Episode 210

full
Published on:

19th Oct 2024

Diversification 2.0: Mastering the Art of Portable Alpha

Portable alpha (or as we like to call it: Return Stacking) has become increasingly popular in the financial media (including recent notes from industry giants like BlackRock, Russell Investments, and AQR) but many advisors are left asking: What does portable alpha mean? How might it benefit clients? How can I implement it?

At Return Stacked Portfolio Solutions we have made it our mission to thoughtfully and transparently help allocate into a portable alpha framework for client portfolios.

Join us for this deep dive podcast with Corey Hoffstein, CIO of Newfound Research, and Rodrigo Gordillo, President and Portfolio Manager at ReSolve Asset Management Global, as we explore:

  • What 'Portable Alpha' is: Review of the history and theory of the concept.
  • Outperformance Potential: Portable alpha/return stacking allows allocators to stack asset classes/strategies with positive expected returns on top of core assets which can help improve the likelihood of outperforming the market.
  • Diversification Benefits: Using return stacking to stack low correlation strategies on top of the core portfolio can help reduce portfolio drawdowns, thus influencing likelihood of achieving financial plan goals.
  • Behavioral Benefits: Sticking with low-correlation diversifiers can be difficult for clients. Return stacking can improve the likelihood clients stick with diversifiers long enough for them to realize the benefits.

*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.

Transcript
Corey Hoffstein:

And this was.

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sort of mind breaking was that the

alpha, if we can call it alpha, that

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was being generated, the excess return

above the S& P 500 of this program,

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was not coming from the asset that

investors were trying to get exposure to.

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It wasn't coming from the beta.

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It wasn't coming from security

selection within equities.

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It was coming from where

PIMCO thought they had skill,

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security selection in bonds.

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And they were able to port that

alpha on top of the S& P 500

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beta that investors wanted.

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And thus, the concept of

portable alpha was largely born.

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It was actually originally called

transportable alpha, eventually

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shortened to portable alpha.

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Rodrigo Gordillo: Hello,

everybody, and welcome to the

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ReturnStack Portable Alpha webinar.

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thank you everyone for joining us today.

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My name is Rodrigo Gordillo

and, uh, today we're going to

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be talking about Portable Alpha.

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I'm the president of Resolve

Asset Management and co founder

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of the Return Stacked ETFs.

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And it's my pleasure to have you all

join us for what I think is going

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to be an enlightened discussion on

a topic that's gaining significant

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traction in financial media.

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I mean, We've had close to 350 people

sign up for this webinar already, which

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is actually the largest group that we've

had in any one of these webinars thus far.

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And there's just honestly an

incredible update and discussion

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around the topic recently.

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We're super excited to cover

it all in detail today.

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And we're very lucky to have with us

Corey Hofstein, the Chief Investment

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Officer of Newfound Research, my fellow

co founder of the Return Stacked ETFs.

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Corey's an absolute visionary

in quantitative investing

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and portfolio construction.

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He really is known for his innovative

approach as to tackling complex

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financial topics and making them

as accessible as possible to the

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advisor and investor community.

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So he's a great person

to have on board today.

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Of course, the focus being Portable Alpha.

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This strategy.

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really involves separating beta, which

is passive market returns, from alpha,

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which is the excess return from active

management, to help us build more

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efficient and diversified portfolios.

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Now, of course, this

concept isn't entirely new.

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It actually dates all the way back to

the:

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PIMCO, PIMCO stock plus, um, concept that

has been around for a bunch of decades.

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Corey will cover that in detail,

and You know, it died for a bit.

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We're going to cover that as well, but

recently it's got a resurgence and as

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advisors and investors are seeking to

enhance returns or better risk manage

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their portfolios in what is likely

to be a low yield environment, right?

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We have high valuations in stocks.

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We're starting to see

yields come back down again.

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And so today what we're going

to cover is four major things.

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We're going to cover an approach

that institutions have used since

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the 1980s to pursue excess returns in

their portfolios and see how we can

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transfer that over to the retail space.

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How we can pursue alpha in high

conviction, high opportunity areas

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without disrupting the, you know,

hallowed core stock and bond exposure

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that everybody needs to have exposure to.

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And how this approach can be used to

introduce alternative diversifiers

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and may even help curb some

behavioral biases of using them.

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Those alternatives and ultimately we're

going to try to give you some examples

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of how one can implement it today.

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So, throughout this webinar, I'll be

moderating the discussion and I may

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post some questions to Corey to unpack

these concepts as thoroughly as he can.

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We do encourage you to submit

questions via the chat function.

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I'll try to address as many

of those as possible during

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the Q& A session at the end.

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And I think we're ready, but before I

pass over the mic to Corey, We did have

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a few poll questions that I'm hoping

that the audience participates in.

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Um, so the first poll question

is how many people here are A.

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actively using Portable Alpha slash

return stacking and portfolios today?

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B.

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how many people are contemplating

the use of Portable Alpha and

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return stacking in portfolios?

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And C.

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don't currently use Portable Alpha or

return stacking in portfolios today?

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All right, I see that

the poll is moving along.

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Give that a few seconds to

get a nice sense of things.

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Oh, it's looking good.

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Option A is, uh, is winning though.

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Moving around.

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Give it five more seconds.

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Okay,

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I'm going to end the poll there

for everybody to see, um, and

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we're going to share the results.

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So we see, um, around 45 percent of people

are currently using it, 36 percent are

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contemplating it, and 20 percent around 19

percent are not, uh, currently using it.

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Okay, so just a quick follow up

question, um, the next, uh, could

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you put up the next one, Ani, please?

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Of those who do use Portable

Alpha, um, what has been the

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most significant challenge to

implementing it in your organization?

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And the first question is, lack

of understanding and experience,

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poor experience in the past, or you

struggle finding reliable overlays?

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Okay.

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Lack of understanding

and experience is 49%.

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Poor experience in the past is 16%.

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And then struggle finding

reliable overlays is.

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Okay, great.

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So this will kind of give you

a good feel, Corey, for the

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audience and their sophistication.

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It looks like we have a lot of people here

with, with some experience, so we might

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be able to delve deeper into the topic.

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But without further ado, you have

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Corey Hoffstein: the floor.

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Well, wonderful.

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Thank you, Rod.

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Really excited to talk on this

topic today because it's a topic I'm

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really very passionate about and I

don't want to bury the lead here.

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Rod talked about all the

things you're going to learn.

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I want to talk about what

I hope you take away.

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And for me, the core concept that I hope

you take away is that being thoughtful.

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about how you actually structure your

portfolio may be a much simpler and

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I would argue smarter way to pursue

outperformance and diversification, uh,

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particularly versus traditional means.

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And that's what portable alpha and more

broadly return stacking is all about.

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This is an idea, as Rod mentioned, that

select institutions have been using for

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decades and it is, I think, gaining.

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Relevance again because it's not

just limited to institutions who have

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coverage from banks that are now able

to implement this, but through mutual

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funds and ETFs this is a concept that

can now be implemented by everyone.

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So let's start with what is the

problem that return stacking and

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portable alpha are trying to solve.

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Now on this slide, what I

have is a breakdown of the

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MSCI All Country World Index.

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So this is a global equity benchmark

broken down mostly into regional

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components and then within those regions

broken down by market capitalization.

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And I've highlighted two slices.

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That big blue slice on the right is U.

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S.

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large cap, which as of today is Over

50 percent of the MSCI ACWI index.

