Bonus Interview-Return Stacked ETFs: What You Need To Know

Speaker 1 0:07

Here to dive into industry trends with leading ETF experts, this is ETF spotlight with Nina Mishra.

Nina Mishra 0:17

Hello, and welcome to ETF spotlight. I'm your host, Nina Mishra. My guest today is Rodrigo Guardillo, president and portfolio manager of Resolve Asset Management. We are talking about return stacking and return stacked EDS. So return stacking also known as portable alpha has been employed by institutions for a long time, and it basically involves using leverage to enhance overall returns and add diversification benefits to a portfolio.

But this sophisticated strategy was generally out of reach for retail investors. And now, thanks to ETFs, these strategies, these complex sophisticated strategies are becoming accessible to ordinary investors as well. And Resolve now has a suite of 5 return stacked ETFs. Their flagship fund, RST, which is just a little over a year old, has already gathered over 220 million, and, their suite now exceeds 750,000,000 in AUM. Rodrigo, welcome.

Great to have you with us today.

Rodrigo Gordillo 1:43

Thank you for having me, Nina.

Nina Mishra 1:45

So let's start with the basic question. What is return stacking? Please explain to a layperson.

Rodrigo Gordillo 1:52

Sure. Sure. As you mentioned, return stacking is a new name to an old concept. But just to kinda make it simple, the versions of return stacking that we're putting together tend to be the idea of layering one investment return on top of another so that we can achieve more than a dollar of exposure for each dollar invested. So if you give us a dollar, we're gonna give you $2 of exposure.

But importantly, that second dollar tends to be a non correlated either asset class or alternative investment strategy that helps with diversification.

Nina Mishra 2:30

Awesome. Now, let's talk about the potential benefits as well. Talk about the investment case for return stacking.

Rodrigo Gordillo 2:38

Sure. I think that the idea here is by being able to unlock these prepackaged solutions, unlock this diversification, it really does allow investors to maintain their core and stock bond exposure while at the same time introducing new diversifying return streams. Right? Because if you think about the history of, adding diversifiers to a to your own portfolio, if you're an investment adviser to their client's portfolio, it's been quite treacherous, especially when, you know, your your favorite toys, your favorite domestic equity markets have been the best performing asset class. Right?

So if you ever tried to add diversification through any sort of non correlated alternative strategy, it was an exercise in addition via subtraction. You had to sell things that you really liked in order to buy things that you weren't quite sure of. And the hurdles for those alternative sleeves were very difficult. Right? The hurdle needed to be positive returns most years.

Sure. But more importantly, they tended to need it they needed to be from a behavioral perspective, they needed to outperform the base benchmark of the core portfolio more often than they did. And so if you have something that's non correlated true alpha, but has a volatility profile of 5% annualizing at 10, that's gonna be a tough hold. So the concept here is to say, instead of addition by subtraction, why don't we go ahead and do a yes and solution where we can say to people, yes. Keep your equity and bond portfolio and stack these diversifiers on top.

And so the way this would work practically is you would say let's say you had an investment product that was for every dollar you bought, it's a dollar of the S and P and another dollar of liquid alternative. Well, you could sell 10% of your S and P 500 portfolio by this product that gives you your S and P 500 exposure right back. But when you put your x-ray goggles on, you're getting an additional 10% stack of this diversifier. In essence, stacking the returns of those diversifiers on top of your whole portfolio. And that way, at the end of the year, if that alternative strategy or that stack that you decided to add, it was positive, whether it was a little bit positive or a lot positive, you would get your benchmark portfolio plus that excess return.

ok at the return since August: 2007

The S and P has annualized at just around 10 during that period. Long duration bonds around 4. Cost of borrow around 0.8. You add those up, you come in at around the same return as PSLVX. So we don't have to look for it to realize how valuable a stack like that could be.

And this is really where alpha beta separation came in. Institutions started using it and, but it wasn't available for retail in a very clear and concise way. I think, up until we started really putting pieces together, educating and talking about it.

