Trinary Capital Income Model with Alternatives
The 40/60 portfolio (40% equities, 60% fixed income) has been a workhouse of spending models in investment management for decades. Variations of it have existed: some with a focus on specific types of equities; some with a focus on specific type of fixed income; and others with both. The amount of granularity below within those categories is infinitely divisible. Performance, of course, will also vary with those choices, some to the portfolio's detriment. Given the current state of the market and the plethora of options that are becoming more and more available to the average investor, we have to ask ourselves whether the longevity of the 40/60 portfolio originates from its success or naked inertia.
At Trinary Capital, we believe that there are options that may suit some investors better, and we believe that exploring those options and embracing changes in the investment management industry are both part of our fiduciary duty. To that end, we introduce The Trinary Income Model with Alternatives - 40/30/30 or 40% equities, 30% fixed income, and 30% alternatives.
Let's review how investors have historically drawn down on a 40/60 portfolio. This is represented in Figure 1. If we consider 5 periods of 5 years, we can spilt our 40/60 portfolio into a series of portfolios with increasing equities and decreasing fixed income. Why do we do that? The expectation is that the payoff from equities will become greater in the long run despite short term market fluctuations. Along that same line of thinking, we expect short term stock market fluctuations will have a more muted impact on fixed income. In numbers, this looks like 40/60 = 0/100 + 20/80 + 40/60 + 60/40 + 80/20 in Year 0. As we spend down the first portfolio, composed solely of fixed income (0/100), we have a 50/50 portfolio composed of 50/50 = 20/80 + 40/60 + 60/40 + 80/20 and so on. This division allows the equities to experience long term equity premiums.
The unanswered questions in this approach are hanging in the air
- Where do stocks go from historically high multiples of forward earnings.
- Where does fixed income go from historically depressed interest rates and a threat of inflation?
Those are questions which deserve longer answers than we can accommodate here. The point that we can raise here is diversification; we can diversify these risks with alternatives.
Alternatives can be a valuable tool for diversification. At Trinary Capital we believe we have developed a unique way of combining liquid alternatives into an effective and controlled asset class for exactly that reason. Please see our academic paper in the Journal of Investment Management (A Portfolio Strategy with Hedge Funds and Liquid Alternatives (joim.com)). In balancing the alternatives allocation against equities we believe we can more effectively provide long term benefits to diversification. It is at this point where we must point out that this is not the superficial exercising of filling an alternatives bucket with gold, oil, corn, or any other generic combination of alternatives. At Trinary Capital we have a quantitative approach driven by mathematics for designing this unique allocation. The upshot of this approach is in Figure 2. We believe this may be a more effective way of spending down a 40/60 portfolio with alternative investments. We believe that alternatives allocation balances out the muted returns in equities during stock market downturns and the lackluster returns of fixed income after inflation is considered. The evolution of the spending portfolio is analogous to that described previously.
Trinary Capital believes in incorporating modern offerings in investment management into investor portfolio in an intelligent and quantitively driven manner for the benefit of our clients. This involves bringing a level of sophistication typically reserved for Institutional Investors and Ultra High Net Worth clients to the average investor.