A new paper by Rodrigo Gordillo and Adam Butler of Resolve Asset Management and Corey Hoffstein of Newfound Research is out this week, purporting to add a new term to the investing lexicon – “Return Stacking.”
What? What is return stacking, and what are stacked returns? Well, you can download the full paper here to find out more. We also sat down with both Corey & Rodrigo on our podcast( listen or watch)to talk about return stacking, but we couldn’t help but take some notes during our reading of the paper.
Our quick summary… return stacking is a nicer, more tangible way of saying, “juice up your returns with some leverage”.
Our less quick summary… If you do it correctly with non-correlated assets, the additional leverage can reduce risk, not increase it.
Our longer summary… keep reading below
So, for us futures folks, this isn’t something new. You can hold a T-Bill as collateral in your futures account, using its value to margin your positions – in essence ‘stacking’ the futures P&L of your account on top of the T-Bill return. Here’s a snippet from a 2015 blog post talking through this:
Managed futures secret weapon, so to speak, is its ability to harness the power of U.S. Treasury Bills while it is putting trades on with commodity futures. In short, the secret weapon is the ability to earn both interest and trading returns on the same money.
This concept was also floated around back in the day as ‘portable alpha’. Here’s a hedge fund journal piece from 2006, and this snippet from a CME education piece putting its history all the way back to 1982:
FACTOID: Portable alpha strategies with equities trace their beginnings back to 1982. Shortly after the launch of the S&P 500 contract, Bill Gross, the founder of PIMCO and Myron Scholes, a PIMCO board member, got together after a board meeting and discussed how the new stock index futures contract could be combined with active fixed income management to create incremental returns above the benchmark S&P 500 index. Four years later, the strategy was the linchpin of the PIMCO StocksPLUS program, designed to enhance passive returns with portable alpha strategies. Alpha measures the active return on an investment or the excess return above a benchmark such as the S&P 500.
Our own Jeff Malec also had a thread not too long ago highlighting the move amongst many in the alts space to start pairing beta with their alpha strategies:
Something interesting is happening in the Alts space of late, with more and more Alts folks moving into stocks.
Is this creating somewhat of a hidden stock market bid, hiding here in plain sight?
Time for a thread
— Jeff Malec (@AttainCap2) May 10, 2021
Need more in Low Return environment
Now, all these old-timers like Bill Gross would stack their returns to add a few percent a year and beat the competition. But the Resolve/Newfound paper points out that today’s pricey levels for stocks and bonds (rates low) imply ‘depressed returns’ moving forward. If you have a 7% target return and assets can only throw off 3% a year because of these implied lower returns – what to do? You can reach for yield by going out the risk curve or… stack returns to remain diversified and merely increase the leverage a bit. One could argue you’re swapping credit risk or the like for correlation risk, and there is undoubtedly no free lunch. But in contrast to the new bond mantra of return-free risk – if you’re taking on some additional risk, you might as well get paid for it.
Stacking without Stressing
What’s also new here in the Resolve/Newfound piece is they aren’t talking about opening a futures account or getting a swap in place with a bank for some replication strategy. We’re not all Bill Gross with Myron Scholes on the board. No. The real title of the paper should perhaps be – ‘Return Stacking with things you can buy today in your Schwab account.’ Indeed, one of their main takeaways here is “managed access to leverage,” saying the Return Stacking Portfolio provides cost-efficient leverage without requiring the end investor to manage any derivative positions within their account directly. Now, we’ll argue that managing those positions isn’t that hard when you have pros like RCM Alts assisting you… but back to the paper.
They identify 10 “products” (ETFs or mutual funds) that are already doing a bit of stacking inside of their products and can be purchased by anybody, outlining how much exposure each has to various asset classes:
There’s everything from a fund doing an even split of stocks and bonds but at 1.5x times the cash on hand, to stocks and commodities, to the 7 layered ‘Product 2’ with exposure across passive and active equities and bonds, L/S commodities, Global Macro, and Vol totaling nominal exposure of 2x (or 200%) of the cash on hand. That one’s most certainly the Rational Resolve Adaptive Asset Allocation Fund (RDMIX), and the authors point out that Product 1 and Product 2 are their products.
So how do you put all this together and stack the returns in your portfolio? Last week, we highlighted in a blog post how the guys at Mutiny Funds are stacking four different return drivers at a straight 50% each in their new Cockroach Fund. But for this Resolve/Newfound paper, they take a bit different approach and test a portfolio of these products targeting a 60/40 portfolio with 30% managed futures (yeah!) and 30% global macro stacked on top.
That would be 160% of exposure for those counting at home, with some key non-correlated alternative investment exposure ‘stacked’ on top of the core 60/40 exposure. How’d it do? The results are impressive, reducing drawdowns while capturing the lion’s share of returns – but you’ll need to download the paper to check that out.
So which ‘Product’ is which in the paper? The author’s do point out that the first two are their own, which you can identify quickly enough by spending some time on their websites:
After that, Figure 7 and Table 1 in the paper give you enough intel to figure out who’s who in the zoo:
And, of course, these aren’t the only players in the game of applying capital efficiency inside an ETF/mutual fund. Here’s a few more that ‘stack’ returns from different asset classes:
And a bevy of products that add options or volatility overlays either as stand-alone products or onto their beta exposures:
Who did we miss? Let us know in the comments below, and again – don’t forget to check out the full Resolve/Newfound piece here.