An Alternative to Being Long the S&P 500

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inbox788
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An Alternative to Being Long the S&P 500

Post by inbox788 » Thu Jun 23, 2016 1:57 pm

Evaluating harebrained ideas vs. potentially profitable tilts.

I've come across the Larry Portfolio, which is an extreme Small Cap Value tilt IMO. Then there is the Permanent portfolio that's sometimes discussed as a replacement portfolio. And the often accepted 10% REIT tilt.
http://www.nytimes.com/2011/12/24/your- ... folio.html

This fellow suggest replacing SP500 with XIV/TLT pair, and backtested the results 5 years:
Image

http://realmoney.thestreet.com/articles ... ong-sp-500

I don't wish to get involved why 3 fund portfolio discussion is better than xyz. I'm interested in what factors one looks at when deciding on one or another strategy. Past performance or backtesting seems to be a major determinant. Why would you choose to follow a strategy that backtested or has performed poorly? And if you use future expectations or prospects, where do you attain the estimates and how do you know know if it's correct or repeatable?

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saltycaper
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Re: An Alternative to Being Long the S&P 500

Post by saltycaper » Thu Jun 23, 2016 2:25 pm

I use the criteria, "If you can't justify your asset allocation without using a chart, you probably don't have sufficiently good reasons for your asset allocation."
Quod vitae sectabor iter?

jjface
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Re: An Alternative to Being Long the S&P 500

Post by jjface » Thu Jun 23, 2016 3:06 pm

5 years ... umm no.

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RyeWhiskey
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Re: An Alternative to Being Long the S&P 500

Post by RyeWhiskey » Thu Jun 23, 2016 5:55 pm

The Larry portfolio and the Permanent Portfolio are both great portfolios if you know why you have them as opposed to say, a simple 3-fund. Each of these 'alternative' portfolios are constructed for very particular reasons, not simply because they backtest well. You would need to know these reasons and have them resonate with you in order to hold them through periods of underperformance (in other words, to stay the course). I don't think a five year backtest is adequate reason to deviate so widely from whatever your current portfolio may be. :beer
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lack_ey
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Re: An Alternative to Being Long the S&P 500

Post by lack_ey » Thu Jun 23, 2016 6:38 pm

To be clear, that is VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and iShares 20+ Year Treasury Bond ETF (TLT) at a 20/80 mix. With an ETN you get counterparty risk, there's all the issues with these kinds of products, and the ER is high here too, so without even considering the underlying merits this probably isn't the right way to go. That is, if you want to implement a strategy like this, I don't think you'd actually want to be buying and holding XIV itself. You might just roll the underlying VIX futures yourself. And to be honest, rather than use TLT in general, you could probably just buy a couple of long-dated Treasury notes and sit on them (selling and rebuying new ones every year or whenever), saving the 0.15% ER on the fund. It's not like Treasuries are illiquid.

When doing any backtest, it's important to understand the context and what happened over the period. Check starting and ending conditions in the very least to see what has changed. One obvious point that jumps out here was that long-term interest rates fell, and long-term Treasuries had a fairly reliable and significant negative correlation with market risk over this period, making long-term Treasuries a really great diversifier.

What XIV does is effectively short volatility. This is widely known and fairly accepted to be a reasonable investment strategy with long-term positive returns. After all, it's risky and effectively serves as selling insurance to other people. When stocks plunge, volatility usually spikes, and if you're selling volatility you lose. Over this period, realized volatility was pretty tame, with things cooling off after 2011 for the most part.

Not too surprisingly, XIV and US stocks had a daily correlation over 0.8, with both negatively correlated with long-term Treasuries. Furthermore, for giggles, regressing XIV on CAPM beta gives a market exposure of 4.3 over the period with an R^2 around 0.7 (and high negative alpha). Short volatility is definitely not the same thing as stock exposure, but in some way this is not incredibly different from some kind of leveraged stock with long-term bonds play, which in fact looked to have been better over the same period. Note that the comparison uses yearly rebalancing rather than wide bands as in the linked article. You can change the rebalancing frequently and that does seem to help. This is a largely superficial analysis, though.

