In honor of the Final Four this weekend, Composer is hosting a competition of symphonies. What I want to know is: who ya got?! Throw a comment below for your pick.

For our face-off, we selected four symphonies with very different compositions: simple, complex, leveraged, and niche.

Imagine the following as an intimate interview with each contender. You know, get to know them and understand what makes them tick. And, for each symphony, I’ll give you my take on the strategy.

The winner? The one you choose to invest in.

Let’s take a look at the contenders:

‍The Buffett

‍Tale of the Tape

In the NCAA tournament, a team’s record throughout the season determines its seed. For our symphonies, we use annualized returns over the last ten years.

March 29th, 2012 - March 29th 2022

The seeding:

As we know, past returns are not indicative of future performance. Your job is to pick the symphony that best fits your portfolio over the next ten years.

Hedgefundie’s Excellent Adventure became an internet sensation and was the topic of one of our earliest blogs. Now the refined version sits as the #1 seed in our competition. Let’s kick the tires and see if the symphony can live up to the hype.

When I begin reviewing a symphony, I like to collapse all of the blocks so I can understand the logic. Then, I click into each bucket to see how each one works.

This symphony is Risk-Off if SPY has experienced a Drawdown of 5% or more over the past two weeks. Otherwise, the symphony is Risk On. The core, Risk On, part of this strategy is a simple risk parity strategy of 55% UPRO (3x leveraged S&P 500) and 45% TMF (3x leveraged 20Y+ Treasuries). The Risk Off branch of the symphony equally weights gold, Treasury Inflation-Protected Securities (TIPS), and short-term bonds. This combination of relatively less risky assets offers a safe haven for the symphony in times of market stress.

Using the allocation graph in the Composer editor, you can see how often the strategy shifts between each state.

March 29th, 2012 - March 29th, 2022

Remember from the Understanding Leveraged ETF blog that volatility can significantly impact returns. Hedgefundie’s Excellent Adventure Refined attempts to mitigate this issue and avoid large drawdowns by shifting to Risk-Off.

Hedgefundie’s Excellent Adventure Refined is relatively simple and easy to grasp in a few minutes. I like that. However, it also employs leveraged ETFs, which ratchets up the due diligence and risk tolerance required by investors. If you need proof, look at the 1-year returns for the strategy:

March 29th, 2012 - March 29th, 2022

A combination of falling bond prices and a pull-back in stocks was a potent 1-2 punch.

Next up is The Buffet—the old guard. Of the final four, it’s the simplest strategy in the running. I commented on the symphony in the backtesting blog:

What do folks think about the divergence in equity and bond market signals? Are you bullish or cautious in this rising rate environment?

Brackets may be broken (thanks a lot, Saint Peter’s), but symphonies keep chugging along.

Stocks rose for a second straight week, while bond prices fell as yields increased. The 10-year US treasury finished the week at 2.49%, up from 1.51% at the end of 2021.

Volatility showed up in oil and bonds. Oil rose to finish the week at $113 a barrel, but in recent weeks it has traded below $100 and above $130. In bonds, the 10-year rose 30 basis points and IEF (-2.7%) was the worst-performing benchmark ETF. Last week’s volatility, measured by standard deviation, for IEF (~12%) was more than double the level for the past year (~6%).

Another positive week for equities strengthened Risk On signals. The S&P 500 is above its 200-day moving average, and the large-cap index is outperforming bonds YTD. In addition, volatility for the S&P 500 was muted (17.5%). Bond market signals remain cautious with higher volatility and short-term treasuries (SHY) outperforming the aggregate market (BND).

This past week I chatted with a scientist who is using Composer to create and invest in systematic investment strategies. What do folks think about rules-based investing?

Speaking with folks about the blog in recent weeks, I’ve heard that personal stories have been some of the most impactful. My conversations with Kris and Pietros helped bring Composer to life. Writing 101, I know. But with investing, it’s not so straightforward.

The investment community isn’t good at sharing. Investors desperately try to maintain their edge by keeping their best ideas and algorithms secret. The thought of alpha decay and being front-run keeps portfolio managers up at night.

However, communities have sprung up for retail investors. Twitter (Fintwit), Commonstock, and Reddit have vibrant discussions about markets and strategies. Perhaps retail investors are more willing to share their perspective because they aren’t trading billions of dollars and don’t have their returns meticulously compared to benchmarks.

