NTSX: With inflation normalizing, this leveraged bond/equity ETF is a buy

I have the WisdomTree US Efficient Core Fund (NYSEARCA:NTSX), a 1.50x leveraged mixed fund, several times in the past. I was generally optimistic as the fund's strategy should lead to higher returns and lower drawdowns. Inflation is NTSXs Achilles heel: The fund has significantly underperformed during periods of inflation, most recently in 2022. Now that inflation has been finally defeated, the fund is likely to generate above-average returns with below-average risk in the future and is a buy.

NTSX – Basics

• Sponsor: WisdomTree
• Dividend yield: 1.12%
• Cost ratio: 0.20%
• Debt ratio: 50%

NTSX – Strategy Overview

I'll start with an explanation and investment thesis on more traditional balanced funds before taking a look at NTSX itself.

Traditional mixed funds invest part of their assets in stocks and part in government bonds. A 60/40 split is common.

Balanced portfolios are effectively always safer and less volatile than those that invest exclusively in equities, partly because of asset class diversification, partly because government bonds themselves are safer and less volatile than equities. Losses are also generally smaller because government bonds tend to perform better during downturns and recessions.

Balanced portfolios almost always underperform stocks because government bonds yield less than stocks. For example, traditional balanced portfolios have underperformed the S&P 500 by more than 5% annually since the fund's inception.

Overall, risk-adjusted returns tend to be quite high, as for example the most the last two decades. The data I have is a bit old, but I will soon cover more recent events.

Although balanced funds have comparatively high risk-adjusted returns, absolute returns are generally lower than those of stocks. This can be seen in the chart above and when comparing the returns of Vanguard Target Retirement Funds, balanced funds aimed at future retirees, to those of the S&P 500.

Against this background, some investors have opted for the creation leveraged balanced portfolios with the aim of achieving both risk-adjusted and And absolute returns.

NTSX itself is a 1.50x leveraged balanced fund with a 90/60 exposure to stocks and government bonds. In practice, this means that NTSX shareholders receive 90% of the returns and losses of the stock market and 60% of the government bonds. The fund achieves this by investing in the following three components:

• Equity component: For every dollar invested in the ETF, NTSX has invested $90 in large-cap stocks. The fund experiences about 90% of the returns and losses of the S&P 500.
• Treasury component: NTSX has $60 in Treasury futures for every $100 invested in the ETF. The fund experiences about 60% of the returns and losses of intermediate-term Treasury bonds.
• Bar component: NTSX's Treasury futures require $10 for every $100 invested in the fund to be posted as short-term collateral, producing returns comparable to U.S. Treasury bills.

NTSX's strategy has a direct impact on the fund's performance.

In most cases, both stocks and government bonds rise, leading to significant gains for the fund. Leverage amplifies these gains, resulting in outperformance.

In some cases, both stocks and government bonds are down, resulting in significant losses. Leverage amplifies these losses, resulting in underperformance.

Total returns depend on the relative magnitude or frequency of the above scenarios. In the long term, both equities and government bonds generate gains, so the fund should achieve better performance over the long term. If periods of decline in equity and government bond prices occur more frequently, the Fund could perform worse over the long term. Significant, prolonged stress in the equity and government bond markets could also result in significant, prolonged losses and poorer performance.

Since the inception of NTSX, we have experienced a period of equity and financial losses, the rise in inflation from 2022 to 2023. NTSX has, as expected, shown a significantly below-average performance during this period.

The above losses have completely wiped out previous outperformance and are responsible for NTSX underperforming the S&P 500 since its inception. Drawdowns have also been higher, see above.

On a more positive note, these losses were not so large that they were irrecoverable. This is sometimes the case with leveraged funds and is therefore important to check and specify.

Although NTSX has underperformed since its inception, I am still overall bullish for three reasons.

First, periods of losses in both the stock market and government bonds are unusual. Inflation spikes have occurred only twice in the last half century: after the pandemic and in the 1970s. losses have occurred a few more times, but generally they were smaller and short-lived.

Second, selling NTSX when there is a threat of inflation seems perfectly possible. I said this in early 2022, just before the Fed started raising interest rates. Finding the right market timing is never easy, but avoiding investing during times of increased macroeconomic stress or risk is much easier.

Third, correlations between stocks and Treasuries have turned negative again as inflation seems to have finally normalized. This can be seen in the mini-dip in early August: stocks declined on worsening economic conditions, Treasuries rose on expectations of future rate cuts, NTSX posted comparatively small losses.

In my opinion, the conditions are such that correlations should remain positive / neither stocks nor government bonds should suffer losses. Either we get a recession and thus higher government bond prices with stock losses or a soft landing with further stock gains and government bonds stability. Inflation could The increase keeps shooting up, but that seems unlikely.

For this reason, I am bullish on NTSX and believe it will outperform the S&P 500 in the future. As an aside, the fund has slightly outperformed since my last article in late 2023:

NTSX's underperformance was entirely due to the recent spike in inflation, which if you avoid, the fund will outperform, as it has since my last article.

Diploma

NTSX's leveraged and balanced equity and Treasury holdings should outperform the S&P 500 over the long term, with slightly less risk and less volatility. While that hasn't been the case since inception, I'm confident it will be in the future, so I rate the fund a Buy.