Return Stack Anything: Portable Alpha with RSSB

If you haven't heard of the ReturnStack lineup before, Ultimately, what this suite aims to do is to unlock the benefits of diversification. And this is done by allowing you to introduce alternative investment strategies and exposures into your portfolio without having to sacrifice your core stock and bond exposure.

Now in the suite, Each ETF follows the same simple formula, which is for every dollar invested, we're going to provide a dollar of either a core stock or bond exposure, plus an extra dollar to an alternative asset class or investment strategy. And we launched our first ETF in February 2023, and the suite, um, the suite just actually passed over four hundred, eight hundred and forty million dollars, and hopefully rapidly toward a billion by the end of the year.

We only have a couple of weeks scoring. we're excited by that growth. Obviously, there's a demand for it. And today, uh, I'm actually quite excited for Corey, uh, to specifically talk about the return stack global stocks in bonds, ETF, that's RSSB. And he will have a chance to really walk the audience through, through the many ways that one could utilize this unique ETF to enhance portfolio diversification and really allow for all types of unique stacking opportunities.

And importantly here for this webinar is that please do feel free to ask any questions along the way in the chat bot. You can just type it in. I'll do my best in responding real time to you, or if I can kind of nudge Corey and ask him questions as he goes along. Um, so with that, Corey, I'm excited to turn it over to you to do the deep dive.

So whatever alternative investment class, asset class or strategy, you can now turn that into an overlay on your portfolio. So really excited to talk about it. Before I get there though, I want to talk about this concept of portable alpha. This was an institutional idea that was very, very popular in the 2010s or excuse me, in the, in the 2000s and then post 2008 really dissipated in popularity. except among a select few institutions who really had a like extreme success using it.

We actually just did a podcast with the CIO of Delta's Pension, John Glidden, who had an unbelievable turnaround at their pension. You can check out our Get Stacked podcast, or we actually published a quick A case study on our website. You can check that out. That went live today talking about how he used Portable Alpha to take a dramatically underfunded pension and get it to an overfunded status. Really a great story and a great success case of using Portable Alpha.

Where I want to start with is what is Portable Alpha? This term is coming back. We're seeing it a lot more in the news. If you haven't heard of it, if you're unfamiliar with it, that's that's not a surprise. It really has been exclusively an institutional concept. So I want to start with a quick explanation of what it is, and more important than what it is, I want to start with what problem is Portable Alpha ultimately trying to solve.

And as you can probably guess from the name, the Alpha part of the name, what Portable Alpha was originally designed to solve was for allocators and professional investors who were trying to beat their benchmark The portable alpha was effectively invented as a new way to try to beat a benchmark in a more sophisticated manner. So I want to start with this picture, right? Because this is actually, the story goes back to the 1980s with PIMCO.

They were actually the originators of the portable alpha idea. It's a little fuzzy. I'll give them credit. There's a couple other folks who take credit. But largely I think the story starts with PIMCO in the 1980s when they were running some bond mandates. Now this is a current breakdown of the U. S. aggregate bond index, but you can guess that probably back in the 1980s, the total exposure to treasuries wasn't too dissimilar.

When we look at the U. S. aggregate bond index today, there is a large slug of U. S. treasury exposure, and so if you're trying to beat this benchmark as a bond manager, One of the choices you have to make is am I going to touch that U. S. Treasury exposure or am I going to take some off benchmark bets, right? Because there really isn't a tremendous amount of security selection you can do within U. S. Treasuries. A 10 year U. S. Treasury is largely fungible with any other 10 year U. S. Treasury.

So if you have 10 year U. S. Treasury exposure in your benchmark, How are you supposed to beat that unless you go maybe buy corporates or mortgage backed securities and take some off, off benchmark bets in terms of how much treasury exposure you're going to have? Well, in the early 1980s, some very sophisticated and thoughtful investors at PIMCO said, well, what if we, what if we did something a little bit different?

