Selling Volatility Is Easy To Get Wrong

RCM Alternatives shared conclusions from Dunn Capital about the types of alternatives to use and how to size them in a portfolio. Cutting to the chase, they say it is more effective to have 15% in volatile alternatives like managed futures than to have 30% in low vol alternatives. I would think of low vol alternatives as being various types of arbitrage or the way client/personal holding PPFIX sells volatility that is very far out of the money. 

The argument is similar to the argument for capital efficiency. While I am not a fan of 15% in managed futures, putting 15% in high vol alts should be just as effective as a larger weighting to low vol diversifiers. Using their numbers, 15% in high vol alts allows more of the portfolio to be in equities which are the thing that goes up the most, most of the time. 

 

A 14 year sample size is pretty good. Clearly, 30% in low vol alts in Portfolio 2 caused a lag but the volatility was also noticeably lower which is probably more about the smaller weight to equities than the alts. The Sharpe and Sortino numbers don't show much difference. It's not clear to me that one approach is obviously better, some will be willing to have volatility to get more basis points of growth. 

The lack of differentiation between Portfolios 1 and 4 it noteworthy. Portfolio 4's result is essentially identical but it allows for better diversification with 5% each in three different high vol diversifiers instead of loading up on managed futures. 

Quick pivot, GraniteShares is continuing to add to its YieldBoost suite. The basic idea is that these funds sell put option spreads, a bullish strategy, on 2X levered ETFs. I believe YSPY which does this with a 2X S&P 500 ETF is the second longest tenured fund in the suite with one for Tesla being the first one. Sticking with YPSY to avoid crazy CEO risk, here's what YSPY has done.

And here is the one for Nvidia (NVDA) which started trading in May as NVYY compared to NVDY which is the YieldMax covered call fund.

These are not proxies for their underlying reference securities. They one way or another sell the volatility of the underlying reference securities and that is a different thing. 

The erosion of these, every time I look is always pretty swift but the total return is almost always positive. I can't think of an instance where the total return has been negative but there probably are at least a couple. Again, these should not be expected to track the common on a total return basis unless the common goes into a death spiral. Nvidia common stock is up 36% since NVYY started trading so not that far off but the articles that say these lag are correct in terms of simple numbers but miss the point of not being proxies for the common stock. And to make clear one point, whenever the next bear market comes along that lasts more than a month, all of the crazy high yielders should be expected to go down a lot.

GraniteShares listed two new ones including one AZYY which references Amazon. 

Selling volatility is a valid strategy but there are probably more ways to get it wrong than get it right. That alone might reasonably dissuade people. I continue to spend time on this because I am convinced funds that sell volatility will at some point figure out a way to lessen the drawbacks and I want to understand that evolution when it happens. 

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 Catastrophe To Learn From

Here's a wild one by way of Bloomberg about the following high yield muni bond fund.

It holds/held mostly unrated bonds that don't trade, there really is no market for them. They are valued using pricing services that try to compare versus similar bonds. This is not uncommon but the pricing isn't necessarily accurate. The fund was carrying a couple of issues at 70-80 cents on the dollar that were more correctly valued at less than five cents. 

The fund faced heavy redemptions as part of the fallout from the April crash which cascaded into a series of unfortunate circumstances eventually leading to what looks like a permanent impairment of capital. 

Part of Bloomberg's coverage included an investor whose advisor put him into the fund leading to an arbitration filing. I asked Copilot to find the arbitration filing to see what percentage of the the investor's account was in the fund and while a percentage was not available, Copilot's conclusion from the filing was that it had to have been a large percentage. 

It was already a one star fund for poor risk adjusted returns before this happened, also according to Copilot.

If ever there was the perfect anecdote for diversifying your diversifiers, this is it. Over a long enough period, the odds of owning one or two things that blow up like this is pretty high. It may be unavoidable but the impact of such a blow up can be pretty easily mitigated with correct position sizing.

Per Bloomberg, RJMAX was yielding 300 basis points or so above high quality muni's. Whether that spread was a enough compensation is a different discussion but even if it was enough compensation, 300 or more basis points tells you it is risky. The way I size some of the esoteric fixed income segments is pretty small. If a client is 60/40 then I might go with 8-10% of the fixed income sleeve or 3.2%-4% of the overall portfolio. A 65% drop in a 4% weighted bond fund would be a 260 basis point hit to the portfolio. That is not a ruinous hit to the client's portfolio. 

Somewhere on an advisor's priority list (very high up) should be making sure clients aren't financially damaged by what you do. Let's be clear though, if the S&P 500 drops 50% and the equity allocation in a portfolio drops 55% that is not what I mean. A long time ago, a reader shared that he had 25% of his portfolio in a lottery ticket biotech that I believe was working on something for migraines. The stock blew up. It was his own doing but an advisor doing something like that is what I mean. Without knowing, if the advisor in the RJMAX story had 10% of the client's total portfolio, I don't think even that would rise to the level of ruinous but that is far more than I would ever do. A 20% weighting to something with the idiosyncratic risk of RJMAX would probably cross the line. 

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.

How The Hell Are Stocks Going To Go Up?

It is difficult to look at the totality of what is going on in America and feel good. This post will not express true political ideology in the context of the current state of the country, but simply acknowledge there is division and disharmony and the observation that both parties blame the other. 

