Derisking my Portfolio with a Leveraged Mutual Fund

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bmritz
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Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Jan 27, 2018 4:33 pm

Ok — provocative title, I know…hear me out...

The long and short of it is that I want to buy a leveraged mutual fund DXSLX to move towards a more efficient portfolio by keeping my stock exposure constant and adding to my bond exposure. Read on for details.

Here is my current situation:

Emergency funds: 3 months expenses
Debt:
  • 18,000 Student Loans @ 6%
  • 1,320 Employer Student Loan Re-payment @ 0%
Tax Filing Status: Married
Tax Rate: 22% Federal, 3.3% State, 1.75% County
State of Residence: Indiana
Ages: 27 & 25
Current Asset allocation: 90% stocks / 10% bonds
Current International allocation: 33% of stocks


My tax-adjusted target Allocations currently are as follows:

Total US Stock Market 54.00%
Reit 6.00%
Total US Bond Market 10.00%
Developed International Markets 20.00%
Emerging Markets 10.00%


Current retirement assets

Taxable
None

His 401k
14.2% 100% Schwab S&P 500 Index Fund (SWPPX) (.03%)
Company matches 50% of contributions up to 2% of salary.

His Roth IRA at Vanguard
9% Vanguard Total Bond Market Investor Class (VBMFX) (0.15%)
10% Vanguard Emerging Markets Stock Index Fund Investor Shares (VEIEX) (0.32%) (~$8,600)
5% VANGUARD REIT INDEX ETF (VNQ) (.12%)
<1% VANGUARD TOTAL STOCK MARKET ETF (VTI) (.04%)

Her Roth IRA at Vanguard
8% Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) (0.15%)

His Rollover IRA at Fidelity
19% Fidelity® International Index Fund Premium Class (FSIVX) (0.06%)
33% Fidelity® Total Market Index Fund Premium Class (FSTVX) (0.035%)

I’ve had this allocation for 3 years now, rebalancing monthly at the beginning of each month.

Portolio size is currently just above 6 figures and all are in tax-advantaged accounts — an employer 401k, a traditional ira (rolled over from previous employer), and his/her roth iras, and an hsa. I currently max out his 401k, two roth IRAs, and his HSA for the family, as well as contribute $14,400/yr towards the student loan (target mid-2019 to be debt free).

The issue:

I eventually want to take my AA from 90/10 to 125/125 (50/50 leveraged 2x). Because of the way my accounts are split up, until my portfolio grows to where I can comfortably commit to 125/125, I will move towards a 90/30 allocation through a leveraged mutual fund the Direxion Monthly S&P 500 Bull Fund (DXSLX).

The prospectus for the fund can be found here: http://www.direxioninvestments.com/prod ... ll-2x-fund.

From the website:
The Direxion Monthly S&P 500 Bull & Bear 2X Funds seek monthly investment results, before fees and expenses, of 200% of the calendar month performance of the S&P 500® Index.
I want to do this for much the same reasons stated in the classic thread “Should I use margin to buy a balanced fund?” . After reading through the entire thread, I agree that the proper way to adjust risk over time should be to adjust leverage on an efficient portfolio, rather than adjust allocations from stocks to bonds over time. My estimate of an efficient portfolio right now for the future is 50/50 given the low bond rates, however I can be convinced it is anywhere from about 30/70 to 55/45 (nobody knows nothin…).

Being that I am relatively young in my investing life, with future contributions as the majority of my portfolio value, I would like to leverage a 50/50 portfolio 2.5x. However, that is difficult to do given my current portfolio size and the way my assets are divided over several different accounts. In the meantime, I’d like to move from my current 90/10 to a 90/30 allocation, to move towards a more efficient portfolio.

There are 3 ways I can see I can get leverage:
* Margin loan in interactive brokers — Downside is 2.92% interest rate right now on amounts up to 300k…
* Futures market (S&P e-mini) — Downside is the current notional value of >$140k on one contract right now, which would automatically give me more leverage than I want given my portfolio size, and also a heighted risk from having at most 60k in one account that further restricts my ability to take on leverage.
* DXSLX — Downside is the 1.49% expense ratio, along with potential tracking error.

I would like to invest in DXSLX until my portfolio size in a single account becomes large enough for me to invest in the e-mini without taking outsized risk. I figure that will be around the time when one account gets to the notional value of the e-mini.

Here are the reasons NOT to do this, and why I still want to after considering them:

CONCERN: "The expense ratio of 1.49% is too high."
ANSWER:
I am getting 2x the exposure to the S&P 500 index, so in effect the expense ratio is 75 basis points on an exposure-normalized basis. That is still really bad for an index fund, but not as egregious as the 1.49% looks. Another way to think about this is that I’m paying ~1.46% interest on a margin loan to invest in the index, which I think is a good deal compared to ~2.5% on interactive brokers. That interest rate is not competitive with the implicit rate on futures, but futures contracts would force me to take on more leverage than I currently want.

CONCERN: "You'll lose because of Volatility Drag on constant leverage"
For a summary of this concern see here: https://dqydj.com/dont-use-leveraged-etfs-unless/ or here: http://etfdb.com/leveraged-etfs/leverag ... with-etfs/
ANSWER:
This fund targets 2x the MONTHLY return, not daily return. So in effect, you’ll only get the “buying high and selling low” effect of constant leverage 12 times a year, which is hugely different than ~250 times a year. In addition, I re-balance every month anyway, so I will rebalance the fund every month to bring the notional value of the fund (2x my investment) in line with my target allocation. In other words every time the fund resets their leverage (which is on the last trading day of the month), I will re-balance my portfolio to bring that new leverage amount in line with my AA. This will neutralize ALL volitility drag from the fund.

CONCERN: "The market is high right now, better not use leverage."
ANSWER:
Either you believe in market timing or not, and I don't. So now is as good a time as ever to be invested. Besides, at least in the intermediate term, I won't be increasing stock exposure, but rather using the leverage to keep stock exposure constant while using the freed up liquidity to invest in bonds.

So, I put it to you bogleheads — What am I missing? Are there other reasons not to do this you can think of? I'm looking to see this from a fresh angle.

Thanks for all your comments in advance -- this is a fantastic community!

P.S. Yes, I have read the infamous market timer thread; and No, I don't plan leveraging higher than 2.5x, leveraging anything riskier than 50/50, using a credit card for loans, or leveraging anything other than stocks/bonds (& perhaps international stock indicies). I definitely have the temperament to stay the course and stick to these rules.

Stonebr
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Stonebr » Sat Jan 27, 2018 4:38 pm

This idea of yours is so diametrically opposed to the Boglehead philosophy that you will get almost no sympathy or support here.

I suggest you try reading the wiki pages.
"have more than thou showest, | speak less than thou knowest" -- The Fool in King Lear

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whodidntante
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by whodidntante » Sat Jan 27, 2018 4:41 pm

I use leverage and I'm not going to lecture you about it. But I'm not doing it via an expensive fund. I didn't look at the fund, but I think your assumption that the ER includes leverage costs is most likely not correct.

KeepinItPositive
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by KeepinItPositive » Sat Jan 27, 2018 4:51 pm

I personally wouldn't do this for a couple reasons
1. Philosophically this feels closer to gambling than slow-and-steady investing to me
2. I'd be very concerned about the behavioral impact when the market turns South. I feel like I would be more capable of staying the course with my own money than borrowed money.

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Tyler Aspect
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Tyler Aspect » Sat Jan 27, 2018 4:53 pm

Personal finance is about responsibility. Since you are married when you gamble with your finances you are also gambling with your wife's financial future. Don't risk your marriage with this scheme.

Impatience is not good for your financial life.
Last edited by Tyler Aspect on Sat Jan 27, 2018 4:55 pm, edited 1 time in total.
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stlutz
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by stlutz » Sat Jan 27, 2018 4:53 pm

10 year performance comparison:

Vanguard Index 500: 8.49%/yr.
Direxion 2x Bull Fund: 6.15%/yr.

The leveraged fund looks more attractive for shorter time periods when the market was going in one direction (up).

As a long-term investment, this doesn't look like a good way to lever up your returns. At least it hasn't been through a full market cycle.

Dottie57
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Dottie57 » Sat Jan 27, 2018 4:57 pm

I don't see it. Why Add risk to a 90/10 portfolio. Buy bonds instead.

You are chasing returns. It may end up biting you in the butt.

CppCoder
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by CppCoder » Sat Jan 27, 2018 5:10 pm

What are you missing? Bankruptcy? This is a colossally bad idea.

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Steelersfan
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Steelersfan » Sat Jan 27, 2018 5:24 pm

Stonebr wrote:
Sat Jan 27, 2018 4:38 pm
This idea of yours is so diametrically opposed to the Boglehead philosophy that you will get almost no sympathy or support here.
Within less than an hour your predictive powers shine through.

Have you ever thought about stock picking to leverage them? :oops:

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nisiprius
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by nisiprius » Sat Jan 27, 2018 5:25 pm

I'm sorry, I haven't had a chance to look into the "monthly" leveraged funds.

Do you understand clear why the older, daily leveraged funds are not appropriate for anything but short-term trading?

My initial reaction is that there is no such thing as a free lunch. True 2X leverage gives you double returns--with the not-so-potential risk of margin calls and financial ruin. It just does not seem possible to me that a mutual fund, which is free from those risks, could nevertheless give you the same results as true leverage. It seems too good to be true. As with perpetual motion, it may not be easy to spot where the problem lies, but it has to be there.

I looked at the description of the fund and I see all of the usual warnings
There is no guarantee the funds will meet its stated investment objective... You know that TRADING is different than investing. But the opportunity to take advantage of short-term trends is only won, if you get the direction right.
What I haven't look at yet, and don't understand--maybe you can explain it to me--is what this means:
In practice, this means that Leveraged Index-based Funds react to gains by increasing market exposure and react to losses by decreasing market exposure....

Managing Intra-Month Purchases of Monthly Leveraged Index-Based Fund – This piece is designed to provided details on how to manage intra-monthly purchases of these funds, how to understand the changes in exposure that invariably occur each day of the month, and the tools that Direxion offers to help investors understand current exposure level – so they can make educated decisions about any leveraged index-based fund purchase they may be considering.

The Impact of Changing Market Exposure on Monthly Leveraged Index-Based Fund Performance Leveraged index-based fund performance can be significantly affected both positively and negatively by fluctuating market exposure. This piece provides a clear understanding of how market exposure can affect performance of these investments over time.
Have you read those two papers? Obviously these funds aren't some magic box that simply doubles your return (as true leverage would) without any tradeoffs. There's a tradeoff somewhere. Where is it and what is it?

If this fund is what you think it is, why has it only attracted $134 million in investments?

Image
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stlutz
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by stlutz » Sat Jan 27, 2018 5:31 pm

Steelersfan wrote:
Sat Jan 27, 2018 5:24 pm
Stonebr wrote:
Sat Jan 27, 2018 4:38 pm
This idea of yours is so diametrically opposed to the Boglehead philosophy that you will get almost no sympathy or support here.
Within less than an hour your predictive powers shine through.

Have you ever thought about stock picking to leverage them? :oops:
Don't forget to add some market timing. Maybe throw some gold futures in as well. :D

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Nestegg_User
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Nestegg_User » Sat Jan 27, 2018 5:45 pm

Awww, come on people... you’re not thinking far enough out there.... how about leveraged bitcoin futures...now you’re talking :wink:



if the OP had done any research on long term holding of leveraged funds, then they wouldn’t have needed to post, AND they’d then realize that it would do anything BUT de-risk their portfolio
Last edited by Nestegg_User on Sat Jan 27, 2018 5:47 pm, edited 1 time in total.

bmritz
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Jan 27, 2018 5:46 pm

whodidntante wrote:
Sat Jan 27, 2018 4:41 pm
I use leverage and I'm not going to lecture you about it. But I'm not doing it via an expensive fund. I didn't look at the fund, but I think your assumption that the ER includes leverage costs is most likely not correct.
OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.

Below is a copy of the "Fees and Expenses of the Fund" part of the Summary Prospectus:
Fees and Expenses of the Fund
This table describes the fees and expenses that you may pay if you buy and hold shares of the Fund.

Annual Fund Operating Expenses (expenses that you pay each year as a percentage of the value of your investment)
Management Fees 0.75%
Distribution and/or Service (12b-1) Fees 0.25%
Other Expenses 0.35%
Acquired Fund Fees and Expenses(10) 0.14%
Total Annual Fund Operating Expenses 1.49%
Expense Cap/Reimbursement(1) 0.00%
Total Annual Fund Operating Expenses After Expense Cap/Reimbursement 1.49%


Example - This example is intended to help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the Fund for the time periods indicated and then redeem all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years
Investor Class $152 $471 $813 $1,779
Can I also ask you how you might access leverage with an account of ~$60k? Is there another idea I'm missing that wasn't in my 3 listed in the OP?

