Swedroe: Volatility As A Strategy

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Random Walker
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Swedroe: Volatility As A Strategy

Post by Random Walker » Tue Aug 01, 2017 11:37 pm

http://www.etf.com/sections/index-inves ... y-strategy

In this article Larry describes investing in the sale of volatility insurance. It turns out that in diverse markets (equities, bonds, currencies, commodities) realized volatility most often is less than expected volatility. This is not a market inefficiency. Rather it is a premium that investors are willing to pay for downside protection. Investors in volatility have the opportunity to pick up a consistent premium with the risk being a big left tail when markets tank. For investors looking to improve portfolio efficiency by diversifying across sources of return, the Variance Risk Premium offers potential. Interested in Boglehead thoughts on the article.

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Re: Swedroe: Volatility As A Strategy

Post by saltycaper » Tue Aug 01, 2017 11:59 pm

Random Walker wrote:
Interested in Boglehead thoughts on the article.
I find it interesting but lacking in implementability for the average individual investor.

(I also find it to be spread across too many pages.)
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Re: Swedroe: Volatility As A Strategy

Post by Random Walker » Wed Aug 02, 2017 12:20 am

Yes it's one of Larry's longer articles. But I think the issue of these alternative sources of return is big for MPT fans. Investments with returns uncorrelated to both stocks and bonds have the potential to really improve portfolio efficiency. Move the portfolio closer to the northwest corner of risk v return plot, decrease volatility drag, improve Sharpe Ratio. I believe most of these alternatives Larry has discussed should decrease left tail risk when used as a substitute for equities, but this one appears to increase the tail risk. Although it does diversify the volatility premium way beyond equities alone.

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Re: Swedroe: Volatility As A Strategy

Post by saltycaper » Wed Aug 02, 2017 12:26 am

That's all good and well, but how are we to invest in this potential source of return? The article seemed a little light on that aspect.

(When providing the forum with its Swedroe "fix", you can link to the "full page view" rather than the paginated view, unless you work for ETF.com. :D)
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Re: Swedroe: Volatility As A Strategy

Post by Day9 » Wed Aug 02, 2017 1:30 am

My first reaction is yeah the downside shows up at the wrong time. But that's why there's a premium, isn't there. A portfolio would need to have plenty of funds allocated to investments that do not tank when both stocks and selling volatility tank (with high correlation). Term risk comes to mind. What else is there though? I suppose some special funds that capture factors like small, value, momentum, quality, etc without necessarily loading up on market beta. But I don't know offhand how these factors correlate during big market drops. Value did well in 2000 tech bubble crash.
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Re: Swedroe: Volatility As A Strategy

Post by lack_ey » Wed Aug 02, 2017 2:30 am

Even to the extent that the downside shows up at the wrong time (and there are plenty of non-equity markets to do this in), I think this is still useful. The issue is in implementation and getting access. This is all pretty obvious and something I'd invest in if it were readily available and not too expensive. But it's not.

I do know that Stone Ridge has non-mutual-fund structures running variance risk premium strategies, but they're very expensive and not widely available.

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Re: Swedroe: Volatility As A Strategy

Post by james22 » Wed Aug 02, 2017 3:54 am

Random Walker wrote:http://www.etf.com/sections/index-inves ... y-strategy
It turns out that in diverse markets (equities, bonds, currencies, commodities) realized volatility most often is less than expected volatility.
Yeah, but today I believe realized volatility will be much, much greater than expected (come the Minsky moment).

I agree with Swedroe on most things, but not here.

Just as he considers it rational to increase equity allocation/exposure to risk when expected returns are low (rather than go to cash), his response to a measure (volatility/valuation) is exactly opposite that of a value investor.
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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Wed Aug 02, 2017 9:13 am

Day9 wrote:My first reaction is yeah the downside shows up at the wrong time. But that's why there's a premium, isn't there. A portfolio would need to have plenty of funds allocated to investments that do not tank when both stocks and selling volatility tank (with high correlation). Term risk comes to mind. What else is there though? I suppose some special funds that capture factors like small, value, momentum, quality, etc without necessarily loading up on market beta. But I don't know offhand how these factors correlate during big market drops. Value did well in 2000 tech bubble crash.
I'm iffy on this trade. But the idea in shorting volatility is you have unused margin. Say for example you hold a 100% stock portfolio. Volatility starts going up, your portfolio is down 5% and you sell 10% of that original portfolio's price in volatility. Volatility triples in price from where you sold and your portfolio goes down 15% more for 20%. Your position is now 10X in cash, 80X in stock -30X in volatility. Margin requirement for the volatility is 1.3 so you are way over. Now of course if the volatility closes out at there and doesn't come back down, your stocks are probably down to -40% and you have to pay leaving you: -20X in cash, 60X in stock. You are down 60% when the market is down 40%. That's the risk you are getting paid for.

That doesn't happen most of the time though. Most of the time when volatility starts going up, it goes right back down and you pocket 5%. Overall its a profitable trade since that scenario is something like 10x as likely as the bad one. Short volatility is a 8% annual asset that just needs assets to act as insurance.

Disclaimer: I am currently long not short volatility (obviously losing on that trade in this market).
Last edited by jbolden1517 on Wed Aug 02, 2017 12:32 pm, edited 1 time in total.

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Re: Swedroe: Volatility As A Strategy

Post by aegis965 » Wed Aug 02, 2017 9:35 am

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 10:28 am

Random Walker wrote:http://www.etf.com/sections/index-inves ... y-strategy

In this article Larry describes investing in the sale of volatility insurance. It turns out that in diverse markets (equities, bonds, currencies, commodities) realized volatility most often is less than expected volatility. This is not a market inefficiency. Rather it is a premium that investors are willing to pay for downside protection. Investors in volatility have the opportunity to pick up a consistent premium with the risk being a big left tail when markets tank. For investors looking to improve portfolio efficiency by diversifying across sources of return, the Variance Risk Premium offers potential. Interested in Boglehead thoughts on the article.

Dave
Edit: My original post was a misunderstanding. Dave is talking about Variance Risk Premium being another source of return. It appears that the Stone Ridge product has equity like returns or even higher than equity returns in exchange for risk of the rare big loss in a market crisis. More return for more risk but apparently the extra risk taken is well worth it in light of the potentially larger return. The article talked about the Sharpe ratio of a portfolio actually increasing with a addition of a small percentage amount of such a product. This is an attempt to add yet another high return product with (hopefully) low volatility to the Stock Market.

This is a return to the Volatility Drag thread that ran for a long time and generated some really good discussion. Pretty much, my early posts in the thread expressed skepticism whether or not this was a real phenomenon. These were some of my best posts, I was quite proud of them. Then people with more quant skills than I argued that it was a real phenomenon and that volatility over time was a drag on returns. Though my head was skeptical, my heart was in agreement as I have added volatile non-correlating asset classes with real investment returns over time to give my portfolio a smoother ride. I added bonds to my portfolio, though they reduced returns, they also greatly reduced portfolio volatility. I then said that diversifying across factors gave an investor the best shot of reducing portfolio drag. I concluded that sometimes this works and sometimes doesn't. The factor diversification worked brilliantly in the 2000-2002 bear market and failed in the 2008-2009 bear market and financial crisis.

