The Challenges Of Being A Long Term Investor

If you ask most market participants, I think they'd say they are "long term" investors but what does long term mean? There are of course many definitions. For me, I tend to hold for many many years. Quite a few client holdings have been in the portfolio for more than 15 years.

Have you ever heard/read something like, if you'd put $1000 into some stock 25 years ago and just held it, you'd have some huge dollar amount today? It would be great to have put a few bucks into Amazon 25 years ago and have $1 million's worth today but what does that really look at feel like.

I've owned this stock for clients going back to at least 2011. I added in price levels of a few peaks along with subsequent declines. There are plenty more than the few I drew into the chart but want to make a simple point about how difficult holding a stock can be. 

Dropping from $27 down to $16 like in 2016 is a very difficult thing to sit through. Sometimes the thesis does change and you should sell. Sometimes stocks just go down for some sort of shorter term news and sometimes the thesis is just flat out wrong. If the thesis does turn out to be wrong then the investor needs to realize that or if the thesis still stands up and the market is "wrong" for a few months, then the investor needs to be able to recognize that as well. In the end we still might make a mistake in selling or make a mistake in holding on. 

Type 2 diabetes being a growth industry seemed like a pretty easy bet to make way back then which helped me in sorting out what to do and of course luck plays a big role in outcomes like this. T2D was one thing back then, there was obviously no reasonable expectation for drugs like Wegovy and Ozempic. Of course, better than those drugs would be to cut carbohydrate consumptions and lift weights. The thesis for the stock has worked so far because most people won't do that, they'd rather take medication even if there are side effects and Wegovy has a doozy of a list of side effects. 

Have you ever sold a stock, even if it did well, only to see it go much higher? Of course, every investor who uses individual stocks has done that. I will close out reiterating that it is very easy to get just one thing wrong and end up missing a great rise or end up sitting in something that ends up doing very poorly. An investor of individual stocks is likely to have some of both, that's ok, it goes with the territory. 

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.

My Time In The Virtual Classroom

Over the last couple of weeks I've sat in on a few industry related webinars including what I would call more of a direct sales presentation. I don't usually do a lot of this sort of thing but if nothing else these could help me take the temperature of what is going on in the RIA space outside my normal routine. If I was lucky, I'd learn some things which I am very interested in doing. 

One presentation about about incorporating more individual stocks into client portfolios which I've included since day 1. The industry seems to have moved away from stock picking to far more ETF-only model portfolios. At high level, it has never made sense to me that one wrapper could be the best way to capture every segment of the market. I haven't used this term in a while here but I am very much wrapper agnostic when it comes to individual issues, ETFs and mutual funds. Yes, ETFs are better than mutual funds most of the time for apples to apples exposures but there are a lot of strategies that don't lend themselves very well to ETFs.

The presentation was from a company that employs growth at a reasonable price (GARP) and if I wanted, I could outsource some portion of client accounts to them to manage. I don't want to do that but could I learn something about portfolio construction? The short answer for this one was no. There was a lot of "and we can help you close the business" which is not an opportunity to learn. 

Another one was the one on one (two guys actually) sales presentation for an AI platform. Understanding what AI can do is high on my interest list. Is there an application that will allow me to move forward wit my approach to portfolio construction? The product focused mostly in individual stocks. Basically it could go out to the web to find, filter and interpret all kinds of information and then make suggestions in reaction to news for a given company, the industry it is in, a little top down information for changing portfolio weightings or swapping out names. Based on such and such, reduce your exposure to Intel or swap Intel for AMD (neither stock is in my ownership universe) for example. 

The focus for now was far shorter term than how manage, it was unergodic 

It was clear that this can absolutely evolve into something I would add in to my process. Most of the portfolio work, not talking research, I do is spreadsheet related. AI will at some point take all the spreadsheet work off my plate and do it for me. Maybe there are other platforms that will already do what I am talking about. I write all the time about BTAL and the Merger Fund (MERIX) as two alternatives I use. AI will be able to quickly find potential substitutes, back test them into the portfolio and probably project forward a set of expectations of whether MERIX is the right hold for a horizontal line that tilts upward or maybe I should switch to convertible arbitrage or something similar.

