Saturday, February 17, 2024

Risk Parity Meets Permanent Portfolio?

Bloomberg had a short writeup on the tough time that tail risk funds have had and reported that the Simplify Tail Risk Strategy Fund (CYA) was finally going to be liquidated at the end of the month after a shockingly bad run. 


CAOS is the Alpha Architect Tail Risk ETF and TAIL is the Cambria Tail Risk ETF. The tail risk strategy focuses on regularly buying puts as crash protection, possibly bear market protection depending on how a bear market rolls out. Where stocks go up most of the time, puts in this strategy often expire worthless so that reality creates some amount of bleed. TAIL owns puts and intermediate treasuries. It did very well in the Pandemic Crash but not so well in 2022. 

We've looked at CAOS here before. It mostly uses box spreads instead of treasuries and manages the puts in such a way to try to minimize the bleed that you see in TAIL. CAOS as a horizontal line alt that tilts upward slightly could be appealing but if the put strategy is actively managed then it seems possible that it might not own enough puts in some random market event. If that happened, it wouldn't go up in the face of crash...potentially. Box spread fund that might go up in a crash? Ok, fine but not great. I'm skeptical I guess because as I have watched the fund, I think I see a positive correlation to equities even if it is very low. Maybe it will prove me wrong in the next adverse market event. 

CYA owned several Simplify fixed income products, but now just T-bills along with weekly S&P 500 puts and it also has a VIX debit call spread on as well. The VIX spread is much larger than the SPX put positions. Maybe it was always heavy in VIX products, got that continuously wrong and that overwhelmed the rest of the fund? I'm speculating on that. Trying to build in a little VIX exposure might make sense but the current holdings are more like a lot of VIX with a few SPX puts thrown in. Regardless of whether my take is right or wrong, the fund is down 99%, did a reverse 1 for 20 split that didn't help and Bloomberg says it is closing. I've bagged on the fund a little but here, more so on Twitter.  

Blogger Nomadic Samuel wrote a post about the AQR Style Premia Alternative Fund (QSPIX) which a Morningstar 5 Star fund. It is a complex fund that at a high level goes long and short various asset classes, pairing various attributes against each other. Not sure if Sam made this graphic or if it is from AQR.


That looks simple but there are a lot of moving parts to determine cheap versus expensive or lower risk versus higher risk and so on. The carry sleeve is no doubt more involved that what I am doing below but it's fine for a blog post. I wanted to see if I could replicate some or all of the effect with far fewer moving parts.


Below is what I used to replicate QSPIX.


Obviously I didn't include commodities and maybe I didn't really include fixed income just allocating to BIL. Long the Aussie dollar, short the yen is the stereotypical carry trade, or it used to be. The huge weighting to BTAL is a proxy for shorting higher risk but not really underperformers except in a downturn. And I thought that long minimum volatility could be a proxy for going long, lower risk.

From the AQR site, QSPIX "aims to deliver attractive risk adjusted returns with low correlation to traditional stock/bond portfolios by investing in a broad and diversified range of alternative risk premia." So a core holding, I think that conceptually it could be risk parity meets the Permanent Portfolio? The fund site appears to benchmark to a 3 month T-bill index. 

It is a surprise though that the fund has a higher standard deviation than VBAIX and less return. Ten years is a good sample size. The lag can be attributed to something going wrong from mid-2018 to the end of 2021. I didn't see old quarterly reports on the site to explain what happened in those years. 

I am in no way taking a shot at the fund but I am very interested in replicating and exploring the cross market dynamics using what I think is at least part of their thought process. The portfolio I created, the yellow line, clearly wouldn't keep up with equities but it is closer to VBAIX than I would have guessed and the standard deviation is significantly lower than either fund and it never had a down year in 10. 


The year by year results are fascinating. In some years, the replication tracked very closely to QSPIX and some years it looked nothing like QSPIX. If you think the replication portfolio might be valid then you probably would have been thrilled in 2022 but in 2023 it was only up 1/4 of what VBAIX gained. This reiterates a crucial point. Whatever your idea of valid is, there will absolutely be years that try your patience and belief in what you're doing. The ten year result seems good to me but up 4.47% last year would have been difficult to sit through. 

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