The ETF That Melted My Computer

Someone on Bloomberg TV said something to the effect that today was Jerome Powell's worst performance in a post-FOMC press conference in his tenure.

About the only thing that did well after the last hour carnage were first responder defensives like tail risk, inverse funds and VIX products. For what it's worth, the Alpha Architect Tail Risk ETF (CAOS) was up today. I mention that as a follow up because we've looked at it several times and it seems like it's not easy to know what you're going to get with that one. As another follow up, client holding CBOE Holdings (CBOE) was up 1%.

The chart today is just another datapoint for the theory/belief that CBOE is something of a proxy for the VIX complex which trades at the CBOE. It probably is not correct to say it is always going to function as a first responder defensive but the idea does hold at least a little water.

Over the last week or two, there's been some deterioration in markets in terms of leadership again getting narrower, favoring fewer stocks that is typically considered unhealthy market behavior. Who knows how this will play out, will it be no big deal at all, like the Great Dip Of August, 2024 or something more serious but whatever it will be, it will end at some point and then markets will start to work higher. I've been writing this same passage for I don't know how many years and every time, the only variable is how long it takes to end. 

The ReturnStacked Bonds & Merger Arbitrage ETF (RSBA) started trading this week. I've mentioned it a couple of times thinking that like ReturnStacked's other ETFs with fixed income, that it would have AGG-like exposure but instead it has a treasury ladder. The positions are not loaded onto the website as of this writing but the term "ladder" implies there will be at least some duration in the mix. Obviously if you like the idea of these products which create "portable alpha" using leverage, you have to want the exposures they have. For the bonds and funds of theirs you have to want AGG-like exposure or in the case of RSBA, a treasury ladder.

I still think it would be easier to use one of the Tradr 2X Long SPY ETFs for the leverage. They have one that resets Weekly, Monthly and Quarterly although the daily one from ProShares hasn't drifted that much over the years. If someone wanted 20% in alts and was concerned about tracking error (I think at times you want tracking error but please leave a comment if you feel differently), an example would be 60% in a plain vanilla S&P 500 fund, 20% in a 2x fund and then 20% in whatever alts you want. To me, there are fewer moving parts than a fund that combines two exposures. To be clear though, I don't want leverage in that manner. 

And finally the fund that melted my computer is from GraniteShares. They are right in the mix of single stock ETFs. I saw this from Eric Balchunas on Tuesday and figured, ok, more single stock covered call ETFs with a couple of indexes thrown in too.

Well sir, that is not what these are. I first need to say that it appears as though they only started TSYY on Wednesday and the webpage for TSYY isn't quite set up yet but in chatting with someone through the website, the YieldBOOST suite sells puts on 2x Long ETFs. So TSYY sells puts on TSLL.

There's almost no information on the TSYY webpage so I have no idea if the 3% decline versus 8% for the common actually captures what the fund is about but yes am I going to dig in more when/if more of them list and when there is real info posted about TSYY, probably tomorrow. I had an idea about how to use these crazy high yielding, derivative income funds. 

Conceptually, the idea would be like barbelling equities but for fixed income instead where in this case a disproportionate amount of the yield and volatility would be concentrated in the GraniteShares fund of your choice or YieldMax fund of your choice. 

We don't have a very long sample to look at. Dividends are not reinvested. Below are the incomes of each.

A quick note about the 85/15 blend, I'd think anyone taking this seriously would want to split that large of a portfolio weighting between several crazy high yielders not just one. Despite the incendiary nature of the crazy high yielders, working in just 5%-15% in those products with the rest in T-bills backtests as far less volatile than TLH with much more yield. I'd be confident that the volatility profile of a 95/5 blend would stand up with most if not all the crazy high yielders but I'd be far less confident about the 85/15 blend standing up in that manner. 

The crazy high yielders (I am repeating the word crazy very frequently on purpose) should be expected to deplete but they're not instant vaporware. The worst of these I've seen is the YieldMax TSLA Covered Call ETF (TSLY) which is down 58% on a price basis over two years. In its first 12 months, TSLY fell just over 40% on a price basis with a "yield" of close to 50%. 

Back to the NVDY portfolios above, as sort of a mental accounting for this, the T-bill yield could very possibly cover rebalancing NVDY back up to 5% while the NVDY payout is withdrawn. There's very little capital at risk in case the crazy high yielder chosen blows up. 

This is of course theoretical. The drawbacks to the idea include the possibility that all of these get destroyed in the next bear market, they are taxed as ordinary income which makes it unwise in certain circumstances and hopefully everyone now realizes they are not proxies for their reference securities. NVDY is not a proxy for Nvidia common stock, it is a product that sells Nvidia volatility which is different. 

Based on the Defiance put selling ETFs, I doubt the YieldBOOST suite will have less bleed from the put selling versus the synthetic covered calls in the YieldMax funds but I will study them all the same.

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. 

Have A Very Yieldy Christmas

From T Rowe Price on ten year Treasuries. 

And from a different Bloomberg article quoting the same CIO.

We've talked about this plenty of times. I don't know about volatility relative to other sovereigns but US treasuries have become more volatile than they used to be and that volatility is now less predictable than it used to be. There was a stretch there earlier in the year where a lot of pundits were saying to lock in yields for intermediate and longer dated treasuries. 

Yes, the chart is price only but there was no need to take on equity like volatility back then or now (TLT and TLH have higher standard deviations than the S&P 500 this year) for yields in the fours. There are plenty of yield sources with comparable or better yields with nowhere near that kind of volatility. 

YieldMax launched two new funds this week in partnership/agreement with Dorsey Wright. The first one is the YieldMax Dorsey Wright Hybrid 5 Income ETF (FIVY). The process looks at the YieldMax fund universe and selects the five best underlying common stocks based on momentum, target weighted at 8% each and then adds the five corresponding YieldMax ETFs at 12% each. For example it has Netflix (NFLX) common stock and YieldMax NFLX Option Income ETF (NFLY). The other four stocks are Microstrategy, Meta, Tesla and Nvidia. So FIVY blends common stocks and their corresponding covered call ETF.