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So if you are a global investor,

you are over 50 percent of your

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equities are in us equities.

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And then that green slice is

international developed EFI, small

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and mid cap coming in at just 7.

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7%.

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And what I want to highlight here

is for each of those categories

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for us, large cap and EFI smid cap.

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What I did is I went and I found what's

called the success rate of active

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managers, uh, in, in actually delivering

excess returns versus their benchmark.

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So I went to the Morningstar active

versus passive barometer report.

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And I said, over the last 15 years, what

percent of managers in these categories

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have actually beaten their benchmark.

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And if you look at the U.

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S.

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large cap slice there, what you

see is less than 10 percent of

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managers actually beat their

benchmark over the last 15 years.

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In other words, if you 50, reround the

clock 15 years ago and just chose a

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manager at random, you had a less than

1 in 10 chance of identifying a manager

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who actually would beat the benchmark.

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Compare that to the EFY small and mid cap.

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It had over four times

the success rate, right?

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So you had a four times better chance

if you were just choosing at random

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of actually identifying a manager

who would go on to beat the benchmark

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and deliver those excess returns

for you over the next 15 years.

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Now, my guess is for all the U.

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S.

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allocators on this call today,

99 percent of them have never

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even looked at evaluating an

EFI small cap, mid cap manager.

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And that's largely because

one, this is a global pie.

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Most U.

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S.

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investors actually have

a much larger slice of U.

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S.

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large cap equity because

of A home equity bias.

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Um, but two, when you have

so much exposure to U.

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S.

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large cap, that's where you want

to focus your efforts, where

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all your capital is allocated.

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And yet you have this trade off

where, where the majority of your

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capital is allocated is actually the

place that's hardest to find alpha.

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And, and even though the EFE small and

mid cap has a four times better chance

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of delivering alpha historically,

I'll point out it's still below a coin

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flip that you would have actually been

able to identify a manager At random.

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And so particularly in the U S large

cap space, it's a big question of,

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do I have the manager search skill

to find that one in 10 manager who

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is actually going to deliver alpha

for me over the next 15 years?

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And if not, what do I do with

this massive part of my portfolio?

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That's eating up all my capital.

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Now this was a question that

PIMCO faced in the:

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equities but actually in bonds.

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They ran a large number of

treasury mandates as well as

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a large number of fixed income

mandates that were benchmarked.

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To broad U.

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S.

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fixed income.

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What I have here is a snapshot

today of how the Bloomberg U.

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S.

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aggregate bond index has broken out.

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And what I've highlighted

is the treasury allocation.

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44 percent of this

benchmark is in treasuries.

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And so if we're trying to beat this

benchmark, this is almost a 50 percent

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slice in which security selection

really isn't going to help us.

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A 10 year U.

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S.

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treasury is fungible with

all the other 10 year U.

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S.

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treasuries.

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And so unless we're willing to take

credit or duration risk, go outside U.

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S.

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treasuries to maybe corporates or

something else, this is a big chunk

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of the, of the pie that becomes very

difficult for us to try to beat.

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And again, just eats up a lot of dead

capital from an active risk perspective.

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So, What did PIMCO do?

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Well, some very clever PMs realized

that instead of investing in U.

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S.

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treasuries themselves, instead of

actually buying the bonds, they could

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use derivatives, capital efficient

derivatives, to gain exposure to the

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asset class and only have to use a

little bit of that capital, of that

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say 44%, only give a little bit of

that capital as collateral and free

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up the rest of that cash to invest.

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So if, for example, if they invested

it in cash, um, they, they would

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basically end up with the same return.

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So let me walk through this,

because this can be a little bit

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confusing without an analogy.

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Imagine you have a million

dollars and you're looking at

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buying a million dollar house.

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One of your options is

to just buy the house.

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Right?

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You give them the million dollars,

and in return, you get a house.

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And that's effectively what you'd have

on the left side of this equation.

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You, you bought the actual

asset, and you would earn the

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actual return of that asset.

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The other option is that you go

to a bank, and you get a mortgage,

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and you finance your purchase.

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And you keep that million dollars,

and you get the return of the house.

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Minus the financing cost of that mortgage.

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And so long as you take that million

dollars and invest it in something that's

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going to offset that financing cost

of the mortgage, you're net neutral.

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But you now have all that cash

available to you if you want to use it.

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And what the folks at PIMCO realized

was, well, they could take all that

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cash that's available to them and

say, well, what if we not just tried

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to offset that cost of our mortgage,

but what if we tried to outperform it?

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What if instead of investing in short

term T bills, which are effectively

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the cost of financing embedded in

treasury futures, what if we took

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a little bit of duration risk?

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What if we took a little

bit of credit risk?

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What if we went out on the risk

curve a little, not a lot, just a

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little, to try to get a yield pickup?

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And if you work that equation

through and say, well, I'm still

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getting the returns of the U.

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S.

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Treasuries, Minus the embedded cost of

financing, but now I'm taking all that

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cash and investing in something that's

going to outperform that financing.

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Well, now all of a sudden I took a

big dead slice of my portfolio where

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I couldn't perform security selection,

where I didn't think I had an alpha

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edge, and transformed it to add the

ability to create an alpha edge.

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Here, where PIMCO said they thought they

had an edge in selecting short term bonds.

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And so, in effect, they were able

to port all this sort of short term

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bond selection alpha on top of the U.

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S.

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Treasury position they had that

was the otherwise dead space.

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That happened in the early 1980s.

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This is what they call

their bonds plus program.

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In 1986, S& P 500 futures launched

and PIMCO pretty quickly realized,

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excuse me, it might've been 1983,

either way,:

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quickly realized that the same thing

could be done with equities, right?

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If you were an investor and you had

a U S equity mandate, PIMCO said.

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Well, give us the cash.

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And what we'll do is we'll get you S& P

500 exposure through S& P 500 futures.

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They're going to track that

S& P 500 exposure perfectly.

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They're going to have a cost of financing

embedded, but if we take all the cash

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that we freed up and we invest it in

short term, slightly riskier bonds,

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you know, slightly, maybe short term

corporate bonds, try to get a little

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bit of yield pickup versus that cost

of financing, suddenly we are going to

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be able to provide you S& P 500 returns

plus a little bit of return and what's

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incredibly powerful about this concept.

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And this was.

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sort of mind breaking was that the

alpha, if we can call it alpha, that

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was being generated, the excess return

above the S& P 500 of this program,

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was not coming from the asset that

investors were trying to get exposure to.

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It wasn't coming from the beta.

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It wasn't coming from security

selection within equities.

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It was coming from where

PIMCO thought they had skill,

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security selection in bonds.

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And they were able to port that

alpha on top of the S& P 500

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beta that investors wanted.

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And thus, the concept of

portable alpha was largely born.

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It was actually originally called

transportable alpha, eventually

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shortened to portable alpha.

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And almost 10 or 15 years went by

before institutions realized that

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this could be generalized far more

than the way that PIMCO was doing it.

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If you look at the concept more

generically, basically what's happening

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is institutions will look at their

portfolio and find areas of large

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swaths of beta that they have low

conviction that active managers will

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be able to outperform that beta.

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And if they believe that that beta can

be cheaply replicated using derivatives,

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such as say the S& P could be replicated

by buying S& P 500 futures, then they're

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able to free up quite a bit of cash.

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that they can then

allocate to other places.

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And those other places for PIMCO was,

well, we can pick short term bonds,

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but we can go far beyond allocating

just short term bonds when we think

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about finding additional alpha sources.

