Smoothing Out Your Portfolio's Ride

A round up of my recent reading.

Barry Ritholtz Tweeted the following quote from Seth Klarman; “Do you want to trail the market -- when it’s going up or when it’s going down?” This quote underlies the entire idea that I have referred to for years which is smoothing out the ride of the portfolio over the course of the entire stock market cycle. This why I focus so much on portfolio defense and being on the look out for what can go wrong for markets, like tariffs for example, as opposed to what can go right. Large declines breed emotional responses and while large declines in the market cannot be avoided there is the chance to avoid the full brunt of large declines. Things that can go right takes care of itself as the domestic equity market has an up year about 72% of the time.

Barron's posted a personal finance article with 10 Rules for Financial Success. Their rules were mostly things you would expect including setting goals, how to save and how to seek advice. No list like this is going to be comprehensive of course but a couple of glaring omissions were living below your means and taking the time to learn about market cycles, what they might do to emotions and the panic sales that could ensue from heightened emotions.

Michael Batnick had a great post titled The Coddling of the American Investor. The high level takeaway is the the powers that be, however you define that term, are trying to insulate markets and by extension market participants from large declines. At Michael notes, this sort of thing makes us more fragile. We might be seeing this at a societal level as a result of the everyone gets a trophy mentality that has come into existence in the last 20 years. Sometimes you lose the game, sometimes, you get a very bad grade, sometimes you don't get the job, sometimes you don't get the promotion you think you deserve and sometimes someone says something very nasty or rude to you. If there is an argument for being inoculated from all negative outcomes, I don't know what it is, and if presented with that argument, I would not understand it.

Shane Parrish had an article titled The Danger of Comparing Yourself to Others. As Shane says, "comparisons between people are a recipe for unhappiness." I love this sentiment and I address it regularly. Once you figure yourself out and what you really want, you can focus on that and have a much better chance of making it happen. My wife and I are working on a project right now that I'll be able to talk about later this summer but part of the process has been an introspective look at the life we have created for ourselves. We get to live in the woods and work from home doing what we love. We figured out ages ago the things we care about and the things we don't. Figuring out the via negativa of what we don't care about makes life much easier.

A couple of complicated new ETFs caught my eye. The first is the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) which tries to benefit from fixed income volatility and a steepening yield curve. It does this with an 85% allocation to Schwab US TIPS ETF (SCHP) and 15% in over the counter options that target volatility and steepening. It is a sophisticated strategy, of course I have no idea if it will work out. It would not be suitable for anyone who doesn't understand the implications of a steep for flat yield curve.

The fund's first month looks pretty good as the curve has become more inverted (negative steep?), clearly despite the huge weighting in SCHP the overlay is capable of making a performance difference. While I feel the need to see how it trades for a while before I'd even consider owning it clients, it does not strike me as a proxy for TIPS exposure.

The other fund is the iM DBi Managed Futures Strategy ETF (DBMF). I used managed futures for most clients during the financial crisis. The quick version of it is that the strategy goes long asset classes with favorable intermediate trends (usually 10 month or 200 day) and short asset classes with unfavorable intermediate trends. Favorable or unfavorable is based on technical analysis. The appeal is that managed futures should have a negative or very low correlation to equities. In the last ten years, the performance of the strategy has been terrible in nominal terms but it has done what it is supposed to do which is have a negative correlation to equities. Stocks have rocketed higher and managed futures by and large are down. The question of course is will managed futures do well again the next time equities falter (I have decent confidence in that) and the other question is, will DBi's version of managed futures do well and for that there is no way to know.

Net net it is positive that sophisticated strategies are available to retail sized accounts but the learning curve is steep and the sizing should be small.

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