Should I use margin to buy a balanced fund?

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garlandwhizzer
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Re: Should I use margin to buy a balanced fund?

Post by garlandwhizzer » Thu Jun 02, 2016 1:30 pm

Should I use margin to buy a balanced fund? No.

Garland Whizzer

joglehead
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Re: Should I use margin to buy a balanced fund?

Post by joglehead » Thu Jun 02, 2016 4:01 pm

Thanks Rob and Day9 that is interesting. It makes sense that due to margin call, max drawdown is an important consideration. It does, however, mean that rather than picking the portfolio with the highest rate of return vs. standard deviation, we are selecting based on our historical sample of drawdowns for different portfolios. In this case we are counting on a persistent negative correlation between US bonds and equities to continue a particular pattern of return dispersion. I'm sure you've thought about and perhaps discussed this Rob but correlations are obviously not constant, and as you've alluded to, our sample size probably isn't big enough to capture 5-sigma events where the negative correlation doesn't hold. Just want to make sure I'm thinking straight about the assumptions and risks.

Also, sorry for rehashing discussions you've already had. You almost need to add an FAQ post to this thread :) .

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Mon Jun 06, 2016 7:08 pm

Keep in mind that the future might not be anything like the past. Take any type of historical analysis with a grain of salt. The example was just that and not really a guide on how to pick your leverage. Hopefully, it was able to make a point -- not all risk is the same, so using something like standard deviation is an imperfect way to compare different risks because it treats everything as if they had a normal distribution. For example, as humans we treat loss very differently than gains. Say that we estimate the returns for stocks as +10%. A return of -10% or +30% would both be off by 20% from the estimate and statistically treated the same. However, we value the outcomes very differently.

Correlations are another very tricky measure. Ideally, when we invest, we choose assets that we expect will have positive returns over our investment period, right? That directly implies that there will be some positive correlation. When we say correlation, what we really want to understand is the behavior of one asset when the other goes down.

There have been some attempts to enhance Modern Portfolio Theory and change the definition of risk from standard deviation to a more intuitive one that only looks at "downside" as the risk. One example is Post-Modern Portfolio Theory.

DrF
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Re: Should I use margin to buy a balanced fund?

Post by DrF » Wed Aug 03, 2016 4:48 pm

Was wondering if you'd had a chance to update your spreadsheets recently. It'd be interesting to know how the experiment has done with the downturn in late '15 and early '16, then the uptick until now.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Wed Aug 03, 2016 5:04 pm

Good question. I am still doing the experiment, but I haven't had the time to keep the spreadsheet updated. You aren't the only person to ask, so I figure I need to find some time to work on it.

I will say that the portfolio is definitely up from the beginning of the year, and I am looking at double digit returns since the beginning of 2015 until now. I'll need to get an updated CAGR so we can do an apples-to-apples comparison.

DrF
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Re: Should I use margin to buy a balanced fund?

Post by DrF » Thu Aug 04, 2016 12:31 pm

Rob Bertram wrote:While the long-term Sharpe ratio might be the same, different aspects of the risk profile improve when I switch to a portfolio that is heavily weighted in short-term treasuries. For example, max drawdown is more favorable for the short-term treasury portfolio. The Sortino ratio is higher. Here's an example in Portfolio Visualizer: 40/60 vs 10/5/85 (asset class, fund)

As for the leverage ratio, say that I'm comfortable with a maximum 75-80% loss. The 40/60 portfolio saw a 15% drawdown, so I was going about 5-6x with that portfolio. The 10/5/85% portfolio saw a 3% max drawdown, so I could go about 25-26x. And I am still in the "accumulation" phase, I can stay at the upper end of those leverage numbers and not sweat it.
Rob,

I was going through your backtesting and I'm unsure if the asset class and fund portfolio examples you linked is apples-to-apples. Seems like for the asset class test you shouldn't have put anything in the total stock market section (instead you would choose large cap blend for a S&P500 index), or in the 10-year (in scenario #1) and intermediate-term treasuries sections (in scenario #2), but rather 20% and 85% into the short-term treasuries section (in scenarios #1 and 2 respectively). This, I think, more accurately reflects the same assets as the "fund" example you linked, and more importantly, probably resembles your real life portfolio. As a bonus, when testing by asset class the data go back to 1972, rather than 1992 using the specific funds (20 more years worth of testing). I've also changed the scenario to more accurately reflect what you are doing (continual contributions vs lump sum), unfortunately it won't let me model monthly contributions.

Running this setup, the 40/60 portfolio gives a max drawdown of 11.76%, while the 10/5/85 portfolio gives a max drawdown of just 0.73%. Both have almost identical Sharpe ratios, with a slightly higher Sortino ratio for the 10/5/85. Therefore, you could leverage the 40/60 portfolio still only 6-7x, but the 10/5/85 portfolio could be leveraged >100x if you were willing to accept an 80% loss at some point.

Have you run the analysis to test where a break even point is between the higher CAGR but lower leveraged vs the lower CAGR but higher leveraged portfolio? Because the 40/60 portfolio gives much better IRR (+2.75% annually) over the entire 1972-2015 analysis.

DrF
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Re: Should I use margin to buy a balanced fund?

Post by DrF » Fri Aug 05, 2016 11:20 am

Also, are you concerned about the recent 3 and 5 year rolling returns for the 10/5/85 portfolio? The chart is pretty right skewed, with much of the best returns coming in the late 70s-90s. I guess if you take even a very low 2% average 3 year rolling return and multiply it by 25, 50, or 100x using leverage, the return should come out pretty great.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Fri Aug 05, 2016 12:15 pm

We might be splitting hairs as to which asset class is an acceptable proxy for the S&P 500. You're right that the total stock market has small cap whereas the S&P 500 does not, but the S&P 500 has some mid cap however Large Cap Blend does not. As far as the 20% allocation to 5-year, 10-year, and 20-year treasuries, that was an attempt to diversify across term risk. Nisiprius points out in a different thread that (from a CAPM perspective) leverage and duration for treasuries are mathematically equivalent. That is why I eliminated the intermediate-term treasuries and replaced them with short-term treasuries in the second portfolio. I still feel that long-term treasuries add some uncorrelated volatility to stocks, though it might not be statistically different from shorter-term treasuries.

One thing to keep in mind when calculating the maximum leverage ratio is that max drawdown needs to include the financing rate as well. So for example, even though the 10/5/85 portfolio had a historic max drawdown of 0.73%, the cost to borrow might have been 4%. So a realistic leverage ratio might be 15x. (And one word of caution, intra-year drawdown was likely much higher than 0.73%.)
DrF wrote:Have you run the analysis to test where a break even point is between the higher CAGR but lower leveraged vs the lower CAGR but higher leveraged portfolio? Because the 40/60 portfolio gives much better IRR (+2.75% annually) over the entire 1972-2015 analysis.
That's the power of the Sharpe ratio (and CAPM), right? Portfolios with the same Sharpe ratio have the same risk-adjusted return. The increased return is offset by the increased risk (standard deviation). There is no break even point from a CAPM perspective.

