Return Stacking is a topic we wrote about recently (Part 1 and Part 2). Those posts briefly covered some of the basics including:
It also introduced the line-up of Return Stacked ETFs shown in Table 1.
| ETF | Asset Class 1 | Asset Class 2 | Net Assets |
|---|---|---|---|
| RSBT | US Bonds | Managed Futures | $50M |
| RSSB | Global Equities | US Treasuries | $69M |
| RSST | US Equities | Managed Futures | $67M |
As we pointed out last time, these ETFs have limited return history. Therefore, we specify proxy ETFs to model the return streams of the two sub-asset classes harvested by each Stack Returned fund. Table 2 shows how we will map them to liquid securities currently available to retail investors.
| Asset Class | ETF Proxy | Description | Inception |
|---|---|---|---|
| Global Equities | VT | Vanguard Total World Stock Index Fund | 2009 |
| Managed Futures | WDTI | WisdomTree Managed Futures Strategy | 2011 |
| US Bonds | AGG | iShares Core US Aggregate Bond | 2004 |
| US Equities | SPY | SPDR S&P 500 | 1994 |
| US Treasuries | IEF | iShares 10 Year Treasury | 2002 |
We have made liberal use of a simple OLS framework to analyze which asset classes have the most potential to add orthogonal returns to an existing portfolio. This post is going to use the same framework but this time we focus on RSSB and (by proxy) the VT and IEF ETFs.
To proxy US Treasuries we considered using GOVT since RSSB has an equal weighted exposure to 2, 5, 10, and longer dated bonds. However, the GOVT inception date is 2012 and we opted for longer history and chose IEF since it more or less approximates the mid-point of those tenors.
As a quick refresher, we reintroduce the model here. It is a multivariate regression given by the following equation:
$$ r_t - r_f = \alpha + \beta_1\left(r_{1t} - r_f\right) + \beta_2\left(r_{2t} - r_f\right) + \epsilon_t $$ where $$r_t := \text{diversifying asset return}$$ $$r_{1t} := \text{asset class 1 return}$$ $$r_{2t} := \text{asset class 2 return}$$ $$r_f := \text{risk free rate}$$ $$\alpha_t := \text{intercept}$$ $$\beta_1 := \text{asset class 1 exposure}$$ $$\beta_2 := \text{asset class 2 exposure}$$
We focus on the intercept and asset class exposures (the alphas and the betas). In order to measure how much improvement a given ETF adds to RSBT we define a simple score whose purpose is to measure how much additional alpha is added per unit of beta. The naive score we have chosen takes the form
$$\text{Score} = \frac{\alpha}{|\beta_1| + |\beta_2|}$$
This ratio rewards assests with higher alpha and penalizes those with betas that deviate from zero.
Tables 3 through Table 9 show an assortment of ETFs we have chosen to consider. Each table shows the start and end dates that correspond to the cross-section of data available for VT, IEF, and each asset class ETF.
As shown in Table 3, commodities were not additive for the previous 15 years.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| GLD | Gold | 1.00 | 0.19 | 0.94 | 0.89 | 2008 | 2023 |
| DBC | DB Index | -4.49 | 0.45 | -0.08 | -8.40 | 2008 | 2023 |
| GSG | GSCI | -7.43 | 0.52 | -0.19 | -10.56 | 2008 | 2023 |
| USO | Oil | -13.38 | 0.76 | -0.42 | -11.30 | 2008 | 2023 |
While GLD does have a positive score, as a long-term holding it does not add much to portfolios holding rates with tenors longer than 10 years. This is confirmed empirically by the near unit exposure to IEF.
Table 4 says that including credit is additive to RSSB.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| JNK | Bloomberg Barclays High Yield | 3.03 | 0.35 | 0.12 | 6.40 | 2008 | 2023 |
| HYG | iBoxx $ High Yield | 2.52 | 0.36 | 0.15 | 4.94 | 2008 | 2023 |
| LQD | iBoxx $ Investment Grade | 1.07 | 0.14 | 0.90 | 1.02 | 2008 | 2023 |
| AGG | US Aggregate | 0.53 | 0.05 | 0.61 | 0.80 | 2008 | 2023 |
In particular, high yield (with its modest exposure to both VT and IEF) contributes the most.
The currency ETFs in Table 5 show that UUP (bullish dollar fund) is additive.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| UUP | US Dollar Fund | 3.60 | -0.16 | -0.30 | 7.76 | 2008 | 2023 |
| FXE | Euro Currency | -5.00 | 0.18 | 0.24 | -11.88 | 2008 | 2023 |
Adding exposure to the Euro is detractive in the last 15 years.
