By Victor Haghani and James White
Thank you to all our Elm investors who joined us for our mid-year call. You can find audio and video recordings of the call here:
We also thought it would be helpful to provide written answers to some of the excellent questions we received on the call:
1) Where do you see fair value for the S&P 500?
We don’t have a concept of “fair value” which is central to our framework, for the S&P500 or for asset classes in general. Nothing we do at Elm is predicated on figuring out a “correct” level for asset prices, or a belief that asset prices will mean-revert to some given level over time. The historical data for equity markets in particular does not support mean-reversion to simple valuation metrics. If there is such mean-reversion, it’s happening in such a complex and variable way with enough regime-shifts that it’s not useful in the context of an investment program like Elm’s which is trying to be robust across many market environments.
Instead, what we focus on for equity markets is expected real returns, which we can reasonably estimate without relying on mean-reversion or specific views about fair value. We use 1/CAPE as our predictor of the long-term real returns for a broad equity market, and thus we estimate the equity risk premium as 1/CAPE – 10y TIPS Real Yield. Positions by asset class are then set proportionally to risk premia, and inversely to volatility (via the momentum signal).
2) What is your opinion about the following conjecture? “The Fed is going to raise rates until something breaks. Then they will pivot.” How close are we to something breaking?
We generally don’t find it helpful to forecast, or even have strong opinions about, macro-economic events or variables. Some of this is because Elm’s goal is to be robust, algorithmic, and not rely on our personal “reading” of markets as a source of investment returns. We also think that consistently forecasting macro-economic events with any accuracy is incredibly difficult, and that linkages between the economy and markets are sufficiently weak and variable that even if you perfectly forecasted the future economic environment, it would still be very difficult to accurately forecast market prices and returns.
As an anecdotal example, consider what happened during 2020 related to the pandemic. Had you been sitting in 2019 with a crystal ball, such that you know that a pandemic and serious economic damage is coming, and you had to forecast the S&P500’s full-year return over 2020, it’s highly unlikely that +18.4%, or anything close to it, is what you would have forecast.
3) Since you calculate equity risk premia relative to TIPS, why don’t you use TIPS as the residual asset in Elm’s Balanced strategies?
Using long-dated TIPS as the residual asset would be the setup most philosophically consistent with our intellectual framework. However, while we value using a consistent framework quite highly, we also place value on our strategies being relatively simple, intuitive, and aligning with what we (Victor and James) want for ourselves, and what our clients want for their own portfolios. From that perspective, having potentially large residual “minimum-risk” positions in long-term TIPS, which can be quite volatile in present value dollar terms, doesn’t feel entirely comfortable or desirable.
We have been seriously considering expanding the prominence of TIPS in the Baseline portfolio for Elm’s Balanced strategies, and also considering more significant changes to how we handle fixed-income assets in general. Our minds aren’t made up yet, but we’ll keep you updated on these developments as we get closer to implementing changes.
4) Why did Elm Global Balanced hold about 10% in Long-term Fixed Income for most of 2020, but none now?
Elm’s long-term fixed income complex consists of US TIPS, US Munis, and US Investment-grade nominal bonds. These buckets had positive momentum through April 2021 which was supporting a relatively small allocation. Since then momentum transitioned to negative, after which the target allocations have been close to zero.
5) Can I move my SMA accounts from Fidelity to Schwab to avoid the quarterly custody fee at Fidelity?
Our clients can now choose SMAs at either Fidelity at Schwab, and we’re happy to accommodate moving accounts from Fidelity to Schwab or from Schwab to Fidelity; it’s an easy process. In general, we view the service offerings as roughly equal, and we have not seen a large number of clients move their accounts either way. While Fidelity charges a custody fee of $42.50/quarter, they have a money-market sweep fund which pays near-market interest rates on cash, while Schwab does not. So holding non-Elm accounts with cash in them is significantly more convenient at Fidelity than Schwab, a benefit which we feel is roughly comparable to the cost of the fee for reasonable account sizes.
6) Are the charts from the Apps on the Elm website available in table format?
Historical returns data can be exported to excel using the ‘Download Data’ button in the Historical Returns tool here. Asset allocation data in table format can be seen, but not downloaded directly, using the ‘Asset Allocation Viewer’ tool here.