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by whodidntante » Sat Jan 27, 2018 6:03 pm

bmritz wrote:
Sat Jan 27, 2018 5:46 pm
whodidntante wrote:
Sat Jan 27, 2018 4:41 pm
I use leverage and I'm not going to lecture you about it. But I'm not doing it via an expensive fund. I didn't look at the fund, but I think your assumption that the ER includes leverage costs is most likely not correct.
OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.

Below is a copy of the "Fees and Expenses of the Fund" part of the Summary Prospectus:

Can I also ask you how you might access leverage with an account of ~$60k? Is there another idea I'm missing that wasn't in my 3 listed in the OP?
That depends on how they are accomplishing the leverage. According to the prospectus, they are allowed to use derivatives, and it looks like what they've actually done is buy swaps. Swaps have an internalized cost that would not be reflected in the ER, and the organization laying the swap gets that. The internalized cost would be reflected in the return. They aren't borrowing the money, buying an additional 100% of stocks with it, and reflecting the interest cost in the ER, for example. The ER is covering their trading costs, management fees, etc.

As for how to accomplish leverage, remember that money is fungible. I do not have to go and buy a futures contract, buy options, or take a margin loan in order to accomplish leverage. You might have noticed that there are tons of "should I payoff my mortgage threads" on Bogleheads. In my case, I could easily sell investments to pay off my mortgage, but I don't because it's at a low rate and I would rather be leveraged. Same when I bought my car, I took a low rate loan. I also float some amount of money on 0% credit cards. Within an IRA, you would be limited to using options or maybe futures, assuming it is not possible to add money from outside sources.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by nisiprius » Sat Jan 27, 2018 6:13 pm

....The long and short of it is that I want to buy a leveraged mutual fund DXSLX to move towards a more efficient portfolio by keeping my stock exposure constant and adding to my bond exposure... This fund targets 2x the MONTHLY return, not daily return. So in effect, you’ll only get the “buying high and selling low” effect of constant leverage 12 times a year, which is hugely different than ~250 times a year.
Whoa. I had no idea DXSLX had been out for such a long time. I assumed it was something new.

Did you actually take a look at the growth chart?

For comparison, I'm going compare it (blue) to
VFINX (orange, the Vanguard 500 index fund),
and ULPIX (green, ProFunds UltraBull Fund) (a daily-rebalanced 2X leveraged S&P fund).

Doesn't this bother you at all?

Source
Image

Over the time period DXSLX has existed, this "2X leveraged" fund not only failed to double the return of the S&P 500 fund, it failed to beat the S&P 500 fund.

Furthermore, the supposedly better monthly rebalanced DXSLX actually fell further than ULPIX during 2008-2009. VFINX, a sick-making 54% plunge; ULPIX (daily-rebalanced), a staggering 84% loss... and DXSLX, a ... words fail me... 91% loss.

With ULPIX, at least at the very end you would have had more than with VFINX, although not even close to double. (VFINX added $17,734, ULPIX $22,915. Nope, not 2X, not even close; only 1.3X). But as I say, DXSLX actually underperformed the unleveraged fund.

So much for the idea that monthly rebalancing in a leveraged fund is vastly better than daily rebalancing.

Typical leveraged fund and ETF behavior. Did a great job of doubling the losses on the way down; doubling the gains on the way up, nope.

Put aside the question of whether it's reasonable to use leverage. It probably isn't, but the first thing you need to deal with is that It is not reasonable to use a leveraged fund or ETF for long-term investing.
Last edited by nisiprius on Sat Jan 27, 2018 6:26 pm, edited 3 times in total.
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stlutz
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by stlutz » Sat Jan 27, 2018 6:22 pm

OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.
I would look at the annual report on the Fidelity site. The fund basically has two investments: 1) A Fidelity money-market fund; 2) a swap contract. The former serves as collateral for the later. Looking at the one they held at the time of their annual report, their contract has a cost of 1.55%. And that cost gets levered by the same ratio as the swap contract. So, your leverage costs are about 3%/yr. That's *not* included in the expense ratio--if you look at the statement of operations all of the swap contract accounting is separate from the fund expenses.

Note: I'm not an expert on swap contracts, so I'm hoping someone will correct me if I'm interpreting the annual report incorrectly.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Jan 27, 2018 8:42 pm

whodidntante wrote:
Sat Jan 27, 2018 6:03 pm
bmritz wrote:
Sat Jan 27, 2018 5:46 pm
whodidntante wrote:
Sat Jan 27, 2018 4:41 pm
I use leverage and I'm not going to lecture you about it. But I'm not doing it via an expensive fund. I didn't look at the fund, but I think your assumption that the ER includes leverage costs is most likely not correct.
OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.

Below is a copy of the "Fees and Expenses of the Fund" part of the Summary Prospectus:

Can I also ask you how you might access leverage with an account of ~$60k? Is there another idea I'm missing that wasn't in my 3 listed in the OP?
That depends on how they are accomplishing the leverage. According to the prospectus, they are allowed to use derivatives, and it looks like what they've actually done is buy swaps. Swaps have an internalized cost that would not be reflected in the ER, and the organization laying the swap gets that. The internalized cost would be reflected in the return. They aren't borrowing the money, buying an additional 100% of stocks with it, and reflecting the interest cost in the ER, for example. The ER is covering their trading costs, management fees, etc.

As for how to accomplish leverage, remember that money is fungible. I do not have to go and buy a futures contract, buy options, or take a margin loan in order to accomplish leverage. You might have noticed that there are tons of "should I payoff my mortgage threads" on Bogleheads. In my case, I could easily sell investments to pay off my mortgage, but I don't because it's at a low rate and I would rather be leveraged. Same when I bought my car, I took a low rate loan. I also float some amount of money on 0% credit cards. Within an IRA, you would be limited to using options or maybe futures, assuming it is not possible to add money from outside sources.
Thank you for the great feedback. I did see they use swaps but I was thinking that the cost of leverage in the swap was rolled into their expense ratio. I'll look a little deeper into how the swaps are financed -- it looks like later down in the thread someone else shows the cost comes to 3% -- if that's the case....I'm out!

Completely understand paying off the mortgage slowly and investing the difference... that's a safer way to keep liquidity to invest, and an example I'll likely follow when the time comes to buy a home.

