My Favorite Alternative Funds

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DaufuskieNate
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Re: My Favorite Alternative Funds

Post by DaufuskieNate » Thu Oct 12, 2017 5:42 am

packer16 wrote:
Wed Oct 11, 2017 6:53 pm
The costs are the big issue here. You pay 2% for something you can get from some of the best insurance risk managers in the world for a few basis points. The portfolio would have a more than a 1.75% cost advantage per year coming out of the gate.

Packer
BRK has Selling, General and Administrative expenses of about $18 billion. That's 3.9% of their $460 billion market cap. It may only cost you a few basis points to hold BRK in your fund or account, but it certainly costs you more to have exposure to their reinsurance contracts. They have expenses too. I get it that you think holding insurance companies is better than owning a portfolio of reinsurance contracts, but the expense comparison you are trying to make is not apples to apples.

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packer16
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Re: My Favorite Alternative Funds

Post by packer16 » Thu Oct 12, 2017 7:06 am

You are correct, however for that $18 billion in expenses you get $18.2b in non-insurance after-tax income per year. So if those earnings earnings are capitalized at lets say 6.7% (15x P/E) you get $271.6 billion dollars. The additional value more than offsets the even small overhead Berkshire charges. In addition, the float generated by the re-insurance contract are generating more income than the contracts SRRIX holds.

It would be an interesting experiment to develop an insurance index of BKR, MKL & FFH & compare the results to SRRIX. Historically, this index has outperformed SRRIX significantly. I am not saying that re-insurance is not a good diversifying idea, it is. I just think folks need to look at alternative implementations, exp. if alternatives are cheaper, to get similar exposure.

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smackboy1
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Re: My Favorite Alternative Funds

Post by smackboy1 » Thu Oct 12, 2017 8:58 am

But isn't comparing SRRIX to the stock of reinsurance companies missing the point? An investment in SRRIX is exposure to returns and risks of only the profits and losses of the insurance underwriting. The quotas it holds are like profit/loss sharing contracts. Whereas investing in BRK or Munich Re or Lloyd's is exposure to returns and risks of the entire company which includes the profits and losses of the insurance underwriting, PLUS the rest of the company balance sheet. The companies invest their cash in the market, e.g. stocks and bonds or other businesses, which is not really want I want. I don't want correlation with the market. I want to own something that is correlated only with natural disaster losses. If I wanted market returns I would be better off buying it in the form of a broadly diversified passive index based fund rather than being forced to own whatever BRK owns.

Of course if I wanted to own BRK because I like Warren Buffet, that's a different kettle of fish. I bought BRK when it was down, along with every other stock, in 2008.

Owning SRRIX is like buying just the frosting without having to own the entire cupcake. Maybe I don't want cake because I already have enough of it elsewhere.
Disclaimer: nothing written here should be taken as legal advice, but I did stay at a Holiday Inn Express last night.

Random Walker
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Re: My Favorite Alternative Funds

Post by Random Walker » Thu Oct 12, 2017 11:19 am

I agree with smackboy1,
The point of SRRIX is to invest in reinsurance only, totally independent and uncorrelated with the stock market. The point is to diversify away from market beta. Once one invests in the stocks of insurance companies traded on the secondary market, he is completely exposing himself to more of the same market beta risk.

Dave

lack_ey
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Re: My Favorite Alternative Funds

Post by lack_ey » Thu Oct 12, 2017 11:33 am

What really counts is the performance ex-market. So if you subtract out the market beta of the stocks, what does that residual performance look like and what might it look like going forward? It could be a better deal in the end; I haven't looked in that carefully and I imagine it's difficult with the lack of performance history available for something like the Stone Ridge product.

Market correlation is fine as long as what you're getting on top of the market exposure is worthwhile going forward. Can a stock plausibly provide an excess return above market exposures on average under conditions under which the market return is low or negative? But there are also reasons to be skeptical of the stocks and the correlation is far from irrelevant. Also, if there exist stocks than that, that's effectively alpha over market beta, and that's therefore also a claim that there are stocks with negative alpha.

If you think about it, building a portfolio of relatively low-beta stocks with relatively low correlation to each other is similar to the goal of a minimum volatility-type fund. So there is some potential justification for some overweights relative to market cap.

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packer16
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Re: My Favorite Alternative Funds

Post by packer16 » Fri Oct 13, 2017 6:44 pm

I do not get the attraction of lower returning non-correlated assets. These assets smooth out returns but is there value in a smoothed but lower return. If you constrained by a constant withdraw rate this is the case. However, as an individual you do not have such a constraint as you can use a variable withdraw rate plan, buckets or vary expenses. This IMO is one of the pluses about Bogleheads (i.e. to develop strategies to deal with a non constant withdraw rate). If you can do this then you can invest primarily in the highest return assets & can less about the smoothness. There is a cost for smoothness so if you skip the cost you can have a bigger pot at the end.