Now, having said that, there are different types of risk than standard deviation, so the two portfolios are definitely not the same. The drawdown (left-tail -- whatever you want to call it) risk is clearly different between the 40/60 and the 10/5/85 portfolio. One way to compare the two portfolios at different leverage ratios is to focus on the notional stock percentage. For example, say I am contemplating going 6x 40/60 or 26x 10/5/85. They both have similar expected drawdowns. The notional stock position would be 240% (6x40) for the first portfolio and 260% (26x10) for the second.

And, of course, I should warn everyone that the above is an example and not a result of analysis.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Fri Aug 05, 2016 12:19 pm

DrF wrote:Also, are you concerned about the recent 3 and 5 year rolling returns for the 10/5/85 portfolio? The chart is pretty right skewed, with much of the best returns coming in the late 70s-90s. I guess if you take even a very low 2% average 3 year rolling return and multiply it by 25, 50, or 100x using leverage, the return should come out pretty great.
Nope, I'm not concerned at all at the prospect of lower expected returns. I am happy to take 2% (or 1.5% after 0.5% financing) and multiply it by 25.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sun Aug 07, 2016 12:22 pm

The spreadsheet is mostly updated. I've been working on it between other activities, so I might have accidentally missed a few things, but it looks to be accurate.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Mon Aug 08, 2016 6:21 am

So I guess the next question after a couple years of 50% returns is what to do once I hit my target. The simple answer is that I'll reduce my leverage. That is the essence of the strategy outlined in Ayres and Nalebuff's "Mortgage your Retirement." Though, I haven't really put much thought into a strategy thinking that it would be years off.

Technically, Ayers and Nalebuff suggest leveraging stocks until you hit your target stock allocation notional value, then de-risk in two different phase. Start by de-leveraging stocks, and finally buy bonds to your target AA. My approach is slightly different in that I'm leveraging a balanced portfolio of stocks and bonds, so the strategy to reduce risk is a little easier -- I just reduce my leverage and maintain my AA.

Here's my current plan. I am open to comments, but this is my current thinking. The following numbers are in notional values.
  • Less than $10 million, target 26 - 30x leverage.
  • Between $10 and $12 million, target 21 - 25x leverage.
  • Between $12 and $15 million, target 16 - 20x leverage.
  • Above $15 million, target 10 - 15x leverage.
For reference, the notional value of the portfolio today is around $6.45 million.

DrF
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Re: Should I use margin to buy a balanced fund?

Post by DrF » Mon Aug 08, 2016 9:45 am

Hi Rob,

Excellent returns so far! A few things that pop out at me -

1) Did you expect to see such volatility in your 10/5/85 portfolio? It looks like your maximal drawdown was ~36% on 1-13-16. This seems like a relatively large drawdown for the moderate market action over the period, no? What happens when the fed really starts to change rates? Unexpected election results? Large scale terrorist attack?

2) Have you thought about modeling without continuous contributions? Seems like it would have greater drawdown/more volatility.

3) IMO the leverage is a bit high given the volatility in the brief history of the experiment. You levered up to 45x at your peak drawdown. Have you thought about reducing the leverage going forward? Is the goal to push the envelope to see how much leverage can be applied, or is it to safely beat the market?

4) Your deleveraging plan doesn't quite make sense to me in that you could realistically stay levered at 16-20x from now until forever due to the original setup of the balanced portfolio. I'd go a little more conservative on the front end (reduce exposure to black swan event), but keep the leverage higher long-term. Less risk and more reward IMO.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Mon Aug 08, 2016 5:09 pm

Well, the benchmark portfolio (100% stocks) had about 23% return over the same period. That was from the continual monthly accumulation over a rather volatile period. Getting 2x the return for 3x the volatility is mostly an exercise of personal risk tolerance.
  1. I don't know what volatility looks like. From a statistical/modeling standpoint, I understand what it represents. But I can't honestly say that I could prepare myself for higher volatility. I have made an argument that higher amounts of leverage have higher volatility which allow for more frequent rebalancing -- sometimes called volatility harvesting. I definitely planned for it from that perspective. On the other, hand I do know what drawdown looks like, and I have prepared myself for 75-80% drawdown.
  2. Yes, I did my original risk modeling with no contributions. And you are correct, periodic contributions have a significant impact on how much leverage I can use. One thing to keep in mind is that the market has never dropped by 50% in a single day or month. It happens over years.
  3. Well, I am outlining when and how I plan to reduce leverage. :) The original goal of the exercise was to push the envelope and to see how well my modeling works. I don't want to go bust, but I do want to see if I can understand that boundary. Plus, this experiment with my own money allows me to validate my risk tolerance.
  4. Be careful, you need to include the financing rate when calculating the max drawdown. For example, if interest rates rise to 4% and markets are flat, then I lose 60% of my portfolio at 15x leverage. Long-term, interest rates may not stay as low as they are now.
If I ever get tired of rolling futures contracts, I'll probably transition to a 2-fund portfolio so I can focus on more important things and enjoy life. With large amounts of leverage (greater than $3 million), margin loans from Interactive Brokers start to become competitive with futures financing rates.

DrF
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Re: Should I use margin to buy a balanced fund?

Post by DrF » Wed Aug 10, 2016 2:45 pm

On your spreadsheet, were you able to auto populate the daily close prices for the bond futures? If so, could you explain how?

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Wed Aug 10, 2016 5:19 pm

DrF wrote:On your spreadsheet, were you able to auto populate the daily close prices for the bond futures? If so, could you explain how?
Sadly, no. I use Quandl to get the futures closing prices. I tried to use google formulas to get the ETF close prices, but the formulas would occasionally return #N/A for no apparent reason. So the spreadsheet is all manual right now which is why I've been lazy about keeping it updated.

Swelfie
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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Wed Aug 10, 2016 6:47 pm

Rob Bertram wrote:Sadly, no. I use Quandl to get the futures closing prices. I tried to use google formulas to get the ETF close prices, but the formulas would occasionally return #N/A for no apparent reason. So the spreadsheet is all manual right now which is why I've been lazy about keeping it updated.
=GOOGLEFINANCE() gets stuck sometimes. An F5 always fixes it for me.

Beliavsky
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Re: Should I use margin to buy a balanced fund?

Post by Beliavsky » Thu Aug 11, 2016 6:28 pm

Thanks to the OP for an interesting thread.

Are the stock index futures used S&P 500 futures? If you believe in international diversification, should you add stock index futures from other markets, use the Eurostoxx 50, FTSE 100, and Nikkei? They are all accessible from Interactive Brokers, I believe. The S&P has done better than most other markets in recent decades, but the question is whether one should expect that to continue.

Heavy leverage does carry the small but non-zero risk of a "black swan" that does not appear in the backtest but which results in returns below -100%. This cannot happen in a typical Boglehead portfolio that is long mutual funds and ETFs without the use of margin. Have you considered creating an limited liability corporation (LLC) and trading the strategy through that? If I were trading the strategy in substantial size, I would probably do this.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Thu Aug 11, 2016 9:59 pm

Beliavsky wrote:Thanks to the OP for an interesting thread.

