Risky Business
are. The diffusion of heat over time, for example, parallels the diffusion of stock prices. Putting his research into practical terms, Berns explains that it’s all about risk and how people perceive it.
Kim and Berns were taking a risk when they started a firm without an angel backing them. Maybe Kim was trying to prove something. He came to the U.S. at age 4. His parents, now retired, started out with a fruit stand in Queens, New York, and eventually built a wholesaling business. If they could succeed as entrepreneurs, surely he could. He says of his work launching ETFs at Pimco: “Once you’ve built a $20 billion platform, what do you have? You don’t own it. It’s just a job.”
The duo raised enough equity from family and friends to get the business off the ground. At the half-billion-dollar mark in assets they had enough credibility to land outside money. A billionaire Kim doesn’t identify stepped up with $10 million for a 25% stake.
The rate hedge fund, which has $296 million, consists in large part of bets against Treasury bonds. It owns out-of-the-money put options that hit pay dirt if, six years from now, 20-year Treasurys are yielding a percentage point more than they are currently.
Rates don’t have to move past the strike point of those options for the options to become more valuable. When interest rates rise, as they have this year, long-shot puts have a much better chance of paying off, and rise in price.
Simplify offers no illusion that its rate hedge fund is, by itself, a way to make money. It’s more like fire insurance. Own some of it alongside a more conventional fixed-income asset, like a portfolio of long-maturity municipal bonds, and holding onto that asset through bull and bear markets becomes more tolerable.
A different sort of strategy is built into Simplify Hedged Equity ETF. This one has the put-option antidotes to bear markets already added to the S&P 500 portfolio they’re designed to protect. The combination is intended to compete with that old standby of pension investing, the 60/40 blend of stocks and bonds. So far this year, with the S&P down 16% and the overall bond market down 10%, Simplify’s offering is looking good. Hedged Equity is down 8%; the Vanguard Balanced Index Fund is down 15%.
Investors have a warped notion of risk, Berns says, and wind up with portfolios they can’t stick with during severe market moves. Their advisors don’t always prepare them. Indeed, he adds, “people on Wall Street work hard to hide the
By William Baldwin
Eliminate risk from a portfolio? Can’t be done, unless you eliminate return (Treasury bills don’t even keep up with inflation). You can, however, dull the pain of a bear market. The (ticker: PFIX; expense ratio: 0.5%) is a strong analgesic, this year moving up not quite five times as fast as the overall bond market went down. A $10,000 dose should roughly halve the damage done by rising rates to a $100,000 stake in a total bond market fund. If interest rates go back down, PFIX will be a loser, but that would be a nice problem to have, since your core bond fund will be doing well.
William Baldwin is Investment Strategies columnist.