I promise to go through and read Larry's article and will comment. My concern is that many of the strategies used to limit portfolio drag are overgrazed and we may be kidding ourselves. The biggest example I can think of are bonds themselves, bond yields are a lot lower than they used to be, my expectation is that their cushioning effect in bear markets will be less in the future as interest rates don't have as far to fall. I also believe that defensive stocks and the low volatility stocks are now overpriced as money flooded in and that investors will be disappointed in the next bear market. I did see an article on Morningstar that investors are pulling out of low volatility stocks but one article does not make a trend.
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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 11:04 am

I have read the article, my eyes glazed over a bit as I am not a quant. Pretty much it seems that most often expected volatility is higher than what actually occurs. Below is a key quote:
Larry Swedroe said:

For example, the implied volatility of S&P 500 Index options has exceeded the realized index volatility 85% of the time from January 1990 to September 2014. And options historically have traded about 4.4 percentage points above subsequent realized volatility.
 
It’s important to understand that this should not be interpreted to mean the option market tends to overestimate future volatility. Instead, the more likely explanation is that option prices incorporate a risk, or insurance, premium.
Edit:
Therefore, the VRP (volatility risk premium) should be considered a unique risk premium that investors with long investment horizons and stable finances can harvest, allowing them to take on cyclical risks that show up in bad times.


There is a drawback:
It’s important to note that Fallon, Park and Yu found that “on average, that transaction costs reduce gross returns by 47%, a significant reduction.”
My sense is that the Volatility Risk Premium is about 4%. Swedroe talks about "patient trading" to reduce transaction costs. He recommends Stone Ridge Products to try to capture this. My off the top of the head guess is that such a fund should return about 3% after costs. Edit: The returns must be equity like in order to take on "those cyclical risks that show up at bad times.

What makes me a bit uneasy is how such a fund would react in a true market crisis. Pretty much, you never know for sure what other market players, such as hedge funds are doing out there. Markets have a way of doing the very thing you don't expect. I suppose what is supposed to happen is that in normal times, such a Stone Ridge fund would return 3% to 4% a year and then hopefully spike a bit in a market crisis, being the diversifier you need when you most need it. I use the words "suppose" and "supposed to" because such "insurance" often doesn't work as hoped for in a true crisis. I think of how "portfolio insurance" actually increased the effects of the October 1987 market crash. Again, as I look at this, my sense is that it should work, the key word being "should."

Edit: Contrary to my earlier thoughts, it appears the fund is in effect selling options and harvesting the Volatility Risk Premium. It appears that the fund achieves equity like returns in normal times with the expectation that things will go south in a market crisis. So you are taking a nice risk premium year after year in exchange for the risk of an occasional big loss. To get equity like returns, there must be leverage in there.

Again, contrary to my earlier thoughts, this fund is not an insurance policy against volatility. What the fund is doing is assuming the risks of being the insurer and scooping up the premium that comes with taking on the associated risk. I initially misunderstood the article. This fund would be an equity like investment. Sort of reminds me of re-insurance, except you are, in effect, insuring the financial markets.

Another source of my confusion is the expected return of such a strategy. The sense I get is that they are expecting 10-12% annual returns. Otherwise, why take the risk? How are they getting to equity like returns? I then see 4% numbers and then according to the asset class ranges of other numbers. The article talks about the VRP for stocks being 11.8% back in the 1870's but being more like 4% today because of more liquid, transparent and efficient markets.


I also have never done options. I recently exercised a warrant for one and a fraction shares of AIG stock. It gave me the right to buy a share of AIG stock at about $40 a share, I got the fractional share in cash. That is the sum total of my experience with such instruments.

So Larry is a really smart guy, his argument looks well thought out and well reasoned, but I just somehow feel uneasy about this. Partly because I have no experience with options.
Last edited by nedsaid on Wed Aug 02, 2017 11:54 am, edited 2 times in total.
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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 11:20 am

Okay, a couple of questions here.

If you invested in such a fund, what would be your expectations of its performance? How do you expect for it to react in a true market crisis?

Does this fund short? Does the fund use leverage? Does this fund use put options on the market? In other words, how does this fund actually work? It looks like the fund is selling options, am I right?

Is this fund expected to have equity like returns? Or is it more a proxy for bonds? It sounds like this is equity-like.

A good explanation would be in order. Thanks.
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Re: Swedroe: Volatility As A Strategy

Post by lack_ey » Wed Aug 02, 2017 11:49 am

nedsaid wrote:Okay, a couple of questions here.

If you invested in such a fund, what would be your expectations of its performance? How do you expect for it to react in a true market crisis?

Does this fund short? Does the fund use leverage? Does this fund use put options on the market? In other words, how does this fund actually work? It looks like the fund is selling options, am I right?

Is this fund expected to have equity like returns? Or is it more a proxy for bonds? It sounds like this is equity-like.

A good explanation would be in order. Thanks.
You can't really answer these questions so generally. There are a lot of different strategies that involve shorting volatility. Risk will depend on what exactly is being done. If all you're doing is writing (shorting) put options on stocks, okay, you're going to get burned if the market crashes and everybody knows that. That's why it may be helpful to try to sell volatility across different markets, not all of which are so correlated. All else equal, if we're running two different funds with the exact same positions but you write X contracts and I write 2X per dollar invested, my fund is going to be riskier. Likewise return will vary a lot by implementation and strategy.

You're usually looking at option writing, swaps, etc. Quite possibly a range of other things to hedge out positions so as to isolate out the short volatility exposure, if that's a goal.

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 11:58 am

lack_ey wrote:
nedsaid wrote:Okay, a couple of questions here.

If you invested in such a fund, what would be your expectations of its performance? How do you expect for it to react in a true market crisis?

Does this fund short? Does the fund use leverage? Does this fund use put options on the market? In other words, how does this fund actually work? It looks like the fund is selling options, am I right?

Is this fund expected to have equity like returns? Or is it more a proxy for bonds? It sounds like this is equity-like.

A good explanation would be in order. Thanks.
You can't really answer these questions so generally. There are a lot of different strategies that involve shorting volatility. Risk will depend on what exactly is being done. If all you're doing is writing (shorting) put options on stocks, okay, you're going to get burned if the market crashes and everybody knows that. That's why it may be helpful to try to sell volatility across different markets, not all of which are so correlated. All else equal, if we're running two different funds with the exact same positions but you write X contracts and I write 2X per dollar invested, my fund is going to be riskier. Likewise return will vary a lot by implementation and strategy.