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So again, let's break

this down step by step.

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Step one here, you are going and looking

at your portfolio and saying, there are

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large allocations that I have that I don't

have conviction that active management

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is going to generate alpha, particularly

after fees or with any significant

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degree of certainty, and I believe that

I can replicate this using derivatives.

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This is the view an

institution would have.

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The institution will then go and try

to replicate that passive portfolio.

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So again, let's say the S& P

500, they might go to a bank

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and ask for a total return swap.

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They might go trade futures and

get S& P 500 futures exposure.

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They could synthetically

replicate it with options.

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There's a variety of available

choices here, but the point is

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they're going to choose A derivative

structure that effectively gives

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them leverage, much like, again,

buying a house using a mortgage.

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They're able to get all the

exposure of the S& P 500 without

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putting the cash up front.

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Now, they'll hold a little bit of cash

aside as cash collateral, but not nearly

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all the capital that you would need.

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So I want to dive in here, just peel

back the onion one layer deeper, because

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I think, I think it's, it's worth it to

really drive home how this is working.

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Let's say I was an institution and

wanted a hundred million dollars

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of exposure to the S& P 500.

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One way I could get that exposure is

I could just buy a hundred million

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dollars worth of an S& P 500 ETF.

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I put this together a few weeks ago, so

the numbers aren't perfect for today's

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market, but you know, if you're going

to go buy the SPY ETF, you're basically

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buying 175, 000 shares of SPY to get

a hundred million dollars of exposure.

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And you're done.

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And again, you're going to have the very

physical presence of the S& P there.

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The other thing you could do is you

could go and buy all the underlying

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components of the S& P 500.

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Then you've got to manage the

index additions and deletions over

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time and figure out what you want

to do with the dividends, right?

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But again, it's more or less the same

thing as buying this S& P 500 ETF.

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You're just managing the basket yourself.

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The third thing you could do is

you could buy S& P 500 futures.

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Now, without diving too deep, the

important part is today, every

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futures contract gives you the

notional exposure of about 280,

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000 worth of S& P 500, right?

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And so for 100 million of exposure, it

means you only have to buy 350 contracts.

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Now, if you go to CME, And ask how much

margin you need to post for each contract.

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They'll say it's about 14, 000, right?

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So you have to put up 14, 000

in cash to get about 280, 000.

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of exposure the S& P 500.

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That's about 5 percent

of the capital, right?

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That's like basically buying a

house by putting 5 percent down.

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Similar ish concept.

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But what that means now is that you've

only had to put up about 5 million

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to get 100 million of exposure, and

the other 95 million is now free.

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for you to do whatever you want.

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Now prudence would tell us we probably

don't want to run our margin limits that

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tight, we want to have a nice liquidity

buffer, but the point is through using

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the futures we get the exposure to the

S& P 500, but we've now freed up all

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this cash that we can invest elsewhere.

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And that elsewhere doesn't just have to

be short term bonds the way PIMCO did

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it, that elsewhere could be long short

equity strategies, it could be CTAs,

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it could be global macro strategies,

it could be event driven strategies,

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it could be any source of alpha Or

diversifier or asset class or strategy

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that you think is going to generate

positive returns above cash over time.

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Rodrigo Gordillo: Rod.

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One question that came up in this chart

here is how safe is the safety buffer?

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Um, I don't know if

you can expand on that.

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Obviously it's going to

depend on the institution, but

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Corey Hoffstein: yeah.

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So this is going to depend

both on the institution and

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what you're porting on top of.

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And the alpha source.

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And I know that that's a lot, but

if you are porting, say on top

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of the S& P 500, that underlying

index is very volatile, right?

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That S& P 500 can drop 50%.

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:

And so you're going to want a much

larger safety buffer to make sure you

363

:

don't have any meaningful margin calls.

364

:

If you're porting on top of, you know,

if your policy portfolio or strategic

365

:

allocation has a big bond allocation,

you could port on top of bonds.

366

:

And require much, uh, much less

of a safety buffer because bonds

367

:

are just going to move less.

368

:

I actually, uh, recently had a

conversation with a very large, uh,

369

:

public pension who's been doing portable

alpha for a better part of a decade.

370

:

And they said that they're,

they internally only port on top

371

:

of bonds for this very reason.

372

:

Um, they, they used to

port on top of equities.

373

:

They said it's harder to

manage operationally for this

374

:

margin and safety buffer.

375

:

And so they choose to

port on top of bonds.

376

:

So that's one of the, you know,

again, it's going to vary depending

377

:

on what you're porting on top of.

378

:

End of the day picture that really

matters here is how this all comes

379

:

together to generate a return, right?

380

:

And what we get when we talk

about the end picture is.

381

:

When you run the Portable Alpha program,

you get that S& P 500 exposure and

382

:

you add this alpha source on top.

383

:

And this portfolio will outperform

so long as that alpha source

384

:

outperforms cash over the long run.

385

:

Cash here being basically T bills.

386

:

And so this is, for many people, a

totally new way of thinking about

387

:

generating outperformance, right?

388

:

You don't need to beat the market.

389

:

by finding a manager who

can pick stocks better.

390

:

You can beat the market by structurally

changing your portfolio to free

391

:

up capital to invest in something

that you just think is going to

392

:

beat T bills over the long run.

393

:

And suddenly that allows us to

think about all sorts of different

394

:

investing components as Lego

building blocks in many ways, right?

395

:

So what we've done here is we've taken

the return for all these different asset

396

:

classes and hedge fund strategies Whether

it's gold or trend following or market

397

:

neutral, long, short, relative value.

398

:

And we've said, what is their return

been above T bills over the long run?

399

:

That excess return is effectively the

thing that through Portable Alpha we can

400

:

try to stack on top of our portfolio.

401

:

And then we can sort of mix

and match as we see fit, right?

402

:

Maybe you're someone who believes in

having a big allocation to gold in your

403

:

portfolio, or maybe you like the idea of

long short equity and matching it with a

404

:

macro strategy, or trend following plus

carry strategies, and you can choose both

405

:

the size, And the combination of what

you're stacking on top to try to match

406

:

the active risk budget that you have,

as well as meet your core objectives.

407

:

And so if we compare the old world

way of thinking about trying to beat

408

:

the market, right, to the new world

approach, I think there is some

409

:

substantial improvements in terms of the

likelihood of generating outperformance.

410

:

In the left half of this slide, what we

show is the performance of top quartile U.

411

:

S.

412

:

large cap equity managers

over the last decade.

413

:

So these are managers, uh, who

out, who are in the, again,

414

:

top 25 percent of the category.

415

:

They generated, on average, about

120 basis points of excess returns.

416

:

So the market returned

about 11 and a half percent.

417

:

They added about another 120

basis points on top of that.

418

:

And that assumes again, you could rewind

the clock a decade ago, identify that top

419

:

someone in that top quartile or a basket

of managers in that top quartile and

420

:

stick with them over the next 10 years.

421

:

I want to compare that to

the second graph, which just

422

:

basically takes the S& P 500 U.

423

:

S.

424

:

large cap and stacks generic

hedge fund category beta on top.

425

:

Here I'm just using a generic

Credit Suisse hedge fund

426

:

index, minus that cash return.

427

:

And you can see without having to do

anything special, without even trying

428

:

to pick the best performing hedge fund

managers, just saying give me generic

429

:

hedge fund beta, you would have stacked

275 basis points on top of the S& P.

