Portfolio Strategy

The Quant Strategy That's 20-5 Against

The S&P 500: Part 2
Apr. 13, 2021 8:00 AM ET | NTSX, PSLDX, SP500 | 32 Comments | 34 Likes

Summary
In October, I profiled a strategy that historically has had a 2.5 percent annual return
advantage over the S&P 500.

The strategy required the use of futures, which many investors find intimidating.

Now I've found effective ETF and mutual fund implementations that any investor can
plug-and-play in 5 minutes or less.

The strategy is simple, effective, and beats the S&P 500 in theory and in practice.
Photo by small smiles/iStock via Getty Images

A Classic Quant Idea: Leverage + Stock/Bond Diversification

I love finding cool investments and helping people get in on them. Case in point–I went
in for surgery last week, and the last thing I can remember is talking about Bitcoin with
the anesthesia team. I had plenty of reading time recovering, so I took it upon myself to
look at some old strategies I've shared and how I can improve them.

In October, I shared The Quant Strategy That's 20-5 Against the S&P 500 since 1995.
This strategy built on previous ideas I've shared, which involve using simple quantitative
theories like risk parity (in the broad sense), volatility targeting, and negative correlations
to outperform the market. I shared more implementation ideas in November with How
I'd Invest $1 Million and got excellent reader feedback on both pros and cons. This
builds on the work I've done analyzing leveraged ETFs, futures, and alternative asset
allocation ideas over the past few years. I learn as much from my readers as they learn
from me, and I feel I've been able to improve the strategies.
My original article asks a simple question. If a 60/40 portfolio has a better risk-adjusted
return than a 100 percent stock portfolio, then why not apply leverage to a ~60/40
portfolio instead of go 100 percent equities? You're more diversified than a 100 percent
equity portfolio so the drawdowns aren't as bad, and you gain from rebalancing
(especially if stocks and bonds are negatively correlated as they have been in recent
years). Here's what the academic research says about the idea.

I found that the strategy beat the S&P 500 by over 2.5 percent per year, with little to no
effort. The trouble with the strategy is that it requires specialized knowledge and about
~$100k in capital to execute. Now, I've found you an ETF strategy that you can execute
with $100 for a similar return advantage.

Here's the updated backtest for the original strategy I shared, the quant strategy is in
blue and the S&P 500 is in red.

Leveraged balanced portfolio vs. the S&P 500

Source: Portfolio Visualizer

When Treasury yields were half what they were now I said they made no sense and risk
parity was pretty much dead. This meant the strategy has underperformed the S&P 500
since the vaccine news broke and interest rates moved sharply higher. But now, I can
ballpark your return at 200 basis points over cash of carry and rolldown on the 10-year
Treasury, which while not the most riveting investment, will make you money as long as
cash rates stay at zero. If you have inflation protection elsewhere in your portfolio (you
should) and you plan on rebalancing periodically, you will be fine over the course of the
business cycle. The issue with some of the quant strategies I've shared over the years is
that they generally require leverage to execute them. Leverage requires management,
and the cheapest way to get it generally is to use futures. Futures have high minimum
trade sizes and don't come with an instruction manual though, so many of my readers
get intimidated.

How to Build A Quant Portfolio With One ETF

NTSX (NTSX) is a 90/60 ETF introduced by mutual fund company WisdomTree. They
basically take the same idea I just shared and wrapped it into an ETF. They leverage a
traditional 60/40 portfolio by 1.5x, turning it into a 90/60. The "90" is the S&P 500, held in
stocks, and the "60" is various Treasury futures set to roughly the duration of the 10-year
Treasury. They then rebalance any time the allocation is off by 5 percent or more. This
means as stocks go up, they accumulate Treasuries, and when stocks go down, they buy
stocks. WisdomTree charges the ETF 20 basis points annually for management. I
checked the bid-ask spread and it's about 8 cents as of my writing this, so patient limit
orders are a good idea if you want to buy it.

Combining Treasury futures and stocks in this way is extremely tax-efficient and has a
track record of beating the S&P 500 in both rising and falling markets. NTSX is catching
on and has a little under $500 million in assets under management. The ETF has beaten
the S&P 500 by around 200 basis points annually since inception, with less volatility.

NTSX vs. the S&P 500

Source: Portfolio Visualizer

It's hard for NTSX to hurt you much, the main issue is if stocks and bonds go down at
the same time. Historically, this isn't super common, as the long-run correlation between
stocks and Treasuries has ranged from mildly positive to strongly negative. Even if
stocks and bonds do go down at the same time, diversification can only help you
compared to being concentrated at the same level of leverage. The volatility is lower
than the S&P 500 and the kind of shocks that would cause problems to NTSX would
cause far greater problems to other market participants (think banks and other parties
with power to lobby the Fed) long before NTSX feels much pain. I'd always recommend
pairing ETFs like NTSX with holdings of gold, selected value stocks, bitcoin, and real
estate.

Another solid fund with a similar strategy is Pimco's StocksPlus Long Duration Fund
(PSLDX). NTSX applies leverage to Treasuries, while Pimco buys mostly bonds and
applies more of the leverage with S&P 500 futures. I think that these two funds pair well
together because section 1256 taxation should allow you to offset losses in one asset
class with gains in another, as well as take advantage of the carryback and carryforward
provisions.

If anyone at Pimco is reading this, I think a similar fund that invests in S&P 500 futures
and municipal bonds would be a hit with me and my readers as well. The tax treatment
of PSLDX isn't quite as favorable as NTSX, so you might consider putting it in a
retirement account if you're concerned about getting ordinary income.
PSLDX has returned 16.2 percent annually since inception–it's a more aggressive fund
than NTSX, with its benchmark as 100 percent stocks plus 100 percent bonds - 100
percent cash.

Conclusion
If you've liked my work on quantitative investing but can't or don't want to trade futures, I
believe I may have solved your problem. You can now buy into the quant strategy I
researched for about $100. A 2 percent higher annual return over time than the S&P 500
means about 45 percent more terminal wealth over a 25-year time horizon. My key ideas
for investment success are simple quant strategies, value investing, and solid portfolio
strategy/asset allocation. They've worked for me over the years, and I expect them to
continue to work for me and you too.

Take a look at NTSX and PSLDX for yourself and feel free to share your thoughts in the
comments!

This article was written by

Logan Kane
14.05K Followers

Author and entrepreneur. My articles typically cover portfolio strategy, value investing, and behavioral fi... more

Disclosure: I am/we are long NTSX. I wrote this article myself, and it expresses my own opinions. I
am not receiving compensation for it (other than from Seeking Alpha). I have no business
relationship with any company whose stock is mentioned in this article.

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