You're usually looking at option writing, swaps, etc. Quite possibly a range of other things to hedge out positions so as to isolate out the short volatility exposure, if that's a goal.
Lack_ey, you are the exact person I wanted to respond to this. I edited my second post. Contrary to what I originally thought, this product is NOT portfolio insurance. Instead, the fund is acting as the insurer and scooping up the risk premium in exchange for taking the more rare big loss in a market crisis.

Thank you for the answer. I know that we have limited information.
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Re: Swedroe: Volatility As A Strategy

Post by lack_ey » Wed Aug 02, 2017 12:18 pm

Well, the thing is that the article is not about any particular fund, just a class of investing strategies. It's even broader than for example a type of fund/structure like equity market neutral, where already you're looking at a broad range of potential risk levels—some funds may be sector neutral, while others may not, and some may be substantially more leveraged than others, so it depends.


btw re: crisis scenarios, you could also short vol by selling calls. I don't think that's as profitable on average, though, but I think still positive. Also, if you're short a put, you can't lose more than the asset dropping to zero, no matter what the market conditions. I guess there could be trouble if you don't have the cash to pay up and need to start exiting positions early.

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Re: Swedroe: Volatility As A Strategy

Post by Random Walker » Wed Aug 02, 2017 12:37 pm

Nedsaid,
I don't really understand options either, but I think I can answer a few of the questions. Yes, I agree that an owner of this fund is effectively selling volatility insurance, and volatility spikes when markets tank. So the investor is getting a premium for the risk of doing really badly in bad times. The fund participates in much more than just equity markets; it also diversifies risks by investing in volatility premium in bond, commodities, interest rate markets. The fund does use leverage to generate equity like expected returns.
An investor might generate their Variance risk premium position by taking from either equities or bonds. In either case the Sharpe ratio should increase. If take from equities, portfolio expected return should be about the same, portfolio SD decreased, Sharpe ratio higher. If take from bonds, portfolio expected return should be higher, SD will be higher, but Sharpe ratio should be higher as well. There is that increased left tail risk though!
This fund, like the other AQR and Stone Ridge alternatives discussed on this board, is quite tax inefficient. The equity like returns are pre-tax. So I would only hold as an alternative to equities in a tax advantaged account. The after tax return should still be greater than Municipal bonds, so I believe can make sense to hold this fund in taxable account as alternative to munis if investor is willing to accept the additional risk.

Dave

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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Wed Aug 02, 2017 12:46 pm

Generally the best way to the volatility short play is to sell the future and settle for cash, not to hold a fund. There are funds that hold cash plus the futures. A good example is XIV: https://finance.yahoo.com/quote/XIV?ltr=1 (the name comes from VIX spelled backwards since it is short the VIX). You can see the amazing return in a bull market. The last few months as this has been one of the hot funds with retail investors in this fund terrify Credit Suisse (who insures finances... the fund). They've a couple times tried to remind investors that if the VIX were to suddenly spike 80% the fund would get a margin call and would be trying to buyback the futures in a spiking market, quite likely going to 0. This fund is meant for people to hedge their long put positions but is being used for return. They aren't happy about it, but they'll take their money if they insist.

But for your purposes it represents how this trade works when everything goes well. I (and for that matter the fund's manager) suspect we'll see over the next year what it not going well looks like.

As I mentioned, I'm on the opposite side of this trade. I think we are seeing the birth of a new asset class (volatility) with derivatives over the next several decades becoming a mainstream investment. So I mostly agree with Larry.

Also the annual return from short volatility is 8%. Which makes sense
By definition: Stocks (SP500) return = dividends - cash return + short volatility return (spot VIX)

since stocks are just a messy way to hold a short volatility position.

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 12:48 pm

I am seeing a shift here. It looks like Larry Swedroe is really pushing hard into alternative investments. He, the academics, and Buckingham are looking hard for sources of return wherever they can find them. This is telling me there is less and less optimism about future expected returns from the US Stock Market and of course this is a function of very low interest rates as well.
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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Wed Aug 02, 2017 12:51 pm

lack_ey wrote: you could also short vol by selling calls. I don't think that's as profitable on average, though, but I think still positive. Also, if you're short a put, you can't lose more than the asset dropping to zero, no matter what the market conditions. I guess there could be trouble if you don't have the cash to pay up and need to start exiting positions early.
You get bought back instantly if you fall below: 100% of the option market value plus 15% of the underlying index value less out-of-the money amount, if any, to a minimum for calls of option market value plus 10% of the underlying index value.

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Wed Aug 02, 2017 7:34 pm

Okay, I have learned some things on good authority. I have posted here with some minor style changes and spelling a few things out. This is not my work. Enjoy:

A few things. First, the academic research on the Volatility Risk Premium is as strong as it is on anything, and obviously quite logical and intuitive.

Second, Stone Ridge fund sells volatility on hundreds of contracts across four asset classes, which are generally uncorrelated. So that greatly reduces tail risk. So think of it this, say you sell 100 different contracts with implied vols of 25% (realized say of 20). What's the volatility of the portfolio----way below 20 because the 100 contracts have low correlation. So you are collecting vol on each contract of 25 but the portfolio volatility is only say 10 realized. And you don't have anywhere near the tail risks.

Third, Stone Ridge isn't only a patient trader, they are market makers in these contracts and basically start out each year in effect with significant profit expected from being the market maker, not the price taker, that saves the entire spread or most of it, in most cases. They only trade where costs are low.

Expected return we think is say 7% conservatively (equity like) with 10 vol and low correlation to stocks and bonds.

Note this isn't new investment, it's been sitting on balance sheets of the Yale Endowments of the world for decades, it is just that now you can access it without the hedge fund fees due to interval structure.
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Re: Swedroe: Volatility As A Strategy

Post by stlutz » Wed Aug 02, 2017 11:31 pm

Yeah, but today I believe realized volatility will be much, much greater than expected (come the Minsky moment).

I agree with Swedroe on most things, but not here.

Just as he considers it rational to increase equity allocation/exposure to risk when expected returns are low (rather than go to cash), his response to a measure (volatility/valuation) is exactly opposite that of a value investor.
These are excellent points. I agree that I couldn't be talked into shorting equity volatility when the VIX is ~10. And I agree with the larger point about whether or not to take more risk when one expects little premium from doing so.

Finally, I've made this comment before but it always cracks me up that Larry's articles on ETF.com always advise investing in anything but ETFs. :D

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Re: Swedroe: Volatility As A Strategy

Post by stlutz » Wed Aug 02, 2017 11:32 pm

Is this approach really any different from simply writing naked puts?

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Re: Swedroe: Volatility As A Strategy

Post by Random Walker » Thu Aug 03, 2017 12:25 am

I don't think Larry would just say if expected returns are lower, then a person should increase equity allocation. I would expect he would say evaluate need to take risk. If expected returns are low and need more money, then take more equity risk. Alternatively, if past excellent returns have gotten individual closer to his goals and future expected returns are lower, then take equity risk off the table.

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Re: Swedroe: Volatility As A Strategy

Post by james22 » Thu Aug 03, 2017 4:12 am

Funny, both Larry and Taleb favor barbell portfolios, but they've very different ideas of risk.