Thanks again for taking the time to dig into the prospectus. This is exactly why I posted -- to maybe dig up something in there that I was previously missing. The generosity of people on this forum with their time is much appreciated.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Jan 27, 2018 8:56 pm

stlutz wrote:
Sat Jan 27, 2018 6:22 pm
OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.
I would look at the annual report on the Fidelity site. The fund basically has two investments: 1) A Fidelity money-market fund; 2) a swap contract. The former serves as collateral for the later. Looking at the one they held at the time of their annual report, their contract has a cost of 1.55%. And that cost gets levered by the same ratio as the swap contract. So, your leverage costs are about 3%/yr. That's *not* included in the expense ratio--if you look at the statement of operations all of the swap contract accounting is separate from the fund expenses.

Note: I'm not an expert on swap contracts, so I'm hoping someone will correct me if I'm interpreting the annual report incorrectly.
THANK YOU! I see exactly what you are saying in the Annual Report. At 3% this doesn't look like a good option -- I'll dig in a little further but at first glance I see what you're seeing.

This is exactly why I posted here. Thanks for taking the time to dig in!

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by nisiprius » Sun Jan 28, 2018 7:45 am

bmritz, just to be clear--since you don't spell it out: are you explicitly following the strategy espoused by Ayres and Nalebuff, in an article entitled "Mortgage Your Retirement," and their later book? Those are the people who inspired Market Timer. Or did you come by the same idea independently?
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by in_reality » Sun Jan 28, 2018 8:10 am

Monthly leverage - nice!

Jul 2006 - Dec 2017 CAGR
DXELX -2.66% [Direxion Mthly Emerg Mkts Bull 2X]
VEMAX 5.88% [Vanguard Emerging Mkts Stock Idx Adm]

I know you said US stocks, but we don't know what the next 10 years will be. If CAGR of an un-leveraged index is 5.88% and your return is -2.66%, I don't see how that's helpful for you. Nor do I understand how we could know that will definitely not be the case.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Valuethinker » Sun Jan 28, 2018 8:37 am

bmritz wrote:
Sat Jan 27, 2018 4:33 pm


I want to do this for much the same reasons stated in the classic thread “Should I use margin to buy a balanced fund?” . After reading through the entire thread, I agree that the proper way to adjust risk over time should be to adjust leverage on an efficient portfolio, rather than adjust allocations from stocks to bonds over time. My estimate of an efficient portfolio right now for the future is 50/50 given the low bond rates, however I can be convinced it is anywhere from about 30/70 to 55/45 (nobody knows nothin…).
1. the problem with this strategy is your borrowing rate is always higher than your lending rate (bond fund yield) therefore you always lose on the financing cost?

2. by the Merton theory of option pricing (which is equivalent to Black Scholes) you are in essence duplicating an option portfolio.

Therefore is it not cheaper to leverage up simply by buying call options on the S&P 500?

That is what the mutual fund manager is doing with this product, in essence. Why pay their management fee?

3. the problem with leverage in stock investing is that you can be called-- the duration of equities as an investment is much greater than the duration of any borrowing you can do.

Mortgaging and buying stocks works, because unless we are in another Japan, you have say 25-30 years (less amortization payments on principal, so the effective duration of a mortgage is more like 15 years, I suspect) to repay. Thus, it's quite likely the bet will be In The Money at some point over the next 30 years.

4. I suggest (re)reading Benoit Mandelbrot The Misbehavior of Markets. There are some pretty frightening stats out there about financial market prices (and, in fact, housing prices if you read Neil Monnery "Safe as Houses": which collates all the century + long housing price data we have (Amsterdam since 1630s, Paris since 1300s, late 19th century Australia to present day, etc.).

The volatility of financial markets is much greater than we think. And the returns pattern is fractal.

5. We have people here who remember the Great Depression (Taylor Larrimore). We also have people who live in Japan; who remember the stock market bear markets of 2000 & 2008/9 (most of us); who remember the Crash of 1987; who remember the 1970s (when inflation to some extent disguised how horrifically stock markets performed).

Like the bitcoin threads, these sorts of threads (leverage and stock investing; 100% equities etc.) flag up to those who do remember these times that top of the market is closer rather than further away.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by grabiner » Sun Jan 28, 2018 10:54 am

Valuethinker wrote:
Sun Jan 28, 2018 8:37 am
3. the problem with leverage in stock investing is that you can be called-- the duration of equities as an investment is much greater than the duration of any borrowing you can do.

Mortgaging and buying stocks works, because unless we are in another Japan, you have say 25-30 years (less amortization payments on principal, so the effective duration of a mortgage is more like 15 years, I suspect) to repay. Thus, it's quite likely the bet will be In The Money at some point over the next 30 years.
The earlier payments on a mortgage are worth more in present value than the later payments, so the effective duration of a mortgage is less than half the term. For a 30-year mortgage, the effective duration is about 12 years.

But mortgaging your home while holding stocks is still reasonable, because the home increases your risk tolerance. Effectively, the home is an annuity which pays you one month's housing every month. If your portfolio income declines by 20%, your standard of living won't decline by 20% when some of that living comes from your house (or from other annuities such as SS And pensions.)
Wiki David Grabiner

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sun Jan 28, 2018 6:21 pm

nisiprius wrote:
Sat Jan 27, 2018 6:13 pm
Whoa. I had no idea DXSLX had been out for such a long time. I assumed it was something new.

Did you actually take a look at the growth chart?

For comparison, I'm going compare it (blue) to
VFINX (orange, the Vanguard 500 index fund),
and ULPIX (green, ProFunds UltraBull Fund) (a daily-rebalanced 2X leveraged S&P fund).

Doesn't this bother you at all?

Source
Image
[/b]
Nearing_Destination wrote:
Sat Jan 27, 2018 5:45 pm
Awww, come on people... you’re not thinking far enough out there.... how about leveraged bitcoin futures...now you’re talking :wink:

if the OP had done any research on long term holding of leveraged funds, then they wouldn’t have needed to post
in_reality wrote:
Sun Jan 28, 2018 8:10 am
Monthly leverage - nice!