Are the stock index futures used S&P 500 futures? If you believe in international diversification, should you add stock index futures from other markets, use the Eurostoxx 50, FTSE 100, and Nikkei? They are all accessible from Interactive Brokers, I believe. The S&P has done better than most other markets in recent decades, but the question is whether one should expect that to continue.

Heavy leverage does carry the small but non-zero risk of a "black swan" that does not appear in the backtest but which results in returns below -100%. This cannot happen in a typical Boglehead portfolio that is long mutual funds and ETFs without the use of margin. Have you considered creating an limited liability corporation (LLC) and trading the strategy through that? If I were trading the strategy in substantial size, I would probably do this.
Yep, I'm using the e-mini S&P 500 futures. In general, I believe in international stock diversification. The problem is that there is no good single future for international. Right now, stocks are only 10% of the portfolio. If I were to add international to the mix, it would only be 3%, and it's not worth the effort. I feel that I get sufficient diversification with S&P500 and treasuries. There's no reason for perfect to get in the way of something that is good.

When I reduce leverage, I could establish an international stock position using an ETF (i.e., VXUS).

edit: I forgot to address the 100% loss question. Nope, no plans to create an LLC to isolate myself from a potential black swan. I've spent some significant time modeling a stock/treasury portfolio, so this experiment is to validate my model and strategy. So far, it is behaving as I expected. I will have to do this for several years so as not to confuse outcome with strategy.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sat Aug 13, 2016 11:26 am

DrF wrote:2) Have you thought about modeling without continuous contributions? Seems like it would have greater drawdown/more volatility.
So I answered the direct question above. (Yes, I did my core modeling without continual contributions.) And I did some modeling to see how much more I can leverage with contributions (accumulation phase). However, I have not yet modeled what withdrawals (decumulation) do to the risk profile.

I want to think of a withdrawal from the portfolio as a temporary increase in leverage. I wouldn't sell any assets unless I was at some maximum threshold. I'm still working on an approach and welcome comments.

Swelfie
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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Sat Aug 13, 2016 7:05 pm

Rob Bertram wrote:So I answered the direct question above. (Yes, I did my core modeling without continual contributions.) And I did some modeling to see how much more I can leverage with contributions (accumulation phase). However, I have not yet modeled what withdrawals (decumulation) do to the risk profile.

I want to think of a withdrawal from the portfolio as a temporary increase in leverage. I wouldn't sell any assets unless I was at some maximum threshold. I'm still working on an approach and welcome comments.
I use a very similar portfolio, although mine is more complex (I adjust equity exposure in domestic, developed and emerging markets separately based on momentum+ valuation, I'm 40/60 equities/bonds with long term treasuries on the equities side when I pull out of equities in a market based on the above metric, I have a slight momentum/quality/small/value tilt and I throw in just a splash of commodities and tips all to keep standard deviation down) . I also am no where near as levered as you, and for good reason; you have way more short term treasuries. Buy the idea is similar; reduce std dev in a balanced portfolio and lever up to a sane gearing for that std dev.

What I do is this: measure std dev in backtest and in live trading. I calculate estimated CAGR in backtest, shiller-cape/bond-yield/est factor returns, and live trading returns. This gives 2 std dev measures and 3 CAGR measures. From these I calculate 6 separate kelly criterion measurements and take the minimum, since none of these can be trusted I want the most conservative. This is my maximum target leverage.

Then I track some economic indicators. I want to be delevering in anticipation of times that may force me to lever up above my kelly criterion. If yield curve is inverted in any way, or vix>20 or vxv>20 or vxv:vix>1.2 (indicating expected steep ride in vix) or unemployment is higher than 12 month moving average, then all dividends and contributions go to delevering the portfolio. I keep track of my lowest leverage during these periods and set that as my target to stay under. In months when none of these indicators are present, I move my leverage target towards my kelly criterion at a rate of 1/VIX per month. This edges me towards my max leverage during good times and delevers in more uncertain times.

I would expect it to work the same for drawdown, but with contributions just being negative. I don't expect to be levered during drawdown though. I plan on hitting a target and letting the portfolio just delever itself to 1x and then maintain.

aaaaaaabbbbbbbbbb
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Re: Should I use margin to buy a balanced fund?

Post by aaaaaaabbbbbbbbbb » Sun Aug 14, 2016 1:04 am

I'm checking in to see how well you've done but I'm a bit confused. The spreadsheet you linked to in the OP (which I haven't entirely figured out) says an IRR of about ~0% for both the benchmark and the leveraged strategy, if I'm reading it correctly. Is this correct? What about the potential changes in your strategy that you've mentioned? Have you switched to 26x 10/90 as you've contemplated? Is that being tracked somewhere?

I guess what I'm trying to say is I'd appreciate it if you could provide a short performance/changes-in-investment-strategy summary for someone who can't figure out what happened in the last ten pages.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sun Aug 14, 2016 10:06 am

Here are the cliff notes:
Rob Bertram wrote:Nisiprius has a thread called Does higher volatility make long-term bonds + stocks better than intermediate-term bonds + stocks?. He shows that bonds with different duration have the same risk-adjusted returns, so one can convert a stock/long-term bond portfolio to a stock/intermediate bond by adjusting the asset allocation (and possibly adding leverage).

With that in mind, I could see simplifying my portfolio from 5x 40% stock/30% long-term bond/30% intermediate-term bond to (for example) 10x 10% stock/90% short-term bond. I'm not sure if that's the correct AA, but I'll definitely spend some time pulling up historical data for 2-year treasuries.
Rob Bertram wrote:I'm still digging up 2-year treasury data, but it looks fairly promising so far. A 10x 10% stock/90% short-term treasury portfolio seems to do better than the 2.5x 40/60 portfolio I've been modeling. So 24x of the 10/90 portfolio would be similar to the 6x that I am doing now. (Yes, leverage is down from 7x to about 6x due to monthly contributions and market movements.)

I am noticing that a 10% stock / 5% long-term treasury / 85% short-term treasury has a similar risk-adjusted return.

I have to roll contracts at the end of the month. I will have my models updated before then, and I'll switch to 2-year futures if it makes sense. I'll post an update when I have better information.
Rob Bertram wrote:The spreadsheet is mostly updated. I've been working on it between other activities, so I might have accidentally missed a few things, but it looks to be accurate.
From a portfolio standpoint, I "simplified" it by converting the intermediate treasuries to short-term treasuries and increasing the leverage such that they have the same Sharpe ratio. From a maximum drawdown perspective, the 85% short-term treasuries have less interest rate sensitivity and recover faster. I switched to the 26x portfolio about a year ago. The experiment is up about 46% compared to the benchmark portfolio's 22%.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Fri Aug 19, 2016 3:17 pm

Swelfie wrote:I would expect it to work the same for drawdown, but with contributions just being negative. I don't expect to be levered during drawdown though. I plan on hitting a target and letting the portfolio just delever itself to 1x and then maintain.
That is one approach. Construct a portfolio for extreme leverage during the accumulation phase. Once you hit your number, switch to a conventional portfolio with conventional withdrawal rate.

