There's a Munger Quote For That

Some quick hits today.

By now you've probably heard about the hedge fund called Situational Awareness run by Leopold Aschenbrenner. He made an absolute fortune leveraging up to bet on all the AI-adjacent stocks that were leading markets higher before they started to rollover in June. The leverage that made him a genius on the way up destroyed the fund on the way down. 

The Old Rope Research blog was apparently a believer in Leo and then wrote this mea culpa. In there, he called Aschenbrenner Lumpy Leo, referring to lumpy returns and attributed a quote to Charlie Munger about "preferring a smooth 10% return to a lumpy 15%." That is a great and concise way to sum up what we are trying to do here. 

This chart from Bespoke Investment Group is insane to me. 

I may not have mentioned it before but I am not a fan of bond duration. 

Recently, I learned quite a bit about outsourced chief investment officers (OCIO) in my work with the Del E. Webb Foundation. Basically, OCIO is a fancy term for the type of specialized investment manager that is equipped to provide service to foundations and endowments. It may seem like I'm making fun of the term but not the work they do. 

I will have more about this later this summer but in talking to one firm, there was one quip that really made an impression. In wanting to stress the importance of the relationship and services provided, they said anyone can manage the money. 

A quick detour, "relationship and services" is very important, there are complexities that differ from a person just trying to save for and then navigate through their retirement. 

But we can still dissect the portfolios. Typically, there's a lot allocated to equities, 65% was a common number. That 65% would include maybe 10-15% in private equity. Firms will often manage public equity with active managers with maybe a small sleeve allocated to index funds. A common allocation to alternatives as diversifiers other than private equity would also be in the 10-15% range. Based on my small sample size, these firms don't seem too interested in doing much with actively managing fixed income which if correct more universally, surprises me. 

I pulled some information about returns and volatility of OCIO managed accounts from Grok for three years ending 03/31/2026.

There's nothing special about the endowment and foundations numbers. There's nothing wrong with them either but they don't refute the claim that anyone can manage the money.

Portfolio 1 attempts a very generic replication. ACWI at 65% involves two decisions; the weighting which is consistent with what many OCIOs do and including foreign with ACWI as opposed to domestic only. APHPX and QMHIX are intended to be the the alts sleeve mixing something that is hedge fund-ish and managed futures. The income sleeve has a little more thought to it. SRDAX is an income fund but it goes off the beaten path and FLOT requires deciding to avoid duration. 

I couldn't really tease out better OCIO data even trying multiple AIs but if a person working at an OCIO shop says anyone can manage the money and we can get similar returns to what OCIOs can achieve then this supports the idea that investors can get "institutional" outcomes with brokerage accessible funds. That's huge and did not exist 20 years ago. 

The result is a little better than what Grok found but isn't all that interesting actually. It tracks very closely to the more generic Portfolio 2 but with noticeably better compounding and slightly less volatility. Both are valid but not special. Inflation ran at 3.04% so both were better than CPI plus 5% which is good of course but that is a short window we're looking at and stocks did fantastically well over that stretch.

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. 

CPI Plus 2.72%?

There's been a lot of attention lately to real yields on TIPS approaching 3%. These yields that Copilot found are probably stale by a few days but current enough for this post. 

We've talked more about the concept of real yields/return a few times lately. Generically, a real yield of 2% is considered a benchmark or sort of minimum standard. Real yields have been heading in the right direction from the perspective of investors for the last few years based on the UTEN ETF, which is not a TIPS product, but haven't been attractive.

This relates to recent posts where we've talked about foundations often seeking CPI plus 5% for an entire portfolio, the context of this is CPI plus almost 3% for a sleeve of the portfolio. The ten year and further out TIPS are still duration. If interest rates go meaningfully higher without a big step up in headline inflation then the prices of TIPS bought at 5.11% nominal/2.72% real will still go down a lot in price. If rates move higher along with noticeably higher price inflation, then the par value will be reset but it's sort of sequence thing for how much prices might drop as par increases teeter totter with interest rate sensitivities. 

Before going any further, if this sort of real yield appeals to you enough to allocate to TIPS, buy individual TIPS not ETFs or mutual funds. 

TIPS aren't my favorite. We can build a portfolio with a higher real yield that is far less volatile. I built this study;

I included TIP but there's not much information there, the duration is just under seven years. The real yield from the first table for a 20 year TIPS is 2.72%. The volatility of a 20 year TIPS should be similar to a 20 year regular bond and you can see the volatility of TLH which tracks 10-20 years. 

The specifics of the portfolio I built aren't important but a couple of details, 50% of it is FLOT which not a high yielding fund. It currently shows 4.53% on Yahoo Finance. The other half is split between 7 funds which each have 6-8% weightings to dilute the risk a bit. There is some volatility in the yield numbers flowing from the portfolio. 

In the context of CPI plus 5%, despite our result with the above income portfolio that has no equity exposure, you'd need a growth component (equities) to have a reasonable chance for CPI plus 5% for a longer period. 

Maybe you don't need that but if you do, even 20% equities should nudge up the plus X% number.

Adding 20% to equities and reducing the income positions proportionately had a total return for the period study of 11.27% and while that sounds good to me, it compounded 500 basis points less than a simple 60/40 portfolio. 

