Great (But Wrong) Expecations
by Roger Nusbaum, ETF Strategist, AdvisorShares
A favorite topic to blog about has long been alternative ways to allocate assets beyond the 60/40 standby as well as the extent to which big market trends influence allocation decisions.
In a recent post about allocating to liquid alternatives I used the example of owning gold as capturing this arc in terms of low correlation to equities and the impatience exhibited by some when low correlation to equities turns out to mean poor performance when equities go up a lot.
In a couple of different recent posts I’ve talked about how the alternatives conversation has expanded beyond managing equity volatility to trying to build an income portfolio that somehow generates yield while avoiding excessive interest rate risk and credit risk. This idea gave birth a few years ago to the niche unconstrained bond funds.
Barron’s profiled the manager of a fund over the weekend that appears to be unconstrained although the article never used the word. The current allocation, subject to change of course, includes many income market sectors you’d expect like high yield, loans and preferred stocks but it also includes a lot of equity exposure presumably with a big tilt to dividends including 13% to a covered call strategy as well as separate allocations to international and domestic equities.
Based on what’s published in the article the fund allocates about 25% to equities but as an actively managed fund its long term results look like that of a bond fund not an equity fund.
The point is not to render an opinion about the fund but to point out how some managers are trying to assemble yield for clients/fund holders. The fun has a lot of AUM and a high rating which means nothing in terms of future results but the strategy is alternative, goes to a lot of different places for yield and has had success. I think this line of thought is consistent with what I started writing about and implementing more than ten years ago. A treasury ladder and a couple of CDs are very unlikely to get the job done for the time being. Owning treasuries at this point is probably more about trading them for capital gains which some people can do but they stopped being about yield quite a while ago.
This gets us to a comment left on the Seeking Alpha version on the above mentioned posted regarding a 50/30/20 allocation which refers to a mutual fund company suggesting 20% to alternatives (I think 20% is too high). The commenter discloses “14% in bonds, 57% in stocks and 29% in Alternatives (Dividend paying stocks).
The commenter says it works for him and I won’t question that. Dividend stocks might go down less than other stocks during adverse market conditions but that is nowhere near the same thing as being bond proxies which is how the commenter referred to them. In the previous bear market, utilities fell close to 40%, staples fell a little over 25% and telecom fell a little over 45% in a down 56% (for the S&P 500) world and of course many dividend oriented ETFs fell more than the S&P because they were so heavy in financial stocks.
In an equity portfolio, down 25-30% in a down 50% world is an outstanding relative result especially in the context of a long term investment strategy but that is not what anyone expects a bond or bond proxy to do…or a true alternative strategy.
Obviously anything can misfire which is why you diversify but in my last post where I talked about having correct expectations for your holdings, the correct expectation for dividend paying stocks, and actually reasonable expectation would be a better choice of words here, might be that they go down less and while that may or may not work out in the next bear market, thinking dividend stocks will take on bond-like volatility in a bear market is absolutely the wrong expectation.
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