But let's assume for the sake of discussion that I continue to maintain a leveraged portfolio into retirement: I have $1.5m leveraged 10x for a notional portfolio value of $15m. Let's say that I want to withdraw 6% of that portfolio, or $90k per year. I choose not to sell any assets but let my leverage drift, that puts my leverage ratio up to 15m/1.41m = 10.6x. That is well within my 10x - 15x leverage target. From a different perspective, the 10/5/85 portfolio has an expected 1% return after financing costs. Leveraging that 10x - 15x would put me around 10% - 15% expected return. That should easily sustain a 6% withdrawal rate.

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Thu Aug 25, 2016 4:03 pm

Conversation continued from Time Diversification - bottom line, what do you do?.
Swelfie wrote:
Rob Bertram wrote:I think we might be going down two different paths. My comments are around a balanced portfolio of stocks and bonds. Transitioning a portfolio from intermediate-term bonds to short-term bonds is an exercise in aligning the Sharpe ratio. I might have confused you, the goal was not to synthesize a higher-duration bond by leveraging lower-duration bonds.

Leverage definitely increases the interest rate sensitivity linearly. For example, if I leveraged 2-year duration bonds by 3x, I would expect a 6% drop in value for every 1% increase in yield. That makes sense, right? The notional portfolio drops by 2%, and that is magnified by my 3x leverage. On the other hand, the notional portfolio still consists of 2-year duration bonds, so I would expect the point of indifference to still be 2 years (assuming no future change in yield), not 6 years.
Yeah, I know your intent wasn't to synthesize a longer duration bond by leverage, I'm just saying that's what you did ;). And I did some of math. The bond you synthesize when you leverage a 2 year term to maturity bond has the duration determined by the function (durationOfBondsCarried * ValueOfBondsCarried - durationOfNegativeBondPayingForLeverage * valueOfLeverage)/ValueOfUnleveragedBonds. Since the duration of a 2 year Treasury is about 1.96, if you lever it out 2.5x you get a 6-7 year bond. Close to 5 but it overshoots because you aren't scaling term to maturity linearly, you are scaling duration. Your 25x is basically turning those 2 year bonds into 40 year bonds.
Leverage does wonky things to bonds. When you say duration, which of the following do you mean?
  1. Interest rate sensitivity: When interest rates rise by Y%, the bond value drops by (Y * D)%
  2. Years to point of indifference: When interest rates rise by Y%, the number of years D of reinvesting cash flow to recover from the above drop
I agree that (A) scales linearly with leverage. However, (B) does not. The notional portfolio will still reach a point of indifference in D years. Now, financing will be a drag on portfolio returns, but interest rate changes are not necessarily uniform across the yield curve.
Swelfie wrote:Now my thought was that maybe it didn't make sense to floor leverage, because with a good yield roll, half your returns can be roll with the other half being coupon (and anything else just market timing luck from yield volatility). So maybe, when levering bonds, since your coupon you really have no control over, nor do you have control over yield to maturity, you can have a better sharpe ratio be moving your term to maturity to an optimal yield roll, but keeping it a 40 year bond in duration. So maybe when you roll your contract, if your best yield roll is out at 10 year Treasuries this quarter, you might want to roll your contract there but drop your leverage from 25x to about 3.9x, which would give you the same synthetic position you are in now from a risk perspective but your expected returns would be better, giving you a better sharpe ratio. I mean, you are rolling anyway, just ask the spreadsheet where to roll to and what leverage level to retain your same position at a better expected return. But when I started playing with the maths i think I am seeing some anomalies and I think there might be something to this inherently higher sharpe ratios on short term that isn't explained by the roll yield (although that seems to be a competing factor). I'm mathing more and looking for that paper you mentioned now. I definitely need some complicated back testing on this to be sure.
Remember, that my focus is a balanced portfolio. When my portfolio grows (either from my monthly contributions or from appreciation), I buy more assets up to my target leverage ratio and according to my AA. Having a lower limit allows me to compound the growth. Ignoring contract rolls, I only sell to rebalance (which hasn't been necessary yet). Though, there has been plenty of buying of one asset mostly due to volatility.

I'm not sure that I see the value in the yield roll and capitalizing on the volatility. But maybe I don't truly understand its importance. I hear what you are saying, though. Higher yield means that price is lower. So instead of looking at the bond portion of my portfolio as a fixed amount of money, I should look at it as some measure of "duration" (interest rate sensitivity). If that number is 40 years, I could get there with 2x 20-year, 4x 10-year, 8x 5-year, or 20x 2-year. When I roll my futures contracts, you are saying I should pick the cheapest one. More precisely, pick the one with the highest Sharpe ratio.

I'll have to work through a couple of examples and see what would happen with a 0.25% rate change.

Swelfie
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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Thu Aug 25, 2016 9:19 pm

Rob Bertram wrote:I'm not sure that I see the value in the yield roll and capitalizing on the volatility. But maybe I don't truly understand its importance. I hear what you are saying, though. Higher yield means that price is lower. So instead of looking at the bond portion of my portfolio as a fixed amount of money, I should look at it as some measure of "duration" (interest rate sensitivity). If that number is 40 years, I could get there with 2x 20-year, 4x 10-year, 8x 5-year, or 20x 2-year. When I roll my futures contracts, you are saying I should pick the cheapest one. More precisely, pick the one with the highest Sharpe ratio.
Yes, that is what I was saying. I'm going down a research rabbit hole and second guessing myself now that I'm looking at the unreasonable returns of 3 and 6 months treasuries. I'm wishing there was a 3 or 6 month future contract to play with on these. The sharpe ratio for 3 months is pretty unbelievable. 2 year gets you only part of the way there.

But yes, you are correct in what I was saying for the most part. (and I misspoke earlier, 2yr treasuries leveraged 25x are more like 55yr treasuries in duration.) So say you wanted to take your 10/5/85 portfolio and leverage it 25x. The way to do it as I was stating is to take the 10/5 portion and leverage 25x. Then take the 85 portion and consider it a single 55yr treasury bond. Now take the difference in current yield between a 1 and 2 year treasury, a 3 and 5 year treasury, and a 7 and 10 year treasury, a 10 and 20 year treasury, and a 20 and 30 year treasury, as these are the futures you can buy. divide each of these 5 numbers by the number of days in the period between them. That gives you the slope of the yield curve at each of these points. Take the highest slope and calculate the amount of leverage it would take to make a bond at that point into a synthetic 55 year treasury. Then roll your future into that point, which should leave you with the same effective risk you were at before you rolled, for instance, moving you from a 25x 2 yr into a 1.5x 30 yr. All other things being equal, that synthetic bond should produce the highest gain (due to more rapid yield reduction as the bond ages) and the highest resilience to rate changes (increases in yield should be muted and decreases amplified due to mean regression) of all 5 of your choices for the immediate future.

But now I'm not so sure. Looking at very low maturity bonds I do see an advantage to this affect, but there seems to be another factor, or factors in play. It may be BaB, or something else. I'm planning on back testing this strategy against your portfolio using 3 month, 6 month and 1 year treasuries to see how they compare against each other. Right now I'm thinking the 3 month will dominate. A 3/6 month switching strategy like above may beat it, but I'm starting to think that above 2 years this other mystery factor dominates yield roll most of the time. Now if only there was a good contract for 3 month treasuries.

And yes, I am interest in you expounding on your point #2 above.