Jul 2006 - Dec 2017 CAGR
DXELX -2.66% [Direxion Mthly Emerg Mkts Bull 2X]
VEMAX 5.88% [Vanguard Emerging Mkts Stock Idx Adm]

I know you said US stocks, but we don't know what the next 10 years will be. If CAGR of an un-leveraged index is 5.88% and your return is -2.66%, I don't see how that's helpful for you. Nor do I understand how we could know that will definitely not be the case.
OK -- I made provocative title to get some criticism going. Give me a chance here to show how this could be a good long term investment if the cost of capital was actually 1.49% as I originally thought. (NOTE: It now looks like it is >3%, which is a non starter for me.)

First -- I 100% understand and AGREE that it is a poor long term investment to buy and hold a leveraged fund for a longer period due to volatility drag, as I stated in my OP. With leveraged funds, in a sideways market with some volatility, you will come out behind the actual 2x performance of the underlying. I illustrate why that is the case with the typical example, which was illustrated in two links in my OP:

----------------------------------------------------------------------------------------------------

VOLATILITY DRAG ILLUSTRATED

UNLEVERED
Start: $100 in SPY (Balance: $100, Notional: $100)
Day 1: SPY gains 25% (Balance: $125, Notional: $125)
Day 2: SPY loses 20% (Balance: $125*.8 = $100, , Notional: $100)

LEVERED (We should expect this to come out to $100 if there was no such thing as volatility drag--but there is so it will come out to less)
Start: $100 in SSO ( ProShares Ultra S&P500 ) (Balance: $100, Notional: $200)
Day 1: SPY gains 25% SSO Gains 50% (Balance: $100 + ($200*0.25) = $150)
Between Day 1 & Day 2: SSO Re-levers up, so your notional goes to $300 (Balance: $150, Notional $300) (It re-levers DAILY)
Day 2: SPY loses 20%, SSO Loses 40% (Balance: $150 - ($300*-.02)= $90)

$90 after day 2 in the LEVERED case is less than the $100 we would have expected from just straight 2x returns on the underlying index over the 2 days. I call that Volatility Drag.

----------------------------------------------------------------------------------------------------

That is why you see the charts of DXSLX lagging the index over years time. I get that. Volatility drag was listed as my second concern in my original post, and I laid out a short summary of how I would neutralize this effect. It wasn't very clear because I was trying to save space, but I go into more detail below:

In my original post, I proposed using the leveraged fund to take my AA from 90/10 to 90/30, essentially leveraging a 75/25 portfolio 1.2x. I can use DXSLX to leverage my stock portion by 1.28x by purchasing a combination of DXLSX and SPY. Essentially, the portfolio I propose to hold is:

20% DXSLX
50% SPY
30% BND

This gives me the 90/30 stock/bond exposure I desire.

The problem correctly pointed out several times in this thread with funds like DXSLX is that they use constant leverage, essentially buying high and selling low. If SPY increases, DXLSX responds by increasing its exposure the next month to always keep a 2x leverage ratio. Leverage using margin is different -- when the underlying asset increases, your effective leverage ratio decreases. If you originally have a leverage ratio of 2x on margin, and SPY increases, your leverage ratio is now decreased, and because you are now less leveraged, any volatility back down doesn't hurt as much as it otherwise would using a leveraged fund with constant leverage. Again, this is what causes all the poor performance everyone sees with funds like these.

I propose to manually adjust the leverage ratio by re-balancing between SPY/DXLSX/BND every month, to always expose me to 90/30 SPY/BND. This is why DXSLX being a monthly fund is important -- I could theoretically re-balance daily, but transactions costs would eat into returns big time. Monthly is doable -- in fact the only reason I considered this strategy was because I recently found out about monthly leveraged funds.

Here is an example of the rebalance effect -- I'll give an example here without bonds that is exactly analogous to the Volatility Drag Example, only when I rebalance between SPY and SSO, there will be no volatility drag, and I will end up exactly where I started.

----------------------------------------------------------------------------------------------------

VOLATILITY DRAG NEUTRALIZATION THROUGH RE-BALANCING ILLUSTRATED

LEVERED (We should expect this to come out to $100 if there was no such thing as volatility drag--And it will when we rebalance)

Start: $100 in SSO, $0 in SPY (Balance: $100, Notional: $200)
Day 1: SPY gains 25%, SSO Gains 50% (Balance: $100 + ($100*0.5) = $150) ($150 SSO, $0 SPY)
Between Day 1 & Day 2: SSO Re-levers up, so your notional SSO goes to $300
Between Day 1 & Day 2: You Re-Balance to bring your leverage ratio down. Sell $50 of SSO and buy $50 of SPY (Balance: $100 SSO, $50 SPY) (Notional $250 instead of $300)
Day 2: SPY loses 20%, SSO Loses 40% (Balance: ($100*.6) + ($50*.8)= $100.00 ) (NO VOLATILITY DRAG)

----------------------------------------------------------------------------------------------------

All of the poor performance quoted in this thread does not take into account this re-balancing strategy, and is not a valid indictment of the strategy.

What would be a valid indictment? Well, there is no such thing as a free lunch in investing. In the above example, I am way over-levered, because if SSO decreases on the first day, I an unable to increase my leverage as needed to gain back all of my leveraged losses if SPY gains back it's losses. Because of the 2x leverage cap on SSO, I have no ability to increase my leverage above 2x as a margin portfolio naturally would if the price of the underlying decreases.

So, what is my solution? Take a safe amount of leverage.

My 20% DXLSX /50 SPY%/30 BND% leveraged 1.2x has enough SPY and BND to re-balance into DXSLX to weather a 50% monthly decline in SPY and a 50% monthly decline in BND in the same month, and still preserve it's 1.2x return to a 75/25 unlevered portfolio when geometrically averaged across the two periods. (Well, as long as DXLSX is around after a 50% decline in SPY to allow me to re-balance back into it.)

DXSLX disappearing is one of the failure modes of this strategy. Another is over-levering by investing too much in DXSLX and not enough in SPY -- an extreme example of over-leverage would be similar to my example with 100% SSO. But a more realistic example might be taking 1.24 leverage in a 40 stock/60 bond portfolio (which appears safe at first glance), but actually would force you to dip into your 60% Bond Allocation to re-leverage declines in your stock portion given just a 10% decrease in SPY. 1.24x leverage on 40/60 would seem safe, but the mechanics of using DXSLX for that leverage make for some funky scenarios. It's a little counterintuitive, but having a higher stock allocation here helps you avoid the "margin call" scenario of this strategy of having to break your set AA.

Hope that makes things a little clearer. Thanks for all of the though provoking comments on this thread -- you really have made me examine my assumptions about the strategy -- Keep the heat on and let me know what you can pick apart from this post!