What if instead of buying U. S. treasuries with our cash, we buy U. S. treasury futures? Now, U. S. Treasury futures are going to give us the total return of U. S. Treasuries, but does so in a levered manner. So we only have to put up a little bit of capital to get that exposure. The return of those U. S. Treasury futures is in effect going to be the return of U. S. Treasuries minus that cost of leverage.

And then we're going to have a whole bunch of cash left over with which we can invest however we want. To make this, if you don't know futures, sort of the simple way to think about this is, let's say you wanted to buy a house, a million dollar house, and you have a million dollars in cash. Well, one choice is you can just buy the house. In this case, that would just be like equivalent to just buying the treasury bond.

Or you could go to a bank and get a mortgage, maybe put 200, 000 down, get an 800, 000 mortgage. You then get the return of the house minus the cost of financing with your mortgage, and you have 800, 000 of cash left over. Now, then the question becomes, what do you do with that cash? And that's where PIMCO said, well, we can invest that cash to outperform our cost of financing.

In our analogy, say, the cost of the mortgage interest that you're paying, well then you have effectively added return on top of that original thing you're investing in. For PIMCO it was the treasuries, in our case it's the house. And so that's a very powerful concept because it unlocks sort of that beta you're getting, the treasuries, versus how you are able to add something on top by thoughtfully using some leverage and financing.

Now what's important about using treasury futures is that historically like if you go look at mortgage rates today The actual financing costs of mortgages can be quite high, and a significant spread above, say, the equivalent, uh, duration for U. S. Treasury, right? You're gonna borrow at a much higher rate than the U. S. government is. But if you look at the embedded cost of financing inside of Treasury futures, it's historically been a lot closer to T bill rates.

So what I have in this graph is going back the last five years. I've plotted the three month LIBOR rate or SOFR. It sort of starts LIBOR and SOFR. Uh, the black line is your three month T bill rate and the green line is the embedded cost of financing inside of a 10 year U. S. Treasury futures contract. And what you can see is that green line has historically, while not perfectly fit, Very closely danced around that black line.

And so what we can say is if we're using something like us treasury futures to replicate treasuries, we're actually getting that treasury return minus e bills. And that's a, one of the lowest costs of financing you can get, right? That is the short term borrowing rate of the us government. And we're effectively able to tap into that through the futures market.

The reason that's powerful and what PIMCO did and what became known as their bonds plus strategy is they said, okay, let's replace our treasuries with these treasury futures. We're going to put a little cash aside for margin, right? We need that. That's sort of like a down payment for the house. That's how we're managing these treasury futures as they move up and down.

Now those treasury futures are going to have Um, a financing cost equal to T bills, but what if we take that cash that's left over and invest it in short term, slightly worse credit quality, maybe some stuff with some embedded optionality like mortgage backed securities, things that we think are close to cash, cash like in terms of risk, but slightly riskier to earn a slightly higher return.

And if we can earn that slightly higher return above the financing rate, we've effectively stacked that return on top of our bonds, right? And so they were able to take their security selection advantage in short term bonds to outperform cash and then stack that excess return on top of treasuries. And that's how they were able to basically create alpha in that big slug of treasuries that they had that otherwise there was really no security selection opportunity.

Now, a couple of years after this, they realized this didn't have to simply be done in the world of bonds. They could take the same idea and do it in U. S. equities. I think it was 1985 or 1986 that the U. S., uh, that the S& P 500 futures started trading. And what PIMCO realized is they said, look, our advantage is in picking bonds. We don't think we can pick stocks. But what if we simply said we're going to buy S& P 500 futures to get S& P 500 exposure?

We're going to put some cash aside as margin, and then we'll use the rest of the portfolio to invest in short term, you know, high quality corporates, maybe some embedded optionality with some mortgages, again, some, some cash like instruments that take on a little bit more risk and by outperforming cash, the cost of financing in those S& P futures, we can create what looks like alpha. And right.