Lastly, I sat in on a presentation from Fidelity about investing in alternatives, liquid and otherwise. This was for advisors and while it wasn't so basic as to be a first introduction it was pretty basic. It's not clear what they were selling if anything but since Fidelity has a huge RIA business maybe it was just about education which I am in favor of but if that was the case, I would have appreciated a lot more meat on the bone.

Listed in the presentation materials were three Fidelity mutual funds that target different strategies. 

• Fidelity Hedged Equity (FEQJX)
• Fidelity Risk Parity (FAPYX)
• Fidelity Macro Opportunities (FAQEX)

My initial reaction is to think it positive that a heavy weight like Fidelity is trying to get into the space, hopefully the funds can add value. They are new, so for now, they are pretty tough to evaluate to the point of any conclusions.

FEQJX only goes back to late 2022. In its short time it has a CAGR of 18.37 versus 30.12% for the Vanguard S&P 500 ETF (VOO) with a standard deviation that is 328 bp less than VOO. It will typically allocate 80% to stocks which seems low and there is an implication that the other 20% will going into put options to hedge. If that is right, then it sounds very hedged. There's no great way to evaluate an 18 month track record where the stock market has gone almost straight up. Going forward there are a couple of things to look for. Might it give a result along the lines of 75/50 (75% of the upside with only 50% of the downside)? Or with enough track record could it be spliced into the equity allocation to create a lower volatility portfolio without giving up too much upside?

I built the following risk parity comparison for FAPYX.

I've never been a fan of the version of risk parity that simply leverages up on fixed income no matter what. The reason I built the risk parity portfolios at 70/30 is to see if we can increase the equity exposure versus 60/40 while lowering the volatility. We've been able to achieve this with other alternatives in past blog posts but not with this type of risk parity. 

As of its last reporting, FAPYX allocated just under 60% to equities, 80% to fixed income and 55% to futures and swaps which is kind of vague but does include gold. Risk parity is a very small fund space and it seems hard to do well in a fund wrapper. AQR seems to have figured it out better than most other fund providers if that interests you. 

Trying to look through to what macro funds are doing is usually very difficult because of the leverage obtained using derivatives and that is the case with FAQEX. JDJIX is the John Hancock Diversified Macro Fund. I don't know that fund, I just pulled it from a list of top alt funds that Standpoint publishes.

FAQEX is also leveraged. It allocates 19% to equities, 125% to fixed income and then close to another 100% in various derivatives so it too is sort of a risk parity fund. The contribution to a portfolio from JDJIX versus FAQEX is stark, about 400 basis points of outperformance with a somewhat lower standard deviation. FAQEX, the way I added it results in a proxy for 60/40 with no real advantage. Maybe FAQEX will evolve to add more value than it has so far.

I've said this more than a few times but a big part of the learning, researching process is going through things that don't immediately offer utility or maybe never will. I don't know how many times we've talked about the RPAR ETF, it is interesting to me to study but has zero appeal for using in client portfolios. 

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.

Lou Glutz Wants To Sell You An Annuity!

I saw National Lampoon's Vacation in a theater. The car scene was one of my favorite parts of the movie. I immediately thought of Lou Glutz (the Eugene Levy character) when I stumbled into two articles about annuities. One was at Barron's and another from Advisor Hub.

My standard preamble when talking about annuities is that I am not licensed to sell annuities. I had my insurance license ages ago for one job but never sold an insurance product. The typical annuity is very expensive and very complex. I am aware of one inexpensive annuity product from Vanguard. I've never looked into it but where there is at least one that is cheap maybe there are some others?

The Advisor Hub article is about the possibility/probability that the fiduciary standard will soon be applied to annuities and the extent to which brokerage firms are trying to fight that. The Barron's article takes a positive stance noting that higher interest rates make annuities "more attractive" and that "experts say annuities have become more consumer friendly in recent years as insurers lessened fees."

I have a bias here against annuities. The typical annuities just seems like a cringe money grab for the person selling the annuity. Agree with me, don't agree with me, either way but regardless of my bias, that doesn't invalidate the idea of annuitizing some portion of your assets. Many people view Social Security as an annuity of sorts with an inflation rider. 

There are plenty of people who would benefit from creating a guaranteed stream of income from a portion of their assets realizing they may or may not benefit from the longevity pool aspect of the concept. Annuities have high payouts because some portion of annuity buyers won't live to an very old age and they surrender their annuity assets when they die. There are exceptions but those exceptions cost more money. 