I've been a registered Libertarian for ages but my beliefs range from Libertarian to independent. On some issues I am conservative and others I am liberal. An anecdote from the aftermath of Tuesday night's structure fire that might tell you where I am coming from. 

The picture is a screen grab of two of our trucks from a drone video that a realtor came and took the next morning and posted online. The video includes shots of the front of what was the house, the rubble and the surrounding houses. This upset a lot of people, if your house burned down you might not want a detailed video of it posted online. Apparently, quite a few people called the president of the fire board to complain and we discussed it briefly and yesterday's monthly meeting. My penny and half of input was he's an adult trying to run a business here (as a realtor) and if he made a bad decision, let him own the consequences, it has nothing to do with us. There was agreement of course as it's an obvious conclusion. 

More succinctly, the starting point of my beliefs  is "between consenting adults."

A few times in the past I'd said that the country's economic issues related to things like debt, deficits and Social Security are bigger in terms of origins and solutions than our political cycles. The priority of getting reelected tends to make it hard to find political solutions but at the same time, I am not calling for longer political terms so I don't know what the answer is. Maybe a congressman or senator only gets eight years or ten years so you better make it count which might appeal to a sense of vanity and legacy. 

I don't place complete blame on the current party in power, these issues started years ago. Did our deterioration start under the second Bush? Did Clinton leave a little more of a mess for Bush when he left? Does it all land on Obamacare? There is probably no single right answer so there can be no single wrong answer either.

The initial reaction to Biden's presidency seems very negative, maybe this is odd but his term made no impression on me at all. He sat in the chair for four years. Whether you love or hate Trump, I'm not sure how the agenda resembles anything that is conservative in a political sense, it's unrecognizable as conservative ideology. I think it is fair to say the division in the country these days is terrible for everyone and I have no idea what the path to healing that division will be.

With all of that, how the hell are stocks going to up? Is the threat now worse than the reality of The Financial Crisis? I don't know. The 2000's were not a good decade for domestic stocks but some things still went up in value, notably foreign stocks and gold. 

If current threats cause another decade like the 2000's, that would be unfortunate but against a backdrop like that, there will be things that go up. If you have a diversified portfolio that goes narrower than a broad based index or a 60/40 fund then you probably already own some of what will go up whenever the next market malaise comes. 

With markets currently close to all time highs, it should be easier to take a more objective look at your portfolio to assess how robust it is or isn't in case bad things happen to the broad indexes. As is my typical viewpoint, I don't want to try to predict what, more like protect against if.

My idea of portfolio robustness means having some things that very reliably go up when stocks go down, owning a couple that probably will go up if stocks go down and a couple of things that pretty much always go up a little no matter what is going on. That describes protection but it is diversification like maybe foreign equities and a theme or two in the mix is where the chance for owning the non-hedge market segments that go up. If you include individual stocks, you might have luck that way too in a lost decade. 

Another aspect of robustness is having the proper asset allocation to prevent accumulators from panic selling and allows decumulators to meet their income needs without selling low. 

Again, with everything going on, how the hell are stocks going to up? I don't know but stocks do tend to go up far more often than not. That's not going to change over the intermediate and longer term regardless of whether there is a period where returns run below trend. 

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 Selling Puts The Answer?

Update update I made a decimal error, the put sale proceeds would be $287.00 for two months, not $2870. The two month return would be about 1% annualizing out to 6% if it could be repeated six times. Really dumb mistake but I thought about this post overnight and realized the error. Sorry everyone. 

Barron's wrote about the prospect of yields going down and offered a couple of very standard ideas including a 2 star global bond fund. And on a related note, Bloomberg covered the success that PIMCO has had this year making a very good call on yield curve steepening leading to a strong 2025 up to this point. 

In terms of looking for yield, one of the comments (always read the comments) suggested selling put options. Selling puts is a bullish strategy where the person buying the put is protecting against or betting on a decline in the price of the underlying and the put seller wins the trade if the underlying doesn't drop below the strike price of the put. Winning in this context is getting to keep the premium without having the put assigned forcing the put seller to buy the stock at the strike price. 

If a stock is trading around $310 and a two month put struck at $270 is sold for $2.87, the seller keeps the $2.87 as long as the stock stays above $270. The multiplier on all of this is 100. One option controls 100 shares so the strike price is 100 shares at $270 so $27,000 worth of stock potentially and the option premium taken in would be $2870. 

Those numbers are JP Morgan (JPM) common stock and a put struck at $270 that expires on November 21. The reason I picked JPM as an example is that over the long term it has looked like the stock market so I am on the lookout for whether the stock has a lot of seriously negative divergences versus the market. In early 2005, the S&P 500 was going higher and JPM took a real turn lower. That was the only incidence I can find of a meaningful divergence. However, the stock very consistently goes down a lot more than the S&P 500 when the index turns down. So maybe anytime the market catches a cold, JPM tends to catch pneumonia and there have been a few instances where the index caught a cold and JPM caught tuberculosis. 

Sticking with our example, selling a put would mean segregating enough cash to buy the 100 shares for each put sold. So there would need to be at least $27,000 in the money market to pay for the stock if assigned so the $2870 in premium could be thought of as the return. $2870/$27,000 is 10.6% for the two months. If, and it's a big if, that trade can be repeated six times, two months six times equals one year, and the return is compelling of course. If that is too close to the money, a lower struck put could be sold instead, the November $260 was bid at $1.93 late Friday for a two month return of 7.14%. 

