April 5, 2021: DoubleLine Shiller CAPE 10 Based Funds Update

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Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Monday May 3, 2021.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

DoubleLine Shiller CAPE 10 Based Funds Update

We discussed DoubleLine Shiller CAPE 10 based funds two years ago (see this). We are interested in these funds as they are some representatives of so called ‘quant’ based (or ‘enhanced’) index funds that utilize both value and technical factors. Many long term readers understand that we are a fan of investment strategies using both fundamental and price momentum factors. Our Asset Allocation Composite (AAC) strategy, for example, uses a combination of macro fundamental factors and asset price momentum.

The strategy

Just to recap, here is the investment strategy for both DSENX (DoubleLine Shiller Enhanced CAPE N) and DLEUX (DoubleLine Shiller Enhanced International CAPE N):

Based on DoubleLine’s literature and this, we summarize the funds’ strategy:

Find relative CAPE10 ratio: dividing a sector’s current CAPE® ratio by its 20-year rolling average CAPE® ratio and rank the sectors use the relative ratios.

Select 5 most undervalued (smallest relative ratios) sectors

Remove the sector with the worst trailing 12-month price momentum and invest the remaining 4 sectors equally weight

Use swaps to invest in these sectors while using the cash to invest in fixed income bonds as collateral.

The Shiller CAPE 10 metrics for international fund are based on Barclay’s Shiller indexes on MSCI international sectors. In our previous newsletter (March 29, 2021: International Stocks vs. US Stocks), we actually looked at the Barclay’s Shiller indexes over various countries.

The most interesting part in the above strategy is that it removes the most relatively undervalued (based on Shiller CAPE 10 metrics) sector that has the worst trailing 12-month price momentum. So it tries to avoid the relatively undervalued sector that has ‘bad’ price momentum. On the other hand, the strategy only avoids one and chooses the other 4 sectors, regardless of their price momentum. So it’s possible it actually invests in some sectors that are in a down trend momentum.

The other important part of this strategy is that it uses ‘swap’ derivative. A swap derivative is essentially a contract between two parties where one party (in this case, one of the DoubleLine funds, say) bets on the positive returns of a sector the fund invests in while the other party (the seller) bets on the negative returns. The seller here is most likely a market maker that can easily hold large amount of underlying stocks and it thus uses the swap on the other side to hedge out its exposure. The seller derives its profit from the contract’s premium. This kinds of swaps are sometimes called off-exchange or off-counter derivatives as they are not traded publicly.

We would like to point out that off-counter swaps played a central role in the recent infamous Archegos’ market disruption. However, in DoubleLine funds’ case, if swaps are fully backed by safe bonds in 1:1 ratio (thus no leverage), they are relatively safe, assuming the other counter party is in a strong financial position.

Both PIMCO and DoubleLine like to use swaps to boost their funds’ returns as they can use their bond investing capability to invest the cash in a bond portfolio which hopefully can deliver extra returns after paying off the premium of the swaps.

Recent returns

Well, it turns out that the strategy has again delivered.

The following is the latest US fund DSENX’s returns, compared with S&P 500 index fund (VFINX):

DoubleLine US Shiller fund DSENX vs. S&P 500 index (as of 4/1/2021):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	Since* 11/1/2013
DSENX (DoubleLine Shiller Enhanced CAPE N)	7.4%	81.2%	16.8%	17.2%	15.7%
VFINX (Vanguard 500 Index Investor)	7.4%	65.3%	17.1%	16.3%	13.9%

*: fund inception date

This is impressive as the fund is essentially more a value based fund. We all know that value investments have lagged behind growth and even general broad base indexes until recently. The fund was ahead when we last time reviewed it in October 2018 (see this).

What’s more, the international fund finally outperformed the traditional index fund by some meaningful margins now:

DoubleLine International Shiller Fund DLEUX vs. Vanguard international index fund (as of 4/1/2021):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	Since* 12/28/2016
DLEUX (DoubleLine Shiller Enhanced International CAPE N)	7.1%	72.1%	9.2%	10.5%
VGTSX (Vanguard Total Intl Stock Index Inv)	5.2%	59.8%	6.9%	11%

*: fund inception date

The international fund lagged behind when reviewed in 2018. Now, for the past 3 years, it has caught up, even though, since its inception, it still lagged behind the index fund by 0.5% annually.

Market Overview

There have been some real positive news recently. First, the Covid-19 pandemic is fading as more and more people are vaccinated. For example, the three largest states California, New York and Texas have began to make vaccines available to most people: Texas actually opened up to anyone on March 29, New York opened up to anyone older than 30 on March 31, and California opened up to anyone older than 50 on April 1. The Covid-19 death rate has trending down fast based on CDC data (unfortunately, the Covid Tracking site has ended its data collection. We salute the contributors for their volunteering work!):

Whether there will be another wave caused by the variants is still unknown. However, so far, it does look very promising.

On the other hand, the unemployment rate has trending down fast:

As markets are forward looking, investors have crowded to stocks in some frenzy pace, pushing stock indexes to another record.

For now, we are concerned about either too much of a good thing or some unforeseen disruptive events can fast derail the very over heated markets. We again believe investors should be cautiously optimistic and allocate their assets according to their risk tolerance.

We reiterate the following practice:

For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation now reached another high. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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