430

:

Now we think you can be far more

thoughtful than this, but again,

431

:

the point here is do we have higher

conviction in our ability to identify

432

:

some long only equity manager

that can actually generate alpha?

433

:

Or do we have higher conviction in

our ability to identify a diversified

434

:

collection of alternatives that are going

to be able to beat cash over the long run?

435

:

And I think that's profoundly powerful

when it comes to thinking about generating

436

:

outperformance in our own portfolios.

437

:

Now, what's really interesting to me

about Portable Alpha is it's always been

438

:

this concept about beating the market.

439

:

But more fundamentally, what Portable

Alpha does is it solves what we

440

:

would call this funding problem.

441

:

One of the things we've said at Return

Stack Portfolio Solutions is that

442

:

diversification has always been this

process of addition through subtraction.

443

:

Thank you.

444

:

If you want to historically have

added diversifiers to your portfolio,

445

:

most investors had to sell down

something else to make room.

446

:

So as an example, on the far left, we

have an investor's benchmark allocation.

447

:

Typical, traditional 60 percent

stocks, 40 percent bonds.

448

:

And let's say they wanted to add 20

percent in some alternative diversifiers,

449

:

whether it's Some of the passive

asset class like gold or an active

450

:

investment strategy, the old world

approach required them to sell down

451

:

some of their stocks and some of their

bonds to make room for that allocation.

452

:

And the potential problem here is

it creates a two form hurdle rate.

453

:

First from performance perspective,

those alternatives have to outperform

454

:

the things that they replace.

455

:

to add value to the portfolio, right?

456

:

So whatever you're selling, whatever

you're buying effectively has to

457

:

outperform whatever you've sold.

458

:

Second is, in my opinion, creates an

important behavioral hurdle, right?

459

:

You're selling things that most

clients are comfortable with.

460

:

Stocks and bonds, they tend to be cheaper,

more transparent, uh, more tax efficient,

461

:

and you're replacing it with alternatives

that often they don't understand are

462

:

higher cost, less tax efficient, and it

creates, once again, this trade off of,

463

:

of a behavioral hurdle rate that it makes

it hard for the clients to stick with that

464

:

alternative when it is inevitably going to

underperform what you sold to make room.

465

:

The new world approach, that portable

alpha, And what we more generically

466

:

call return stacking, right?

467

:

When it's not just about trying to pursue

excess returns, but when it's also about

468

:

how we can just generally think about

structuring a portfolio, this new world

469

:

approach solves this funding problem.

470

:

by layering the alternative

on top of the benchmark.

471

:

You no longer have to make room,

you can just add it as an X, as an

472

:

additional, uh, allocation, effectively

expanding your canvas that you can,

473

:

that you can paint with, paint on.

474

:

So I want to go into a little

bit of an example of how this is

475

:

sort of played out historically.

476

:

People who know me will know that I

love Managed Futures Trend Following.

477

:

It's where I've spent a The majority of

my career and a ton of time in research.

478

:

And for those who don't know what

Manfruture's trend following is,

479

:

Manfruture's trend following is

an active strategy that can go

480

:

long and short, equity indices,

bonds, currencies, and commodities.

481

:

It typically uses trends.

482

:

to drive the signals when trends are

positive it'll buy when trends are

483

:

negative it'll sell and if you look at

the category what you found historically

484

:

is a really attractive return stream

from a diversification perspective it's

485

:

had very low correlation to stocks and

bonds it has exhibited positive long term

486

:

excess returns above the cash rate It's

exhibited at least, you know, going back

487

:

20, 30 years, positive returns during

large equity drawdowns and positive

488

:

returns during inflationary periods.

489

:

It's a very dynamic

strategy, very attractive.

490

:

So the question is why don't more

people have it in their portfolio?

491

:

And I would argue it is

this funding problem, right?

492

:

We all agree in this industry

that all else held equal, more

493

:

diversification is better than less.

494

:

But if we look at the average

allocator's portfolio, it typically

495

:

is just very stock and bond heavy.

496

:

And it's in my opinion, because of this

problem that to make room in a portfolio,

497

:

you have to sell those stocks and bonds.

498

:

And that lead leads to

incredible behavioral frictions.

499

:

I want to, I want to use a

chart to try to explain that.

500

:

So in the early two thousands, investors

would have loved alternatives, right?

501

:

What this chart shows is the relative

performance of, of a 50, 30, 20,

502

:

50 percent stocks, 30 percent

bonds, 20 percent managed futures.

503

:

Versus the benchmark 60 40.

504

:

And so when the line's going up, that more

diversified portfolio is outperforming.

505

:

When the line is going

down, it's underperforming.

506

:

And what you can see is that

alternatives were great for the

507

:

lost decade of equities, right?

508

:

The 2000 to 2010 ish period was

ultimately a lost equi a lost decade.

509

:

And so selling your equities and selling

your bonds to make room for a diversifier

510

:

like Managed Futures that did well

during that decade, clients loved it.

511

:

And if you were around during that

period, you'll remember everyone

512

:

was investing in EM and commodities

and making room for alternatives.

513

:

And then it was almost like the

decade flipped over and you got the

514

:

exact opposite story, which is U.

515

:

S.

516

:

stocks and bonds just went on

this perpetual bid grind up and

517

:

everything else underperformed.

518

:

on a relative basis, right?

519

:

And no surprise, alternatives were bad

for the last decade of alternatives.

520

:

So if you were selling stocks and

bonds to make room for managed futures,

521

:

this was a very painful experience.

522

:

And again, it creates this behavioral

hurdle because clients aren't

523

:

going to necessarily understand why

they have them in the portfolio.

524

:

And it's very hard for a client to

stick with 10 years of underperformance

525

:

versus something that's cheaper and

more transparent and more tax efficient.

526

:

And so, to me, it's no surprise that

by the end of the:

527

:

were increasingly narrowly focused on U.

528

:

S.

529

:

equities and U.

530

:

S.

531

:

bonds.

532

:

Rodrigo Gordillo: And I just want

to make something, I think, clear

533

:

on this chart is that what we're

not saying is that they had negative

534

:

performance during this period.

535

:

They just underperformed the 6040

to such an extent that by the end of

536

:

the period, you would have, you know,

you're, you're back to where you were

537

:

had you started investing in 2000, right?

538

:

So it's the relative performance

that's a problem here.

539

:

You're still, you know,

they're still doing positively.

540

:

They're just doing worse than a 6040.

541

:

Thank you.

542

:

Corey Hoffstein: And so this

shows up, this behavioral issue

543

:

shows up in the actual data.

544

:

This table is from Morningstar, and

what it's showing is the investment

545

:

returns versus investor returns

of different managed futures

546

:

funds from 2019 through 2022.

547

:

2022 being a great year

for managed futures.

548

:

And the investment returns like,

well, if you invested a dollar at the

549

:

beginning, took it out at the end, what

was your total return over the period?

550

:

The investor returns actually track.

551

:

Dollars coming in and out of the fund

and how the average investor performed.

552

:

And what you find looking across

the category is that the gap between

553

:

what the investment realized and what

the average dollar weighted investor

554

:

realized was over 300 basis points.

555

:

Right?

556

:

Suggesting that most investors ended

up performance chasing this investment,

557

:

getting, not being in when they needed

to be, chasing good performance, and

558

:

then ended up selling out after the

run had already commenced and they

559

:

started potentially losing money again.

560

:

Again, timing diversification

is very, very hard.

