A New Way to Tackle This Market Moment
A strategy called ‘return stacking’ can free up part of your portfolio.
3 min
When there’s nowhere to run, nowhere to hide, what do you do?
U.S. stocks aren’t far from their all-time highs, while the income investors can earn from bonds is a pittance. So investing in stocks feels risky, and bond yields are too thin to do you much good.
The obvious solution is to diversify: outside the U.S., outside of stocks and bonds, and into assets that can protect you from bear markets or an inflationary shock. To do that, you’d normally have to sell some stocks or bonds to free up cash.
That isn’t the only way to diversify, though. Some investors engage in a tactic they like to call “return stacking.”
An illustration of this odd-sounding approach is an exchange-traded fund, WisdomTree U.S. Efficient Core, with $676 million in assets and 0.2% in annual expenses. Since its launch just over three years ago, it has slightly outperformed the S&P 500, after fees, with a smoother ride.
The fund takes a novel approach to diversification. It keeps 90% of its assets in a portfolio of stocks highly similar to the S&P 500 index. It keeps 10% in cash and cash equivalents. It then uses that cash as collateral to buy futures contracts on U.S. Treasurys.
Those futures are a low-cost form of leverage, or borrowing. This gives investors more bang for their buck. For every dollar you invest, the fund provides $1.50 in exposure to stocks and bonds.
And here’s the crucial point: Of that $1.50, 90 cents (or 60%) goes into stocks and 60 cents (40%) into bonds.
That creates the functional equivalent of owning a so-called balanced fund, with about 60% in U.S. stocks and 40% in U.S. bonds, one-and-a-half times over.
It also creates flexibility for an investor.
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.
“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,” Mr. Schwartz says.
Corey Hoffstein, chief investment officer at Newfound Research LLC, an asset-management firm in Wellesley Hills, Mass., calls this “return stacking.”
On top of your $2,000 stack of stocks and bonds, you could put your remaining $1,000 into assets that could hedge their risks—a commodity fund, perhaps, or inflation-protected I bonds from the U.S. government.
Wait a minute. Isn’t leverage dangerous?
Long-Term Capital Management, Lehman Brothers and China Evergrande all imploded because they borrowed too much money at too high a cost. So did speculators in the crash of 1929 and the South Sea bubble of 1720.
Moderate amounts of cheap leverage, however, can raise returns without sending risks through the roof. That approach isn’t radical, reckless or even new.
In the 1950s, economist James Tobin, who would later win a Nobel Prize for his research, demonstrated that investors could raise their return not only by buying riskier securities, but also by buying safer securities using leverage.
In a 1996 article, Cliff Asness, co-founder of AQR Capital Management in Greenwich, Conn., found that between 1926 and 1993, a 60/40 portfolio bought with about 50% borrowed money would have lost less in its worst month than an unleveraged 100% stock portfolio did. Those results have held up since then.
The world’s most renowned investor, Warren Buffett, has long relied on float, or insurance premiums that come in before claims have to be paid out, to amplify Berkshire Hathaway’s returns. Mr. Buffett has used that low-cost leverage—“money we hold but don’t own”—to crank up the capital he can deploy. That has given Berkshire “quite an edge,” he has said, “over our competitors.”
At least five years ago, several people with Twitter accounts, including the anonymous @Nonrelatedsense and @econompic, along with Mr. Hoffstein, began chatting about how investors could leverage Treasury bonds to improve the efficiency of their portfolios.
The anonymous author of the @Nonrelatedsense account died in 2019, but his tweets helped inspire WisdomTree to create the ETF, says Mr. Schwartz. (Besides its U.S. fund, WisdomTree also offers versions that combine the same cash and futures exposure with either international or emerging-market stocks.)
Other firms, including Pimco, DoubleLine and Newton Investment Management, offer funds that may use futures to leverage portfolios of stocks and other assets, although they are held primarily by institutional investors.
“Return stacking” on top of this kind of leveraged fund makes good sense when you have a finite amount of money to put to work for the long run—perhaps in your individual retirement account, a Roth IRA or a gift to one of your kids or grandchildren.
Over long horizons, interest-rate fluctuations should wash out, compounding should have time to work and diversification can do magic. Then a little leverage can be your friend, not your enemy.
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Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual
Competitive pressure and creativity have made Chinese-designed and -built electric cars formidable competitors
4 min
China rocked the auto world twice this year. First, its electric vehicles stunned Western rivals at the Shanghai auto show with their quality, features and price. Then came reports that in the first quarter of 2023 it dethroned Japan as the world’s largest auto exporter.