It seems logical then that this space will evolve to become simpler and go from insanely expensive to merely not cheap. We looked at one new idea a couple of weeks ago from Stone Ridge. They have a suite of mutual funds that turn into tontines at age 80. You can sell before 80 but at 80, you're locked in. 

I can't envision the scenario where I will think someone should buy an annuity as we now know them, insanely expensive and very complex, but there is no reason not to stay on top of how the idea of annuitizing assets evolves, if it evolves. Creating a guaranteed income stream where you might benefit from good health habits for the cost of a mutual fund seems like it could help a lot of people. The Stone Ridge suite notwithstanding, I don't think we are there yet for reasons I outlined in that other post but again I am convinced this will evolve favorably. 

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.

Duration & Volatility Follow Ups

Today we have some market opinions and data that serve as good follow ups to our discussion this week about duration and volatility. 

PIMCO is warning that our excessive debt loads could take the treasury market back to where it was in the 1980's in terms of very high yields like 8, 10 or 12%. We talked yesterday about whether intermediate treasury yields might ever get to 6 or 7%. What PIMCO is calling for would be a much rougher environment for the economy. 

Possibly related, Torsten Slok said the following via a Tweet from Katie Greifeld.

We mentioned that after starting with six expected rate cuts for 2024, consensus backed off to three and maybe now less, Slok says no rate cuts. If price inflation continues to hover above 2% then I'm not sure why the FOMC would lower rates in a meaningful way the market is hoping for. 

And if that wasn't all, BCA is calling for a recession which could send stocks down 26% by their reckoning.

A twenty whatever percent decline in conjunction with a recession is not particularly noteworthy, we've all been through worse. I think the odds of a recession coming from the current mix has lessened quite a bit meaning that something new would have to be added to the current stew to tip us into a recession. That is little more than a guess though, it doesn't really matter in that we know there will be more recessions in the future, typically the stock market reacts, that reaction then ends and the market goes on to a new high. The only variable is how long that takes. 

The above table is from Charlie Bilello. It quantifies things that we talk about all the time, first being that stocks are the thing that goes up the most, most of the time. I've been saying stocks go up 72% of the time and that appears now to have nudged up to 73%. I think the table is yet another confirmation of how things work. Markets go down about a quarter of the time. 

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 Bond Market Volatility

Barron's had a quick profile on the Blackrock Flexible Income Fund (BINC) which is an active ETF managed by Rick Reider. I am less interested int he fund than this excerpt from the beginning of the article.

It pretty much parrots what we've been talking about here for ages. I've been saying meaningful yield without too much volatility is what investors hope the bond portion of their portfolio will give. That just isn't the reality. The diversification benefits of intermediate and longer term bonds is not what it used to be. The simple 40 year trade for bonds of "number go up" is finished and as a matter of math, can't be repeated.

Taking volatility out of a fixed income portfolio is fairly simple. an investor can get most of the way there just by shortening duration and diversifying among different income sectors. Interest rate risk/duration is a big source of volatility. That might not be great wording, longer maturities have more convexity, more sensitivity to changes in interest rates. I'm not saying outperforming is fairly simple, just that reducing volatility is, even if eliminating volatility entirely might be a little trickier. 

Less so in the last few weeks but late in 2023 a lot of pundits were saying it was time to add duration despite those yields being lower than short dated paper. They seemed to be selling the fear that yields would be going down and that we should lock in now (back then). Since then the idea of six (was is six?) rate cuts this year unraveled down to three and while the inflation data has improved mightily since a couple of years ago or so, it sort of stopped going down for the time being. 

Part of where I am coming from on this is how terribly wrong the consensus has been on how to engage fixed income markets for such a long time. There was not widespread concern over the inherent risk of buying 10 year paper yielding 2%....and then it went much lower, dramatically increasing the risk. Great for anyone who traded those moves successfully for capital gains but if that is not your trade, it is not my trade, then you should have avoided that part of the market as we said here all along. 

Several times I've cited corporate issues I've seen in accounts I don't manage maturing in the mid-2030's being carried at 70 cents on the dollar. They're going to stay there for many years unless rates go down dramatically. That might happen but that is an awful spot to be in.

How many investors didn't realize declines like this were possible? Worse, how many advisors didn't realize?