Here, they'd make completely opposite bets.
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Re: Swedroe: Volatility As A Strategy

Post by lazyday » Thu Aug 03, 2017 5:06 am

stlutz wrote:I agree that I couldn't be talked into shorting equity volatility when the VIX is ~10.
Wouldn't it depend on what you're paid for it?

If the VIX was 10 and recent actual volatility was 5, then maybe it would be smarter to short volatility than to own the S&P 500.

Hope that makes sense, I don't know anything about shorting volatility. Maybe this instead: if volatility staying the same as it is today means that shorting it earns me 10% per year on the maximum amount that I can lose, then I'd rather earn that than own the S&P.

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Re: Swedroe: Volatility As A Strategy

Post by grok87 » Thu Aug 03, 2017 6:03 am

"The authors based their volatility returns primarily on two instruments: variance swaps and options. Their data series has an earliest start date of 1995, with starting dates varying depending on data availability."

Yep. Nicely missing the 1987 crash
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Re: Swedroe: Volatility As A Strategy

Post by acanthurus » Thu Aug 03, 2017 7:26 am

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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Thu Aug 03, 2017 7:59 am

acanthurus wrote:
jbolden1517 wrote: As I mentioned, I'm on the opposite side of this trade. I think we are seeing the birth of a new asset class (volatility) with derivatives over the next several decades becoming a mainstream investment. So I mostly agree with Larry.

Also the annual return from short volatility is 8%. Which makes sense
By definition: Stocks (SP500) return = dividends - cash return + short volatility return (spot VIX)

since stocks are just a messy way to hold a short volatility position.
Do I read this correctly that you are long vol? If so what's your take on the best way to go about that? VXX seems to track ^VIX terribly, and I have no experience with futures to know if using /VX directly is a good or bad idea. I've got a basic understanding of equity options and pricing but not much beyond that.

Really enjoying your contributions to the forum btw.
Merrill Edge doesn't offer futures yet. So the way I'm playing it is calls on the VIX. The downside of this is I'm paying both contango and theta, which is expensive. On the upside I've been able to hold tremendous upside for very little risk. Something like 2500 options on the future for $2k ain't bad. What's really nice about it you get a double whammy when VIX shoots up. First off as VIX goes up the option for fixed implied volatility goes up fast. Also if VIX is higher the implied volatility on all options is higher than average. So far that seems to be more true of VIX options. So these things really really move with the VIX. Tremendous upside swings whenever the VIX moves, and unfortunately so far then you give it all back and then some as the waves of VIX shorts move in.

I actually think options may be the best way regardless. But if you are at say Schwab you could also just hold the future and just pay contango and not pay theta. Less gambling more investing. For example November right now is trading at 13.7 which I think is the sweetspot. Your downside is only about 25% and a triple or better is the upside. Aug and Jan I think are too expensive. Sep (12.6), Oct (13.3) Dec (13.92) don't look bad if you want to diversify your range. The way I see it the problem with the pure contango play is there is a lot of contango. Everybody know these short VIX guys are going to get their heads handed to them, they just don't know when. I learned in the 1990s insanity can last a lot longer than you think it can. You have to take a much bigger position to make money. Its harder to be losing 20% on a big position than 100% on a smaller one while waiting for the stupidity to end.

VXX I have no idea how to use it. I'm just learning volatility myself. So take the above with a big grain of salt. But would love to discuss this. We have the birth of a new asset class. Kinda exciting.

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Re: Swedroe: Volatility As A Strategy

Post by acanthurus » Thu Aug 03, 2017 8:29 am

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Re: Swedroe: Volatility As A Strategy

Post by acanthurus » Thu Aug 03, 2017 9:01 am

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jbolden1517
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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Thu Aug 03, 2017 1:04 pm

acanthurus wrote: You post interesting things that make me think, so I'm fine with you being merely less new at this than me :)
Well thank you!
acanthurus wrote: Are VIX options standard American options?
Yes but remember they are options on the future which will eventually settle for cash.
acanthurus wrote: Are you managing theta by buying moderately long dated contracts and rolling them well before expiry?
Too long and a sudden spike likely won't help me because contango would reverse. So I'm only 3-5 month out and try to roll at 2. With the sell of volatility last month I got trapped in my position. Now I have a lottery ticket on the 9/20 and and 11/15s as the real position. So yes I'm paying way more theta than I wanted to.
acanthurus wrote: Also are these taxed at the 60/40 LT/ST gains rates since they are options on the index itself?
Leaps can be taxed at LT everything else is income. So very tax inefficient. But you can do calls in an IRA and I'm doing it there as well as taxable.
acanthurus wrote: If they are American style, does the ability to exercise longer dated VIX options early give them an advantage over longer dated futures that can only be exercised at expiration? (I'm assuming VX futures can only be exercised at expiration, but like I said, I'm a futures newb).
I don't think so since they are just options on the future.
acanthurus wrote: If vol spikes, do the shorter term futures benefit more than the longer term contracts since vol spikes seem to be short-lived assuming the futures can't be exercised until expiration?
Yep. A VIX is technically 0-30 days, a spot price. The further out you are the less it matters. But they do correlate with one another since volatility is somewhat sticky. In terms of the options it hasn't seemed to matter much what the date was.
acanthurus wrote: I've read too much Taleb and seen too many forum posts on options boards to think selling vol is a good idea long term. I just don't know the best way to go long with derivatives. Back testing using the pure ^VIX index as a small portfolio diversifier (60/30/10 variation of the standard 60/40 portfolio) shows some great results over the last 20 years and has me interested.
Agree to all. My current method sucks but the price was too compelling especially when I first got in.
acanthurus wrote: I'm probably demonstrating how green I am at this with this post, so be gentle :)
Not at all. This is tough.
acanthurus wrote: EDIT: I just came across this, looks like I have some reading to do:
https://cfe.cboe.com/education/tradingvolatility.pdf
Oh that is an awesome read. Thanks for the suggestion.

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Re: Swedroe: Volatility As A Strategy

Post by Swelfie » Thu Aug 03, 2017 9:01 pm

One mechanism to capture this premium fairly risk free is to sell covered calls at your rebalancing bands, which I do in my tax deferred account in order to avoid short term capital gains on the return.

For instance, I hold VWO (vanguard emerging markets) for my EM aspect of my AA. I buy 200 EEM. 100 of those is my holdings and I sell a call at my upper rebalancing band covered by these (because VWO options aren't very liquid.) The other 100 are my potential holdings, and I sell a call covered by these on my lower rebalancing band. If my lower call expires out of the money, then I buy the equivalent holdings of VWO, along with selling next quarters options. If it expires in the money, I either roll the option or buy back the 100 EEM. This is equivalent to rebalancing by buying 100 VWO when the price goes too far down, or just holding when it doesn't, except I earn the volatility premium. On the upper band I do similarly.