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. 

A Doozy Of A Day

This is a doozy of a quote from Torsten Slok via Bloomberg.

Here's how treasuries did on Wednesday. 

You can see most of the selling further out the curve happened as Kevin Warsh gave his press conference which was also a doozy. The respective drops in the seven year and five year is obviously less problematic.

Is the market doing the FOMC's job? Warsh sort of said that in the presser

The next batch are semiconductors, then broad tech, the S&P 500 and SPXT is the S&P 500 excluding the tech sector. From their respective highs in June, SOXX is down 27%, XLK is down almost 15%, SPY is down 3.8% and SPXT is down less than one percent from its high which was this month, not in June.

If this event turns out to be serious or memorable (or both), I think today gave a good look of what it will look like. Excess in the AI and AI adjacent space and unreliable volatility in the bond market will be front and center. We've been talking some about the excess in parts of the tech sector and talking constantly about the unreliable volatility of bonds a lot. 

We've had similar conversations in previous big events, I'm not sure what you do if you were overweight tech a month ago with no negative convexity on board. Maybe today is the bottom? At some point, industries like semiconductors, themes like the CHAT ETF or stocks like Oracle will find a bottom, time will bail those holders out eventually, there's just no way to know what they will have to endure or for how long. I mentioned ORCL because the decline has been stunning, I would be shocked if it went out of business at the end of this but to be clear, I am not a buyer at any price. 

I think anyone who was underweight tech coming into June, no tech is not realistic, and has been avoiding fixed income duration will fair better through this, if it turns out to be serious, but I would not count on skating through with no decline. My hope would be to avoid the worst of it. My experience has been that avoiding the worst of these events is repeatable. 

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. 

Should We Optimize For Sharpe Ratio?

Franklin Templeton is an ETF provider that gets very little attention. They do some interesting things and they also have model portfolios to support their funds. 

It's a 10/90 but it's not intended to be a standalone portfolio. As I take it, it could be used as a fixed income replacement along the lines of ProShares Hedge Fund Replication (HDG) or NY Life Hedge Multi-Strategy Tracker (QAI) as suggested by Claude. 

First is how Franklin model compares to HDG and QAI.

IUSB is similar to AGG but a little broader and has done slightly better that I will plan on using for blogging purposes going forward instead of AGG. The model took a less volatile path to a similar result as both HDG and QAI. A quick note, I switched out ARB from the model in favor of MNA to be able to go back a little further. If you look at the performance numbers, they fair worse than what I got because I am only able to grab what is in the model now, not track the changes it made along the way. 

Building the model out to a 40% weighting with 60% to equities, certainly helps the growth rate versus putting the 40% in IUSB but doesn't help much with volatility. Other than the 2020 Pandemic Crash though, the model has consistently done better in drawdowns. 

Here's a four minute excerpt from a podcast featuring Cliff Asness. The key line from Cliff was "you need to be able to short sell to create an uncorrelated return." QLEIX below is long biased, MERIX is market neutral and BTAL is short biased.

MERIX is client/personal holding the Merger Fund and ok, that might be the correlation but take a look for yourself, I would say it looks nothing like the stock market. It's by no means negatively correlated but regardless of the stats, having held the fund since the Financial Crisis, for my money it does not behave like the stock market even a little bit. 

Cliff also talked risk parity weighting of assets without using the term risk parity. He talked about leveraging up to even out the risk taken between assets with low/un/negative correlations. 

The holdings are SPY for equities, IUSB for bonds, AQMIX for managed futures and GLD.

It is very amusing that the way to optimize risk adjusted return (Sharpe Ratio) is to have no AGG-like bond exposure. Interestingly, if we replace IUSB with MERIX, the Optimized Sharpe Ratio recommendation was 25% each to SPY and AQMIX, 30% to MERIX and the rest in gold. 

Other than the Pandemic Crash, Optimized with MERIX has been a very smooth ride.

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. 

Additive To Your Long Term Result

Here's a quote from Jonathan Hoenig;

The best portfolios are designed to protect capital first while pursuing steady, absolute returns over time—not reacting to every market swing.

From Stephen Harvey of Sagard Wealth;

And Matthew Tuttle. 

You've been hearing for years about ETFs democratizing access to various strategies, including from me. I think the ETF industry has forced the mutual fund industry to also up its game. If you've been reading this site for a while then you already have at least a start at knowing how to do what all three quotes are talking about. 

The underlying premise connecting all three quotes is how to avoid making behavioral and allocational mistakes. One way to do this is to avoid obvious signs of excess. I've got some track record for this with banks in the build up to the Financial Crisis, bonds yielding nothing as Tuttle says and now with AI and AI-adjacent themes. 

There were enough non-bank financials 20 years ago (more now) that being slightly underweight the sector while avoiding banks almost entirely (held on to BNS which clients still have) wouldn't have been too disruptive if there'd never been a crisis. There were/are countless alternatives to bonds and bond funds with duration that would do what I think people want bond and bond funds to do, we've looked at this countless times. Completely avoiding tech today is impractical, it's too big a piece of the market to be zero weight. 