P.S. Just for completeness here is the worksheet I have for my 90 stock/30 bond portfolio in a 50% down scenario:

SPY Returns
Month 1 -50%
Month 2 120%

BND Returns
Month 1 -50%
Month 2 0%

Image
Last edited by bmritz on Mon Jan 29, 2018 7:30 am, edited 5 times in total.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sun Jan 28, 2018 6:32 pm

nisiprius wrote:
Sun Jan 28, 2018 7:45 am
bmritz, just to be clear--since you don't spell it out: are you explicitly following the strategy espoused by Ayres and Nalebuff, in an article entitled "Mortgage Your Retirement," and their later book? Those are the people who inspired Market Timer. Or did you come by the same idea independently?
I'm not following their exact strategy -- I haven't read them, so all I know is what has been mentioned of them here. It seems like they recommend LEAPS? I looked in to call options on fidelity but calculated financing cost for liquid options as ~3%, which I didn't want to take on.

I came to the idea thinking that I'm not properly getting compensated for the risk I'm taking at 90/10. 90/10 is not efficient in my estimation, so I'm taking more risk than needed for all that stock return. I thought I could lower my risk while keep a similar return profile by moving to 90/30. Thus the title "Derisking my Portfolio with a Leveraged Mutual Fund."

P.S. 90/30 might actually be a little more risk for a little more return than 90/10-- I haven't actually run the exact numbers yet.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Phineas J. Whoopee » Sun Jan 28, 2018 6:36 pm

From the Bogleheads wiki: Inverse and leveraged ETFs

I suggest you don't do it unless you thoroughly understand it, and once you do thoroughly understand it you won't do it.

PJW

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by stlutz » Sun Jan 28, 2018 7:09 pm

To step back and take a bigger picture, the problem you are trying to "solve" has been attacked in many different ways:

--Borrowing on margin
--Long-term call options
--High volatility stocks (i.e. getting higher beta via stock selection).

As we've discussed above, both options 1 and 2 give you the potential of higher returns, but a likelihood of lower returns over time. But option 3 also follows the same pattern--historical research has revealed that high volatility stocks generally provide lower returns than do low volatility stocks--both on an absolute and a risk-adjusted basis.

What you are looking for is simply not something that the markets have offered historically. That doesn't mean they never will, but basically what you need is for the segments of the market that are looking to lever their positions (e.g. AQR to pick an example that often comes up around here) to give up and say that leverage doesn't work. That would allow for the way that asset pricing works to change. Right now that is not occurring.

Now, if you are currently 90/10, one way to potentially make your portfolio work better would be to switch from BND to long-term bonds like TLT, VGLT, EDV etc.--i.e. lever your duration exposure. That would have made your portfolio more efficient in the last two big bear markets (2001 & 2008). Conventional wisdom is that the one type of individual investor who should consider a tilt to long-term bonds is the person with 90% stocks. Of course LT bonds would made things worse back in '73/74, so this is also far from an approach that is guaranteed to "work".

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by in_reality » Sun Jan 28, 2018 7:22 pm

bmritz wrote:
Sun Jan 28, 2018 6:21 pm
P.S. Just for completeness here is the worksheet I have for my 90 stock/30 bond portfolio in a 50% down scenario:
So you modeled a situation where the 2X monthly isn't hurt by going 50% down compared to a non-levered portfolio.

The actual returns on DXELX will show you with certainty that your model isn't the only possibility.

So yeah I agree, things can work out in the biggest drops. But I don't agree that they necessarily will.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by b.lock » Sun Jan 28, 2018 9:24 pm

OP, I don't think your idea is crazy. I have about 5% of my portfolio in UPRO. I've held it for about 4 months, despite the SEC warnings that it should not be held for longer than a day, and it's gained over 50% since then. However, it's easy to make money when the stock market is breaking records almost every day.

It's surprising to me that your fund has lagged market recovery for years, as some others have posted. Many other leveraged funds have successfully returned 2x or 3x the market over the last few years. So you might want to look into UPRO or some others. I think playing with leverage in a relatively safe way such as funds and ETFs is a fun experiment. Still you will get little sympathy from bogleheads if your experiment fails :beer

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by nisiprius » Sun Jan 28, 2018 9:35 pm

Phineas J. Whoopee wrote:
Sun Jan 28, 2018 6:36 pm
From the Bogleheads wiki: Inverse and leveraged ETFs

I suggest you don't do it unless you thoroughly understand it, and once you do thoroughly understand it you won't do it.

PJW
He says he can undo the effect by using a monthly-rebalanced leveraged fund and rebalancing himself monthly to counteract the effect of the fund's rebalancing. I haven't yet tried to understand what he's saying so I don't know if it it's credible.

(My knee jerk reaction is that he's saying "I agree that DXSLX isn't perpetual motion, but I've figured out how to turn it into perpetual motion by adding this spring here and this cam there.")
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by in_reality » Sun Jan 28, 2018 9:56 pm

nisiprius wrote:
Sun Jan 28, 2018 9:35 pm
Phineas J. Whoopee wrote:
Sun Jan 28, 2018 6:36 pm
From the Bogleheads wiki: Inverse and leveraged ETFs

I suggest you don't do it unless you thoroughly understand it, and once you do thoroughly understand it you won't do it.

PJW
He says he can undo the effect by using a monthly-rebalanced leveraged fund and rebalancing himself monthly to counteract the effect of the fund's rebalancing. I haven't yet tried to understand what he's saying so I don't know if it it's credible.

(My knee jerk reaction is that he's saying "I agree that DXSLX isn't perpetual motion, but I've figured out how to turn it into perpetual motion by adding this spring here and this cam there.")
Look at the sample of -50%

M1 90% stocks 30% bonds
M2 112.5% stocks 37.5% bonds

Leverage increased to show no loss due to an assumed big recovery.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Mon Jan 29, 2018 6:55 am

in_reality wrote:
Sun Jan 28, 2018 7:22 pm
bmritz wrote:
Sun Jan 28, 2018 6:21 pm
P.S. Just for completeness here is the worksheet I have for my 90 stock/30 bond portfolio in a 50% down scenario:
So you modeled a situation where the 2X monthly isn't hurt by going 50% down compared to a non-levered portfolio.

The actual returns on DXELX will show you with certainty that your model isn't the only possibility.