Nina Mishra 6:29

Now let's talk about the risk because investors will wonder for the return stacking results and stacking of the risks too. There was an article on Bloomberg dotcom recently. The title was Lovered Trade That Blew Up in 2,008 Gets A $600,000,000 EDF redo. And this article talked about your ETFs. And investors remember that, Long Term Capital Management, Lehman Brothers, they had all imploded because of excessive leverage.

So, please, tell us what happened during the financial crisis and what's different now.

Rodrigo Gordillo 7:15

o is what tended to happen in: 2008

Right? So I mentioned earlier that the idea of portable alpha is that you grab your base portfolio that you like, and then you stack something that's different on top. Right? And alpha alpha meaning that it should have zero correlation, very low correlation to the thing that you're stacking on top, ideally. And the reality of what happened in 08, and, of course, you never know who's naked until the tide goes out as Warren Buffett says all the time.

What happened in 08 is that people were using leverage in order to get more exposures to things that they like. But what they liked, these hedge funds that they were using, were actually just more long of the same things. So they were levering up more risk assets than I think the underlying users either, inadvertently, or or explicitly decided to do. So when you have more than 100% exposure to equity markets and the equity markets go down, you're gonna go down what the equity markets did plus more. And broadly speaking, that's how the implementation of portable alpha, there was a lot of lessons, hard lessons learned.

A lot of people got burnt. And the recognition is that if you're gonna use this, you better be sure that you're gonna that that you should be stacking things that are going to actually mitigate losses rather than exacerbate them. And so the the first few stacks that we have launched are designed explicitly for them. These if you look at the landscape of alternative strategies that one can stack on top of equities and bonds, the ones that we have selected are the ones that when you look at the correlation history of these strategies across the board, they tend to have the lowest correlation to equities and bonds and have the, historically proven to actually provide really strong positive returns during prolonged both equity and bond bear markets. Right?

So if you can imagine, now you're stacking something that helps you reduce your maximum future trough loss of your beta portfolio. All of a sudden, this concept, portable alpha plus diversification makes a lot of sense.

Nina Mishra 9:58

Yes. And, since you mentioned Warren Buffett, arguably the greatest investor of all time, I just wanted to add that he has used low cost leverage and, Berkshire as well. And in fact, he has said that, this has given Berkshire quite an edge over their competitors. So now let's take the example of your flagship fund, RSST. And, could you walk us through the investment strategy, what exactly it holds, and how is the, strategy achieved?

Rodrigo Gordillo: 10:35

Sure. Yeah. So RSST is basically for every dollar that you give us on that ETF, you're gonna get a full dollar of US large cap equities, and then you're gonna get another full dollar of an exposure to a managed futures trend strategy. Okay. So for a 100% exposure to the S and P large cap, the US equity large cap and a 100% exposure to a managed futures trend strategy.

Now why is managed futures the kind of the first alternative strategy that we clung on to, managed futures trend in particular. Well, it's kind of in the name. Right? Trend following has been around again for decades. If you go back to the turtle traders in the eighties, these were individuals that were trading not just equities.

Right? Because I think a lot of people think about liquid alternatives as choosing the best stocks and then shorting the worst stocks. But in the future space, what you tend to have is a very, very well diversified broad market that includes all of the global equity indices, all of the major bond indices, all of the major currencies, as well as all of the major commodities. And so you have this broad basket of securities to choose from, and futures allows you to very easily go long and short all of those markets. And the turtle traders were just looking at trends.

They were looking at charts and seeing if the trend was up. They are they recognize that they were likely to continue to be up over the next period. And if trends were down, they were likely to continue to be down over the next period. And if they were diversified across the bets and were updating their bets every single day, then they saw that they got returns that were that were upward sloping over long periods of time and had very low correlation equities and bonds. And in particular, when trends are really robust, you know, when the trends are most obvious and they're prolonged weeks months long, you tend to have the best outcomes for a managed futures trend.

It's it makes sense intuitively if you're following trends. Right? The longer the trend, the more persistent, the more money you're gonna make in a trend strategy. And guess what? When when do those very strong trends tend to rise?