I think being underweight or avoiding excesses is easier than picking what will do best. Occasionally sidestepping an implosion, so not even every implosion, will be very additive to your long term result. 

The link quoting Harvey is from Chief Investment Officer and while I am unfamiliar with Harvey and his firm the context is institutional portfolios. The strategies and exposures he is talking about can be found with an abundance of choice from mutual funds now and to a lesser extent, ETFs. Quick note, pound for pound, ETFs are the better way to go but not everything goes best into the ETF wrapper.

Harsh closeout coming, too many people in the industry are still talking about and using very plain vanilla fixed income products that simply haven't been doing what investors would hope for and expect (repeating for emphasis). 

I've put up similar versions of this chart many times before, what do you want your equity offset, let's not called it fixed income, to look like. I think to avoiding duration will continue to be very additive to your long term result.

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. 

Don't Focus On What You Can't Do

The starting point for today's post comes from a couple of different articles at the Wall Street Journal. The first one is about the retirement situation in Thailand. If you think the US is in rough shape, Thailand appears to be far worse. The equivalent of Social Security pays $18-$35 per month. 

That sounds low but there was no context around those numbers. Grok says a "frugal/basic" lifestyle ranges from $700-$1000/mo. Thailand has essentially no pension-like system at that low dollar amount and the WSJ contends that most people have no savings either. The default assumption seems to be that old people will move in with and be cared for by their children. The few people profiled as caregivers in this context are in their 50's/60's and they are portrayed as themselves being physically worn out. 

I don't know how you make a $35 payment (if accurate) work in the context of a $700 lifestyle but this example sheds a little light that maybe things don't have to be as universally dire in the US even if things are plenty challenging here. I'm not in denial about the US' retirement challenges, more like ok, this is the situation, what can we do about it.

A couple grossing $50,000/yr (current median is $65,000) where just one spouse works is taking home $3550/mo. If the one earner retires in 2030 at age 67 still making $50,000, his Social Security would be $1602 in today's dollars and the spousal benefit would be $801 for a total of $2403 so they are short of their working take home pay by $1147/mo. A positive for this situation would be they own a house and their mortgage will be paid at age 67 or sooner. There is the potential for their Medicare premiums to be less than regular health insurance but there some moving parts to that part of the equation. If the mortgage is not paid off, then yes something will have to give, probably some sort of part time work to make up the gap. 

The other WSJ article looked at Supersizing Your Retirement Account including contribute the max $70,000 to your 401k (for self employed) and a couple of others that seem financially out of reach for most people. The comments went pretty hard after the $70,000 idea. 

As opposed to taking the advice about putting $70,000 away as the only idea, I took the context of the article to be focused on people about 50 with little saved but making pretty good incomes, not killing it. If that is their situation, what can they do about it?

I think a plausible scenario at 50 is a house that had a 15 year mortgage now being free an clear, kids up and out successfully and diverting what has been the mortgage payment into retirement savings. If this worked out to be $25,000/yr, after 20 years of compounding at 7% (not a heroic assumption) they'd have just over $1 million when they are 70. Yes, maybe they don't want to work that long but at 50 with very little saved, something might have to give, will probably have to give. 

The backtest considers three different broad, multi-asset funds; GMO Benchmark Free (GBMFX), Permanent Portfolio (PRPFX) and Vanguard Balanced Index (VBIAX). Starting 20 years ago with $2000, putting $2070 per month in and you can see the totals as of today.

If this couple had accumulated $100,000 by the time they were 50 and started on this $2070/mo plan, putting it all into GBMFX would now be worth $1,313.000, PRPFX would be at $1,753,000 and VBIAX would have grown to $1,850,000. A quick note, when I played around with different timeframes, GBMFX compounded much closer to the other two.

The big takeaway is simple. Assess your situation and then figure out what you can do. You can't save $70,000 in one year? Ok, what can you do? 

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. 

El Hombre Es Muy Macro

Barron's wrote about Social Security again. There wasn't much that was new except quantifying how much money people would forgo if payouts actually get cut in 2032. As an example, my age 70 benefit added to my wife's age 64 benefit (our intention is to take it when I turn 70, she'd be 64) adds up to $6684 in today's dollars. A 23% reduction would be $1537/mo times 12 months times 25 years would be a lifetime hit of $461,196 in constant dollars. 

The article took a stab at how to make that up by investing an extra lump sum amount now into Vanguard Balanced Index Fund. Using their math and thought process, I would need to invest $192,000 to have made up the $461,000 in 15 years. I realize there's a few more moving parts than that but it does give some context. 

While Barron's mentioned VBAIX, Bloomberg says that Gen-Z investors are "ditching" bonds in favor of more cash and cash proxies. They are getting almost the same yield without the volatility or the interest rate risk. Amusingly, Bloomberg is citing work done by Vanguard for the ditching bonds comment. 

I stumbled into a new fund to look at for anyone wanting to ditch their bonds. The Dynamic Alpha Macro Fund (DYMIX) allocates 50% to domestic equity ETFs and 50% to macro strategies. It seems similar to BLNDX or QNZIX which both split between equities and managed futures. 

The results for DYMIX have been strong. It has compounded at 21% since its inception in 2023 but with a high degree of volatility.

