Reducing Portfolio Volatility
A couple of days ago we looked at a portfolio that included 25% allocations to gold and Bitcoin and labeled it an everyone into the bunker portfolio. A portfolio that at most would only have 25% in equities can be right in certain situations but I think would make it difficult for people relying on asset price appreciation to accumulate enough money for their retirement.
That brings us to today's post about the Universa Tail Hedge fund managed by Mark Spitznagel, Nassim Taleb is affiliated with the fund as an advisor. The basic idea is that the fund loads up on put options and probably other types of derivatives that benefit from declines in markets. As the name implies, it offers a hedge (they also refer to it as insurance) against extreme tail events like a pandemic. The latest news is that the fund was up 3600% in March. They provide some data that show a portfolio invested 96.67% in the S&P 500 and 3.33% in Universa would have had a slight gain in March versus a 12% drop that resulted from just owning the S&P 500.
As a quick side bar, I'm not quite following their math there. In a $100,000, owning $3300 worth of something that went up 3600% would have resulted in an astronomical gain for the overall $100,000. Here's the Bloomberg version of the story and this is the Zerohedge version to double check the stated return or my thought process.
Universa is not an exchange traded product, I am aware of at least fund that does something similar which is Cambria Tail Risk ETF (TAIL) which is a client holding. It owns a lot of treasuries and a few puts, presumably fewer puts than Universa but the fund has the tendency to zig when the market zags far more often than not. Regardless of the math, the Universa data makes a point that I have been making since before the financial crisis which is that it only takes a little bit of hedge to protect a portfolio. When I say protect, I mean for it to go down less than the market or worded a little differently, manage the volatility.
A lot of market participants are not fans of maintaining hedges, even small ones, or otherwise trying to manage volatility. Back in the 2000's I used to go to a lot of investment conferences and often was a panelist at them. At one conference I attended, I asked a panelist how he managed volatility and he said he didn't do that. The context was that I was the odd ball, very likely asking the wrong question.
I am a huge believer in managing volatility. When things are going well, it is easy to forget why managing volatility matters but then something like what we're going through now happens and investors think about getting too defensive. The time to map out a strategy for managing volatility is not after the large decline occurs. I've recounted 100 times how in the kind of early days of the financial crisis, someone left a comment on a post of mine saying they should just put it all in Hussman (one of the funds managed by John Hussman) and forget about it. Hussman may have had literally the worst results of any mutual fund manager during the bull market with one fund down a lot and another that appears to have not had any reasonable upcapture.
Stocks are still going to be the long term outperformer (if you don't believe that then you probably should sell) but the trade off is volatility, volatility that at times causes emotional desperation. I want to do what I can to try to prevent that desperation which for me means doing something akin to what Universa does (I started doing this before Universa was founded and obviously I am not the originator of the concept).
Hedging has evolved for retail sized accounts. The Universa fund is not accessible for retail sized accounts but TAIL is as are the other funds I have written about as well as countless other funds in this niche that I haven't stumbled across (yet?).
Taleb clearly and regularly makes the argument for always maintaining at least a little exposure to some sort of tail risk strategy and while it is probably a source of impatience for most of the cycle it is times like now where his argument finds the biggest audience.
I've owned BTAL for clients for just a shade under two years and started writing about it a couple of months before I added it. Here is a two year chart;
BTAL is not a true tail risk strategy but I believe does fit the bill as being a diversifier. While I am thrilled with the two year result there have been multi-month periods where it has lagged noticeably and going forward, there will be more such multi-month periods where it lags.
If you can see where maybe a little perpetual exposure to some sort of diversifier makes sense then you have to accept there will be periods where your chosen diversifier will be a source of frustration. Taleb's point is that you cannot reasonably predict when something bad for markets will occur which is the argument for maintaining the exposure.