The other fund is the YieldMax Dorsey Wright Featured 5 Income ETF (FEAT) and it just owns those same five YieldMax covered call ETFs target weighted at 20% as follows.

Who knows if blending momentum with derivative income in FIVY will have some sort of positive effect but the idea is interesting to me. We've looked before at pairing a small slice of one of these with a "normal" allocation to the underlying common stock. The ratio FIVY is using would seem to still have deterioration unless the dividends are reinvested but even then might not look so great.

That's the year to date of all the YieldMax funds in FIVY. The next chart compares what FIVY is doing with my idea from earlier this year and just owning 100% TSLA. Dividends are not reinvested in this one. 

Does the 90/10 combo make any sense? That's not clear to me but for anyone really wanting Tesla with some income, the 90/10 combo turns it into a 4% yielder based on 2024's payout thus far. 

A few days ago, I stumbled into a useful way to think about the YieldMax ETFs. They are not really proxies for their reference equities, the are products that sell volatility on their reference equities. 

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. 

Long/Short Diversification To The Rescue

Let's start with The Endowment Syndrome: Why Elite Funds Are Falling Behind. Before we really jump in, it's important to understand that endowment funds and foundation type accounts have infinite time horizons that we do not. That reality can change some of the calculus between endowments and individual investor accounts but there are things we can learn from their asset allocations all the same. 

The big idea is that endowments have drifted into having huge allocations to alternative assets which have generally lagged simpler building block exposures accessible to individual accounts through brokerage platforms like a 60/40 portfolio. An interesting comment in the article is that the allocations to alternatives are typically far bigger now than Jack Meyer from Harvard or David Swensen from Yale ever had. The two of them were pretty much pioneers with using alts but based on the article, Meyer and Swensen appear to have better understood the drawbacks and limitations.

The article blames behavioral factors for the huge allocations to alts including vanity. We've touched on that here once or twice, there is an ego stroke to having sophisticated strategies in a portfolio and I think we could sub in the word complex for sophisticated. A repeat theme here though for years has been that equities are the thing that goes up the most, most of the time. If you need normal growth for your plan financial to work then you need an equity-based portfolio maybe hedged with small exposures to alternatives, not an alternative-based portfolio hedged with a little equity exposure. Put differently, simplicity hedged with a little complexity. 

This brings us to a paper from Man Institute that appears to conclude that mixing "long/short quality" with managed futures can help offset the random results that managed futures have when volatility spikes. In the 2020 Pandemic Crash, managed futures did very well at one end of the scale but did poorly in the Great Dip of Early August 2024 as an example at the other end of the scale. 

They have a scatter chart that shows how truly random the performance of managed futures is during volatility spikes. The paper assumes that volatility spikes equate to negative stock market events. The paper distilled a pretty good explanation for why managed futures does well in a volatility spike or why it does poorly. They attribute the different to how it is positioned with longer dated treasuries, long or short. Bonds tend to rally when there is some sort of external event that adversely effects markets. So if bonds were in a negative trend resulting in a short position and then bonds rally as happened in August, managed futures do poorly. If bonds were already in a positive trend like they were in the 2020 Pandemic Crash then managed futures will do well. 

Looking at the chart, I can see why managed futures would have been short TLT, a proxy for treasuries, back in August of this year. TLT started to turn higher in the spring but using a 10 month signal, managed futures could very well have been short. You can see BTAL going up last August which is should do as more of a first responder type of alternative. Putting on my Karl Popper hat, seeing QLEIX not work in August, maybe the paper is wrong. 

The second chart leads into the 2020 Pandemic Crash. You can see why managed futures might have been long treasuries. BTAL went up of course. EBSIX didn't do that well so maybe it was something with that fund, another fund I use did well through this event. 

Where there can be divergences between different managed futures funds, a common suggestion is to split the allocation between multiple funds. We've talked about that once or twice. An easy type of differentiation is to split between a fund that implements the full strategy which might be trading 90-100 markets and a replicator which might trade 10-20 markets. A more difficult way to try to split up the exposure would be to try to differentiate how funds risk-weight differently. Larry Swedroe wrote an article that cites splitting a managed futures allocation between six different managers. 

Back to QLEIX which again struggled in 2020. For what it's worth, in the 2020 event, although QLEIX fell quite a bit, it was about 900 basis points better than the S&P 500. 

The long/short discussion seemed to drift between two different types, the kind offered by the AQR Long/Short Equity Fund (QLEIX) and the kind offered by client/personal holding AGFiQ US Market Neutral Anti-Beta ETF (BTAL). That's why I included both funds in the charts.  Below are a couple of ways to implement what Man appears to be talking about. 

Neither Portfolios 1 or 2 are stock market proxies but offer compelling long term results versus VBAIX. The standard deviation and betas of both are much lower than VBAIX and of course they both did better in 2022, each going up close to 10%. Look though from the start of the study until the end of 2021, both lagged considerably. If we stop the study at the end of 2021, Portfolio 1 compounded at 6.89% and Portfolio 2 compounded at 9.25% versus 11.09% for VBAIX. 

That really can be a long time to languish depending on someone's specific makeup but a portfolio that can get most of the broad market's return with much lower volatility is a pretty good way to go. 

I think this also helps create context for the drawbacks of backtesting. They can be useful for creating some understanding and setting expectations for things like volatility, how well the defensive holdings might do and with setting some performance expectations. If VBAIX is up 20% next year, you can expect Portfolios 1 and 2 to be up less but you have no way of knowing ahead of time whether less means it goes up 4% or 16%. If VBAIX goes down 20% next year, you can expect that Portfolios 1 and 2 would be down less but you have no way of knowing whether less means down 3% or down 16%. A lucky outcome against a 20% decline for VBAIX could be that 1 and 2 go up like they did in 2022 but there is no way to know ahead of 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. 

