Opportunity Zone Funds

Hey guys. This is the post number 11, the blog post for the week ending May 11. Today we’re going to discuss Opportunity Zone Funds. What are they? Why am I interested in them? What are the pros? What are the cons? And what’s the bottom line?

An Opportunity Zone Fund is a fund that invests in and makes substantial improvements in an at-least-somewhat-undercapitalized area called an opportunity zone. The idea here is to get money to flow to areas of the country other than Silicon Valley, Wall Street, Seattle, Boston, Washington D.C. and other flourishing coastal cities, to incentivize investors to invest in places that need the money. I’m from one of those places — shout out to exit 4B — so I can tell you that God (and Andrew Yang) knows they need it. And the incentives are these:  

  1. if you keep your money invested in this area for at least ten years, then you will pay NO capital gains tax on your profits from the investment. (The other benefit here is what I like to call the illiquidity premium. To avoid capital gains, I can’t touch this investment for 10 years. Great. The more likely you mess with your investments, the more likely you are to fuck them up.)
  2. And if the money you invest is a capital gain from a prior investment, then you can defer paying that capital gain until either December 31, 2026 or until you sell the new OZ investment, whichever come first. So your money grows tax free during that time, like an IRA.
  3. And finally, you can not only defer, but reduce the taxes on that prior gain as well:  after 5 years your taxes go down by 10%, and after 7 years, they go down by an additional 5%, which means that in total 15% of that prior gain is excluded from taxation.

Knowing the history of the idea also helps in understanding it. Basically, the idea started when Facebook billionaire with a conscience Sean Parker (otherwise known as the Lord of the Rings wedding guy — God, this is a good time to be a geek) went to Tanzania and was like, fuck, this place is super poor and needs investment but I’d never invest here because it’s too risky, And then he realized that there were place in his own country that were the same way — need the investment, too risky to invest in. (“Domestic emerging markets” to use Cory Booker’s memorable phrase.) And Parker was like, what could I do to fix that? And his answer was to get the reward to outweigh the risk.

So think about this:  what if the next Facebook is located in an Opportunity Zone? Then if you invest in an OZ Fund that invests in that next Facebook, then when it blows up, your tax on your 2000x Peter Thiel-esque return will be … $0. That’s right. Tax free billions, bitches. Jeff Bezos style, but without the shady Amazon shit. Because that next Facebook should still be paying profits on its income, but you, as an early investor who had the balls/social conscience to take your talents ($) to Oakland, pay no taxes on your investment. Boom — now the potential reward is so sweet that you’re willing to take the risk and invest in American Tanzania.

In my particular case, American Tanzania appears to be the greater Phoenix metropolitan area, where my OZ fund, Virtua, has made its initial investments (although the fund plans to invest outside that area in the future). And my OZ fund is investing in real estate — hotels and apartments — not start-ups. So I’m not going to get a tax-free 2000% return. But I might, if everything goes well, get their target tax-free 14% return, and that’s not bad.

The problem here is that there aren’t that many OZ funds yet. And the ones I found that look half-way reputable, like Virtua, all invest in real estate.

That’s okay, because I’ve been looking to increase my exposure to investment real estate.  And I wanted to try an OZ fund for the tax benefit. This is the best one I could find when I made the investment in January 2019. I researched it online and talked to their sales rep several times. Read a Wall Street Journal article about them. No red flags were raised. But in retrospect, I should have done better due diligence. I should have asked for the names of some existing limited partners to talk to, and then I should have called them up to see if they were happy with the investment. Also, in the course of writing this article, I found some negative stuff about them online that either wasn’t there yet, or I just didn’t find at the time, to the effect that some clients are unhappy because they have too many projects going and aren’t great at communicating with clients. That said, nothing negative has happened to me and hopefully it won’t. You’re never going to make everyone happy all the time, and hopefully the negative stuff I found is the exception, not the rule.  

Anyway, I went with Virtua. But new OZ funds are coming up all the time because there are literally opportunity zones in every state. For example, another fund I seriously considered is offered by Fundrise (a crowd-funding real estate platform I’ve invested with before, but not in their OZ fund). And here is one, The Pearl Fund, that goes where the real potential is — start-ups that just happen to be located in an opportunity zone. See prior best case tax free Facebook IPO. But the minimum investment is very high — $250,000 — and who knows if they are legit? I would have to do some serious due diligence before putting that kind of money in.

So, to sum up.

  • Pros:  potential major tax reduction; potential diversification; lack of liquidity.
  • Cons:  physical area of investment may be riskier than prime real estate; not many opportunity zone funds to choose from yet, but more all the time.
  • Bottom line:  no risk, no reward. I invested in Virtua’s OZ fund. Too soon to know whether that was the right call. I’ll let you know in 10 years. But whether I picked the right one or not, I am confident that OZ funds are a good idea — the trick is to find the right one.