If between now and November 21, the stock crashes or the index crashes (expecting JPM would feel a crash worse), the put seller would be paying $270 per share for a stock that might be trading at $240 or $250 or whatever. Not a riskless trade by any means but reasonably a differentiated return.

There are funds that sell index puts targeting different types of outcomes that we've looked at many times before. 

YSPY is a crazy high yielder on track to yield 50%. WTPI from WisdomTree used to be PUTW and it yields about 11% and looks similar to the types of covered call funds that are not crazy high yielders. Client and personal holding PPFIX as you can see is very absolute return-ish only selling puts very far out of the money. The yield is a round 4%, so similar to T-bills but is differentiated, and there might be some price appreciation along the way too. 

The price only PPFIX has had the highest CAGR in the very short time sampled, the tortoise/hare analogy might fit here. The erosion to YSPY, the chart goes back to its inception, has been swift. At some point I'm sure it will reverse split. The index it tracks isn't going to zero so it won't go to zero but the percentage drop could resemble some of the VIX products. That could be fine for some sort of drawdown or depletion strategy but this is not one to misunderstand.

Back to the PIMCO trade about yield curve dynamics, great for them they got that right, there is some differentiation in doing that but that is not one I would ever attempt with client money, it seems like a binary bet akin to guessing what interest rates will do. 

One of the other comments suggested closed end funds for yield. Yes there is yield there but there is also volatility. 

Copilot says that for the last ten years, JPC's yield has averaged between 7-8%. Yahoo shows the yield now at 9.67%. It had 7and 8% yields back when treasury yields were sub-100 basis points so that much of a spread over riskless T-bills tells you there is risk and/or volatility. Again, according to Copilot the characterizations of the distributions has been mostly actual yield but there have been some periods where ROC was kind of high. 

Looking at the backtest stats, the price only CAGR has only been a decline of 91 basis points, that's not so bad in exchange for that yield but...

...the drawdowns have been brutal. FWIW, the volatility profile is much lower than YieldMax funds or other crazy high yielders but JPC doesn't "yield" 50% either. 

I haven't used CEFs for clients in ages but I am not dismissive of them. I think the volatility potential calls for small allocations for anyone interested. A small slice can create disproportionately high income to a portfolio and like with other very yieldy products, a normal allocation to equities has a good chance of more than overcoming any price erosion. 

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.

Structure Fire!

Tuesday night, Walker Fire was called out to a structure fire around 10pm. Part of the process for responding to any incident is an evaluation of what is actually happening which can sometimes differ what what the person calling 911 might think they're seeing. For a fire, we tell dispatch that there is a "working fire" when there's actually fire.

Sometimes it may come in as a fire but not actually be one but this was. One of our firefighters lives very close to the scene and let us know on our tactical channel that it was a fire and I in turn relayed to our dispatch. My telling dispatch "working fire" signals to any other departments coming to assist (this is known as mutual aid) that there is really a fire too. 

The fire occurred about a minute or two away from a substation we have that has one engine that is four miles from our main station. We have six firefighters that live up in the area I am talking about so they were able to grab that engine get to the scene quickly and start the process of trying to prevent things from getting worse. In this instance, getting worse would have meant embers blowing onto other houses, there were quite a few very close by including one that might have only been 50 feet away. Another potential bad outcome could have been ripping as a ground fire and then taking out other houses.

We came from where the arrows are, driving uphill to what I called lower road. The reporting party or RP called from that one house at the bottom of the drawing marked RP so we were called to that address. The fire though was actually on Upper road. It was all very bunched up and the fire was easily reached with hose from Lower road. Both Upper and Lower roads dead end.

Engine 85 is the truck stationed in the area and was on scene first. I drove Engine 86 with two other firefighters and I assumed IC (incident command) when we arrived and also functioned as the engine operator (engineer) of 86 for most of the incident. Having two roles on an incident this complex is not ideal but it just played out that way. 85 pulled hose straight up from their truck toward the back of the house and 86 pulled hose up toward the front of the house. 

Shortly thereafter, mutual aid arrived at what seemed like the same time, one engine from two different departments. They checked in with me when they arrived and asked "where do you need us?" Fortunately, I knew they layout of the area also I did not want to turn Lower road into more of a parking lot than it already was so I asked them to go in on Upper road and work from up there. For anyone who has been a firefighter my thinking was that engines 1 and 2 (not their real numbers) could get the A and B sides while we worked the C and D sides. 

The larger red box is the house and the smaller was a wood pile that went up that some of our personnel worked on. WT stands for water tender which is a water truck. Ours hold 2000 gallons, far more than what engines carry. They'd fill the engines, run dry eventually, then go refill and come back.

We were able to knock down the fire pretty quickly which greatly reduces the threat of the fire spreading. Shortly after this point I released the two mutual aid engines. 

From there it went from drama and high leverage to the drudgery of trying to actually extinguish the fire. There was what was essentially deep rubble inside footprint of the house. The rubble was deep like quicksand so there was no way to get in there with hose and effectively, fully put it out, this would have been unsafe in my opinion. 

At this point we started to use foam to try to smother the heat. We used a lot and got to the point where there was just one area that was still obviously retaining heat. There could have been other areas holding heat, we couldn't be certain but there was the one area where after foaming it up pretty good, smoke would start coming up again 10-20 minutes later. 