How is China in contention to lead the world’s most lucrative and prestigious consumer goods market, one long dominated by American, European, Japanese and South Korean nameplates? The answer is a unique combination of industrial policy, protectionism and homegrown competitive dynamism. Western policy makers and business leaders are better prepared for the first two than the third.
Start with industrial policy—the use of government resources to help favoured sectors. China has practiced industrial policy for decades. While it’s finding increased favour even in the U.S., the concept remains controversial. Governments have a poor record of identifying winning technologies and often end up subsidising inferior and wasteful capacity, including in China.
But in the case of EVs, Chinese industrial policy had a couple of things going for it. First, governments around the world saw climate change as an enduring threat that would require decade-long interventions to transition away from fossil fuels. China bet correctly that in transportation, the transition would favour electric vehicles.
In 2009, China started handing out generous subsidies to buyers of EVs. Public procurement of taxis and buses was targeted to electric vehicles, rechargers were subsidised, and provincial governments stumped up capital for lithium mining and refining for EV batteries. In 2020 NIO, at the time an aspiring challenger to Tesla, avoided bankruptcy thanks to a government-led bailout.
While industrial policy guaranteed a demand for EVs, protectionism ensured those EVs would be made in China, by Chinese companies. To qualify for subsidies, cars had to be domestically made, although foreign brands did qualify. They also had to have batteries made by Chinese companies, giving Chinese national champions like Contemporary Amperex Technology and BYD an advantage over then-market leaders from Japan and South Korea.
To sell in China, foreign automakers had to abide by conditions intended to upgrade the local industry’s skills. State-owned Guangzhou Automobile Group developed the manufacturing know-how necessary to become a player in EVs thanks to joint ventures with Toyota and Honda, said Gregor Sebastian, an analyst at Germany’s Mercator Institute for China Studies.
Despite all that government support, sales of EVs remained weak until 2019, when China let Tesla open a wholly owned factory in Shanghai. “It took this catalyst…to boost interest and increase the level of competitiveness of the local Chinese makers,” said Tu Le, managing director of Sino Auto Insights, a research service specialising in the Chinese auto industry.
Back in 2011 Pony Ma, the founder of Tencent, explained what set Chinese capitalism apart from its American counterpart. “In America, when you bring an idea to market you usually have several months before competition pops up, allowing you to capture significant market share,” he said, according to Fast Company, a technology magazine. “In China, you can have hundreds of competitors within the first hours of going live. Ideas are not important in China—execution is.”
Thanks to that competition and focus on execution, the EV industry went from a niche industrial-policy project to a sprawling ecosystem of predominantly private companies. Much of this happened below the Western radar while China was cut off from the world because of Covid-19 restrictions.
When Western auto executives flew in for April’s Shanghai auto show, “they saw a sea of green plates, a sea of Chinese brands,” said Le, referring to the green license plates assigned to clean-energy vehicles in China. “They hear the sounds of the door closing, sit inside and look at the quality of the materials, the fabric or the plastic on the console, that’s the other holy s— moment—they’ve caught up to us.”
Manufacturers of gasoline cars are product-oriented, whereas EV manufacturers, like tech companies, are user-oriented, Le said. Chinese EVs feature at least two, often three, display screens, one suitable for watching movies from the back seat, multiple lidars (laser-based sensors) for driver assistance, and even a microphone for karaoke (quickly copied by Tesla). Meanwhile, Chinese suppliers such as CATL have gone from laggard to leader.
Chinese dominance of EVs isn’t preordained. The low barriers to entry exploited by Chinese brands also open the door to future non-Chinese competitors. Nor does China’s success in EVs necessarily translate to other sectors where industrial policy matters less and creativity, privacy and deeply woven technological capability—such as software, cloud computing and semiconductors—matter more.
Still, the threat to Western auto market share posed by Chinese EVs is one for which Western policy makers have no obvious answer. “You can shut off your own market and to a certain extent that will shield production for your domestic needs,” said Sebastian. “The question really is, what are you going to do for the global south, countries that are still very happily trading with China?”
Western companies themselves are likely to respond by deepening their presence in China—not to sell cars, but for proximity to the most sophisticated customers and suppliers. Jörg Wuttke, the past president of the European Union Chamber of Commerce in China, calls China a “fitness centre.” Even as conditions there become steadily more difficult, Western multinationals “have to be there. It keeps you fit.”
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual
