New Whitepaper by Newfound Research on Tactical Fixed Income

Newfound Research has a new (or revised) whitepaper out on the concept of tactical fixed income.  Ignore for the moment that their mutual fund that expresses this idea is down > 5% since the beginning of 2015 (expected yield is around 3%), I think that what they are trying to say about risk-managed systematic investing in fixed income is worth listening to.

Why important? Because many prognosticators from CNBC to McKinsey to econoblogosphere bloggers to major banks and brokers to retirement researchers to university academics are all setting our expectations for returns from equities and fixed income to be lower in the near future than they have been in the recent past (maybe that is music to a contrarian ready to take the other side?).  The assessment is fair enough though, I guess, given where we are right now in the markets, especially fixed income -- as long as we admit no one can ever predict the future or returns.  But for retirees, for whom the game is no longer (if it ever was) an "infinite-length MPT game with no withdrawals," the risks are pretty high for portfolio depletion from, among other things, sequence of returns risk and there is a compelling if not overwhelming need to plan ahead and get in front of a bad series of returns especially when everything is looking bad.  Speaking of forecasting, just for fun here is a story I read recently here:  "As reported by Jason Zweig (and a story told by the late, great Peter Bernstein) in The Wall Street Journal, the Nobel laureate Kenneth Arrow did a tour of duty as a weather forecaster for the U.S. Air Force during World War II. Ordered to evaluate mathematical models for predicting the weather one month ahead, he found that they were worthless. When he reported his findings, his superiors sent back another order: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”"

So, returns might be bad across the board for a while. Add in a (low-ish?) probability for inflation and retirement math that says that a sequence of returns that is crummy early in a retirement can zero out a portfolio faster than you think it can and we have a recipe that looks for better or worse like the 1970s…maybe worse.  That was a killer decade for retirees.  This is not an abstract intellectual comment, by the way: ask my mother (if she were still alive), or me who cared for her in her later years (or me as a skin-in-the-game early retiree), what the 1970s does to a retiree's portfolio.  As the story above implies, we still need to plan whatever the pros and cons of forecasting might be.

So, what does one do? I have no idea really. I'm guessing batten down the hatches and allocate well but then I'm not an advisor. It's for you to decide; your financial advisor can give you some advice on how to set yourself up.  I have to mention here, though, that I have advocated earlier (here)  that a small percentage of moderately sophisticated retail investors, in the face of expected (maybe, maybe not) bad returns across traditional risk classes (think equity & fixed income) might want to consider the following: 1) seek alternative risk premia that enhance the return and non-correlation characteristics of a traditional portfolio, and 2) try to do some of this themselves at lower cost while noting the obvious trade off that it is a little bit of work, and risky work at that.  The reason I bring this up, though, is that in reading the white paper I recognized that what they were describing was one of several pillars of one of my own private alt risk strategies: using momentum principles on a diversified assemblage of fixed income categories, categories that come into and out of momentum at different times and in different ways.  This is something I have been practicing since 2011 with varying degrees of success.  

Here, for example, over a too-short a slice of time (2014-Q12016), is a chart that compares: a) the strategy that includes (but is not limited to) a tactical fixed income component, and b) a hypothetical set of two or five portfolios of ETFs that might or might not be proxies for standard asset allocation categories, depending on whom you ask:

This chart tells us absolutely nothing, by the way, except that for an absurdly short, possibly cherry-picked, period of time (in this chart anyway) one private trader/investor could get decent risk adjusted returns from something that is similar what NewFound is talking about with respect to tactical fixed income (again, let's forget that their execution on this idea looks like it falls a little short in 2015).   My point is also not that I or anyone else could do this forever or that I've got some lock on a perfect strategy for all market conditions (that kind of hubris would be quickly crushed by the universe) it is that: a) I am on board with what they (NewFound) are trying to say about tactical approaches in this asset class, and b) that I have live-tested something like it in the market for enough years that I don't think it is a complete figment of their or my imagination.  I am also saying that I concur with the more-often-than-not fallible forecasters that the years to come might be a little dicey in standard asset classes…so we need to watch out for ourselves and our families.