561

:

You want to just have it perpetually

embedded in your portfolio.

562

:

But the old world way of making

room makes it very hard to stick

563

:

with from a behavioral perspective.

564

:

Contrast the new world way where we are

stacking alternatives on top, right?

565

:

So what we have here is the same graph

as before, but now instead of the 50,

566

:

30, 20 relative to a 60, 40, we have

the 60, 40, 20 relative to a 60, 40.

567

:

And you can see the relative

outperformance in the

568

:

2000s, not as strong, right?

569

:

Because again, that was

a lost decade for equity.

570

:

So by selling equities and

putting in managed futures,

571

:

you got that full return gap.

572

:

Here you still hold the

equities in the:

573

:

But you do get the benefit of having

those alternatives stacked on top.

574

:

And then in the 2010s, when those

alternatives largely went sideways

575

:

and stocks and bonds went on to have

sort of the highest Sharpe ratio ever

576

:

for a 60 40 portfolio, you didn't

necessarily lag behind because you

577

:

had to make room in your portfolio

and you had that big opportunity cost.

578

:

By stacking an alternative on top that

largely went nowhere, you Your performance

579

:

of the portfolio continued to keep up

with the generic 60 40 and so you had

580

:

potentially that diversifier in place

for when:

581

:

again going to prove its worth as a

diversifier versus stocks and bonds.

582

:

And so both from a performance and a

behavioral perspective, we think that

583

:

this concept of stacking diversifiers

on top of your portfolio rather than

584

:

selling core stocks and bonds to make

room is much more sustainable and

585

:

additive from both the diversification

and potential outperformance perspective.

586

:

And so we call this more generic idea of

Portable alpha return stacking, right?

587

:

The core idea here is that we are

layering one investment on top of each

588

:

other, achieving more than a dollar

of exposure for every dollar invested.

589

:

So as an example, uh, you could stack

a hundred percent managed futures trend

590

:

following on top of a hundred percent U.

591

:

S.

592

:

equity exposure.

593

:

And what's really exciting today

is that there are a number of funds

594

:

that are available that allow you

to implement this concept, whether

595

:

you want to do return stacking.

596

:

For diversification or you want to

pursue portable alpha for excess returns.

597

:

This is now achievable to anyone,

even if they don't have access

598

:

to banks and total return swaps.

599

:

Even if you can't manage derivatives,

you can use mutual funds and

600

:

ETFs to implement this concept.

601

:

The first way is through

what we call pre stacked.

602

:

fund solutions.

603

:

So here, these are funds that are going

to give you simultaneous exposure.

604

:

When you invest a dollar, you're

going to get a dollar of some

605

:

core beta plus some exposure,

alternative exposure layered on top.

606

:

So in this example, uh, we have a 100

100 fund that's going to give you for

607

:

every dollar invested a hundred percent

exposure to bonds and then a hundred

608

:

percent exposure to some alternative.

609

:

And you can see that if you have your

strategic, Call it 50 50 portfolio,

610

:

50 percent stocks, 50 percent bonds.

611

:

If you sell say 20 percent of those

bonds and invest in this 100 100

612

:

fund, if we X ray through what

we will get back is our strategic

613

:

portfolio, the 50 50 plus a stack of

that 20 percent alternative on top.

614

:

From the investor's perspective, right?

615

:

You're still allocating a hundred

percent of your portfolio.

616

:

You're just using a fund

that implements that stack.

617

:

And so these are pre stacked

fund solutions of which there are

618

:

a variety in the market today,

both mutual funds and ETFs.

619

:

And this presumes that you're going

to want to, you have a particular

620

:

alternative you want to stack on

top, and you can find a manager that

621

:

is doing that in a pre stacked way.

622

:

And you like the way they do it.

623

:

The other option is what we call

capital efficient solutions.

624

:

So these are going to be funds that

give you simultaneous exposure to

625

:

stocks and bonds, not because you

want to stack more bonds on top

626

:

of your portfolio, but because it

allows you to get the same stock bond

627

:

allocation with less capital deployed.

628

:

So as an example, let's

say there was a fund.

629

:

That for every dollar you invest, you get

a hundred percent exposure to equities

630

:

and a hundred percent exposure to bonds.

631

:

If you were a 60 40 investor, 60 percent

stocks, 40 percent bonds, you could

632

:

sell 10 percent of your stocks, sell

10 percent of your bonds, and put 10

633

:

percent into this 100 100 portfolio.

634

:

That 10 percent in the 100 100

portfolio would give you back 10

635

:

percent stocks and 10 percent bonds.

636

:

And now you've freed up 10

percent of your portfolio.

637

:

If you put that 10 percent in T

bills, these two portfolios will

638

:

effectively return the same thing,

but now you're free to invest

639

:

that 10 percent however you want.

640

:

You could invest it in a

strategic diversifier like gold.

641

:

You could invest it in an

active investment strategy.

642

:

You could run your own tactical

views through that freed up 10%.

643

:

And so long as that thing you

invest in outperforms cash, you

644

:

will have created outperformance

versus your 60 40 benchmark, right?

645

:

No longer does the outperformance

have to come from security

646

:

selection in your stocks or

security selection in your bonds.

647

:

You can simply say I've stacked

something on top that I think

648

:

is going to outperform cash.

649

:

And if it does, over your

investment horizon, you will

650

:

have outperformed your benchmark.

651

:

So some really key takeaways here.

652

:

One, portable alpha, or what we more

generically call return stacking, allows

653

:

investors to pursue alpha in alternatives

without disrupting that core beta.

654

:

Right?

655

:

Not just without disrupting, it

allows you to go outside of the core

656

:

beta to find those sources of alpha.

657

:

Particularly those core betas that we

think are hyper efficient, that it's

658

:

just really hard to beat the market.

659

:

We believe that there are some

alternatives like managed futures, as

660

:

an example, that can offer both a source

of potential excess returns, as well

661

:

as profound diversification versus a

traditionally allocated 60 40 portfolio

662

:

or just generic stock bond portfolio.

663

:

And so return stacking is

a more generic concept.

664

:

We believe can help mitigate

the behavioral biases associated

665

:

with diversification by solving

that funding problem, right?

666

:

Instead of having to make room

in your portfolio, you can now

667

:

stack these alternatives on

top of your core allocation.

668

:

And whether you choose to pursue this

with pre stacked fund solutions, or

669

:

capital efficient strategies, both offer

practical ways for every investor today

670

:

to implement return stacking as a concept.

671

:

So with that, I want to say

thank you everyone for tuning in.

672

:

Um, we're going to turn to some Q& A,

but quickly before that, I just want

673

:

to say if you have any questions about

implementing the concepts of Portable

674

:

Alpha or return stacking in your

portfolio, you can go to returnstacked.

675

:

com.

676

:

Go to the contact page.

677

:

You can either submit a question there

if one comes up after the webinar, or you

678

:

can schedule a time to meet with our team.

679

:

They're always happy and we'll

loop all the PMs in if necessary

680

:

if you want to do a deep dive.

681

:

There's also a huge amount of content

written about not only things you can

682

:

potentially stack and the pros and

cons of stacking them, but Things like

683

:

what's the tax efficiency of stacking?

684

:

Uh, what are the risks of stacking?

685

:

Uh, what are the costs of stacking?

686

:

Different ideas for how to

make this work, both for

687

:

diversification and outperformance.

688

:

How does it work, uh,

in a retirement context?