The decline since February seems noteworthy but is probably easily dissected. The fund's literature refers to the fund has having very low turnover with the macro sleeve only having three holdings; gold, copper and five year treasury notes. It seems apparent that the majority of the macro sleeve is in gold and that the fund hasn't sold any of its position. Since gold rolled over, the decline in copper has been modest as has the decline for five year treasuries. 

Morningstar says the turn over is 3% which means very little trading, very little. I don't really understand how a fund that never trades can be a macro fund as opposed to more of a multi-asset fund. The result can still be good, it is good irrespective of the current drawdown the fund is in.

The counterpoint to whether it might be better thought of as a multi-asset fund is there is very little under the hood of DYMIX that can go wrong. The literature mentions simplicity, the look through is easy and the only risk is the decisions made not some sort of complexity working against the NAV. The decisions have mostly been correct based on the result but for the last few months gold has hurt.

The backtest is interesting.

In terms of volatility, DYMIX is a bit of a hot potato but Portfolio 2 could be thought of as an example of how to incorporate a hot potato in with other holdings with different attributes to blend into a pretty smooth ride. I would not count on the growth rate to continue to be that strong but I think the volatility attributes could be pretty durable. 

In terms of DYMIX, I think of macro strategies making a lot of small bets not one huge bet (gold in this case). I'm not going to be interested in pursuing the fund for clients but I think it could be useful for blogging purposes for studying ways to concentrate volatility into smaller slices of the portfolio like we did today. 

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.

Avoiding Costly Mistakes

The annual number is out from Fidelity about how much money someone who is 65 today can expect to spend on healthcare expenses for the rest of their lives. The 2026 number is $185,500 per person so $371,000 per couple which is up 7.5% from last year's number. 

One little detail in there that I suspected but wasn't sure is that "a little under half (45%) of Fidelity’s total comes from Part B and Part D premiums" but that excludes a supplemental plan like Part G. That makes the numbers a little less scary. A married couple might be looking instead at $204,050. Grok says the median Part G premium in Arizona is $170-$220 per person for 2026. Figure $4800 for the year times a 30 year retirement adds up to $144,000 so then we're left worrying about $58,050 from the Fidelity number?

That doesn't sound so bad but I don't believe it. We mention this number every year when the update comes out but deconstructing this way makes it seem useless. All I can say, repeat actually, is that it is up to us to prevent/solve our health issues. Eat less sugar/carbs and lift weights. 

The median number of prescriptions for a 65 year old is 4.3. I've told stories about going on medical calls with the fire department and the couple of instances where older people were very proud of not taking any prescriptions (the calls were for accidents/injuries, not medical events). Taking up some good habits can reduce the number of meds people take or push the need to start taking meds to an older age. If we're partially debunking the Fidelity number, ok but we can save quite a bit of money if we can avoid the polypharmacy treadmill altogether or at the very least, delay when we start. 

Bloomberg columnist Kathryn Anne Edwards said she can fix Social Security in six words. "Scrap the cap, invest the rest." Edwards says getting rid of the cap, the income level at which people stop paying payroll tax currently at $185,000, would solve half the problem and she is optimistic that investing a portion of the money into the stock market would work out well, maybe leading to a cut in payroll taxes at some point. 

If they eliminate the cap, will you be affected by that? Would you be paying more? If they do nothing and payouts actually get cut in 2032, would you be adversely affected by that? Everyone would be impacted but would you be hurt is what I am asking. Something will have to give for them to fix it. What's worse for you? Paying more on the way in or getting less on the way out? Whichever one is worse for you is the one to plan for. 

My all in as self-employed is 12.4% (with Medicare it's 15.3%). It's not like I make $400,000-$500,000 but at that level someone might be paying an extra $26,660 to $39,060. Although there is a write-off to offset that (talk to your accountant) paying a lot more in payroll tax for many years might work out worse than getting your benefit cut. 

The Washington Post wrote about long term care and assisted living expenses cutting into the "great wealth transfer" that is supposed to occur over the next ten or 20 years. There were of course anecdotes that are truly sad about people living in some sort of facility for many years, more years than is typical, draining a family's finances. 

This sent me on a little bit of a hunt to try to learn more. Take my comments as these might be good questions to ask an elder law attorney not as being definitive or declarative. 

When people run out of assets, Medicaid then kicks in to pay the cost. "Assets" does not include IRA accounts once someone has begun taking RMDs. "Assets" does not include the primary residence with some conditions including that one spouse is still living in the house (there are a couple of others). 

Second homes apparently do count as assets and would need to be sold. 

In quite a few previous posts I've said there are a lot of things that people can get wrong about retirement and estate planning if they don't hire someone to help. It's learnable but mistakes in this realm can be very expensive and the point of primary residences is one of them. The primary residence may need to be shielded from the state/government reclaiming some portion of what they paid for your loved one's advanced care and they can come after it once the second spouse dies (there's a little more nuance). Depending on the state you live in, the property can be deeded in such a way or titled in a certain type of trust to shield from dollars being reclaimed. 

I looked this up on two different AI's and there were some conflicting answers but I am very confident that in many states this can be done but again, I think it requires an elder law attorney. One of the anecdotes in the article was of a 96 year old woman who has been in a facility for 15 years for dementia. Being brutal, I believe that is an extreme outlier for duration but thinking in terms of reclaiming versus a home's value, there'd be nothing left for the heirs. 