I learned a long time ago, I've not very good at "predicting" interest rates. If you've been reading this site and previous blog locations before this one, you know that I've been framing this as avoiding risk and avoiding volatility. Maybe that's a little easier. Getting paid 2% for 10 years just is not attractive. Maybe at 7% it makes more sense to take on the volatility, there'd be a lot less risk buying at 7%. I have no idea if 7% will ever come again or 6% but we can get decent yields from much shorter durations and if the middle of the curve or even further out ever goes up a lot then we can talk about buying at that time. 

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.

Coasting Into Long Duration

More quick hits.

Flow Financial Planning blogged about something it calls Coast FIRE. It's a play on FIRE which stands for financial independence/retire early. We've looked at this quite a few times favoring the idea of achieving some measure of financial independence but not so much actually retiring early.

Coast FIRE is a catchier phrase for an idea we've narrowed in on which is the optionality that goes with making some good financial decisions early on so that you have more optionality later but before you retire. The optionality comes from getting to a point at maybe 50 (a little younger, a little older?) where you no longer need to save for retirement or save as much. This optionality allows for moving into a career that is more about your passion than the need to maximize your income in a job that may no longer be enjoyable. When this sort of financial independence is achieved at an earlier age, Flow Financial would say you are coasting into retirement. 

Cullen Roche looked at the 60/40 portfolio concept through an interesting lens. The main takeaways are that one, 60/40 is not dead and that two, different assets have different durations. He works through a little theory coming with equities being an 18 year asset and bonds being a 5 year asset. 

Realizing that money you need in the short term should not be invested in something that can go down in value is a pretty important thing to understand, we talk about this all the time in the context of sequence of return risk. It is important to understand equities as a long duration asset but I've never quantified equities and fixed income as precisely as Cullen does. The importance comes in understanding diversification and the importance of long term thinking in the equity portion of your portfolio.

The stock names don't matter, it's just an example. Both stocks have compounded at more than double the rate of the S&P 500, the yellow bar on the chart. The stocks have outperformed more often than not in individual years but you can see there are period of dreadful underperformance too. Being able to sit in a name when it is lagging, like the blue bar in 2015 or the red bar in 2016, requires a lot of patience but that patience is more easily found when you think in terms of stocks being long duration assets regardless of whether 18 years is the right number or not. 

Additionally on this point. In a portfolio of narrow based holdings, you might have an opinion on what your best performers will be this year or the next couple of years but you can't actually know which is why you diversify. 

Barry Ritholtz interviewed David Dunning...Dunning as in Dunning-Kreuger. The simplified definition is over estimating your ability out of ignorance. The interview also touched on a more interesting aspect related to knowing yourself and what you value as truly important. 

We've looked at this a lot. I've thankfully been aware of this personally for a long time and I believe my life has been better for it. I think people struggle with this which leads to many years wasted, pursuing the "wrong" outcome, wrong for them. I value time and day to day enjoyment of life over a bigger paycheck. I have no idea whether I'd be making a fortune as an advisor in a big city but you don't move to Prescott expecting to rake in big bucks. 

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.

Brand New ETFs Off To Interesting Starts

A few quick hits today.

There was news reported in multiple places from Fidelity's survey showing the number of 401k millionaires grew last year by 11.5%. Part of the headline in the link I am including refers to these people as poster children for staying the course. Staying the course hopefully starts at a younger age but whenever it starts, the discipline to put in a meaningful percentage every year and let the market do its thing for you makes the path to a workable, financial outcome much easier to achieve. 

How old are you now? Where was the S&P 500 when you started and where is it now? The stock market will continue to saw tooth higher in the future, with or without you so you might as well go along for the ride. The fancy word for this that I like to use is ergodicity. The stock market is ergodic, it will generally work from the lower left to the upper right at some annualized rate. This isn't always easy to remember, like maybe in 2022, but it is always true. If you don't believe that, you should probably sell out right now and never buy stocks again. That's not a sarcastic comment. Don't own stocks if you don't believe they will go higher over the long term

A month ago, I mentioned the then brand new Defiance Treasury Alternative ETF (TRES). It owns short dated treasuries and uses option combos consisting of "credit spreads, debit spreads, long calls and long puts." Currently it has combos on TLT, it looks like credit spreads using calls and puts and then long more calls and puts beyond what is spread off. It appears somewhat directional with more long puts than long calls after netting out the short options in each spread. 

