Less Portable, More Alpha?

Barron's cited research from Edward McQuarrie (we looked at something else from McQuarrie in June) that tried to make the case for bonds instead of stocks. 

No. 

If you want to make a case for including bonds, ok, that's different. I would disagree but including some bonds to offset the ups and downs of 100% equities might turn out to the be the right thing. But that was not the context.  

We frequently focus on how to get the volatility muting effects that people want from bonds without taking on the risk and volatility that is now inherent in bonds with duration. As I started to frame this post out in my head I saw a reference to portable alpha somewhere. 

The most common application of portable alpha is combining beta exposures like an index fund for equities and AGG-like or treasury bond exposure for fixed income and then adding some sort of alpha (outperformance) source in such a way that usually involves leverage. Maybe a program doing this would use S&P 500 futures for equities and the leverage component, maybe actual bonds and then some sort of intended alpha source that after a lesson learned from the Financial Crisis should be uncorrelated to equities like a hedge fund or managed futures. 

Portfolio 1 is an example of success with leveraging up. It gets leverage from SSO which is 2x the S&P 500. IEF is 7-10 year treasuries and the other three are different types of alts that should maintain a low or negative correlation to equities. In real life, putting 30% in SSO and leaving it in there would be a tremendous act of faith. 

The PIMCO Stocks PLUS Long Duration (PSLDX) goes down this road with 100% exposure to both stocks and long bonds. WisdomTree Efficient Core (NTSX) came along in 2018, it's 90% stocks, 60% bonds so a 67% allocation to it equals 100% into VBAIX which leaves 33% for alpha sources/diversifiers. 

Updating the first example to include a version with PSLDX and NTSX;

All three outperformed plain vanilla 60/40 in Portfolio 4 with the PSLDX version having the best growth rate and good volatility result. The version with NTSX has lowest Sharpe Ratio of the three portable alpha portfolios but a CAGR 131 basis points ahead of plain vanilla is pretty good. 

The alts help the three versions outperform a little during adverse market events but there doesn't appear to be a ton of reliable crisis alpha.

In previous blog posts, we've looked at building these sorts of portfolio but without including bonds with duration. For the last few years bonds have of course struggled but that struggle under the hood hasn't necessarily been a problem for the backtests. At least one of the alts (managed futures in 2022 or gold last year for example) helped bail out the struggling bonds during various negative market events. 

Then I found this paper from Man Financial (I'm guessing we looked at it a couple of years ago when it was published too). Here's their take on building an institutional portable alpha portfolio.

Below, I am using AQMIX and QSPIX as proxies simply because they have long track records. Man talked about possibly doubling returns with 100/100 equities/managed futures but I couldn't recreate that. The results are interesting though. 

Moving closer to something plausible. Portfolios 3 and 4 should say 50% SSO not SPY.

All three have 50% in SSO which is the equivalent to 100% in the S&P 500 subject to any tracking issues so the portfolios are 100/50 and all three outperformed with less volatility. They all did much better in 2022 than just the S&P 500 but in the other drawdowns, the fast ones in late 2018, 2020, 2025 and 2026 they didn't help much.

The final iteration is 80/20 and I threw in 60/40 with VBAIX

They lag SPY with quite a bit less volatility. They outperform VBAIX with a little more volatility but their drawdowns have been shorter than VBIAX' which is an interesting tidbit. Is it worth it? The Sharpe Ratio and the volatility numbers suggest it probably it but ultimately that would be up to the end user. 

The bigger point is about how very sophisticated strategies can be adapted to retail sized accounts through regular brokerage accounts and the extent to which alts can help dial in volatility and add defensiveness to diversified portfolios.  

Tying back into portable alpha, I am not a fan of leveraging up to build a portfolio but I think the process we explored takes some influence from portable alpha which I am comfortable with.