When you start a business, no matter how much research you do, you don’t know all of the issues that you will run into. What has struck me since I wrote the piece On Bonds in Retail Accounts is that I need to run a bond strategy.
Now, I played with synthetic alternatives, and I may still offer some of them. I could offer clients that I partially hedge my equity holdings. Synthetically, on the hedged portion they earn something close to a t-bill rate on average, which is near zero these days, and after my fees negative, though after my performance, hopefully positive. Here is what I ended up writing to a couple clients of mine:
I think I’ve said it before, but market-timing is not a core skill of mine. Can’t do it. What I can do is pick stocks. I’ve had discussions like this with a few others, and if they have a taxable account, and want to hedge their positions, I’ve been toying with an idea, and I’d like to bounce it off you. For taxable accounts, I offer long only and market neutral, but there’s no reason why I couldn’t offer any percentage hedging in-between zero and full. That would allow people to implement their view of the markets, and if their views change, hopefully not at the wrong time, they could change their hedge amount.
I hedge by shorting Spiders [SPY] against the longs in the portfolio. My beta seems to be around 0.95, even with the cash I hold, so a fully hedged account of $100,000 looks something like this:
$ 85,000 stocks
I’ve thought about this three ways. Someone could say to me:
1) Take down the SPY hedge bit by bit over ## months
2) Leave me ##% hedged until I tell you otherwise
3) Here’s a schedule of how much net equity exposure I want at various levels of the S&P 500.
And, I think I could do any of those for clients. Remember, this is only for taxable accounts at present. I have not figured out a cost-effective way for doing this on tax deferred accounts. I suppose I could do it by going to cash or high quality bonds, but is that something people would want for their IRAs?
But when I think about it, the synthetic strategies are only for those who believe deeply in my stock picking abilities, to the degree that any sort of bond strategy versus cash is blown away by the alpha of my stock picking. In the past, that would have been true. In the future who can tell? My good performance could have all been “luck.”
At a prior employer in the mid-2000s, I ran a balanced strategy that was 50% my stock strategy and 50% a bond strategy that I developed. Though the stock strategy provided most of the alpha, the bond strategy provided much more alpha than most bond strategies did.
In basic, my bond strategy is this: analyze bond spreads relative to likely losses. Invest accordingly. If all of the major risk factors are underpriced, invest in foreign bonds, analyzing which countries are willing to accept appreciation of their currency. I don’t want to put words in the mouth of PIMCO, but this is what I think their unconstrained strategy looks like.
As for me, with smaller accounts, I will be using ETFs and CEFs. The fees will be a lot lower than what I charge for equities. There are accounts that need bonds as well as equities and don’t want to have multiple accounts. I am facing that reality, and have come to the conclusion that I have to offer a bond strategy.
To my readers, do you have any advice for me? Since I am mainly serving individuals, I think I have to go this way, and not be “equities only.” Let me know.