The WisdomTree US Efficiency Core Fund (NEW YORK:NTSX) is a balanced fund with 1.50x leverage, focused on stocks, but with significant investments in Treasuries.
In my view, the fund now offers investors moderately stronger returns on the stock lower risk. On the other hand, the fund tends to underperform when inflation is high and rising, as was the case at the beginning of the year. I rate the fund a buy, but investors concerned about inflation may prefer to avoid the fund altogether.
- Sponsor: WisdomTree
- Forward dividend yield: 4.09%
- Expense ratio: 0.20%
- Leverage ratio: 50%
NTSX – Strategy Summary
First some context.
NTSX is a leveraged balanced fund.
Traditional balanced portfolios invest in both stocks and bonds without leverage. A 60% allocation to stocks plus a 40% allocation to Treasuries is standard, although the exact percentages vary.
Traditional balanced portfolios are generally safer than stocks, since treasuries are relatively safer assets and since these asset classes tend to be negatively correlated. As an example, the BlackRock 60/40 Target Allocation Fund (BAGPX) suffered lower losses than the S&P 500 during the first quarter of 2020, the start of the coronavirus pandemic.
Traditional balanced portfolios generally have much lower returns than stocks, as treasuries have lower long-term returns than stocks. As an example, BAGPX has achieved a CAGR of 6.0% over the past ten years, compared to 11.0% for the S&P 500. BAGPX’s returns are likely to be somewhat higher going forward, as Treasury yields are much higher. higher now than in the past. The fund will likely continue to underperform the S&P 500, however.
Traditional balanced portfolios tend to have strong risk-adjusted returns, since treasuries and stocks are negatively correlated, so their inclusion ends up reducing risk more than returns. Risk-adjusted returns have averaged in recent years, as Treasury yields and returns were much lower in the past. Risk-adjusted returns are likely to improve at higher rates.
While Treasury yields have risen, traditional balanced portfolios offer investors strong risk-adjusted returns, some safety, but lower returns than stocks. In theory, there is a simple solution to the latter: leverage. or of levers Balanced portfolios can achieve S&P 500-like returns by increasing their equity allocations over 60%. Although doing so would increase risk and volatility, a higher allocation to Treasuries can cancel this.
NTSX is one such leveraged balanced fund, with an exposure of 90% to stocks, 60% to Treasuries, for a leverage ratio of 1.50x. In other words, for every $1.00 invested in the fund, investors get exposure to $0.90 in stocks and $0.60 in Treasuries. Treasury exposure is gained through investments in Treasury futures, an inexpensive source of leverage, and a source that allows the fund to achieve exposures greater than 1.0x.
Although NTSX uses leverage, the risks are generally moderate, with the fund seeing losses of 12.9% during the first quarter of 2020. The losses were lower than those of the S&P 500 and effectively equal to those of BAGPX. Leverage generally means more losses during downturns, but it didn’t in this particular case.
The NTSX looks just as volatile as the S&P 500, maybe a little more.
NTSX’s track record of performance is much stronger than that of traditional balanced portfolios, due to its higher equity exposure. However, the fund has underperformed the S&P 500 due to recent Treasury losses.
In my opinion, NTSX’s expected long-term returns are much higher, as Treasury yields are much higher now than in the past.
As an example, assuming equity returns of 10.0% and Treasury yields of 4.0%, NTSX would see returns of 11.4%, higher than stocks and higher than those in the past. Both are reasonable, even somewhat conservative, assumptions, as equity returns have been just above 10.0% for decades, and Treasuries 4.5% – 5.3%.
NTSX’s risk-adjusted returns look quite good, as returns have been strong while risks are moderate. In my view, NTSX’s risk-adjusted returns will be even stronger going forward, as returns will be higher (see above) while risks remain the same.
In my view, NTSX’s balanced equity and treasury portfolio will achieve strong total and risk-adjusted returns going forward, making the fund a buy.
NTSX – Risks and Negatives
NTSX is a strong fund, but it is not a risk-free and downside fund. Two stand out.
First, there is the simple fact that the fund has underperformed expectations in the past. Returns have been adequate, but not particularly strong. I expect the fund to outperform the S&P 500 going forward, but it has underperformed said index since inception. Treasury yields have risen, so have future returns MUST be higher, but I would definitely feel more confident if the fund’s track record was stronger, and I think the same is true for most investors.
Second, there is the fact that the fund’s strategy is somewhat dependent on the negative correlation of stocks and treasuries. If they are, leverage does not necessarily increase risk, volatility or losses during downturns, as was the case in the first quarter of 2020 and as has been the case for most of the fund’s history. If Treasuries and stocks are not negatively correlated, leverage BEN increase risk and, potentially, can lead to significant losses and under-performance.
Stocks and Treasuries can be positively correlated for many reasons. For now, higher inflation seems the most likely option. Higher inflation means higher interest rates, which almost necessarily means lower Treasury prices and should cause equity prices to fall. As an example, NTSX significantly underperformed in 2022, during which inflation and rates skyrocketed.
Avoiding NTSX when inflation risks are high seems wise. The said as much in early 2022just before inflation started to rise and just before the fund started to malfunction.
I want to emphasize the point above: the NTSX strategy fails when stocks and Treasuries are positively correlated, as it tends to be when inflation is high and rising. If you manage to avoid that scenario, the fund performs much better. In fact, the NTSX had outperformed the S&P 500, and with much lower risk, from the beginning to the end of 2021, before inflation seriously picked up.
As inflation continues to decline, hitting zero M/M last October, the above is of less concern to NTSX and its investors. NTSX’s strategy was ineffective when inflation was high, but will prove to be much more effective going forward, as inflation appears to have fully normalized by now.
Finally, there is the issue of value erosion or beta drift that is endemic to most leveraged ETFs. Simply put, leveraged ETFs sometimes do not perform a naive extrapolation of their underlying asset returns. So over the long term NTSX may underperform compared to a 90% allocation to stocks and 60% to Treasuries. There are several reasons/ways this could happen. Chief among these is the fact that leverage sometimes magnifies losses and, if these are significant enough, the fund can be left with very few assets, with very little to ever recover. For some funds, these issues are important enough that only short-term investments are advisable.
In my view, the above is not a significant concern for NTSX, since the fund is not overly leveraged, and since Treasuries and equities are generally negatively correlated. The NTSX has underperformed compared to an allocation of 90% to the S&P 500 and 60% to a Treasury index ETF, but some of that was due to small differences in maturities (the NTSX was slightly more skewed towards the end of along the curve). I have seen very little erosion of value for NTSX, so far.
Considering the above, I believe a long-term investment in NTSX is reasonable. More conservative and risk-averse investors may disagree.
NTSX is a leveraged equity and treasury balanced fund. NTSX’s strategy tends to result in strong returns with below-average risk, with some exceptions, including periods of significant inflation. In my opinion, NTSX’s positives outweigh its negatives and risks, and so the fund is a buy.