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Re: Should I use margin to buy a balanced fund?

Post by Beliavsky » Fri Aug 26, 2016 5:31 am

Swelfie wrote:
Rob Bertram wrote:I'm not sure that I see the value in the yield roll and capitalizing on the volatility. But maybe I don't truly understand its importance. I hear what you are saying, though. Higher yield means that price is lower. So instead of looking at the bond portion of my portfolio as a fixed amount of money, I should look at it as some measure of "duration" (interest rate sensitivity). If that number is 40 years, I could get there with 2x 20-year, 4x 10-year, 8x 5-year, or 20x 2-year. When I roll my futures contracts, you are saying I should pick the cheapest one. More precisely, pick the one with the highest Sharpe ratio.
Yes, that is what I was saying. I'm going down a research rabbit hole and second guessing myself now that I'm looking at the unreasonable returns of 3 and 6 months treasuries. I'm wishing there was a 3 or 6 month future contract to play with on these. The sharpe ratio for 3 months is pretty unbelievable. 2 year gets you only part of the way there.
The Sharpe ratio over the last 3 months should not get too much weight in setting current positions, but even over longer periods, the Sharpe ratio of short-term bonds has been high. One can buy Eurodollar or Fed Funds futures to capture this risk premium, although Eurodollar futures also have some exposure to the credit risk of big banks.

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Re: Should I use margin to buy a balanced fund?

Post by DrF » Fri Aug 26, 2016 9:40 am

Swelfie wrote:But yes, you are correct in what I was saying for the most part. (and I misspoke earlier, 2yr treasuries leveraged 25x are more like 55yr treasuries in duration.) So say you wanted to take your 10/5/85 portfolio and leverage it 25x. The way to do it as I was stating is to take the 10/5 portion and leverage 25x. Then take the 85 portion and consider it a single 55yr treasury bond. Now take the difference in current yield between a 1 and 2 year treasury, a 3 and 5 year treasury, and a 7 and 10 year treasury, a 10 and 20 year treasury, and a 20 and 30 year treasury, as these are the futures you can buy. divide each of these 5 numbers by the number of days in the period between them. That gives you the slope of the yield curve at each of these points. Take the highest slope and calculate the amount of leverage it would take to make a bond at that point into a synthetic 55 year treasury. Then roll your future into that point, which should leave you with the same effective risk you were at before you rolled, for instance, moving you from a 25x 2 yr into a 1.5x 30 yr. All other things being equal, that synthetic bond should produce the highest gain (due to more rapid yield reduction as the bond ages) and the highest resilience to rate changes (increases in yield should be muted and decreases amplified due to mean regression) of all 5 of your choices for the immediate future.

But now I'm not so sure. Looking at very low maturity bonds I do see an advantage to this affect, but there seems to be another factor, or factors in play. It may be BaB, or something else. I'm planning on back testing this strategy against your portfolio using 3 month, 6 month and 1 year treasuries to see how they compare against each other. Right now I'm thinking the 3 month will dominate. A 3/6 month switching strategy like above may beat it, but I'm starting to think that above 2 years this other mystery factor dominates yield roll most of the time. Now if only there was a good contract for 3 month treasuries.
I don't think that Rob is interested in "gain" necessarily from the 5/85 bond positions, but think of it rather as a ballast. Leveraging the e-mini 25x (even though you're only holding it at 10% of your portfolio), can cause some major stress. So, the rest of your portfolio you want to either hold 1) assets that are uncorrelated with the e-mini, 2) assets that don't have inherently large volatility, or 3) assets that are uncorrelated and don't have large volatility. LTTs get you #1, but can be very volatile. STTs get you 1 and 2, plus a bonus of being more resilient (compared to longer term debt) in a rising interest rate environment (which we are more than likely very near). You want a portfolio that lets the 10% do all the work, and the 90% to provide safe harbor for your account. Ideally, the 10/5/85 leveraged at 25x should return a minimum of 2.5x the S&P500, with REDUCED volatility.

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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Sun Aug 28, 2016 3:25 am

DrF wrote: I don't think that Rob is interested in "gain" necessarily from the 5/85 bond positions, but think of it rather as a ballast. Leveraging the e-mini 25x (even though you're only holding it at 10% of your portfolio), can cause some major stress. So, the rest of your portfolio you want to either hold 1) assets that are uncorrelated with the e-mini, 2) assets that don't have inherently large volatility, or 3) assets that are uncorrelated and don't have large volatility. LTTs get you #1, but can be very volatile. STTs get you 1 and 2, plus a bonus of being more resilient (compared to longer term debt) in a rising interest rate environment (which we are more than likely very near). You want a portfolio that lets the 10% do all the work, and the 90% to provide safe harbor for your account. Ideally, the 10/5/85 leveraged at 25x should return a minimum of 2.5x the S&P500, with REDUCED volatility.
At 85%, by my calculations the STTs have pretty much the same expected returns as the eminis, and leveraged to am aproximately 45 year duration they are WAY more susceptible to rate hikes than a 30 year bond, especially since a rate hike is likely to flatten the yield curve, affecting his 2 years disproportionately. But so this isn't the case of taking your risk on the equity side. Rob is taking his risk and return fairly equally on both sides (which I like, he's pretty maximally diversified stock/bond-wise).

But I wasnt really talking about increasing returns on the bond side. I was thinking it might reduce volatility.

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Re: Should I use margin to buy a balanced fund?

Post by collected » Wed Aug 31, 2016 4:35 am

You should not use leverage (meaning more than 100% liquid assets) to buy a balanced fund. Even if it costs nothing to be leveraged the expected return can actually be lower depending on the leverage amount and standard deviation amount. If an asset were to go up 0.01% every single day with no chance of it ever going down then you go 10,000x leveraged on it and make money. However once you add in that standard deviation amount you'll notice that the more volatility an asset has the more likely you are to lose money either by rebalancing or risk of ruin.

Theoretically the risk of ruin approaches near 100% over a long enough time period if deleveraging isn't implemented. However if the position is deleveraged/rebalanced then you'll be selling the position after it falls which lowers the rate of return. It takes a 100% gain to offset a 50% loss and because of this if you flipped a coin and increased your bankroll by 50% if you landed on heads and decreased your bankroll by 50% if you landed on tails then your expected rate of return on each flip would be negative 13.33%.

In the real world you are going to pay money to be leveraged. For example in e-mini futures you're going to have to pay spread when rolling onto the next month and be under the 60/40 rule. Whether or not leverage actually increases the rate of return is based on factors such as leveraged amount, deviation, expected rate of return of the asset, cost to borrow etc... We don't know what those things really are going to be in the future. Going leveraged might look good on paper now however being just 1% off can result in massive loses over an unleveraged portfolio.

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Re: Should I use margin to buy a balanced fund?

Post by Waba » Fri Sep 09, 2016 9:03 pm

I was wondering, with both bonds and stocks taking a bit of a hit today, what damage did that do to the leveraged portfolio?

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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Sat Sep 10, 2016 12:14 am

Waba wrote:I was wondering, with both bonds and stocks taking a bit of a hit today, what damage did that do to the leveraged portfolio?
My 1MM in 2 year Treasury futures lost something like $200 today, so it's not a big swing on the bond portion of the portfolio.

