Buy Negative Returning Assets
Would you allocate to an asset KNOWING that its expected return is zero in the long run, or even negative?
Most people’s intuition is “that’s a stupid idea”.
That intuition, however, is wrong. Assets should be evaluated on how they interact together with other assets in a portfolio. Not based on their individual profile.
It's possible that an asset with a negative return can improve your portfolio. Let me give you an example.
There is long/short ETF that has been around since 2011 – the AGF US Market Neutral Anti-Beta ETF (ticker ‘BTAL’). Its net equity exposure is zero as it goes long low volatility stocks and short high volatility stocks, essentially providing the spread between low and high beta stocks. This translates to a portfolio that has a negative beta and is therefore negatively correlated with equities. Since inception though, it has produced a cumulative total return of -13% (as of May 2024).
Why would anyone put this in a portfolio? After 12+ years, its return is negative.
Even the total US bond market, or aggregate “agg” bonds, has a cumulative return of 20% over this same period, despite crashing +20% during the 2022 rate hiking cycle.
But what happens if you replace the 40% allocation to bonds in the traditional 60/40 portfolio with the AGF US Market Neutral Anti-Beta ETF (ticker ‘BTAL’)?
You can reduce risk (std deviation) by 25%, nearly double the risk/adjusted return (Sharpe), and reduce portfolio drawdown:
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But looking at the graph, the traditional 60/40 portfolio still outperforms the portfolio with BTAL over this period. If your client has a long-term time horizon, why not still choose this portfolio?
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The reason is that portfolio risk is simply a variable that can be adjusted.
If your client can tolerate a standard deviation of 9.37% (that of the traditional 60/40 portfolio), then increase the risk profile of the Alternative Portfolio to this level - translating to greater returns for the same risk.
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Risk matching the underlying holdings would results in the following allocation:
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SSO -ProShares Ultra SP500 42%
BTAL -AGF US Market Neutral Anti-Beta 58%
Now for the same risk (std deviation and drawdown) as the traditional 60/40 portfolio, returns are improved:
The principles involved are:
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-????????? Consider the risk/return profile of the portfolio of assets, not each asset individually
-????????? Look for assets with negative correlation to improve a portfolio’s profile. Even if these assets have a negative expected return
-????????? Scale the efficient portfolio for investors across the risk spectrum to achieve the desired profile
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I continue to believe that portfolio construction is the single greatest tool that we advisors have for adding value and improving outcomes for our clients. It’s not about “beating the market” through stock picking, or timing the market’s ups and downs. It’s about understanding that a portfolio can be greater than the sum of its parts.
-Daniel Snover, CFA
President at CompEdge Financial Services
9 个月Great post.
Total Portfolio Approach for Family Offices and E&Fs
9 个月This has been one of my favorite exposures for YEARS. First time I've seen someone else consider it ??
Managing Director | Investments
9 个月Great stuff! However, depending on your allocation you may need leverage to scale an entire portfolio to the same risk level. And, building a reasonably diversified subset of assets/strategies/managers which is truly resilient, i.e. has stable zero correlation to equities, is a hard thing to do, as correlations do change over time. And these changes in correlations would require adjusting leverage dynamically. But I totally agree on the overall message on portfolio construction - most allocators don't spend enough time on these concepts.
I help successful business owners keep more of what they earn and have a bigger impact on their family, purpose, and retirement.
9 个月Great article, Daniel. I hope you're doing well!