C'mon Gen-X, Time To Rally

Bloomberg had an article titled As Gen-X Nears Retirement, Many Fear They Can't Afford It-Now or Ever. The article profiled a half dozen Gen-Xers ranging from 45-60. Most of them definitely have accumulated decent sums thus far, maybe not enough to be on track for what they think they need, but they aren't in desperate trouble except for maybe one of them. Generally they all plan to work to 70 or beyond out of necessity. 

There was an odd and I believe inaccurate emphasis on workplace retirement plans pivoting from defined benefit plans (pensions) to defined contribution plans (401k) starting around the turn of the century. My second real job after college started in 1993 and at that point many companies had already switched from pensions to 401k including that second job. People entering the workforce in 2000 were not the 401k guinea pigs. According ICI via Microsoft Co-Pilot, in 1985 there were 30,000 401k plans. There was no information on what percent 30,000 was back then, but those folks were the guinea pigs. 

I'm not skeptical that employers to a poor job with educating employees but for an audience of new employees in their 20's it can be wrapped up in a couple of sentences. "You're gonna want to retire some day and your 401k is how do it. Put in as much as you can afford every paycheck and buy a stock index fund (there were plenty of them 35 years ago), the company is gonna match some of it and then in ten years, start learning about personal finance." Optimal? Probably not. Adequate? Probably so. Simple? Hell yes.

At some older age, I'll assume 50's, you start to begin to understand if/when/how you'll retire in terms of the dollars and cents of it. If at 35 or 40 some sort of financial calculator told you your "number" is $1,300,000 at age 65 and at 55 you have $275,000, there's a low probability of hitting your number. If you have $900,000 with ten years to go, odds are pretty good of hitting that number. 

The number you anchored to when you were younger is essentially meaningless. Whenever you retire, whatever amount you have, that is your reality, that is what you have to make work. If your total nut is $82,000 in today's dollars, your Social Security combines to $40,000 and a safe withdrawal rate from savings is $31,000 then you gotta figure some way to make up that $11,000 difference. That could mean cutting back somehow (many different ways to do that) or creating a third income stream of which there are infinite ways to do that. These sorts of numbers can reasonably start to take shape quite a few years before you hope to retire giving plenty of time to work on creating an income stream if needed. 

The article tried to scare readers about Social Security getting cut but gave no detail or context. If Social Security actually ever gets reduced, older Gen-x is not going to be impacted across the board. I wrote a post earlier working through my guess that maybe starting around birthyear 1975, younger Gen-X, could face across the board reductions. More likely for older Gen-X is some sort of means testing that impacts the very wealthy. Another idea I haven't seen anywhere else but from me is the elimination of the spousal benefit, not to be confused with the survivor benefit. Still though, the odds of any reductions are incredibly remote. I would still take the time to run your numbers assuming a 20-30% reduction all the same.

There was very little from any of the profiled Gen-Xers about health and fitness except for the 60 year old with very little accumulated. We spend a lot of time on diet and exercise here because good health is crucial to a successful retirement. We learn as children not to eat too much sugar. There is a learning curve to what that actually means beyond cookies, candy and soda but the less sugar we eat, the healthier we will be. I won't go too far down the rabbit hole on this point but the list of health benefits from less sugar (sugar=carbohydrates) is endless. The more meals you eat consisting of any combo of meat, eggs, fish and cheese the healthier you'll be. If you're vegan, you need to figure out how to make up consumption of quite a few micronutrients and amino acids. I think it's doable, not 100% certain, but there is a learning curve to this too.

We learn as children that it is important to exercise. The list of health benefits from lifting weights is endless. Maintaining the ability to walk fast, bend down to pick heavy things and have a strong grip are all important benchmarks for physical health. Harshness coming but for most people, the only thing between having a very similar body shape to what they looked like in their 20's is habits. If you Google Dick Van Dyke's recent appearance on Kimmel, it is obvious that at 99 he pretty much has the same physique as he had 60 years ago when he played Rob Petrie. I've mentioned once or twice we have 97 year old neighbor who walks every day down on the paved road. From far away he looks like a teenager walking. I just learned the other day he plays pickleball. 

The great thing is no matter your state now, irrespective of age, the body is very forgiving. A lot of problems are reversible with changes to habits but you have to start. Think of the money saved not having prescriptions and the time saved not going to the doctor all the time. 

With a nod to yesterday's post, having health and fitness in order is our best shot to maximize our flexibility, resiliency and optionality.

And a follow up to last night's blog post related to very expensive things that happen and can throw off retirement plan math.

That is Rooster. Rooster loves duck toys. My wife brought that duck toy home yesterday and Rooster spent the afternoon loving it. He was so selfish with it, so motivated that no one else play with the duck that he swallowed it. My wife figured out that he swallowed it right away. "That makes no sense, he's never swallowed a toy like that before" I said. The odds of Rooster passing the duck were very low. This was potentially a very expensive problem. My wife guessed $3000-$4000. She runs a huge animal rescue here in Prescott so her guess is pretty educated. 

We had something similar happen many years ago and fortunately I remembered the solution. He had to drink hydrogen peroxide which would make him throw up and out would come the duck. By drink I mean one of us (me) had to hold him while the other poured the peroxide down his throat. It took two or three minutes for Rooster to start throwing up and up came the duck on the second lurching. I was worried about having to pull the duck out if it got stuck in his throat on the way back up but thankfully it came right out. 

In yesterday's post, I had more expensive things in mind than what this could have been but still, no one ever wants to write a four figure check to the veterinarian. We were lucky that between the two of us, we knew what to do. That won't always be the case. 

