2021 Portfolio Thoughts (Part 2 – Asset Classes)

The starting point for constructing the portfolio for early 2021 starts from considering the themes that I have outlined earlier. There are three steps to consider: (1) Laying out the asset classes which will respond well to these themes, (2) Understanding the allocations between these asset classes, (3) Identifying where things might go wrong and tweaking the allocations.

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1 – Laying out the asset classes by themes: The first step is to lay out the asset classes that are expected to do well around the themes listed in Part 1 of this blog and also the asset classes that are NOT expected to do well in these themes.

Here are the “Broad” asset classes that constitute the puzzle pieces that need to be put in place for the right portfolio allocation:

1. US Equities: This includes sub-components such as Financials, Utilities, Energy, Materials, Industrials, Health Care, Tech, Communications services, etc.
2. Mid-to-long term Treasury bonds (Long Term, Intermediate term)
3. Gold and Precious metals
4. Commodities
5. International Equities: This is also a broad asset class and includes broad equity indices for various countries
6. Real Estate
7. Bitcoin and other Cryptocurrencies
8. Cash and Short Term Bonds

Themes	Asset Classes aligned to the Themes	Asset Classes NOT aligned to the Themes
USD currency debasement	Gold, Bitcoin, Commodities, International Equities, Real Assets (Real Estate, Commodities)	US Treasury Bonds, Cash in USD
Vaccine	US Equity sub-sectors: Energy, Airlines, Travel, Hospitality	Fear trades such as Gold or Long Dated Treasury bonds, Work from Home Trades such as Zoom
Continued liquidity injections and Stimulus	Broader US Equity Index, Gold, “Robinhood” Asset Classes (Tesla/Apple, etc.)
Continued passive flows	Broader US Equity Index
Inflation assumptions	Commodities, Energy / Oil, Materials, Precious Metals, Select Equities, TIPS, International Equities – countries that have commodities as a major component of GDP (Russia, Brazil)	Cash, Bonds (especially longer duration bonds)
High equity valuations / Segmented Recovery	Gap between high performance and fiscally prudent companies vs. highly indebted companies may grow. Traditional value based investing focused on companies with a strong balance sheet and a stable income flow may finally start to make sense again	Equities that have not used Covid as an opportunity to restructure, high leverage
Continuing rise of China	Broader China Index, China Tech Index, Commodities, Energy / Oil	Bitcoin (at the extreme)
New Technologies	1) 5G plays – Infrastructure (Towers, Fiber, Small Cells, Data Centers) 2) Broader Tech plays – given a lot of tech is being run in a conglomerate manner 3) Tech heavy pharma play
Other Themes	ESG Index, Select municipal bonds for taxation purposes, UK Index (Pound exposed)

There are a large number of asset classes that I have thrown out in the table above and it may make sense to look at each of the asset classes in a bit more detail (although I will restrain myself from going in too deep).

US Equities: As mentioned earlier, US Equities have been at all time highs. However, not every sector has partaken in this mad spike up and while the expected forward returns are low due to high valuations, there are still some places where there may be opportunities. As describer in an earlier blog, there may still be opportunity for equities to go higher with continued injection in liquidity. Here is my suggestion for US Equities:

US Equity Sector Pick	Rationale
Broader SPY / VTI	Benefits from continued injection of liquidity and stimulus
Energy / Oil	Currently we have multi-decades low valuation in Oil companies. If the vaccines work out, one could see pent up travel demand coming back up by mid-2021. The supply will be constrained in the future given Biden’s ESG focus and inability to really drive supply up. OPEC has also started to show supply discipline. As such, I would expect a significant spike up in the Oil prices. Select companies like ExxonMobil, Chevron and Hess have high dividends as well as low valuations. This is also an attractive segment that can help hedge against Inflation.
5G Plays	Overall potential for 5G services is immense. At the bottom of the 5G stack lies the telecom infrastructure which is something that is generally attractive to me as an income and growth play. Combination of Fiber, Towers, Data Centers and Small Cells may provide the right growth and dividend play.
Food and Agriculture Commodities	Agricultural commodities and food stock may form inflation hedge and focus on basic necessities. Better if they have international exposure as well to hit on multiple themes
Other Attractive sectors	Financials, Utilities and Materials sector may represent positive valuations and fundamentals
Small Caps	Russell 2000 Value index may have a bit more attractive valuation vs. SPY. However, its something that I will personally skip in my portfolio construction

Mid-to-long term Treasury bonds: This one is a bit tricky. Currently, the yields for US Treasury bonds are one of the highest in the developed world. Even the PIGS countries (Portugal, Italy, Greece, Spain) bonds have a lower yield than US. The foreigners continue to buy the Treasury bonds. Treasury bond holdings also form a significant position in risk-parity portfolio such as the Ray Dalio’s “all-weather” portfolio. However, it is becoming clear that while the Fed short end of the treasuries can be pinned, the longer end can really move. If that is the case, and as discussed above, if Treasury is on the losing end of every theme – there may be a reason to reduce the position in Treasuries (especially for the long term duration).

Gold and Precious metals: At the face of it, the simple story for Gold (and may be Silver) seems pretty straightforward. Gold is the hedge for fiat currency debasement and may also be a small semi-hedge for inflation as well. As mentioned earlier, there appears to be a high likelihood of fiat currency debasement given all the money printing / balance sheet expansion of Fed. Now the counter to that simple point, could be a nuance that instead of gold all the new buyers are going into Bitcoin. If that is happening then Gold should not see a big jump. In any case, the way that I will position it is being in both Gold as well as Bitcoin, given the prospects of fiat currency debasement.