A month is obviously no time at all but this isn't a great first impression. Even if this first month turns out to be an aberration, it is a good reminder how quickly complex option positioning can go against you... until today. It certainly has been a smooth ride but it's been almost straight down. 

About a week ago I mentioned the newly listed Calamos Alternative NASDAQ & Bond ETF (CANQ). It is a multi-asset fund consisting of fixed income and equity exposure. It puts 90% into what appears to be a diversified fixed income portfolio with exposure to quite a few different income sectors via ETFs. The other 10% goes into long term call options on several NASDAQ stocks as well as calls on the Direxion Equalweight NASDAQ 100. 

In my post I said the fund appeared to be leveraged despite the prospectus not mentioning it. I was able to speak to the someone else at Calamos and it is leveraged along the lines, it appears, like the Return Stacked Stocks & Bonds ETF (RSSB). With the notional value of the calls in CANQ, the amount of stock controlled by all the calls, it looks to be a 90/100 bonds/stocks or 90/90. Calamos bases the notional equity exposure on the price of the common stock, not the strike price of the option. In that other post, I used Adobe as an example, the fund owns 1 call struck at $711 but the correct way to look at it is based on the price of the common not the strike price of the options.

A couple of interesting points. I mentioned the prospectus referring to this as a convertible security proxy. The answer on this is yes. Convertibles have a lot of equity beta so maybe this fund will too, I'd expect that to be the case but we'll see. My contact at Calamos said that none of the equities owned in the fund (via call options) have convertible securities outstanding. The combo of the calls and the fixed income then might give a convertible effect. That will be something to follow up on. 

NASDAQ is considered a tech proxy but that isn't quite right. It's close but not 100% tech. The fund has calls on a bunch of mega cap tech but also has calls on Costco and Pepsico. I'll try to circle back in six months to see how it compares to RSSB and also a convertible fund.

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.

Did Barron's Just Undercut Every Article It Has Ever Published?

Jack Hough's Streetwise Column in Barron's took an interesting turn this week. He said that all any investors need is a stock index fund, probably just an S&P 500 fund and a bond fund. Maybe a little into an international fund but you don't need emerging markets. REITs? Forget about 'em. Commodities? No way. Thematic funds? Get outta here with that. 

Regarding bonds, Jack said "You need bonds—not because they’re good for making money, but because they hold their value better than stocks when the market goes kablooey." First, of course what he is saying is valid. The plainest vanilla stock/bonds mix will get the job done over the long term.

Also included in the list of things investors don't need were options, preferred stocks, convertibles and private equity. Part of his logic is that many of these things are in the S&P 500, you're already getting them. That is correct, technically but whatever you're looking for from REITs, or private equity or any of the others, you're not going to see it impact the portfolio as part of an index fund. In the case of real estate a 2.29% weighting and for "private equity" companies it's about 17 basis points (looked at XLF holdings and then did a little math), that's just not going to move the needle.

You may agree with Jack about not needing those things, that's valid, my point is that owning an index fund isn't a proxy for them.

More interestingly than what investors may or may not need is a pretty obvious behavior on display in the column. Regardless of what stocks should be doing these days, equity markets markets are doing fantastically well. Note that stocks do what they shouldn't all the time which is why it is best to avoid jumping all the way out. Times like now, at all time highs, make it easy to talk about just owning an index fund, having a heavy allocation to stocks and thinking you can just hold that and chill. It reveals complete amnesia about what it feels like when we are grinding through a large, serious decline. 

Forgetting is a normal thing for investors, I've seen it repeat over and over. I certainly have no idea whether Jack gets scared during large declines (I doubt it) but it is important to remember what your reaction and thought process was during 2022, the Pandemic Crash in 2020, whatever the hell happened in December 2018, going back to the Financial Crisis, the Internet Bubble, Long Term Capital blowing up in 1998, the Asian Contagion in 1997, Orange County's bankruptcy in 1994, Iraq bombing Kuwait in 1991, the failed UAL LBO in 1989, the 1987 Crash and a whole bunch of others in between that I am forgetting. 

Mistakes during those types of events are what managing portfolios is all about. Market discipline matters after large declines, avoiding panic is avoiding permanently impairing your capital. I've cited the example a few times of bonds bought 3-4 years ago when rates were at their lows that now have 30% paper losses and below market yields for holders. That would be a terrible position to be in but anyone selling would be hard pressed to make that money back in the bond market. Market discipline matters at all time highs to avoid greed, to avoid panic buying only to get whipsawed by the next large decline.