I was going to rebalance anyway if the price changed dramatically, so there is not really much risk there except that I don't rebalance at the "optimal" point occasionally. Most of the time I exited within the bands and just collect my premium.

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Re: Swedroe: Volatility As A Strategy

Post by lack_ey » Thu Aug 03, 2017 9:57 pm

A lot of this thread is discussing a very narrow, specific trade on volatility for the stock market. The VIX products are too narrow and have their issues.

The idea in the article and the papers is to do this for a lot of different assets, hence something like 1987 not being as big a problem. And of course if you already have long equity exposure as we all do here, selling vol in equities is not as diversifying a potential source of return as doing it elsewhere. Position sizing and diversification are key.

Ideally you would also look around at the different strike prices to see what is particularly in demand and sell that.

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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Fri Aug 04, 2017 4:48 pm

lack_ey wrote:A lot of this thread is discussing a very narrow, specific trade on volatility for the stock market. The VIX products are too narrow and have their issues.

The idea in the article and the papers is to do this for a lot of different assets, hence something like 1987 not being as big a problem. And of course if you already have long equity exposure as we all do here, selling vol in equities is not as diversifying a potential source of return as doing it elsewhere. Position sizing and diversification are key.

Ideally you would also look around at the different strike prices to see what is particularly in demand and sell that.
Agree. We got distracted because I was explaining how short volatility worked, added the disclaimer that I was long, we had a discussion about how to go long and my experience.... At the end of the day lots of people here know stocks better than most investments. We could switch to something like Interest Rate Swap Volatility Index (SRVIX) which I think might be interesting for the bond guys. But I have 0 experience with this product.

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Re: Swedroe: Volatility As A Strategy

Post by Top99% » Sat Aug 05, 2017 11:12 am

nedsaid wrote:I am seeing a shift here. It looks like Larry Swedroe is really pushing hard into alternative investments. He, the academics, and Buckingham are looking hard for sources of return wherever they can find them. This is telling me there is less and less optimism about future expected returns from the US Stock Market and of course this is a function of very low interest rates as well.
That is my take on things as well. It seems like in the US at least there is too much money chasing "traditional" investments and to use a Bernstein quote (roughly) even the formerly hidden umbrella shops seem to have been discovered and made available via ETFs . All this being said I am only willing to stray ~15% into alts. So, hopefully the market timing/active management police will let me go with a warning.
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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Sat Aug 05, 2017 12:32 pm

Top99% wrote:
nedsaid wrote:I am seeing a shift here. It looks like Larry Swedroe is really pushing hard into alternative investments. He, the academics, and Buckingham are looking hard for sources of return wherever they can find them. This is telling me there is less and less optimism about future expected returns from the US Stock Market and of course this is a function of very low interest rates as well.
That is my take on things as well. It seems like in the US at least there is too much money chasing "traditional" investments and to use a Bernstein quote (roughly) even the formerly hidden umbrella shops seem to have been discovered and made available via ETFs . All this being said I am only willing to stray ~15% into alts. So, hopefully the market timing/active management police will let me go with a warning.
I am doing this mostly on my own. It is kind of like watching stunts performed on television with the "don't try this at home" disclaimer. I do work with an independent broker with about 30% of my retirement and he pretty much sticks with traditional plain vanilla type of investments. Earlier in his career, he played a bit with options but his opinion is that sticking with the basics works pretty well. He doesn't believe in such stuff as commodities. It seems that we outsmart ourselves. It has been interested to see his evolution over the years, he was pretty much a stockbroker and now does a lot with ETFs and lower cost mutual funds. He has a few stocks he is always looking at but he talks a lot about ETFs and funds.

Your investing philosophy needs to be in alignment with that of your advisor. So were I to work with Larry's firm, Buckingham, I would pretty much "get with the program" whatever the program is. It just doesn't work to pay an advisor and then spend your time fighting their recommendations. Their expertise is the whole reason to hire them in the first place.

Yes, I have been ticketed not only by the market timing/active management police but also by the guardians of investment purity and hygiene who were aghast at my rather relaxed attitude toward rebalancing. Fortunately, the judge is pretty easy, no big fines to pay. This forum is sort of like a confession booth where I anonymously confess my investing faults, failures, and outright sins.
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Re: Swedroe: Volatility As A Strategy

Post by lack_ey » Mon Aug 07, 2017 3:53 pm

There's also a vast amount of money in alts these days. Hedge fund AUM is above $3 trillion, though a lot of them just have substantial long positions in traditional assets.

More relevantly here, vol trading (short side, selling) as part of institutional portfolios and other structures is old news.

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Tue Aug 08, 2017 10:42 am

More information from a very good source. I did a bit of editing. Again, this is not my work:

And in case of lendx and reinsurance that is exactly what the funds are doing, putting you in banking and reinsurance business.

in case of the Volatility Risk Premium, that's different, and it's not a hedge at all, but selling volatility insurance and as you would expect since volatility is a risk it carries a risk premium (which of course loses money sometimes), but the tail risk is greatly reduced by diversifying the source of the volatility selling across multiple asset classes.

Unfortunately at this point the Stone Ridge funds are only available from a very small group of advisors.
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Re: Swedroe: Volatility As A Strategy

Post by Taylor Larimore » Tue Aug 08, 2017 11:19 am

Interested in Boglehead thoughts on the article.
Dave:

After many years of unsuccessfully trying to beat-the-market with complicated strategies, I learned that it is a fools errand for most of us. These experts agree:
Scott Adams, author of Dilbert: "I once tried to write a book about personal investing. After extensive research I realized I could describe everything that a young first-time investor needs to know on one page."

Antoine de Saint-Exupéry: "A designer knows he has achieved perfection not when there is nothing left to add, but when there is nothing left to take away."

Christine Benz, Morningstar Director of Personal Finance: "Simplicity is one of the greatest--but in my view, woefully underrated--virtues when managing a portfolio."

Bill Bernstein, author of Four Pillars of Investing: ""The more real people I get to know, the more I am convinced the simpler the solution, the better the solution."

Richard Bernstein, Merrill Lynch strategist: "Investors find it hard to believe that ignoring the vast majority of investment noise might actually improve their performance."

Jack Bogle: "Simplicity is the master key to financial success."

Dan Bortolotti, CFP, and author of The Money Sense Guide to the Perfect Portfolio: "The peace of mind that comes with a simple investing strategy is priceless."

Jack Brennan, former Vanguard CEO and author of Straight Talk on Investing: "It's in the interest of many financial service companies to make you think that investing is difficult.--It's really quite simple."

Warren Buffet: "To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these."

Scott Burns, creator of The Couch Potato Strategy: The advocates of complexity are generally people who are making their living from the complexity they create for us.”

Ben Carlson, author of A Wealth of Common Sense: ""I’ve spent my entire career working in portfolio management. This experience has taught me that less is always more when making investment decisions. Simplicity trumps complexity."

Jean Chatzky, NBC Financial Editor: "The problem with so much personal financial advice is that it's unnecessarily complicated, often with the goal of selling you something you don't need."