The cost of a smooth re-insurance return stream is high versus a stream that includes other cash flows from other assets that create diversification internally. I am skeptical that the benefits expected will be realized as they assume correlations of the past will continue in the future & a portfolio of BRK, MRK & FFH will beat any re-insurance fund & if they beat them by sufficient margins then correlation has less utility than more return.

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Random Walker
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Re: My Favorite Alternative Funds

Post by Random Walker » Fri Oct 13, 2017 10:44 pm

Packer16 wrote
I do not get the attraction of lower returning non-correlated assets.
For me, I took from the Muni bond portion of my portfolio to create the SRRIX position. I expect Pre tax SRRIX returns to be equity like at perhaps 6%ish. I expect post tax returns to be substantially less, yet still more than what municipal bonds will make me. So compared to my portfolio without SRRIX, I expect the addition to improve expected return more than increase in risk, and expect higher Sharpe ratio.

Dave

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packer16
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Re: My Favorite Alternative Funds

Post by packer16 » Sat Oct 14, 2017 6:26 am

Dave,

Clearly you are taking in higher than bond like risk in your switch. I think if you are willing to take on more risk with a portion of your bond allocation (which I think makes great sense given interest rates today), you should also consider other alternative assets which can provide higher returns, like NNN real estate with an expected return in the low teens or buying a basket of re-insurance stocks. The cost of getting pure exposure is pretty high at 2% per year versus the lower cost alternatives of NNN real estate or re-insurance stocks.

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Valuethinker
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Re: My Favorite Alternative Funds

Post by Valuethinker » Sat Oct 14, 2017 8:33 am

smackboy1 wrote:
Thu Oct 12, 2017 8:58 am
But isn't comparing SRRIX to the stock of reinsurance companies missing the point? An investment in SRRIX is exposure to returns and risks of only the profits and losses of the insurance underwriting. The quotas it holds are like profit/loss sharing contracts. Whereas investing in BRK or Munich Re or Lloyd's is exposure to returns and risks of the entire company which includes the profits and losses of the insurance underwriting, PLUS the rest of the company balance sheet.
Just to clarify, Lloyd's Bank is not the insurance market, Lloyd's of London-- AFAIK there is no historical connection. Lloyd's of London was originally Edward Lloyd's coffee house, where backers of sailing ventures to the Indies met to insure their ships and cargo.

Lloyd's is a market, like the London Stock Exchange. It's not publicly listed (the LSE is now listed).

There are some listed Lloyd's brokers, although not as many as there used to be.
The companies invest their cash in the market, e.g. stocks and bonds or other businesses, which is not really want I want. I don't want correlation with the market. I want to own something that is correlated only with natural disaster losses. If I wanted market returns I would be better off buying it in the form of a broadly diversified passive index based fund rather than being forced to own whatever BRK owns.

Of course if I wanted to own BRK because I like Warren Buffet, that's a different kettle of fish. I bought BRK when it was down, along with every other stock, in 2008.

Owning SRRIX is like buying just the frosting without having to own the entire cupcake. Maybe I don't want cake because I already have enough of it elsewhere.
That is a fair characterization of the difference between investing in Lloyd's brokers, or insurers, or reinsurers vs. investing in reinsurance contracts themselves.

garlandwhizzer
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Re: My Favorite Alternative Funds

Post by garlandwhizzer » Sat Oct 14, 2017 5:34 pm

It's all a matter of personal taste, but alternate invests other than equity (US and INTL, cap weight and factor) in addition to high quality US high bonds are for me sufficient. I expect my portfolio value to go up and down in the short term but to go up reliably over the long term. I am comfortable with that. The main appeal of VRRIX as I understood it, was supposed to be "stock-like returns with bond-like risk." Backtesting up until Sept. 2017 supported that claim. However starting in Sept. 2017 we've had unusual damage from multiple major hurricanes, and now a major fires in California, all of which affect insurers and re-insurers bottom lines. The principal value of VRRIX has dropped more than 13% in less than 2 months. That is clearly not "bond-like risk." Quality bonds even in a bond bear market don't lose that much in several years. We don't know whether VRRIX's future returns are going to be stock-like or not. I suspect not as, to the surprise of many, the bull market keeps chugging on after 8 years. Up to now, the claim of "stock-like returns with bond-like risk" seems dubious.

