Building a chaos-resistant portfolio | Mutual Fund Observer

In everyday language, we use “chaos” to mean complete disorder or randomness – like a toddler’s playroom after a long afternoon or a desk buried under scattered papers. This kind of chaos implies there’s no underlying order or pattern at all. It suggests a temporary state of disarray that can be resolved or brought back to order.

There is, however, a second use of the term. In chaos theory, “chaos” has a precise and quite different meaning. It describes systems that appear random on the surface. These systems are unpredictable in detail but still have an underlying order and produce recognizable patterns. This kind of chaos is a permanent state, intrinsic to the system’s nature, where small changes in initial conditions can lead to vastly different outcomes.

A great example is my rubber duck. If I wander down to the banks of the Mississippi River and fling my duck into the water, I will be completely unable to answer the question “Where will your duck be in one minute or one hour?” beyond “somewhere in the river, likely.” But if you were to ask “Where will your duck be two months from now?” I could have more confidence in say “visiting New Orleans.” I can’t say exactly where or exactly when, but the river is a constrained system with predictable long-term tendencies.

2025 may see an intersection of both sorts of chaos: an intrinsically chaotic market system overlaid by the prospect of policy chaos initiated by the new presidential administration. In the weeks since the election, the president-elect has threatened 25% tariffs on goods from Mexico and Canada, 10% tariffs on Chinese goods, and 100% tariffs on goods from the BRIC nations, including China, if they undermine the US dollar. They might undermine the dollar by shifting exchange policies to peg prices against a basket of currencies, rather than the dollar. That seems to reflect fears of erratic US policies and burgeoning federal debt. A preliminary analysis by the University of Pennsylvania concluded that Mr. Trump’s proposals would increase the national debt by $4.1 trillion if everything went well and just under $6 trillion if it doesn’t. (What might qualify as “going poorly”? Hostile responses from countries affected by tariffs and supply chain disruptions for US companies dependent on factories in those countries. I’m setting aside prospects of war or climate disaster.) Morningstar’s John Rekenthaler forecasts a short-term spike in inflation which will be compounded if the Federal Reserve becomes less independent, as Mr. Trump promised, since he favored zero interest rates even during economic booms. Meanwhile, crypto booms.

Mr. Rekenthaler’s analysis of both candidates’ plans ends with the question, “What, me worry?” and a link to …

Quick recap: in the short term markets are highly unpredictable (chaos theory) and likely to be exceptionally so in the immediate future (Trump). In the long term, markets have predictable dynamics and central tendencies (like the Mississippi River does) that give us greater confidence the further out we look.

The question is, how do you persevere through the shorter-term chaos in order to continue capturing the longer-term gains?

Chaos and your portfolio

If you are young with a comfortable career trajectory and a reasonable long-term plan, do nothing. Both Warren Buffett, Ben Carlson, and John Rekenthaler affirm the same proposition: over long periods, no one ever wins by betting against the US markets. And, over those same long periods, no one ever loses by betting with them. In short: if you don’t need your money for twenty-plus years invest regularly and cheaply in (mostly) American stocks, stop reading this essay now and get on with life. Your money will be waiting for you when the time comes.

Not all of us have the luxury of that degree of Cynical detachment from the world.  Five strategies for the rest of us to survive chaos of both sorts.

1. Let other people worry for you. Effectively responding to sudden changes requires a degree of obsession and access to extensive data that average investors don’t have. “I saw this guy on TikTok,” or “I read Reddit,” or “I got a feeling” is not a sign that you have either sufficient data or a clue about how to read it. If you don’t have the willingness to stay put, or the skills and resources to dynamically adjust position sizes based on current market chaos levels, hire someone who does. It’s money well spent.

   There are three ways of doing that. One, hire a financial advisor who has been through it before and who hasn’t surrendered to the impulse to make change for the sake of change. Two, hire a fund manager who has been through it before and who has a record of careful adaptation to changing conditions. Consider:

   • FPA Crescent: Crescent is a moderately aggressive allocation mutual fund that aims to generate equity-like returns over the long term while taking less risk than the market and avoiding permanent impairment of capital. The fund’s focus on investing in higher-quality businesses with protective moats, good returns on capital, and exemplary management teams, combined with its ability to adapt to market conditions, makes it an attractive option for investors seeking a balance between growth and risk management.  The fund has a 30+ year record, has averaged over 10% annually since inception with one-third less volatility than the stock market, is an MFO Great Owl Fund and has high insider commitment.