And so this concept of portable alpha is born because what they're doing is generating returns in bonds. And stacking that on top of stocks, right? So the, where they're generating the excess returns has now been unlocked from the underlying asset, the beta that most investors are buying for. And this became known as PIMCO's Stocks Plus program and has been running since the mid 1980s, uh, with great popularity, right?

Because again, the idea is you can get your S& P 500 exposure, but you don't need to pick stocks better to beat the market. Hempco is able to say, no, we think we can pick bonds better and we're going to take that ability and stack it on top of the equity beta you want. So it's a profoundly powerful construct that they unlock. And this is something that in the early 2000s was adopted by a tremendous number of institutions who said, well, we don't just have to pick bonds with that cash.

We can do whatever we want. And that's where things really started to see, well, we can take our betas, whether it's stocks or bonds and stack on all sorts of hedge fund strategies. What we, when we take a step back and say, well, what does this really unlock for investors? What we think this unlocks is what we call the funding problem of alternative strategies.

This idea that if you are traditionally benchmarking to a portfolio of stocks and bonds and you want to add alternatives to your portfolio, you typically have to sell those stocks and bonds to make room for those alternatives. So your classic 60 percent stocks, 40 percent bonds becomes say a 50, 30, 20. The problem with this approach is that by selling stocks and bonds to make room for your alternatives, you create a hurdle rate problem.

A hurdle rate both in the rate of return that those alternatives have to have and hopefully outperform to be additive to the portfolio, but also a behavioral hurdle rate in our experience. Stocks and bonds tend to be much more transparent to end investors and stakeholders.

Alternatives tend to be higher cost, less tax efficient, less transparent, and just behaviorally harder for investors to stick with over the long run to reap the benefits of the diversification that they bring to the portfolio. This new world approach of Portable Alpha, again, not really new world, it's been around for 40 years, but is being reintroduced now, allows us to say, let's keep the 60 40 and let's stack those alternatives on top. So let's keep that core benchmark.

And use our active risk budget to add these alternatives on top. And again, we think this really solves that funding problem because no longer do you need to outperform the stocks and bonds you sold, you simply need to outperform your financing rate. And if you're thoughtful as to how you're constructing this stacking, that financing rate can be as low as T bills. And what this then allows us to do is say, well, we can be really thoughtful about where we are using our active risk budget, right?

If we are benchmarking to some passive 60 40 portfolio and we choose to be active, does it make sense to be active in picking stocks? Well, we've all seen the SPIVA report, for example, that would tell you over the last 15 years, Only 10 percent of large cap managers have actually beat their benchmark after costs. It's a very hard thing to do, and it takes an exceptional amount of skill to identify those managers and stick with them over that period to reap those benefits.

And even if you do, sort of the average alpha they generate isn't that great. So on the, on the left side here, what we have is what the return would have looked like in a decomposed fashion. If you had managed to pick a top four tile U. S. large cap equity manager over the 2013 to the end of 2023. So the prior decade, and what you would see is that.

You would have earned a 12. 84 percent annualized return, about 120 dips of which would have come from manager alpha, the vast majority of which would have come from underlying beta in U. S. large caps. Consider the new world approach, which says, well, instead of trying to find alpha in the place that's proven to be one of the hardest to find alpha, what if we just buy our beta, right, and stack on top, in this case some hedge fund beta.

So just basically chose a generic hedge fund benchmark, didn't even have any skill, didn't try to do any hedge fund selection, just said just give me broad hedge fund exposure, stack that on top, get rid of the financing rate, the cost of cash, and you would have added 275 basis points. So really no skill needed there in terms of manager selection, and you would have more than doubled the excess returns you would have added to your portfolio.

So again, what we think is a truly profoundly, uh, important unlock for the way we think about spending that active risk budget for investors in the pursuit of outperformance. And when you use this framework, really what it allows you to do is think of any alternative investment strategy or asset class as sort of these Lego building blocks.

When we look at the long term returns, if we cut out the cash component, if we say what are, what's the excess component of these different asset classes, whether it's gold or trend following or market neutral, long, short or event driven strategies. If we subtract out that T bill rate, whatever's left over would have been effectively what we can think about stacking on top of our betas, right? And the, and again, we can mix and match these to whatever objective or outcome we're looking for.

