lady acquaintance of my wife's moved to La Paz, Mexico which is way down near Cabo. San Felipe is about two hours south of the Calexico/Mexicali boarder crossing. In college, we used to go to San Felipe for the first few days of spring break. 

The picture is actually Rosarito Beach, that's me at the net setting the ball in 1989. It's as close as I can get to San Felipe without pulling stuff out of storage. Between the Italy video and the friend in La Paz BC, it just popped into my head, what's going on in San Felipe? 

Based on pictures on the internet, the town has grown a lot which is not surprising but it still very much looks like an outpost to me. It looks like the desert, just next to a body of water, the Gulf of Baja. 

That's a 4 br house for $239,000 on a 30,000 square foot lot. It's in a community that has a golf course with a lake and you can see the gulf in the background. The house needs some work the listing says but the house looks cared for as opposed to neglected. There's weirdness with the garage from the above picture. One of the pictures shows a mini-split.

There are plenty of cheaper houses there too. This one below is asking $179,000, it has 3br but is in a neighborhood. There are complexities to home ownership that are not insurmountable but do need to be worked through. Because San Felipe is on the water, there are a couple of legal residency statuses and each one has requirements for home ownership. There is also a complexity to the land the house sits on. Hawaii has something similar, the terminology in Hawaii is fee simple where you own the house and the land or leasehold where you own the house and lease the land. You'd have to dig in more but this is not unheard of.

For the internet, the best bet is probably Starlink. There is reliable cell signal in town. Many houses there have solar so that's not a problem in terms of rules, it seems like it's kind of recommended along with a generator. The water is still not safe to drink and there is not enough rain for catchment to be viable. Property tax for a $300,000 house would be $300-$750/yr plus there is another annual fee that AI described as sort of a banking/administrative fee to own a house which might tie into the residency issues. 

For serious medical issues, you'd probably need to go to Mexicali which is to say you'd really need to go to San Diego or maybe Phoenix. For routine physicals and dentals, San Felipe has adequate services, likewise for injuries but not Level 1 traumas. Prescott can't accommodate Level 1 traumas either, that is common for smaller towns. 

For under age 65, health insurance can be pretty cheap. Americans can go through a process to enroll in Instituto Mexicano del Seguro Social which would be $2000/yr for both ($1000 each) but doesn't cover preexisting. Paying for services out of pocket sounds cheap, a full battery of blood work would be about $80. 

There is no Costco, Walmart or Home Depot in San Felipe. There are several grocery stores including one that is owned by Walmart so there are Walmart brand items in town. There is hardware store. Interestingly, Amazon delivers to San Felipe.

In terms of safety, the area is rated 3: Reconsider Travel. Highway 5 is the main corridor from Calexico to San Felipe. The suggestion is to drive during the day and stay on the pavement. The Highway is not riskless to be sure but it is in the interest of the crime organizations to keep the highway clear with traffic moving but really, stay on the pavement. The town of San Felipe is significantly safer than the road to get there. 

The population has about tripled since I went there in the 80's but it still is very much an outpost sort of town. Out of 20,000 people who live there, 3000-5000 are American or Canadian. 

We're not moving to Mexico. 

Coincidentally, this morning there is another Barron's article about retiring to another country, primarily Canada, Mexico or the UK. That article tilted more toward people feeling like they need to leave the US for political reasons. The driver here is the financial aspect of trying to problem solve for an underfunded retirement. 

My only experience with healthcare in another country is the care my father received in Spain. He lived there for about 35 years, he got cancer shortly after his 88th birthday and died about six months later. The care he received was terrible. All the years he was there and getting just normal care like annual physicals and treatment for a broken hip when he was 71, the care was perfectly adequate. 

Because I think it plays a role in just about every retirement decision, someone who believes they need to retire in another country to make the numbers work will have dramatically more optionality if they have their health dialed in. 

For the 20 plus years I have been blogging, I have talked about the potential for "something having to give" if the desired retirement lifestyle won't work as a function of dollars and cents. Usually that has meant figuring out how to spend less, working longer in a primary career or taking up some sort of post retirement gig. Something else that might have to give is living in the US. Many countries are considerably cheaper.

We've looked at Ecuador countless times in this context over many years. Since then, political instability and cartel activity have both increased. I've noted that and said maybe an American couple would want to leave in the face of that and maybe they would but according to Gemini, the real story is that Cuenca and other inland expat areas have been unaffected by what has transpired elsewhere in the country. 

Interestingly, Gemini says that Cuenca is far cheaper than San Felipe.

Cuenca is probably safer too. I say probably because San Felipe's stats appear to be lumped in with Mexicali and Tijuana. The climate in Cuenca is quite moderate compared to Felipe being very hot.

Panama gets favorable attention as an expat destination. It is safer than San Felipe and about the same as Cuenca. For costs, it is much more than Cuenca and a little more than San Felipe. The climate in Boquette, Panama is similar to Cuenca because both are at elevation and Panama's healthcare appears to be the best of the three. One other thing going for Panama is that they use the US dollar for its currency. 