, or,: 2022

And so that's that's the the benefit of tacking on something like Trend Strategy as a stack. Now why don't people use this as just a an addition bias of attraction to their portfolio? Because one of the drawbacks of Massachusetts trend following is that most of the returns come at the tails, come at those big events, and then you get modest returns most other years. Right? So when you're, again, when you're competing against consistent 8 to 15% returns on a calendar year basis with the S and P 500 versus something that's giving you 2, 3, 4% most years and then a big double digit 20, 30% in the the best years.

But your most years, you're getting hurt. It feels like you're losing most of the time when you're when you're trying to make move in your portfolio. But when you stack this on top and you're making an extra 1, 2, 3 percent in moderate years, that is a ton of value that you're able to add to the portfolio. And because of the non correlation, you're you're stacking those returns, but not necessarily stacking those risks. So, you know, that's kinda like the high level.

%. In: 2022

So in: 2009

Nina Mishra: 15:30

Yeah. I recall, 2022, which was a very challenging year for investors because most major asset classes had a terrible performance, stocks, bonds, everything. And one area that managed to shine in 2022 was managed futures. So DBMF, and EDF, which invest in managed futures, was up over 30% then. And, our listeners will recall that we had Andrew Bayer on the show then.

You mentioned the longer term performance of these strategies. So I just wanted to discuss the, performance of RS ST so far as well. So I looked at the performance. It is since inception, it is up about 18%, whereas the S and P 500 index is about up about 27% during this period. So is our SSD performing like it is supposed to perform?

And should investors compare the performance to stocks or to a 60, 40 blend of equities and bonds? And or should they not look at the shorter performance at all because these strategies, the aim of these strategies is a smoother ride over a longer period, or they should see these as insurance against bear markets, which which you also mentioned. So could you talk about how investors should look at the performance?

Rodrigo Gordillo: 17:06

Yeah. So so the the ETF is just I think we just ticked over a year. And the way they should, if they want to see exactly the components, they can just add the S and P 500 return and they can look at the return of the managed future space. And you can look at it, morning star index or the SOC 10 trend index, add those 2 up and see how it's done. And as I mentioned, 2022 is great for that space.

2023 and and a little bit of this year has not been great. And so that differential is the fact that managed futures trend as a whole has had, I think, you know, between 8 10% loss since we launched. Right. So it's just an unfortunate launch period. Have we done it a year before?

Or you can just look at any one of the managed futures managers, and you'll see the benefits of having that in your portfolio. When you look at the history of the index, you're looking at 8 out of 10 years, the index tends to provide positive returns, 2 out of 10 years negative returns. So some years you're gonna stack positively. Most years you're gonna stack positively if if history is any indication and few years are not, and we happen to be in a year that we're not. Now are people buying a 100% of the portfolio in this?

No. Right? The goal here when we look at advisors and investors is especially a starting position of 20% means that if you're in a 100% equity investor and you've just stacked, you know, you sold 10, 20% of your equities and replaced it with our SST, then that 20%. Since inception is underperforming, you know, by your portfolio as a whole would be outperforming by an underperforming by around 2%. So it's not the end of the world, but as time goes by, if we do continue to get those 8 out of 10 years positive, you'll end up over time stacking, in, in a positive way.

And so, you know, one of the key use cases here, for portable alpha historically has been how do we beat our benchmark over time? If stock picking is really, really tough. And I think an answer to that could be you stack non correlated strategies on top. And if they on average perform positively, then you are on average going to be able to outperform your benchmark. And then how much of that outperformance you want or how different you want to be from your benchmark will be defined by how much, how big a stack do you put into your portfolio?

It's a 10, 20, 30, 40, 50. That's what, that's where it becomes, you know, a very personal matter.

Nina Mishra: 19:41

Right. So whenever we talk about leverage in the ETF world, whenever we look at leverage ETFs, we talk about volatility volatility drag as well. So the ups and downs of the market can hurt levered ETF a lot. So could you talk about the volatility drag on these ETFs, return stock ETFs, and how you manage the volatility drag?

Rodrigo Gordillo: 20:08

Yeah. So, I mean, volatility drag is something that isn't just, explicitly an issue for labor products. Volatility drag is a mathematical reality, a compounding reality that applies to any investment, and, and, and involves any investments volatility. So if you think about a, the S and P 500, you know, from 2,000 to now, I think the volatility is roughly 20% annualized standard deviation, right? That's the volatility.

