Contents of this month’s post include:
- Prepare for annual rebalancing: J.P. Morgan estimates USD 300bn equity sell-off for balanced funds
- Portfolio changes: Introduction of VIX and Bitcoin
- Temporarily decreased inflation-linked bonds in deflation fright
- Monthly Update for November
- Book tip: Beyond Blockchain: The Death of the Dollar and the Rise of Digital Currency by Erik Townsend (link at the bottom of the article)
- In case you missed it: My latest Insight article about How VIX ETFs can improve portfolio performance and stability in volatile environments
Hi, and great to have you back for a new portfolio update filled to the brink with content.
Hope you are in good health and are preparing for a safe holiday seasons coming up. It is going to be a rather different Christmas this year as many countries are imposing extended restrictions by end of December. Celebrations with family will perhaps not be possible for many unfortunately, and that is a tough thing. One can only hope that our sacrifice to stay at home with only immediate family will help us avoid a third wave and as many unnecessary deaths as possible before vaccines can be rolled out on a larger scale next year.
I had hopes on joining my girlfriend on her trip to her family in Italy, but with the new restrictions, it seems more likely I will be stuck in Sweden for Christmas and New Years. It is unfortunate, but what can you do? This year has been challenging in many ways.
Winter is coming here in Sweden, and the darkness with it. I read that someone likened how it is to live here in the winter months to living in a refrigerator with a broken lamp. It is actually a quite accurate description, as the sun sets already around 3pm.
We have a lot of ground to cover in this month’s update, so let’s just dive into it. I have made some structural changes to my portfolio and will therefore spend some time to lay down my reasoning for the changes. This includes an addition of VIX and Bitcoin, but also a temporary decrease in inflation-linked bonds. Before going into my reasoning on these changes, we will have a look at the coming rebalancing period in late December.
Thoughts on this year’s rebalancing
But first, a gentle reminder that the great rebalancing period is ahead of us. For all investors and asset managers using a risk parity strategy, periodical rebalancing is a fundamental feat of the strategy.
If you haven’t seen this already, I greatly recommend this white paper by ReSolve Asset Management on the added value from rebalancing. It will add return to your portfolio, thanks to reaping of risk premiums while offsetting marker risk. According to the whitepaper Maximizing the Rebalancing Premium, the return of a risk parity portfolio through rebalancing only can be expected to be up to 1.19% annually more than the average return of the assets in the portfolio over the same comparison period – a simple increase of return without additional risk.
As a retail investor, it is often enough to rebalance annually, but it is not uncommon that it occurs more often than that. Most risk parity funds will rebalance on a quarterly basis.
This means that a new rebalancing date is coming up, when funds will billions in AUM will rebalance their portfolio. During times when asset prices have not swung by much between quarters, the effects on prices may be minor.
However, for December 2020, J.P. Morgan expects that funds with $1.5tr in AUM will rebalance their portfolios toward the end of year. This number includes the plethora of “balanced” 60/40 portfolios. Because stocks and government bonds have seen a great development in opposite directions, with stocks being the better performing asset, it looks like there may come pressure on stock prices toward the end of Q4 when these funds are rebalanced. According to J.P. Morgan, equity selling of around $300bn may be expected.
This means that the market will temporarily temporarily flooded by supply of equities, albeit this pressure will normalize the following days. Conversely, these same $300bn will be flowing into other asset classes such as bonds.
What can you do? Retail investors usually take the time during the holidays to review their investments, making adjustments, and rebalancing. Avoid being caught by the pressure on stock prices and rising prices on government bonds on the last trading day of 2020. If you rebalance your portfolio on this same day, you risk not getting the best prices and will thus not benefit as much from rebalancing.
Therefore, sit down a few days earlier than you had planned and rebalance your portfolio with time to spare. Thus, you will be done with your portfolio overview already before the funds hit the market to shift their holdings. Instead, you can enjoy a nice warm cup of tea without needing to worry about what goes on in the markets.