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 To Make The 4% Rule Complicated As F*$%

That was my thought as I read this article from Barron's that has Morningstar suggesting that new retirees only take 3.7% in 2025 instead of the typical 4%. In November we wrote about the guy who created the 4% rule saying 7% is probably ok, Morningstar says 3.7% based on expected stock market returns. Expected equals guess. That guess could very well be right, returns might be less over the next ten years than the previous ten years but the process that created the 4% rule addressed that with testing that started in 1926. Bengen, the guy who derived the 4% rule, said 4% was the worst case scenario so when someone like Morningstar says something lower, as we say at the fire department, slow down and process information. 4% was the worst case. Bengen says that now, with a couple of more decades to add to the study, the worst case, worst case, has inched up closer to 5%. 

The annual inflation adjustment also seems like an unnecessary complication. If last year, you took $38,000 and then price inflation was 2.9% you'd lift the $38,000 up to $39,102. Growth in the portfolio takes care of that. A $38,000 withdrawal implies $950,000 in retirement assets. If the investor was up 10%, $950,000, less the $38,000 plus the 10% gain of $91,200 leaves the investor with $1,003,200. Taking 4% of $1,003,200 the next year would equal $40,128. 

Making it even simpler, for years I've said just take 1% every three months. Whatever the value of the assets at the end of the quarter, take 1%. Yes, there will be flexibility required every few years if the market is down a lot. Even then though, if you've set aside money toward expenses, that is to avoid an adverse sequence of return, you may not need to reduce what you take or if you have some sort of first responder defensive holding that will go up a lot when stock go down a lot, you can sell that after stocks go down a lot to increase the cash on hand. 

In Bengen's study, 4% never failed. I don't believe 5% ever failed. It would take many things going wrong all at once for a quarterly withdrawal 1% or 1.25% to end up failing. For anyone really worried about this, I would suggest figuring out how to create another income stream. I'm not being snarky with that, my wife an I have another income stream, but not because I am concerned about 4-5% failing. Here's why in response to the following comment.

Mr. Hauck, that's not what the 4% is really about. I've never heard Bengen or an anyone else say this but it's a point that I've thought for years is crucial to what the 4% rule is really about. The 4% rule is really about giving yourself the flexibility to pay for very expensive and unexpected things. I don't mean a $1200 vet bill, I mean very expensive things. 

Take the scenario above taking $38,000 at 4% of $950,000 or $40,128 the next year. Could something happen with your house that is very expensive and not covered by insurance cost $20,000? Relative to a comfortable $40,000 withdrawal, $20,000 is a lot of money and now you're at 6%. What about a scenario where one of your kids needs help that is expensive? Would you say no? I realize that some people would say no, I am not judging either way but in your life what are some things that could come along that might be very expensive that could throw off your comfortable 4-5% withdrawal rate? Where I live, I've heard stories of wells failing, foundations failing, a little less dramatically something involving roads or driveway access could be expensive too.

Taking only 4-5% most of the time allows for absorbing the occasional financial hit. If we take the $950,000 example at the start of 2020 and following through to now assuming returns 300 basis points lower than the Vanguard Balanced Index Fund in up years, so disregard the 10% gain I mentioned, and taking 4% per year would now have $1,060,000. It's a useful period to study because of the big drop in 2022. Now, at the start of 2025 a $31,000 fixit comes long, plus the $40,000+/- withdrawal. This might not be comfortable but unless VBAIX goes down 40% next year and that's all they're 100% allocated to that fund, this isn't a catastrophic event. 

Rewind back to the $950,000 at the start of 2020, everything the same expect the withdrawal rate was 6% all the way through and the current balance would be $954,000. Now comes the $31,000 fixit and the 4% withdrawal. That's about $70,000 out the door. 

How many expensive fixits should we expect over the course of a 30 year retirement (use the number of years more applicable to you)? I don't know the answer but not knowing argues for being conservative with withdrawals, taking 1% or maybe 1.25% every three months. 

I think the key words here are flexibility, resiliency and optionality. A higher withdrawal rate diminishes our access to all three of those.

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 Way To Look At Single Stock Covered Call Funds

One of the ReturnStacked guys Tweeted out a chart about combining bonds and merger arbitrage. They've had something with merger arbitrage in the hopper and maybe that's coming soon. There was a comment on the post from someone with the following slide but no mention of it yet on the ReturnStacked website.

Their other funds with bond exposure, offer AGG-like bond exposure and so for now, I would imagine this will have the same exposure. I built out the following to try to understand what this blend might do. 

Putting 40% in client holding MERIX instead of AGG or using leverage or mixing the two without leverage has offered a better result. Portfolio 3 has slightly better returns, slightly lower standard deviation and slightly higher Sharpe Ratio. Portfolio 3 also has the best Calmar Ratio but not the best Kurtosis number. 

I think the message here is the importance of knowing what to avoid, in this case AGG. I can't stress enough the importance of avoiding or being extremely underweight AGG-like fixed income exposure or any sort of bond duration. I'm a huge believer in arbitrage exposure, but obviously IRL I wouldn't put anywhere near 40% in it or in any single diversifier. 

YieldMax single stock covered call funds? Bob Elliott from Unlimited Funds has thoughts.

First to the "dividends." If characterized as dividends (ordinary income), then yes these are not tax efficient. I couldn't find on the website how the dividends are characterized. Derivative income funds tracking broad indexes like the S&P 500 tend to get more favorable tax treatment. FWIW, the internet thinks the YieldMax payouts are taxed as ordinary income. 

When Bob says they lag behind their respective underlying security he is correct but his comment might have triggered a different way to think about this. Using Bob's example, you are not buying Nvidia, you are buying a product that sells Nvidia volatility and that is different. 

Here's YieldMax Tesla (TSLY) versus the common stock price only.

And now total return.