Closing out on Jack's comment that "you need bonds..." If he means duration, the part of the bond market that is volatile, we've written 100 posts debunking that. The volatility regime of duration and the correlation attributes make them far less useful for diversification than they used to be. Of course "used to be" was a 40 year bull market that mathematically cannot be repeated. I continue to focus on short term yielders and low volatility alternatives that function as proxies for what I think people hope bonds will do. Bonds might be valid but are far from optimal.

Remembering the emotion felt during market events is a great way to minimize mistakes. Whenever the next scary market event comes, it will eventually end, the market will then start to go up and eventually make an new high, the only variable is how long that all takes. I've been repeating that last sentence for I don't know how many years, it has always been true and I will always believe that it will be true for future market events. 

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 New Index To Make An ETF

First a followup to yesterday's post about return stacking and the notion of the free 10% that Corey isolated in his blog post. Underpinning what ReturnStacked ETFs are trying to offer is a way to add alternative strategies to a portfolio without having to shave off a little equity or bond exposure or shave off exposure to both in order to make room for whatever alt someone might want to add.

Used in a manner like we described yesterday or other approaches, the portfolio can maintain its 60/40 stocks/bonds mix and then "add alternatives on top" is how I think I've heard them describe it. By maintaining the 60/40, the portfolio avoids tracking error. You've got the 60/40 in there by way of a capital efficient fund so no tracking error as they view it. The alt then give the chance to add some sort of effect with adding alpha or reducing volatility as the most common objectives.

I'm pretty sure that sums up their position. Two points from me. I'm not sure that the thing they are trying to avoid, tracking error, actually needs to be avoided. If the objective is looking like the benchmark for the most part and then reducing volatility, then I  think you don't really need the leverage. If you're trying to outperform on the upside, it still comes down to picking the right thing. Try to add alpha with Nvidia (NVDA) and you'd have had good luck over the last couple of years regardless of sizing and regardless of whether your return stacked or not. If you tried to add alpha with Bank of America (BAC) then you've had bad luck over the last couple of years regardless of sizing and regardless of whether you return stacked or not. 

Where they are talking about alts, some alts are pretty reliable like client and personal holding BTAL which reduces volatility in what seems like every instance and managed futures which usually does, even if not quite as reliably as BTAL. 

You really need to choose carefully with some alts and accept what they are trying to do or don't use them. Merger arbitrage is not going to contribute to outperformance to the upside. I have faith in it lowering volatility but zero expectation of adding basis points in an up year.

With all the options related ETFs that have hit the market lately, here is another idea that I bet someone will ETF. This comes via Marketwatch and something called the CBOE Dispersion Index. The idea is to go long volatility of individual stocks and short volatility of indexes in a sort of spread trade. I found the chart on Google Finance.

A spread-type of strategy should be less volatile than the underlying and that has been the case so far for DSPX but it is still very new. I am curious enough about it to try to learn more including what could go wrong with this sort of spread trade. I also threw in client holding PPFIX onto the chart which might be the least volatile fund that sells.....ahem...volatility. 

Volatility as an asset class is fascinating to me for there being a wide range of how to use it ranging from incendiary risk shorting the close to the money VIX to covered calls which is not something that can end in catastrophe but can get left far behind in a bull market. For what it is worth, I have previously described PPFIX as picking up pennies a mile and a half in front of the steamroller. It sells puts that are very, very far out of the money. 

There can be a place for small exposure to certain volatility strategies but these are not simple and have risks that have to be understood before going in. I just mentioned the risk of covered call funds. Look at XYLD and QYLD, both from Global X and have been around for a long time. Like I mentioned, this strategy can get left far behind and these two seem to fit that bill exactly. That's not bad or good, that's the tradeoff. 

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 Practical Application Of Return Stacking?

Corey Hoffstein from ReturnStacked ETFs and Newfound wrote a quick blog post to support the ReturnStacked Global Stock & Bonds ETF (RSSB). RSSB leverages up to offer 100% exposure to both equities and bonds. The following graphic from his post pretty much sums up the argument.