Acorns: Do They Really Grow Into Trees? Or Do They Just Die?


So let’s talk about a little app I’ve been using for a bit. It’s called Acorns. And what it does is, it rounds up your purchases to the nearest dollar and then invests the difference. So, for example, my car was in the shop recently and I walked down from the garage to a nearby coffee shop (Dancing Goats — highly recommend) and had breakfast. The bill came to $7.02. Acorns rounded up to 8 bucks and took the 98 cent difference and put it aside to be invested. When these round-ups total $5, the app invests them for you.

I’ve been using Acorns for two months. Not long, but long enough to form an opinion.

Let me give you the bad news first. There is some stuff I don’t like about the app.

First of all, investment performance has been mediocre. In the two months I’ve been using this thing, my investments are up +2.75%. Which is problematic, because I’m in their Aggressive allocation, which has me 100% in equities. For a 100% equity portfolio, my benchmark is the market, the S&P 500 index, which is up 5.06% in that same time span. So, admittedly small sample size, but in that period Acorn’s portfolio is underperforming the market by -2.31%.

Second, I don’t love a couple of the funds in the portfolio. Acorns has me in VOO, which is Vanguard’s market-cap weighted S&P 500 ETF. This is not a bad choice. It’s cheap exposure to the market. But I prefer equally weighted exposure, not market-cap weighted, because equal weighting has delivered outperformance over long time periods because of its increased exposure to the smaller, cheaper companies in the market.  I would rather Acorns gave me S&P 500 exposure via the equally-weighted RSP ETF, but, alas, that’s not an option. In addition, Acorns gives me domestic small cap exposure via Vanguard’s VB ETF. The problem here is that VB has no quality filter. Small companies tend to outperform big ones over time, because some of those small companies become big ones, but that only works if you can screen out the shitty small companies that are likely to remain small forever. Because they suck. One way to do this is to combine small with profitable, which is what IJR does. Or to combine small with low-volatility, which is what XSLV does. But in Acorns, you take what they give you, and they only give you VB.  

Now for the good news. There’s a lot I do like about Acorns.

First of all, it uses all Vanguard funds, at least in its equity allocations, which is what I have. And Vanguard is the gold standard. Because it’s cheap, highly liquid, and broadly diversified (even within a given asset class, it holds a lot of stuff, minimizing single company risk). And it’s owned by its shareholders, i.e. by you and me, so it’s less likely to fuck us.

Second, it forces me to save. Those automatic round-ups every time I use my Discover card add up over time. Specifically, for the average Acorns user, they add up to $30/month. And it also made it easy for me to invest an extra $25/week from my checking account. I knew I was supposed to be doing this before Acorns, but I wasn’t. Now I am.  And that shit adds up. My account is projected to be worth $376,972 when I die right on schedule at age 90 in 45 years. That’s real money. It’s real money my wife and kids will have that they wouldn’t have had otherwise. That means a lot.

The bottom line is:  I recommend Acorns. Because it will help you save and it will invest your savings in a reasonable way. Which means years from now you’ll have a fuck ton of money you wouldn’t have had otherwise. That’s legit.

If you want to give Acorns a try, here’s my referral link. https://www.acorns.com/invite/R8L879  (Full disclosure:  use the link, and Acorns will send me a little bit of money as a thank you. So thank you.)

Honoring Jack Bogle Via FeeX


You probably know that Jack Bogle, the founder of Vanguard, died recently. Vanguard was really the creator of the low cost index fund, which made it possible for the retail investor to outperform most active managers over time. So, in honor of Bogle, let’s review my current holdings and sell any expensive stuff, switching to cheaper, better alternatives where possible.

The website that lets you do this is FeeX. This is some good shit right here. You can set your parameters and then the site will find you funds that meet your parameters. So, for example, I told the site I wanted only ETFs, because they tend to be cheaper than mutual funds and they also save you money on taxes. I told it I wanted 85% or more similarity to my existing funds. And I wanted better overall past performance than my existing funds.

The first recommendation was to switch from the Spyder S&P Fossil Fuel Reserves Free ETF (SPYX) to the SPDR portfolio large cap ETF (SPLG). This would mean going from a .2% expense ratio to a .03% expense ratio, but still maintaining 96% similar content of the ETF. And there is better overall past performance. 1 year -2.32% vs -1.86%. 3 year 14.08% vs 14.18%. But FeeX gives you alternatives, too. One alternative that I may wish to consider for better small and midcap exposure, is the Ishares Core S&P Total US Stock Market ETF (ITOT), with .03% expense ratio, 95% similarity of assets, and -2.27% 1 year, and 14.19% annualized 3 year performance.

