Asset Allocation Ahead of the Algo Apocalypse

Gold, softs, small caps, hedge funds

Cutting to the chase, if I were a CFA I would recommend a portfolio with 10% in gold, 10% in soft commodities (agricultural products like wheat, corn, coffee, cacao, sugar etc.), 20% in a trusted global small cap fund, and 60% in a basket of different hedge fund strategies.

Disclaimer: Nothing on my site is to be construed as recommendations to buy or sell anything. All my writing is for educational and entertainment purposes, so be a responsible adult and consult a professional financial consultant before putting any money at risk, anywhere. Again: I don’t make recommendations. Never. Ever.

My own asset portfolio currently consists of an apartment, ten private companies, and various fixed income streams (loans and obligations). And precious metals.

Oh, and my girlfriend manages a little money for me, a portfolio that currently is exposed to, e.g., Spotify, Hennes & Mauritz, Gran Colombia Gold, Azelio and various soft commodity ETFs.

FAQ

I’m often asked what to invest in. It’s a hard question to answer. It depends on who’s asking, how much risk they can take, i.e., if they’ll freak out if they lose 5%, 10% or 50% in the interim, what their investment horizon is, and not least how active they will be.

By the way, did you know I’ve learned everything I know about strategy and perseverence by Adrian at TQM? Okay, not everything, but he has added a lot of value regarding not least mindset through his 30 Challenges, newsletters and more (affiliate link – the reason I have one is that we approve of each other’s material).

There are several categories of answers, including the following:

  • Don’t invest at all. Just live it up as you get your hands on the money, or keep a buffer at the bank. The strategy is called: invest everything in your personal experience while you still have the time and energy.
  • Set aside a fixed amount every month and buy a global stock index for the money. Don’t look at the result for 40 years. Zero time and resources wasted.
  • Buy precious metals for 90% of your wealth. I’ll help you re-allocate when it’s time in a few years or so. Highly contrarian, zero income-generating, advice-contingent strategy.
  • Go for the Dogs Of Dow, with annual weight adjustments, i.e., a stocks only, slightly sophisticated strategy, with medium level maintenance
  • Invest everything in your own education, skills and business
  • Just buy a basket of hedgefunds and go back to sleep
  • Create and maintain a true asset allocation strategy with medium-frequent adjustments: stocks + fixed income + real assets (real estate, precious metals, commodities) + businesses (own, private equity).

The last bullet point warrants its own full text book, but I’ll try to break it down in just a few paragraphs.

Asset Allocation

First, some would advocate fixed weights for the various asset classes; 25% each if you choose four different pizza slices, 20% each if five and so on. I think you should be way blder than that. Risky assets like certain categories of listed stocks and private equity perform much better than the others during equity bull markets, as well as in total over time. Take advantage of that by on average allocating more than a “fair” share to equities.

Second, the weights shouldn’t be static, but dynamic and dependent on A) absolute valuation metrics, B) relative valuation metrics, C) recent performance (in particular stock market crashes that last 2 years).

Third, we are different, and thus there is no way you could invest the same way I do. I can make new assessments and investment calls every day if I’d like, and you don’t have access to information about when I change my mind.

When I describe a good portfolio allocation, I consider how I think the investor will manage the portfolio when I’m not looking, as well as how I think they’ll react to paper losses.

Fourth, as a general rule, over the very long term some kind of exposure to the general profit making part of growing economies is warranted. Ergo: over time most people should load up on stocks, perhaps even with a little leverage on average.

Leverage

I hesitated over that last statement, since most people aren’t equipped to decide when to use leverage, what kind of leverage and how much leverage. Consequently, most people use too much at precisely the wrong time and end up permanently destroying their capital.

On an economy-wide level this tendency is apparent in NYSE margin loan statistics, corporate indebtedness statistics and not least buyback and insider buying data series. Loans, leverage, buybacks and insider buying always peaks right before serious market downturns.

