Blasphemy, BLASPHEMY!

Let's start with the following.

The long term result of the mystery portfolio and plain vanilla 60/40 are identical. There's really only two years with meaningful differentiation. The mystery lagged by a lot in 2020 and went down much less in 2022. The stats in the fist screen grab do favor 60/40 but mystery has a lower standard deviation and slightly better excess kurtosis reading. 

The 60/40 does better in fast declines but the mystery portfolio did quite a bit better in the one slow decline available in the study period. I might prefer the mystery portfolio but I think the time frame is long enough to say they are both valid, returning CPI plus more than 6%. 

Quick detour. Goldman Sachs is buying Neos Investments an ETF provider that specializes in derivative income funds. SPYI references the S&P 500, QQQI references the QQQ, BTCI references Bitcoin and they have other funds which gets them to sneaky high $32 billion in AUM. Back in April, Goldman closed its deal to buy Innovator Capital which is known for its buffer funds. Goldman moved heavy into derivative income and buffer funds because investors like both types of products a lot. Really a lot. 

Back to the mystery portfolio which is 70% buffer fund and 30% derivative income fund. The buffer fund is Innovator (BJUL) which I chose because AI thinks it is the first buffer fund. Despite it being older and newer funds presumably having improvements, Portfoliolab, via Gemini, ranks it above 83% of the buffer field.

The derivative income fund isn't even an ETF, it's the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX), a closed end fund, which has been around for about 20 years. Right now it trades at about a 9% discount to NAV and yields 8.8%. The mystery buffer/derivative income portfolio's price only return was 7.66% annualized. 

When I first built the buffer/derivative income portfolio I used Invesco Buywrite (PBP) which I believe is the oldest covered call ETF and the CAGR using that fund was 9.14% which is still pretty good, still CPI plus 5.54%. 

Since I've mentioned Portfoliolab a couple of times recently, here's part of how they evaluate portfolios. 

This tells us there is nothing especially bad or good about the BJUL/SPXX blend, it's very ordinary. To the same point, here is the same analysis for 60% SPY/40% IUSB.

Yes, BJUL/SPXX scores a little better but the free version of the website only goes back one year and for the last year, the buffer/derivative income portfolio outperformed by 98 basis points with slightly less volatility. 

Both covered calls and buffer funds get a lot of bad press. Here's AQR on covered calls funds and here they are on buffer funds. Many times I've said "just don't with buffer funds." I concede most of the negatives about these funds but the outputs can be just fine, they can be ordinary and ordinary can get it done. 

Gemini took data from a report by Commonfund that calculates the collective CAGR for endowments for the last eight years was 8.92%. The time frame isn't exact to our BJUL/SPXX study but it gives some context of the validity of the result by building a portfolio with two of the most hated (by the smart money) types of products there is. The lesson here, for me too, is to not be so snooty. If an investor has taken the time to actually understand the pros and cons of buffer funds and derivative income funds and they still want to use them, then why not? I'd never thought about the type of portfolio we looked at today so I feel like I learned something. 

We'll close out with a quote from a Barron's article about managing stock market volatility.

A popular choice is a fixed indexed annuity with an income rider. Fixed indexed annuities offer protection against market downturns by limiting upside in a bull market. With an income rider, there’s the option to turn on an income stream at any time and collect guaranteed income for life.

Or, instead of an annuity, someone could use a buffer strategy for a while and then flip that into derivative income when they are ready to take income (it may not last for life though). No need, I'll show myself 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.