   • Leuthold Core Investment Fund. Leuthold Core Investment is a tactical asset allocation fund that aims to achieve capital appreciation and income while minimizing risk through flexible portfolio management. With a focus on industry selection and the ability to adjust exposure across various asset classes, the fund has demonstrated strong performance, outperforming its Lipper Flexible Fund peers by 1.5% annually over the past decade with significantly lower volatility. The fund’s disciplined, quantitative approach to asset allocation and security selection, combined with its long-term track record of capturing over 80% of the S&P 500’s annual returns while exposing investors to less than 70% of the volatility, makes it an attractive option for investors seeking a balanced approach to risk management and returns. Devotees of ETFs should consider Leuthold Core ETF (LCR).

   Three, hire someone who can game the market for you. Where FPA and Leuthold are balanced funds that mostly tilt their portfolios as conditions change, some funds – both long-short equity and managed futures – attempt to actively, and sometimes dramatically, shift course with shifting conditions. Sadly, most such funds are overpriced failures, and few have long track records. Among the most promising options is Standpoint Multi-Asset.

   • Standpoint Multi-Asset Fund. Standpoint seeks positive absolute returns through an “All-Weather strategy.” The fund holds a global equity portfolio built from regional equity ETFs. The strategy also invests, both long and short, in exchange traded futures contracts from seven sectors: equity indexes, currencies, interest rates, metals, grains, soft commodities, and energy. The managers attempt to participate in medium- to long-term trends in global futures markets and to produce a reasonable return premium in exchange for assuming risk. The argument for Standpoint is much like the old argument for managed futures: it can provide absolute positive returns with muted volatility even when the equity markets correct, or the fixed-income markets are priced to return less than zero in the immediate future. “Our edge,” manager Eric Crittenden says, “is that we know how to build a good macro program without the traditional 2 & 20 fee structure.” It is designed to be a permanent piece of your portfolio: simple, durable, and resilient. Standpoint is trying to offer an island of predictability that investors might use to complement and strengthen their core portfolios. With positive absolute returns each year since inception (15.2% YTD in 2024), they have earned a place on your due diligence list.

2. Increase exposure to quality companies. Mr. Buffett’s declaration, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” is borne out by his enduring success and by a lot of academic and professional research. As we noted in “The Quality Anomaly,”

   The broadest sense of a quality company is one that uses its resources prudently: quality companies tend to have little or no debt, substantial free cash flows, steady and predictable earnings, and perhaps high returns on equity. Passive strategies and many active ones have a strong backward focus: they limit themselves to firms that have bright pasts, without actively inquiring about their future prospects.

   Nonetheless, the evidence is compelling that high-quality stocks purchased at reasonable prices are about the closest thing to a free lunch in the investing world. In general, you have to pay for your lunch one way or another. The only rationale for buying crazy-volatile investments (IPOs, for instance) is the prospect of crazy-high returns. The only rationale for buying modest returns (three-month T-bills) is the promise of low volatility.

   With quality stocks purchased at a reasonable price (call it QARP), that tradeoff does not occur. QARP stocks offer both higher long-term returns and lower volatility than run-of-the-mill equities.

   Higher quality investments will not always lead the market, when animal spirits run wild, trash tends to dominate in terms of pure returns.  Consider:

   • GQG Partners US Select Quality Equity or GQG Partners US Quality Dividend Income. Both are managed by Rajiv Jain, whose record of excellence stretches over decades and whose firm is entirely devoted to investing in high-quality equities.  GQG Partners primarily relies on fundamental, rather than quantitative, research to evaluate each business based on financial strength, sustainability of earnings growth, and quality of management. The investment strategy is quality first; from the pool of firms that meet its quality standards, it goes looking for undervalued companies with substantial dividends. GQG is more typically a value than a growth investor. We have previously profiled GQG Global Quality Dividend, now named Quality Dividend Income. The same discipline applies across all GQG funds. For you, the key question is whether you want direct international exposure in your portfolio at a time when tit-for-tat trade wars are discouragingly possible (and disruptive).