Andrew Clarke, author of "Wealth of Experience": "In investing, simple is usually more productive than complex."

Jonathan Clements, Wall Street Journal columnist: "Investing is simple. To be sure, you can make it ludicrously complicated."

J.L.Collins, author of The Simple Path to Wealth: The more complex an investment is, the less likely it is to be profitable. At best they are costly. At worst they are a cesspool of swindlers.

Paul Crafter, author of "Investment Guide": "After doing it all, I now feel I've come around in a complete circle, ending up with this: The more I learn, the less I really need to know."

James Dahle, Editor of The White-Coat Investor: "In my view, the simpler the financial product, the better it is for the consumer."

Edsger Dijkstra, famed physicist: “Simplicity is a great virtue but it requires hard work to achieve it and education to appreciate it. And to make matters worse: complexity sells better.”

Laura Dogu, Ambassador to Nicaragua and co-author of "The Bogleheads Guide to Retirement Planning": A simple portfolio is actually the ultimate in sophistication. It almost always lowers cost (including taxes), makes analysis easier, simplifies rebalancing, simplifies tax-preparation, reduces paper-work and record-keeping, and enables caregivers and heirs to easily take-over the portfolio when necessary. Best of all, a simple portfolio allows the investor to spend more time with family and friends."

Michael Edesess, author of The Big Invesment Lie: "As a mathematician I know when mathematical-sounding analyses are little more than elaborate sales pitches, designed to thoroughly obscure the simple fact that smart investing is non-mathematical and accessible to everyone."

Albert Einstein: "The five ascending levels of intellect are: smart, intelligent, brilliant, genius, simple."

Charles Ellis, co-author of "The Elements of Investing": "KISS investing--Keep It Simple, Sweetheart--is the best and easiest and lowest cost and worry-free way to invest for retirement security."

Javier Estrada Ph.D., Professor of finance: "Simplicity is often underrated; simple static strategies (balanced portfolios) have been shown to perform as well as—and often better than—more complex strategies in a wide variety of settings."

Paul Farrell, author of "The Lazy Person's Guide to Investing": "Perhaps the most amazing insight I got out of this review of the investment habits of Nobel laureates is the simplicity of their investing strategies."

Rick Ferri, CFA, advisor, and author of six financial books:[/i] "Don’t assume that a complex strategy is better than a simple strategy. The only thing extra complexity is likely to add is extra cost."

The Finance Buff: "Making fewer decisions usually leads to better results than making more decisions."

Future Metrics looked at the performance of 224 pension plans over about 14 years compared with the performance of 60% S&P 500 index and 40% aggregate bond index benchmark. Of those 224 plans, only 19 beat that simple benchmark.

Gensler & Baer, authors of "The Great Mutual Fund Trap": "If you simply buy and hold you don't need to read investing magazines, watch financial news networks, subscribe to newsletters, or pay a broker to execute new trades."

Benjamin Graham, author, teacher, famed investor: "If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse. -- In the stock market, the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions we draw therefrom."

Alan Greenspan, former Chairman of the Federal Reserve: "This decade is strewn with examples of bright people who thought they built a better mousetrap that could consistently extract abnormal returns from financial markets. Some succeed for a time. But while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist."

Morgan Housel: financial columnist for Wall Street Journal and Motley Fool's "Simple almost always beats complex."

Daniel Kahneman, Nobel Laureate: "All of us would be better investors if we just made fewer decisions"

Edmund Kean: "Complexity is easy. Simplicity is hard."

Kiplinger: "The big secret to successful investing is that it's actually not all that complicated. Most of the mumbo jumbo doesn't matter."

Darrow Kirkpatrick, author of Retiring Sooner: "In financial life, you should run from complexity, and run toward simplicity."

Michael LeBoeuf, author of "The Millionaire in You": "The master key to wealth can be summed up in just one word: Simplicity."

Bruce Lee: "One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity"

Leonardo da Vinci: “Simplicity is the ultimate sophistication.”

Peter Lynch, legendary fund manager: "If you spend more than fifteen minutes a year worrying about the market, you've wasted twelve minutes."

MIT Study: "The less well-informed group did far better than the group that was given all the financial news."

Scott MacKillop, CEO First Ascent Asset Management: " People who don’t know any better equate complexity with sophistication. But truly it takes more sophistication to build elegantly simple portfolios."

Joe Maglia, CEO TD Ameritrade: "Wall Street goes out of its way to make investing incredibly sophisticated and complex because they can make a tremendous amount of money by doing so."

Burton Malkiel, author of "Random Walk Down Wall Street": "The overarching rule for achieving financial security: Keep it simple. -- The most important financial advice is stunningly simple and fits on an index card."

John Markese, CEO of American Association of Individual Investors: "If you have more than eight funds you should slap yourself."

Wm McNabb, Vanguard CEO: "If you can't understand an investment product in five minutes, walk away."

Eric McWhinnie, chief analyst, Wall Street Cheat Sheet: "Keep your investment strategy simple and steer clear of complicated vehicles that are designed to benefit the people selling them."

James Montier, author of The Little Book of Behavioral Investing : "Never underestimate the value of doing nothing."

Morningstar Guide to Mutual Funds: "Good investing doesn't have to be complicated. In fact, simplification may lead to better investment results."

Issac Newton: “Truth is ever to be found in the simplicity, and not in the multiplicity and confusion of things.”

Suze Orman: "We make investing so complicated and it really is not. -- A total market index fund is a great one-stop-shopping choice that provides you instant diversification among different types of stocks."

Mike Piper, financial author: "There's an entire industry built on convincing us that investing is complicated."

"David Nadig, president of Index Universe's ETF Analytics: "Most investors—myself included—are better off the simpler we keep things."

Jane Bryant Quinn, syndicated columnist and author of "Smart and Simple Financial Strategies": "You shouldn't buy anything too complex to explain to the average 12-year old."

John Rekenthaler, Morningstar Research Director: "How many funds should you have? Four to six should do.-- A complex investment strategy, with many moving parts, means more wheels that are stuck at any given time, leading to more questions and more uncertainty."

Rodc on Bogleheads Forum: "While doing this financial engineering my wife who does no math just shook her head at my optimization games and said, 'Rod, life is uncertain, get over it.' After a lot of work, I discovered much to my surprise, she was right."

Allan Roth, CFP, CPA, author and advisor: "Investing in eight words: Maximize diversification and discipline; minimize expenses and emotions.”

Paul Samuelson, Nobel Laureate: "Investing should be like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."

Bill Schulthies, author of "The Coffeehouse Investor": "When you simplify your investment decisions, not only do you enrich your life by spending more time on families, friends and careers, but you enhance portfolio returns in the process."

Chandon Sengupta, author of "The Only Proven Road to Investment Success": "There is overwhelming evidence that the simplest possible investment method works much better than all the other more complex ones."

