F-innovation

I went on Resolve Riffs with Adam Butler and Rodrigo. It was a totally free-form no prep episode. We mostly talked education and parenting stuff. There’s investing repartee on the back end.

It’s worth an evergreen reminder — The InvestResolve team did a great podcast series teaching risk-parity which is another term for diversified portfolio (it’s just that the term “risk-parity” implies the weightings depend on the volatility and cross-correlations of the portfolio components).

I published a summary a few years ago:

InvestResolve Masterclass On Risk Parity (Moontower guide)

If you are short on time focus on the first 3 parts:

• The First Question: Security selection or asset allocation
• What True Diversification Really Is And How To Maximize It
• The 2 Fundamental Drivers That Determine All Economic Regimes

I think one of the coolest aspects of these products and the education around them is what it says about the waterline of investing knowledge — it’s constantly rising. What the institutional world understands about portfolio construction trickles down to retail on a lag but it does trickle down.

The lag depends on a mix of:

• regulation (ie portfolio margining)
• complexity (advisors are the messengers of new financial innovation to most of the public although there’s plenty of asset manager blogs or even blogs like this one that reach DIY investors)
• cost (fintech can scale the some of the analytical, data, execution, and funding over large user bases)

The Return Stacked funds bring the same techniques for structuring efficient portfolios that professional fund mangers have understood for decades to retail investors.

Corey does an amazing job explaining the principles in this video interview in a simple way:

🎙️Building a 100% Stock Portfolio Using Return Stacking (Millennial Investing)

My notes:

Rethinking How Your Portfolio is Constructed

Modern Portfolio Theory tells us to find the most diversified portfolio and lever it up. AQR’s Cliff Asness showed that if you take a portfolio that looks very close to a 60-40 and lever it up 1.5 times, historically, you would’ve had a higher return and about the exact same risk as equities. They call diversification “the only free lunch in markets”. It largely is. There’s no benefit really to foregoing diversification, but often you have to use leverage to really unlock those benefits.

Most people in 100% equities know that when you go to a 60-40, you’re de-risking your portfolio — you’re selling stocks to buy bonds that are less risky. The only way a 60-40 can compete, even though it’s more diversified, over the long run is by levering it back up to the same amount of risk.

• Notes on tax efficiency
  • Equity future inefficient: because it rolls (short-term cap gain)
  • Bond future is short-term cap gain but at 60/40 vs regular t-bonds (which are state tax-exempt but normal income at fed level — really depends on investor unique situation: https://www.simplify.us/blog/can-futures-based-bond-funds-improve-tax-efficiency)
  • Remedy: ETFs and Tax advantaged accounts OR trade-off for alpha
• Leverage
  • optimal math number vs behaviorally prudent number (difference bt risk capacity and risk tolerance)
  • Leverage has bad reputation but if only if you pair it with concentration. All disasters have leverage at the scene of the crime but usually to increase a concentrated position.
  • leverage + true diversification is an unlock and really the big thing that institutional investors understand that the average investor doesn’t. That’s the key innovation here — capital-efficient exposure to leverage while diversification keeps the risk unchanged
• Fees are lower than they appear because need to normalize them to amount of risk

Finally in the spirit of retail investing strategies getting smarter, the post I wrote on Thursday is on the topic you are going to hear a lot more about using your existing portfolio to collateralize a long/short overlay enabling the possibility of generating additional alpha as well a bank of short-term tax losses which can be applied in the future to match the timing of selling your large winners.

• Tax Loss Harvesting on Levered Long/Short