All in all, I don't think you should ever consider a complete replacement for stocks as they provide a source of returns that is relatively durable as far as investments go, hard to replicate elsewhere, and very easy and cheap to access. On the broader question of incorporating short volatility for some potential extra diversification or some kind of alternate and risky source of returns, a 5-year backtest doesn't say much. There's more literature to look at for a better picture.

In any case, the more unconventional the position, the more you better be sure about it and the better you should understand it, so if you have to ask the answer is going to be no. Much of this stuff you may want to leave for the institutional investors.

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Aptenodytes
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Re: An Alternative to Being Long the S&P 500

Post by Aptenodytes » Thu Jun 23, 2016 8:45 pm

Evaluating harebrained ideas vs. potentially profitable tilts.
I'm interested in what factors one looks at when deciding on one or another strategy. Past performance or backtesting seems to be a major determinant. Why would you choose to follow a strategy that backtested or has performed poorly? And if you use future expectations or prospects, where do you attain the estimates and how do you know know if it's correct or repeatable?
1) Don't evaluate harebrained ideas.
2) When deciding among strategies, I suggest that you only choose among strategies that have all passed the basic tests of being logical, supported by economic theory, and consistent with the empirical evidence. This is a kind of corollary of (1).
3) If you do that then you are largely finding the proven strategy that is the best fit for you.
4) Recall that all the strategies that meet the criteria of (2) include "stay the course" as part of their DNA. So then you have an additional reason to stick with (1).

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dmcmahon
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Re: An Alternative to Being Long the S&P 500

Post by dmcmahon » Thu Jun 23, 2016 8:56 pm

How tax efficient is that 80/20 mix?

Lobster
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Re: An Alternative to Being Long the S&P 500

Post by Lobster » Thu Jun 23, 2016 10:31 pm

I am full boglehead after 6 months and 8 books. What I've seen in this community is that many investors are still comfortable dynamically adjusting their AA based on their perception of the current market trends. This is destructive. It's investors who chase after yield who end up underperforming the same funds they invest in. Low cost is essential. Performance chasing within low cost funds will still result in lower returns. Pick an AA based on sound fundamentals and stay the course. This is the only path to success, and the reason Bogle continues to recommend that investors don't peek. It's not so much about peeking as it is about staying the course. Tilt or no tilt, alternatives or no alternatives. Pick your AA and stay the stinking course!.
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heyyou
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Re: An Alternative to Being Long the S&P 500

Post by heyyou » Fri Jun 24, 2016 12:15 am

It's investors who chase after yield who end up underperforming the same funds they invest in.
Those are the speculators, even if they are speculating in index funds. The investors are the ones who buy and hold, staying the course. Warren Buffett's favorite holding period is "forever."
An Alternative to Being Long the S&P 500
Mel has done well with his Unloved Midcaps and VG's Extended Market fund has some large caps but with much fewer giant businesses.

Since the 2000 Crash, my preference is to tilt away from the S&P500, since I no longer trust what the public selects as the most popular stocks. My returns are good enough, and I know that I don't know what will be optimal. Saving extra, early and often, worked well for me (retired at 55 ten years ago), and saving was within my control, so no need to try to boost my returns. We just get what we get and we expect to adapt to the average of our future returns.

inbox788
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Re: An Alternative to Being Long the S&P 500