If you add up all of the calendar years and you average them out, you're going to get a number that's much higher than what your compound rate is. And that, that compound rate, the equation is the arithmetic return. So the simple addition of those years minus half of the variance, right? So the higher, the variance of a portfolio, the more it's going to eat in to your average return. And so 20% volatility, if you have 10% return, and you're, you know, you have a lot of variance, you might eat up, let's say you, you, you subtract 5%, that's your compound rate of return.

But what if you were able to create a portfolio with the same level of volatility, but double the return? Then the variance hasn't changed. The variance drag does, hasn't changed. And the, and the geometric rate of return has gone up. When you look at 2 X S and P 500, you're not just trying to double your arithmetic return, but you're also quadrupling your variance.

Does that make sense? That's the 2, 2 times bulls, ETFs that you see you're quadrupling variance while you're trying to double the arithmetic return, meaning that the geometric return isn't 2 X, the non Libert version. Now, fast forward to return to stack. One of the key benefits of diversification is that you can increase the portfolio's return. This is finance 101, right?

The idea that if you create a more efficient portfolio of asset classes that have positive expected returns, but Zig when the other ones zag, it means that you can increase the return while not necessarily increasing risk. So when you look at the S and P 500 at 20% volatility, and then you stack on top a managed futures carry strategy, for example, with a 10% volatility, the addition of 20 plus 10 is 30. But because of the of of the stack zigging, when it when the other strategy zags, what we find is that the volatility of the combined one plus one is just over 20. It actually barely budgets. It barely increases in risk.

And so the variance drag goes up a tiny bit, but by no means does it quadruple. And that is the benefit of diversity. That's why concentrated leverage is not only a problem from catastrophic events, but it's also a problem from a return drag over time. If you're able to to use leverage to increase returns but maintain volatility, then that's kind of the magic formula. And that is, like, you know, that's, William Sharp's thesis and the what won him the Nobel prize.

So it's nothing new.

Nina Mishra: 23:31

Great explanation. So you have, 5 ETFs. Currently you offer 5 ETFs. We talked about RS SD. Could you tell us a little bit about other ETFs in this suite as well?

And how should investors pick and choose from these products?

Rodrigo Gordillo: 23:52

We've got 5 products. We have one that's very different than the other 4. So let me start with that one. The first one doesn't try to do anything fancy at all. It tries to kind of mimic what PIMCO had done before, but in even more simpler terms, it's, it's, it's for helping you create room in your portfolio for a couple of use cases.

You can, you can stack your own diversifiers or you can create a cash buffer in your portfolio to use whenever you want. And so that first one is RSSB, return stack, stocks and bonds. And that gives you 100% exposure to global equities and 100% exposure to, a ladder treasury portfolio that has similar duration to, to a aggregate, US aggregate bond index with 6, 6, 6 and a half years duration. Right? So similar to what the average bond portfolio is for most Americans.

And so you get a dollar of equities, dollar bonds. And the use case there is that you can say, look, I'm going to sell 10% of my equities, 10% of my bonds. I've raised $20 in cash. I'm only going to use half of that money. I've raised to buy our SSB.

Now I have that back. If I x-ray my portfolio, I got my equities back and I got my bonds back. I'm fully allocated. Plus I have $10 cash in there that I can just invest in T Bell. And then just sit there with it and wait for an opportunity for when the markets fall and do a Warren Buffett approach where the when there's blood on the streets, you can you can use that money to buy more.

Or if you like a specific alternative manager that's been doing has that has made you positive returns for 15 years, but never beaten the S and P 500, this gives you an opportunity to keep that manager, but stack those returns on top. So that's the first kind of capital efficient ETF, super simple, 40 basis points, 41 basis points. I think the next 4 are, they're the base are either equity basis, US equity basis, or bond basis. There's 2 of them have equity US equity exposure as their base, and 2 of them have US bond exposure as a base. And what we're stacking on top of, one is managed futures trend following, which I went through in detail, on top of the S and P 500 that the RSST and then RSP T bonds and trend is aggregate us bond index plus managed futures trend.