ITOT has .81% micro cap, 4.7% small cap, 15.15% mid cap, and 79.27% large cap exposure, versus 0% micro, 0% small, .75% mid, and 99.25% large cap for SPLG. To the extent you believe, as I do, that small cap tends to outperform large cap over sufficiently long time periods, then you prefer ITOT.

The irony, of course, is that neither of these is a Vanguard fund and this is a Bogle post. The Vanguard alternative, VTI, is more expensive than ITOT. .04% versus .03% expense ratio. Is that extra .01% justified by performance? VTI has -2.18% 1 year return and 14.24% 3 year return. ITOT has -2.27% 1 year, and 14.19% 3 year return. OOOH! Looks like Vanguard outperforms the extra cost! Now, now I can really honor Bogle.

But wait! What about the size exposures of the Vanguard funds versus the iShares fund? VTI is .77% micro cap, 4.5% small cap, 15.10% mid cap, and 79.57% large cap, versus .81% micro, 4.7% small, 15.15% mid, and 79.27% large for ITOT. So, Vanguard has ever-so-slightly less micro, small, and mid cap exposure, and ever-so-slightly more large cap exposure than its iShares competitor. Meh. Not a significant difference. Switching to VTI. Plus, VTI is etf.com’s “analyst pick” for broad U.S. equity exposure.

The other fund that FeeX recommends I switch out of in my TD account is VWO, Vanguard’s emerging market ETF. The State Street equivalent, SPEM, is cheaper (.11% versus .14%) with better performance (-13.62% one, 14.75% three, 5.26% five, and 9.8% ten year returns for SPEM, versus -14.49% one year, 13.14% three year, 4.56% five, and 9.29% ten year returns for VWO). So I’ll be switching from VWO to SPEM. You win some, you lose some, Vanguard. But the Vanguard founder’s general insight remains, I think, true:  keep fees low AND reduce concentration risk by using cheap, liquid, diversified funds.

Any other recommended switches? Yes! Parnassus Endeavor! Now this one is a little sad for me, because this was one of my favorite mutual funds. Outperformed the market for years. But its manager, Jerome Dodson, retired, and the new guy isn’t as good. Performance has suffered lately. So I’m happy to see some suggested replacements. First two suggestons are large cap growth funds, one from Schwab and one from Vanguard. I’m rejecting both of these because large growth is a poor bet over the long haul. Too high expectations because of the growth tilt, without the upside potential of small cap. This leaves me with the Invesco S&P 500 Momentum fund, SPMO. Momentum is a proven factor, per the academics, with long-term tendency to beat the market. Liquidity is a concern because the fund has only $60 million assets under management, but I’m going to be buying and holding this, so eff it. And Invesco is a local Atlanta company, so I’d like to support them. I’ll be saving significantly on expense ratio, going from .92% down to .13%. And I’ll get better performance:  going from -8.28% to .64% over the past year and from 15.35% to 15.52% over the past 3 years (less of a difference, but that’s because Dodson was the manager for 2 of those years, and like I said he’s gone now so I expect the big difference over the past year is more indicative of what to expect going forward). So, yeah, SPMO it is.

The real point is this:  FeeX is legit. Use it. And go back and revisit and keep using it every so often. Jack Bogle would approve.

2018 Investment Retrospective: TAIL Risk Portfolio Insurance? Did It Work?

When last we looked at my investment in Cambria’s TAIL ETF, it made me look dumb. In late October of 2018, it was down 6.43% while the larger market was up 2.55%. So it was underperforming by 8.98%.

All that reversed in December. The S&P swooned, dropping into a bear market, defined as a 20% decline from the previous high. And TAIL soared, just as it was supposed to do when the S&P dropped. By the close of 2018, TAIL was up for 2.33% for the year, while the S&P, as captured by Vanguard’s VOO ETF, was down 4.42%. The portfolio insurance paid off, outperforming the market by 6.75%.

The market has rallied some this year, and TAIL has concomitantly fallen. That’s okay. Bridgewater’s Ray Dalio, who I respect the hell out of, thinks a recession will come in 2020. 48.6% of CFO’s think it will come in 2019; 82% expect the recession by 2020. But this isn’t an exact science. We know the market is in the late stages of the cycle, and many experts are expecting a recession in either 2019 or 2020, but no one can pinpoint the onset. So I will keep my portfolio insurance and it will be there when I need it. In the meantime, it enables me to remain fully invested and reap whatever gains remain before the cycle ends.