To be clear, this is outside the sphere of what I do. Hopefully this promotes awareness and can help you ask some good questions to avoid an expensive mistake. 

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 It Safe To Extend Duration? (Hint: No)

Last week I got an email from an old school mutual fund company for a webinar they were having this morning that was going to look at fixed income with the title Beyond Duration: Diversify Your Fixed Income Alpha. 

With that title, I'm in, they're leading with the right things, let see where it goes. It was a pitch for a fund of theirs which is ok, that's common, maybe I can learn something or maybe it might be one to start the process to study for eventual inclusion in client accounts. BLNDX came from an email solicitation so I'm not dismissive of every email that comes in.

A few minutes in and the manager has been talking different things they've done to differentiate versus "core bond" or as we say here, AGG-like exposure. Ok, lets see what all this talk looks like. 

Over the entire 15 years, the fund clearly outperformed AGG but for all the talk about strategy and tactics, there's no differentiation and it rode the market all the way down in 2022. Yahoo shows the fund with a 4.00% trailing 12 month yield compared to 3.97% for AGG. The fund gets three stars, it is outperforming but if you agree that AGG is not answer then I don't see how this other fund could possibly be the answer either. 

You've probably seen where interest rates have taken a little bit of leg higher over the last couple of months or so. The ten year treasury now yields 4.65% and the 30 year is up to 5.15%.

The chart is price only. UTHY tracks the 30 year, UTEN the ten year and BOXX uses options to replicate the return of T-bills. Yes, I am banging the same drum. The potential yield from these longer dated proxies does not adequately compensate holders for the risk or the volatility. There has been no shortage of pundits since late 2022 saying that "now is finally the time to add duration" and that has been bad advice. 

USVN tracks the seven year treasury note which is pretty close to AGG. If an investor would put 40% into a bond fund with the word core in the name or a 5, 7 or ten year treasury ETF, maybe they would consider splitting that up into several different exposures with better yields and little to no interest rate risk. Doing so would actually be much less risky.

The returns are adjusted for inflation and while that return is attractive, the bigger focus is a much lower volatility, although not visible on this screen there is a much lower standard deviation, the drawdowns have been much shallower except for the Tariff Panic when the drawdown was slightly shallower not much shallower.

In relation to a couple of other posts lately, it's a funny coincidence that Portfolio 3 above has a return of CPI plus 5 even if just by 9 basis points. I would absolutely not rely on a mix of alternative income sectors and strategic alts intended to be income market substitutes to deliver CPI plus 5. Yeah it might happen, but I think counting on it would end badly. If the objective appeals to you, I think you're going to need a decent amount of equity beta and Portfolio 3 has none. 

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.

Cracking The TPA Code

We've tried a couple of times to get into the total portfolio approach (TPA) process for managing endowment/foundation accounts. It's sort of a nebulous concept but Meketa Investment Group did a good job of dissecting the concept to separate what might be useful for individual investors versus parts of it that don't apply. For example, there's a lot related to governance which is a whole involved thing that I only scratched the surface of in my time with the Del E. Webb Foundation.

Meketa says "TPA represents a meaningful evolution in how institutional investors can think about portfolio construction." Maybe it's a meaningful evolution or a little more humbly, a way to makes a few changes that can lead to a better understanding of what you own and a more wholistic approach to how you view your portfolio. 

It starts with a reference portfolio which I would say isn't that different than a benchmark. The public pension of New Zealand is an early proponent of TPA and its reference portfolio is 75% global equities, 5% New Zealand equities and 20% bonds. That's not their actual portfolio. The reference is more like asking, how do we add value versus just indexing 75/5/20? That is probably a simplification but states it very plainly and I think is useful for individual investors.

We've talked here, in terms of just having a plain vanilla 60/40 portfolio or adding different exposures to try to improve against just buying VBAIX. Improve against VBAIX could mean several different things like outperforming, being less volatile and so on. We add BTAL and managed futures along with a couple of other things to try to smooth out the ride. That will either add value over the long term or not (I believe it does) versus just buying VBAIX. While the NZ reference portfolio is a simple 75/5/20, the fund allocates about 15% to private equity. Indexing 75/5/20 would get it done but they believe adding private equity will be better than just indexing 75/5/20. It also owns 10,000 hectares of farmland, again the managers must believe they are adding value versus indexing 75/5/20. 

It is not clear to me that adopting a reference portfolio is different than benchmarking. It seems instead like creating a more accurate benchmark. For example, the Permanent Portfolio Fund (PRPFX) is a quadrant based strategy that invests 25% equally into stocks, long bonds, gold and cash. Sort of. It is an actively managed fund and can take some liberties. It benchmarks to both the S&P 500 and a 3 month T-bill index. If it were to adopt TPA with a reference portfolio then maybe the reference would be 25% to SPY, 25% TLT, 25% in GLD and 25% in some sort of cash proxy. Then as the managers make active decisions, I think it has owned silver off and on for example, they'd be able to measure the effect of those active decisions. 