Retail investors are trying to fund retirement, put kids through school, and achieve financial independence, and a community sharing ideas, lessons learned, and empathy can be a helpful resource. This is probably why Bogleheads, the online forum of Jack Bogle disciples, has lasted so long.

I recently saw this picture on Twitter (h/t @agustinlebron3), and I shared it with the Composer team with the caption “Composer pushes retail investors towards the efficient frontier.”

The goal for retail investors isn’t necessarily to beat the market but instead to build portfolios that meet each individual's unique objectives and risk tolerance. In other words, the goal is to get closer to this efficient frontier of investing.

To that end, I think we can learn a lot from each other, and I am bullish on the investment community. I don’t mean encouraging each other to put our life savings into an options trade on Robinhood, but having conversations about portfolio construction and asset classes I’m all for.

In the Lab

This past week, I sat down with a Composer power user who is constantly in the Composer lab, building and testing symphonies. Ram Samudrala is a professor whose research focuses on computational biology, genomics, and proteomics. Impressive, right? Save some science for the other professors.

By now, you know the drill on these conversations. Ram's opinions and conclusions are his own, and should not be considered as investment advice. Investing involves the risk of loss, including principal and returns are not guaranteed. This writing is an uncompensated testimonial from a current Beta user of Composer.

Ram talks at ~1,000 words per minute, but I leaned closer and closer to Zoom to avoid missing anything. He has boundless energy and an incredibly sharp mind.

A wily veteran, Ram has been investing for over 22 years, navigating the Dotcom Bubble and the Global Financial Crisis. He’s the middle reliever who has played in the post-season and been 30 games under .500.

In addition, Ram is a student of investing. He became interested in algorithmic trading and taught himself to code so he could experiment with new strategies.

Where does Composer come into the story? Scrolling through Reddit one day, Ram saw the Composer allocation chart and was hooked.

I mean, it is beautiful.

From Ram on his investing journey and Composer:

“My interest in the stock market stems from the fact that it's a complex system, and that's what I've spent my career modeling, complex (biological) systems. I see a lot of parallels between market behavior and biological systems in terms of the dynamics and complexity. It's a bit of problem-solving with game theory that makes it fun, and of course, Composer makes some parts of that easy.”

Weekly update from Composer. How did your portfolio perform last week?

March Madness! Stocks came roaring back last week, posting their best returns of 2022. A welcome reprieve after a few tough weeks. In other news, the Federal Reserve is finally on the move, raising their target rate 25bps and signaling their intention to raise rates at each of their six remaining meetings this year. You can read our thoughts on inflation here.

Where has the vol gone? Volatility expectations, as measured by the CBOE VIX Index, fell to 24 down from 38 earlier this month. It would appear, however, that volatility moved to China.

This past week with equities surging, we saw a divergence in signal performance. Equities are outperforming bonds for the one-week and one-month periods, shifting some symphonies to Risk On. However, symphonies using relative bond market performance as a signal most likely remain in Risk Off, as BND is underperforming short-term treasuries (SHY). Further, the S&P 500 finished the week slightly below its 200-day moving average, signaling caution.

FYI: Investment Strategy = Symphony

How are folks handling higher inflation in their portfolio? Are you willing to ride this wave out and bet on equities for the long-term or have you invested in inflation hedges like commodities or TIPS?

Some thoughts on inflation from this weeks blog:

I was going to write a post about inflation right after I started at Composer, but I thought, “Nah, it’s going to fade after all these supply chain issues get sorted and Omicron goes away”. And then, I was going to write about it when it hit 7% in January, but I got distracted by Risk Parity. So, here we are…

I can’t ignore it anymore.

Ugh. I am the Fed.

Inflation, measured by the Consumer Price Index, hit nearly 8% for February, a four-decade high. Somewhat concerning is that household’s expectation of future inflation also increased. This is worrying because the Fed is able to control inflation, in part, because people believe the Fed can control inflation. If people believe prices will continue to go up in the future, they may push for a raise now. Similarly, if companies expect input prices to increase in the future they may continue raising their prices today.

From the CEO of ACCO Brands on price increases:

“We didn’t fully recover last year from inflationary cost increases. So the plan is to continue to raise our prices until we recover.”

Expectations of higher future inflation may make it more difficult for the Fed to engineer a soft landing with interest rate hikes. However, the Fed started the process yesterday with a 25 basis point increase in the target federal funds rate and signaled an aggressive 6 more rate increases this year.

The path we took to get to this point is understandable, if not ridiculous when you write it all down. A global pandemic ripped through supply chains causing disruptions and shortages on everything from computer chips to toilet paper. Everytime we thought the pandemic was easing a new variant emerged to disrupt everything all over again.