   • GMO US Quality ETF. The GMO ETF emulates the strategy in the five-star GMO Quality Fund. Two differences: the ETF focuses only on the US slice of the universe, and it doesn’t require a $750 million minimum initial investment (as Quality IV does). Quality has consistently been a top 10% performer. The ETF charges 50 basis points.

3. Consider a short-term high yield fund. These funds typically invest in fixed-income securities whose returns are uncorrelated to the gyrations of the Fed. Short-term high-yield bonds have provided comparable returns to the broader high-yield market but with significantly lower volatility. This is partly due to the “pull-to-par” phenomenon, where bond prices converge towards their par value as they approach maturity, reducing sensitivity to economic conditions.

   Over the course of a full market cycle, such funds tend to return about 4% per year. Over the cycle that followed the dot-com crash, 4.1%. Global financial crisis: 4.6%. Covid era: 4.3%.  The two most compelling options, based on both Morningstar’s metrics and ours, are:

   • RiverPark Short Term High Yield. Short-Term High Yield invests in, well, short-term, high-yield debt securities. Its strategy focuses on identifying opportunities where the credit ratings may not fully reflect a company’s ability to meet its short-term obligations. The fund targets investments in companies undergoing or expected to undergo corporate events, such as reorganizations or funding changes, which could enhance their capacity to repay debt. About to celebrate its 15^th anniversary, the fund, the fund has the highest Sharpe ratio (over 5.0 since inception) in existence. That is, it offers a better risk-return tradeoff than any other fund or ETF.  You might anticipate returns of 3-5% with negligible downside.

   • Intrepid Income. Intrepid Income Fund is a fixed income fund that primarily invests in U.S. corporate bonds, aiming to generate strong risk-adjusted returns and high current income while protecting and growing capital. With a focus on downside protection and risk control, the fund typically invests in smaller bond issues of less than $500 million, targeting businesses with low leverage ratios and consistent cash flows1. The fund’s strategy has demonstrated resilience while maintaining a relatively concentrated portfolio of 15 to 70 high-yield securities. You might anticipate returns of 4-5%.

4. Avoid any investment that everyone is talking about. They’re dumb in good times and disastrous in fraught ones. There are three problems with such investments.

   • They are overpriced. Everyone gets excited, then they get stupid which leads to a “buy first, regret later” impulse that pushes the price of magical investments skyward. That leads to volatility and lower returns. Morningstar’s Jeff Ptak, in reviewing the latest “Mind the Gap” study, warns:

     Narrow funds are usually more volatile by their very nature, and our findings suggest a link between higher volatility and wider investor return gaps. But volatility aside, these strategies are usually higher maintenance, forcing investors to make buy or sell decisions at what can be fraught times.

   • The vehicles that bring them to you are designed to transfer wealth from your account to the advisor’s account. To be clear: the people who offer these investments to you have zero loyalty to the investments or to their investors. Zero. MFO has chronicled a huge number of ETF conversions where, after nine months, the Space Rock Exploitation ETF suddenly becomes The AI Arbitrage Effect ETF.

   • Their best returns are past by the time you hear of them. The investing world is dominated by (a) obsessive people with vastly more resources than you and (b) passionate hucksters on TikTok whose job it is to generate a following for themselves, not security for you. That’s captured in The Rekenthaler Rule: “If the bozos know about it, it doesn’t work anymore.” (I suspect we’re the “bozos” in question.)

   Your investment goal is not having something to brag about. Your goal is to provide security and help meet your life goals. Slow and steady is almost always a surer strategy.