That tragic historic fact aside, there are times to use smart leverage, and it’s right when the mentioned data series are near their lows. Unfortunately loans can be hard to get just when you want one, so you have to secure your loan earlier but hold off using the money until you get a fat enough pitch.

Alright, back to the portfolio allocation decision. This is what I told a friend earlier today:

  • 10-20% gold
  • 10-20% (soft, agri) commodities
  • 20% global small caps managed by a trusted and experienced PM
  • 40-60% a basket of various hedge funds with uncorrelated strategies

Why gold?

Gold and commodities are very cheap compared to stocks and the amount of currency in circulation, not to mention the vast quantities of outstanding credit and derivatives. In addition to all that government welfare promises require inflation or money printing of hitherto unheard of proportions.

If you own real stuff like gold, silver, uranium, real estate or a business, you only sell if the money you get in return will buy you some other real stuff you want in a reasonable quantity. When the amount of money in circulation doubles, you can expect prices on all tangibles to double too. Don’t sell for less, nobody else will.

Liqudity sloshing

So far mainly stocks have been on the receiving end, but the liquidity sloshing around the system is bound to reach metals and food sooner or later.

In any case, most governments have taken on more debt than they can handle with the current monetary system, and when they perform a re-set, it will most likely be against a basket of various moneys — including gold. It’s around that time, shortly after the re-set, a gold owner makes the switch from gold to stocks.

However, since you never know how far a bull market can go, or how far the madness of central bankers can push the system to avoid a crash on their watch, you’re more or less forced to hold some stocks at all times.

Right now, I advocate a minimum of stocks in relation to your average strategy, since we are within the 5% most expensive, euphoric, overbought and long-lived bull markets of all time. For some, like me, that means close to 0% listed stocks, or even outright net short stocks! In practice, however, I’m actually around 1% net long listed stocks. In addition, my private equity holdings amount to maybe 50% of my net worth, although it’s pretty hard to estimate their value at this point.

And then there is gold/silver, loans and real estate.

Well, that’s me. And you’re not me. Neither is my friend. I told him I like (Swedish) Robur’s global small cap fund that’s managed by Jens Barnevik. And as a basket of hedge funds I always mention Brummer Multi Strategy with 2x built-in leverage.

I have all my private pension money in BMS2xL, and I estimate that alone would be enough to carry me from retirement to the grave in a reasonably comfortable way.

However, that’s how things look now, when gold and commodities are cheap, P2P loans yield 7-10%, some corporate bonds even more, not to mention my private loans where the range is truly huge, and stocks are at their most expensive in 200 years right at the top of a record long expansion and the build-up of more leverage than ever at record-speed.

Algo-apocalypse or U-zombie

After what could either be an algo-apocalypse, a 75% crash in record time, or a drawn out, slow zombie death by a thousand cuts, U-formed profit recession, the tables will most likely have turned completely.

In the latter case, imagine impotent but vengeful central bankers spewing helicopter money over everone and everything they can shake a stick at, while companies fight tooth and nail to make their bond holders whole, and consequently having to cut back on investments, employees and growth. One company’s cutbacks and slow growth means less sales for another.

Thus the zombie disease of investment cutbacks spreads to the whole system. Nervous bond holders keep counting coupons and return of capital, while business owners constantly stare Chapter 11 in the face.

When stock market valuations have normalized, started to normalize, or possibly are going through a period of undershooting, it’s time to overweight equities, while underweighting all other asset classes. Maybe you should even go as far as consider going more than 100% long equities, if you have access to controlled and reliable financing and are dead sure of a secure line of income.

But which equities? Well, once again the Dogs Of Dow could be a place to look. Or stalwart cyclicals. Banks usually perform well after a (financial) crash. But beware of highly indebted companies, if I’m right that the downturn will be drawn out. Some of the latter might default given long time enough to recovery.

Too hard

If you realize this simply is too much work for you, perhaps somebody else should manage your money for you. Or you should aim for one of the simpler strategies.

That’s why I always come back to a portfolio of gold, fixed income, stocks and hedge funds.

