By Richard Morey
May 4, 2024
Tactical Allocation Portfolio
Current allocations/First Quarter Performance:
14% ULTRA SHORT-TERM BONDS
This includes the Treasury note due in July and the EFT symbol MINT. We’ll be selling the Treasury note in our model portfolio in order to fund the purchase of the gold & silver fund described below.
Cash – 4%
This is what will remain in our cash equivalent after the Treasury bond is sold to purchase gold/silver. The remaining amount will be in MINT or PIMCO Enhanced Short Maturity. MINT is a great place to park money. It’s yielding just over 5%, and at last check they owned 673 bonds, 99.8% investment grade, with an average duration of .23 or just under 3 months. And it’s completely liquid, with any risk managed by the best, i.e. PIMCO.
22.5% PIMCO MORTGAGE OPPORTUNITIES
This allocation was higher until 12% was sold to establish a position in AQR Managed Futures. It remains a great fund, paying 6.88% on government-backed or linked mortgage bonds. [1]*
- This is relatively short-term debt, but unless a person needs to start receiving income from the money now or soon, we plan to sell it to establish our pure “defensive growth” position whenever risk takes another swing at this bubble.
- An income-oriented fund like PIMCO Mortgage Opportunities is designed to give out competitive income very safely. I would therefore expect their government-backed/linked bonds will lead to good gains when risk hits.
- The fact it’s being sold in the Tactical Allocation Portfolio is due solely to the fact I want to achieve more than PIMCO Mortgage Opportunities can when risk hits.
If income is your focus for this money – in whole or in part – please let us know. We’ll then add you to our list of clients who want a selected amount dedicated to generating income now and, typically, going forward. In that case we’ll likely keep some or all of PIMCO Mortgage Opportunities.
25% PIMCO INCOME
This is our “core” fixed income fund as it’s the best combination of high yield/low volatility I’ve ever seen, plus it has put out 6%+ in annual income, quarterly, since 1996, except during the height of the pandemic. [2]*
For those who want some amount of their money putting out steady cash, I would keep some or all of these two bonds funds, especially PIMCO Income. Then most likely in the first few months of a severe downturn, I expect the bond market to freeze up like it did in 2020 when you couldn’t sell any bonds – including Treasuries.
As soon as the bond market is back and open for business, I plan to sell whatever is left in PIMCO Mortgage & PIMCO Income to invest in two other PIMCO Income funds which could be yielding 15% or more, for up to 5+ years, if purchased right after a liquidity crisis.
61.5% TOTAL CURRENTLY IN FIXED INCOME
Below is the quarterly performance for the four bonds/bond funds presently in our model portfolio. This is what you get – within a certain tolerance – when you leave it completely up to me. Do that and your numbers & percentages should line up closely to those in this report – if they don’t, please let me know to discuss the deviation.
We began the year with 78% in four bond funds/Treasury, and ended the quarter with 61.5% in these same funds. In the first quarter they performed as follows:
UT Treasury Note–-–-–-–-–-–-––––1.19%
PIMCO Enhanced Short Maturity–—-2.11%
PIMCO Mortgage Opportunities–––-1.45%
PIMCO Income–-–-–-–-–-–-–-––-–-1.27%
35% IN MANAGED FUTURES
Quarterly Performance:
In the first quarter, managed futures boosted our returns:
Campbell Systematic Macro–-–-–-–-6.00% [3]*
AQR Manages Futures-–-–-–-–-–—-11.96% [4]*
AQR is one of the oldest and best managed future companies. They’re perhaps the most innovative and, at least at times, the most successful. When volatility increases, AQR shines. They go down more than Campbell in a downturn for managed futures, but they can profit from volatility almost as quickly as Campbell. They can also profit more than Campbell when managed futures have a big upswing.
None of the above statements are guarantees of the future but simply a description of how the funds have performed, most often, in the past. It’s also worth noting that the Campbell people begrudging respect one competitor more than all the others – AQR. Even as they pointed out how their system is superior in several consequential ways, they also admitted AQR was the best in one key area called their upside potential. They do this with only slightly more risk than Campbell, so they’re a worthy competitor.
Summary of 1st Quarter Performance
Combined, the portfolio made 1.97%. Over 4 quarters, that would give us 7.88%, which is slightly over the target set when we decided to take advantage of high rates while we waited for volatility to start back up enough, in enough markets. The target set last October when putting over 75% in the PIMCO funds/Treasury was 7% (after fees).
Anticipated Future Changes to Portfolio
Please note the following changes are for our model portfolio which has up to 100% of the portfolio in defensive growth investments during a downturn. .
The first change was adding 12% to AQR Managed Futures, giving us a total of 35% in this category.
Should inflation continue to rise, or should volatility (i.e. risk) hit many markets, I would add to managed futures, ending with the following allocations:
- 25% Campbell Systematic Macro
- 15% AQR Managed Futures
- 10% PIMCO Trends Managed Futures
We’re also planning to purchase 7.5% of the total into a gold and silver fund (symbol CEF). They simply own and store the physical gold and silver in secure locations in Southern Canada.
Should inflation begin to take hold more firmly, and gold continue to rise, hopefully on a short-term drawdown I would double the amount in gold to 15% of the total. This would give us the following allocations:
- 50% Managed Futures Funds
- 15% Gold/silver
- 35% in PIMCO income fund(s)
FINAL STEP
Once stocks have begun to fall in earnest, the 35% remaining in PIMCO Income funds will be sold (unless the individual client has asked to remain with income funds for the long-term).
The proceeds will go into 2-4 additional funds designed to profit from risk. Two of them may be from a category called Equity Long-Short (with a negative correlation to US stocks). They are described on the next page.
Should the funds we’re already monitoring again demonstrate they will rise (sufficiently) when stocks fall, the current plan is to put the remaining 35% in the PIMCO income funds into them no later than the time stocks have fallen 10%. (I clearly want quite a bit of confirmation this time around!)
Alternative Quantitative Funds – Equity Long-Short with Negative Correlation to Stocks
One good alternative to diversify further and take advantage of volatile markets are quantitative programs that have high upside when stocks fall. This is due to the fact they have a high negative correlation to the stock market. This means they may go up when stocks go down but can also go down, at least some, when stocks rise.
We haven’t purchased these types of funds yet due to the fact stocks have been rising and their negative correlation to stocks is so strong. But should stocks come tumbling down, that same negative correlation can lead to strong returns.
Pure equity long-short funds by their nature aren’t very volatile. They also don’t make much at all much of the time. To maximize their return potential in a downturn, the best such funds automatically increase the negative correlation with the S&P 500 as stocks fall. This is essentially what managed futures funds do, but the fact the equity long-short funds do it using a completely different approach, with almost no correlation to managed futures, gives us added diversification value.
These funds function mostly independently from the bond market, though they typically converge when there’s a “slight to safety.”
Thus far, the most reliable equity long-short fund we’ve found for a hedge against stocks is Hussman Strategic Growth (HSGFX) This fund has struggled during the years when stocks have roared, but it can and has delivered excellent returns when the opposite has occurred.
For example, Hussman Strategic Growth made 18.85% in 2020 and 17.32% in 2022. Combined, they made 18% more than stocks during these two years. While I don’t know, I suspect that may be the fund’s true target, i.e. to make, on average, as much or more than stocks lose in a downturn. That’s my target for what they’re doing.
For now, that’s the only alternative fund we have fully vetted and trust to have that big negative correlation to stocks when they fall. By the time stocks have fallen 10%, I suspect we’ll see which approaches are beginning to outperform and can split the remaining 35% into Hussman and two or three other funds.
[1 through 3] Source: Morningstar.com 3/31/24
[4] Source: Morningstar.com 3/31/24; this fund was purchased on 3/13/24