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The Evolution Of Asset Allocation

The possible evolution of asset allocation is something to learn about and then solve

Nassim Taleb tweeted “Sophisticated minds adopt simplified lifestyles; simplistic minds are drawn to overly sophisticated lifestyles.” I think there is a parallel to constructing an investment portfolio and then navigating through with that portfolio. For my money, the simpler the better realizing though that we all have different ideas of what constitutes “simple.”

No matter what anyone’s definition of simple is, it is important to realize that owning just a couple of broad index funds, assuming an appropriate asset allocation, can get the job done for the long-term goal of having enough money for retirement. That is not to say that owning just a couple of broad index funds will always be optimal, it won’t, but it can get the job done also assuming an adequate savings rate.

Simplicity though needs to coexist with evolution. If you believe that an allocation to bonds can dampen equity volatility to reduce the odds of panic selling, ok, but what sort of an allocation should you have to an asset class may not move much in price (that’s probably what you want) but doesn’t have any yield? There are of course lower credit pockets of fixed income that have some yield, but you may not want to put 40% of your portfolio into junk bonds.

These thoughts were going through my head as I read this article from Barron’s about asset allocation. The article looked 12 asset classes over the past 20 years, trying to use a mix of returns and standard deviation to figure a way forward. They ignored the idea of correlation. From the start of my blogging 17 years ago, blending together assets with different correlations to manage portfolio volatility has been a big driver in my process. Is that simple? Some would say yes and some would say no. Simple is relative but I think it is very important for participant or client sleep factor.

I could make it very simple. I could just go 100% into Standpoint Multi-Asset Fund (BLNDX or REMIX). The fund is fairly new, I’ve mentioned it many times and is a client and personal holding. It goes 50/50 equities and managed futures. Managed futures, a form of trend following, tends to have a negative to low correlation to equites. The back test of that blend and the first year and half of performance of the fund show a gradual rise from the lower left of the chart to the upper right with very little volatility. The result has been ideal and if we could know that it would always do that then there’s your simplicity. Of course there is no way to know that, no fund will always perform exactly as hoped for so I am not even slightly tempted to own just one fund.

A very simple portfolio of two funds could be comprised of some S&P 500 fund combined with a much smaller allocation to AGFiQ U.S. Market Neutral Anti-Beta Fund (BTAL) which I have also written about many times and is a client and personal holding. I think BTAL offers a great hedge but it does not always “work” the way you’d hope. Now rewrite those last two sentences subbing in Cambria Tail Risk ETF (TAIL). Either BTAL or TAIL could do the job for managing volatility of equities, I have unyielding faith that they will, but for some random period they could disappoint for whatever reason, for any reason.

But all three of those funds, BLNDX, BTAL and TAIL, address another layer which is the evolution of portfolio management. Whereas the Barron’s study looked at 12 asset classes, four of which were fixed income or cash as ways to diversify equity volatility, I would argue that managed futures, long short (BTAL is long short) and tail risk as strategies even if not asset classes will be better ways to offset equity volatility than yieldless fixed income.

Part of what has made fixed income effective in this regard in the past is the yield. Twenty years ago, treasuries yielded 5%. Thirty years ago, it was more like 8%. The fixed income world is different now so maybe then asset allocation should be different. I believe this to be the case, plenty of portfolio managers say otherwise, you need to draw your own conclusion.

Another strategy that I think can function as an asset class is asymmetry and there is an update on accessing Bitcoin in a brokerage account with the launch this past week of the Bitcoin Strategy ProFund (BTCFX). While the ETF filings keep piling up with no movement, this fund was approved. It owns the front month future, not actual Bitcoin. There will be some dispersion between underlying Bitcoin and the front month future and the extent of the dispersion will vary. There will be months where the process of rolling from the expiring contract to the subsequent contract will be done at a loss. BTCFX is not ideal but I think it will be preferable to Grayscale Bitcoin Trust (GBTC) which has to grapple with premium/discount to NAV issues. I’m not going to consider GBTC for wide client use because of the premium/discount characteristic. It might be a different story if it ever converts to an ETF which is Grayscale’s hope.

I own a little GBTC and I bought a little BTCFX as a way to test drive it for possible client inclusion for clients where a percent (or maybe less?) to asymmetry is appropriate. I’ve talked about these sorts of test drives before. I get a better sense of whether a fund will meet expectations owning it directly versus just following it. I did this with BLNDX which I did end up buying for clients and some others that I ended up not buying for clients.

Like many things, the possible evolution of asset allocation is something to learn about and then solve.