2018 Investment Retrospective: Bitwise 10 Cryptocurrency Index

The Bitwise 10 Private Index Fund is a cryptocurrency index fund. It invests in the top 10 cryptocurrencies by market cap. My investment was down 66.62% in 2018. Should I sell, hold steady, or buy more?

Let’s review what the investment is and why I made it to begin with.

Crypto:  Store of Value; Form of Payment (especially across borders); and Programmable Money (i.e. Smart Contracts)

There are three basic use cases for crypto, to my mind:  store of value; cross-border payments; and smart contracts.

Store of value means bitcoin as digital gold. The idea is that bitcoin replaces, or at least steals market share from, gold, as a store of value. Gold has value because we say it does. Bitcoin also has value if we say it does. Why bitcoin? Because it is the largest and oldest crypto, with the best name recognition — and these are all reasons why we — humanity — ascribe value to it. Why bitcoin over gold? Supply and demand and portability. The new supply of bitcoin is, per the software, supposed to slow down over time and then max out, reach a ceiling. It should then increase in value because they’re not making any more of it. The problem is that bitcoin keeps forking, splitting off into new variants. Each new variant increases the supply. In other words, they are making more of it, they’re just giving it a different name, like “Bitcoin Cash” or “Bitcoin Gold”. Still, these variants have not really caught on to a huge extent, so it may be that the limited supply thesis still holds, just that the supply isn’t quite as limited as it was supposed to be. Portability seems obvious — it is easier to transport ones and zeros rather than gold bullion. Bitwise claims that the market is huge, that if bitcoin replaces gold as a store of value, then each bitcoin will be worth over $400,000, which would obviously be awesome in comparison to bitcoin’s current worth of $3,622. Will that happen? Who knows?

Cross-border payments seeks to solve the problem of moving money from one currency into another more quickly and more cheaply. As someone who still has Argentinean dollars jammed into his top drawer from his honeymoon six years ago, I can attest that this is a real problem and I like the idea of solving it. This is what Ripple and Stellar/Lumens are trying to do. Will they succeed? Can they disrupt Western Union and Swift? Who knows? They have some big partners — foreign banks, IBM — but they haven’t reached critical mass yet.

Smart contracts gets into the realm of ethereum and its competitors. The idea is that the money itself is programmable — it will go to Joe if he does x, per the contract. Somehow, the software knows if Joe fulfilled the contract. Do I understand this? No, I do not. This is some super sci fi shit. But ethereum was the number 2 crypto by market cap for quite a while, so maybe there is something to it. Is this real? Is it crap? Will it become real? Who the fuck knows?

So I called my old college buddy Sung Hu, who has worked in Silicon Valley for years, first for a major search engine, then a major social network, now a fin tech startup. I said “Hoss, what’s up with this crypto shit? Is it real?” And he said “No idea. Let me ask around and I’ll get back to you.” So he asked around, and he got back to me, and he said, “The software engineers I’ve talked to say it’s real, but which particular crypto will survive and which will fade away, no one knows.”

So, assuming that crypto will survive, then how to invest in it? That leads to our next topic.

Indexing versus Picking Coins

I don’t know which particular types of crypto will survive. So I want to own a bunch of them. I want an index. The Bitwise 10 holds the top 10 cryptos, weighted by market cap. So, by owning this index, I own about 85% of the value of the crypto market. By owning only the top 10, I avoid all the bullshit initial coin offerings. No Dogecoin. No Tron. This protects me from scams.

And I want a fluid index. The Bitwise 10 reconstitutes monthly. So as a coin gets widespread adoption, I get exposure to it. Maybe I’m wrong about Tron being bullshit. Okay, if Tron reaches the top 10, then I’ll get exposure to it, and the amount of exposure will be proportional to its success. This is, in a sense, a poor man’s trend-following, which is good because trend-following limits risk. You can see that in a lot of asset classes over a lot of time periods. And I saw it myself when I was trading crypto.

Buy and Hold versus Trend Following

During the last crypto bull market, I used trend following to cash out before the shit truly hit the fan, more than tripling my investment. The problem was that it was really difficult to do, logistically. Security is an issue because exchanges get hacked fairly frequently. So, I had to buy flash drives and keep them in a safe deposit box and drive to the bank when I wanted to make a withdrawal and drive back afterwards and I lost a flash drive for several weeks and thought I had essentially dropped thousands of dollars in an airport parking lot but then I found it the flash drive hidden too well by me in my house, thank god, but still, the stress. So, security was an issue and liquidity was an issue. And the market in crypto trades literally 24/7 so I had to monitor it every day all day and all night. Crazy-making.

The Bitwise 10 avoids all that. Buy and hold protects me against myself and against the crazy stress.