The argument for TSLY looking anything like the common stock is non-existent. I've pretty much been saying this since they started trading, the more volatile ones, maybe all their funds, can't keep up with the ex-dividend reductions. TSLY is a product that sells Tesla volatility it is not a product that tracks Tesla common stock. Selling volatility is a valid strategy but as I always say it is tricky, with the YieldMax funds being a good example. Being intrigued by these, which I am, does not mean I've ever going to use one, I can't see that happening, but I wouldn't rule out someone finding utility with them and I will probably continue to keep tabs on them. 

Bloomberg hosted the ETFs in Depth Conference earlier this week. I don't know how much if any of it will be accessible online but some snippets have been Tweeted out including some detail about Nouriel Roubini's appearance to talk about the recently listed Atlas America ETF (USAF) that he manages. Part of the why for the fund is Roubini wanting to do more than write about his opinions, he wants to put his process to work, hence USAF. 

If you've heard Roubini anytime recently, he thinks bonds with duration should be avoided, like me, and USAF allocates away from duration. We took a closer look at USAF when it first listed. The backtest looked like a horizontal line tilting upward with a 5% CAGR.

Making his case at the Bloomberg event, Roubini cited geo-politics, climate issues, automation and a few other things that he says will contribute to a more inflationary environment which will be bad for the typical 60/40 portfolio. He's almost always bearish, that's his thing. If someone is always bearish, they're going to be correct occasionally. Is this one of those times where he will be correct? I have no idea but if you agree with him, I would say it makes sense to have some first responder defensives onboard whether that's tail risk, inverse or the type of long short that will go up when stocks drop. 

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.

Blackrock Weighs In On Bitcoin

Blackrock (client holding) has some thoughts about how much Bitcoin is reasonable to hold. Not surprisingly, they say 1-2% which is what just about everyone says, including me--for anyone open to the possibility that it all turns out to be nonsense. I'm not taking the Peter Schiff stance, I've owned it for a while and not planning on selling soon but it could just be internet hokum all the same.

A 1-2% allocation to Bitcoin, they say, contributes the same risk to a 60/40 as holding the Mag 7 stocks. I couldn't find where they quantified how much of a 60/40 in the Mag 7 but if we assume an index weight, the Mag 7 equals 33.55% of the S&P 500 so a 60% equity allocation would mean 20.13% in the Mag 7. 

James Seyffart posted the following from the Blackrock report that quantifies the risk added.

I have no idea if Blackrock has the correct numbers or not but it hits on what we talk about all the time here in terms of barbelling risk or volatility, depending on how you look at it, and understanding the role that various holdings offer to a portfolio. If you own the any of the Mag 7 stocks individually, you expect them to outperform to the upside. If you own a consumer staples stock with a beta of 0.6 that yields 4%, you expect it to be more of a steady eddy. 

There is a big difference though between getting that "risk" from Bitcoin versus owning the tech sector. Bitcoin is flat out risk, it could go away. With a sector, like tech, the broader you go it becomes more about volatility than risk. The tech sector isn't going to zero. 

Something horrible, like the internet bubble could happen but the sector would come back. The Technology Sector SPDR (XLK) peaked out in $60 in 2000 and it bottomed in 2002 at $12. Today, that fund is at $240. There are no doubt plenty of individual names that were in XLK 25 years ago that have disappeared but the sector is just fine. 

If you go narrower, like to semiconductors, that moves further along the scale to risk. The old Semiconductor HOLDR (SMH) which has since changed its name and the process, fell even more in the dotcom bubble. Going narrower still, the Internet Architecture HOLDR turned out be be pure risk as just about everything in that fund went to zero when the internet bubble popped and never came back. 

Today, there are more tech sector ETFs. If you buy one of them, there's no real risk, more like potential volatility and yes someone who is a forced seller after a 40% decline would be in trouble but the next time tech gets cut in half, there might be a shakeup in the constituency but the sector would come back and go on to a new high eventually. If you own the Roundhill Magnificent Seven ETF (MAGS), that takes on more risk. All seven going to zero doesn't seem like a reasonable probability but one or two of them? In the right circumstance, why not? If Tesla goes to zero, that would be an enormous and permanent hit. Risk. If you own Tesla via an S&P 500 fund and it goes to zero, that would be 2% and not too damaging. How much risk would you say you have, if you owned Tesla via client holding XLY? If you owned twice as much XLY than was in the S&P 500, your exposure to Tesla would be 3.4%. Would you think if that 3.4% crapping out as risk or volatility? In the low single digits, I'd call it volatility. I don't know where the tipping point in this context for when volatility becomes risk but all of this is different than how to look at Bitcoin. 

Bitcoin is all risk. The risk you take might be small but it is all risk. 

Marketwatch had a useful summary of a paper from Emory University that concludes the optimal retirement portfolio allocation is 33% domestic stocks and 67% foreign stocks, so no bonds. Here's a link to the paper which is 81 pages long, I didn't read it. Over a 30 year period, 33/67 outperforms 60/40 they said. Using Vanguard mutual funds below was the best I could do to recreate the result.

The 33/67 blend outperforms 60/40 by 26 basis points per year over the 28 years. The tradeoff is a much higher standard deviation, 18.01% to 11.05% and much worse max drawdown, 59.36% to 36.25%. There is nothing compelling for me from the 33/67 portfolio. The argument for more equities though, makes perfect sense from the standpoint that equities are the thing that goes up the most, most of the time. 

There are tradeoffs obviously; more volatility and larger drawdowns. People own bonds in hopes of mitigating the volatility and drawdowns of 100% equities. I'm not in that camp with bonds with duration but there other types of holdings that can function in the way people hope that bonds will. Setting cash aside for expected expenses is another way to mitigate equity volatility. The point is to have a portfolio that you can ride the entire cycle with and avoid being a forced seller after a large decline. 

