Addressing Pre-Retirement Jitters

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Includes: BAB, BSJM, FAAR, FXN, HDG, IAU, ICVT, IEI, MNA, PRF, QYLD, SHY, SRLN
by: Roger Nusbaum
Summary

An all-ETF portfolio to protect against adverse sequence of returns early in retirement.

Sometimes the difference between success and failure in retirement boils down to difference in timing.

An alternative asset allocation to target a specific outcome.

In yesterday's post on my page at TheMaven I looked at ETF portfolios put together by Toroso Asset Management. The portfolios are interesting and going through other's people work can be a great way to learn. I made a comment in passing about one of the portfolios. I said that Toroso's All Weather Plus could be of interest for "someone worried about adverse sequence of returns for the couple of years before they retire and right after they retire." So I spent some time working on something similar that I called Pre & Early Retirement Anxiety Reducing ETF Portfolio or PERAREP. I tried to come up with a funny acronym, but struck out.

The Toroso All Weather Plus Portfolio had equal 25% weightings to US equities, aggressive bonds, short term treasuries and gold. It's a little more involved so click through above for the details. Putting 25% in gold is a non-starter for me. The Toroso portfolio can include alternatives in the gold sleeve and 25% is usually more than I want in alternatives. But where the objective of something like All Weather isn't really about capturing equity market growth but rather about a positive low-volatility return, 20-25% may not be too much.

Wanting to change up the asset allocation a little I went with 25% to equities, 30% to yield, 25% to cash (or cash proxies) and 20% to alternatives. I tried to capture some themes that are in client portfolios currently, so some of this will seem familiar if you've read my content before, but with different funds. The equity exposure is broad based and a little different than what you might typically see.

Equity 25% of the portfolio

  • Invesco FTSE RAFI U.S. 1000 ETF (NYSE:PRF) 10% - quality bias, different sector weightings than SPX, outperforms, heavy financials
  • First Trust Mid Cap Core AlphaDEX Fund (NASDAQ:FNX) 5% - multi-factor, outperforms, not heavy in financials
  • Horizons Nasdaq-100 Covered Call ETF (NASDAQ:QYLD) 5% - very heavy in tech, 10% yield
  • iShares Convertible Bond ETF (BATS:ICVT) 5% - equity attributes on the way up, bond attributes on the way down, heavy tech

Yield 30% of the portfolio

  • iShares 3-7 Year Treasury Bond ETF (NYSEARCA:IEI) 10% - no yield pick up in 7-10 year ETF but that has more interest rate risk
  • Invesco Taxable Municipal Bond ETF (NYSE:BAB) 8% - yield in the 4's, duration in the 8's
  • Invesco BulletShares® 2022 High Yield Corporate Bond ETF (NYSE:BSJM) 6% - yield in the 5's, 43% in BB, 48% in B
  • SPDR Blackstone / GSO Senior Loan ETF (NYSEARCA:SRLN) 6% - yield in the 4's, loans take credit risk, not interest rate risk

Cash 25% of the portfolio

  • Two year T-bills 15% - actual T-bills, not a fund, they pay better than 2.5%
  • iShares 1-3 Year Treasury Bond ETF (NYSEARCA:SHY) 10% - might be easier to sell for cash management needs

Alternatives 20% of the portfolio

  • ​First Trust Alternative Absolute Return Strategy ETF (NASDAQ:FAAR) 5% - similar to a managed futures strategy
  • IQ Merger Arbitrage ETF (NYSEARCA:MNA) 5% - big believer in merger arbitrage as a diversifier
  • ProShares Hedge Replication ETF (NYSEARCA:HDG) 5% - hedge fund replication with a decent track record
  • iShares Gold Trust (NYSEARCA:IAU) 5% - gold tends to have a low to negative correlation to equities

In the list of the holdings I provide some of the rationale for the holdings so I'll just add a little bit more color. Any time I talk about using broad based funds, including in yesterday's post, I talk about looking through to the holdings to make sure there are no unintended sector overweights. 40% in tech is sub-optimal unless you want 40% in tech (you probably should not want that much in one sector). The equity sleeve does have a high 30% weighting to tech, but about 1/3 of that comes from ICVT. The allocation then relies on convertible bonds trading like bonds in the face of an equity market decline. The yield from QYLD will bump up the yield of the entire portfolio and can smooth out the ride, but such a high yield is a risk factor.

If the equity market did rollover into a bear market, simply selling PRF would reduce the vulnerability to a large downturn considerably, but you could sell any of the other equity funds too.

The fixed income sleeve does not take a lot of interest rate risk; BAB would have the most. There is some credit risk, but bank loans are higher up in the capital structure than bonds and the vast majority of BSJM has a relatively high credit rating. I think those products would hold up just fine in the context of an equity bear market. If there is some sort of black swan decline that breaks things that have never been broken before (the Financial Crisis broke things like auction rate preferreds and commercial paper), all the exposures are small and the funds are easily sold.

Cash is cash but to explain my comment about liquidity: T-bills are of course very liquid but depending on the amount you wanted to sell the pricing could be more favorable selling the ETF.

The alternatives are all things I write about on a regular basis. FAAR is not managed futures but it appears to be similar in terms of what it trades. The strategy is opaque: it targets 3 month T-bills plus 3% and has started out with a good track record.

Someone spending more time on this could probably enhance it, but as it stands now it covers a lot of bases and should have a low equity beta; PRF is just a touch under the S&P 500; QYLD had a very low beta; FXN is high; and iShares doesn't report a beta for ICVT but I would assume it has close to an equity beta.

This was a good exercise to look at a bunch of funds that I might not have otherwise taken the time to learn or relearn about. To be clear, I put this together in just a couple of hours during a Red Sox game, which is likely far less than the time that Toroso put into devising and then testing the All Weather Plus. The point is that ETFs can be combined to deliver some very targeted/customized outcomes while precisely managing exposures, volatility and correlations.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.