The free 10% can go toward maybe adding potential alpha or helping to smooth out the ride or whatever else an investors might come up with, maybe going hog wild with Bitcoin asymmetry. Corey suggested that 10% go toward funds that I would describe as being in the realm of all-weather. I replicated Corey's idea with Portfolio number 2 as follows.

That nets out to 60/40 plus the free 10% going to ARBIX. Below, I compared it to VBAIX and I built Portfolio 3 that I think delivers almost the same thing as Corey's idea.

NTSX is the 90/60 ETF. It is leveraged up in such a way that a 67% weight to it is the same as putting 100% into VBAIX. BIL is the SPDR Treasury Bill ETF which is a cash proxy. Both Portfolio's 2 and 3 had a little better growth with a little lower volatility. 

None of the three will protect against a huge downturn like we had in 2022.

The two alternative strategy portfolios were pretty much right in line with VBAIX in 2022. If we spend more time looking and built more into the free 10% we might get better results. As presented, I also tried AQRIX to see if that was any better but it wasn't, I'm not sure something like Portfolio 2 is worth doing. If there is any value to Portfolio 3 it is that the 23% in BIL will help protect against sequence of return risk by setting cash aside for income needs. It doesn't protect against a decline, it segregates cash for income needs. All three portfolios are proxies for the same thing but the first two will not protect against an adverse sequence of returns. 

Both alt portfolios are closer to leveraging down than leveraging up. We've explored quite a few ways to leverage down that have yielded better results than today's post by incorporating negatively correlated assets which none of these do. Today's exercise is maybe an prequel to what we've explored before. Where today portfolios are very simple, they give some good context to the other concepts we've looked at over the last couple of years. 

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.

Working In Retirement; WSJ Readers Have Opinions

The Wall Street Journal had an article comprised of a bunch of anecdotes from retirees who went back to work for various reasons. The work seemed mostly like gigs as opposed to second careers, one guy got his CDL and drives a school bus which is more of gig to me. There was a former nurse who did a couple of things after retiring from nursing and then went back to it which seems more careerish. Financial considerations were part of it but only one person said flat out, they need the money. That person though also believes he has more to offer to his profession as a videographer so purpose was at least part of his equation.

As always with these articles, read the comments. Commenters ranged from "retire as soon as humanly possible" to "I will never retire no matter what." One interesting trend in the comments was the honest lack of understanding of why someone else would have a different belief. "Why the hell would you want to keep working?"

All of this is of course fascinating to me. I am pretty sure that there are people who want to retire to do nothing. One comment seemed to be looking forward to being bored. One insightful comment talked about dividing time into thirds where 1/3 was something purposeful whether that was work or volunteering, 1/3 was more routine things like exercise and hobby time and 1/3 for family. I paraphrased that. 

Hopefully people spend time trying to figure out what their life will be like when they hit ages that are usually associated being of retirement age. There are multiple levels here including finances, day to day lifestyle, visibility for anything that might change like being very involved helping aging parents or having to help adult children or whatever else. 

Obviously if the dollars don't work (not enough of them) then something will have to give. Maybe working in some capacity to a later than desired age, maybe some serious lifestyle cutbacks or a combination of the two. 

I regularly share my beliefs about lifestyle in terms of purpose, whether it pays or not but I try not to project that onto how other people "should" live their retired life. I do think we all need to devote thought to what we each want to do. That entails figuring out what it really important to us, owing nothing to anyone else.

If someone thinks they are looking forward to being bored, if that's you, some sort of backup idea might make sense, I could being wrong about that. I spoke to a buddy today who I wouldn't say is gung ho to retire yesterday but he doesn't really enjoy his job which is a challenging dynamic for someone in his mid-50's. He said that if you enjoyed it, it wouldn't be a job. I kept my mouth shut but that isn't how I view things at all. Regardless of where my friend goes professionally, I am a huge believer that it is possible to genuinely enjoy what you do, find purpose in it which leads to putting in your best effort. I feel as though that combination of enjoyment, purpose and effort can provide a pretty decent shot of converting into a relatively lucrative part-time gig at an older age if needed or wanted. 

There is also the psychology of retiring that can be challenging and difficult to see coming. One of the comments made the same point, the transition from accumulating to withdrawing can be very difficult. I've said before that I think that will be uncomfortable for me but reasonably speaking, people might not learn that about themselves until the withdrawals start. 