Crypto and Climate Change

One legit criticism of crypto is that it uses a fuck ton of electricity. As long as that electricity is generated from fossil fuels, then, crypto contributes to climate change, which is literally killing people. I deal with this by buying carbon offsets and putting solar panels on my house and supporting a Green New Deal. It’s not a perfect solution, not even close. Climate change requires societal change and I support that change because I want my kids and potential grandkids to have a decent planet to live on. But in the meantime, I have to make investment decisions based on the world as it is.

Correlation

Crypto is uncorrelated with the equity markets. This makes it a good diversifier for my main portfolio. Of course, lack of correlation is not enough. An uncorrelated investment that sucks still sucks. We’re looking for uncorrelated good investments, those that make money independent of other investments that are also making money. Crypto has done that over some significant time periods, measured in years. Will it continue to do so? Who the hell knows? I hope so.

The other thing I can tell you is that if you look at the charts, Bitcoin is highly correlated with the rest of the crypto market. So, one way to play this would be to just trade Bitcoin. You would gain in ease of trading, although you would lose something in diversification.

Conclusion

So, should I buy more? Be greedy when others are fearful, they say. And when I take those risk tolerance surveys, they say, what would you do if the market dropped 50%? And I say, I would invest more. So I should put my money where my mouth is. Finally, there is at least some reason to believe that some smart money is investing in crypto:  university endowments, including Yale, for example.

For all these reasons, I will increase my investment in cryptocurrencies by an additional 10%. That should be enough to move the needle a bit if crypto rallies, but without causing me to change my lifestyle if it goes to zero.

2018 Investments Retrospective: Allocate Smartly

First of all, let me apologize for not having posted in a while. I got caught up in a very time-consuming real estate deal that ultimately fell apart. And then I went on a family vacation to Maine for a week in which I got in some serious bonding, eating, drinking, game-playing, hot-tubing, sledding, and snowman-making, but no writing. And I know some of you (Hi Craig!) noticed the lack of updates to the blog.

But it’s a new year and we’re getting back on track with at least 1 blog post per week.

I thought we’d do a retrospective. Review how my investments performed in 2018 and see what we can learn to improve investment performance in 2019.

Let’s begin with Allocate Smartly. This portfolio was up .32% in 2018. So, essentially flat. Compare that to “the market”, the S&P 500, as represented by perhaps the largest and most liquid S&P 500 ETF, SPY, which was down 5.24% over the same time period. To my mind, this goes to the value of the downside protection conferred by a tactical asset allocation (TAA) strategy. In a year in which the market lost money, my TAA strategy held its value and even gained a bit.

Now, what could I have done better with this investment? 2 possibilities come to mind. The first we’ll call strategy selection. The second we’ll call implementation.

Could I have selected a better TAA strategy? I certainly could have picked one that performed better in 2018. The top performing TAA strategy tracked by Allocate Smartly was the Vigilant Asset Allocation (Vigilant). Vigilant earned 11.32%. In a year in which the market was down 5%, Vigilant was up 11%. I’m no math surgeon, but that’s a +16% difference. That’s awesome.

Now, I’ve always like Vigilant because it uses market breadth as an indicator, which I think makes sense in an increasingly globalized world in which everything is connected. So my custom portfolio has been 50% Vigilant. But I am also 20% allocated to Ray Dalio’s All-Weather strategy, which was down 2.88% in 2018; 10% to Accelerating Dual Momentum, which was up 4.3%; and 20% to Keuning’s Generalized Protective Momentum, which was up 4.15%. Should I increase my allocation to Vigilant?

I think not, because only 20% of my portfolio was allocated to a strategy that lost money in 2018. 30% of my portfolio was allocated to strategies that gained over 4%. 50% was allocated to Vigilant, which gained 11%? So why was my portfolio essentially flat?

I think because of the tranching. This is a fancy word for dollar cost averaging a strategy, for implementing it via multiple trading days to cut risk. I did this by trading the Vigilant strategy once a week, or 4 times a month. But the strategy is really designed to trade only once per month, specifically at the end of the month. And the authors of the strategy discuss, in their paper, that by doing so they may avoid “flash crashes”. The argument in favor of tranching is that you diversify across time, thereby further minimizing risk. But in 2018 at least, that diversification hurt performance. It was an example of what Wes Gray calls “diworsification”, where you hurt performance by diversifying into bad (or at least worse) ideas.

