Daily Brief - 5 ‘lego blocks’ to add to your portfolio (Dec 8, 2021)

It’s hard to allocate your portfolio these days.

Stock and bonds are the two pillars of any asset allocation, and they hardly look like a great choice. The stock market is at dot.com levels of valuations, and inflation might knock bonds down at any moment.

Where should I put my hard-earned cash?” is a common question we hear almost every day - as much from friends who work in PE and VC, as from our friendly barista at the local coffee hangout who trades crypto on his phone.

Now asset allocation is a very personal choice, driven by your interest, investing horizon and risk preferences.

But it can’t hurt to share some ideas that challenge the perception that the market is un-investable these days.

So here are some “Lego blocks” for your portfolio construction exercise.

Portfolio Lego Block #1: Make sure your portfolio has a Value bedrock

Enough with these calls of overvalued equities.

The stock market these days is more polarised than the political landscape in the western countries.

On the one hand, there’s TSLA and a coterie of other growth stocks who are driving SPX to the moon 🚀.

On the other hand, there are hundreds of stocks at all-time-low P/E.

If the market will turn on us, mean reversion will bring value back to the spotlight. So if you want value in your portfolio you can find it in spades. Check the “Cheap Valuation” filter in Explore.

Portfolio Lego Block #2: Don’t diss bonds

As someone who actively shorted bonds for a good part of our careers, let us tell you that shorting bonds is Not Fun (™). A combination of carry and low volatility makes bonds always more attractive on the long side of your portfolio.

Sure, unwinding QE + hiking rates is unlikely to drive these bonds much higher. And bonds don’t seem to be much of a risk-off hedge anymore - just look at the last month.

However, they remain a good dry-powder stash for any retracement and they provide yield. And you can use them to do other fun stuff (see last point below).

Also, if you want an inflation hedge look into TIPS i.e. treasury bonds that pay up in proportion to inflation - here’s the US 10Y TIPS.

Bonds are still your friends, even if you don’t hang out with them as often as you used to.

Portfolio Lego Block #3: Go for crypto

You know you want it.

As crypto finds its way into mainstream investing, and tries to find viable solutions for it’s monstrous energy consumption levels, institutions are taking note.

Whether it’s because you fear inflation or because you want momentum in your portfolio, it’s time for any allocation to think seriously about the role of crypto in your baskets.

And guess what, if you like to buy after a good washout now’s your time: Bitcoin just fell 25%!

Portfolio Lego Block #4: The secret about commodities

Was COVID good or bad for commodities?

One story says commodities are crashing because of faltering demand (from Omicron this time), the other story says they are rising because of the supply chain crunch caused by COVID in general.

As the latter is much more persistent than the former, we definitely edge towards saying that commodities might have a role to play throughout the recovery.

But here’s something interesting that you might not know: were you aware that commodities carry interest?

Here’s some numbers from US futures (all links lead to the chart):

This carry is the difference between the price of the commodity now, and the price paid in one year. If sugar in 1 year is 20% cheaper than today, then Sugar has 25% carry.

Portfolio Lego Block #5: The enduring allure of Gold & other shiny metals

Not much to say here - gold is one of those commodities that defy market laws.

For one, Gold is associated with an inflation hedge so if you are worried about inflation, make a space for the shiny metal in your portfolio.

Bonus - Portfolio Lego Set: Bonds + Calls

What follows is the do-it-yourself version of a popular structured product that wealth management used to pander across most developed markets. It’s not for everyone but it’s certainly a fun conceptual exercise if like us you love option plays - so here it goes.

So let’s say you don’t tolerate losses. Just can’t deal with them. You want 100% cash protection.

Then as the textbook says all you can get is the risk-free return. That’s the 1.2% yield that you got from the 5y US Treasury in point #2.

The fun part is that with 1.2% play money per year you can still try to capture some returns.

A 12-month call option on SPX can cost you 6% on a good day, subject to VIX being on the lower side. That means that you can exchange 1.2% of yield from the bond for 20% exposure of your portfolio to SPX upside.

So if the market is up 10% next year, you are up...2%. Meh that does not sound fun right?

Worry not! Your best friend is here to help: leverage.

As long as the curve is steep, you can leverage this structure via futures. With 2x leverage, you can increase your SPX exposure to almost 40%. Or be 20% long AND 20% short with a put.

Option structuring is always fun.