The most useful concept from TPA is the central premise is that the portfolio should be managed as a single unit rather than as a collection of separate holdings. Focus on the bottom line of the portfolio not how the individual holdings are doing. Things like BTAL, managed futures and gold are probably not going to be your best performers. If they are your best performers then chances are things in the world aren't going very well. Long time readers, how many times have I said that phrase? 

It is quite clear that holding the right type of diversifiers will smooth out the ride over the long term. If you believe in the concept of diversifiers smoothing out the ride then your view of BTAL or whatever you use is that it is insurance. It's role is to go up when stocks go down. Yes, in some random event that may not happen, but its contribution (that is a key word for TPA) is protection against declines. 

We've talked many times about tech and consumer discretionary tending to outperform the broad market over the long term. Their contribution is to provide a lot of a portfolio's growth. A utility stock or food stock's contribution is to be a little steadier and maybe provide some yield to the portfolio. 

In a TPA construct, each holding contributes something to the bottom line result of the portfolio which are terms we've talked about many times before. Calling it TPA might just be a fancy way to rephrase and old concept, rephrase a top down concept anyway. 

Another component of TPA is risk budgeting. That can mean anything but the application is to quantify the risk taken by deviating from your reference portfolio. Risk in this context equates to tracking error not necessarily return, yeah that's fuzzy. I will need spend a little more time digging into that to see how it could be applied to individual investor accounts. 

Last thing for today is this screengrab.

The Future Fund of Australia references CPI plus 4-5 which is interesting in the context of a couple of our recent posts. 

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.

CPI Plus 5; Digging Deeper

The other day I mentioned wanting spend a little more time on the endowment/foundation model that seeks an absolute sort of return of CPI plus some number, like CPI plus 5% as what I believe is a common objective in this realm. 

The Alaska Permanent Fund switched to CPI plus 5% at some point along the way. In 2011 there's no overt mention of this objective in its documentation but now when you load the page it says "Achieve a minimum of 5.0% annualized excess return over CPI over a market cycle, net of all fees." 

It's most recent report shows this target allocation;

• Public Equities 32%
• Fixed Income 20%
• Private Equity 18%
• Real Estate 11%
• Private Credit 10%
• Absolute Return 7%
• Tactical Opportunity 1%
• Cash 1%

Has it been working?

The results have been mixed, five years yes and five years no in the last ten. Over the last ten years though it did meet its objective with 2021 being a big contributor to the ten year result but not the sole reason. 

Backtesting the Alaska Permanent probably isn't productive because of  occasional changes in mandates and allocations that happen every so often but not as often as CalPERS which seems overhaul itself every couple of years. 

Putnam had a suite of funds that pursued this sort of thing including the Putnam Absolute Return 500 Fund that had symbol PJMDX. It targeted a real return of 5%. There was another one that targeted a 3% real return and another that targeted a real return of 7%.

The thesis for these funds came out of the Financial Crisis as a way to get returns without traumatic volatility. The failure of the suite was that they were too conservatively allocated, not enough exposure to equities. PJMDX' lifetime CAGR was 2.21 versus an inflation rate over that period of 1.75%. The standard deviation was low though at 3.35%. Cash plus fixed income ran at 75-90% of the fund. The execution really was a misfire. 

A lot of the back story here came from Gemini. It asked if I wanted to look at "modern" ETFs that achieve CPI plus 5. It offered NYLI Hedge Multi-Tracker ETF (QAI), State Street Multi Asset Real Return ETF (RLY) and Unlimited Hedge Multi Strategy Tracker (HFND). Since HFND's inception, the three funds have been at least 5% ahead of inflation but going back further, QAI and RLY haven't been anywhere close to that result going back to 2012. 

Obviously owning a lot of equities should exceed CPI plus 5% over any medium or longer time horizon but the way I am trying to apply CPI plus 5 is to smooth out the ride to have shallower drawdowns understanding that the tradeoff will probably be less upside. 

Here's a piece of research from Fidelity that says a foundation that is "70% equity/30% bond portfolio of public assets is likely to fall short of that $5 million annual goal 66% of the time" with the context being $100 million in assets. Even covering 4% will fall short 20% of the time.

Comparing 70/30, SPY/IEF to inflation on testfol.io for 50 years, 70/30 was better than CPI plus 5 in 33 of the last 50 full years so a little better than what Fidelity found. The average compounding over 50 years was 10.73% versus 3.59% for inflation. CPI plus 7.14%. If we look at the more common 60/40 mix, it exceeded inflation by 5 in 31 out of 50 individual years compounding at 10.24%. CPI plus 6.65%.

Similar to 75/50, this becomes a pursuit to try to achieve the desired outcome with a little less volatility or maybe to reduce the drawdown that you'd expect from 70/30 or 60/40.

To do this we could combine funds like BLNDX, QDSIX and APHPX or a few other funds. This is BLNDX plus QDSIX.

That has worked looking back and it might work going forward but what this sort of thing, just mixing a bunch of alts, is that you probably don't years like 70/30 up 20 or more percent versus 2-3% for inflation. There were quite a few of those years which gives more margin of error versus targeting CPI plus 5 and never getting more than CPI plus 7 to help offset the years where going all alts actually declines for whatever reason. 