One of the most important related concepts for this discussion is optionality. If the article alluded to optionality it did so very subtly, almost undetectable. Maybe I am projecting a belief onto others but the more optionality we can give ourselves, the easier every aspect of life becomes. 

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.

Risk Parity Meets Permanent Portfolio?

Bloomberg had a short writeup on the tough time that tail risk funds have had and reported that the Simplify Tail Risk Strategy Fund (CYA) was finally going to be liquidated at the end of the month after a shockingly bad run. 

CAOS is the Alpha Architect Tail Risk ETF and TAIL is the Cambria Tail Risk ETF. The tail risk strategy focuses on regularly buying puts as crash protection, possibly bear market protection depending on how a bear market rolls out. Where stocks go up most of the time, puts in this strategy often expire worthless so that reality creates some amount of bleed. TAIL owns puts and intermediate treasuries. It did very well in the Pandemic Crash but not so well in 2022. 

We've looked at CAOS here before. It mostly uses box spreads instead of treasuries and manages the puts in such a way to try to minimize the bleed that you see in TAIL. CAOS as a horizontal line alt that tilts upward slightly could be appealing but if the put strategy is actively managed then it seems possible that it might not own enough puts in some random market event. If that happened, it wouldn't go up in the face of crash...potentially. Box spread fund that might go up in a crash? Ok, fine but not great. I'm skeptical I guess because as I have watched the fund, I think I see a positive correlation to equities even if it is very low. Maybe it will prove me wrong in the next adverse market event. 

CYA owned several Simplify fixed income products, but now just T-bills along with weekly S&P 500 puts and it also has a VIX debit call spread on as well. The VIX spread is much larger than the SPX put positions. Maybe it was always heavy in VIX products, got that continuously wrong and that overwhelmed the rest of the fund? I'm speculating on that. Trying to build in a little VIX exposure might make sense but the current holdings are more like a lot of VIX with a few SPX puts thrown in. Regardless of whether my take is right or wrong, the fund is down 99%, did a reverse 1 for 20 split that didn't help and Bloomberg says it is closing. I've bagged on the fund a little but here, more so on Twitter.  

Blogger Nomadic Samuel wrote a post about the AQR Style Premia Alternative Fund (QSPIX) which a Morningstar 5 Star fund. It is a complex fund that at a high level goes long and short various asset classes, pairing various attributes against each other. Not sure if Sam made this graphic or if it is from AQR.

That looks simple but there are a lot of moving parts to determine cheap versus expensive or lower risk versus higher risk and so on. The carry sleeve is no doubt more involved that what I am doing below but it's fine for a blog post. I wanted to see if I could replicate some or all of the effect with far fewer moving parts.

Below is what I used to replicate QSPIX.

Obviously I didn't include commodities and maybe I didn't really include fixed income just allocating to BIL. Long the Aussie dollar, short the yen is the stereotypical carry trade, or it used to be. The huge weighting to BTAL is a proxy for shorting higher risk but not really underperformers except in a downturn. And I thought that long minimum volatility could be a proxy for going long, lower risk.

From the AQR site, QSPIX "aims to deliver attractive risk adjusted returns with low correlation to traditional stock/bond portfolios by investing in a broad and diversified range of alternative risk premia." So a core holding, I think that conceptually it could be risk parity meets the Permanent Portfolio? The fund site appears to benchmark to a 3 month T-bill index. 

It is a surprise though that the fund has a higher standard deviation than VBAIX and less return. Ten years is a good sample size. The lag can be attributed to something going wrong from mid-2018 to the end of 2021. I didn't see old quarterly reports on the site to explain what happened in those years. 

I am in no way taking a shot at the fund but I am very interested in replicating and exploring the cross market dynamics using what I think is at least part of their thought process. The portfolio I created, the yellow line, clearly wouldn't keep up with equities but it is closer to VBAIX than I would have guessed and the standard deviation is significantly lower than either fund and it never had a down year in 10. 

The year by year results are fascinating. In some years, the replication tracked very closely to QSPIX and some years it looked nothing like QSPIX. If you think the replication portfolio might be valid then you probably would have been thrilled in 2022 but in 2023 it was only up 1/4 of what VBAIX gained. This reiterates a crucial point. Whatever your idea of valid is, there will absolutely be years that try your patience and belief in what you're doing. The ten year result seems good to me but up 4.47% last year would have been difficult to sit through. 

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.