And finally, I bag on the Simplify funds a fair bit but there are at least a couple that do pretty well. One I've mentioned that I think does a good job is the Simplify Hedged Equity ETF (HEQT). HEQT got a 5 Star Rating from Morningstar, so congrats to them on the fund's success. The big idea is that HEQT owns the S&P 500, sells covered calls with varying strike prices and expirations and buys put spreads below the market. 

You can see in the numbers that so far, HEQT has flirted with 75/50, 75% of the upside with only 50% of the downside. There are other funds that seek a similar result, maybe HEQT is the best of the lot, or not but there is a tradeoff to this strategy, giving up some portion of the upside. That's not a bad thing necessarily but can be the sort of thing that leads to impatience which is not an ingredient for investing success. 

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.

Leverage, Leverage, I Gotta Have Leverage

The ReturnStacked guys aren't the only ones talking about portable alpha lately. This paper from Aspect Capital has some interesting thoughts. First, was a bit of a history lesson covering the failure of the portable alpha strategy during the Financial Crisis. 

The big idea in simple terms is to add something that offers the potential to outperform the basic building blocks of stocks and bonds and do so via leverage. So adding a potential alpha source on top of beta (the basic building blocks). If at the start of the year, someone put 100% into the Vanguard Balanced Index Fund (VBAIX) as a proxy for a 60/40 portfolio, then to employ a portable alpha strategy, they could use leverage to add something to hopefully make it additive to returns. If someone leveraged up by 20% to buy Intel (INTC), they'd be underperforming YTD up 6.24% versus up 17% because Intel is down 59% this year. If they had levered up to buy MicroStrategy (MSTR), they'd be pretty happy up 118% because MSTR is up 550% this year.

Imagine the Intel scenario of down 59% on top of VBAIX dropping 16% in 2022. The way portable used to primarily be implemented was to leverage up with correlated assets and it ended up going very badly in 2008 when equities dropped 40%. It has evolved now to move away from leveraging up, moving closer to leveraging down as we've described it but not quite. It still leverages up but it adds diversifiers and the Aspect Capital paper notes that they believe managed futures is the best way to employ portable alpha. 

Aspect tries to find the optimal leveraged allocation to managed futures on top of the "normal" beta portfolio. By their work 30% leverage into managed futures or 40% leverage into managed futures both offer compelling metrics toward being optimal. 

Over the long term, the 40 or 30% allocations to managed futures on top of VBAIX added a little over 100 basis points of return per year with roughly the same standard deviation and slightly better Sharpe Ratios. Most of the improved return can be attributed to 2022. Managed futures did what investors who own it, hope it will do that year. If we stop that backtest at the end of 2021, the two levered portfolios outperformed by five and four basis points respectively, each with noticeably higher standard deviations and lower Sharpe Ratios. 

Then I threw in an unlevered 90/10 mix. You can decide for yourself whether that adds value or not but it's at least in the ballpark without the risk of leverage. The Aspect paper mentions the risk sort of. They mention it without acknowledging it. From page 6, "Because managed futures can benefit from both rising and falling markets, so long as trends present themselves..." What if trends don't present themselves, meaning what if they don't persist? What if they are choppy with the occasional whipsaw like the last year and a half? 

It's not a reasonable probability that managed futures would fall 60% the way INTC has this year, but there is nothing that says managed futures must go up when stocks go down. Yes, they probably will but in terms we've discussed recently, managed futures is not a first responder like an inverse fund, tail risk or certain VIX products. There's no direct cause and effect with managed futures like there is with an inverse fund. The risk to 40% or 30% of managed futures via leverage is that in a year like 2008, instead of going up like they "should," managed futures drops 15 or 20%. In 2008, VBAIX was down 23%. A 20% drop in managed futures that is leveraged to a 40% weight would have added another 800 basis points to the decline (simple math).

The risk/reward in this example doesn't seem worth it to me.

For more leverage, here's the highlight of a filing as Tweeted by Eric Balchunas from a firm he called Quantify Chaos. There's a company called Quantify Funds which runs the STKD Bitcoin and Gold ETF (BTGD). They would seem to be connected somehow but for now, look at the heat coming off that picture, but don't look too long.

The comments obviously had a field day with this but I can see an application of this idea. A tiny slice of the portfolio into one of these, provided there was a fund with two names that you liked, could be a way to allocate to asymmetry. 

I've told this 100 times but two connections for me to asymmetry or barbelling. The first from when I worked at Fisher Investments in 2002. Two of the smarter guys there were intrigued by the notion that through the 90's an allocation of 2% short Nikkei Futures and 98% cash equaled the return of the S&P 500. As I've said, I have no idea if they were correct but the idea of getting a market equaling return with so little capital at risk is fascinating. Then a few years later, Nassim Taleb started to talk about taking extreme risk with 10% of the portfolio and the rest in T-bills. 

We just looked at this in a slightly different context and the implication is not that it is easy to pick the next Nvidia or whatever but someone so inclined can put in the work, draw some conclusions and make small allocations that either work out or not. If it works out, see the MSTR example above. If it doesn't work out, the impact on the portfolio would be small. 

The above do not rebalance with the idea being, to let the asymmetric potential really work or allow it to crap out. In Portfolio 1, I chose one stock that is up a ton and another that has lagged behind the S&P 500 considerably. Going 1 for 2 in this context might be unrealistic but going 2 for 2 would be very unrealistic. 

5% each into Tesla and Qualcom, the rest in T-bills pretty much equaled the returns of the VBAIX albeit with quite a bit more volatility. I'd put an asterisk by the volatility number because of how little of the original capital was exposed to risk. That may not resonate with you but that's sort of the whole point of barbelling. It's constructive if you allocate down to the sector level, or narrower than that, to realize that there's some variation of the Pareto Principle driving portfolio returns. 

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.

Modeling Regret

Below are the closing numbers from Monday for two momentum ETFs and SPY which tracks the S&P 500. Below that as you can see are how each of the three funds did in 2023 where momentum lagged behind.