All in it was about 12 hours and one of those calls that we'll always remember.

WSJ Joins The Party

The WSJ wrote about three alternatives to the typical 60/40 portfolio allocation, all three of which we've looked at here before. I added a fifth.

The results

Our backtest goes to Aug 30, 2000 because that was the timeframe WSJ cited. Portfolio 5 simulates 67% in NSTX which leverages up in such a way that 67% to that fund equals 100% in VBAIX. 

Was the leverage in Portfolio 5 worth it? Based on growth rate it seems like it was. Because of the volatility, the Sharpe Ratio wasn't impressed just being right in the middle of the pack and there hasn't been reliable crisis alpha.

If you're interested in very simple 30/70, iShares has an ETF for that with symbol AOK which has $630 million in AUM. For what it's worth, I think 70% in bonds in the AGG/intermediate or longer treasuries sense is a dreadful idea. 

I've been writing about most of these alts for a very long term and certainly the idea of avoiding duration for much longer than that and I am convinced it works. MERIX/PPFIX are client and personal holdings.

VBAIX' return with AOK's volatility. IRL, I might want smaller weightings to more alts though or maybe a larger allocation to something like TFLO or add in T-Bills.

We just got back from a quick trip, so just a short, fun post. 

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.

I Made A Bored Ape!

Remember NFTs, bored apes and pudgy penguins?

"Ryder Ripps" shared his story on Twitter about buying the following bored ape a few years ago for $425,000 and just now selling it for $37,000. 

I would be willing to let this go for just $25,000.

Don't even think about right clicking on it.

This is a part of the crypto mania I never understood when it was at its height and still don't understand it now. I said pretty much the same thing several times regarding my interest which was they are fun to look at for a moment before moving on. I don't understand they're having any monetary value.

Ripps got a lot of comments about right clicking and so on and he kept talking about the sense of community with these, "You cannot access the Culture through Right Click Save" he said. The loss though left a "hole in my chest."

The whole thing from Ripps might be satirical but if you were following this you know the dollars involved were this big. I still see some of this now, people posting these so it's not dead but the decline has been staggering for anyone who paid up. DappRadar says the decline has been 93% from the peak which is consistent with Ripps' story. 

I have this card of Darnell Hillman that I doubt was even $5. If you're any kind of basketball fan and don't know about Hillman or the ABA, it would be a very fun rabbit hole to go down. Get the book Loose Balls by Terry Pluto. The book is fun and so is having the card.

See the forest for the trees on these things and make good decisions. Is a bored ape akin to a baseball or basketball card? That seems plausible from the outside looking in or maybe Garbage Pail Kids? NFTers would tell me to fuck off with that comparison but maybe one you really like is worth $10-$20. Not $10,000, a plain $10, a fun little thing.

But I will still let Ape With SCBA go for $25,000. No takers? How about if I reduce it slightly to $100? 

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.

Making It Work

Let's follow up on Saturday's post about a portion of a a newly retired 65 year old's portfolio that is in a taxable account. The idea is he is willing to drawdown or even deplete this piece of money while waiting until 70 to take Social Security and/or take IRA distributions. 

Here's a version of what we talked about in that post. 

Yes, I took a shortcut putting all 10% into NFLY. BKLN and EMPIX are both in my ownership universe. WTPI is the old PUTW ETF. WisdomTree tweaked the strategy but it still sells put options. It has a trailing yield of about 11% with quite a bit of equity beta.

The first result starts with $300,000 and assumes $30,000 comes out each year.

As I mentioned on Saturday, I thought a normalish allocation to plain vanilla equities has a decent chance of outgrowing the erosion of the YieldMax allocation. The "yield' of the portfolio was around 10%. 

The second version assumes taking $60,000 per year. Part of the idea if I wasn't clear is the willingness for some depletion of the starting balance of $300,000. The bigger goal is that the money lasts for what he needs, the five years from 65 to 70 even if most of it is exhausted at 70 years old. Anything leftover could be thought of as found money. After two years with a 20% withdrawal rate he still has $278,000.

The portfolio lacks any sort of crisis alpha or defense. If one of the five years in question sees a huge market decline, this portfolio probably will go down in a similar fashion. If the market does have a hideous decline in year three which is where we are in relation to the backtest, being able to still pull out $60,000 until 70 seems plausible. 

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.

Bloomberg Dives In On Crazy High Yielders

Bloomberg had a doozy of an article about how Gen-Z investors are seeking out yield in pursuit of FIRE (financial independence/retire early) instead of YOLO asymmetry. Intended or not, the article is a fantastic behavioral palooza. I remembered the gift link!

Just working from top to bottom, the first paragraph labels the idea of a long career with a short retirement before dying as being a ripoff. In those terms, sure, that does not sound like a recipe for a great path through life. The implications are that work sucks, retirement is short and very limiting and then it's over. I think the sentiment really is about capturing a skeptical sentiment held by some portion of younger people. Who knows how many people view things that way but it tracks that plenty do. 

It is up to each of us individually to solve this for ourselves. If someone is self aware enough to observe this potentially grim life path, then maybe they are self aware enough to do something about it like trying to find work they actually enjoy and that they find purposeful or add in outside activities that can make life more purposeful. 