Changes to my portfolio in November
In November, I have made both some structural changes and a temporary change to my All Seasons Portfolio. Let us go through them one by one with some reasoning. If you have any thoughts and opinions on these changes, drop a comment at the bottom of this post so that we can discuss further. I look forward to hearing your thoughts on these changes and if you have similar (or opposite) ideas.
Bought VIX (3% of portfolio)
In case you missed it, in November, I published an Insight article on VIX (CBOE’s volatility index) and how you can use VIX products, such as ETFs investing in VIX futures contracts, as an insurance policy and hedge your portfolio against periods of increased implied market volatility.
In that article, I analysed how a VIX ETF could have significantly lowered volatility and improved return (both absolute and risk-adjusted) of an All Seasons Portfolio through the coronavirus meltdown in March 2020. Even by only allocating 3% of the portfolio to VIX, the portfolio performance was clearly more stable through one of the worst drawdowns on the stock market in history. Through 10 days in March, no asset class was immune to the panic as equities, bonds, gold, commodities, and cryptocurrencies all fell. Only VIX products gained, and they gained a lot.
Based on the analysis in that article, I have concluded that to improve stability and long term performance of my portfolio, I have introduced 3% VIX in my All Seasons Portfolio. My ETF of choice is the Lyxor S&P 500 VIX Futures Enhanced Roll UCITS ETF – Acc (LU0832435464 / Ticker: VOOL/VOO).
As VIX is an asset class biased to perform well in low-growth environments and is inflation-neutral, I have adjusted other asset classes in my portfolio by decreasing both long-term government bonds (-2%) and inflation-linked bonds (-1%). The difference between bond types with respect to magnitude of decrease relates to the prevailing difference in how much of these assets I aim held in my portfolio: I had 40% long-term government bonds and 15% inflation-linked bonds.
I will not write any further analysis here, but instead recommend checking out my longer article from November 2020 on the subject for more details.
Bought Bitcoin (3% of portfolio)
While the addition of VIX was more related to insuring against periods of lower economic growth, I have also made an adjustment more related to periods of higher inflation and (potentially) higher economic growth.
In November 2020, I have decided to add Bitcoin to my portfolio. By no means am I a first mover, but rather, I have made it a point to first become confident in cryptocurrencies and especially bitcoin as an investment before jumping on the train.
During November, the price of Bitcoin have closed in on its previous all-time highs from late 2018 just below USD 20,000.
Compared to the surge in 2018, I see several variables are different this time around. I will write a longer article on my views on Bitcoin in the coming months with further analysis. I will thus only brush on the most important items summarized here.
- If 2018 was the year of first movers and only a general curiosity, in 2020, cryptocurrencies have taken several steps toward being recognized as an actual asset class. It is not there yet, but moving toward it with wider use.
- From 2020, institutional investors and funds have received green light to allocate to Bitcoin, increasing demand.
- It is easier to pay with Bitcoin, or at least with Bitcoin-linked money. For example, Paypal introduced BTC for its wallets in the autumn of 2020.
- Bitcoin is being used as a means of payment in South American countries in a response to hyperinflation an unstable economies. For example, Pizza Hut in Venezuela now accepts payment with Bitcoin from beginning of December 2020.
While there remain many aspects with cryptocurrencies and Bitcoin in special that are yet to be solved before they can be used on a larger scale, I do not find it to be a bad idea to get small exposure to BTC. I have thus allocated 3% of my portfolio to Bitcoin in anticipation of further positive development, while not risking my wealth with a huge bet. Cryptocurrencies are a rather volatile asset class, which means that if a larger portion of a portfolio is allocated to them, risk balances would easily be thrown off.
I have chosen to attain my exposure through a tracker denominated in SEK (Swedish Krona): the Bitcoin Tracker One (SE0007126024 / Ticker: COINXBT). There is also a EUR version available, the Bitcoin Tracker Euro (SE0007525332 / Ticker: COINXBE). Both are listed on the Stockholm Stock Exchange.