Commodities: As it appears right now, there appears to be a strong case for commodities overall. As Biden comes in, one would expect a significant amount of spend on alternative energy and electrification of grids driving up the prices of copper. We would also expect a significant amount of infrastructure spending driving the prices of steel. As EVs start to capture share, one would expect an increase in Ni, Cd, Li mining. Since Fukushima, Uranium prices have been low. Overall, there is a strong case for Commodities. The problem, however, is that commodities are harder to trade since you have to trade futures. This results in backwardation and contago issues and these kind of issues prevent retail traders to make money on this. There is a way to look into copper mining and steel producing companies – some of these are already up 70+% from their bottom.

International Equities: International diversification may not have increased the returns in the past decade given strong performance of US stocks. However, it may make sense to assign some allocations to international market given the poles of global power splitting between US, Europe and China. Additionally, with the potential of USD decline, getting some external currency exposure may also make sense. China would require a strong allocation within the international market even beyond its current market weight in the global portfolio.

Real Estate: Real estate exposure can be through actual hard real estate or through REITs. As mentioned this can be an inflation and also an income play. I also like to cover this through Telecom Infra play (Towers, Fiber, Small Cells and Data Centers) which can provide exposure to both Real Estate as well as 5G market.

Bitcoin and other Cryptocurrencies: The latest increase in Bitcoin and other cryptocurrency appears real unlike the Dec 2017 increases. This time there is the start of institutional investment. We have even seen a company like Microstrategy raise $400m at low yields to invest in Bitcoin (which may represent 0.1% of the market cap and presumably a huge portion of daily/weekly transaction value). Bitcoin may be in its early innings – institutional money has just started pouring in and the hockey stick is just starting. I think having 1-3% of portfolio in Bitcoin may not be a bad idea.

However, its not a slam dunk by any means. There are many structural flaws with it. Considering Bitcoin as a store of value seems counter intuitive when the price fluctuates from $5K to $30K in a couple of months. Also Bitcoin is basically owned by a cabal – 2% of the accounts hold 95% of all the bitcoins which appears to be anything but comforting. If anyone invests in Bitcoin, I think they should really consider it normal that the investment can easily go down 60-70%. It is also something that is a parallel money system vs. the dollar or yuan – and its something that can easily be regulated down (e.g., through mark to market taxes or holding tax), or even outlawed. Remember that in 1933, Roosevelt outlawed the holding of Gold – so why can’t owning bitcoin be outlawed, especially if this is going to infringe on the dollar hegemony. Other considerations to bitcoin is that China is building its own China owned cryptocurrency network called DCEP and that will be competing with Bitcoin. Facebook’s Libra was a venture into the cryptocurrency space – but something that was shelved. However, State owned cryptocurrencies can easily be built up and can compete with Bitcoin. While some industry veterans have called Bitcoin as “turds”, others like Stan Druckenmiller have flipped to Bitcoin.

Net my view into bitcoin is that it is in its early innings, and can be a very fast growth instrument with very little institutional investments. I had invested into Bitcoin with full realization that my investment can go to zero. As I mentioned this is a bet against fiat currency debasement – and should be combined with Gold. My preference is Gold: Bitcoin ratio of about 80:20 or so.

Cash and Short Term Bonds: Ray Dalio has said “Cash is Trash” in a recent conference. This is more true with tons of money printing. Inflation and fiat currency debasement might really drive the value of cash down. However, that being said, its unclear when the next dip in the stock prices happen and in order to maintain some dry powder its important to keep a good proportion of your assets in cash.

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2 – Asset Allocations: Here is my personal target. It may be different for other people

Asset Classes	% Allocation	Potential Tickers
US Equities – Broad Based	20%	SPY – Important to have SPY Exposure to ensure adequate financial and Tech VTI – Total Stock Market
US Equities – Energy / Oil	3%	XOM, Chevron, Hess
US Equities – 5G	2%	AMT, CLNY Currently researching other tickers and will add over time
US Equities – Other	5%	Financials, Utilities and Materials, Food and Agricultural Commodities
US Equities (Total)	30%
International Equities (China, India, Russia, Brazil, Japan, UK, others)	10%	MCHI, EPI, VXUS Others based on specific country valuations
Gold	10%	IAU, Gold Miners
Commodities	7.5%	VAW, Vale, FCX, X Through US Equities – will also be getting exposure from Energy and Oil
Long Term Treasury Bonds	5%	TLT
Short Term Treasury Bonds	5%	IEF
Real Estate	15%	Owned Real Estate
Bitcoin and Other Cryptos	2.5%	BTC (primary), ETH, LTC (Secondary)
Cash and Other	15%
Total	100%

I think this first draft allocation addresses the themes that I have outlined earlier and in the previous version of the blog. One of the things to consider is how this portfolio allocation would have done. Attached are a couple of outputs from PortfolioCharts run on a close approximation of this portfolio. Note that we cannot readily replicate the exact portfolio since currently Portfolio Charts does not have crypto or industry sub-components indexes.

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In getting to the portfolio answer, there are other broader questions to consider around this allocation.

These questions may include: (1) why should one not put all eggs in the broad market index basket?, (2) Do we have opportunity for aggressive growth in the portfolio? (3) How have we considered other macros trends such as long volatility?, (4) Is it better to stick to the “all-weather” or “Golden Butterfly” portfolios?, (5) Is there a prior historical time when these conditions were in place and how would this portfolio fare at that time?

We can address that in the third part of this blog.

Acknowledgements: Thanks to Tyler for letting me use outputs from PortfolioCharts