There was a short bio of a 26 year old who has been influenced by his grandfather having worked in a factory his whole life in more of a traditional work then retire arc. The 26 year old said he didn't want lock away his capital until he's 65. He stopped contributing to retirement accounts to instead build a dividend portfolio to live off the income. He also has a huge YouTube channel so presumably that generates income but the article never mentioned any income. 

One component of the FIRE movement is it really is a movement with plenty of Socials (Facebook groups, reddits and other YouTube channels not to mention blogs) that create genuine community support for people at all commitment levels of FIRE.

Bloomberg asserts that "dividends and chill" is much closer to what FIRE is really about than YOLO asymmetry.

The there was a discussion of investors falling for a dividend fallacy that dividends improve returns, the article asserted they don't. In the 15 years since the Schwab Dividend ETF (SCHD) has been trading it has outperformed the S&P 500 on a total return basis five different years. The cumulative total return for  SCHD was 411% versus 582%. The Vanguard Dividend Appreciation Fund (VIG) has outperformed the S&P 500 on total return basis six out of 20 years and lagged far behind cumulatively. 

Additionally, dividends aren't necessarily tax efficient either. There are of course circumstances where tax efficiency may not be too important, obviously there is no tax implication in qualified accounts and speaking personally, if I was living off a dividend portfolio with a very low effective tax rate I wouldn't be too concerned about the taxes. 

If that search result is correct, then on $100,000 in qualified dividend income, 15% tax would be due on $5950 which is $892, an effective tax rate of less than 1%. We are all entitled to our beliefs, and this sort of effective tax rate wouldn't bother me. 

A diversified portfolio should probably include traditional dividend payers like staples stocks, certain healthcare and so on. But I have never been a fan of dividend-only portfolios as preached by a lot of Seeking Alphans way back when (I've long ago lost all contact with SA and have no idea what the vibe there is anymore).

You knew it was coming, YieldMax! Parts of the cohort are big on the YieldMax funds as well as the other crazy high yielders. 

Looking at MicroStrategy and its corresponding YieldMax. The $463,000 figure is buying the common stock when MSTY listed. The $343,000 number is buying MSTY and reinvesting the distributions. The $72,000 is buying MSTY and taking out the distributions to live on.

The $270,000 was described as above.

I follow YieldMax on Twitter and they post regularly. The comments have turned on them. People are upset about the NAV erosion. The opportunity cost of going heavy into a YieldMax product versus a common stock that does even just decently tends to be enormous. That's clearly the case with MicroStrategy and MSTY. 

Mike Venuto (disclosure, I know Mike) from Tidal which is the white label provider for YieldMax was quoted as saying “If you want to just own the underlying stock, own the underlying stock. We’re not trying to beat the underlying — we’re trying to turn the volatility of the stock into income. People who are only trying to get the upside should not buy YieldMax products.” Or as we have said here, they are not proxies for the common stock. YieldMax products and the other crazy high yielders combine the stock with selling the volatility of the stock and that is a different thing. 

MSTY has been trading for 18 months and the NAV erosion as been 26% while the common is up 370% (per testfol.io). Contrasting with a stock and corresponding YieldMax that is less volatile and avoids crazy CEO risk, since the inception of the YieldMax Netflix (NFLY) just over two years ago, NFLY has eroded by 13% while the common has gone up 183%. 

Copilot says that MSTY's distributions total $45.41 since inception versus a starting price around $20 and now it trades around $15. We've talked a little about a scenario where someone is maybe 65 and retired but wants to wait to take SS and wait to take IRA distributions. If this person has a good sized taxable account they might be able to construct a portfolio that includes some exposure to very high yielders with the willingness to draw the balance down. 

As crazy as MSTY is, the erosion has only been 23% in the face of providing a lot of "income" in just a year and half. My example of the 65 year old looking to stretch a portfolio for just five years from MSTY's inception, he's already 18 months in and still has 75% of his MSTY balance left. 

The other day we looked at putting 10% of a portfolio into a bunch of different crazy high yielders to minimize idiosyncratic risk while putting the other 90% into a broad index fund. Looking to stretch out a little more income for this 65 year old, there are plenty higher yielding income sectors to also include without going further into crazy high yielders. There's a decent chance that the growth of a 60% allocation to plain vanilla equities can outgrow the erosion of 1% each into ten different crazy high yielders.

The idea is trying to let the balance last longer than taking 10% of mostly principal to cover the five year gap we're working with in this post. 

So imagine 60% in plain vanilla equities, 30% in higher yielding fixed income like catastrophe bonds, bank loans and so on with 10% in crazy high yielders as noted above. The question is, would our 65 year old investor be better off just going plain vanilla 60/40. Looking back, the answer is probably yes, that's pretty clear. However looking forward, in a lower return environment, a portfolio with a small allocation to selling volatility might have a better result. It's an additional source of return. Remember, most of the YieldMax products have a positive total return. That positive total return may not come close to the common but they are not the common stock, they combine the common with selling the volatility of the common.  

I don't think the YieldMax structure can fail. At a low enough price, the funds will reverse split and carry on. If the company disappeared then yes, the individual YieldMax would fail so to speak. I'm not worried about Netflix any time soon in this context but MicroStrategy might be a different story. 

Can't fail? Ok but look at the YieldMax ULTY.

Hedge fund in an ETF? Maybe, but ouch.

The image quoting Venuto was pulled from a Tweet and the comments are brutal.

And the characterization of the distributions for tax purposes. Others have reported real problems on this front. Sometimes they are returns of capital and other times they are ordinary income. Ok, but the reported problem is the recharacterization of the distributions which really is a problem.