We've been talking a lot lately about momentum, it has outperformed market cap weighting (MCW) more often than not it seems but nothing is infallible. These two momentum ETFs lagged by similar amounts in 2021. Picking one fund for modeling purposes in a blog post because over time it outperforms is one thing. It's not that picking one fund to serve as an equity proxy is invalid it's just at times that one fund will cause a tidal wave of regret like if everything seems like it's up 20% and your one fund is flat. 

As I play around with these portfolios I've seen funds that miss almost entirely for a short period. YTD, the Invesco Russell 1000 Dynamic Multi-Factor ETF (OMFL) is up 8.5 % as one example. The fund is not broken, that sort of lag happens occasionally. From it's inception until just a few months ago, OMFL had outperformed the S&P 500. This happens with any valid strategy. I don't think owning 10 broad based index ETFs is the answer but other than for blogging purposes, maybe a couple can be a solution.

Here's a simple expression of that idea with 75% in SPMO and 25% in PUTW. It has the identical return as MCW with noticeably lower standard deviation, smaller max drawdown and much better Calmar and Kurtosis numbers.

I listened to an incredible podcast interview of Bruce Berkowitz who manages the Fairholme Fund (FAIRX). This is a very unusual story and while I followed what he said, I don't necessarily follow the logic. Twenty and 25 years ago, Berkowitz was the epitome of a star manager. The fund did lights out good, he ran concentrated portfolios without much turnover. He was famous for owning names like Fannie Mae and Freddie Mac. Unfortunately, after making a ton on those names he rode them down to receivership in the financial crisis. 

You can see to the left of the chart, FAIRX pulled away from the S&P 500 with a similar volatility profile. Then in the Financial Crisis it did far worse and since then it has had much more volatility than the index on the way to a much lower growth rate over the last ten years per Portfoliovisualizer. You can see year by year, it very rarely resembles the index.

FAIRX has essentially morphed into a one stock mutual fund. According to the Fidelity page I linked to above. St Joe (JOE) which is a land company comprises 78.65% of the fund, Enterprise Products Partners takes up  6.42%, there's less than 1% in a mining company and the rest is cash. Berkowitz is the chairman of JOE's board. If I understood the podcast correctly, as fundholders got out due to performance, he sold other things and just kept JOE. He and "his affiliates" own 38% of the fund which is about $2 billion in AUM and JOE's market cap is about $2.8 billion. 

He expects remaining fundholders to sell, he doesn't expect anyone to buy the fund and he doesn't care. He is investing for his family, he views his holdings as being about generational wealth which speaks to his time horizon. That allows him to not be concerned about the periods he lags the market either. 

He had a great quote in the interview saying "you don't need to do much better than 8-9% as long as you don't lose." He places high priority on owning his time and continuing to learn. These points came up several times during the interview. The fund is quirky to be sure but the interview was fascinating.

A useful lesson from the podcast, was the understanding and matter of fact acceptance that there will be periods that he underperforms. His 8-9% quote is about independence from obsessing over looking like the stock market all the time. If you want to do that, put it all in a broad based, market cap weighted fund. You'll be pleased most of the time and miserable, full of regret every few years. The focus here is to strike a balance between capturing upside while not feeling all the regret that goes with holding onto MCW no matter what. 

Here's a short Substack from Joachim Klement about how profitable market making against retail traders is. The way to avoid being someone else's profit center is to trade less. 

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

An Updated Permanent Portfolio

Earlier on Monday I look at a couple of different proxies for the Permanent Portfolio. The big idea as we've talked about here many times is that it equal weights stocks, long bonds, gold and cash at 25% each so that no matter what is going on in the world, at least one of the four is holding up well. There is a mutual fund by that name with symbol PRPFX and the concept inspires many of the portfolios we study here like the Cockroach Portfolio by Mutiny Funds.

I wanted to take a stab at trying to improve the long term result of the Permanent Portfolio which are pretty good. Portfolio 1 is 25% each to Invesco S&P 500 Momentum (SPMO), Stone Ridge Hi Yield Reinsurance (SHRIX) which is Cat bonds, SPDR Gold Trust (GLD) and Campbell Systematic Macro (EBSIX) for managed futures. 

The asymmetry modeled into Portfolio 2 is Nvidia. The idea is not to imply I can pick something that goes to the moon but to understand the impact if you can pick something and get it right. The portfolios do not rebalance in the back test to show the impact of asymmetry working. If something chosen for it's asymmetry goes to zero then the math doesn't cause too many problems, just a small drag, at least early on. If from here, Nvidia went to zero, the impact would be meaningful but wouldn't be worse off from the starting point in a meaningful way.

In addition to the data in the screen grab, Portfolio 1 has the best Calmar Ratio with Portfolio 2 close behind and Portfolio 1 had far and away the best Kurtosis. In 2022, Portfolio 1 was flat, Portfolio 2 was down 10% which speaks to the impact of NVDA going down 50% that year, PRPFX was down 5% and VBAIX was down 17%. 

As we said in yesterday's blog post, any sort of real world application of this wouldn't have to be limited to four or five holdings. SPMO could be replaced with a broader mix of ETFs and single stocks, one managed futures fund could be replaced by a couple or maybe add in other second responder type defensives, there are plenty of strategies with similar volatility profiles as SHRIX to diversify that sleeve and maybe the gold could be combined with some broader commodity exposure. 

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.

Taking From AQR's Process

AQR has a paper out that looks at sizing liquid and illiquid alternatives into a diversified portfolio. Obviously there a lot of math involved and quite a bit of the paper devoted the role return assumptions play in their process. Keeping things simpler for this blog post, here's a graphic from the paper that cuts to the heart of the paper. 

Since I'm not a fan of illiquid, aka private, we'll just stick with the first two columns. Yes their Long Term has some private equity but I think we work around that without creating a huge distortion while sticking with names we typically use for blogging purposes. 

