Larry Swedroe Q: sequence risk

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mlewis
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Larry Swedroe Q: sequence risk

Post by mlewis » Thu Jun 12, 2014 8:31 am

I understand the "Larry Portfolio" and it seems like a good strategy. But is this necessarily the best strategy for somebody who is saving or drawing down their portfolio over 30 years (as most people are doing one of). With heavy exposure to the SV asset class don't you face a risk that SV will underperform during a critical period, such as the end of the saver's timeframe or the beginning of the retiree's? Don't you face more "sequence risk" with a smaller group of asset classes in you portfolio?
Malcolm

Roy
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Re: Larry Swedroe Q: sequence risk

Post by Roy » Thu Jun 12, 2014 8:47 am

mlewis wrote:I understand the "Larry Portfolio" and it seems like a good strategy. But is this necessarily the best strategy for somebody who is saving or drawing down their portfolio over 30 years (as most people are doing one of). With heavy exposure to the SV asset class don't you face a risk that SV will underperform during a critical period, such as the end of the saver's timeframe or the beginning of the retiree's? Don't you face more "sequence risk" with a smaller group of asset classes in you portfolio?
Malcolm

Hi, Malcolm,

The LP is designed to work best when severe market drops crush higher beta portfolios (the Black Swan events as described in his new book); that is when it tends to outperform. The rest of the time it did pretty well considering its low commitment to equities. It tended to underperform higher beta portfolios in big market upswings. Regarding the timing of SV declines, this seems more challenging to predict. Around 2009, Larry showed some data that might be helpful to your question (using 83 years of data). I don't know if having more (equity) asset classes would offer significantly better protection than the LP or a TSM approach.

• TSM and SV both had 24 years where the returns were Negative.
• 18 of those 24 years both TSM and SV were Negative (same time).
• There were 6 years where TSM was Negative and SV Positive.
• There were 6 years where SV was Negative and TSM Positive.
• There were NO extended periods where SV was Negative and TSM Positive.
• The years where SV was Negative and TSM positive = 1939,1948,1953,1960,1987,1998.
• The years where TSM was Negative and SV positive = 1970,1977,1981,2000,2001,2007.
• There were no 2 consecutive years where SV went down and TSM up.
• There was 1 string of 2 years where TSM went down and SV up (2000-2001).

steve_14
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Re: Larry Swedroe Q: sequence risk

Post by steve_14 » Thu Jun 12, 2014 8:51 am

Q: Could a big bet on a corner of the market that's been hot lately (just as it was ice cold in the 80s and 90s) underperform during the draw-down phase?
A: Yes, which is why the experts unanimously argue for broadly diversified portfolios and against performance chasing.

dbr
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Re: Larry Swedroe Q: sequence risk

Post by dbr » Thu Jun 12, 2014 9:07 am

mlewis wrote:I understand the "Larry Portfolio" and it seems like a good strategy. But is this necessarily the best strategy for somebody who is saving or drawing down their portfolio over 30 years (as most people are doing one of). With heavy exposure to the SV asset class don't you face a risk that SV will underperform during a critical period, such as the end of the saver's timeframe or the beginning of the retiree's? Don't you face more "sequence risk" with a smaller group of asset classes in you portfolio?
Malcolm
The whole idea is that the Larry portfolio does NOT have a heavy exposure to highly volatile assets. The idea is to select more volatile volatile assets but less of them compared to a total market stock portfolio plus bonds that would have similar return. The idea is to reduce the tail risk of having the largest losses in stocks have too much of an effect on the portfolio as a whole while maintaining the expected return. Whether and to what degree data supports the idea you would have to investigate.

PS Larry did agree in responding to a question that the Larry Portfolio would probably reduce the likelihood of retirement ruin at a set particular withdrawal rate.

larryswedroe
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Re: Larry Swedroe Q: sequence risk

Post by larryswedroe » Thu Jun 12, 2014 10:19 am

First, the LP can be used to either
A) increase expected returns and risk by holding the same equity allocation but tilting more (or as much as possible) to small value, the highest expected returning asset class.
B) keep expected returns the same but lower risk by lowering beta exposure in amount sufficient to offset the higher expected return of the equity portion

No "right" way to use it. But if want to cut left tail risk without reducing expected returns IMO this is the best way to do that---giving up some right tail opportunity at the same time of course. So if have low marginal utility of wealth use it as in B above, if have high marginal utility of wealth use it as in A above

And yes if used in B you increase the odds of your portfolio NOT running out of money at a given withdrawal rate at "cost" of reducing the odds of leaving a certain sized estate (trading right tail opportunity for left tail reduction)

So doesn't matter if in accumulation or withdrawal really, can be used in both. Depends on marginal utility of wealth really. But in withdrawal where left tail risks can become heightened then IMO it is really a better mousetrap. Assuming of course that you can avoid the dread disease of tracking error regret resulting from confusing strategy with outcome

Larry

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docneil88
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Re: Larry Swedroe Q: sequence risk

Post by docneil88 » Fri Jun 13, 2014 2:52 am

mlewis wrote:...don't you face a risk that SV will underperform during a critical period, such as the end of the saver's timeframe or the beginning of the retiree's? Don't you face more "sequence risk" with a smaller group of asset classes in you portfolio?
Malcolm
Hi mlewis, Those risks can be largely mitigated by dividing your SV (small value) allocation between US SV, Foreign Developed SV, and Emerging Markets SV (or Emerging Markets Value, given the dearth of Emerging Markets SV funds). Best, Neil

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