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Re: Should I use margin to buy a balanced fund?

Post by in_reality » Sat Sep 10, 2016 1:34 am

Swelfie wrote:
Waba wrote:I was wondering, with both bonds and stocks taking a bit of a hit today, what damage did that do to the leveraged portfolio?
My 1MM in 2 year Treasury futures lost something like $200 today, so it's not a big swing on the bond portion of the portfolio.
What happens in a threat of default or actual default?

The treasury has been on record before as saying"there's no way to avoid a default without raising the debt limit". What if the debt hadn't been raised?

No problem?

Of course I expect the US to pay eventually so the question is really about a short term market crisis as opposed to the actual economic collapse of the US.

How would markets react? You'd sail through with no margin call? I wonder how stocks would react too.

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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Sat Sep 10, 2016 2:09 am

in_reality wrote:How would markets react? You'd sail through with no margin call? I wonder how stocks would react too.
For me personally, in such an event I'd probably be more concerned on the equity side. In the event of a US Treasury default everything is going to be tanking hard. I would suspect that 2 year Treasuries would be tanking the least since everyone knows the us will make good eventually. Developed international bonds might be doing good on such a day.

But let's imagine that 2yr Treasuries is my entire portfolio to keep things simple. It's about $600 margin for $220,000 of 2 year Treasuries. Now this is in my pre-tax 401k, so if I utilize my actual margin and take a loan then taxes are pretty high (essentially income tax level) so I don't utilize debt for margin although I could.

So portfolio margins account of $200k let's say. 10x gearing on 2k Treasuries. That's 2MM In Treasuries with a required margin of about $5000 cash needed. I'm not sure what portfolio margins would give me, but probably 10% needed to keep my position open. So o would have around $380,000 equity to support a position requiring $5000 so 2 year Treasuries would need to fall around 20% before I needed to start selling. That doesn't account for new contributions, which i would undoubtedly be making in such an event, on top of my regular monthly contribution.

Could 2 year Treasuries fall by 20%? Any thing is possible, but that would be unprecedented for something often referred to as the "risk free rate". Im thinking in such a black swan environment that we are all screwed. I would likely hunker down in 3x leveraged 5 year ETFs, await recovery and lick my wounds. I would certainly not escape that unscathed.

Since I'm not in 100% Treasuries though, the equity side of my portfolio would kill me much faster I assume were the world to catch fire like that.

For perspective, today was a very bad day for Treasuries. At its worst 2 years were down about 0.05%. 20% loss is apocalyptic.
Last edited by Swelfie on Sat Sep 10, 2016 2:22 am, edited 1 time in total.

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Re: Should I use margin to buy a balanced fund?

Post by in_reality » Sat Sep 10, 2016 2:22 am

Swelfie wrote:
in_reality wrote:How would markets react? You'd sail through with no margin call? I wonder how stocks would react too.
For me personally, in such an event I'd probably be more concerned on the equity side. In the event of a US Treasury default everything is going to be tanking hard. I would suspect that 2 year Treasuries would be tanking the least since everyone knows the us will make good eventually. Developed international bonds might be doing good on such a day.

But let's imagine that 2yr Treasuries is my entire portfolio to keep things simple. It's about $600 margin for $220,000 of 2 year Treasuries. Now this is in my pre-tax 401k, so if I utilize my actual margin and take a loan then taxes are pretty high (essentially income tax level) so I don't utilize debt for margin although I could.

So portfolio margins account of $200k let's say. 10x gearing on 2k Treasuries. That's 2MM In Treasuries with a required margin of about $5000 cash needed. I'm not sure what portfolio margins would give me, but probably 10% needed to keep my position open. So o would have around $380,000 equity to support a position requiring $5000 so 2 year Treasuries would need to fall around 20% before I needed to start selling. That doesn't account for new contributions, which i would undoubtedly be making in such an event, on top of my regular monthly contribution.

Could 2 year Treasuries fall by 20%? Any thing is possible, but that would be unprecedented for something often referred to as the "risk free rate". Im thinking in such a black swan environment that we are all screwed. I would likely hunker down in 3x leveraged 5 year ETFs, await recovery and lick my wounds. I would certainly not escape that unscathed.

Since I'm not in 100% Treasuries though, the equity side of my portfolio would kill me much faster I assume were the world to catch fire like that.
I think you are right about the two years not being at real risk and we'd likely see a resolution in weeks if not months.

I don't see it as a black swan though. There's no reason it should ever happen and the risk free rate should be just that.

Still the treasury was on record saying it will happen unless something is done about it... so let's not pretend it can't happen at least for a short time until it's too painful and corrected.

I bet your plan would get through. Too nervous myself.

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Re: Should I use margin to buy a balanced fund?

Post by Park » Sat Sep 10, 2016 2:48 pm

When people use leverage, it's commonly done to lever a stock portfolio. In that case, one is levering the equity risk premium. What's different about this thread is that the goal is to lever a stock/bond portfolio. It looks like bond exposure is only through government bonds. So one is levering the equity risk premium and the interest rate risk premium. You're diversifying across risk premia that don't correlate.

https://www.cfasociety.org/minnesota/Si ... _Pandl.pdf

The following is from the link above. Historically, the equity risk premium is about 5% (excess return of US stocks over Treasury bills).

From 1952-2009, the excess return of Treasury bonds over bills was 0.3%-1.4%. The return depended on how long term the bond was. Maximal excess return was for 5-7 year Treasuries at 1.4%. Dimson, Marsh and Staunton found a bond risk premium of 0.7% in the US from 1900-2000.

For levering bonds to work, the interest rate on your loan has to be near the risk free rate. For a retail investor, the only way I know of to get near the risk free rate are bond futures. Then, there will also be the costs of trading.

The bond risk premium is small. After taking into account all the costs associating with levering bonds, it might be less than small.

Ilmanen in "Expected Returns" states that the equity risk premium in the US from 1926-2009 was 5.7%, and the value premium was 4.1%. I agree that levering noncorrelating risk premia makes sense. But the expected return on the bond risk premium is small. Might it not be a better idea to lever the equity risk premium and the value premium?
Last edited by Park on Sat Sep 10, 2016 3:05 pm, edited 1 time in total.

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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Sat Sep 10, 2016 3:03 pm

Park wrote:When people use leverage, it's commonly done to lever a stock portfolio. In that case, one is levering the equity risk premium. What's different about this thread is that the goal is to lever a stock/bond portfolio. It looks like bond exposure is only through government bonds. So one is levering the equity risk premium and the interest rate risk premium. You're diversifying across risk premia that don't correlate.

https://www.cfasociety.org/minnesota/Si ... _Pandl.pdf

The following is from the link above. Historically, the equity risk premium is about 5% (excess return of US stocks over Treasury bills).

From 1952-2009, the excess return of Treasury bonds over bills was 0.3%-1.4%. The return depended on how long term the bond was. Maximal excess return was for 5-7 year Treasuries at 1.4%. Dimson, Marsh and Staunton found a bond risk premium of 0.7% in the US from 1900-2000.