So we could say, well, instead of trying to pick stocks, why don't we just buy the S& P 500 and stack some gold on top? Or we could stack some trend following or some macro or some equity long short. Again, in whatever combination we want that creates an outcome that we want. Maybe it's, we want absolute returns, uh, low vol alpha, excess returns, or maybe we want.

some sort of stack that we think is going to provide profound diversification in certain sort of market environments, high inflation environments, or, uh, a breakdown of fiat, right? You could think about stacking a little bit of gold and Bitcoin. There's all sorts of creative things you can do when you unlock this framework. Question is then, how do you do this, right? Because I mentioned at the very beginning, the way PIMCO did this is they bought. U. S. Treasury futures.

And then they bought S& P 500 futures and most allocators don't have the ability to do that themselves, either because their mandate prohibits it, or they don't have the ability to do it on behalf of their clients. And that's where RSSB comes in. And that's why we think RSSB is such an exciting product because it allows you to unlock this return stacking and portable alpha concept. By simply using an ETF.

So RSSB, when you give us a dollar, we are going to give you a dollar of global equity exposure and a dollar of U. S. Treasury exposure. And the way we do that is very simple. You give us a dollar and we're going to put 90 cents in, or effectively 90 cents, in passive. low cost equity exposure. We're basically trying to give you something as close to call it MSCI Acqui or FTSE Global All Cap type exposure. No active bets being made on the equity side. Every dollar, 90 cents is going into that.

And then we're going to put 10 cents in basically T bills. And those T bills are going to serve as collateral for us to buy 10 cents of equity futures to help us fill out the rest of that dollar. as well as a dollar of treasury future exposure. It's going to be a ladder of two, five, ten, and long bond U. S. treasuries equally weighted, so 25 percent in each.

When you take that exposure combined, what we're getting is a dollar of equities plus a dollar of treasuries, and those treasury futures are going to include that cost of financing, and which is we've seen is historically close to T bills. And so this tool then is is a tool of capital efficiency. You're getting two dollars of exposure for every dollar you invest. Now the way most people have, would have historically looked at a fund like this would have been as a standalone, right?

They would have said, well what have global stocks done historically? What have bonds done historically? What happens if you look at something where you stack them on top of each other and pay, you know, a financing rate equal to T bills? Black line global stocks, blue line bonds, green line would have been if you stack them together and pay the financing rate. And what I would argue is this is the complete wrong way to look at this product.

Because this product is not meant to say buy this instead of global equities and you're going to outperform over the long run. What this product is meant to do is help you free up capital in your portfolio to then use to stack other concepts and ideas. So in my opinion, this is a much better way to think about a product like this.

That if I put 50 cents into a product like this and 50 cents in T bills, that return is going to look almost equivalent to 50 percent global stock, 50 percent bond portfolio. Right? The black line, the green line match here.

And that's important because that 50, 50 percent in a product like RSSB, Giving you returns that look like a dollar in a 50 50 means that the rest of that portfolio, the other 50 cents in T bills, can then be used to invest in whatever you want, and that will effectively be stacked on that original 50 50. Now most people don't have a 50 50, they have a 60 40 or a 70 30, so, and most people aren't going to want a huge stack anyway, they might want a 10 percent stack or a 20 percent stack.

So the way we think about using this is, for whatever stack size you want, you basically need to sell enough stocks and bonds. And then get the exposure back with RSSB to create the room for whatever alternative stack you want. So let's say you have a 60 40, 60 percent stocks, 40 percent bonds, and you wanted a 20 percent stack of alternatives. Well, what you could do is you could sell 20 percent of your stocks, sell 20 percent of your bonds, and put 20 percent into RSSB.

Now, remember, RSSB is going to give you a dollar of stocks and a dollar of bonds for every dollar you invest. So that 20 percent in RSSB is going to give you back 20 percent stocks and 20 percent bonds. And then you have left over 20 percent of your portfolio with which you can invest in alternatives.