Gold is your insurance against systemic risks and rampant inflation, and your source of purchase resources after a stack market crash. Fixed income takes care of your most urgent everyday needs. Stocks makes sure you get some of the upward drift of the world economy (although I really think everybody should try to at least perform some market timing, like buying much more after two negative years, or sell most when stocks are 100% more expensive than the historic average).

And finally, a basket of hedgefunds puts hundreds of brilliant absolute return focused asset managers to work, doing their best to create decent performance in both bull and bear markets in a wide range of uncorrelated asset classes. If you want risky assets-like performance but don’t want stock market crash-like downside, products like Brummer Multi Strategy (2xL) should form the basis of your portfolio.

Please note that I used to work at Brummer & Partners (2000-2014), but don’t have any affiliation with the group today. I just happen to like the product.

So, where did all of this put us?

Avoid stocks now and focus on gold, agri and a diversified basket of hedgefunds. Be prepared to allocate your money the other way around after a crash, but keep in mind it might be a U-shaped recovery that takes more than the usual 2 years before a clear uptrend is established. Look to Japan and some European indices for guidance. How should you best have played the Nikkei between 1990 and 2010?

Make sure you sleep well. The point of all wealth is well-being

Loans, including P2P loans, will probably be honored over time, which at the same time will be an important reason for the slow recovery. Size your exposure intelligently so you can sleep well at night when thinking about the individuals that might or might not be able to meet the payments due to you. Just don’t rely on them to provide ample liquidity when you want to go levered long the stock market in 2026. For that you’ll need gold.

P.S. Remember that guy Adrian at TQM that I mentioned above? Check out his 30 Challenges here (affiliate link), if you’re interested in a method to establish surprisingly effective habits. As an investor you’ll need it, since your hardest job is keeping yourself in check.

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9 Comments

  1. Finns det något sätt för retail att köpa softs sen miffo 2 stängde ner amerikanska ETFer?

    • Det finns en del ETF:er i Tyskland. Anna Svahn brukar skriva upp vilka som är tillgängliga (och relativt bra) på sin blogg

  2. I am trying to build up a strong portfolio base through quality hedgefunds, but I am a bit disappointed in BMSs performance the last few years and trying to evaluate alternatives. Do you have any input on the following hedgefunds that I have sorted out based on last 10 year performance, sharpe etc:
    Gladiator (closed at the moment but maybe reopening is possible along the road)
    Prior Nilsson Idea
    Alcur

    • I think Brummer will make a return. Strong teams, weird market. I actually think the poor performance is a mark of excellence given the state of the market. That said, Gladiator and Alcur aren’t bad either, although I don’t have any inside on those.

      With BMS (2xL) you’ll never have to think about reallocating capital based on cycle or market timing, it’s a true all weather portfolio with zero maintenance. Sure, high fees, poor recent performance and never a great upside, but over time it’s like a freight train slowly chugging along.

  3. Good article… lots to consider. I am almost entirely in fixed income, cash, with 3% gold. Hedge funds and private equity are not open to small investors like me. I have no interest in stocks until there is a major correction. There is just no margin for error with record prices and the level of fraud in the current climate.

    Commodities may be interesting to consider. P2P lending would not fit my style and I would be concerned about the default rate in a downturn. I just watched “The Big Short” again last night. Who is investigating the borrowers on an ongoing basis, and how are those portfolios priced? No thanks :)

    As an american I don’t want more gold. The dollar will be the safe haven investment for the next few decades. When another major currency resets it may then become the safe haven, and I will re-assess my gold position. If I were not living in a USD world I would definitely be diversifying currencies.

  4. Exquisite article!
    I would love to see the percentages of your different positions; e.g. how much precious metals do you own?
    And why are you recommending 40-60 % in hedge funds, when you don’t own any in your private portfolio?

