Tuesday, May 7, 2019

F@ck Everything... We’re Going 120/80

Jeremy had spent most nights over the previous 30+ years on this earth in search of the next big ETF. After all, you don’t “aspire to be at the forefront of innovative ways for marrying the benefits of the exchange-traded fund structure with goals that are associated with active managers” by sitting around and doing nothing.

The problem was for as much as he searched and probed, the same tired investment ideas presented themselves over and over again. Sometimes these offerings had catchy names. Other times they had ever reduced costs. But nothing brought Jeremy the joy that he was in search of.

Disgruntled and lonely, Jeremy needed a break from the madness. So on the fateful morning of November 18th, 2017, Jeremy logged into Twitter. And shortly thereafter, his life would never be the same.

Making the Impossible, Possible

Based upon the now infamous interview with investment guru Corey Hoffstein in Barrons, the two users not so affectionately referred to as “trolls” that “lacked social skills” did what they did best.

Jake and Unrelated Nonsense argued. And argue they did.

But this argument was not like their previous arguments involving taxes or fast food. Rather, this argument was the FinTwit version of catching lightning in a bottle. You see… these two debated the merits of Corey’s idea of leveraged beta exposure by coming up with a 90% stock / 60% bond strategy that historically outperformed a 100% stock allocation with similar risk.

But that’s not where things ended.

This strategy also offered the flexibility to be held at a 2/3 weight, matching exposure of a traditional 60/40 portfolio and allowing the remaining 1/3 to be allocated to alpha strategies (click here for an older post outlining how a levered portfolio can make room for an alpha generating allocation).

Better Act Fast 

“I remember thinking this idea was just sitting there for the taking”, Jeremy is rumored to have remarked to his team back at Wisdomtree. “These idiots were just giving away their ideas for free. I had to act fast.”

And fast he acted. On August 2nd, 2018, less than one year from that fateful morning on Twitter, the ETF $NTSX was launched. Seven months later this ETF would be known as the award winning ETF, taking home the gold for best new allocation ETF.

More Free Advice

If you think this is where the story ends, you would be wrong.

On May 6th, 2019, nine years to the day of the Flash Crash, investment legend Corey Hoffstein came out with a post outlining his tactical approach to the 90/60 concept, improving outcomes for investors further (side note I do highly recommend you check it out). This was followed the very next day by the another approach I am about to share.

You see, an investor need not just use plain vanilla S&P 500 beta for the equity exposure within a 90/60 portfolio. In fact, an investor comfortable with a long-term volatility profile similar to equities could even ramp up the beta exposure past 90/60 if they could find an equity allocation that had lower volatility than the market.

Introducing the 120/80 S&P 500 Low Volatility Strategy

Since its November 1992 launch, the S&P 500 Low Volatility index has a realized volatility of 10.9%, 23% less than the S&P 500 index. As Lawrence Hamtil has pointed out in detail in a variety of posts, while there have been moments of pain, this lower volatility has not required a sacrifice in return over the longer term.

As Twitter influencer Michael Doherty pointed out, a simple allocation that swapped the S&P 500 Low Volatility Index into the 90/60 framework results in improved historical performance. The strategy now has a historical volatility a full 30% lower than the S&P 500 since 1992. As a result, an investor can keep the same 1.5 (stock):1 (bond) ratio of a 60/40 portfolio intact, but given the reduced volatility of the S&P 500 Low Volatility / Treasury portfolio can lever up the exposure 2x to 120/80 with similar historical volatility of the S&P 500.

An equity curve shows there have of course been periods this strategy would have underperformed (and past performance yada yada yada the future), but the returns have largely been consistent and outsized.

In addition, the increased exposure to equities within the strategy means that a reduced allocation to this strategy can be utilized at the portfolio level to maintain stock / bond exposure; as an example as 50% weight to 120/60 = the 60/40 traditional stock / bond notional allocation, now leaving 50% of a portfolio to pursue alpha oriented strategies.

Your move Jeremy.

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