Back to Bloomberg and this passage about another personal anecdote.

So far, Arteaga has invested some of the proceeds from the sale of his house and two cars, and about $30,000 in margin loans, taking his portfolio to $160,000. He hopes this nest egg will generate $9,000 of income a month, though that figure doesn’t factor in the payments he’s making on his margin loans or the tax bills he is likely to face.

So $108,000 for the year out of a $160,000 account? Ooof, my guy, no. My example above, I'm thinking maybe 8-10%/yr, maybe taking some principal out to to achieve that level. It could work but would not be riskless but this guy thinks he's going to get more than 50% out. He can take (more than) half out but the account isn't going to last very long. 

Another anecdote.

VanWagenen says he cashed out his wife’s retirement account and invested the money in various YieldMax ETFs and other high-yield products (he kept a 401(k) from his employer). He still has a day job as an accountant, but he uses his investment income to pay his mortgage, gas and internet bills and to make the monthly payment on his Plymouth minivan.

Oh boy. Don't do this. What we laid out above is fun theory and I think could work but going all in on YieldMax as implied is a catastrophe waiting to happen. Cashed out his wife's retirement? If you're VanWagenen and wanted to go all in on YieldMax, why would you make it worse paying the tax and the penalty on the 401k? Why wouldn't you do it from a rollover IRA? Honey, how can we make a terrible decision even worse? Wait, I know how we can do it!

One thing I picked up on is that these people in their 20's and 30's don't understand what it is to be in your 50's and 60's. At 25, I certainly did not understand 50. At 50 or 60 you might be old or with a few good habits you might be biologically young. I used to say this more frequently here but being 50, now 59 ahem, with a little money in the bank and still able to get it done physically is a great spot to be in and I don't think the people profiled can see this. 

The best thing I can tell someone that age is keep investing simple, pay your dues, live below your means and take care of yourself (diet and exercise). Forty will be here before you know it and following that path, you'll have plenty of optionality when you get there.

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.

Why Does Anyone Need This?

Thursday I mentioned a backtest that the ReturnStacked guys put up on YouTube showing the negative correlation between equities and managed futures. A little later I noticed how much the ReturnStacked Bonds & Managed Futures (RSBT) is down. With RSBT "for every $1 invested, the RSBT aims to provide $1 of exposure to U.S. bonds and $1 of exposure to a managed futures strategy."

Using the same four managed futures mutual funds they used on YouTube, I built out the following. 

Portfolio 2 should replicate RSBT and being short CASHX to build that one should at least partially address the financing cost. Portfolio 3 is an unleveraged version. 

To be clear, no one suggests putting 100% of a portfolio into RSBT and I wouldn't tell anyone to put 100% into the unleveraged version, they're just for what I believe is apples to apples context. Looking at the numbers, I don't know why anyone needs this and I don't think it solves any problems. 

Changing things up a little to a more modest allocation to managed futures with bonds without any leverage.

Simple isn't always the better choice but it often is the better choice. 

Barron's wrote about how to use AI in an investing context. I've said this before, I think AI can help when used correctly with the right expectations but we need to spend time learning how to use it. All the more so if you're an advisor. For now, my engagement has mostly been asking it to find things, compare funds/strategies and ask it why I might be wrong about something. 

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.

All Weather Update

ETF.com had another good post, diving in on the SPDR Bridgewater All Weather ETF (ALLW). The fund has been successful both in terms of assets raised and I think the performance is probably in line with what they had in mind but not really game changing.

ALLW is quadrant inspired risk parity. In the comparison I built, HFND is hedge fund replication managed by Bob Elliott who worked at Bridgewater, FAPYX is Fidelity's risk parity fund and FIRS is quadrant inspired without risk parity and one that I am test driving in one of my accounts. FIRS has some Bitcoin in it and a fair amount of gold which accounts for a meaningful chunk of the outperformance. 

I doubt they are thrilled doubt the volatility numbers for ALLW, assuming testfol.io has it right. It's a very short sample size but its had the same volatility as VBAIX with 240 basis points less in growth. I wouldn't expect it to necessarily keep up with VBAIX unless commodities ripped and they owned the right ones.

If someone is interested in ALLW, what are they trying to do, what effect are they trying to add? The next question should then be is there a way to get the same effect in a different way? It's too soon to say definitively yes at this point but I suspect there are better ways.

With some overlap, iShares posted a sort of fall outlook with thoughts about asset allocation that I took as being shorter term in nature. The centerpiece was the iShares US Equity Factor Rotation Strategy ETF (DYNF). It's a five star fund but it's not obvious that there's a ton of differentiation. There's been some but I don't think it has netted out to a lot. 

They like the belly of the yield curve at 3-7 years and suggest their fund BINC managed by Rick Rieder. BINC has done much better than AGG, higher returns with much less volatility. Included in their discussion was their Bitcoin ETF and the iShares Advantage Large Cap Income ETF (BALI). BALI is a derivative income fund that has been around for almost two years. 

A little more substantively, they note that the correlations between bonds and stocks has changed calling it "less reliable" which is of course the conversation we've been having here for a long time. This next quote was interesting even if it's about steering the conversation to BALI. 

Investors are diversifying beyond traditional bonds, seeking strategies that blend income, risk management, and long-term growth potential.