George Sisti, CFP, MarketWatch contributor: "There is no perfect portfolio — yours should emphasize simplicity and shun complexity."

Larry Swedroe, author of "The Successful Investor Today": "The more complex the investment, the faster you should run away."

David Swensen, Yale Chief Investment Officer: "As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run."

Henry David Thoreau: “Our life is frittered away by detail. Simplify, simplify.”

Andrew Tobias, author of The Only Investment Guide You Will Ever Need: "I believe in selecting the most straightforward and easiest-to-implement strategy for achieving our goals."

Tweddell and Pierce, authors of "Winning with Index Mutual Funds": "Keep it simple. Investment success depends on asset allocation, diversification, and risk management, not on complexity."

Eric Tyson, author of "Mutual Funds for Dummies:" "Planners may try to make it all so complicated that you believe you can't possibly manage your finances or make major financial decisions without them."

Walter Updegrave, Editor of Money magazine: "Simpler is better. Ignore the siren song of sophisticated investments"

Richard Young, author of "The Intelligence Report": "If you can't run your portfolio taking 60 minutes a month, it's too complicated."

Karen Wallace, Morningstar senior editor: "Having fewer accounts can help you streamline your monitoring and rebalancing efforts. And having your assets in one place can allow you to better assess your overall asset mix.

Jason Zweig, Wall Street Journal columnist and author of "The Intelligent Investor": "The less you fool with your portfolio, the less often you'll play the fool."

Warren Buffett: "There seems to be some perverse human characteristic that likes to make easy things difficult."
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Tue Aug 08, 2017 11:46 am

Taylor Larimore wrote: After many years of unsuccessfully trying to beat-the-market with complicated strategies, I learned that it is a fools errand for most of us. These experts agree:
I have never understood how you can write so eloquently about bear markets, especially the depression. Write so passionately about how people are underestimating the risk of stocks. And at the same time urge everyone to do nothing to avoid stock risk. Alternatives add complexity, no question. But they do so in exchange for safety.
Taylor Larimore wrote: Larry Swedroe, author of "The Successful Investor Today": "The more complex the investment, the faster you should run away."
We are actually discussing a strategy that Larry recommended.

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Re: Swedroe: Volatility As A Strategy

Post by nedsaid » Tue Aug 08, 2017 11:58 am

Pretty much, retail investors have access now to AQR Funds, which are sort of like hedge funds for the masses. Stone Ridge gets you into the banking business, the reinsurance business, and the portfolio insurance business. Stone Ridge funds are the actual businesses themselves but you have limited liquidity. The theory is that you get into the business itself and get the returns from that business without beta, the volatility risk from traded securities. In both reinsurance and portfolio insurance, you get steady equity like returns in exchange for the risk of catastrophic casualty losses and bear markets. Steady returns in exchange for big losses from time to time. In theory, these equity like returns have low correlation to the stock market itself.

For the most part, these strategies require advisors in order to access. We will have to see how these investments perform.
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Re: Swedroe: Volatility As A Strategy

Post by Random Walker » Tue Aug 08, 2017 12:57 pm

Einstein said something to the effect "Everything should be made as simple as possible, but not simpler". I agree that in general complexity in investing is something to be wary of. I also agree that we can get very far Investing simply and cheaply with a TSM approach. The very best diversifier of equity risk is very cheap high quality short duration bonds. That being said, modern portfolio theory shows that adding less than perfectly correlated sources of return to a portfolio will increase portfolio efficiency. Increased portfolio efficiency does translate into more real money.
If we start with a basic cheap TSM equity fund as the anchor of a portfolio, the best diversifier will be a cheap dose of bonds. As we add additional non correlated sources of return, the marginal cost increases rapidly. In order of rapidly increasing marginal cost are international, small value, momentum, long/short factors, and then stuff like reinsurance, alternative lending, Variance risk premium. Each of the above additions will almost certainly increase portfolio efficiency and most certainly increase portfolio cost. Very very difficult, if not impossible, to know ex ante if the cost is worthwhile.
As pointed out above, one of the greatest advocates for low cost passive investing, Larry Swedroe, is also an advocate for these relatively expensive alternatives. That means they warrant serious consideration. He has stated in the past that cost alone is not what matters; it is cost per unit value added that matters.
In the past I have written about the real cost of volatility drag. It is partially this cost that has gotten me interested in the alternatives. Perhaps much more significant are behavioral issues. Placing one's bet on a single factor, market beta, will result in some tremendous euphoric and stomach churning swings. Might an investor diversified across sources of return / factors be more likely to stick to his plan? Or will an investor confidently stick to his plan knowing that it's greatest benefit is its low cost? Different people will certainly answer these questions differently.

Dave

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Bonds and Fixed Income vs. Alternate Stocks

Post by Taylor Larimore » Tue Aug 08, 2017 2:35 pm

jbolden1517 wrote:
I have never understood how you can write so eloquently about bear markets, especially the depression. Write so passionately about how people are underestimating the risk of stocks. And at the same time urge everyone to do nothing to avoid stock risk. Alternatives add complexity, no question. But they do so in exchange for safety.
jbolden1517:

I have NEVER "urged everyone to do nothing to avoid stock risk." All eight of our portfolios in The Bogleheads' Guide to Investing include bonds to avoid stock risk.

I simply believe that adding cash, CDs or a good quality short- or intermediate term bond fund to a portfolio (with their less stock correlation) is a much better way to avoid stock risk than adding alternate stocks.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Correction

Post by nedsaid » Tue Aug 08, 2017 2:47 pm

Taylor Larimore wrote:
jbolden1517 wrote:
I have never understood how you can write so eloquently about bear markets, especially the depression. Write so passionately about how people are underestimating the risk of stocks. And at the same time urge everyone to do nothing to avoid stock risk. Alternatives add complexity, no question. But they do so in exchange for safety.
jbolden1517:

I have NEVER "urged everyone to do nothing to avoid stock risk." All eight of our portfolios in The Bogleheads' Guide to Investing include bonds for safety.

I simply believe that adding cash, CDs or a good quality short- or intermediate term bond fund to a portfolio (with their less stock correlation) is a much better way to avoid stock risk than adding alternate stocks.

Best wishes.
Taylor
Taylor, you are right that good old bonds are probably the best way to dampen stock risk. If bonds were yielding 6% and not 2%, there would be much less interest in alternatives. It seems like a lot of these alternatives are a proxy for bonds, finding 6% returns that don't correlate with the stock market.

Another thing that has been brought up on this forum is that because interest rates are so low, the cushioning effect of bonds in bear markets is much less. Two reasons, you get a much lower cash flow from the bonds and also interest rates have very little room left to fall. Typically in a bear market you could count on a fat 6% coupon from bonds plus the capital appreciation from lower interest rates. I guess how well bonds act as a cushion depends upon what caused the bear market in the first place. In the 1973-74 stagflation bear market, it was a tough environment for both stocks and bonds. Ultimately, rates went up and went up a lot to kill off inflation. Most often, if the bear market is caused by recession, the Fed will drop interest rates in an attempt to get the economy moving again.

