Related: Alternative ETFs Have a Volatility Problem
The categories we look to employ at Newfound include: hedge fund beta (HDG), equity long/short (FTLS, GURU, RALS), dividend swaps (DIVY), event-driven (MNA), volatility (HVPW), and currency carry (DBV). Again, while each of these approaches comes with it significant risks, by diversifying within across many we can control our overall volatility profile and exposure to traditional market risks.
Hedge
For many investors, Treasuries serve as the asset class of last resort, giving it crisis alpha qualities that make it a tremendous diversifier against both instantaneous and prolonged equity crashes. In this sleeve, we believe that a position in longer-dated Treasuries is still warranted (e.g. IEF), but other exposures may also work well, including managed futures (WDTI), exposure to the U.S. dollar (USDU), or even equity long/shorts that run a negative beta (BTAL).
Rebuild
The benefit of an unbundle and rebuild approach is that it allows us not only to construct out the portfolio for each objective as we see fit, but also rebuild our overall allocation with greater consideration of our personal risk tolerances and objectives. For example, the Barclay’s U.S. Aggregate has a 60%+ allocation towards U.S. Government Treasuries and Agencies, indicating a reduced potential for current income but a strong utility as a flight-to-safety hedge.
A retiree, for example, might be less concerned about having a flight-to-safety hedge, as their overall profile is already extremely conservative, than they are about finding and delivering stable income. They may choose to allocate more towards the income sleeve than the hedging sleeve.
A growth investor, on the other hand, may have no real need for current income, and is only using the fixed income exposure as a ballast to their significant equity exposure. In this case, they may choose to put a larger focus on the diversification and hedging sleeves.
In Practice
At Newfound, we employ this unbundle and rebuild approach in our Total Return portfolio.
We focus on specifically building sleeves that meet the income, diversification, and hedging objectives, and then use a simple volatility-weighting portfolio construction process such that each sleeve contributes equally to the overall risk of the portfolio.
By doing so, we believe that we can create a portfolio with an overall risk profile similar to that of core fixed income, but with a more diversified source of returns, significantly reducing our overall exposure and reliance on interest rates as a return driver.