I don't think we've articulated derivative income in the context of blending income and risk management. Covered call funds are certainly marketed that way but in it's most basic form, selling calls caps the upside and while the income can soften the blow on the way down, during a real whoosh, expecting a covered call fund to also drop a lot is the mindset I would suggest. Newer variations might cap less of the upside with 0dte options or some that sell puts for income and so on. Yes there are drawbacks to derivative income funds but I wouldn't discount the possibility that tweaks to the strategy could make them better products in the future beyond some of the very narrow theory we've kicked around in previous posts. 

The ReturnStacked guys had a show on YouTube today trying to make the case for managed futures now. Obviously they are big believers in managed futures given the funds they've launched but of course after fantastic returns in 2022 and a resurgence in popularity because of those returns, managed futures has appeared to struggle. 

Making the same point I made many times in the 2010's, managed futures tends to be negatively correlated to equities. If equities are ripping higher, there's a good chance managed futures won't be doing well. They posted the following during the presentation that makes the same point.

Decade to date, it's pretty much been doing exactly what it's supposed to do. It looked like this in the 2010's as well. I posted the same type of chart many times in the 2010's, they looked similar to this and I think makes the point of what a terrible idea 20% into managed futures is. Toward the end of the show, one of the guys said they didn't think 5% in managed futures would do much to help. The push back to that is to diversify your diversifiers. 

No single diversifier should be thought of as infallible. If managed futures "works" nine out of ten times, great, but what about that one time it doesn't? What if equities drop 50% in some bear market event and a 20% allocation to managed futures drops 18% and what if that happens one year before the person plans to retire? Equities are the thing that goes up the most, most of the time which is important to keep in mind when trying to size alternative strategies. 

We'll close out with Larry Swedroe going after buffer funds. He seemed to be going after the ones that offer 100% downside protection. I don't have the 100% buffers dialed in but he lays out how they still lose money in opportunity cost and that what they own are 95% in T-bills and 5% in a call spread which makes the 70 basis point fee expensive. He says that you could "easily construct this strategy yourself for a fraction of the cost." 

That's not necessarily accurate. The chances are that the friction for someone putting on an odd lot sized spread would add up to more than the fee of the fund. Additionally, even if 70 basis points is too much, there is some value in having the fund put the trade on for you. 

A bigger point is that I think he is viewing these as a replacement for equities which as we discussed yesterday, they are not replacements for equities. I'm not a fan of these at all but any critique should focus on the right thing. FWIW, I do believe there are probably easier ways to access portfolio protection without capping the upside.

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.

Time To Rethink Everything About Asset Allocation?

William Bengen, deriver of the 4% rule for sustainable retirement withdrawals, was on the wire this week again making the case that 4% is now too conservative, likely allowing people to get to the end with still too much money unspent.

The way the article reads, Bengen treats the optimal withdrawal rate target as constantly moving. Four percent might be too low for the reason Bengen cites. Backtesting 60% simulated S&P 500/40% simulated 3-7 year treasuries on testfol.io goes back to 1962 and has compounded at 8.8%. That 8.8% includes an unrepeatable 40 year run ending in 2021 where the 3-7 year treasury compounded at 6.79%.

One idea about the sustainability of 4% that I don't think I've seen addressed elsewhere is that it's not just about taking 4% every year, it is about being able to sustain in the face of the occasional, very expensive one-off that has to be paid for. Who budgets for their next roof replacement? We replaced our roof in 2018 or maybe 2019. Maybe that means we have to do so again in the late 2030's or early 2040's. Where one offs play a role, I think a moving target for a withdrawal rate is a bad idea. 

You know what you are spending now. Hopefully if you're not retired yet, you have at least some sort of rough outline of what your retirement spending will be. If Social Security (should you use a reduced SS amount?) plus 5% of your portfolio will provide enough money for what you have in mind, great but what is your vulnerability to something like a new roof or any other not enormous surprises? To me, 4% is about expenses and one-offs not just expenses. 

Humble Dollar also picked up on the Bengen interview, talking a little more about asset allocation. Bengen assumed a 50/50 mix of stocks and bonds for his study. Humble Dollar talked about a normal (my word not theirs) range for equities between 45% and 75%. A retirement plan with a huge margin for error, like maybe a good sized account with the intention of continuing to work probably doesn't need 75% in equities. A retirement plan where maybe the account is large but the person doesn't want to work or no longer can work probably needs more than 45%. 

An allocation mix could come down to some combination of growth and real positive return. Real positive return could mean TIPS of course but if TIPS interest you, buy individual issues, not the funds. I think a lot of the alts we look at here could sub in for TIPS in terms of similar volatility profiles and max drawdowns but with slightly higher growth rates.

For the same period, the Vanguard Short Term TIPS ETF (VTIP) compounded at 3.58% with a volatility of 2.98%. TIP got hit very hard in 2022. Remember from yesterday, BALT is not equities. You might make fun of it as a substitute for TIPS funds, but it is not equities. If not equities, what can it be used for? Some sort of real return, low volatility vehicle? Maybe. 

Before digging in, note the green highlight. Testfol.io added Calmar Ratio which divides the growth rate by the max drawdown such that the higher the number the better. 