689

:

How does it work in a growth context?

690

:

And so there's been a ton of articles

written over the last decade.

691

:

So if you are looking for particular

insights, that is a great place to start.

692

:

And with that Rod, I will turn

it back to you for some Q and A.

693

:

Rodrigo Gordillo: Great job, Corey.

694

:

That was fantastic.

695

:

Very informative.

696

:

Um, you know, I actually want to

start with something that you said

697

:

in connection to a bunch of questions

that we've had, um, when you were

698

:

discussing allocating to that stack,

to those portable alpha stacks.

699

:

The questions revolve around, you know,

what is the best way to rebalance,

700

:

uh, across and what is the best way

to time when they're underperforming?

701

:

You know, how should one think about

strategic asset allocation versus

702

:

tactical asset allocation, if at all?

703

:

Corey Hoffstein: So a lot of the

point of this stacking, right, is

704

:

to avoid the tactical in many ways.

705

:

So if we go back maybe a couple of

slides to just the generic picture, old

706

:

world versus new world, right, whatever

we're stacking on top, hopefully we

707

:

have a high confidence view that it

will generate returns in excess of

708

:

T bills over our investment horizon.

709

:

Maybe not in the short term, um,

right, because anything can happen in

710

:

the short term, but over whatever our

investment horizon is, we think it's

711

:

going to be additive to our portfolio.

712

:

And so a lot of what we're trying

to achieve here is avoiding

713

:

the need to be tactical, right?

714

:

I don't have a view as to what managed

futures are going to do over the next 3,

715

:

6, 12 months, but I have high conviction

that over the next 20 years, they're going

716

:

to generate a positive return and be a

good diversifier to my stocks and bonds.

717

:

And so I'm just going to layer

them on top of my portfolio.

718

:

This is exactly what I do in my

PA, by the way, uh, so that I don't

719

:

have to make that timing decision.

720

:

That said, it doesn't preclude people

from running tactical strategies, right?

721

:

We talked about this idea of using

capital efficiency to free up room.

722

:

You can, in theory, and I've met with

advisors and allocators who do this, who

723

:

say, when I have no view, I will just

put that freed up 10 percent of cash in T

724

:

bills, and I know I'm going to effectively

get the same return as my 60 40.

725

:

But man, I'm really worried about

inflation over the next year.

726

:

So I'm going to take some of that 10

percent and I'm going to put it in

727

:

commodities as a, as a bit of a hedge.

728

:

Or I might put a little bit

of crypto in there, right?

729

:

1%, 2 percent of the new crypto ETFs.

730

:

And then when I, when I don't

have that macroeconomic view,

731

:

I can take it off again.

732

:

And so you can use the, this concept to

express tactical bets for sure, but when

733

:

it comes to stacking the alternatives,

in my view, a lot of what we focus on

734

:

at ReturnStack Portfolio Solutions and

with our ETF suite is strategic stacks.

735

:

Rodrigo Gordillo: Excellent.

736

:

So let's, let's continue to go down

that path of When you allocate these

737

:

portable alphas and, and the risks that

are involved because, you know, we talked

738

:

about how PIMCO was around in the 1980s

doing this, it became super popular.

739

:

I think the number up to 2008

was that 25% of institutions were

740

:

using some sort of portable alpha.

741

:

Then we didn't hear about it for

a decade plus what happened that

742

:

took people's, uh, foot off the

gas, if not completely off the gas.

743

:

Corey Hoffstein: Yeah.

744

:

So I, I mentioned this idea of.

745

:

That pension, right, that said they

will never allocate portable alpha on

746

:

top of the S& P because of the risk

they always do out of the top bonds.

747

:

That was a lesson hard learned in 2008.

748

:

Doesn't mean it can't be done, by

the way, but you need to be careful.

749

:

So if we actually look at like the

picture of portable alpha, right,

750

:

where you're replacing some generic

index with some derivative, and

751

:

then you're buying an alpha source.

752

:

What happened in 2008 was, Multipart.

753

:

One, there were people who were

replacing equities with highly

754

:

levered derivatives, right?

755

:

S and p total return swaps that they

weren't having enough margin or, or

756

:

safety buffer, particularly in the case

that markets went on to fall 50%, right?

757

:

If, if markets fall 50% and you only

have a 20% margin buffer, well you're

758

:

gonna run outta capital and your

position's gonna get closed on you.

759

:

So you need the ability to

rebalance between whatever you're

760

:

porting or stacking on top.

761

:

Now a lot of what was being allocated

to were hedge fund strategies and

762

:

there was a two fold problem here.

763

:

The first was that the alpha that was

supposedly there was actually ended up

764

:

being highly correlated to equity markets

during this huge liquidity crunch.

765

:

It really wasn't diversifying alpha and

it was really liquidity risk packaged

766

:

up as alpha and then express the same

losses that happened as the equity.

767

:

So you were losing on your equities at the

same time you were losing on your alpha.

768

:

And then when these institutions went to

redeem from that, uh, hedge fund, either

769

:

that caused the losses to be greater,

creating this liquidity spiral, right?

770

:

Or the hedge funds just outright gated the

redemption, which meant they couldn't come

771

:

up with the cash to meet the margin costs.

772

:

The last part being, some of

the counterparties, right, were

773

:

banks that went bust, right?

774

:

If your counterparty was Lehman and

you had an S& P 500 total return swap,

775

:

you were left hanging saying, I don't

know where my exposure lies anymore.

776

:

And so, operationally, it was a mess from

a, from a, what was getting ported on top.

777

:

I think, candidly, things

went a little too far.

778

:

People didn't have enough scrutiny

as to what was being added.

779

:

They weren't balancing their

liquidity needs appropriately.

780

:

When you talk to people implementing

Portable Alpha today, They are mostly

781

:

focusing on liquid alternative strategies

that they can redeem very easily.

782

:

Things that they have a high

confidence are going to be

783

:

uncorrelated with stocks and bonds.

784

:

And they are trying to port on top

of assets that they don't think can

785

:

drop 50 percent in a year, right?

786

:

They're porting on their lower duration

treasury exposure, for example.

787

:

And so there's much less

risk of a margin call.

788

:

So there were some hard

lessons learned in:

789

:

I don't think it was a

knock on the concept.

790

:

I think it was a knock on

how it was implemented.

791

:

And I'll add, uh, you know, PIMCO

has been, again, doing this in some

792

:

fashion since the 1980s, had zero

problem in their implementation.

793

:

Rodrigo Gordillo: I was going

to say that, I mean, it's the

794

:

important evolution as well today.

795

:

Maybe it's not an evolution because

PIMCO has been doing it forever.

796

:

Is that when you're

looking at public products?

797

:

You are getting, you

have to be liquid, right?

798

:

You are, you are required to have

liquidity whether you're stacking

799

:

nothing or stacking something.

800

:

And the ability to manage that safety

buffer, margin buffer, isn't just about

801

:

how much safety buffer do I have, but

also can I redeem out of my alpha source

802

:

so I can manage the risk as it happens.

803

:

Uh, and then there's also the non recourse

aspect of funds that make it even more

804

:

attractive to the average investor.

805

:

So, Corey, let's talk about, let's

continue down the path of risk.

806

:

Um, we have We're stacking,

we're, we're levering.

807

:

I'm going to say the word we haven't said.

808

:

I don't think I've said that word

too much today, but we are levering.

809

:

And when people in the ETF space and

mutual fund space here of leverage,

810

:

they hear about the two times S&

P 500 ETFs, the three times bull.