For levering bonds to work, the interest rate on your loan has to be near the risk free rate. For a retail investor, the only way I know of to get near the risk free rate are bond futures. Then, there will also be the costs of trading.

The bond risk premium is small. After taking into account all the costs associating with levering bonds, it might be less than small.
Currently I calculate that the cost of carrying a future contract on 2 year us Treasuries is approximately equal to the fed overnight rate, or 0.4%. This results in a positive yield of 0. 39%. I don't quite understand why the market supports lending rates this low, but it appears to right now. I monitor this and will likely severely lower my bond allocation if it goes negative, but right now it appears to be a mechanism for positive returns in exchange for a bit of term risk (and credit risk as the most recent poster postulated, but you can't really get less credit risk. If short term us Treasuries default, is FDIC any safer?).

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Re: Should I use margin to buy a balanced fund?

Post by in_reality » Sun Sep 11, 2016 7:45 am

Swelfie wrote:If short term us Treasuries default, is FDIC any safer?
2 answers.

a) Yes maybe and b) probably not.

a) for a likely temporary budget fight type default, FDIC is probably safer I'd think because not all CDs/banks would be threatened by bankrupcies while all treasuries would seemingly be effected.

b) if they really defaulted though, FDIC would be a goner too.

Is there a safer asset? Probably not. Still, what would market gyrations be if such an event occurred? You seem to think you'd be able to muddle through.

It does seem like being radical to prove the devotion to your beliefs is all the rage and contagious these day, but maybe it's just a remote risk you have to take ... (that someone could muster the political backing to say no more debt and block a ceiling raise).

Don't let me worry you. You seem to have a handle on things!

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Re: Should I use margin to buy a balanced fund?

Post by DrF » Thu Sep 15, 2016 1:02 pm

Rob Bertram wrote:So I guess the next question after a couple years of 50% returns is what to do once I hit my target. The simple answer is that I'll reduce my leverage. That is the essence of the strategy outlined in Ayres and Nalebuff's "Mortgage your Retirement." Though, I haven't really put much thought into a strategy thinking that it would be years off.

Technically, Ayers and Nalebuff suggest leveraging stocks until you hit your target stock allocation notional value, then de-risk in two different phase. Start by de-leveraging stocks, and finally buy bonds to your target AA. My approach is slightly different in that I'm leveraging a balanced portfolio of stocks and bonds, so the strategy to reduce risk is a little easier -- I just reduce my leverage and maintain my AA.

Here's my current plan. I am open to comments, but this is my current thinking. The following numbers are in notional values.
  • Less than $10 million, target 26 - 30x leverage.
  • Between $10 and $12 million, target 21 - 25x leverage.
  • Between $12 and $15 million, target 16 - 20x leverage.
  • Above $15 million, target 10 - 15x leverage.
For reference, the notional value of the portfolio today is around $6.45 million.
I've done some backtesting and it looks like if you lever up (say to 25x) and then leave the portfolio alone (just roll the same number of contracts when necessary), the portfolio just drifts down over time (obviously as values rise). What I'd do is: every time the portfolio de-levers to ~10x, lever it up to 25x (and correct any AA drift) and let the leverage drift down again. Or, you could just adjust your leverage 4x a year (at contract rollover times) to whatever level you wanted, say ~20x. The portfolio should be pretty well protected, unless there were some black swan event right after you upped your leverage. Once you stop contributions, you could always put a trailing stop on your contracts. Maybe 25-30%?

I've also been looking at how much a particular asset class would need to drop in order to trigger a margin call. With the 10/5/85 portfolio, it looks like for every $132,000 of portfolio value you should own ~3 contracts of ES, ~13 contracts of ZT, and ~1 contract of ZB. So, with maintenance requirements of $4200, $650, and $3750 respectively you would get a margin call if ES notional dropped by ~33.5%, ZT by ~3.78%, and ZB by ~64.88% with no change in value of the other 2 assets. Obviously, if they all start moving negative at the same time you would get a call much more quickly. So, if 33.5%, 3.78%, and 64.88% are our max values to trigger a margin call, we can re-set those values to 100% (for 100% chance of a margin call for that asset). If each asset drops by 25% (real = ~8.38% ES, ~0.95% for ZT, ~16.22% for ZB), of the 100% maximum for a margin call, all at the same time - you would be fine. By my calculations, the maximum correlated drop % for all assets would be ~33.33% (real = ~11.18% ES, ~1.26% ZT, ~21.63% ZB). We have seen the S&P 500 drawdown by over 50%, my modeling of ZT (very crudely done using VFISX as proxy) estimates that ZT had a max drawdown of ~2.23% in 1994 (I'm not sure if this has been the historical max?), and ZB (using VUSTX as proxy) had a drawdown of ~16.68% (but it is feasible in the current market to see ~50% or more decrease in ZB value over the next few years).

I also recently came across these articles, which seem relevant to the OP experiment:
http://www.bloomberg.com/news/articles/ ... -says-bofa
http://www.bloomberg.com/news/articles/ ... ntertwined
http://www.bloomberg.com/news/articles/ ... est-trades

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Re: Should I use margin to buy a balanced fund?

Post by siamond » Tue Nov 08, 2016 1:10 pm

joglehead wrote:lack_ey, the spreadsheet Rob pointed me towards is here.

The data sources listed are below. I'm not sure how they are used collectively in the spreadsheet.
COMM - Commodities/Natural Resources
Collaterallized Chase Index 1972-1990
DJ-AIJ plus T-Bills 1991-1996
DJ-AIG plus Yahoo's IPS 'category' returns 1997-2001 (prior to VIPSX)
DJ-AIJ plus VIPSX - 2001-2002
Pimco PCRIX 2003+

This is assuming the T-bill rate for borrowing.
Joglehead, please check this post. Feedback welcome.

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Re: Should I use margin to buy a balanced fund?

Post by frejd » Tue Nov 29, 2016 6:57 pm

Fantastic discussion, really enjoyed watching the investment strategies evolve over the past two years and appreciate all the thoughtful analysis and discussion - especially to Rob Bertram for his spreadsheets and willingness to share his progress in such a public manner.

I've been thinking quite a bit about this strategy, and was wondering if anyone has tried to apply the 10/5/85 @26+ concepts to create a similar portfolio with a lower amount of investment capital.

It seems like you can piece something together with ~80k or more of initial capital, but anything below that provides challenges trying to maintain AA and leverage ratios, especially in long-term treasury bonds where just 1 futures contract grants such a large exposure.

I'm not aware of any "ultramini" investment products for these bond markets provided by the CME - do they exist somewhere? If they do, does anyone even use them?

This portfolio seems like it has a fantastic use case in those looking to jump-start a modest amount of investment capital into a "useful" amount, but I haven't been able to figure out a way to make things work in the 10k-40k starting capital range with the investment products that I'm aware of. Anyone have any success?