These are all extreme portfolios but sort of inline with being quadrant inspired. If you take out BALT and run similar tests, you can go back to 2017 and back that far, the CAGR is the same as VBAIX but with a lot less volatility. If you just use client holding BKLN, you can go back to early 2011 and in that period, it lagged VBAIX by 210 basis points, 7.08% annually versus 9.18%, but again, much less volatility. And from early 2011, inflation compounded at 2.64% so irrespective of what the benchmark did, the real return and volatility tradeoffs were pretty good.

I've said many times that 25% in gold is too much for me as is mid-teens in alternative strategies but where bonds aren't reliable anymore, it seems better to balance growth (equities) against a combo of holdings that offer low vol/positive real return. I would go a little more diverse than just five funds though. 

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 Equities

Apparently, Goldman Sachs put out a paper "making the case for buffer ETFs" and Cliff Asness made fun of them and linked to AQR's work that draws negative conclusions about buffers.  

One thing we try to do here is look at things that most people hate and see if there is a way to use them, maybe there's a contrarian angle? The crazy high yielding ETFs are an example of that.

One of the five above is the Innovator Defined Wealth Shield ETF (BALT). The other four are various alternative funds that lean market neutral/absolute return. BALT is not the purple line. Whichever one is BALT clearly is not a proxy for equities. On ETF IQ one time, someone from Innovator said that the symbol was a play on words for Bond ALTernative, BALT. So not equities. Don't look at it as equities. It's not equities. 

Is the return stream or volatility or real return useful in your mix? It doesn't have to be, I am not going to buy BALT anytime soon but I have several alts in my ownership universe that look like BALT.

Yes, this would turn out badly for the vast majority of people and yes, Tenev is talking his book but if it really is true that AI is crowding out entry level jobs then it is a decent bet that later stage jobs that people eventually get promoted into might also get crowded out. If all that happens then people will need to figure out how to make their way. This is all a path toward UBI and it's hard to see how UBI would be anything more than simply sustaining. People would need to figure something out, probably involving the internet even if that something is not trading for a living. 

Short one tonight.

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 Realistic Way To Replicate College Endowments

Man Institute did a deep dive on capital market assumptions with a favorable bias toward risk parity. Risk parity weights different asset classes by their risk in such a way that each asset class contributes the same amount of risk to the portfolio so the strategy would own more in bonds typically, often with leverage, to equal the risk exposure of equities. 

Similar to the crazy high yielder ETFs we looked at on Sunday, I am not a huge fan of risk parity but the strategy is still fascinating and I think there is something to learn by studying risk weighting. 

A lot to unpack here. Portfolio 2 is not something that can replicated in a brokerage account but the leverage used creates useful context for what risk parity might look like with funds that we regularly use for blogging purposes. BSJR is a client holding. 

Portfolio 3 offers one way to build a leveraged portfolio thanks to NTSX' capital efficiency. NTSX leverages up such that a 67% weighting to it equals 100% into VBAIX so a 64% weighting to that fund gives Portfolio 3 a 57.3% weighting to equities and 74% in fixed income/fixed income substitutes. AQRIX used to be the AQR Risk Parity Fund and while the fund changed its name a while back it still incorporates much of the risk parity strategy. Portfolio 5 is a lot of risk parity with ROM to add a little more equity exposure in a capital efficient manner.

AQRIX as an exception here, but there hasn't been much in the way of crisis alpha with this idea. Portfolio 5 did go down less in 2022 but just a little less. I tried to equal out the volatility which is a little different than the risk. 

The way we've constructed risk parity, I'm not sure there's much value in trying to replicate it. There's nothing catastrophic here but not very additive either. 90% or 100% in any alt fund is really a bad idea. Ruling something out can be just as useful as ruling something in.

With the slightly longer timeframe of this one, the AQRIX/ROM combo is a little more compelling but still no element of crisis alpha. 

The Wall Street Journal took another look at college endowment portfolios including this chart.

You can hover over it to get exact numbers and yes, not all of them add up to 100. The averages are 57.7% to equity (public and private combined), 21.1% in hedge funds, 11.2% in real assets, 5.6% in bonds and 3.3% in cash. The averages add up to just shy of 100% for obvious reasons. Combining private and public equity makes this something a little easier to replicate and for the most part, the combined equity allocations are pretty close to a "normal" allocation that an individual might have. There are plenty of mutual funds that are hedge fund-ish with quite a few different strategies that offer differentiated return streams versus equities and bonds. 

There is an infinite number of ways to go with this. Where it could be useful and/or realistic is that most of these are heaviest in plain vanilla equities, I constructed them to not take interest rate risk, I split the hedge fund proxies into to two disparate strategies and EIPCX is new to the blog, it is a commodity fund that utilizes a futures curve strategy to minimize the detrimental effect of contango where possible and benefit from backwardation where possible. This means it should do better than something like DBC. The first few years that EIPCX traded, that wasn't really the outcome but lately it has had more success in this regard.  

Domestic equities have done much better than foreign for quite a while until this year, unless this year turns out to be an anomaly in a longer trend. Obviously if domestic does better going forward then Portfolio 1 would outperform the other two and if foreign outperforms, Portfolio 1 would lag. 

Portfolios 1, 2 and 3 offered real crisis alpha in 2022 but fared worse in both the 2020 Pandemic Crash and this year's Liberation Day Panic. I threw in 90% AQRIX/10% ROM from above for a little more context.

I think I'd describe 1, 2 and 3 as being valid, I think they could get the job done but not unusually robust along the lines of some other ideas we've played around with. 

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.