811

:

And then we get into things like,

you know, the rebalancing, decay,

812

:

the, the variance decay, the double

the risk, double the exposure.

813

:

How do we think about the differences

between those two structures?

814

:

So when

815

:

Corey Hoffstein: we talk about these

pre stacked solutions, whether it's

816

:

capital efficient or your pre stacked

alternatives, how do they compare

817

:

to your traditional 2x products?

818

:

And I think what's really important

to think about here is the embedded

819

:

diversification that's happening

when you are doing the stacking.

820

:

So.

821

:

Um, on this slide, what I have is,

is the volatility of an S& P 500

822

:

fund, which has historically been

around 15, 15 and a half, versus the

823

:

volatility of a two times S& P 500 fund.

824

:

And no surprise, the two times

S& P 500 fund basically has

825

:

double the volatility, right?

826

:

And so you end up with

a very volatile product.

827

:

If you were to take the S& P 500 and

stack on top, say, generic trend following

828

:

index, like the Stock Gen CTA index,

You can't just add them together, right?

829

:

The vol of the S& P 500 is about 15.

830

:

5.

831

:

The long term vol of the Sock

Gen Trend Index is about 14.

832

:

You can't just say 15 plus 14 equals 29.

833

:

Because the way diversification

works by being uncorrelated to

834

:

each other, you actually see the

diversification of the portfolio drop.

835

:

This isn't new to anyone

who invests, right?

836

:

This is just the basic

principle of diversification.

837

:

So when you're doing this

stacking, yes, an S& P plus.

838

:

Say managed futures index type strategy

will be more volatile than the S&

839

:

P, but it's not necessarily going

to be double the volatility, right?

840

:

Because a lot of what's being traded

both long and short in that managed

841

:

futures strategy is not equity exposure.

842

:

It's bonds and currencies and commodities

that may be doing totally independent

843

:

things from what equity markets are doing.

844

:

And so when we think of that, the thing

that comes up all the time is both the

845

:

risk of the product itself, but also that

variance drag that everyone talks about.

846

:

Well, that variance drag really comes

from how volatile the product is.

847

:

And so when we go from the S&

P to two times the S& P, yes,

848

:

the return is twice as much.

849

:

But your variance is four

times as much, right?

850

:

When we go from the S& P to S& P plus

Managed Futures, your return is going

851

:

to be S& P plus Managed Futures, but

your vol isn't doubling the same way.

852

:

And so you don't get nearly the

same compounding, uh, variance drag

853

:

risks that show up in a product.

854

:

Or a concept like this, right?

855

:

And this goes back to me.

856

:

I mean, even if we just go way back to

the fundamentals of modern portfolio

857

:

theory, modern portfolio theory

always said find the most diversified

858

:

portfolio, the max sharp portfolio,

and lever it to your risk level, right?

859

:

That's effectively what portable alpha

and return stacking allow you to do.

860

:

And the reason that works is because

it allows you to really unlock

861

:

those benefits of diversification

in stacking these things on top.

862

:

Rodrigo Gordillo: Yeah, I mean, the,

the way when you, when you said returns

863

:

and, and, you know, it's four times the

variance, really, it's the returns are

864

:

the arithmetic returns, a simple addition,

like, if you're doing years, you're just

865

:

simply adding the years in a decade of

the S& P, you get a number, but that

866

:

number isn't what goes into your pocket.

867

:

It isn't the compound return.

868

:

It is the variance that defines how

much of that arithmetic return actually

869

:

goes into your pocket and the bigger the

variance, the less goes into your pocket.

870

:

So.

871

:

You know, in these concepts, when

you're doubling the S& P and quadrupling

872

:

the variance, you're getting less

in your pocket than you think.

873

:

But when you're doing a, when

you're stacking something that's

874

:

diversified, your variance drag is

significantly lower, and therefore the

875

:

stacking, the actual return stacking,

is expected to be higher, right?

876

:

Now, um, what do you think about You

know, that's the kind of top level topic.

877

:

A lot of these, um, even the non

correlated alpha sleeves that have

878

:

nothing to do with the S& P 500

sometimes lose at the same time as the

879

:

S& P or whatever beta you're using.

880

:

How should people think about how

that's going to feel, um, short term and

881

:

long term in terms of risk management?

882

:

Corey Hoffstein: Yeah, it's a

really important question, right?

883

:

Uncorrelated does not mean

negatively correlated.

884

:

Um, if we were to just stack

something that's perfectly negatively

885

:

correlated on top of the S& P.

886

:

Uh, we shouldn't expect a return

other than, you know, the risk

887

:

free rate or else you've somehow

maybe found an arbitrage, right?

888

:

So, so the point is we

have to take some risk.

889

:

Um, on average, on a, at a fund level,

right, if you have the S& P 500 plus

890

:

managed futures, that fund is going

to be more volatile and the average

891

:

drawdown is going to be bigger.

892

:

Average per year.

893

:

What you tend to find though, if

you look at historical samples

894

:

and simulations, is that the big

drawdowns Are not as bad, right?

895

:

You know, again, what zero

correlation means is not when the

896

:

S& P is down, this thing will be up.

897

:

It means when the S& P is down, it's

a coin flip as to whether the whatever

898

:

you're stacking on top is down or up.

899

:

And if it's up, it's a coin flip as

to whether this thing is down or up.

900

:

It should be totally, you get no

information about the direction this thing

901

:

is moving based on what the S& P has done.

902

:

So you get a slightly higher, um, vol.

903

:

That said, again, it goes back to

how you're spending your active risk

904

:

budget, because this isn't really

any different at the end of the day.

905

:

If you're, you know, say buying a value

fund instead of stacking something

906

:

on top of the S& P 500, well, you're

still getting the S& P 500 and then

907

:

you're getting all those active picks.

908

:

And it's possible that the S& P

goes down at the same time those

909

:

active picks underperform, right?

910

:

And so for me, you're getting much

the same concept, but I get to

911

:

choose how I spend my active risk

budget and put it into things I

912

:

have much higher conviction in.

913

:

Rodrigo Gordillo: So the um, when you

look at the stacks and that active

914

:

risk budget that you mentioned, I

think a lot of questions around like

915

:

how much, how much is a good stack?

916

:

Like what should I be

stacking at any given time?

917

:

What's, what's uh, going

to be useful or not?

918

:

You talked a little bit about

your active risk budget.

919

:

Like how should people

think about that amount?

920

:

Corey Hoffstein: Yeah.

921

:

So, so really simple math.

922

:

And then I'll tell you sort

of some practical examples.

923

:

Let's say you have something that has.

924

:

10 percent volatility that you want

to stack on top of your portfolio.

925

:

You have a 60 40 totally passive

and you stack something that

926

:

has 10 percent vol on top.

927

:

For every 10 percent stack you add,

you're creating 1 percent tracking error.

928

:

So what does that mean?

929

:

That means within a given year,

a 1 percent tracking error means

930

:

you'll be mostly plus or minus

2 percent to your benchmark.

931

:

That's the risk you're taking.

932

:

And so what I say to people is, You know

what you're stacking on top if you're

933

:

putting managed futures and gold and

you know other strategies typically

934

:

that blend is going to look like 10%.

935

:

And so if you put a 10 percent

stack on top of your generic:

936

:

you're going to be plus or minus 2%.

937

:

Does that feel good or

does that not feel good?

