Rodrigo Gordillo and Corey Hoffstein – Return Stacking: Strategies for Overcoming a Low Return Environment (The Best Investment Writing Volume 6)

Episode Summary

Executive Summary: This episode summarizes Resolve Asset Management and Newfound Research’s case for “return stacking”: using capital-efficient funds and prudent leverage to keep core 60/40 exposure intact while adding diversifying return streams. The authors argue this can improve expected returns, diversification, liquidity, and tracking error versus traditional or replacement-style alternatives.

Main Topics: Low-return environment and portfolio constraints (Priority: 5/5): The transcript argues that stretched equity and bond valuations make it hard to meet return targets using conventional portfolios alone, forcing investors to choose between reaching for risk, accepting lower returns, or enduring tracking error from diversifiers. Diversification trade-offs (Priority: 5/5): Adding uncorrelated alternatives can reduce volatility, but often lowers expected return and creates performance drift versus benchmark portfolios, which can lead investors to abandon diversifiers prematurely. Return stacking and capital efficiency (Priority: 5/5): The core proposal is to use professionally managed leverage and derivative-based funds to free up capital from core beta exposures, then stack diversifying strategies on top without sacrificing the traditional allocation. Practical implementation with capital-efficient ETFs (Priority: 4/5): The transcript highlights examples such as NTSX and other leveraged/core-plus products that provide embedded exposure, allowing leftover capital to be redeployed into bonds, alternatives, or cash. Model portfolio construction and backtest results (Priority: 4/5): A sample portfolio combining 60/40 exposure with CTA and global macro overlays is presented as a way to preserve traditional exposures while adding low-correlation return streams and improving historical outcomes. Costs, leverage risk, and caveats (Priority: 4/5): The authors acknowledge higher fees and leverage risk, but argue that the improved exposure per dollar, diversification, and rebalancing benefits can justify the added costs if leverage is prudent and diversifiers are truly uncorrelated.

Key Arguments: Traditional 60/40 portfolios may struggle to meet return targets in a low-return regime because both equities and bonds are expensive and likely to deliver lower future returns. Replacing stocks and bonds with alternatives reduces risk, but can materially reduce returns and create tracking error that causes investors to abandon the strategy. A more elegant solution is to use capital-efficient funds that deliver core exposures with less capital, then use the freed-up capital to add diversifying strategies. Modern portfolio theory implies investors should seek the most efficient portfolio and, if needed, apply modest leverage to scale that portfolio rather than chase riskier assets. Leveraged core exposures can outperform plain equities on a risk-adjusted basis; the transcript cites long-run backtests of leveraged 60/40 approaches as support. The proposed stacked portfolio aims to preserve 60/40 exposure while adding CTA and global macro overlays that are structurally low-correlation to traditional assets. Return stacking can improve liquidity and flexibility because freed-up cash can be held, rebalanced, or deployed opportunistically. The biggest concern is diversification failure during crises, so leverage should be prudent and tail-hedging or convexity overlays may be useful. Higher fees are a concern, but the authors argue the fee per unit of exposure declines once leverage is considered and can be offset by the benefits of diversification and rebalancing.

Data Points: Illustrative alternative sleeve allocation: 30% - Example portfolio adds a 30% allocation to alternatives alongside a 70% 60/40 sleeve. Illustrative risk reduction: 28% relative risk reduction - Adding uncorrelated alternatives to the sample portfolio lowers risk materially. Illustrative return reduction: 15% relative return reduction - The same alternative allocation also lowers expected return in the example. Leveraged core exposure: 150% allocation to 60/40 - A borrowing example used to show how leverage can scale the efficient portfolio. NTSX leverage: 1.5x exposure - WisdomTree U.S. Efficient Core ETF provides 1.5 leverage to a 60/40 mix. Capital freed up by NTSX example: One-third of capital - Allocating two-thirds to NTSX provides equivalent 60/40 exposure and frees one-third for other uses. Vanilla 60/40 return: 6.9% annualized - 20-year comparison ending June 2021. Vanilla 60/40 volatility: 8.6% annualized - 20-year comparison ending June 2021. Return stacking portfolio return: 7.7% annualized - Two-thirds in NTSX plus one-third in investment-grade corporate bonds. Return stacking portfolio volatility: 8.9% annualized - Same 20-year comparison ending June 2021. Return improvement: 80 basis points - Return stacking example outperformed the vanilla 60/40 portfolio by 0.8 percentage points annually. Extra volatility: 30 basis points - The return gain came with only a small increase in volatility. Blended expense ratio: 1.29% - Estimated fee load of the example return-stacking portfolio. Expense ratio of balanced fund: 0.07% - Vanguard Balanced Fund used as a low-cost benchmark. Exposure per dollar invested: $1.60 - Fee analysis normalizes cost by total notional exposure. Fee per dollar of exposure: 0.81% - 1.29% divided by 1.6 exposure. Look-through exposure of model portfolio: 161.3% total notional exposure - Table-based model portfolio combining core and alternatives. Look-through equity exposure: 61.9% - Model portfolio target exposure. Look-through bond exposure: 40.3% - Model portfolio target exposure. Managed futures / trend exposure: 28% - Model portfolio overlay allocation. Global macro exposure: 29% - Model portfolio overlay allocation. Convexity exposure: 1% - Model portfolio overlay allocation. Volatility exposure: 0.8% - Model portfolio overlay allocation. Correlation: S&P 500 vs bond index: -0.1 - Daily correlation cited for diversification analysis. Correlation: S&P 500 vs CTA index: -0.05 - Daily correlation cited for diversification analysis. Correlation: S&P 500 vs macro risk premium index: 0.09 - Daily correlation cited for diversification analysis. Correlation: balanced portfolio vs overlay portfolio: 0.06 - Indicates low relationship between core and overlay sleeves. Annualized return uplift of stacked portfolio: almost 4 percentage points per year - Backtest comparison versus the original 60/40 portfolio. Years of outperformance: 18 out of 21 years - Stacked portfolio outperformed the balanced portfolio in most calendar years. Maximum drawdown profile: similar to 60/40 - Despite leverage, drawdown behavior was said to be comparable. Return-to-ulcer ratio: double - Risk-adjusted path metric improved versus the 60/40 portfolio.

Pivotal Quotes: "How to have your cake and eat it too." — Narrator / authorship framing: Introduces the central promise of return stacking: keep core exposure while adding diversifiers. "The concept combines diversification with the prudent application of professionally managed leverage to pursue superior risk-adjusted returns." — Authors: Core thesis of the paper and episode. "Investors are no longer compelled to seek returns by climbing the equity risk curve since they are liberated to experiment with increasing portfolio real estate and return stacking opportunities at a level of risk that they're comfortable with." — Authors: Summarizes the practical goal of freeing capital and avoiding pure risk-taking.

Implications: For investors, the message is to rethink diversification as an overlay, not a replacement. Capital-efficient funds may let portfolios preserve core beta, add alternatives, and potentially improve returns and resilience—if leverage, fees, and diversification failures are managed carefully.