Gemini suggests a 3-6 month test run before moving to an expat destination and that the test run should include the worst time of the year like a rainy season or in the case of San Felipe, the summer. That many months should allow time to get a general sense of what it is like to live there (pick an area that you'd actually live in), learn about doing general errands, understand the infrastructure constraints and get a sense of whether a social network can be built. 

It seems like it is getting more difficult to accumulate enough to make retirement work. Whatever anyone wants to attribute the reasons to, it seems like that is a financial reality. Moving somewhere else can be the answer to some (probably) small slice of the population. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Rough & Rougher

Wall Street got kicked in the stomach on Friday, or maybe a little further south than that. Stocks were down a lot. Big tech was down a lot more. Bonds with duration were down a good bit, not a ton. Managed futures were mostly lower. Gold was also down a lot. Broad commodities were down a little less than gold. Bitcoin spent a little time below $60,000 for the first time in ages.

Client/personal holding BTAL was up a lot....yay? I'm glad it "worked" today but if BTAL is your best performer then things are going badly. REITs, staples, some financials and healthcare were generally green. 

Are markets worried that rates won't get cut anytime soon with the jobs data the most recent nail in that coffin, or are markets worried that there is no end in sight to the war, is it the excesses related to capex spending/debt issuance/equity issuance in the AI/data center theme, were we simply overdue for a pullback or was it something else? Yes.

Today is a great microcosm though for a lot of the portfolio construction theory we play around with here. Let's detour for a moment to what today's blog post was originally going to be about. Finomial Tweeted out a thread of a portfolio review for a capital efficient strategy that looks a lot like something we would work on here.

Here's the backtest result versus 80% equity/20% bonds (Finomial chose that benchmark).

The portfolio that Finomial posted has certainly been more volatile but hard to argue with the longer term result. It's easy to see that volatility on display in both the Tariff Panic last year and the broad reaction to starting the war with Iran. In the Tariff Panic it was down 18% versus 13.8% for 80/20. That is probably attributable to managed futures getting hit very hard during that event and the portfolio has close to 18% in managed futures. 

The point isn't to pick on the portfolio, it is to understand what the experience of riding through with some huge number in managed futures, or gold, or broad commodities or something else would actually feel like and how difficult it might be emotionally.

This sort of day would be challenging for anyone who is heavy in any of these.

We've talked about 5% in TECL which is not heavy IMO but 20% in one day is not nothing. We've never talked about SOXL which is 3x semiconductors. If it is as simple as looking at RSST and subtracting SPY's result to see how their managed futures sleeve did, then it was the biggest decliner of the ones I follow. I threw in HFGM because it targets twice the volatility of global macro. 

What would that table look like if this was the start of a meaningful move lower? Do you remember that fast panic that happened at the end of 2018? Most clients don't but in that fast event but TECL fell by 60%. Sixty percent in an event that many people don't remember. From July 2024 into early August, so just one month, RSST fell by 18%. I remember one or two very bad days in the first week of August but I'm not sure why RSST would have fallen that much but at the same time VBAIX was only down 4%. RSST came back obviously without issue but how difficult would it have been for someone who was heavy in RSST going down 18% in a down 4% world?

This is a difference between theory expressed in backtests versus actually enduring a market event. How did the portfolio that Finomial analyzed do today? Down 3.41%. That's probably not a number that will induce a poor decision but what about a week from now if equities continue lower and the things under the hood of managed futures continue to run counter to the recent trend (managed futures is likely long equities, long gold and long other commodities)?

I hope I am consistent in saying not to go too heavy into any of these diversifiers but if you are going to put 20% into something like managed futures or gold, I would spend time envisioning what it would really feel like when things take a meaningfully negative turn. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Solving Problems

The picture is of the engineer's compartment from Walker Fire's brush truck (type 6 engine).

The hardware pictured is a reducer, an inch and half double female, 2.5 inch double male and a 2.5 inch double female and you can see there is other items in the bin. These tools allow us to change hose size, make connections to truck outlets and even pair up incompatible thread types (there are two types of thread for some reason). The way I have been describing this to new firefighters has always been to say there is no problem that can't be solved out of this compartment, you just need to know what you're looking for. 

The ETF universe is of course similar. I mentioned taking in a new client for my subadvisor relationship early this week. The client came in with 55% in tech with heavy weightings in many of the names that are front and center for the AI/semiconductor mania that we are currently in.

I am hesitant to use the word bubble, I think mania might be a better word. Semantics aside, there is clearly an excess in this theme. Tech/communications is too big to zero out but I've been saying here for ages that I have been underweight. As of right now, tech plus communications adds up to 50% of the S&P 500. History has not been kind to sectors that get above 30%. Obviously there is no way to know when or even if there will be a consequence but the sign of excess is clear. No exposure is a non starter, repeated for emphasis but underweighting is viable.