The nice thing about having only equity and bonds is that one asset provides safety while the other provides increased long term returns. This allows each investor to rather simply titrate the relative weights of two assets exactly to his/her risk/return balance. Alternate investments for the sake of non-correlatioin to traditional assets seems to me, a guy who likes simplicity, a solution in search of a problem. For my purposes the numerous types of equity and the multiple classes of quality bonds are all I need.

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zaboomafoozarg
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Re: My Favorite Alternative Funds

Post by zaboomafoozarg » Sat Oct 14, 2017 7:46 pm

garlandwhizzer wrote:
Sat Oct 14, 2017 5:34 pm
The main appeal of VRRIX
Did you mean SRRIX, the Stone Ridge reinsurance fund?

Having worked in insurance and seeing the behavior of reinsurance, I wouldn't consider it bond-like. It was pretty consistently profitable but occasionally had a bad year that was more than the scale of loss you'd see from a government bond fund or even a total market bond fund.

I'd think about moving part of my stock allocation to a reinsurance fund if it didn't require an advisor to buy the fund.

Random Walker
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Re: My Favorite Alternative Funds

Post by Random Walker » Sat Oct 14, 2017 11:09 pm

GarlandWhizzer,
I’m a factor junkie, but I can’t really argue with anything you wrote. The single bet on market beta lacks diversification from factor point of view. I agree with you that the best diversifier is also the cheapest, high quality bonds. All the diversification beyond market beta and high quality bonds comes at increasing marginal cost and decreasing marginal benefit I believe. Everyone needs to make their own decision regarding increased cost for increased diversification. Costs are certain, the diversification benefits are only potential.

Dave

DaufuskieNate
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Re: My Favorite Alternative Funds

Post by DaufuskieNate » Sun Oct 15, 2017 4:58 am

Garland,

Couple of thoughts. I do not view alternatives as bond-like risk. Volatility-wise, most of them are somewhat lower than stocks and somewhat higher than bonds. Some strategies also have tail risks that need to be understood.

Being risky investments, alternatives also benefit from diversification. I think it make sense to put together several alternatives funds in order to create a series of "bets" that are uncorrelated with stocks and bonds.

getco
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Re: My Favorite Alternative Funds

Post by getco » Sun Oct 15, 2017 7:56 am

Larry Swedroe had some thoughts on alt allocation in April, which I feel add to the discussion (He was/is 2:1 LENDX:SRRIX):
larryswedroe wrote:
Fri Apr 07, 2017 7:06 pm
Stone Ridge etc. say these are risky investments.
Well yes [SRRIX, LENDX] are risky investments, and that wording is what SEC requires of course. And certainly not SUBSTITUTE for CDs, but as alternatives (not sub) to CDs--in the case of LENDX, absolutely. Now you get much higher expected return, with much shorter duration and thus much less inflation risk, but trade off liquidity and some downside risk, but far from equity like risk, as greatest loss I would estimate to be under 10% which is small fraction of worst case for stocks. SRRIX should not be viewed as substitute for CDs, either.

With that said for those with high equity allocations I would recommend taking the allocation to these alternatives from the equity side as they should produce similar returns but greatly dampen portfolio volatility. So say 60% or higher. For those with very low equity allocations and the stomach to accept some more risk, but not equity like risk, then you can CONSIDER taking from bond side (as I did) as expected returns are much higher and it will increase portfolio vol by much less than expected returns as result of diversification benefits and far less than equity vol. So say that would hold for those with less than 40% equity. And if in between might take it pro rata.
-g

garlandwhizzer
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Re: My Favorite Alternative Funds

Post by garlandwhizzer » Sun Oct 15, 2017 12:53 pm

I wrote a post about VRRIX.
zaboomafoozarg wrote:
Did you mean SRRIX, the Stone Ridge reinsurance fund?
Yes, I did mean SRRIX. Thanks for the correction.

Garland Whizzer

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nedsaid
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Re: My Favorite Alternative Funds

Post by nedsaid » Sun Oct 15, 2017 1:58 pm

DaufuskieNate wrote:
Sun Oct 15, 2017 4:58 am
Garland,

Couple of thoughts. I do not view alternatives as bond-like risk. Volatility-wise, most of them are somewhat lower than stocks and somewhat higher than bonds. Some strategies also have tail risks that need to be understood.