Nonetheless, when I get rid of the tranching, performance declines in the backtest. Going back to 1990, the strategy with tranching earns 12.5% annualized with a -7.7% max drawdown, for an Ulcer Performance Index score of 5.21, whereas without tranching, the same strategy does slightly worse, earning 12.4% annualized with -8.7% max drawdown for a 3.98 Ulcer score. Still good (compared to the traditional 60/40 benchmark which earns 8.3% with a -29.5% max drawdown for an Ulcer of only .91), but not quite as good, with more risk.

But I gotta do something, right? So I’m going to play with how much I tranche, and when. And lo and behold, if I decrease from 20% All-Weather to only 10% All-Weather, and increase my day 7 tranche from 10% to 20%, I get a slight increase in return (from 12.5% to 13.1%) AND a slight decrease in risk (from -7.7% max drawdown to -6.9%). So yeah, I’ll go with that.

And as for the second category, implementation, I’m going to make a vow to just to what my TAA strategy tells me to do in my big portfolio. With the exception of portfolio insurance through the tail risk fund (which has been killing it lately) I’m not going to try to improve it. When I have good investment ideas that don’t fit into this strategy, I’ll implement them via my “play money” portfolios at Fidelity or Merrill Edge. But in my main portfolio, I’m not going to fuck with shit. By doing so, I’ll minimize the effect of erroneous intuitions. And I’ll free time up for other endeavors.

Alpha Architect

Jack Vogel knows all about factor investing. Has an undergraduate degree in math, summa cum laude, (from Scranton, but still), and a master’s in math and a PhD in finance, both from Drexel. Knows all the academic stuff about factors. At least, knows a lot more about it than I am ever likely to. (Vogel is also the guy who delivered the funniest line I’ve ever heard in an investing podcast. When asked what factor he most resembles, Vogel said, “Low vol. Because I have the same thing for lunch everyday.” This guy is my hero.)

And Wes Gray was his professor. Gray has a PhD in finance from the esteemed University of Chicago, where he studied under Nobel-prize winner Eugene Fama. And Fama won the Nobel prize for, essentially, inventing factor investing. (What a lineage, in a martial arts master sort of way. Somebody should now be crane-kicked in the balls.)

Gray has written several books. I own three of them — DIY Financial Advisor, Quantitative Value, and Quantitative Momentum — and have actually read two out of the three. They are heavily footnoted and intelligently argued. They translate the social scientific literature into the language of the (hopefully halfway bright) layman.

So, not surprisingly, factor investing is what Alpha Architect does. Specifically, they do what Gray’s books advise everyone to do. Invest in concentrated portfolios of value and momentum stocks, here and abroad, with a trend-following overlay. So let’s unpack that.

Value stocks outperform the market over long time periods. Now, it’s probably true that value is dead among large cap stocks, but Alpha Architect’s value ETFs, QVAL and IVAL, have mostly mid-cap and small-cap stocks. QVAL is 52% midcap and 7% small cap, although it is 41% large cap. IVAL is 50% mid and 12% small.

Momentum stocks outperform the market over long time periods.

Value and momentum are relatively uncorrelated. Specifically, there is a .53 correlation.

There are only so many good investments out there. Shit, there are only so many publicly traded stocks out there — the number of public companies on the U.S. stock exchange has gone down pretty dramatically over recent years. You can spread yourself too thin, to the point where you’ve diversified into bad ideas and you lose the value and momentum edges and end up with something that looks almost exactly like the market you’re trying to beat. So, you have to limit the number of stocks in your portfolio. To how many? Well, the Parnassus Endeavor beat the market for years, and Dodson limited his fund to like 40 stocks (32 currently), so that seems like a good model to follow. And that sort of concentration is what Gray and Vogel do with their ETFs. Currently all their ETFs have 41-51 stocks. Independently arriving at similar conclusions is always a good indicator that the conclusion is reasonable.

Trend-following offers downside protection. Alpha Architect’s backtests indicate that trend-following of the sort practiced by Alpha Architect can reduce max drawdown from 50% to 26% in the domestic equity market, with even better performance internationally. Independent backtests by AllocateSmartly confirm that the trend-following has worked historically. -12% to -15% max drawdown depending on how aggressive a variant of the strategy you use, compared to -29.5% for a 60/40 equities/bond portfolio over the same time period. There is also a logical behavioral finance explanation posited by Alpha Architect as underlying the backtest:  investors overreact to bad news and their risk tolerance goes down as bad shit keeps happening, so they overreact even more.

Does it work? Sometimes. Their international value ETF, IVAL, was recently the best performing fund in its class over a one year period. Will Alpha Architect’’s stuff work over the long term? Time will tell. The science behind the strategies seems relatively strong. But then you have to execute, and continue executing. And even if you do, there is always the potential for periods of underperformance that every strategy has by virtue of being different. And we are underperforming now. The S&P is up .61% year to date, but VMOT is down 11.87%.