5. Curb your enthusiasm: Chaotic markets can trigger fear and greed. Maintain emotional discipline, stick to your investment plan, and avoid impulsive decisions based on short-term market movements. The two easiest ways to execute this strategy:

   Focus on the immediate, not the mediated. The worst day in market history was 19 October 1987 when the market fell 22.6% in one day. Hysteria, suspicion, and fears of a continued unraveling followed. Into the maelstrom stepped Louis Rukeyser, the man who perfected the art of financial television. Uncle Lou began his first show after the Great Crash this way:

   Okay, let’s start with what’s really important tonight. It’s just your money, not your life. Everybody who really loved you a week ago, still loves you tonight. And that’s a heck of a lot more important than the numbers on a brokerage statement. The robins will sing. The crocuses will bloom. Babies will gurgle and puppies will curl up in your lap and drift off happily to sleep, even when the stock market goes temporarily insane.

   And now that that’s all fully in perspective, let me say: ouch! And eek! And medic! Tonight, we’re going to try to make sense out of mass hysteria.

   Put down your phone. Kill the damned notifications. Stay away from the clatter on social media. Kiss your spouse. Hug your kids. Walk your pup. Try a new recipe. Open the bottle of wine that you’ve been saving – for the past decade! – for a sufficiently special occasion. Every day is special (it is, after all, the only one you’ll be gifted today), so you’re right to celebrate it.

   Read history. It’s easy to conclude “This is the worst thing ever!!” only if … well, you’re clueless about what else we’ve overcome. Which is to say, a lot.

   Wander off to your local used bookshop and find a copy of Barbara Tuchman, A Distant Mirror:  The Calamitous 14^th Century (1978), a narrative woven around the family of a single French noble. William Manchester’s A World Lit Only by Fire (1992) examines the transition from medieval to Renaissance Europe. While its scholarship has faced some criticism, it compellingly shows how humanity emerged from the “dark ages” into a period of remarkable cultural and intellectual flourishing. For readers who object to the very term “dark ages” and think that Manchester was too negative on a half millennium of human history, page through Michael Gabriele, The Bright Ages: A New History of Medieval Europe (2021). The Warmth of Other Suns (2010) by Isabel Wilkerson chronicles the Great Migration through intimate personal narratives. Like Tuchman, Wilkerson weaves individual stories into broader historical movements, showing how millions of African Americans transcended systemic oppression to forge new lives.

   Bill Gates, should you care, is currently recommending Doris Kearns Goodwin’s An Unfinished Love Story. DKG is a Pulitzer Prize-winning historian and biographer who was married to the late Dick Goodwin. Goodwin was an adviser to US presidents for decades, from shaping Johnson’s Great Society agenda to drafting Al Gore’s 2000 concession speech. Of it, Gates writes, “It’s hard to deny the similarities between the 1960s and today—a time of political upheaval, generational conflict, and protests on college campuses. Whether you already know a lot about the ’60s or you’re just dipping your toe into those waters, whether you want a deep dive into the art of political writing or a charming story about a married couple who adored each other, you’ll get it from An Unfinished Love Story.” He describes “the lessons it offers about how leaders have tackled tough times” as “both comforting and fascinating.”

   I’m currently reading Kathryn Olmsted, The Newspaper Axis: Six Press Barons Who Enabled Hitler (2022). Immaculate historical scholarship and one sobering passage:

   These modern newspapers favored spectacle over substance, celebrity over leadership, and polemics over sober debate. The most successful publishers discovered they could attract readers by highlighting race, nation and empire – themes that their advertisers could also support. They could make money and gain political power by selling an exclusionary vision of their nations “us” versus “them” … [their] emphasis on individuals, personality, strength and ethno-nationalism could help promote authoritarian politics. (3)

Bottom Line:

Neither chaos nor adversity are new. Nor is overcoming them. Overcoming them begins with a simple admission: we are the co-authors of chaos. Systemic chaos produces anxiety. Our decisions either worsen the situation or meliorate it. Treating the short-term as if it were the long-term. Overreacting to intentionally sensationalized stories. Focusing on the world we can’t control, and the people we’ll never meet, rather than on what we can control and the good we do experience.

A chaos-resistant portfolio stems from three decisions on our part: (1) recognize the noise, (2) favor steady gains over the illusion of spectacular ones, and (3) step away from the noisemakers. In finances, choose indolent. In your real life, choose active. Make a difference where you can. Speak up. Speak kindly. Think kindly. Listen to understand. Volunteer. Donate. Smile at the little ones. Become an agent of anti-chaos and prosper!