Return Stacking Portfolios

schwartzfinal
Global Head of Research
Follow Jeremy Schwartz
10/21/2021

The current market environment provides unique challenges that the WisdomTree Efficient Core Funds can help navigate. We discussed this topic in detail on a recent episode of Behind the Markets, a podcast brought to you by Jeremy Schwartz, WisdomTree’s Global Head of Research. 

In this episode, Jeremy talks to Corey Hoffstein, CIO and co-founder of Newfound Research, and Rodrigo Gordillo, president and portfolio manager at ReSolve Asset Management.

Listeners will hear about:

  • A paper Corey and Rodrigo authored on “Return Stacking™”—they defined the concept and discussed practical implementation views on how to use it in portfolios.

  • Diversifying strategies like managed futures have been out of favor, but Rodrigo saw a notable pickup of discussions following the release of this return stacking paper. 

  • Tactical asset allocation strategies using ETFs or futures, and why diversified systematic strategies can add value in that Return StackedTM framework.

  • How Rodrigo’s firm created the Return StackedTM 60/40: Absolute Return Index, an Index designed to preserve exposure to core stock and bond allocations while bolstering expected risk-adjusted returns with non-correlated return streams like trend following, global macro and tail-hedging strategies. WisdomTree’s Efficient Core ETFs play a role in this Index, and I think it provides a useful example of how to surround efficient core strategies with alternative strategies. 

  • The types of strategies that work well to hedge different inflation regimes, and the dynamics of flows to gold that may have changed its relationship to inflation and unexpected inflation.
    • Corey talks about what he thinks investors should not do with a return stacked approach: add more long-only equities that just leverage up total equity exposure. What he finds most valuable is an absolute return alpha source or other diversifying strategies. Some examples:
      • High-quality corporate bonds 
      • Managed futures and global macro strategies 
      • Commodities or gold if you are willing to take on more tracking error relative to a traditional 60/40. The more you add to this, the more return stacking starts to feel like a risk parity strategy.

  • The risks of risk parity strategies and misconceptions about what drove the bull market in bonds over the last 40 years. People believe the drop in interest rates drove the big bull market in bonds, but previously high coupons were a key driver, in Corey’s view, and the move in interest rates just pushes back or pulls forward returns that come from coupons.
    • Rodrigo discusses what he thinks are misperceptions for risk parity strategies and how a leveraged bond strategy can still perform well in a period of rising interest rates.
    • How risk parity strategies performed during one of the last big inflation-driven markets of the 1970s–1980s when rates were increasing.

  • The role for long/short strategies and other “convexity” strategies as hedges in the market. Convexity is a word you hear a lot with options strategies, and Corey described convexity strategies in simple terms as being able to add higher returns for a given change in the market—in either a positive or negative direction. This becomes most interesting on the downside for hedging strategies.

  • How leverage really hurts portfolios in large down markets when all correlations go to 1 and everything declines together. Strategies that can hedge drawdowns—when applied with levered approaches—are something Corey finds valuable. 

  • How to think about managed futures strategies in a return stacked approach. Rodrigo talks about how the low returns of managed futures strategies were a real challenge when funded from a traditional 60/40 environment. But a return stacked portfolio added on top is a very different story and something investors should look for now with greater adoption of strategies like WisdomTree’s Efficient Core Funds.

 

You can listen to the full episode below: 

Important Risks Related to this Article

Risks related to NTSX, NTSE and NTSI:

While the Funds are actively managed, their investment processes are expected to be heavily dependent on quantitative models and the models may not perform as intended. Equity securities, such as common stocks, are subject to market, economic and business risks that may cause their prices to fluctuate. The Funds invest in derivatives to gain exposure to U.S. Treasuries. The return on a derivative instrument may not correlate with the return of its underlying reference asset. The Funds’ use of derivatives will give rise to leverage. Derivatives can be volatile and may be less liquid than other securities. As a result, the value of an investment in the Funds may change quickly and without warning, and you may lose money. Interest rate risk is the risk that fixed income securities, and financial instruments related to fixed income securities, will decline in value because of an increase in interest rates and changes to other factors, such as perception of an issuer’s creditworthiness.

Additional risks specific to NTSI:

Investments in non-U.S. securities involve political, regulatory and economic risks that may not be present in U.S. securities. For example, foreign securities may be subject to risk of loss due to foreign currency fluctuations, political or economic instability or geographic events that adversely impact issuers of foreign securities.

Additional risks specific to NTSE:

Investments in non-U.S. securities involve political, regulatory and economic risks that may not be present in U.S. securities. For example, foreign securities may be subject to risk of loss due to foreign currency fluctuations, political or economic instability or geographic events that adversely impact issuers of foreign securities. Investments in securities and instruments traded in developing or emerging markets, or that provide exposure to such securities or markets, can involve additional risks relating to political, economic or regulatory conditions not associated with investments in U.S. securities and instruments or investments in more developed international markets.

Please read each Fund’s prospectus for specific details regarding the Fund’s risk profile.  

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About the Contributor
schwartzfinal
Global Head of Research
Follow Jeremy Schwartz
Jeremy Schwartz has served as our Global Head of Research since November 2018 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity indexes, quantitative active strategies and multi-asset model portfolios. Mr. Schwartz joined WisdomTree in May 2005 as a Senior Analyst, adding to his responsibilities in February 2007 as Deputy Director of Research and thereafter, from October 2008 to October 2018, as Director of Research. Prior to joining WisdomTree, he was head research assistant for Professor Jeremy Siegel and helped with the research and writing of Stocks for the Long Run and The Future for Investors. Mr. Schwartz also is co-author of the Financial Analysts Journal paper, What Happened to the Original Stocks in the S&P 500? He received his B.S. in Economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Mr. Schwartz is also a member of the CFA Society of Philadelphia.