If you are looking to invest in Bitcoin or other cryptocurrencies directly instead of exchange-traded certificates, consider using Coinbase – the most trusted cryptocurrency exchange with more than 43 million registered users, where you can securely trade more than 30 different cryptocurrencies directly in your own wallet.
Where does Bitcoin fit in an All Seasons Portfolio? In my opinion, it is mostly an inflation-hedge but I believe that for now, it is growth-neutral. Thus, I have adjusted down my commodities (a high-growth asset) exposure by 1ppt from 7.5% to 6.5%, but also inflation-linked bonds (a low-growth asset) with 2ppts from 14% to 12%, which is a further adjustment after the adjustment of VIX.
A more detailed article on Bitcoin will follow so stay tuned. I have no clear time frame for it yet, but will post it first on my Patreon site, and then release it here on the blog. Make sure to subscribe to the newsletter to get a notification as soon as new content becomes available.
The combined additions of VIX and Bitcoin will therefore leave my portfolio from now on to have the below aimed allocation:
As I know, many of you readers have already adopted cryptocurrencies in your portfolios. That has been a good investment the past months. But how much of a portfolio do you think should be allocated to cryptocurrencies?
Sold Inflation-Linked Bonds (temporary)
To fund my new additions described above, I have sold inflation-linked bonds to keep them below their aimed share of the portfolio. This is a temporary precaution, considering the risk for deflation in the short-term.
As TIPS are linked to the inflation rate (usually CPI), when inflation is low or negative, the value of the bonds will decrease.
While inflation rates have been low for the past decade, they have decreased even further in the wake of the coronavirus crisis. Several developed countries are even seeing deflation now by end of 2020, which erodes the face value of the inflation-linked bonds.
I have summarized the inflation in the countries whose inflation-linked bonds are included in the iShares Global Inflation Linked Govt Bond UCITS ETF (IUS5) here below, and as you can see, many show very low and decreasing inflation rates, with several Eurozone countries already seeing deflation.
|Country||Share of IUS5||Last Inflation rate||Previous Inflation Rate||Data Updated|
Table source: Trading Economics , IUS5 holdings per market close 4 December 2020
I have therefore decided to remain underweight in IUS5 (iShares Global Inflation-Linked Bonds ETF) until inflation begins to pick up.
As a reference, the RPAR ETF, employing a strategy similar to the All Seasons Portfolio strategy, has a management rule that it will reduce TIPS as soon as the yield of the 10yr Treasury Bonds falls below 1.00%, which happened in the spring of 2020. This temporary reallocation is reversed after two consecutive quarters of rates of yields above the same 1.00% mark.
This does not mean that the inflation hedge is compromised, as it is merely moved into other asset classes. I remain overweight in gold and cryptocurrencies to maintain protection against a bump in inflation, but now with less negative exposure to deflation.
Portfolio Update November 2020
Now that we have covered the portfolio changes, let us see what happened in November 2020.
In the October 2020 post, I ran a poll on what asset class you believed would have the strongest performance for the month. Top three asset classes voted on were in order of popularity stocks, gold and crypto (Bitcoin). Results below:
Hands down, Bitcoin was the best performing major asset class with a parabolic rise of 40% over the month to USD 19,425. Other cryptocurrencies saw even better return – for example Ethereum rose 57% over the same period.
Stocks saw a good month. Positive vaccine news on 9 November had the S&P 500 spike up sharply, albeit that initial euphoria soon settled down. Regardless, positive momentum continued throughout the month, with the index closing 4.9% above the beginning of the month.
Positive performance was also seen by European stocks and the STOXX 600 index with even stronger gains of 13.1%. Here, the upward momentum was more distinct with few days of significant negative movements.
Gold, on the other hand, posted a weak month in November, sinking down by 5.4% to USD 1,777.39/oz per 30 November 2020. There is some belief among certain investors that this is due to funds being shifted from gold to Bitcoin as both are inflation hedges. However, Bitcoin adoption remains much lower than gold among fund managers, why such substitution must be considered minimal.
