The WisdomTree U.S. Efficient Core Fund (NYSEARCA:NTSX) is a 1.50x leveraged balanced fund, focusing on equities, but with significant investments in treasuries.
In my opinion, right now the fund offers investors stronger returns to equities at moderately lower risk. On the other hand, the fund tends to underperform when inflation is high and rising, as was the case earlier in the year. I rate the fund a buy, but investors concerned about inflation might prefer to avoid the fund altogether.
- Sponsor: WisdomTree
- Forward Dividend yield: 4.09%
- Expense Ratio: 0.20%
- Leverage Ratio: 50%
NTSX – Strategy Overview
Some context first.
NTSX is a leveraged balanced fund.
Traditional balanced portfolios invest in both equities and bonds without leverage. A 60% allocation to equities plus a 40% allocation to treasuries is standard, although exact percentages vary.
Traditional balanced portfolios are generally safer than equities, as treasuries are comparatively safer assets, and as 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 1Q2020, the onset of the coronavirus pandemic.
Traditional balanced portfolios generally have much lower returns than equities, as treasuries have lower long-term returns than equities. As an example, BAGPX has achieved a 6.0% CAGR these past ten years, compared to 11.0% for the S&P 500. BAGPX’s returns will likely be somewhat higher in the future, as treasury yields are much 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, as treasuries and equities are negatively correlated, so their inclusion ends up reducing risk more than returns. Risk-adjusted returns have been about average these past few years, as treasury yields and returns were much lower in the past. Risk-adjusted returns will likely improve with higher rates.
As treasury yields have risen, traditional balanced portfolios offer investors strong risk-adjusted returns, some safety, but lower returns than equities. In theory, there is a simple solution to the latter: leverage. A leveraged balanced portfolio could achieve similar returns to the S&P 500 by boosting their equity allocations above 60%. Although doing so would increase risk and volatility, a higher allocation to treasuries might cancel this out.
NTSX is one such leveraged balanced fund, with a 90% exposure to equities, 60% to treasuries, for a 1.50x leverage ratio. In other words, for every $1.00 invested in the fund, investors get exposure to $0.90 in equities, and $0.60 in treasuries. Exposure to treasuries is gained through investments in treasury futures, a cheap source of leverage, and one which allows the fund to achieve exposures higher than 1.0x.
Although NTSX uses leverage, risks are generally moderate, with the fund seeing losses of 12.9% during 1Q2020. 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 did not in this particular case.
NTSX seems about as volatile as the S&P 500, perhaps a bit more.
NTSX’s performance track record is much stronger than that of traditional balanced portfolios, due to higher equity exposure. The fund has nevertheless underperformed relative to 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 equities, and higher than those in the past. Both are reasonable, even somewhat conservative assumptions, as equity returns have been a bit higher than 10.0% for decades, and treasuries yield 4.5% – 5.3%.
NTSX’s risk-adjusted returns seem reasonably good, as returns have been strong, while risks moderate. In my opinion, NTSX’s risk-adjusted returns will be even stronger moving forward, as returns will be higher (see above), while risks will remain the same.
In my opinion, NTSX’s leveraged balanced equity and treasury portfolio will achieve strong total returns and risk-adjusted returns moving forward, making the fund a buy.
NTSX – Risks and Negatives
NTSX is a strong fund, but it is not one without risks and negatives. Two stand out.
First, is the simple fact that the fund has somewhat underperformed expectations in the past. Returns have been adequate, but not particularly strong. I’m expecting the fund to outperform the S&P 500 moving forward, but it has underperformed said index since inception. Treasury yields have risen, so future returns should be higher, but I would obviously feel more confident if the fund’s track record were stronger, and I imagine the same is true for most investors.
Second, is the fact that the fund’s strategy is somewhat dependent on equities and treasuries being negatively correlated. If they are, leverage does not necessarily increase risk, volatility, or losses during downturns, as was the case in 1Q2020, and as has been the case for most of the fund’s history. If treasuries and equities are not negatively correlated, leverage does increase risk and could, potentially, lead to significant losses and underperformance.
Equities and treasuries could become positively correlated for many reasons. Right now, higher inflation seems like the likeliest option. Higher inflation means higher interest rates, which almost necessarily means lower treasury prices, and should cause equity prices to decrease as well. As an example, NTSX significantly underperformed in 2022, during which inflation and rates skyrocketed.
Avoiding NTSX when inflation risks are high seems wise. I said as much in early 2022, just before inflation started to ramp up, and just before the fund started to underperform.
I want to emphasise the point above: NTSX’s strategy fails when equities and treasuries are positively correlated, as tends to happen when inflation is high and rising. If you manage to avoid that scenario the fund performs much better. In fact, NTSX had outperformed the S&P 500, and at much lower risk, from inception to late 2021, before inflation rose in earnest.
As inflation continues to decrease, hitting zero M/M this past October, the above is less of a concern for NTSX and its investors. NTSX’s strategy was ineffective when inflation was high, but it will prove to be much more effective moving forward, as inflation seems to have fully normalized by now.
Finally, there is the issue of value erosion or beta slippage endemic to most leveraged ETFs. In simple terms, leveraged ETFs sometimes underperform a naive extrapolation of the returns of their underlying assets. So, long-term NTSX might underperform relative to a 90% allocation to equities and 60% allocation to treasuries. There are several reasons / ways this might occur. Chief among these is the fact that leverage sometimes amplifies losses and, if these are significant enough, the fund might be left with extremely few assets, too few to ever recover. For some funds, these issues are significant enough that only short-term investments are advisable.
In my opinion, the above is not a significant concern for NTSX, as the fund is not excessively leveraged, and as treasuries and equities are generally negatively correlated. NTSX has slightly underperformed relative to a 90% allocation to the S&P 500 and 60% allocation to a treasury index ETF, but some of that was due to small differences in maturities (NTSX leaned a bit more toward the long end of the curve). I’ve seen very little value erosion for NTSX, so far.
Considering the above, I believe that a long-term investment in NTSX is reasonable. More conservative, risk-averse investors might disagree.
NTSX is a leveraged balanced equity and treasury fund. NTSX’s strategy tends to result in strong returns with below-average risk, with some exceptions, including during periods of significant inflation. In my opinion, NTSX’s positives outweigh its negatives and risks, and so the fund is a buy.