Post by inbox788 » Fri Jun 24, 2016 5:08 pm

Thanks for many interesting responses. Many a folk here have formed a strong belief about BH investing including myself, but if we didn't have the experience and were presented with various investment methods, the BH market index idea would be lost among the rest. Using economic theory and empirical evidence (i.e. overbought and oversold conditions), it would logically conclude that market timing is possible. Then you need academic studies to dispute this concept, but there are conflicting studies:
Technical Analysis with a Long Term Perspective: Trading Strategies and Market Timing Ability
The results of this test show that complex rules produce high proportions of accurate signals.
http://papers.ssrn.com/sol3/papers.cfm? ... id=1833613
In this paper, we propose a systematic and automatic approach to technical pattern recognition using nonparametric kernel regression, and we apply this method to a large number of U.S. stocks from 1962 to 1996 to evaluate the effectiveness of technical analysis. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution-conditioned on specific technical indicators such as head-and-shoulders or double-bottoms-we find that over the 31-year sample period, several technical indicators do provide incremental information and may have some practical value.
http://web.mit.edu/wangj/www/pap/LoMamayskyWang00.pdf
Aptenodytes wrote:1) Don't evaluate harebrained ideas.
2) When deciding among strategies, I suggest that you only choose among strategies that have all passed the basic tests of being logical, supported by economic theory, and consistent with the empirical evidence. This is a kind of corollary of (1).
3) If you do that then you are largely finding the proven strategy that is the best fit for you.
4) Recall that all the strategies that meet the criteria of (2) include "stay the course" as part of their DNA. So then you have an additional reason to stick with (1).
Therein lies the problem. One doesn't know an idea is harebrained until after the analysis. Fundamental analysis stock picking seems to pass a lot of the criteria mentioned, yet it doesn't live up to it's promise in real funds (i.e. active funds). Technical analysis has a myriad of techniques that work great when applied retroactively, and sometimes proactively, sometimes more so than fundamental analysis.
RyeWhiskey wrote:Each of these 'alternative' portfolios are constructed for very particular reasons, not simply because they backtest well. You would need to know these reasons and have them resonate with you in order to hold them through periods of underperformance (in other words, to stay the course). I don't think a five year backtest is adequate reason to deviate so widely from whatever your current portfolio may be. :beer
Criteria 1) the particular reasons for the portfolio need to make some theoretical sense - fundamental analysis with selecting better companies seems to make theoretical sense, but that's the strategy of many failed active funds. Good companies do not always make good stocks.
2) agree that 5 years is grossly insufficient. Even 20 or 30 year backtesting may not hold. Yet I've seen a lot of articles where main argument was backtested result and the theory didn't make sense. Either the theory was wrong or irrelevant, or I simply didn't understand the theory because it was hard to understand or confusing. One could even argue any backtesting doesn't make sense since we can't make any predictions about future conditions.
Lobster wrote:What I've seen in this community is that many investors are still comfortable dynamically adjusting their AA based on their perception of the current market trends. This is destructive. It's investors who chase after yield who end up underperforming the same funds they invest in. Low cost is essential.

Pick an AA based on sound fundamentals and stay the course. This is the only path to success, and the reason Bogle continues to recommend that investors don't peek. It's not so much about peeking as it is about staying the course. Tilt or no tilt, alternatives or no alternatives. Pick your AA and stay the stinking course!.
Agree, low cost is an essential ingredient and fairly easily measured. Sound fundamentals is a little more abstract, and tilt or alternates are exactly the kind of strategies that lack specific evaluation criteria. Folks often arrive here after trying failed strategies elsewhere. What we don't see are the folks that stopped by here and didn't get and went elsewhere.
heyyou wrote:Mel has done well with his Unloved Midcaps and VG's Extended Market fund has some large caps but with much fewer giant businesses.

Since the 2000 Crash, my preference is to tilt away from the S&P500, since I no longer trust what the public selects as the most popular stocks. My returns are good enough, and I know that I don't know what will be optimal. Saving extra, early and often, worked well for me (retired at 55 ten years ago), and saving was within my control, so no need to try to boost my returns. We just get what we get and we expect to adapt to the average of our future returns.
Again, these theory makes sense on some level (Midcap/Extended Market and avoiding SP500/popular stocks). How is one to judge whether it's an acceptable alternative theory or hogwash? I guess I'm seeking some sort of litmus test, which may not exist.