10-Year U.S. Treasury Bond yields followed the S&P 500 on November 9th on Pfizer’s vaccine news, but have since been declining back down to 0.85% toward late November. Renewed stimulus talks in early December has however bumped up the yields to 0.933% on 1 December while the 30-year yield rose to 1.675% from 1.574%.
The current sentiment appears to be rather contempt now in early December. The challenging period of U.S. elections are behind us (any unpleasant surprises of faithless electorates are not expected), vaccines seem to be in the pipeline for roll out in Q1 2021 (already in December 2020 in certain countries such as the UK) and the EU and UK have again commenced a last effort to settle a trade deal in the wake of Brexit (link to Financial Times; pay wall).
As long as no surprises of a negative nature comes along, it is likely that treasury bond yields and stocks will continue to rise for a while. Remember though that while vaccines can be introduced in the coming months, it will take much longer time until a greater part of the population has been vaccinated. Still, an uncertainty will remain for whether the vaccines now in development will be effective against mutations of the virus, bearing the Danish mink farm dilemma in mind where the virus had jumped from human to mink to human.
At least through December, I am taking the bet to maintain lower exposure to long-term government bonds, which now take up only 29% of my portfolio vs. aimed 38%, and remain with a slight overexposure to stocks (32% vs. 30%).
A quicker roll out of vaccines and a following quicker rebound in the economy, would facilitate that the velocity of the increased money supply could start rising. The money printed by central banks would be easier to spend once economies open up. This could begin driving inflation, but considering how difficult it has been for central banks to push up inflation the past decade with ever growing QE, uncertainty remains. But my hedge against inflation remains by being overweight in gold and cryptocurrencies. At least if another round of stimulus packages are squeezed in between now and a broader roll-out of vaccines, the chances for higher inflation is rising.
I will monitor the development closely through December, and have my fingers hovering above the fictional rebalancing button, ready to get my allocations back to my aimed allocations (save for TIPS, as discussed earlier). Mainly, this includes selling gold and buying government bonds, but I will wait for now, expecting yields to increase further.
At the same time, stocks are very highly valued at USD 100tn for the first time in history, at a ratio of 115% of global GDP. Let that sink in.
Looking more closely at my portfolio, it is mainly the difference discussed in the above paragraph that keeps me from my sought allocation. I am therefore happy and contempt with my portfolio for now, especially with the new introductions of VIX and Bitcoin discussed earlier.
From the fields in the below graph (Portfolio Splits in EUR), stocks (green) saw a good month, while inflation-linked bonds (bottom blue) decreased due to selling (EUR -150). I did add about EUR 250 in new funds, which more or less were used to fund the crypto share.
November was a good month all in all performance wise. Already now, my Bitcoins had made a profit of 5.75% in only two weeks, but as they only make up around 5% of my total portfolio, the impact on total return was limited. Rather, it is the recovery in stocks and commodities that was driving the positive momentum through this month.
Lastly, here’s a view of the ETFs in my portfolio, and the performance of each during the last month, in table form.
|iShares Global Inflation Linked Govt Bond UCITS ETF||TIPS||IE00B3B8PX14||€608.72||€456.00||-25.09% (sell)|
|iShares USD Treasury Bond 20+yr UCITS ETF||Govt Bond Long||IE00BSKRJZ44||€1,252.14||€1,232.46||-1.57%|
|Market Access Rogers International Commodity UCITS ETF||Commodities||LU0249326488||€318.78||€343.39||7.72%|
|Vanguard FTSE All-World UCITS ETF||Equity||IE00B3RBWM25||€1,244.80||€1,359.52||9.22%|
|Lyxor S&P 500 VIX Futures Enhanced Roll UCITS ETF - Acc||VIX||LU0832435464||€0.00||€138.32||New|
|Bitcoin Tracker One||Crypto||SE0007126024||€0.00||€232.47||New|
As always, thank you so much for your attention and for taking the time to read my thoughts. If you have any ideas for what you want to read more (and less) about in these monthly updates and Insights posts, let me know in the comment section or by email to firstname.lastname@example.org. I appreciate all discussions with readers and I believe it adds a lot of value to talk about ideas on investing and strategies.
