I’m hyped. Things David Wagner is hyped for:
- I’m hyped for the market;
- I’m hyped for the Aptus ETF strategies;
- I’m hyped for the structure of our Asset Allocation (MOAR Stock, Less Bonds, Risk Neutral);
- I’m hyped for the Oklahoma v. Tennessee Game in Norman, OK that I’m attending w/ a close friend;
- I’m hyped for the Bengals MNF game; and
- I’m hyped for life.
And it seems the market was hyped for one of the most telegraphed rate cuts ever. It should come as no surprise the Fed cut the policy rate by 50 bps from 5.25%-5.50% –> 4.75%-5.00% – it was well telegraphed. Well; maybe the 50 bps cut was a surprise, instead of 25 bps. But, in the grand scheme of things – who cares? There’s a necessity for investors to focus on what matters and what doesn’t matter. And this is exactly what I want to talk about today –> It pays more to be patient, than clever.
But, if anyone wants to read our thoughts on the cuts, please find John Luke Tyner’s, CFA (Head of Fixed Income) recent blog post here.
Today, I want to focus on something a bit different than I normally do. Below, we’ll touch on the following topics:
- What Really Matters for Allocations, and
- What Does the Rate Cut Mean for the Markets?
Fed Up With Real Rates
Opportunity Cost: What Really Matters for Allocations
I hate to turn this important macroeconomic event into a teaching lesson. But, I firmly have conviction here. Everyone on this musing has heard me say: “The hardest way to get new ideas into your head is to get the old ones out”. And, in my personal opinion, whether it’s academia, television, Twitter, etc., has taught investors the wrong way to think about asset allocation. So, let’s heed the investment wisdom that we learned from Yoda: “You must unlearn what you have learned“.
I’m not here to call anyone out, but more to deliver my beliefs on how an investor should act…or not act, as we’ve received a lot of questions from our partners on if we should add bond proxies to their custom allocation, i.e., Real Estate, REITs, Financials, Utilities. It’s not a secret that these areas of the market have performed well, historically speaking, when interest rates are declining. But, as Brad Rapking, CFA (Portfolio Manager) has said, not all historical results are a result of one binary decision or factor, as they tend to never be a 1:1 outcome.
For example, let’s look at today’s sector performance. Specifically, one day after the Fed cut rates by an amount likely larger than what most people initially believed. Shouldn’t the bond proxies, which benefit from lower rates, be outperforming? Well, they’re not. In fact, they’re all negative!
Investing is hard. Don’t make it harder.
This is why we always say that proper asset allocation drives 90% of a client’s LT returns, while fund selection, stock selection, and market timing are virtually immaterial to returns. I am a firm believer that the best way to seek alpha is through risk mitigation and that you win by making fewer mistakes. Ironically, you make fewer mistakes by making fewer decisions.
I believe that the structure of our asset allocation lets you win more, by taking investment timing out of an allocator’s hands. Let’s think through an example:
Source: Bloomberg, Data as of 06/30/2024. The yield percent in the chart above is the indicated yield which is the annualized yield of the most recent dividend distribution. Yield is not indicative of current or future performance or returns. The Standard Deviation figure is since inception.
Instead of always having to correctly choose the right investment all the time, we take a calculated risk of simply owning more beta. Our off-the-shelf allocations, coined The Impact Series, are 15% overweight to stocks within the Moderate allocation. Said another way, we are 15% underweight fixed income but remain risk neutral. See above for the details.
An example: An allocator is looking to purchase 3% of their model into the real estate sector, which I would argue is immaterial in the grand scheme of things. But, if they are correct, it is alpha accretive. However, I would argue that a rising tide tends to lift all boats and that a simple overweight to beta would also outperform and have a better hit rate of being correct over longer periods of time. For the 3% real estate bet to be accretive to performance, from an opportunity standpoint against an allocation that has a 15% overweight to stocks (like the Aptus Moderate Allocation), the sector would have to outperform by 5x the performance of the beta exposure (in a vacuum). But the more important question should be – what if we are wrong? – again, I’m a big believer that one seeks alpha through being wrong less, not seeking it.
So, if the investment thesis on real estate is wrong, this opens up the allocation to tracking error – bad tracking error. The kickback here would be that all equities go down, meaning that our overweight to beta was also incorrect. I’d argue that’s wrong because we are directly hedging our beta overweight through S&P 500 puts in a few of our Aptus ETFs. We are not specifically hedging the real estate exposure, which is where the tracking error is created. Allocators need to understand that we are directly hedging the exact overweight bet that we are making – owning moar beta – which allows us to formulaically remain risk neutral at the allocation level versus a benchmark that doesn’t have as many growth drivers as us (i.e., stocks). Not only do we have an in-line or lower standard deviation relative to the benchmark (as seen above), but we also have a smaller maximum drawdown.
We use hedges to manage risk, not remove it, allowing us to confidently take on more equity market exposure while keeping potential drawdowns in check with less reliance on fixed income. The hedges are designed to provide convex payoffs; to protect portfolios during large market declines to maximize compounded returns. To us, it’s not about taking less risk. It’s about taking the right amount of risk that protects the drawdowns and captures upside.
Do less; so you can be hyped for life, like me.
What Does the Rate Cut Mean for the Markets?
I’m going to steal this section from Ryan Detrick of Carson Group. He says it perfectly and it’s quick and simple. We all know how long-winded I can be.
“Here are the 20 times the Fed cut rates when the S&P 500 was within 2% of an ATH (based on the day before the cut). The market has been higher after all 20 times and is up 13.9% on avg. Yesterday was the 21st time.”
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2409-22.