So yeah I agree, things can work out in the biggest drops. But I don't agree that they necessarily will.
You make a really good point -- essentially there is a risk of tracking error of DXSLX to the underlying -- that it doesn't exactly give 2x. Indeed - during 2008-2009 it was all over the place with respect to the S&P 500. It has since settled down, but idk if you can trust it during a recession:

Image

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Mon Jan 29, 2018 7:05 am

bmritz wrote:
Sat Jan 27, 2018 8:56 pm
stlutz wrote:
Sat Jan 27, 2018 6:22 pm
OP here. Thanks for pointing that out -- on the prospectus and in Fidelity it lists the net expense ratio as 1.49%. Is it possible that there are leverage costs above the net expense ratio that aren't quoted on the Fidelity page? I haven't heard of that -- but that is why I'm asking here, in case I'm missing something like that.
I would look at the annual report on the Fidelity site. The fund basically has two investments: 1) A Fidelity money-market fund; 2) a swap contract. The former serves as collateral for the later. Looking at the one they held at the time of their annual report, their contract has a cost of 1.55%. And that cost gets levered by the same ratio as the swap contract. So, your leverage costs are about 3%/yr. That's *not* included in the expense ratio--if you look at the statement of operations all of the swap contract accounting is separate from the fund expenses.

Note: I'm not an expert on swap contracts, so I'm hoping someone will correct me if I'm interpreting the annual report incorrectly.
THANK YOU! I see exactly what you are saying in the Annual Report. At 3% this doesn't look like a good option -- I'll dig in a little further but at first glance I see what you're seeing.

This is exactly why I posted here. Thanks for taking the time to dig in!
The average tracking error of DXSLX to 2x S&P 500 Total Returns is 2.714% (during "good times"). Not exactly sure yet how that squares with the 1.55% financing for the swaps or the 1.49% expense ratio, but it's safe to say the real cost of leverage is greater than the 1.49% I originally thought.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Mon Jan 29, 2018 7:18 am

in_reality wrote:
Sun Jan 28, 2018 9:56 pm
nisiprius wrote:
Sun Jan 28, 2018 9:35 pm
Phineas J. Whoopee wrote:
Sun Jan 28, 2018 6:36 pm
From the Bogleheads wiki: Inverse and leveraged ETFs

I suggest you don't do it unless you thoroughly understand it, and once you do thoroughly understand it you won't do it.

PJW
He says he can undo the effect by using a monthly-rebalanced leveraged fund and rebalancing himself monthly to counteract the effect of the fund's rebalancing. I haven't yet tried to understand what he's saying so I don't know if it it's credible.

(My knee jerk reaction is that he's saying "I agree that DXSLX isn't perpetual motion, but I've figured out how to turn it into perpetual motion by adding this spring here and this cam there.")
Look at the sample of -50%

M1 90% stocks 30% bonds
M2 112.5% stocks 37.5% bonds

Leverage increased to show no loss due to an assumed big recovery.
Exactly -- no perpetual motion, just leverage, same as if you borrowed on margin to invest with max leverage ratio of 1.6x (given a 75/25 portfolio). At 1.6x leverage, your "margin call" scenario happens, where you'll have to break your AA and move some bond exposure over to stocks in order to keep your stock exposure where it "should" be.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Mon Jan 29, 2018 3:44 pm

Valuethinker wrote:
Sun Jan 28, 2018 8:37 am
1. the problem with this strategy is your borrowing rate is always higher than your lending rate (bond fund yield) therefore you always lose on the financing cost?
At the beginning of this thread -- I thought the borrowing rate would essentially be 1.49%, which would be less than the expected yield on BND. I actually think the right benchmark to compare to would be the expected return on your portfolio, but that is another story for another thread (It was hashed out in the "Should I lever a Balanced Portfolio" thread I originally linked to.).
Valuethinker wrote:
Sun Jan 28, 2018 8:37 am
2. by the Merton theory of option pricing (which is equivalent to Black Scholes) you are in essence duplicating an option portfolio.

Therefore is it not cheaper to leverage up simply by buying call options on the S&P 500?

That is what the mutual fund manager is doing with this product, in essence. Why pay their management fee?
As for call options, they currently fail the "Invest in what you understand" test for me -- I looked into them briefly but from as much I could figure, the implied financing rate wasn't <2% like I was looking for, so I didn't put a lot of further time into evaluation. The main mystery was how to get out of the option when I was ready to "sell," or what happens when the option expires -- do I have to come up with the strike price in cash to actually purchase the asset?

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by comeinvest » Fri Feb 16, 2018 2:12 am

With equity index futures, you can currently borrow at a rate of about 0.7% (roll richness) + 0.2% (drag from inability of retail investors to use anything else but cash for futures margin) = ca. 0.9% above money market rates. Assuming a long-term expected ERP (equity risk premium) of 4%, or similar assumptions depending on asset allocation, this makes many lifetime leverage strategies viable (and arguably reduces [or arguably increases]) risk, depending on your capital market assumptions and your definition of "risk".
Unfortunately, as a result of recent legislation, the futures roll implied financing spread increased from levels near zero historically, to ca. 0.7%.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Theoretical » Fri Feb 16, 2018 3:43 am

Ok, so here's a couple of options you MAY want to consider.

I think you're thinking the wrong way. What you actually want to do is to leverage bonds not stocks. The stocks' volatility can be a real killer, but if you leverage bonds, well, that's got some potential. In other words, keep your 90% stocks, but move to 90/20 or drop it to 80/40. Risk parity has lots of risk attached to it, but I think for the retail investor, you're going to do better with a less volatile (cheaper) asset in this case.

There've also been some posts on here about rolling your own 2 or 5 year treasury futures, and investing the collateral in a high yield savings account or tax-exempt short-term fund.

Three options to consider - Direction's Monthly 2x Bull 7-10 Treasury Fund DXKLX - which is extremely volatile (about on par with EM), but highly tax efficient. The tracking error has been about 2x IEF's return minus the ER. The real pill though is rising interest rates or worse, inflation, but it definitely performs like an ultra-responsive 7-10 year treasury. One warning, it's based on swaps, so while the flight to quality effect will be extremely magnified, the actual liquidity and counterparty risk is a real factor in a black swan catastrophe.

Another option is to move some of the IRAs to TD Ameritrade and buy PIMCO's Stocks Plus or RAE Fundamental Plus (if you like tilting) funds. At Ameritrade you can buy the Institutional Class shares for a one time $50 commission and then systematically purchase one or more for free thereafter, with free alterations to the schedule as needed. In addition, they will transfer custodian-to-custodian if you'd prefer them to be at Fidelity. These use futures (Stocks Plus) or total return swaps (RAE fundamental) along with collateral of PIMCO's short-term bond strategy. It's more of a nibbling around the margins type strategy in that it does end up giving you some exposure to credit bonds, sharpening returns in good times and worsening them in bad.