And when you take the stocks and bonds and RSSB and add the exposure together, Through an x ray, you get your 60 40 back, and the other things you're investing in, those alternative investment strategies or asset classes, are now effectively stacked on top, at the financing rate, embedded in the leverage that we manage within RSSB, again, using the treasury futures that get you a financing rate close to T bills.

And that's why, if we go back to a graph like this, we would see that the T bill rate, When you invest the 100 100 portfolio, plus T bills, gets you something that looks almost identical to the 50 50. Because those treasury futures have historically had an embedded financing rate almost equivalent to T bills. Incredibly powerful way to borrow. So then, the question is, okay, what do you stack? And there's really, sort of, it's an open ended conversation here.

We have some biases as to what we think you should stack. We have a strong bias that whatever you're stacking, ideally is, has low correlation to stocks and bonds. That's where we can go back to what Rodrigo said at the beginning, that return stacking is all about unlocking the benefits of diversification. But we recognize some people may want to stack for outperformance. Some people may want to stack for diversification and downside protection.

And some people might have more specific outcomes in mind, like they want to stack some sort of fiat hedge, right? So when you're stacking for outperformance, You might think of all these style premia, these, these long short equity strategies, these event driven strategies like merger arb or, or SPAC arb, uh, market risk transfer strategies or some alternative lending strategies.

In stacking for diversification, you might think of things like trend following, or carry, or systematic macro, or even sort of defensive equity long short, quality long short, anti beta long short. Those sort of things can be stacked on top of your portfolio as pseudo hedges. If you're stacking some sort of fiat hedge because you're concerned about the currency in which you're investing in, well, you could try to stack some gold or bitcoin. Again, the combinations are sort of endless.

RSSB is just the vehicle that allows you to do it. Question that comes up is, okay, RSSB allows you to do it. What should we do? How big a stack size should we create? How much of this is that stack going to impact my portfolio? What's it going to do to the volatility of my portfolio? These are questions that come up all the time. And this is where I wanted to take the bold step of trying to do some sort of live demonstration.

Um, We do have some tools that are available to financial professionals and advisors through our website. If you go to returnstack. com and go to the tools section we have some, pretty easy to use Excel tools that allow you to explore this. But I recognize while we're prohibited from giving that to anyone but investment professionals, um, there are other ways in which you can try to explore these concepts on your own. And so

And, and we've all seen the SPIVA reports and the Morningstar Barometer, Active Passive Barometer. It is incredibly hard to beat the market through security selection, especially when you're in an environment like we are today, where large cap U. S. equities absolutely dominate the market. The market cap, and if you're a global investor, 60 percent of your money is in U. S. equities, and the vast majority of that is in U. S. large cap, where alpha is very, very hard to find historically.

Our question is, are your energies better spent thinking through portfolio construction and saying, let me just take the passive beta, and then try to stack things on top that we simply have a higher conviction that that combination of whatever we stack is just going to outperform cash. Doesn't even have to be alpha, right? Your portfolio is truly indifferent between what is alpha and what is a new novel beta that you've never had exposure to before.

Your portfolio is not going to know the difference. And so stacking new novel betas. Can be just as, if not more powerful than spending your energies looking for manager selection and stock selection outbound. And so that is the question that we leave everyone with. We know where we sit, right? We clearly sit on the side that we think stacking is a profoundly powerful concept and should be utilized by all.

Um, and we think RSSB is the tool that really unlocks the ability for people to stack whatever they want. So with that, Rod,

the duration, I believe, is slightly higher than where it is Ag today, but not, not meaningfully, not, not several points higher, probably within a, I think it's within, uh, half a point. So, it is going to be a little bit different, but we do find that that ladder, that equal weight ladder, actually has done a pretty good job approximating Ag without doing anything complicated, just doing equal weight 2, 5, 10, and long bond approximating Ag, over the last 15 20 years.

