From Bloomberg via Yahoo Finance, August 19:
A leveraged strategy for diversifying investments that crashed spectacularly in the financial crisis is back. This time, the designers say they’ve ironed out the problems.
The offering, known as portable alpha since the 1980s but recently rechristened “return stacking,” has caught on in exchange-traded funds sold by Newfound Research and ReSolve Asset Management. Cash is creeping into the ETFs billed as one-stop shops for cross-asset diversification that use borrowed money and derivatives to amp up firepower.
An example is the Return Stacked US Stocks & Managed Futures ETF (ticker RSST), a fund launched in September. For every dollar invested, the fund is designed to give a dollar’s worth of exposure to US equities. Because some of that is achieved through leverage, there’s money left over to add — or stack — another bet on top, in its case a trend-following strategy.
While the math is thorny, the core principle is that if you package up enough uncorrelated bets, it’s no sin to use leverage to juice the overall return. Creators bill them not strictly as standalone products but building blocks in even larger portfolios, boiling down multiple tasks of diversification to a single button click.
It’s the latest attempt by Wall Street to market sophisticated investment concepts to the masses. While portable alpha strategies have delivered solid risk-adjusted gains in good times, they burned pensions and endowments alike in 2008 when leveraged and illiquid wagers backfired.
Rodrigo Gordillo, president and portfolio manager of ReSolve, says the disastrous outcomes of the past were the result of too much leverage concentrated in too few bets. By stacking uncorrelated assets at a time when stocks and bonds are more inclined to move together, he expects the new breed of ETFs to better weather market rough patches.
“We focus on systematic macro as a sprinkling of tail protection and as a recognition that there’s a flaw in an equity-bond portfolio,” he said. “We want to increase stack returns, but we want to keep risk at bay. And you can do that if you’re stacking diverse things that are zigging when the underlying is zagging.”....
....MUCH MORE
As Carnegie Mellon Financial Engineering prof. Dogbert explains, we are dealing with aggregates here:
This, however, leads to a whole new set of problems that come from physically* bundling the gals into the Collateralized Cow Obligation wrapper.
They ask questions like "Does this CCO make my butt look fat" and seriously, how can you answer that without incriminating yourself?
For this reason some practitioners prefer to stick with synthetic livestock, not to be confused with....ummm..., where was I?....
"Oh, but anyway, Toto, we're home. Home! And this is my room, and you're all here. And I'm not gonna leave here ever, ever again, because I love you all, and - oh, Auntie Em - there's no place like home!"
Bingo! We redesign 1987-style portfolio insurance as an ETF, rebrand it as "Compounded Hedging", make it a bit more dynamic with some blackbox AI, patent the software (good luck), copyright the name, sell it to BlackRock and walk away with a quick hundred mil. Easy peasy.