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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Fri Dec 02, 2016 6:46 pm

That is a very good question, frejd. Here are my observations:
  • Don't let the pursuit of perfect be the enemy of good: At the core, the model is a 40% total-stock / 60% intermediate-treasury portfolio leveraged to taste. Transforming the bonds from intermediate to short-term was an exercise of keeping the same Sharpe ration and improving the Sortino ratio so as to reduce margin call. There are less complex portfolios with very similar risk/return profiles that you can achieve with a lower starting dollar amount. For example, a 10% stock / 90% short-term treasury portfolio has virtually the same risk profile as 10% stock/ 5% long-term / 85% short-term treasuries (Portfolio Visualizer link). With about $40k, one could get an e-mini S&P contract and 4x 2-year treasury contract. That would be close enough. For lower amounts, you could use leveraged ETFs for stocks (UPRO is 3x S&P 500) and 2-year treasury futures.
  • You don't need to do the insane leverage ratios that I've chosen: I would encourage people just starting out to begin with something much lower as they haven't truly experienced a bear market to understand their risk tolerance.
  • Remember the fundamentals: The top three factors for building wealth are savings rate, time, and keeping costs low. Master those first, then come back to asset allocation and risk/leverage.

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Re: Should I use margin to buy a balanced fund?

Post by DrF » Mon Dec 05, 2016 12:57 pm

Good to see you post in this thread again Rob. How's the portfolio doing with the current economic whip-sawing, first in stock and now in treasuries?

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Re: Should I use margin to buy a balanced fund?

Post by long_gamma » Thu Jan 19, 2017 11:15 am

Finally went thru' the thread. Very good discussion.

You mentioned financing rate for futures as Libor 3 month in couple of places. I think it is true for equity futures (Libor + small spread), but for bonds it should be Implied Repo Rate. Otherwise with current Libor rates, your leverage could be very costly

Imagegif image hosting

Here is the link for Implied Repo Rate. 3 month T bills could be good approximation to use for historical calculations.
http://www.cmegroup.com/tools-informati ... ytics.html

It was interesting to see you arrived at your asset allocations based on max. draw down. But those max. draw down cited from portfolio visualizer link is based on monthly returns. Based on daily figures that number could be much bigger. With the policy of auto liquidation of Interactive Brokers, better to be careful.

Since the drawdown is the main criterion for your asset allocation, it is better to construct Return vs CVAR (Expected Shortfall) efficient frontier

http://corporate.morningstar.com/ib/doc ... zation.pdf
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

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Re: Should I use margin to buy a balanced fund?

Post by HomerJ » Thu Jan 19, 2017 11:29 am

Rob Bertram wrote:You don't need to do the insane leverage ratios that I've chosen: I would encourage people just starting out to begin with something much lower as they haven't truly experienced a bear market to understand their risk tolerance.
Aren't you just starting out yourself? You haven't experienced a bear market yet either with your "insane leverage ratios".

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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sat Jan 28, 2017 11:00 am

DrF wrote:Good to see you post in this thread again Rob. How's the portfolio doing with the current economic whip-sawing, first in stock and now in treasuries?
Good question. I haven't checked recently except to roll my futures positions. Even then, I didn't pay close attention to the total balance. Yields have been going up, so I know the portfolio is down from the summer high. I should update the Google spreadsheet.

I might have said this before in one of the 1600 posts: When I was watching the portfolio every day, I was very tempted to tinker with it. There was a huge desire to market time. In some rare cases where I could justify hitting a rebalancing band, I would take action. For example, there were some times where there were 50-point swings in the S&P 500 last year. I would really want to jump in and pick up another futures contract or two. And in my head, the market always rebounded when I didn't take action.

The ironic part was that I was wasting a lot of mental energy on lost opportunity from market timing. I wasn't concerned about losing money as the bonds in the portfolio often went in the opposite direction than stocks. In other words, I was really trying to convince myself why I shouldn't increase my market position. I guess you could call it panic buying.

Anyway, the best way to stop this behavior was to focus on not peeking. If I could by a balanced fund that was leveraged, I would buy it and forget about it. Or if one of the Robo advisors offered a leveraged portfolio service with minimal admin fees, I would go that route. I would set up my automatic deposits, and let it ride.

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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sat Jan 28, 2017 11:12 am

long_gamma wrote:Finally went thru' the thread. Very good discussion.

You mentioned financing rate for futures as Libor 3 month in couple of places. I think it is true for equity futures (Libor + small spread), but for bonds it should be Implied Repo Rate. Otherwise with current Libor rates, your leverage could be very costly

Here is the link for Implied Repo Rate. 3 month T bills could be good approximation to use for historical calculations.
http://www.cmegroup.com/tools-informati ... ytics.html

It was interesting to see you arrived at your asset allocations based on max. draw down. But those max. draw down cited from portfolio visualizer link is based on monthly returns. Based on daily figures that number could be much bigger. With the policy of auto liquidation of Interactive Brokers, better to be careful.

Since the drawdown is the main criterion for your asset allocation, it is better to construct Return vs CVAR (Expected Shortfall) efficient frontier

http://corporate.morningstar.com/ib/doc ... zation.pdf
Thank you! I will definitely incorporate your recommendation of return vs CVAR efficient frontier. Having multiple perspectives and measures is always a good thing.

As far as the financing costs go, I used 3mo-Tbill +0.5% for most of my financing estimates when I used historical data back to the 1920s. That was when I was going straight 40% total stock / 60% "total" bond. When I converted to futures, I looked at actual futures prices for key periods. I assumed transaction costs but no financing as it was already included in the futures prices.

But you are correct, leverage with bonds has a double risk factor with financing rates. It is harder to model for sure as the yield curve does not always move in unison.

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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Sat Jan 28, 2017 11:31 am

HomerJ wrote:
Rob Bertram wrote:You don't need to do the insane leverage ratios that I've chosen: I would encourage people just starting out to begin with something much lower as they haven't truly experienced a bear market to understand their risk tolerance.
Aren't you just starting out yourself? You haven't experienced a bear market yet either with your "insane leverage ratios".
I am just starting with leverage, yes. I started in 2014. However, I've been in the market in the form of IRAs and workplace retirement plans (401k) since the mid 90s. And I was almost completely into emerging markets in 2007-2009 when the market dropped. (I made all of the classic mistakes including having an advisor who took a huge commission.) I watched my portfolio drop by over 50%. I didn't panic or change course. So I feel that I can safely say that I have a good understanding for my loss aversion.

But I completely agree that leverage is a much more complicated monster. The daily volatility of a leveraged portfolio is significantly higher than one is used to seeing from even a stock portfolio.

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Re: Should I use margin to buy a balanced fund?

Post by rmelvey » Wed Feb 08, 2017 1:28 pm

How did this portfolio survive the recent bond sell off?

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Re: Should I use margin to buy a balanced fund?

Post by Pocket Cruiser » Wed Mar 29, 2017 11:32 am

Any updates to how the portfolio is doing?

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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Tue Sep 05, 2017 11:04 am

Wow, it's been a lot longer since I've posted an update than I thought. Sorry for that.

The portfolio is doing great. For all the complexity, it is fundamentally a 40% US stock / 60% US treasury portfolio leveraged 6x. To me, it feels a little riskier than a 100% stock portfolio, but the returns are more than double that. Though, I've stopped watching it. I only log in to roll futures contracts. There are probably rebalancing/volatility opportunities that I'm missing, but I'm not at a point where I care enough to do anything about it.

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