Again, in case you missed it, check out my latest Insights post on VIX investing. It is my firm belief that it adds a lot of value and improves the risk-adjusted return of a portfolio. Looking at the poll included in that post, it looks like several readers are considering introducing VIX as a portfolio component. What do you think?
I have also set up a Patreon site, to cover hosting costs, which reach a couple hundred euros annually. If you find any content here at all useful and feel that you can treat me for the equivalent of a double-espresso, read more about what this means on the Support page here on the website. I have a hosting bill of around EUR 140 falling due in November, so any support is extremely helpful, as the monetization of this blog is very limited.
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Looking forward to hearing from you,
Book tip: Beyond Blockchain: The Death of the Dollar and the Rise of Digital Currency
If you are looking for more reading on Bitcoin and cryptocurrencies, I recommend the book Beyond Blockchain: The Death of the Dollar and the Rise of Digital Currency by hedge fund manager Erik Townsend. He also produces the weekly podcast Macro Voices which I believe is a great source of information for any risk parity interested investor. Macro is an extremely important part of investing and in this podcast, you get great interviews with some brilliant minds of the investment industry.
The cryptocurrency trend of the past few years has continued to grow despite widespread predictions that it would just be a flash in the pan. Blockchain is suddenly everyone’s favorite buzzword. But what if there’s more to this story than meets the eye? What if Digital Currency is about to change the world in ways beyond our imagination? And what if geopolitical forces our politicians don’t even understand have already inspired China and Russia to use Digital Currency to attack the U.S. Dollar’s dominance over the global financial system?
The Dollar has served as the world’s reserve currency since 1944, and the fringe benefits have allowed the U.S. Government to borrow and spend beyond its means and run massive trade deficits for decades. Now China and Russia suddenly have a new lever to use which could upset the global balance of power. Who would have guessed that technology breakthroughs conceived by the inventors of cryptocurrency would hand China and Russia just the weapon they needed to attack the Dollar’s rule over the global economy?
The invention of digital cash enables government-issued digital currency systems that could completely modernize the global monetary system. The potential benefits to society are so great that it’s hard to grasp their full magnitude. But a digital currency system introduced by China and Russia could upstage the Dollar and replace it as global reserve currency, causing devastating consequences for the U.S. economy. Which country wins the new digital currency Space Race could change the course of human history.
There’s plenty of evidence that China and Russia are already hard at work. The Chinese central bank is aggressively hiring Blockchain engineers, but has been suspiciously quiet about what they’re working on. Sergei Glaziev, economic advisor to Russian President Vladimir Putin is giving keynote speeches to Blockchain conferences. The Chinese central bank filed more digital currency patents than anyone else in 2017. This book explains why China and Russia are suddenly so interested in Digital Currency technology, and more importantly, what they plan to do with it. Time is short for the U.S. Government to wake up and recognize the threat that now looms over the U.S. Dollar’s dominance at the center of the global financial system, and why Digital Currency technology is likely to be the challengers’ weapon of choice to defeat the Dollar.
Author Erik Townsend is uniquely qualified to sort this puzzle out and tell the entire fascinating story. In his first career, Townsend was a distributed systems architect – an expert in all the technologies used to create cryptocurrencies. In his second career, he was a hedge fund manager who studied reserve currency status extensively. Townsend first gives readers an introduction to both conventional money and digital currency, then gives a detailed introduction to relevant monetary history subjects, and finally ties it all together and explains how a state-sponsored digital currency system could steal the title of global reserve currency from the U.S. Dollar and change the balance of world power.
For anyone interested in the All Seasons Portfolio and Risk Parity investing, I find this a great read as you enhance your understanding for both the vulnerabilities of the economies (ref. discussion above on credit ratings) and government bonds. Or check out other great books on the topic on the Book recommendation page.
Check it out today on Amazon (affiliate link):