Right? So that's kind of a coupling there. And then the next 2 is again, S and P 500 with a managed futures yield strategy. And that's just the same, same markets as the trend strategy, but, but picking it in different ways, instead of picking it based on trend, it's picking it based on the dividends. In other words, the yield or the carry that each one of these ETFs, each one of these markets has at any given time.

And, and it has very low zero correlation equities, bonds, and very low correlation to trends. So it's a logical next thing to add to portfolios and also has a tendency to do pretty well during bear markets. And so again, that one comes with a, a equity base plus the yield R S S Y stocks and yield and a bond base plus managed futures yield, which is R S, BY. And those are the 5 for now.

Nina Mishra: 27:17

Very interesting. So last question, how these products should be used in a portfolio? So let's take the example of a traditional 6040 portfolio. Should investors sell some stocks or bonds to free up cash for these strategies if they want to consider?

Rodrigo Gordillo: 27:35

I mean, the answer is yes. And it all depends on your personal circumstances, obviously. Right? So if you have a, if you're an investment advisor and you have a business that is mostly retirees and, you're worried about inflation and you're worried about bear markets, your portfolio is mostly going to be bonds, right? So it makes probably the most sense to sell some of your bond positions to buy some of the, you know, the R S B Y R S, B T, ETFs in order to stack things that tend to do well in bear markets and inflation regimes.

Right? So that's a use case for using bonds. Then there's the other extreme, which is an advisor and individual who's a 100% equities and wants the opportunity to outperform those equities, wants to aim for that. You know, they tried stock selection, hasn't gone well for them. Maybe stacking will be the way to go.

They could use the RST or RSSY to make, to sell their equity positions, replace them with any one of these or both ideally, because you get more diversity by using both trend and yield. And then you get the stack that on top. And if all goes as planned, then they get to, over time have an opportunity to outperform the just plain vanilla S and P. So it's, I think most investors were seeing the use case being precisely, that, and then there's everything between right. People that are 50, 50 bond equity.

They like the idea of, selling some of their bonds, some of their equities and using a combination of those exchange traded funds. And then for the capital efficient one, which is bonds plus, equities, global equities, then it's kind of you choose your own adventure there as well. You just make room in your portfolio, sell 10% of your bonds, sell 10% of your equities, replace it with this, and then leave it in cash, use it for whatever you want. Maybe if you need to borrow money, that's another one because you're borrowing at institutional rates with these ETFs. So instead of going to the bank and asking got, and you can either sell your portfolio or you go to the bank and ask for a loan, or now you can sell 10% of your bonds and percent of your equities in your portfolio, raise some money, replace it with percent of your bonds, sample percent of your equities in your portfolio, raise some money, replace it with a CTF and whatever cash is left you use for whatever you need to use, hopefully momentarily, while still maintaining your exposure to the markets at the most competitive rates that one can find, given that we're getting our borrow from futures contracts.

Nina Mishra: 30:03

Excellent stuff, Rodrigo. We'll have to leave it there. Thank you so much for joining us today and for sharing your insights. And also congratulations on the success of return stacked ETFs. It's pretty impressive.

Rodrigo Gordillo: 30:16

Thank you, Nina. I really appreciate the time that you've given us. And, you know, if anybody wants to find any of these, they can go to returnstack.com, or you can also reach out to the, the principles. This is a joint venture between resolve asset management and new found research. So you can look us up Corey Hofstein from new found has a great Twitter profile that does a lot of education on this stuff.

So, do follow us if you can.

Nina Mishra: 30:42

That was Rodrigo Gaudio of Resolve Asset Management. Let's quickly recap the tickers. Their flagship fund is RSS T, return stock US stocks and managed futures, RSBT for bonds and managed futures, RSSB for global stocks and bonds, RSSY for US stocks and futures yield, RSBY for bonds and futures yield. Thanks for listening. If you like our show, please leave us a rating on iTunes or wherever you get your podcast.

Also, make sure to subscribe so that you do not miss any episode. If you have any comments, questions, or suggestions, please email podcast at zacks.com.

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