Finally, and this is the strategy I use as a young accumulator, drawn from Bill Bernstein, is to heavily tilt to small value and Emerging Value. These stocks are about 1.5x as volatile as the S&P 500, and so I regard our 60/40 as closer to a 90/10 for that reason. Robert T's 75/25 Large/Small Value Tilted portfolio is more like 1.33x more volatile, so it's close to a 100% stocks portfolio. This is essentially using leverage of sorts in the context of the companies' balance sheets rather than making retail leverage..

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Mar 03, 2018 12:29 pm

comeinvest wrote:
Fri Feb 16, 2018 2:12 am
With equity index futures, you can currently borrow at a rate of about 0.7% (roll richness) + 0.2% (drag from inability of retail investors to use anything else but cash for futures margin) = ca. 0.9% above money market rates. Assuming a long-term expected ERP (equity risk premium) of 4%, or similar assumptions depending on asset allocation, this makes many lifetime leverage strategies viable (and arguably reduces [or arguably increases]) risk, depending on your capital market assumptions and your definition of "risk".
Unfortunately, as a result of recent legislation, the futures roll implied financing spread increased from levels near zero historically, to ca. 0.7%.
Interesting -- thanks for the information. Looking at the Roll Analyzer at CME shows implied rates ~2.5%-2.6%. http://www.cmegroup.com/trading/equity- ... /main.html. What was the name of the legislation that increased the spread? Thats unfortunate because right now 1.5% sounds a whole lot better than 2.5%. I just can't get myself to pull the trigger at 2.5%.

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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by bmritz » Sat Mar 03, 2018 12:29 pm

Theoretical wrote:
Fri Feb 16, 2018 3:43 am
Ok, so here's a couple of options you MAY want to consider.

I think you're thinking the wrong way. What you actually want to do is to leverage bonds not stocks. The stocks' volatility can be a real killer, but if you leverage bonds, well, that's got some potential. In other words, keep your 90% stocks, but move to 90/20 or drop it to 80/40. Risk parity has lots of risk attached to it, but I think for the retail investor, you're going to do better with a less volatile (cheaper) asset in this case.

There've also been some posts on here about rolling your own 2 or 5 year treasury futures, and investing the collateral in a high yield savings account or tax-exempt short-term fund.

Three options to consider - Direction's Monthly 2x Bull 7-10 Treasury Fund DXKLX - which is extremely volatile (about on par with EM), but highly tax efficient. The tracking error has been about 2x IEF's return minus the ER. The real pill though is rising interest rates or worse, inflation, but it definitely performs like an ultra-responsive 7-10 year treasury. One warning, it's based on swaps, so while the flight to quality effect will be extremely magnified, the actual liquidity and counterparty risk is a real factor in a black swan catastrophe.

Another option is to move some of the IRAs to TD Ameritrade and buy PIMCO's Stocks Plus or RAE Fundamental Plus (if you like tilting) funds. At Ameritrade you can buy the Institutional Class shares for a one time $50 commission and then systematically purchase one or more for free thereafter, with free alterations to the schedule as needed. In addition, they will transfer custodian-to-custodian if you'd prefer them to be at Fidelity. These use futures (Stocks Plus) or total return swaps (RAE fundamental) along with collateral of PIMCO's short-term bond strategy. It's more of a nibbling around the margins type strategy in that it does end up giving you some exposure to credit bonds, sharpening returns in good times and worsening them in bad.

Finally, and this is the strategy I use as a young accumulator, drawn from Bill Bernstein, is to heavily tilt to small value and Emerging Value. These stocks are about 1.5x as volatile as the S&P 500, and so I regard our 60/40 as closer to a 90/10 for that reason. Robert T's 75/25 Large/Small Value Tilted portfolio is more like 1.33x more volatile, so it's close to a 100% stocks portfolio. This is essentially using leverage of sorts in the context of the companies' balance sheets rather than making retail leverage..
Thank you for the thoughtful post -- I apologize for just responding now -- been a little busy lately to really dive into some of those recommendations. I agree that leveraging bonds to avoid volatility. It's also likely cheaper to leverage bonds, and because leverage is fungible in a portfolio, my overall cost of leverage would be lower.

I got an opportunity to look into DXKLX a bit today. Analyzing the returns from Yahoo Finance, I found DXKLX's tracking error against 2xIEF to be slightly higher than the ER of DXKLX: about 2.16%. You can cut the numbers a few ways depending on how you treat IEF's dividends, but the chart of monthly tracking error is below. Taking out all monthly tracking errors above 0 and below -50 basis points, leaves an average monthly tracking error of ~18 basis points which comes to 2.16% non-compounded. Tack on .15% for IEF's ER and I believe we're looking at ~2.3% cost of leverage.

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Thanks for the pointer on the PIMCO funds. A brief look at the website and prospectus looks intriguing -- like you say they would be good to just give a little extra exposure in my accumulation years.

Lastly, I've tossed around the ideas of tilting towards emerging and small value (as well as long bonds) before as well. I haven't looked at Bill Bernstein's writings or Robert T, so that will be a little homework for me. Right now, I keep coming to a skepticism that the small value tilt is still there, given it's wide publicism. I can maybe see how more volatility means more return (just because risk must be compensated), but I'll have to think about whether those tilts are really more efficient than a balanced portfolio. I already do slightly tilt towards EM with 10% of my portfolio (11.1% of stocks) in VWO.

Theoretical
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Re: Derisking my Portfolio with a Leveraged Mutual Fund

Post by Theoretical » Sat Mar 03, 2018 12:39 pm

Since you posted, there's also this fund that's coming: http://www.etf.com/sections/daily-etf-w ... nopaging=1

It's a 90/60 Large Cap/Treasury Futures fund, which could be very interesting, especially for taxable accounts.

One thing to be cautious of RE: the PIMCO Plus funds is that their prospecti are pretty clear that the point of the Plus strategy is to provide positive returns NOT ballast or counter-weighting returns in a bear market. The strategy HAS done a good job at covering the expense ratio from the fund management, but it is not really going to give you recession protection. It might do better than the underlying equity assets would do in an inflationary cycle.

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