Barbell strategy - feasible for an individual?

[LayC]

I’m a big fan of Nassim Taleb. He has coined the Barbell strategy which is quite different from what I normally see. If there were an investment company implementing this strategy and accepting my savings (I’m no millionaire - apparently the precondition) I would consider investing there.
The 90% percent part covering inflation seems to be feasible to manage by myself. However, the 10% high risk part (Option trading) that is supposed to return high yields (best case scenario) or in a worst case scenario still leaves the biggest (other) part intact, seems difficult.
So, I have got a few questions:
- Has there been anybody here successfully applied this strategy?
- How much expertise and insight is required to consider option trading in the context of early retirement?
- Are there any (trustworthy - if this can be applied at all ) investment companies that offer such a barbell strategy fund for non-millionairs?
- Are there any companies offering option trading strategy funds yielding good results?



Oliver

 

[tdv2]

I am a newly minted fan of Nassim Taleb, just yesterday finished his book - Fooled By Randomness. Excellent book and not all about markets and investing. I have read and watched some videos where he describes strategies that pay off on the occurrence of "rare events". He goes as far as accepting small losses for an extended period to cover the cost or being in that posture. I find it intriguing, but it's not for me. There are many options trading strategies out there....selling naked calls where you collect a small premium on each with a very high probability--90% or more....problem is when the loss happens, skewness as he describes it. It is said "option sellers eat like chickens but go to the bathroom like elephants" Certainly you can protect against devastating losses but the costs start to pile up.

 

[pb4uski]

While I'm not sure how it aligns with Taleb's barbell strategy, I find SWAN intriguing. They invest 90% of assets in US Treasuries and 10% in ~0.7 delta six-month and twelve-month SPY calls.

While they have only been in operation since late 2018, the index that they are based on has performance data going back much further. They have done well so far... up 17.8% since inception vs +5.2% for SPY.

https://www.early-retirement.org/forums/f44/does-anyone-know-swan-103011.html

 

[OldShooter]

I am a Taleb fan, too. I've read his first two books multiple times. I am now working my way through the 500+ small print pages of "Antifragile."

I see the AA approach, the bucket approach, and the barbell strategy as really being different and highly useful ways of looking at a portfolio. Kind of like looking at a sculpture from several angles.

Start from an AA view: The fixed income tranche can be considered the low risk portion of the barbell and the equity portion can be considered to be the high risk portion. On the low risk side this may cause an investor to buy TIPS (we are 90% TIPS), FDIC insured CDs, or treasury bills, notes, and bonds. It may cause the investor to avoid chasing risk and yield with junk and international bonds. IMO people who are buying junk and international will conclude from taking a barbell view that they are happy deviating from the Taleb model. That's fine, but I think it is still beneficial to them to look from that view.

On the equity side, certainly considered by most to be the higher risk end of the barbell, the sky's the limit. The Taleb strategy of using options is maybe one extreme. The other extreme might be the investor who buys blue chip dividends. We're probably in the middle with 90% global (VT,VTSAX). Again, the dividend investor taking a barbell view might decide he's happy with his strategy or he might, taking Taleb's idea, decide to alter his AA to put more in the fixed/safe side and then take his equity money to a little more aggressive posture.

So, @LayC, I don't think you have to go to 90/10 and go wild with an options strategy to have your very own barbell. But taking a barbell view might cause you to move your AA to be more heavily fixed and to take your equity side towards more risk, like leveraged funds or long/short funds. DW and I wouldn't go that far, but that doesn't mean you can't go that way if you choose.

... I find SWAN intriguing ... While they have only been in operation since late 2018, the index that they are based on has performance data going back much further. They have done well so far... up 17.8% since inception vs +5.2% for SPY. ... l

@LayC, @pb4 is a pretty respected guy around here and I usually agree with him, but here are a couple of cautions on investments like SWAN.

First, all of the statistics and all of the research I am aware of points to the conclusion that past results really are not predictive of future performance. Basically, picking a fund is a dart-throwing game. You can narrow the game by limiting your dart board to certain categories or sectors but from that point you are throwing darts. A respected researcher talks about this here: https://famafrench.dimensional.com/videos/identifying-superior-managers.aspx

Second, simulating the result of a strategy by applying it to historical data is called "backtesting." IMO it is a useful tool when used with great care to, for example, compare two portfolios. @pb4 is quite skilled at this, in fact. The danger arises when someone like the SWAN marketers crow about the fact that their scheme backtests wonderfully. Of course it does, because they have the luxury of following Will Rogers' investment advice: ' If it don't go up, don't buy it." IOW just keep tinkering until you come up with a good backtest story. A good backtest just proves that the marketers have IQs above room temperature.