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JoMoney
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Re: An Alternative to Being Long the S&P 500

Post by JoMoney » Fri Jun 24, 2016 7:03 pm

inbox788 wrote:... How is one to judge whether it's an acceptable alternative theory or hogwash? I guess I'm seeking some sort of litmus test, which may not exist.
The very idea of it being an alternative to main-stream is the litmus test as far as I'm concerned. I'm invested in a broad index because it's representative of what the aggregate consensus is, not because I'm trying to get clever and garner something extra. I'm recognizing that the "alternatives" are something that I don't know, the potential uncertainties and risks could be larger than my understanding. If it was really something I had a good grasp on where the value was coming from and what it was worth to me, then I wouldn't have to go out seeking advice for whether or not it was something worthwhile. The further you step outside your own circle of competence, the more at risk you are of being taken advantage of in a market that may be "Phishing For Phools". There's some protection from it by acknowledging your own limitations and sticking with the heard. How the average person conducted their finances used to be the standard of a fiduciary under the old "prudent man rules". Under the paradigm of a market that's supposedly 'efficient' along some spectrum of risk/return it shouldn't matter what you do, your results will be relative to the risk you take. If it turns out the market isn't as efficient as theorized, then going too far out on a limb by yourself may be putting you at considerably more risk, especially if it's an area you're not uniquely skilled in (or at least more informed than the people selling to you). Without an "efficient market" doing something dumb may have larger consequences than some model suggests.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

long_gamma
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Re: An Alternative to Being Long the S&P 500

Post by long_gamma » Fri Jun 24, 2016 7:41 pm

Instead of looking for alternative to long S&P500, it is better to add other factors to your core portfolio. Momentum, Carry and short vol are other source of returns which can provide diversifying effect.

Since there are lot of discussion about AQR funds here, you already know this. But these portfolio can also be constructed on your own, with out going thru' AQR route.
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

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Re: An Alternative to Being Long the S&P 500

Post by long_gamma » Sat Jun 25, 2016 6:53 am

Your first linked paper is interesting. This type of strategy can be expanded to all markets.

Here is the link, who follows similar strategy and has a blog and a live trade journal in ET.
http://qoppac.blogspot.co.uk/2016/04/fu ... r-two.html
http://www.elitetrader.com/et/index.php ... ng.289589/
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Clive
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Re: An Alternative to Being Long the S&P 500

Post by Clive » Sat Jun 25, 2016 7:33 am

RyeWhiskey wrote:...Permanent Portfolio are both great portfolios if you know why you have them as opposed to say, a simple 3-fund...
Historically taxes/costs on bonds and gold have been high. Consider for instance 1933 all investment grade gold being compulsory purchased to then see the price of gold ramped up 75% higher. Long term holders of gold in effect had their rewards stripped away from them. Took all of the risk for none/less of the reward.

High taxes during periods of high inflation, high yields somewhat go hand-in-hand.

50% 10 year (which a STT/LTT barbell equates), 25% gold, 25% stock bears considerable tax/costs risks that when accounted for present a different outcome/picture compared to gross figures.

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Re: An Alternative to Being Long the S&P 500

Post by David Jay » Sat Jun 25, 2016 9:23 am

inbox788 wrote:... Then you need academic studies to dispute this concept, but there are conflicting studies:
Technical Analysis with a Long Term Perspective: Trading Strategies and Market Timing Ability
The results of this test show that complex rules produce high proportions of accurate signals.
http://papers.ssrn.com/sol3/papers.cfm? ... id=1833613
In this paper, we propose a systematic automatic approach to technical pattern recognition using nonparametric kernel regression, and we apply this method to a large number of U.S. stocks from 1962 to 1996 to evaluate the effectiveness of technical analysis. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution-conditioned on specific technical indicators such as head-and-shoulders or double-bottoms-we find that over the 31-year sample period, several technical indicators do provide incremental information and may have some practical value.
http://web.mit.edu/wangj/www/pap/LoMamayskyWang00.pdf
The problem with most of these studies is that they provide "accurate signals" but they are not actionable/implementable. Yes, there is Alpha in the studies. It is very difficult to create an actual strategy to implement them in your portfolio at costs that improve on "owning the market".