For the Long Term model I built out the following

I'm subbing CBOE and NOC in as proxies for private equity. Private equity ETFs own operating companies not private equity portfolios. ETFs that track the space are more volatile than the broad index without adding outperformance and if we go with Blackstone or KKR, which we've used in other blog posts, the results would be skewed to the point of being useless. CBOE and NOC are fudging a bit but we've used them in many previous blog posts and they've been client holdings for 11 and 20 years respectively. 

And for Yield Based

Here's how it all sorts out.

I'm not sure what timeframe the AQR is using to get return numbers in the sixes versus what we have above in our backtest. The standard volatility numbers are similar but the Sharpe Ratios are much higher in our back test. Maybe the AQR table is a shorter period, giving more weight to 2022 but either way, the point is to take their idea to see if it can be made into a workable portfolio. 

Looking at the year by year, 2020 was the only year where the two AQR portfolios got left way behind. The equity betas of AQR Long Term and AQR Yield Based are low at 0.62 and 0.78 respectively. The Calmar Ratios are much better but the Kurtosis for each one is inferior. 

The first observation is the success of the two portfolios in 2022 despite the lack of any first responder alternatives, relying heavily on managed futures as a second responder defensive. If someone wanted to mimic this in real life, they could build any sort of equity portfolio with that sleeve, not just have one fund and it would make sense to use two or three managed futures funds like maybe one replication fund and one full strategy, same with splitting up the fixed income but I would avoid or greatly underweight any sort of duration. QLEIX is a very good fund but it would take a lot of faith to ever go 15% let alone 30% which I can't see myself wanting to do. 

I'm not sure if what we've done in this post would constitute mimicking the AQR study or more like influenced by it. If influenced, that ties in better with the idea of taking bits of process from others to create your own process. 

One note about all of theses posts, following up on a point I touched on earlier which is that I try to use the same names for these back tests over and over on purpose. I think the continuity is helpful for following the arc of the work we're doing and I think it is a nod to simplicity. I try to avoid using client holdings where possible which is easy where managed futures are concerned but less so client and personal holding BTAL, there no other fund like BTAL that I am aware of. 

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.

Have You Figured It Out Yet?

The other day I mentioned a filing for putwrite ETFs from Tuttle Capital as follows.

When I wrote that post, I looked at some old posts for something related and stumbled into one about CBOE Validus S&P 500 Dynamic Put Write Index ETF from August, 2023. I haven't written about it since so this seems like a good time to take a fresh look. 

Similar to the WisdomTree Putwrite Strategy Fund (PUTW), PUTD sells close to the money puts and looking at the holdings today, there are seven strikes prices all pretty close to the money and all expiring on December 20th. The dividend history has been uneven. Since listing, Yahoo shows three dividends, one at the end of last year, one in July of this year and one in October of this year. Yahoo has it yielding 3.43% versus 11.55% for PUTW.

Here's the performance versus PUTW and client/personal holding PPFIX.

Although not on the screen shot, PUTD and PUTW both have a correlation of 0.95 to the S&P 500 versus -0.19 for PPFIX. The price return difference between PUTD and PUTW is pretty wide due to the difference in yield but on a total return basis they both seem to be trying to do the same thing. Equity-like returns even if they don't quite keep up with stocks, and less volatility which they deliver on. 

From PUTW's inception in late 2015 to end of of 2019, so long before interest rates went up, PUTW had a much lower upcapture. Interest rates go into the math of determining option premiums, so this is a relevant point. 

I threw in PPFIX because where PUTD and PUTW are probably trying to achieve the same thing, PPFIX is trying to achieve something else which is a bond like return with very little volatility. It does not sell puts that are close to the money, it sells far out of the money, If you wanted a return stream that was correlated to equities with less volatility, you wouldn't go with PPFIX, that would be the wrong expectation. This exercise is a good example of looking to see what a fund is trying to do. Someone expecting equity upcapture from PPFIX would be pretty bummed. 

PUTW offered some protection in 2022 dropping only 10% versus the S&P 500 falling 18% but as a horizontal line that tilts upward, PPFIX was up 1.84% that year. Different objectives, different outcomes. 

Selling volatility, that's what these funds are doing, is tricky as I always say. The 2018 Volmageddon is the best example of how bad it can be when things go wrong. My interest far exceeds the allocation I have for client or personal accounts but it is one of those things that is worth studying.

And a follow up to last night's post about seniors who don't want to ever stop working. I circled back to read the comments, always read the comments, and found one that really resonated.

Advisors not wanting to retire is common. I wouldn't say that the majority of advisors feel this way but plenty are in the camp of not wanting to retire. The way I've described this is that while I don't see myself wanting to retire, at some older age like 75, maybe older, maybe younger, people may not want to hire me as their advisor but as was the case 20 years ago when I started blogging and is the case now, I don't know why I would choose to give up the work. 

If you enjoy what you do and you set your own schedule, how different would retirement be? Obviously, this is not a physical endeavor. If firefighting had been my career instead of my volunteer gig that might a different story due to injury or wearing out but even then there are ways to remain attached to a much older age. 

This path for me is less about planning than pursuing interests where they took me. In a more traditional career path at a company, there probably needs to be more planning. Someone who's an engineer at some sort of company may love the work so the planning might be to figure out how to stay engaged with the parts they enjoy. Or if someone gets to 55 and wants to find something new, whether that is a new paid career or just some sort of endeavor in search of a purposeful "retirement," then that too might require planning. Either way, waking up on the first day of retirement and saying to yourself, "ok, now what am I going to do?" is a bad spot to be in.

It's been a while since I've quoted our friend Bill here in Walker who said "you can figure it out now or you can figure it out later but if you can figure it out now, you'll be much happier." Where are you in life? Have you figured it out? The 93 year old RIA figured it out, maybe the rest of us can too. 

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.