For this new client, I sold a lot of the smaller names and shaved down the exposure to the major names he held. My usual tech holding for clients is broad based sector ETF that is heavy in many of the names I was keeping for him albeit in smaller percentages than what we walked in the door with. Loading back up on a sector fund that was top heavy in all the same names made no sense and would have left him very exposed to the same stocks that would be in real trouble if there is ever a consequence to the current AI/semiconductor excess. 

While 50% in tech plus communications is a non-starter for me, 10-12% is too light so into the engineers compartment for the Invesco Equal Weight Tech ETF (RSPT). Instead of 45% in semiconductors it has about 25% and obviously there are no holdings in the low double digits or high single digits. Weaving RSPT in with the holdings we kept/reduced allowed for dialing in some pretty precise percentages to bring him inline with other clients. 

Sort of related with the tech excess, back in May I swapped out market cap weighted ETFs for the few clients who had one for the momentum/quality/value combo we discussed a while back. The momentum ETF is kind of like MCW on steroids and the other two differentiate considerably from MCW and I think the three will combine to give a better result with a less total tech exposure than MCW.

The takeaway here is a point we make regularly which is I am not trying to predict anything, I am trying to avoid, or in this case underweight and obvious build up of risk. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Autocallable Theory

Larry Swedroe did a deep dive on the Calamos US Equity Autocallable Income ETF (CAIE). The basic idea with the fund is that it owns a series of structured notes that mature each week. The fund targets a 14% distribution. The fund would run into serious problems if it's reference index fell 40%. The reference index is similar to the S&P 500. CAIE has sensitivity to the reference index on the way down but in its one test so far, it captured a lot less of the reference index' recovery which is to be expected based on the structure of autocallables. 

You might look at that and decide right away these aren't for you (XV, SBAR and ACYN are also autocallable funds) but there has been no malfunction with them. 

Some points made by Swedroe; first is that 90% of the distribution is a return of capital. Yes it is a very high percentage. He warns that this has the effect of lowering your cost basis in a taxable account so that when/if you sell the cost basis might be nothing, so you'd owe a capital gains tax. Yes but that would be less than the tax on a true dividend. 

Larry then talks about gains being capped as I noted above which is correct. Don't buy this looking for an equity proxy on the upside. Larry notes the 40% threshold for problems starting, that is called a barrier, and yes a decline that big would be bad for the fund but it would be bad for everything. Don't buy this looking for downside protection. He further equates it to being short a put option which gives some good context for how it should behave.

The next issue is the counter party risk with JP Morgan and the cost embedded to pay the counter party. This isn't quite the threat he makes it out to be, if you don't already know this, don't bet too much of your portfolio on the credit worthiness of one bank. The odds of things ending badly for JP Morgan are quite low but sized correctly the actual risk is minimal.

He picks at the complexity and opacity. Yes, they are both, moreso complex than opaque. The strategy is learnable, I'd argue that these funds are less complex than the typical macro fund. Yes it is not cheap too. This is not a three basis point index fund. 

Larry says the NAV must erode and you can see that with SBAR and XV but it hasn't happened yet with CAIE. It probably will erode but I am always leery of using the word must. 

The article finished with checklist of sorts, what you want versus what you get. Once you understand what the fund does you realize that if you want what Larry says you want, you should find a different strategy.

As a matter of curiosity, I'm always going to want to try to find a plausible use for these flawed products, products riddled with drawbacks anyway. I continue to believe there is a use case for things like autocallables and crazy high yielders as part of bridge to the next financial milestone like taking Social Security or taking RMDs with the expectation that any basket of these will deplete toward zero.

The question/tradeoff goes something like this. An investor is 62 and wants to live off a $200,000 bucket of money until they take SS at their preferred age of 68. The income need from this piece of money is $40,000/yr for six years. If they leave the $200,000 in cash they can get five years, plus a couple of months from the interest. How likely would it be to squeeze out a sixth year or even a 7th thanks to the large distributions (ROC and all).

Using a combo of autocallables, not the craziest high yielding YieldMax funds (think Microsoft and Google, not Tesla and Microstrategy), cat bonds, then a sleeve in something like the BCKT or LDDR ETF which both offer depletion strategies and I threw in WTPI which is a pretty high, not crazy high, yielding  ETF that sells put options and doesn't really erode, it doesn't go up on a price basis but it hasn't eroded. There are countless closed end funds that could be part of the discussion to. 

With enough holdings, like maybe a dozen, any sort of issuer risk, strategy risk or idiosyncratic risk could be reasonably diversified.

Back to our $200,000 example, taking $40,000/yr from a basket of these would leave $57,000 left over after six years and probably get the investor through a 7th year with just a little leftover.

If it works out that a lot or most of the "yield" is ROC, that would not count toward modified adjusted income which could keep someone below the income threshold for health insurance from the marketplace to be subsidized which would be helpful until Medicare starts.

There are several grains of salt to take here related to reduced distributions and an extended downturn in markets but to the extent we do some work here on portfolio theory, this one is pretty far out there but still interesting. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.