Bernstein ("Four Pillars") pretty demolished fundamental analysis for me. And don't get me started on "technical" analysis, which is essentially the same as reading chicken entrails.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

long_gamma
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Re: An Alternative to Being Long the S&P 500

Post by long_gamma » Sat Jun 25, 2016 10:00 am

David Jay wrote:
The problem with most of these studies is that they provide "accurate signals" but they are not actionable/implementable. Yes, there is Alpha in the studies. It is very difficult to create an actual strategy to implement them in your portfolio at costs that improve on "owning the market".

Bernstein ("Four Pillars") pretty demolished fundamental analysis for me. And don't get me started on "technical" analysis, which is essentially the same as reading chicken entrails.
To be fair, first paper is a variation of momentum. It has been proven momentum is persistent across all markets. It is actionable and implementable.
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Re: An Alternative to Being Long the S&P 500

Post by Watty » Sat Jun 25, 2016 10:45 am

inbox788 wrote:Evaluating harebrained ideas vs. potentially profitable tilts.
Over the years there have been a number of real profitable strategies that have emerged but once they are known they quickly stop working because too many people try to use them and any possible advantage gets too diluted and the strategy can not only stop working, but it can become under-performing.

In order to succeed with one you not only have to find one but you also need to do it before and better than everyone else and all their super computers.

That isn't to say that having strategy that is different than just a three fund portfolio might not do be able to do something good like be more tax efficient or be less likely to have a sudden drop but those would come at the cost of having a lower risk adjusted portfolio return.
jjface wrote:5 years ... umm no.
The last eight years since the low of the financial crisis have been exceptionally good years for most stocks. I would not try to look for any repeatable performance patterns in that.

inbox788
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Re: An Alternative to Being Long the S&P 500

Post by inbox788 » Sat Jun 25, 2016 12:18 pm

Watty wrote:
inbox788 wrote:Evaluating harebrained ideas vs. potentially profitable tilts.
Over the years there have been a number of real profitable strategies that have emerged but once they are known they quickly stop working because too many people try to use them and any possible advantage gets too diluted and the strategy can not only stop working, but it can become under-performing.

In order to succeed with one you not only have to find one but you also need to do it before and better than everyone else and all their super computers.

That isn't to say that having strategy that is different than just a three fund portfolio might not do be able to do something good like be more tax efficient or be less likely to have a sudden drop but those would come at the cost of having a lower risk adjusted portfolio return.
jjface wrote:5 years ... umm no.
The last eight years since the low of the financial crisis have been exceptionally good years for most stocks. I would not try to look for any repeatable performance patterns in that.
Ah, I think you're describing the efficient market theory at work. And to win, you have to stay ahead of the crowd. And if some folks are able to achieve above average, then that means it's at the cost of those at average (hence lowering the average for the rest) or those doing below average (and that's even before all the fees that subtract from everyone).

https://en.wikipedia.org/wiki/Business_cycle

The repeatable pattern could be the business cycle, and positioning with "cyclical stocks" and "defensive stocks" seems like a good plan, but in reality is a lot harder than it looks, if doable at all.

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Aptenodytes
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Re: An Alternative to Being Long the S&P 500

Post by Aptenodytes » Sat Jun 25, 2016 12:40 pm

inbox788 wrote:
Aptenodytes wrote:1) Don't evaluate harebrained ideas.
2) When deciding among strategies, I suggest that you only choose among strategies that have all passed the basic tests of being logical, supported by economic theory, and consistent with the empirical evidence. This is a kind of corollary of (1).
3) If you do that then you are largely finding the proven strategy that is the best fit for you.
4) Recall that all the strategies that meet the criteria of (2) include "stay the course" as part of their DNA. So then you have an additional reason to stick with (1).
Therein lies the problem. One doesn't know an idea is harebrained until after the analysis. Fundamental analysis stock picking seems to pass a lot of the criteria mentioned, yet it doesn't live up to it's promise in real funds (i.e. active funds). Technical analysis has a myriad of techniques that work great when applied retroactively, and sometimes proactively, sometimes more so than fundamental analysis.
You can omit (1) if you wish. Following 2-4 will save you the grief you are now experiencing. If you choose to also omit (2) I'm afraid you are doomed to wasting a huge amount of time and exposing yourself to unnecessary danger.

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