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De-Risking Your Portfolio Without Giving Up On Strong Returns (Podcast)


J.D. Gardner started ETF firm Aptus to attack what he terms the "behavior gap" in investing, whereby investors routinely underperform their underlying investments by "performance chasing"

Aptus' flagship fund, DRSK, attacks the behavior gap frontally by limiting drawdowns through the use of maturity date bond ETFs and broad index puts.

Yet, DRSK has managed to handily beat the S&P 500 in 2020 by taking advantage of the "sporadic asymmetry" offered by buying a basket of stock calls.

Gardner joins Let's Talk ETFs to explain the philosophy behind DRSK and why he believes Aptus has cracked the code to tamping down risk without giving up on strong returns.

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By Jonathan Liss

Today's guest is J.D. Gardner. J.D. founded Aptus in 2013 to attack what he has termed the "behavior gap in investing", which leads investors to underperform their underlying investments by chasing past performance. As Brad Barber and Terrance Odean demonstrated in their seminal 2011 paper, The Behavior of Individual Investors:

Individual investors (1) underperform standard benchmarks (e.g., a low cost index fund), (2) sell winning investments while holding losing investments (the “disposition effect”), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naïve reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (5) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.

Gardner founded Aptus to help merge theory with reality. According to Gardner, "An investor’s return is more important than an investment’s return." As such, Aptus' funds are designed to minimize behavioral inefficiencies and enhance outcomes. The firm's flagship Defined Risk Strategy ETF (DRSK) has gathered nearly half a billion dollars in less than two years by effectively delivering on the Aptus' mandate. In fact, DRSK has outperformed the S&P 500 YTD by more than 500 basis points - and with much lower drawdowns:

DRSK has managed to achieve this via a three-pronged approach:

1) Create a steady and safe income stream by building bond ladders with the majority of the portfolio via Invesco and iShares defined maturity investment grade corporate bond ETFs (NASDAQ:BSCK), (NASDAQ:BSCL), (NYSEARCA:IBDM), (NYSEARCA:IBDN), (NYSEARCA:IBDO), (NYSEARCA:IBDP), (NYSEARCA:IBDQ), (NYSEARCA:LQD)

2) Protect against downside risk by buying puts on the SPX and (NASDAQ:QQQ)

3) Create upside opportunities by taking advantage of the "sporadic asymmetry" offered by a basket of roughly 20 individual stock calls, diversified across sectors

Surprisingly, this conversation had me rethinking my own portfolio's composition for days afterwards. Whether or not you plan to consider buying DRSK, the approach taken by Gardner in constructing DRSK offers important lessons on how careful portfolio construction can help the vast majority of investors improve their own performance - by combating behavioral biases we often fail to see in ourselves.

Show Notes

  • 2:00 - Describe the economic situation in Alabama as a result of the pandemic
  • 3:30 - Work/life balance
  • 5:00 - What made you decide to start your own ETF firm?
  • 7:00 - The behavioral issues facing the majority of investors
  • 11:00 - What is sporadic asymmetry?
  • 12:45 - How does DRSK merge theory with reality?
  • 15:00 - Fund construction: Building a bond ladder with maturity date bond ETFs (BSCK), (BSCL), (IBDM), (IBDN), (IBDO), (IBDP), (IBDQ) vs. just holding broad bond funds like (LQD)?
  • 19:00 - DRSK and duration risk
  • 21:00 - DRSK and credit risk
  • 27:00 - What percent of the overall return of the fund does the 6% in options represent?
  • 30:00 - Is the call buying strategy designed to replicate the broad market in terms of sector allocations?
  • 32:00 - How did you decide on Southwest (LUV) vs. other airlines (NASDAQ:UAL) (NYSE:DAL)?
  • 36:30 - Broad index puts for hedging
  • 39:00 - How did this hedge cushion the blow in the first quarter of 2020?
  • 42:30 - How is the fund treated for tax purposes?
  • 45:00 - Is this ETF meant to be a core holding?

Disclosure: I am/we are long DRSK, VOO, QQQE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: J.D. Gardner is long DRSK.

Jonathan Liss is long QQQ and VOO.