Where I believe the answer lies is in figuring out how to blend enough simple equity beta and the volatility that goes with it along side alts with the potential for adequate returns in the CPI plus 5 construct. A lot of bonds yielding four point something percent obviously won't do in terms of return contributed to the portfolio but a small slice allocated to something T-bill-ish might help with volatility.

The following Portfolio 1 allocates 50% to S&P 500, 25% to managed futures, 15% to merger arb, 5% to BTAL and 5% to gold using funds that allow for a relatively long backtest.

The long term numbers work. Going year by year, Portfolio 1 achieved CPI plus 5 in 11 out of 17 full and partial years. VBAIX did it 12 times and PRPFX did it nine times. 

To the extent this appeals to anyone, we have a much better opportunity to create this sort of institutional effect in our own portfolios because of how funds have evolved to become more  sophisticated with access to strategies that just were not accessible before. 

As indicated above, this is a variation on 75/50. It's an interesting thought exercise and ultimately has had some influence on how portfolios are constructed but I think the answer is influence not going all in. PJMDX went all in and obviously failed. This is not simple stuff but I am optimistic we are figuring it out. 

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.

A Lot Of Crazy Topped Off With A Little Sanity

Some quick hits today.

Barron's had advice about how to invest a Roth IRA for people unlikely to ever need that money who might have the "goal of passing on as much they can to their heirs." The article solicited input from Harold Evensky, William Bernstein and Larry Swedroe. Most of the advice was to just buy very plain vanilla, market cap weighted funds which of course makes sense. Swedroe included some serious alts in his recommendation including Cliffwater funds. 

The article isn't really an advice piece, it is a thought exercise. Buying Vanguard Total Stock Market Index ETF (VTI) is of course valid but not really something that merits an article in Barron's. It's far more interesting as a thought exercise to do something crazy.

A 50% allocation to the Direxion 3X Long Tech ETF (TECL) is crazy but the 50% to cash tops it off with a little sanity. Sticking with Barron's objective of leaving as much as they can to an heir, this mix gives the opportunity for crazy growth while building up what at first might be an emergency fund and then later a huge stockpile of cash as it rebalances to offer real, financial utility for the heir.

Quantpedia had an interesting article noting that most portfolios are under diversified based on a portfolio of ten common ETFs that have the following correlations;

Quantpedia plugged those ten ETFs into an equal weight portfolio because equal weighting creates the appearance of being well diversified. I am paraphrasing so if you have a better take on that please leave a comment. They ran the ten ETFs through some sort of tool for risk attribution. The way to read the following is that a 10% allocation to BITO, a Bitcoin ETF, contributes 29% of the risk.

Here I model out the equal weight version above along with Finominal's risk weighting against a couple of benchmarks.

I don't actually think anyone would build a portfolio that equal weighted those ten ETFs but doing so for the backtest does support the notion of being under diversified. The portfolio appears to look different but there's no differentiation on the way down. On the way up it lags meaningfully as does the risk weighted version. Finding adequate differentiation to actually add diversification takes some work and if you've been reading this site for a while you probably have a good idea of how I like to approach solving that problem.

Playing around with quadrant inspired portfolios notwithstanding, I think equal weighting is a tough way to make a living. We've looked at a few examples in the past where it can work but I don't love it. 

Here's one we probably haven't looked at before.

The correlations are very low which creates the opportunity for diversification. Modeling those four funds out with equal weighting looks good;

It's simple work to look at different funds and how they correlate to each other as a starting point if equal weighting appeals to you. The correlation matrix above is from Portfoliovisualizer.  QDSIX is a fund of funds so it's not 25% into one strategy but that would be difficult for me. Ditto cat bonds and gold. Weighting the four funds for risk contribution yields an interesting result for anyone who want to plug that into Finominal. 

And One River took a look at work from Meketa about making a portfolio more robust with first responder defensives, second responders and diversifiers. If that seems familiar, we did the same thing almost a year and a half ago. One River titled their piece The Perfect Hedge. Great title. The paper has an element of why say in 100 words what you can say in 1000 words. I didn't take anything new or too definitive from the paper but there comments about managed futures prompted me to try a different take on an idea we've looked at before. 

Managed futures is a big part of the Meketa framework and we obviously spend a ton of time on it here too.

QMHIX is relatively volatile, ABYIX might be the least volatile managed futures fund out there and RYMFX aside from being one with a long track record is in between the two others in terms of volatility. Comparing the blue and red lines, they appear to be (almost) perfectly negatively correlated. They take very different paths to a similar result. The yellow blend blends them together for an interesting result. It has just about all of VBAIX' upside with a much smoother ride. Unfortunately, the time period is cherry picked to omit a dreadful run for managed futures in the 2010's.

Maxing out the backtest actually isn't that bad. It doesn't capture VBAIX' upside too well but it's a decent absolute return type of result, CPI plus four and a quarter. 

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.

Stop The Stock Market, I Want To Get Off

This morning at fire training we did a complex water operation.

The scenario is a fire in the background. The green truck to the far left gets there first and starts spraying water. Then the red truck second from the left get there and does two things, it sprays water on the fire and and fills up the green truck. Then the second red truck, second from the right, gets there to spray water and fill up the other red truck. Finally the water tender, brown truck at the far right, shows up and fills up the second red truck. 