Table 6 demonstrates that REITs have little to add to RSSB.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| VNQ | Real Estate Index | 2.11 | 0.88 | 0.50 | 1.53 | 2008 | 2023 |
| IYR | US Real Estate | 1.60 | 0.87 | 0.51 | 1.16 | 2008 | 2023 |
| RWX | International Real Estate | -4.43 | 0.86 | 0.31 | -3.79 | 2008 | 2023 |
Table 7 suggests that, while short-term rates (i.e., Treasury Bills) Score highly based on our simple metric, there is little reason to add them since they add negligible alpha.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| SGOV | 0-3 Month Treasury | 0.16 | -0.00 | 0.00 | 247.01 | 2020 | 2023 |
| SHV | Short Treasury | 0.10 | 0.00 | 0.01 | 10.92 | 2008 | 2023 |
| SHY | 1-3 Year Treasury | 0.09 | 0.00 | 0.13 | 0.65 | 2008 | 2023 |
| IEI | 3-7 Year Treasury | 0.24 | 0.01 | 0.53 | 0.45 | 2008 | 2023 |
| TLH | 10-20 Year Treasury | -0.11 | -0.02 | 1.42 | -0.08 | 2008 | 2023 |
| TLT | 20+ Year Treasury | -0.70 | -0.05 | 2.09 | -0.33 | 2008 | 2023 |
However, since Treasury Bills are currently yielding close to 6%, perhaps a small allocation for cash management purposes makes sense.
The sector ETFs shown in Table 8 do nothing to diversify our global stock holdings.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| XLV | Health Care | 6.88 | 0.75 | -0.00 | 9.18 | 2008 | 2023 |
| XLK | Technology | 9.69 | 1.04 | 0.02 | 9.14 | 2008 | 2023 |
| XLP | Consumer Staples | 5.55 | 0.56 | 0.11 | 8.20 | 2008 | 2023 |
| XLY | Consumer Discretionary | 7.77 | 0.97 | -0.06 | 7.50 | 2008 | 2023 |
| XLU | Utilities | 4.41 | 0.54 | 0.52 | 4.17 | 2008 | 2023 |
| XLI | Industrials | 4.09 | 0.96 | -0.24 | 3.40 | 2008 | 2023 |
| XLF | Finance | 2.28 | 1.03 | -0.62 | 1.38 | 2008 | 2023 |
| XLC | Communication | 1.12 | 1.08 | 0.11 | 0.94 | 2018 | 2023 |
| XLB | Materials | 1.08 | 1.03 | -0.13 | 0.93 | 2008 | 2023 |
| XLRE | Real Estate | -0.17 | 0.79 | 0.64 | -0.12 | 2015 | 2023 |
| XLE | Energy | -2.20 | 1.06 | -0.33 | -1.57 | 2008 | 2023 |
On the other hand, certain domestic equitiy sectors add alpha. Technology's out performance in recent years, as well as the defensive sectors low exposures to rates, indicate that XLV and XLK are additive.
Based on the results from Table 8 it is not suprising that QQQ and IWF also score well.
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| QQQ | Nasdaq 100 | 9.63 | 1.03 | 0.04 | 8.97 | 2008 | 2023 |
| IWF | Russell 1000 Growth | 7.42 | 0.98 | 0.01 | 7.54 | 2008 | 2023 |
| SPY | SP500 | 4.84 | 0.92 | -0.09 | 4.81 | 2008 | 2023 |
| IWB | Russell 1000 | 4.72 | 0.93 | -0.08 | 4.67 | 2008 | 2023 |
| IWV | Russell 3000 | 4.42 | 0.94 | -0.09 | 4.28 | 2008 | 2023 |
| IWD | Russell 1000 Value | 2.49 | 0.89 | -0.21 | 2.27 | 2008 | 2023 |
| IWM | Russell 2000 | 0.92 | 1.09 | -0.18 | 0.72 | 2008 | 2023 |
| SCZ | MSCI EAFE Small Cap | -1.39 | 0.97 | 0.09 | -1.32 | 2008 | 2023 |
| EFA | MSCI EAFE | -3.56 | 1.01 | 0.02 | -3.47 | 2008 | 2023 |
| EEM | MSCI Emerging | -6.09 | 1.17 | 0.17 | -4.56 | 2008 | 2023 |
Again, they do nothing to diversify our stock holdings but they add alpha and have low exposure to rates.
This simplistic analysis suggests that the ETFs in Table 10 are the most additive to RSSB:
| ETF | Description | Alpha | VT Beta | IEF Beta | Score | Start | End |
|---|---|---|---|---|---|---|---|
| SGOV | 0-3 Month Treasury | 0.16 | -0.00 | 0.00 | 247.01 | 2020 | 2023 |
| XLV | Health Care | 6.88 | 0.75 | -0.00 | 9.18 | 2008 | 2023 |
| QQQ | Nasdaq 100 | 9.63 | 1.03 | 0.04 | 8.97 | 2008 | 2023 |
| UUP | US Dollar Fund | 3.60 | -0.16 | -0.30 | 7.76 | 2008 | 2023 |
| JNK | Bloomberg Barclays High Yield | 3.03 | 0.35 | 0.12 | 6.40 | 2008 | 2023 |
| VNQ | Real Estate Index | 2.11 | 0.88 | 0.50 | 1.53 | 2008 | 2023 |
| GLD | Gold | 1.00 | 0.19 | 0.94 | 0.89 | 2008 | 2023 |
As mentioned earlier, SGOV scores well but adds little alpha historically. Perhaps a small position as a cash management tool or to keep some dry powder makes sense.
Additions of Health Care, US Dollar, and High Yield all seem to make sense. Valuations of constituents in the Nasdaq give us pause and we would be hesitant to add QQQ at this point.
As in our two previous posts, we advise readers to keep in mind that we are only looking at a limited set of ETFs and for a limited amount of data (2008-2023). This analysis is for informational purposes only. Please do your own research.