    I use your adjustably quattro-strategy.
    I sold all stocks last year, but I think a bottom of 25 % instead of 0 % is better, and Graham would agree. Thus, I’m trying to find some stocks that seems better than the s&p index. What do think about keeping 100 % of your stock exposure to emerging market stocks? CAPE is lower than global, and it seems to me that it should perform better than S&P over the long run.
    E.g. doing “dogs of the dow”, but with different indexes instead, like emerging markets, S&P, and Europe stocks?
    Why are you recommending global small cap btw?
    If you divide each asset-class:
    Gold is cheaper than dow; silver is cheaper than gold; platinum is cheapest of them all…
    Thus, I bought some platinum, and I’m quite bullish on gold and silver.
    Furthermore, I bought some Franco-Nevada, although I know nothing more than it’s leveraged to gold, and that it’s a streaming company. Luckily for me, I bought very little, so it might just be some “learning-money” as we say in Sweden.

    But how do you know when commodities are cheap? Do you have any sources or charts? It seems to be cheap vs stocks, but I don’t know vs gold.

    What do YOU think about silver and platinum; what are YOUR reasons that you DON’T own them?

    Looking at the cost of Brummer: 6 % fees really scares me, and it has performed worse than OMX, although the comparison is quite unfair. Brummer do seems like a freight-train indeed, with a CAGR of 6 % since 2002. With 2x leverage, that should be that times 2? Or maybe 1.5, after expenses. Maybe I should buy some…

    P2P-loans like lendify seems lucrative. I’ve read I rule once that you should never have more than 2-3% in ANY investment. Is it reasonable to have 2 % in lendify? Or is it too little? Do you have any such rules of maximum exposure?

    My portfolio right now.
    25 % precious metals (platinum, gold, silver, Franco Nevada)
    48 % cash and short-term treasuries (US, EUR, SWE, GLOBAL)
    25 % long-term treasuries (US, EUR, SWE)
    2 % lendify
    I will dollar cost average in an emerging market index, and will do so until CAPE reaches over 20.
    In the future, I’m thinking 25 % of total portfolio in emerging markets stocks, and some percentages in Brummer, or other hedge funds.

    • And why are you recommending 40-60 % in hedge funds: Least maintenance. I invest in private equity but most people can’t, don’t have access, don’t know how to research/value them. The right basket of hedgefunds is perfect for getting exposure to risky assets without having to think about huge donside risk, cycles or timing.

      I sold all stocks last year, but I think a bottom of 25 % instead of 0 % is better, and Graham would agree: Yes, best for most. That’s why I suggested global small caps

      What do think about keeping 100 % of your stock exposure to emerging market stocks? CAPE should be used market by market. Don’t compare the US CAPE to the Bangladesh CAPE, e.g. It’s not a given that EM performs better than DM over time. Look at China between 1990-2015…

      E.g. doing “dogs of the dow”, but with different indexes instead: good idea, but the exact rules of execution aren’t self-evident

      Small caps: I’m specifically saying Jens Barnevik’s global small cap fund is a good alternative for owning stocks

      But how do you know when commodities are cheap?: you can never KNOW, but agri products are mean reverting since they have an intrinsic value (as food)

      I own silver, both physical and through my gold/silver mining/refining operations in South America

      BMS2xL: just look at the chart of BMS2xL vs hedgefund index vs stocks since 2002. That’s after fees

      Rules of maximum exposure?: No rules, I could imagine having more than 100% in just stocks, e.g. In practice I seem to limit my exposure to 20% of Net Worth per asset class. It really depends on definition of “per what?” and your liquidity needs. THere’s a difference between having 20% of NW in your house vs 20% in a single listed stock, or private equity.

      I never give exact weights, and it’s hard to value some of my private equity holdings. But it’s fair to say I have 10% in precious metals and 50% in private equity (a wide range of industries)

  5. Thanks for sharing for thoughts on asset allocation Mikael. Would be interesting to know what you think about Ray Dalio / Bridgewater’s All weather strategy, which to some extent can be replicated by using ETFs.

    • Thanks. The All Weather is one good way of approaching asset allocation. Ray Dalio is one of the smartest investors out here – neither perma bull nor perma bear, but overall level headed and very consistent in his thinking.

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