Being risky investments, alternatives also benefit from diversification. I think it make sense to put together several alternatives funds in order to create a series of "bets" that are uncorrelated with stocks and bonds.
Boy, it sounds like High Yield Bonds would do a lot of the things we are expecting from Alternatives. These bonds are somewhere in between Stocks and Investment Grade Bonds.
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DaufuskieNate
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Re: My Favorite Alternative Funds

Post by DaufuskieNate » Sun Oct 15, 2017 2:10 pm

nedsaid wrote:
Sun Oct 15, 2017 1:58 pm


Boy, it sounds like High Yield Bonds would do a lot of the things we are expecting from Alternatives. These bonds are somewhere in between Stocks and Investment Grade Bonds.
High Yield Bond funds load up pretty heavily on Beta, Term and Credit Risk. Same stuff you get in regular ole stock and bond portfolios. Not so diversifying.

rrppve
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Re: My Favorite Alternative Funds

Post by rrppve » Sun Oct 15, 2017 2:14 pm

High yield is correlated with equities, so it doesn't provide the same diversification benefit.
My favorite remains QSPIX with its zero beta exposure (equal long and short), positive factor exposure, multi-asset classes and daily liquidity.
The interval nature of LENDX and SRRIX along with difficulty in providing accurate daily pricing of their portfolio components makes me wary.

grok87
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Re: My Favorite Alternative Funds

Post by grok87 » Mon Oct 16, 2017 6:46 am

rrppve wrote:
Sun Oct 15, 2017 2:14 pm
High yield is correlated with equities, so it doesn't provide the same diversification benefit.
My favorite remains QSPIX with its zero beta exposure (equal long and short), positive factor exposure, multi-asset classes and daily liquidity.
The interval nature of LENDX and SRRIX along with difficulty in providing accurate daily pricing of their portfolio components makes me wary.
Watch out for the leverage in qspix.
All good fun until somebody loses an eye...
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packer16
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Re: My Favorite Alternative Funds

Post by packer16 » Mon Oct 16, 2017 7:27 am

Given the comment above on bonds being the best diversifier, I think some of the alternatives that are hybirds between bonds & an asset, like NNN real estate, ship & aircraft leasing, can provide significant diversification for reasonable costs of near 1% and high single digit to low double digit returns.

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garlandwhizzer
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Re: My Favorite Alternative Funds

Post by garlandwhizzer » Mon Oct 16, 2017 11:55 am

I think the use of alternate funds is a matter of personal taste. Lots of smart guys and adept investors use them. Lots of smart guys and adept investors don't use them. I'm with the latter group. Rational arguments can be made on both sides of this question.

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lack_ey
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Re: My Favorite Alternative Funds

Post by lack_ey » Mon Oct 16, 2017 12:40 pm

What you want from alternatives is at least bond-like returns with stock-like risk on the residual exposure you can't get from stocks and bonds, in a way that can plausibly work across different conditions. That is, the performance of the remainder once you subtract out the market beta and so on. Some funds have close to zero already. Others deliberately or accidentally keep some, and in that case you can't really give credit for excess returns over cash if this is from market exposures.

Equity risk is likely the best and most durable risk to take in the long term, but it can make sense to reduce reliance on the directional long-term bet on equities to produce returns, because it can go away for a long time and may not turn out to be as useful as we all think going forward. It's not just equity crash risk but the possibility of stocks doing nothing for 30 years (maybe under low enough growth, private equity beating public equity, public equity valuations being wrong especially near the top with the highest-market-cap stocks, etc.).

I would think about alternatives as falling into one (or more) of these three groups:
1. Not really much different or alternative — e.g. preferred stock, which don't look like much once equity and bond risks have been accounted for (likewise for a number of assets including junk bonds, though there's some evidence of junk bonds providing some limited excess return in exchange for unique risk, that's not explained by investment-grade bond or equity market risk)
2. Non-market related exposure to risk — e.g. direct real estate, timber, catastrophe bonds, peer-to-peer lending (though there may be some indirect relation to market and economic risks)
3. Trading strategy / differential return — relying on holding the right positions, changing these over time, e.g. market neutral-style funds like AQR Style Premia, or really the ex-market part of any active strategy

The first category is definitionally not that diversifying. We don't need a repackaging of existing risks.

The second category should be assets that have strong economic justification for providing return. Some might look at certain MLPs and other businesses, but to a large degree a number of these may be heavily explained by certain equity markets and risks that are obtainable elsewhere. You have to be careful about how much here is actually unique and if it can be expected to provide returns under different conditions. P2P lending definitely has credit risk, but it's not the same credit risk as from corporations, so the residual exposure may still be something unique and worthwhile.

The third category is potentially dangerous because you rely on a manager to pick the right trades over time that can generate a return. If you believe in factors, a factor-based approach might have a decent chance of success here in the long run. Otherwise, this is a bet on discretionary manager skill above costs.

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packer16
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Re: My Favorite Alternative Funds

Post by packer16 » Mon Oct 16, 2017 7:27 pm

Nice description. I would like to hear suggestions for low cost access to number 2 alternatives above.

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