In addition, there’s not enough houses, and no one can build more because of all the supply disruptions. As a result, people are offering way above asking price, bringing suitcases full of cash, and waving inspections to buy homes. And then, after all that(!), Russia invaded Ukraine sending commodities, wheat, metals, and oil, into a frenzy.

The problem is that inflation eats into returns. If my portfolio returns 5%, but everything I need to buy is 7% more expensive, then I am 2% poorer. This is why you often hear investors talk about real returns.

Portfolio return - inflation = real return

So what’s an investor to do? Unfortunately, there is no perfect hedge for inflation.

Stocks are a good long-term hedge against inflation because average equity returns tend to be above inflation. But, the key word in that sentence is average. Short-term inflation spikes can be painful because they often coincide with poor equity market performance.

Further, the usual suspects, TIPs, Bitcoin, and Gold have not performed particularly well during the recent bout of unexpected inflation.

Vanguard research points to commodities as the best hedge against unexpected price increases:

“Over the last three decades, commodities have had a statistically significant and largely consistent positive inflation beta, or predicted reaction to a unit of inflation. The research, led by Sue Wang, Ph.D., an assistant portfolio manager in Vanguard Quantitative Equity Group, found that over the last decade, commodities' inflation beta has fluctuated largely between 7 and 9. This suggests that a 1% rise in unexpected inflation would produce a 7% to 9% rise in commodities.”

And, it’s not just researchers that have homed in on commodities. Reddit has hosted some heated debates on the topic, as well. A poor old investor asks if he or she is too late to the party. Yeah, probably. But, what do I know?

How do folks feel about risk parity strategies? How about the retail implementation through leveraged ETFs? It's been a tough start to the year for RP with high volatility and stocks and bonds both in the red.

My thoughts on risk parity from a recent blog:

My test of how well I understand a topic is to try explaining it to my friends. They’ll listen patiently and ask questions as I’m explaining the concept. As I talk, I often begin to realize that my narrative is unraveling in the face of their questions, and I am repeating the same lines over and over (at a louder and louder volume).

Ugh. Clearly, I don’t know enough to explain the topic simply and therefore I don’t really understand it all. My thoughts aren’t translating to my mouth, and in the case of this blog, won’t translate onto the page. This happened recently with risk parity.

I know. I know. Some of you are yelling at your screen. “It’s intuitive! Balance risk not dollars! Use some leverage! Ray Dalio!” Others may not have heard of risk parity and you’ve already forgiven me. Thank you.

But, for retail investors the practical application of a theoretical risk parity portfolio is a bit more complicated. And, I think a strong understanding of risk parity and the challenges facing retail investors is essential before diving in.

I would also say many of us, myself included, have a long relationship with adding equities to increase expected returns. While we may “get” risk parity, it could take some time to get comfortable building portfolios in a different way.

‍Back to school: Finance 101

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Bear with me a minute while I get finance-y. As simply as I can say it, to create a risk parity portfolio, investors weigh assets by risk (volatility) instead of dollar amounts. Traditional portfolio construction looks at expected returns and volatility (risk) and creates a portfolio that minimizes risks for a desired return. An investor may end up with a portfolio that is 60% equities and 40% bonds (i.e., weighted by dollars).

However, if we assume volatility of 15% for stocks and 5% for bonds and a correlation of 0.2, then stocks will account for over 90% of the risk in a 60 40 portfolio. SeekingAlpha crunched the numbers from 2000 - 2017 and found the risk contribution was actually greater than 100%! This concentration of risk is what risk parity seeks to address.

Leveraged ETFs can be a powerful tool for building portfolios, but do you really understand them? What you don’t know may hurt you.

Why do investors hate real assets? Two thoughts: 1) The long-term return profiles don't look great and 2) access for retail investors can be confusing (e.g., k-1s, futures contracts). BUT real assets are excellent diversifiers and not every holding in a portfolio needs to be growth oriented.

No one wants to talk about commodities until they are surging in value. The current Ukraine-Russia conflict is a great example of that. I built a real assets slug on Composer that can be added to portfolios or used in systematic strategies

I chatted with a power user of Composer, an automated trading platform that supports systematic investing. He shared his perspective on investing and some of his strategies. Check out our conversation:

Backtesting can be incredibly insightful but it can also lead investors astray. I went deep on backtesting and laid out some tips for avoiding common mistakes.