PSLDX One Year Later: Right Idea At The Wrong Time

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In November 2021, I explored the idea of “return stacking” with a piece on the Pimco StocksPlus Long Duration Fund (MUTF:PSLDX). The basic idea behind return stacking is by using leveraged funds and/or futures, you don’t need $1.00 in capital to get $1.00 in notional exposure. This allows you to build a more diversified portfolio than you could otherwise, using your freed-up capital to diversify into things like commodities or long/short strategies and ramp your exposure to bonds to better balance the risk in your portfolio. PSLDX also was/is capable of beating the S&P 500 by fairly large margins over long periods of time.

The timing was exceedingly poor on PSLDX because it came right before the Fed threw in the towel in earnest on their “transitory inflation” call and allowed interest rates to skyrocket. There were lots of other ways to lose money on soaring interest rates and falling stocks, but as a leveraged fund, PSLDX sustained steep losses. My original series of articles on return stacking acknowledged the threat of rising rates but recommended controlling overall duration at the portfolio level and using rebalancing and dollar-cost averaging as the antidotes. In the end, these are helpful but weren’t enough to avoid losing money during a huge interest rate shock like the one that 2022 brought. PSLDX has a lot of duration (about 16 years), so some investors inadvertently took on too much interest rate risk with funds like PSLDX and took a beating from it.

However, putting it in perspective – the total returns for PSLDX are still quite good over the past five years, but if you bought in late 2021 you’re not happy.

Chart
Data by YCharts

To this point, investors who are able to rebalance and dollar cost average should make more money in the long run due to rates being higher now. This is true for interest rate shocks in general. They lead to short-term pain but long-term gains for investors.

PSLDX Did Do Its Job

While PSLDX got hammered this year, it did what it was intended to do in terms of its primary benchmark. Any time a fund puts in a performance like this, it’s worth running tests to see if it’s due to external forces like the market beta or due to internal screwups in portfolio management. PSLDX passed these tests.

I made a 100% stock/100% bond benchmark and compared it to PSLDX in Portfolio Visualizer. The point of this is that it would detect if any weird bets led to PSLDX’s poor performance this year, or if the market was driving it. What I found was that from the peak in November to month-end October, PSLDX beat its benchmark by about 200 bps. Granted, the 100/100 benchmark was down 45% and PSLDX was down 43%, but it shows that the managers of PSLDX are fulfilling their mandate. If your goal was to get some exposure to stocks and bonds for the same dollar so you could diversify elsewhere, then PSLDX did its job. The trouble was finding something worthwhile to diversify into. Commodities saved the day for many investors, but now they’re crashing again on China lockdown fears.

About two thirds of PSLDX’s losses were driven by the bond side, and about one third were driven by stocks. Bonds took some of the heaviest losses in history this year, which made a mockery of the idea of diversification for many investors. Stocks have held up better, but the question is: Has the market crash that crushed bonds been avoided in stocks, or are we barreling straight into it?

One silver lining of PSLDX in markets like 2008 is that the losses on the stock portion can get you a tax refund due to the section 1256 futures used in the fund, you can file an election to carry back tax losses to prior years that you paid taxes. This is a huge advantage for investors because it can get you a fat refund at the bottom of a bear market. If you own funds like Simplify’s Risk Parity Treasury Fund (TYA) and have owned funds like PSLDX in prior years, you can usually write off your losses in one year against previous years’ income, effectively getting money for rebalancing from the government. You should ask your own accountant about this, but tax loss carrybacks are an intended feature of using these strategies. It’s possible that investors can get a tax refund this year as well, depending on their personal circumstances.

What’s Next For PSLDX?

Unfortunately, I think the stock market is likely to resume falling here, while interest rates are likely to rise a bit more, up from 3.7% to perhaps 4.5% on the 30-year (the previous high in October was about 4.35%). But paying 19x earnings for the S&P 500 going into a recession is asking for trouble. You may or may not share my macro views, but my beliefs on how much risk investors should take are separate from whether PSLDX is a useful portfolio tool. PSLDX has shown itself to be a very useful tool to free up capital while maintaining your desired stock and bond exposure and will continue to do so going forward. On a portfolio level, I think investors should keep equity risk as low as possible at the moment and keep duration short.

But if you’re going to own some bonds and want exposure to the S&P 500 anyway, PSLDX is a great way to do it and free up capital to invest in stuff like commodities, preferred stocks, or municipal bonds, depending on your risk preferences. The expense ratio for PSLDX is now 0.61% per annum on the fund, which is down from over 1% previously. But since you get $2 of exposure for $1 in PSLDX, the effective expense ratio is more like 0.3%. The theory on PSLDX is that a leveraged combo of stocks and bonds combined should beat either alone, and I believe this is likely to be true going forward after a very bad year in 2022. Stocks need to come down 20% or so more and bond yields need to come up a bit, but when asset prices are fully normalized PSLDX should offer an excellent risk/reward profile for investors.

There are other investments that I made that got crushed this year that I don’t care to defend because they’re likely not coming back. When you own losing stocks as an investor, the best thing to do in many cases is to take the tax loss and buy back 31 days later (or never, in many cases). But PSLDX is not dead and gone. The theory behind PSLDX over the long run is solid, and I think over periods of 10, 20, or 30 years, funds like these can be extremely helpful in achieving your goals. Investors should look for a better entry point to ramp up exposure, but I feel that will come. I own PSLDX’s sister fund, the WisdomTree “Efficient Core” 90 Stock/60 Bond Fund (NTSX), it’s a similar fund but with a bit less leverage. The idea is the same, but the minimum investment is lower. Investors who want a lower-octane version of PSLDX should check out NTSX.

Conclusion

The pricing of assets in late 2021 was brutal. No matter really how much money you had, valuations were so high that earning enough to live off of future expected investment returns was an almost insurmountable challenge. Throw some inflation and state income tax on top and then subtract health insurance premiums from the monthly net, and things are looking exceedingly grim for the 3 million early COVID-era retirees in the US. If you bought anything in late 2021, whether it was PSLDX, the Nasdaq, or a four-bedroom house in San Diego, then you likely overpaid. The best move then was not at all obvious, but it would have been to sit and cash and wait for the system to blow up (or buy puts). Now asset prices have come down substantially, and they may come down a lot more. When this happens, buyers of PSLDX will find redemption with stocks cheap and bond yields normalized, likely making back the 2022 drawdown over time and then some. Look for the S&P 500 around 3200 and yields of 4.5% or higher on the 30-year Treasury for a highly attractive entry point on PSLDX.

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