An ETF That Nassim Taleb Would Love?

One way to manage portfolio volatility.

One of my favorite topics to write about is a portfolio idea from Nassim Taleb whereby you are very conservative with 90% of your assets and very, very aggressive with the other 10%. When I first heard Taleb talk about this he talked about the 90% going into t-bills denominated in various currencies. Zvi Bodie from Boston University has written about something very similar where the (roughly) 90% goes into TIPS. The big idea is putting very little capital at risk but having the opportunity for market like returns if success is had with the very aggressive 10%. If the 10% doubles then the entire portfolio gains 10% plus the interest on the other 90% would work out to a pretty good market return.

I first encountered this idea during my brief stint at Fisher Investments in 2002. One of my colleagues was fascinated by the idea that in the 90's, a portfolio that went short Nikkei futures with just 2% of the assets had returns that were similar to putting the entire account into the S&P 500. I don't know if he was correct but the idea fascinated me.

During my gig with AdvisorShares I got to know Mark Yusko from Morgan Creek Capital through the ETF he managed. He implemented a version of this by using 3X levered equity ETFs to build the equity portion his multi-asset fund. He also had gold exposure, used levered fixed income funds as well as narrow funds that all blended together to give give what I would describe as a being a hedge fund-like return.

Mark contended that despite the daily reset involved with levered products and the risk that a 2X or 3X won't do what an investor might hope for beyond one day, these funds actually do offer 2X or 3X exposure over longer periods most of the time with 2008 being one notable exception. The chart comparing the Direxion 3X fund and SPY supports Mark's thesis or at least doesn't refute it.

To today's post, there is a new ETF that purports to offer leverage without offering leverage. The new Salt truBeta High Exposure Fund (SLT) is a broad based, domestic equity portfolio built to have a beta higher than the S&P 500. I was not able to find a specific number for the beta but the literature said the fund has an "average truBeta™ estimate of approximately 1.50." It simply owns high beta stocks, there are no derivatives and there is no reset, just an equity portfolio that the sponsors believe will go up 15% if the S&P 500 goes up 10%.

There is at least one other high beta ETF, the PowerShares S&P 500 High Beta Portfolio (SPHB). If you play around with different time periods you will see where it outperforms, lags and trades in line with the S&P 500. You could say that during the bull market it has outperformed, except for the times it hasn't which doesn't actually do much for setting any sort of expectation so it is not clear if the new SLT as a broad based proxy can always outperform when the market is going up.

Risks that go with the daily reset notwithstanding, careful use of the levered funds along the lines of what Mark Yusko did might be a better, broad based route. Even better than that for anyone interested in managing volatility would be to choose narrower ETFs or individual stocks to increase the volatility of the portfolio. Clients have owned Square (SQ) for quite a while and part of the decision to buy was the desire to add a little more beta to the portfolio.

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