 

[pb4uski]

To be clear, I find the strategy that SWAN employs most intriguing... investing predominately in low risk fixed income and then investing in stocks through long-dated calls. SWAN is the only fund or ETF that I am aware that is employing this strategy, but it isn't all that unique.

The backtesting of the SWAN index is to my knowledge is rules-based and not the cherrypicking that my friend Old Shooter is so concerned about. The constitution of the index is based on the following:

The S-Network BlackSwan Core Index (Ticker: SWANXT) holds treasuries and longdated call options (LEAPs) on the SPDR S&P 500 ETF Trust (SPY). The index seeks to realize capital appreciation in line with the performance of SPY while avoiding substantial capital drawdowns.

On each rebalancing date, the index places 90% of its index market capitalization in treasuries and 10% in SPY LEAP call options. Treasury weighting is determined by the option reconstitution schedule.

The treasury portion of the portfolio replicates and maintains the initial duration of the 10- Year US Treasury. The option portion holds 5% of index market capitalization in June 70-delta SPY call options and 5% in December 70-delta SPY call options. Initially and at rebalance date, calls that are purchased should all have at least one year plus one day until expiration when available. Otherwise, the contract with the furthest expiration is purchased for the given month. The 70-delta rule only applies to initial purchases on the rebalance date. Should there not be a 70-delta option, the closest option above 70 will be utilized. On any given rebalance date, the non-traded tranche of options will not be trimmed/added to or rebalanced back to 70-delta calls.

https://snetworkglobalindexes.com/presentation/files/q1-2020-swanxt-presentation.pdf

 

[OldShooter]

Also to be clear ... my comments were intended to be a general caution against worrying too much about past results and naively accepting backtests. @pb4 and I have already had our discussion on SWAN specifically and hold different views. Nothing wrong with that nor is there any reason to rehash it.

 

[tdv2]

Does the back testing in the SWAN literature subtract out the 0.49% expenses each year that the fund incurs? I see that they go back to 2005 with the actual fund only around since last year. If not, it would be interesting to see how that impacts performance over 15 years.

 

[LayC]

SWAN sounds interesting. 2 drawbacks for me. Since I live in Germany I’m impacted by the currency exchange rate. Apparently, to buy it would require me to find out how to do so “directly” in the USA - SWAN has only got a CUSIP hitherto and no ISIN. The latter one is required to buy easily via a domestic bank. Ok, no real obstacle


Oliver

 

[pb4uski]

Does the back testing in the SWAN literature subtract out the 0.49% expenses each year that the fund incurs? I see that they go back to 2005 with the actual fund only around since last year. If not, it would be interesting to see how that impacts performance over 15 years.

I suspect the index does not include expenses, in which case just take 49 bps off of the index total return.

 

[tdv2]

I suspect the index does not include expenses, in which case just take 49 bps off of the index total return.

Thinking about this fund again here this afternoon. I was trying to model in my mind where it might not do well. One scenario would be where the equity market is flat and remains that way for awhile. It would under perform by at least the cost of the options and the additional ER over a simple index or mixture of indexes. Not sure the answer to this question.....for example, when you hold a 6 month spy call option do get the benefit from the dividend yield associated with the underlying asset over the term you are holding it? I would think yes...maybe it's discounted into the cost of the contract??

One other observation----the SWAN etf yields 1.15%. Seems kind of low unless the treasuries it holds are a relatively short duration. A simple AGG type bond index today is yielding ~2.59%. If it's purely a composition scenario no harm no foul.

 

[Navigator]

I am not familiar with Nassim Taleb, but when I was young and foolish I did try trading options. What I learned is that options were priced pretty well, but the expenses associated with buying them made it difficult to make any money over the long run. (Actually, it made losing money over the long run pretty certain!). I now believe the best use of options is to limit losses when the market crashes, as it just did a month or so ago. This lowers gains when market is going up, but smooths out the highs and lows of a portfolio.