938

:

You put a 20 percent stack on you're

going to be plus or minus 4 percent right?

939

:

Does that feel good?

940

:

Does that not feel good?

941

:

What we tend to find in practice and

working with most allocators is that 10

942

:

percent is sort of the The minimum, unless

you have a really high vol alternative

943

:

that you're stacking on, 10 percent tends

to be the minimum to make a difference.

944

:

You start talking about getting

north of 30 percent and clients

945

:

really start to notice that their

portfolio isn't behaving like.

946

:

Generic stock bond portfolio anymore.

947

:

And so really we started to start to

put limiters on it, like the 20 percent

948

:

mark and say, you really have to be sure

your clients are super well educated.

949

:

I personally go well beyond that

limit because this is where I like

950

:

to spend all my active risk budget.

951

:

And I really like the things that I

stack on top, but I have high conviction.

952

:

Conviction cannot be rented, right?

953

:

If you're going to go that route,

you really have to believe it.

954

:

And you have to believe if you're

allocating on behalf of other people,

955

:

whether it's your fund board or.

956

:

Or your, you know, uh, clients, if you're,

if you're an advisor, that they can

957

:

actually stick with what you're doing.

958

:

And we find sort of the best approach

is somewhere around 10 to 20%, and

959

:

don't do all that with one fund.

960

:

Find three or four pre stacked

solutions or things that you can

961

:

stack on top so that none of them

are catching the investor's eye

962

:

from a line item risk perspective.

963

:

Rodrigo Gordillo: Awesome.

964

:

Um, we're a minute in.

965

:

I think there's one more important

one I think we should try and cover

966

:

quickly, which is how viable is return

stacking when it's so expensive to borrow

967

:

in a high interest rate environment?

968

:

Corey Hoffstein: Yeah, so this is a

question we get all the time, which

969

:

is, well, this idea must have been

great in the:

970

:

you were just stacking, uh, on a risk

free rate that was effectively zero.

971

:

And the answer is that we're always

trying to stack excess returns, right?

972

:

And so all we're trying to

do is say, well, what is the

973

:

return of an asset minus cash?

974

:

And people say, well, cash

is so much higher today.

975

:

Surely the return of that

asset has to be less.

976

:

And so I'll consider an

example of an alternative.

977

:

Let's say you were investing

in a managed futures fund.

978

:

Well, when you invest in that

fund, you're going to give them a

979

:

dollar and they're going to take

that dollar and put it in T bills.

980

:

And they're going to use that as

collateral to run their managed

981

:

futures trend following strategy.

982

:

So it doesn't matter whether T bills

are returning 0 or 5 or 10 or 15.

983

:

The excess return is always the

return of that active strategy.

984

:

So it doesn't matter

if rates go up or down.

985

:

And that's true whether these are

what we call cash plus alternatives.

986

:

So.

987

:

Long short equity, uh, a lot of systematic

macro strategies, managed futures, or

988

:

whether they're not cash plus, most

assets or all assets really are things

989

:

that we talk about in excess returns.

990

:

What is their return going

to be in excess of T bills?

991

:

And we generally assume every asset has

a return in excess of T bills or else

992

:

why would you bother investing in it?

993

:

Why wouldn't you just invest in cash?

994

:

And so from that perspective, the

actual level of T bills does not matter.

995

:

Um, because all we're talking

about is the excess returns.

996

:

And again, this is something we have

an article written about, uh, that

997

:

probably explains it a lot better than

I can in 30 seconds to a minute with

998

:

some nice graphical pictures, but it's

a question we receive all the time.

999

:

And we think that this concept

is just as important today.

:

01:00:15,802 --> 01:00:18,022

As it was in a zero interest

rate policy environment.

:

01:00:18,902 --> 01:00:19,572

Rodrigo Gordillo: Great stuff, Corey.

:

01:00:19,572 --> 01:00:21,282

I appreciate the answers.

:

01:00:21,352 --> 01:00:24,032

I appreciate the time and effort

you put into this presentation.

:

01:00:24,492 --> 01:00:26,942

As Corey alluded to, you

know, any questions that

:

01:00:26,972 --> 01:00:28,762

you've had, we didn't answer.

:

01:00:28,762 --> 01:00:30,412

We have answered it on the website.

:

01:00:30,412 --> 01:00:31,662

So literally go to the insights.

:

01:00:31,662 --> 01:00:31,782

com.

:

01:00:32,942 --> 01:00:33,802

Search for it.

:

01:00:33,812 --> 01:00:38,092

We'll have either talked about it in

the podcast or we have written about it.

:

01:00:38,102 --> 01:00:41,542

So, um, that is it for today.

:

01:00:41,552 --> 01:00:44,482

If anybody has any further

questions, please do reach out to us.

:

01:00:44,482 --> 01:00:48,662

Go to the contact us page on the

website, type out your answer or

:

01:00:48,662 --> 01:00:50,282

book a meeting for us to chat.

:

01:00:50,647 --> 01:00:54,127

We'll be, uh, more than glad to get

the team on it and help you out.

:

01:00:54,637 --> 01:00:58,727

Um, if you wanna, uh, look at the

other assets, other areas to get

:

01:00:58,727 --> 01:01:02,427

more information, you know, Corey's

Twitter account is always fantastic.

:

01:01:02,427 --> 01:01:05,607

See Hofstein at, uh, well, I guess, x.

:

01:01:05,797 --> 01:01:06,377

com now.

:

01:01:06,407 --> 01:01:08,007

Also, we're putting a

bunch of stuff on LinkedIn.

:

01:01:08,407 --> 01:01:09,337

I'm at rodgordop.

:

01:01:10,647 --> 01:01:13,717

Um, And, uh, same thing on LinkedIn.

:

01:01:13,857 --> 01:01:18,617

We have a podcast, uh, that we are

pushing out every now and then called

:

01:01:18,617 --> 01:01:22,767

the Get Stacked Investment Podcast,

where we've covered a lot of ground,

:

01:01:22,767 --> 01:01:27,047

a lot of contemporaneous things that

have happened, uh, a little bit of what

:

01:01:27,057 --> 01:01:29,227

happened with different stacks in July.

:

01:01:29,277 --> 01:01:33,227

And so there's, there's a depth of

knowledge there that people can, um,

:

01:01:33,267 --> 01:01:37,337

can dig into and, uh, you know, once you

start taking the red pill on this stuff,

:

01:01:37,587 --> 01:01:39,287

it's, it's really tough to go back.

:

01:01:39,287 --> 01:01:41,317

So we've done our best to try to.

:

01:01:42,622 --> 01:01:47,362

help you get all the way down the rabbit

hole, get comfort so that you can benefit

:

01:01:47,462 --> 01:01:52,192

from the things that institutions have

been benefiting for over 40 years.

:

01:01:52,712 --> 01:01:57,572

So with that, I'd like to thank

everybody and hopefully we'll see

:

01:01:57,572 --> 01:01:59,582

you again soon in the next webinar.

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About the Podcast

Resolve Riffs Investment Podcast
Welcome to ReSolve Riffs Investment Podcast, hosted by the team at ReSolve Global*, where evidence inspires confidence.
These podcasts will dig deep to uncover investment truths and life hacks you won’t find in the mainstream media, covering topics that appeal to left-brained robots, right-brained poets and everyone in between. In this show we interview deep thinkers in the world of quantitative finance such as Larry Swedroe, Meb Faber and many more, all with the goal of helping you reach excellence. Welcome to the journey.


*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.