Model Portfolio Enhancements Update

Here at The Italian Leather Sofa I run a Model Portfolio, an empirical summary of all the concepts around asset allocation and diversification discussed on the blog. It is a short, and hopefully understandable, recap to the “ok, but how do I apply all the theories I read on the blog?” question.

In my real-life portfolio I apply the same concepts, with “enhancements” to tackle the Model Portfolio design shortcomings:

• diversify model risk
• add redundancies
• invest in the latest strategies (basically stuff that is “new” only for retail investors) when it makes sense

Here you can find the first post I did on this topic; it has been more than a year and an update is due.

Stock + Bond

Since NTSX covers only US large caps, I (we?) want international diversification. The first iteration of my portfolio ran 60% NTSX, 30% NTSI and 10% NTSE instead of 100% NTSX.

Now we have 2 ETFs that are diversified by design at our disposal: RSSB and NTSG.

$1 of RSSB provides $1 of exposure to global equities and $1 of exposure to US Treasuries. The good is the additional leverage compared to the NTS- family, the bad is the..tracking error to the target portfolio? That’s how the fund manager explains the ETF underperformance compared to the index it tracks (net of fees).

NTSG is explained here. The gooder is that also the bond sleeve is internationally diversified, the bad is the ESG filter.

I slightly prefer NTSG to RSSB but use both in my portfolio, mainly because the additional leverage helps create space for more diversifiers.

Bonds

Talking about increasing leverage, in the bond sleeve I have added TYA, the Simplify Intermediate Term Treasury Futures Strategy ETF. TYA is basically IEF levered 2.5 times. That’s it 😉

Managed Futures

To diversify the DBMF model risk, in this sleeve I have added RSST and KMLM.

KMLM is the KraneShares Mount Lucas Managed Futures Index Strategy ETF; in its mutual fund form, this is one of the oldest managed futures strategies out there. Aside from its solid past (survivorship bias?), KMLM is attractive because it doesn’t trade equity futures by choice. While this decision can backfire, stocks generally go up and the fund would not explicitly hedge the portfolio in down markets like in 2022, it protects well at stock-market turning points…because it stays uncorrelated by design. KMLM avoids the double-whammy when a stock trend reversal would hammer both sleeves of the portfolio at the same time. It is not the “best” solution but good enough.

RSST is the Return Stacking Stock and Trend ETF. The trend model is more complex than DBMF but so far (not that long TBH) DBMF has done a better job at trending. That said, RSST has leverage: $1 of RSST provides $1 of exposure to US equities and $1 of exposure to trend. If you look at my previous update on my portfolio, there I mentioned RSBT: I simply switched to RSST because in the bond sleeve I already get leverage from TYA.

Alternative Risk Premia

FLSP is the poor man QSPIX. I drafted a post on FLSP that I never published: it is an absolute return fund that seeks to achieve its investment goal by allocating its assets across two underlying alternative investment strategies, which represent top-down and bottom-up approaches to capturing factor-based risk premia. The fund’s top-down risk premia strategy focuses on value, momentum and carry factors in taking both long and short positions across equity, fixed income, commodity and currency asset classes. The Fund’s bottom-up long/short equity strategy focuses on quality, value and momentum factors in determining whether to hold long or short positions in individual equity securities.

So far, it has made a bad impression on QSPIX. The main reason is that it targets a too low volatility level, it is really capital inefficient.

On the other side, SVIX is SVXY on steroids. I wrote about SVXY here: the basic idea is to rebalance frequently while farming the volatility risk premium. The fact that the ETF has such volatility is a plus because we can allocate a small part of the portfolio and still get a decent return. SVIX has a high correlation with the stock market, therefore I include the ETF in the equity bucket of the portfolio.

Tail Risk Protection

Jason Buck says that Tail Risk protection strategies are characterized by 3 elements, out of which you can only pick 2: convexity, bleed and surety.

• Convexity: how much the strategy returns when stocks are in a severe drawdown. The higher the convexity, the lower we have to allocate to the strategy because it creates more return for a unit of capital.
• Bleed: how much the strategy loses when markets are calm
• Surety: will the strategy deliver when markets tank?

The TAIL ETF, for example, has convexity and surety but “pays” for them with a high bleed. Along with TAIL, I use two other ETFs that mix those characteristics differently: CAOS and BTAL.

CAOS is the Alpha Architect Tail Risk ETF; in reality, AA is just the white label ETF provider, the engine of the product is managed by Arin Risk Advisors. CAOS previously existed as a mutual fund with the AVOLX ticker but unfortunately, PortfolioVisualizer doesn’t show its history anymore. CAOS has high convexity and low bleed, but the price for low bleed is not 100% surety. Think about it as market timing: the fund doesn’t offer the same level of protection all the time, it buys insurance only when the price is right (in reality, it is a mix of buying and selling insurance). Despite this, AVOLX’s price jumped when it had to jump but…will it do the same in the future?

BTAL is the AGF US Market Neutral Anti Beta Fund. BTAL’s objective is to provide a consistent negative beta exposure to the U.S. equity market. BTAL strives to achieve this objective by investing primarily in long positions in low-beta U.S. equities and short positions in high-beta U.S. equities on a dollar-neutral basis, within sectors. BTAL has high surety and low bleed, but no convexity.

The Portfolio

The gross allocations are:

• equities: 53% (5% is SVOL, the rest is split 60% US, 30% DMs, 10% EM)
• FLSP: 5%
• bonds: 36% (only Intermediate Treasuries)
• Trend: 26% (equal split of DBMF, KMLM and RSST)
• Commodities: 10% (a 60/40 split of gold via GDE and COM)
• Tail risk: 10% (2.5% TAIL, 2.5% CAOS, 5% BTAL)
• KRBN: 2% (the fun money part)

I think the allocation to bonds is too high (and also too exposed to USD paper). I might shave a couple of points and bring gold to 10%. I also want to find more space, via leverage, to introduce a 10% allocation to carry, probably a combination of RSSY and UEQC. So far, RSSY’s performance has been poor but within the margins they have shown in the white paper that introduced the ETF; will see how 2025 turns out, it might be an incredible mean-reversion opportunity…or a sucker bet 🙂

What I am reading now:

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