And a better job when you get out of Ag and look at just a diversified treasury bucket. So if you look at GOVT, for example, which is an index of all the US treasuries, it actually gets you pretty darn close. The reality is you can use a lot more complicated methods. Um, but when you look under ag, right, you have durations and optionality and, and credit risks that just can't be captured with four simple key, key duration points, uh, with futures.

And so what we opted for was rather than adding a tremendous amount of model risk and trying to match the duration and curvature and convexity perfectly, sticking with the simple ladder seemed to be a, uh, very robust approach.

And that's, that's not a trivial design question. Practically, when I talk about being a U. S. allocator, U. S. investors really predominantly only invest in U. S. bonds. And so when we talk about, unfortunately, just being a U. S. based firm, predominantly selling to U. S. based allocators, the beta they need to be replicated in a structure like RSSB tends to be U. S. bonds, not global bonds. Uh, I would say 99 percent of the portfolios I evaluate includes zero international bond exposure.

Okay. which then assumes you want a 50 50 base and then you're doing a 50 50 plus up to 50 percent alternatives. So there's a there's an inherent limit as to how much you can stack with RSSB because you're only getting two dollars of exposure for every dollar you invest.

Whereas the other products in our suite which are pre stacked alternatives are giving you a dollar of either stocks or bonds depending on the ETF plus a dollar of that alternative and so you can in theory have up to a 100 percent stack. The trade off is being, you are accepting our approach to doing those alternatives. Um, and I understand that there may be alternatives that we don't offer yet that you may want, or you may prefer another, uh, manager's approach to certain alternatives.

And so the trade off is really the flexibility versus how much of a stack size you can create.

Let's say you were to buy our RSST fund, which is every dollar you give us a dollar of U. S. equity plus a dollar of managed futures. That fund has a volatility of 19%. And so if you put 20 percent into that, it's just going to stick out to your stakeholders or end investors, hopefully both in a good way, right? And, you know, from time to time, it's probably going to have a higher average per year drawdown.

We hope the max drawdown is less than just something like equities, but we think on average it's just higher vol. It's higher average annual drawdown. And so that product is going to stick out. And so what we advocate for is actually, if you're going to take this stacked approach, you really probably don't want any individual product to be more than five, maybe at most 10%.

Because otherwise it's going to start to stick out in your quarterly reviews and going to create that behavioral friction as well. And so there's a trade off here of, you know, how do you achieve the stack size you want versus how many, you know, products do you need to mix and match to make sure that none of them stand out too much in doing so.

Versus one that's prepackaged that makes the returns of the S& P and zero returns on the stack. You know, there's also some play there in terms of whether, you know, line item risk is important to you and your clients, um, to consider with all of these types of stacking alternatives. All right, I think we're at the top of the hour now. Uh, I'd like to thank you, Corey, for a fantastic presentation.

You're already getting a lot of comments here, uh, saying that it was an outstanding presentation, and I agree. For everybody here that, um, that wants to learn more about what we're doing, The return Stack is all about. Please do reach out to us, uh, on the website. You go to return stack.com/contact us and you will be able to connect with somebody from the team. We are active participants with our investor community and help create better portfolios.

So if you want to consultation, 50 minute chat. We're available there for you on, uh, for any advisor that wants to, to reach out. And, um, as Corey alluded to some of the other areas of education, if you have a YouTube channel, Return Stacked or YouTube channel, if you look that up, we have the Get Stacked Investment Podcast on returnstacked. com. If you go to the insights page, we have a wide variety of articles that really answer all the questions that we've been asked.

We've tried to be thoughtful about answering that. We'll also be publishing a couple of new, um, articles in the next couple of weeks based on some of the new stacks that are coming out, uh, that I think people would find useful. And, uh, finally we have a section and we have the model portfolio section and the tools base, the section for advisors and that's free. You just need to sign up. And we need to verify that you're an advisor and within 24 hours, you'll get access to it.

And again, happy to help you understand all those, understand the tools and see how those things could help. Any parting thoughts? Anything else you want to talk about, Corey?