And what about the March For The Fallen? Is it a promotional device? Sure. The research indicates that suffering together in pursuit of a goal creates ties that bond people to one another. If you wanted to get your employees to stick together and not jump ship the next time a seemingly-better offer comes along, marching 28 miles with 35 pound packs on your shoulders is a good way to do it. And if you want your investors to stick with you during periods of underperformance, well, this is a good way to achieve that, too. But these aren’t negatives. These are reasons why the March is a smart, evidence-based use of time for the Alpha Architect guys. Which, of course, is what they aspire to do with their investments as well. Does one imply the other? Not really, but it doesn’t hurt. And as for me, as someone who did the March this year, does it reveal something about these guys that gives me more confidence in them as investors? Yes. The March isn’t easy. It requires grit. And grit is something I want in my portfolio managers. Because it implies they won’t give up easy. And that they will deal with reality, not ignore it and not magic think it away. I doubt Bernie Madoff every marched 28 miles through the hills with a heavy pack.

Am I putting my money where my mouth is? Yes. I invested $160,000. I’m down $19,000, or 12%. But I’m staying the course. Because I believe in the research behind their investments, I believe these guys are capable of executing on that research, and I’m too stubborn to quit.

Roofstock

Roofstock is a company that allows you to purchase rental properties. So what, you ask? So is my local realtor. What makes you so great, Roofstock?

I don’t know that Roofstock is so great. But if they are, they are great for a few reasons.

First, they may offer geographic diversity. For example, I live in Atlanta. If I want to buy a rental property in Atlanta, then I can find a local realtor who is recommended by friends and I can ask them to help me find a suitable single-family house to buy. But what if I want to diversify my real estate portfolio by buying a property in Milwaukee? I can do that with Roofstock. And they are in a variety of attractive markets:  Pittsburgh, Minneapolis-St. Paul, Cleveland. These are some of the best cities in the country to buy a home, as measured by price-to-rent ratio.

Second, they connect you with local property management companies. This is key because it would be difficult if not impossible for me to be screening renters, collecting rent, and hiring and monitoring repairmen from across the country.

Third, their properties are inspected before they hit the marketplace. So you can see, for example, ok if I buy this house the heating and air conditioning system only has 2-3 years left on it so I better anticipate putting in another $5,000 to $9,000 for a new system sometime within the next few years.

What kind of return can I get with Roofstock? They have 367 properties for sale right now. Sorted by annual return, the top 25 homes promote returns ranging from 13.7% to 8.8% per year. Compared to the expected rate of return of the highly valued U.S. stock market going forward of 2.6% per year for the next 10 years before inflation (0% after inflation), that looks pretty good.

You can also analyze real estate by cap rate. This is net operating income in year one divided by purchase price. It does not take into account the cost of any loans you get to buy the property. Per Mashvisor, a good cap rate is from 8-12%. Per Nolo, 4% to 10%. The top 50 homes for sale on Roofstock, sorted by cap rate, offer cap rates of 7.5% to 13.4%. That is good.

So those are the pros. What are the cons?

Well, they only have 367 properties for sale total. That’s everything on their platform nationwide. That is a minute fraction of the single family rental home market. Hell, there are at least 2,633 homes of at least 3 bedrooms for sale in Milwaukee alone right now, per Zillow. So, the chances of hitting a primo location seem fairly small to me. The sample size is very limited.

I’m not ready to use Roofstock just yet. I want to use a real estate agent and see if they can find me a better investment property. I’m not in a hurry, so why not give a realtor a shot? If they find me a better investment, great. If not, I can always come back to Roofstock.

AllocateSmartly

So let’s talk about Allocate Smartly. Bottom line:  I love this shit. Let’s talk about why.

Tactical Asset Allocation

You guys remember Hedgeable? Probably not, because they never really caught on from an assets under management perspective, and effectively closed up shop recently. But they were my favorite robo-advisor while they lasted. And the reason they were my favorite robo advisor is that they were the only one that I knew of that focused on downside protection. They had super secret proprietary indicators that would react to increasing risk of a bear market by moving more and more of your portfolio to cash as the risk of a bear market increased. They launched in 2009, shortly after the great financial crisis, and their claim to fame was that their secret sauce would enable you to avoid huge drawdowns like the -55% that the S&P dropped in 2008. Their problem was that you pay a price to hedge. During a bull market, your performance — best case scenario — is that market rise minus the price of your hedge. Well, from the time Hedgeable launched, it’s been nothing but bull market. So, Hedgeable’s performance suffered in comparison to that of other robo-advisors like Betterment and Wealthfront, which were less focused on hedging, and so they never got the clients that their competitors did, and so eventually they had to close shop.

