BTAL Anti-Beta Fund: Still A Great Diversifier

Those who follow me know that I am a rare appreciator of the AGF U.S. Market Neutral Anti-Beta Fund (NYSEARCA:BTAL), a long-short strategy that has produced a cumulative loss of nearly 20% since its 2011 inception — see chart below, purple line. As I will explain in more detail shortly, the appeal of this fund is not its ability to produce profits as a stand-alone holding, but its diversification capabilities instead.

However, so far in 2024, something unusual has happened: BTAL’s share price has climbed well above its expected annual return rate of roughly -2% to zero, despite the S&P 500 (SPY) also having risen by quite a bit. What might be causing the phenomenon, and does a rallying BTAL mean that offsetting underperformance (i.e., reversion to the historical mean) could be ahead?

BTAL: Underrated Diversification Benefits

Before moving forward, I should revisit the investment case for a fund that, in the long run, I expect to produce zero or even small negative annual returns. In my opinion, too many equity investors overvalue the pursuit of high absolute returns and underrate the benefits of limiting portfolio risk. BTAL does not help much with the former (if at all) but can do wonders regarding the latter.

This is the case because the daily returns in BTAL have historically been correlated with those of the S&P 500 by a factor of -0.45. In other words: very often and consistently, BTAL is up when the broad equity market is down. This is music to the ears of diversified investors, especially because BTAL can offer quite a bit of diversification benefits without producing substantial losses in the process — unlike an instrument like the ProShares VIX Short-Term Futures ETF (VIXY), for example, which suffers greatly from negative roll yield.

Last year, I proposed a portfolio invested 60% in SPY and 40% in BTAL (which I will refer to from now on as “BTAL-SPY”), rebalanced quarterly. Not much of a shocker, such an allocation should be expected to produce (and has produced, historically) absolute returns that lagged those of the S&P 500 by a good bit. But maybe more surprisingly to many, the strategy has generated superior risk-adjusted results, as displayed below. Notice the Sortino ratio of 1.79 vs. the S&P 500’s 1.42; and the maximum historical drawdown of only -9% vs. the S&P 500’s -24%.

BTAL-SPY Rallies: Is This A Problem?

So far in 2024, the 60/40 portfolio described above has performed superbly. This is the case because SPY has rallied by 7% in less than three months while, more astoundingly, BTAL has climbed 6%. The simultaneous, bullish movements in these two funds that otherwise tend to move in the opposite direction have culminated in February 2024 having posted the third-best three-month return in the 60/40 portfolio since BTAL’s inception, in 2011. See chart below.

I have a hypothesis that helps to explain the phenomenon. As the US stock market keeps reaching fresh all-time highs, some market participants must be feeling uncomfortable with stretched valuations. The global economy is not necessarily firing on all cylinders, while former hedge fund manager Ray Dalio recently discussed the possibility of stocks being in bubble territory. Therefore, leaning a bit more defensively in the direction of low-beta stocks has been providing an uplift to BTAL this year.

An important question is whether owning BTAL following such a strong rally in the 60/40 portfolio makes sense today. In my opinion, the answer is yes for a couple of reasons.

First, the idea of blending negatively correlated assets to create a more efficient portfolio transcends questions of timing, in my view. Sure, maybe BTAL-SPY will revert to the mean in the short term and give up some of its January-March gains. But over the long haul, I continue to expect the strategy to yield superior risk-adjusted results.

Second, there is no historical evidence that a three-month rally in the strategy leads to weaker returns in the foreseeable future, necessarily. Below are the instances in which the 60/40 portfolio outperformed the most since 2011, followed by what happened next:

• June 2020: the BTAL-SPY strategy produced three-month gains of 9.6%. In the following two months, the portfolio still gained 5% in July and 2% in August.
• December 2021: the portfolio produced three-month gains of 8.5%. While small losses were incurred in January and February 2022, they were largely recouped by March.
• August 2019: the portfolio produced three-month gains of 7.1%. BTAL-SPY still managed to produce small gains in each of the following five months.

In Summary

Make no mistake: owning BTAL is not for everyone. As a stand-alone holding, the fund is unlikely to create wealth, unless the shareholder times entries and exits very well. Even as part of a portfolio, BTAL needs to be balanced properly and often enough (monthly or quarterly, I would argue) to ensure that it is producing the desired diversification benefits without substantially reducing portfolio gains.

Yet, many diversified investors could still take advantage of BTAL, even after the fund managed to rally strongly to start the year. The prize is likely to be superior risk-adjusted returns over the long term, in line with history, which I find quite compelling.