60/40 Portfolio is Doomed: Stoic's Fixed Income Strategy is the Cure
Table of Contents
- Fixed Income Investments
- Government Bonds, Corporate Bonds, and US Stocks
- Stoic AI - Fixed Income Strategy
- DeFi and Stoic
- How Does the Strategy Generate Yield?
- How Does Fixed Income Stay Market Neutral?
- Are Funding Rates Always Positive and Returns Guaranteed?
- Summary
For decades, fixed income investments have acted as a hedge to higher risk assets in investors’ portfolios.
In times of uncertainty, when investors escaped stocks, they would seek refuge in the safety of bonds. Therefore, a portfolio diversified between the two asset classes has traditionally mitigated drawdowns and smoothed out returns. Though, like most things in 2022, the world of investing has been turned upside down.
Today, short-term US Treasuries can earn a better yield compared to DeFi, where rates of return are hitting new lows. Even one of DeFi’s biggest projects and stablecoin issuers, MakerDAO, started buying $500 million in US Treasuries and corporate bonds last month.
However, this year was tough for bonds as well. Benchmark U.S. Treasuries are facing their worst annual returns since 1788.
Moreover, it seems that the neck-wrenching yields which granted worldwide popularity to crypto fixed-income investing through DeFi in early 2020 (which crypto investors have enjoyed these past years) are under heavy pressure right now.
The amount of cash locked up in DeFi products has been declining since early May following the collapse of Terra, and the bankruptcy of crypto lending companies such as Celsius, Voyager, and crypto hedge fund Three Arrows Capital.
This article will cover how Stoic’s Fixed Income strategy faces the current market environment, how it generates yield, and how it performs compared with other benchmarks.
Since the strategy’s inception date, from October 1, 2020 to October 31, 2022, Stoic’s Fixed Income has generated +35.03% return, equaling an annual percentage yield (APY) of 15.5%. Fixed Income generates substantially higher annualized returns than comparable products in the traditional financial markets, even now when bonds yields soared to levels last seen decades ago.
Government Bonds, Corporate Bonds, and US Stocks
The most widely used yield as a benchmark of 10-Year US Treasury is at 4.22% right now, a bit lower than the long term average of 4.26%. The shorter 1 Year Treasury Rate is at 4.80%, compared to the long term average of 2.85%.
The most reliable corporate bonds have yield at 5.23%, compared to the long term average of 6.52%.
Even US stocks, measured by the S&P 500 Index, have historically generated average annualized returns of 10.27%. However, a return can be substantially lower, or even negative, depending when you enter the market.
Stoic AI - Fixed Income Strategy
As we mentioned before, this year was tough for the markets. Let’s observe how Stoic Fixed Income strategy performed during this time.
In the chart above, we see that the Stoic Fixed Income strategy (blue line) generates steady income even in times when the market turned into bearish mode, proving as a good hedge during market turbulence. (S&P 500 Index (green line) had the all-time high in January 2022, after which the bear market occurred).
The iShares 1-3 Year Treasury Bond ETF (SHY) that has exposure to short-term U.S. Treasury bonds (orange line) generated a loss of -6.3%, significantly underperforming Stoic Fixed Income strategy. SHY, as well as other Bond ETFs with a longer or shorter maturity, was hurt hard by the Fed’s aggressive cycle of interest rate increases and by fear that the economy will be pushed into a recession.
Moreover, we see the 60/40 approach that is designed for moderate risk and moderate returns cracked the bell. Stocks and bonds are moving down in the same correlated manner and it seems that the basic 60/40 rule is on track for its worst year ever.
DeFi and Stoic
15.5% APY looks a bit shady at the moment, especially after the Anchor Protocol collapse, offering similar crypto yields. Even 8% APY offered by some centralized crypto lending platforms looks that way. To dive deeper into this topic, we need to observe how Stoic's Fixed Income strategy works.
Stoic's Fixed Income strategy has nothing in common with the popular DeFi, fixed rate-offerings due to the fact that:
- It doesn’t have exposure to any stablecoins
- It doesn’t lend or borrow funds
- It doesn’t stake or farm tokens
- It doesn’t use leverage
Fixed Income simply trades various altcoins based on a sophisticated, hybrid intelligence algorithm.
How Does the Strategy Generate Yield?
The Fixed Income strategy generates yield by collecting funding rates in the Binance Futures market, where the rates are periodic payments made to either long or short traders when:
- The funding rate is positive - traders who are long on a perpetual contract will pay a funding fee to traders who are shorting.
- The funding rate is negative - short traders will pay long traders.
In other words, the algorithm provides liquidity to the market and receives a portion of the fees for that. The main task for the algorithm is to form a portfolio of the assets with the highest funding fees and perform rebalancing in a timely fashion.
How Does Fixed Income Stay Market Neutral?
To be market-neutral and independent from price movements, the algorithm automatically forms equal positions by purchasing spot assets, then shorting them simultaneously on the futures market.
Are the Funding Rates Always Positive and Returns Guaranteed?
No, return is not guaranteed with Fixed Income and can vary depending on market conditions. The strategy earns more when the market grows and earns less when the market falls.
Thanks to positive funding rates dominating in the futures market in history, the strategy earns the yield. Please refer to the charts with funding rates for Bitcoin and Ethereum as example:
As we can see, most of the time, funding rates appear in the positive zone. For the last 2 years, in 1,863 cases out of 2,317 total, or ~80%, traders with Bitcoin long positions paid fees to short position holders. This was almost the same situation for Ethereum displaying 76% of cases where longs were paid to shorts.
Summary
The basic approach for composition investment portfolios that consists of 60% equities and 40% bonds (or other traditional fixed-income offerings) no longer appears to be keeping up with today's market environment. Nowadays, a well-diversified portfolio must include more asset classes than just stocks and bonds.
Stoic’s Fixed Income strategy has proved itself as a good option for hedging during market turbulence and delivered double-digit returns with a reasonable level of risk.
Connect Stoic to achieve sustainable long-term growth of your portfolio.
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Author:
Sasha Sasev
Financial Analyst - Cindicator
Who is Cindicator?
Cindicator is a world-wide team of individuals with expertise in math, data science, quant trading, and finances, working together with one collective mind. Founded in 2015, Cindicator builds predictive analytics by merging collective intelligence and machine learning models. Stoic AI is the company’s flagship product that offers automated trading strategies for cryptocurrency investors. Join us on Telegram or Twitter to stay in touch.
Disclaimer
Information in the article does not, nor does it purport to, constitute any form of professional investment advice, recommendation, or independent analysis.