It's not likely that we'd do this sort of operation with so many trucks but two trucks and a water tender is plausible. The utility of the drill was that we learned how to manage two different PSIs for a couple of the trucks, one PSI coming in and one going out, and generally raised overall understanding of how the pumps work beyond the basics of just getting water flowing. 

I think there is an analogy here to when we explore portfolio theory. Building out various types of all-weather, quadrant-inspired and all the rest can offer some insight into how different asset classes and strategies might interact with each other. I use this process as a lab to reenforce ideas about funds I already use and a way to learn about new funds. 

Obviously I've incorporated AI into this process as a way to check that I am not loading up on one risk unknowingly. For example, loading up on several funds that all take credit risk would not be something I'd want to do. 

On Friday night I was playing around with these two portfolios. I read something that led to my trying to come up with a "Stop The Stock Market, I Want To Get Off" portfolio. I came up with a complex version and a simple version.

I plugged a slightly different version into Copilot and it got most of the funds wrong. One time, Copilot said BLNDX was the best all weather fund there is. Friday night it thought it was a Blackrock fund. For APHPX it read the symbol wrong. It thought PPFIX was a PIMCO fund, it's not. It had the wrong AQR fund. I always have to tell it that SHRIX is a catastrophe bond so it got that one right. And it thought BALT was also a Blackrock fund. Maybe it went out to happy hour and wasn't expecting to have to work.

Then I went to Claude. Claude got the funds right but it made several assumptions that were more like incomplete observations than outright incorrect. It said that "APHPX and PPFIX share a family resemblance" and that they would probably react in the same negative manner to certain negative events like the Tariff Panic 15 months ago. 

Me: Has there been an instance where APHPX and PPFIX reacted similarly in a bad way to the same adverse market event? APHPX and PPFIX are practically uncorrelated.

Claude: Good pushback to check empirically rather than just accept my "family resemblance" framing at face value — and the data mostly backs you up... the evidence supports your claim more than it supports my earlier "they're cousins" framing.

There were others. The point is using AI should probably be an exchange, not just our taking in what it says. I asked what I thought were the obvious questions but there were probably others that could have been asked too. AI is learning but we need to learn too. 

Here's how the two versions of the "Stop The Stock Market, I Want To Get Off" did in a short backtest.

Neither the complex or simple version is going to keep up with 60/40 or the stock market but they are both less volatile than the IEI which is the 3-7 year treasury ETF and I believe they are capable of compounding decently above the rate of price inflation. Lately, I've been digging into foundation allocations and a frequent objective for foundation accounts is CPI plus 5%. We'll get into that more later this summer but both the complex and simple versions are in the ballpark of CPI plus 5%. That outcome with a very low volatility would be interesting if it can be pulled off. 

And speaking of AI....

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.

It's Not All Doom & Gloom

You've probably seen news accounts that Americans believe they will need $1.2 million in savings to maintain their lifestyle after they retire. Barron's reported on a survey from Schroders that details how few people expect to have that much when the time comes. 

A couple of nuggets; only 30% expect to have $1 million, half of those surveyed do not think they will have $500,000 and some other grim variations on the same theme. Before getting into this, I do believe people will figure it out and make it work because they have to. I'm saying with a glass half full sentiment, people will figure it out. 

Needing $1.2 million in today's dollars seems a little high to me as a number across society. That assumes a withdrawal amount of $48000-$60,000 or 4-5 %. Gemini estimates that people born between 1970 and 1980 will get $2400/mo or $28,800 per year in today's dollars for Social Security. That's per person so $4800/$57,600 per couple. Those numbers assume each partner is making $62,030 so the couple is grossing $124,060. 

If this is an Arizona couple, they would be netting $97,502/yr or $8125/mo after putting 4% into their 401ks. If the couple born in 1970 bought a house in 2005 at age 35, the median mortgage payment would have been $1255 in the Phoenix/Scottsdale/Mesa area. Assuming 30 years, the mortgage would be paid off in 2035 when they are 65 and thinking about retiring. 

If they spend all $8125 every month, then their expenses in today's dollars would drop to $6870/mo after the mortgage is paid off. They are getting $4800/mo in Social Security so everything being constant, their retirement account only needs to generate $2870/mo or $34,440/yr. That means their retirement accounts would need to be $688,800 to sustain a 5% withdrawal rate, just over half of the generic $1.2 million. 

If their current spend includes two car payments, maybe they can get down to one car payment or maybe no car payments. If their kids successfully launch, then that would bring down their expenses a little more. The $2400 times 2 is their age 67 amount. If one of them waits one year longer to retire and take SS, then that $2400 would actually be $2592/mo. If they both delay a year then $4800 would become $5184/mo. 

Going through this exercise, I realize there's little to no margin for error and they are vulnerable if SS gets cut but it's not a desperate situation either. If this couple has a $30,000 gap between their Social Security and their spending needs and only have $100,000 saved, yes that will be a difficult place to be with some painful decisions to make. The example we built, there's a $34,000 gap and while having $1.2 million would be great, the scenario can do well with much less. 

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.