RIP Hedgeable. I will always remember fondly the stuffed hedgehog mascot you sent me for being one of your (lamentably few) customers, and the fact that you called your representatives “ninjas” as opposed to the industry-standard “advisors”.

You guys know about Churchill? No, not the old british bulldog — the registered investment advisory (RIA) in Los Angeles helmed by Fred Fern. Churchill did Hedgeable one better. It was already in business during the Great Financial Crisis, had been in business for years, and in 2008 when the S&P dropped 55%, Churchill’s tactical strategy, its flagship portfolio, didn’t drop at all. Whoa. That caught my eye, and I became a Churchill client. And they did fine by me. No complaints. Made me some money. Their tactical strategy lagged the market while I was with them — again, hedging has its price during a bull market. At a minimum, that price is time out of the market as the market moves up, because no indicator of a bear market is 100%. But their other fully invested strategies, a value portfolio and a dividend portfolio, did fine. That said, I was paying them .9% of my assets under management per year in fees — a reasonable price as RIAs go, but not nothing. And certainly more than I was paying Hedgeable, which I think was .75%.

Which brings us to AllocateSmartly. Which is nothing, in fees. Effectively nothing. $30 a month, which is $360 a year, which on a $1 million dollar account, equates to .036% per year in fees. .036% AllocateSmartly versus .75% Hedgeable versus .9% Churchill.

Well, if nothing else, it’s cheaper.

But it’s also better. Because what AllocateSmartly does is pull back the curtain. It gives you access to 45 (as of this date) published tactical asset allocation strategies. It compares them in a variety of relevant ways. And it lets you combine them however you think best. Whereas, with Hedgeable and Churchill, it was a black box. You got their strategy, and their strategy only, and they weren’t telling you what it was or how it worked or how it compared to other tactical asset allocation strategies.

Multiple Strategies

We’re talking 45 strategies! That’s a lot! And they come in different flavors too. You got your four seasons strategies, like Dalio’s All Weather and Browne’s Permanent Portfolio, built to endure all market conditions. You got your portfolio optimization strategies, like Max Sharpe and Max Diversification and Equal Risk Contribution. You got your Momentum and Trend strategies, like Vigilant Asset Allocation and Defensive Asset Allocation and Generalized Protective Momentum. And you got the mother of all combo strategies like AllocateSmartly’s Meta, which is their example of what they think is the best way to combine all the other strategies.

Relevant Comparisons

You can compare all strategies going back 20 years. Some have a longer track record, but all the ones they track have at least a 20 year track record. 20 years of apples to apples. 20 years that includes the Great Financial Crisis. That’s pretty good. That’s a sufficient sample size to be meaningful.

And they’ve got comps you care about. Annual return? The best strategy is Accelerating Dual Momentum — 15.5% per year. Lowest Drawdown? Protective Asset Allocation, with a -6.7% maximum drawdown. Shortest drawdown? Protective Asset Allocation again, with 16 months. Best Sortino ratio (which is one of my favorite metrics because it measures historical return relative to downside volatility, i.e. it doesn’t penalize a strategy for upside volatility, aka making money, unlike Sharpe ratio)? Vigilant Asset Allocation Aggressive, at 2.21. Best Ulcer Performance Index (measure of a strategy’s historical return relative to the length and depth of drawdowns)? Adaptive Asset Allocation at 3.95.

They have a correlation matrix! If we’re ever going to find the Grail, we need correlations. Well, we’ve got ‘em here. This is incredibly helpful in combining strategies, because it enables you to combine high-performing relatively uncorrelated strategies. Which gives you a shot at a portfolio that performs well in lots of different environments. For example, maybe you think UPI is the most important metric. So you definitely want Adaptive Asset Allocation, which has the highest UPI. But what should you combine it with, if you want to diversify away some risk? Well, Vigilant Asset Allocation Aggressive is a high performing strategy that is .52 correlated, whereas the Meta strategy is another high performer that is .80 correlated. So you would want to go with Vigilant because it less correlated with Adaptive.

They have a tax analysis. Which strategy takes the biggest percentage of gains as long term capital gains, which are taxed at the lowest rate? It’s Philosophical Economics’ Growth-Trend Timing at 89%. This is very relevant for taxable accounts, because you can only eat your returns after fees and taxes.

Summary

Alright folks, that’s all the time I’ve got this week. I need to take my 2 year old to meet her favorite author, Kate DiCamillo of Mercy Watson pig book fame. I hope you’ve found this information relevant. If you want to invest in such a way as to focus on downside protection, I hope I’ve convinced you that AllocateSmartly can help.