The jury is out on these alternatives. David Swenson at Yale had good luck with alternative investments but he was early to the party. Other college endowments that tried to copy him did not have his success.
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Re: Correction

Post by lazyday » Tue Aug 08, 2017 2:52 pm

nedsaid wrote:David Swenson at Yale had good luck with alternative investments but he was early to the party. Other college endowments that tried to copy him did not have his success.
He also didn't recommend any to retail investors in Unconventional Success.

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Re: Correction

Post by nedsaid » Tue Aug 08, 2017 2:54 pm

lazyday wrote:
nedsaid wrote:David Swenson at Yale had good luck with alternative investments but he was early to the party. Other college endowments that tried to copy him did not have his success.
He also didn't recommend any to retail investors in Unconventional Success.
Yep. Swenson also had presumably an unlimited time horizon. Makes it much easier to own illiquid assets like private equity and semi-liquid assets like direct real estate and timberland.
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Re: Swedroe: Volatility As A Strategy

Post by jbolden1517 » Tue Aug 08, 2017 3:16 pm

Random Walker wrote: The very best diversifier of equity risk is very cheap high quality short duration bonds.
I think for future you might want to differentiate to others between dilution (deleveraging) and diversification. I suspect from the below you know the distinction but a lot of people on here don't. High quality short duration bonds dilute risk but they do very little to diversify risk they don't have any credit risk and very little duration risk to act as diversifiers. Now of course there are advantages to diluting risk, but that's not the same thing as diversification.
Random Walker wrote: That being said, modern portfolio theory shows that adding less than perfectly correlated sources of return to a portfolio will increase portfolio efficiency. Increased portfolio efficiency does translate into more real money. If we start with a basic cheap TSM equity fund as the anchor of a portfolio, the best diversifier will be a cheap dose of bonds.
Why would that be true?
Random Walker wrote: In the past I have written about the real cost of volatility drag. It is partially this cost that has gotten me interested in the alternatives. Perhaps much more significant are behavioral issues. Placing one's bet on a single factor, market beta, will result in some tremendous euphoric and stomach churning swings. Might an investor diversified across sources of return / factors be more likely to stick to his plan? Or will an investor confidently stick to his plan knowing that it's greatest benefit is its low cost? Different people will certainly answer these questions differently.
I've generally been pretty good to sticking to my plan. I'm also someone who has a pretty low correlation with market beta. It makes a huge difference if even 1/4 of your portfolio is happy when the stock market is down in terms of the degree of anxiety.

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Re: Bonds and Fixed Income vs. Alternate Stocks

Post by jbolden1517 » Tue Aug 08, 2017 3:42 pm

Taylor Larimore wrote:
jbolden1517 wrote:
I have never understood how you can write so eloquently about bear markets, especially the depression. Write so passionately about how people are underestimating the risk of stocks. And at the same time urge everyone to do nothing to avoid stock risk. Alternatives add complexity, no question. But they do so in exchange for safety.
jbolden1517:

I have NEVER "urged everyone to do nothing to avoid stock risk." All eight of our portfolios in The Bogleheads' Guide to Investing include bonds to avoid stock risk. I simply believe that adding cash, CDs or a good quality short- or intermediate term bond fund to a portfolio (with their less stock correlation) is a much better way to avoid stock risk than adding alternate stocks.
I certainly agree bonds help to reduce portfolio risk. I certainly agree you have done a lot to push people towards allocations like 60/40, rather than 100/0 who are starting out. I also like the fact you said less correlation. :happy I think we both agree that a lot of investors underestimate risk. What I'm asking is why attack non-correlating assets as a way to reduce risk without having to reduce return.

Why discourage diversification? Why discourage things like international small which also have low correlation with USA stocks. Why discourage natural resources, energy, REITs, gold, commodities, EM bonds, all low correlation? That's what I don't get. You agree with me 100% on the importance of not creating a situation where a brutal stock market can derail a child's college education or a successful retirement. You warn investors all the time that there are no guarantees that markets recover in 6 mo or 2 years or even 10 years. Yet you work hard to give people the impression they have no choice between accepting low returns or taking on so much stock market risk that they put themselves in lots of danger of disastrous outcomes.

I think you know there are alternative portfolios designs. What would you be holding if you were 35 had an 8 year old. Had $85k for her education and had 10 years to make sure it got to $200? Bonds aren't going to do it.

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Taylor Larimore
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Re: Swedroe: Volatility As A Strategy

Post by Taylor Larimore » Tue Aug 08, 2017 4:37 pm

What would you be holding if you were 35 had an 8 year old. Had $85k for her education and had 10 years to make sure it got to $200? Bonds aren't going to do it.
jbolden1517"

First, I would recognize the fact that NO 85K investment will "make sure it got to $200 in ten years."

Second, I would not put 100% of the investment in stocks.

"What would you be holding?" I would probably put my 85K in a low-cost 529 tax-advantaged college plan containing low-cost Vanguard stock and bond index funds which increases its bond allocation as college years approach.

Best wishes.
Taylor
Last edited by Taylor Larimore on Tue Aug 08, 2017 4:50 pm, edited 1 time in total.
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Bonds and Fixed Income vs. Alternate Stocks

Post by Theoretical » Tue Aug 08, 2017 4:44 pm

jbolden1517 wrote:
Taylor Larimore wrote:
jbolden1517 wrote:
I have never understood how you can write so eloquently about bear markets, especially the depression. Write so passionately about how people are underestimating the risk of stocks. And at the same time urge everyone to do nothing to avoid stock risk. Alternatives add complexity, no question. But they do so in exchange for safety.
jbolden1517:

I have NEVER "urged everyone to do nothing to avoid stock risk." All eight of our portfolios in The Bogleheads' Guide to Investing include bonds to avoid stock risk. I simply believe that adding cash, CDs or a good quality short- or intermediate term bond fund to a portfolio (with their less stock correlation) is a much better way to avoid stock risk than adding alternate stocks.
I certainly agree bonds help to reduce portfolio risk. I certainly agree you have done a lot to push people towards allocations like 60/40, rather than 100/0 who are starting out. I also like the fact you said less correlation. :happy I think we both agree that a lot of investors underestimate risk. What I'm asking is why attack non-correlating assets as a way to reduce risk without having to reduce return.

Why discourage diversification? Why discourage things like international small which also have low correlation with USA stocks. Why discourage natural resources, energy, REITs, gold, commodities, EM bonds, all low correlation? That's what I don't get. You agree with me 100% on the importance of not creating a situation where a brutal stock market can derail a child's college education or a successful retirement. You warn investors all the time that there are no guarantees that markets recover in 6 mo or 2 years or even 10 years. Yet you work hard to give people the impression they have no choice between accepting low returns or taking on so much stock market risk that they put themselves in lots of danger of disastrous outcomes.

I think you know there are alternative portfolios designs. What would you be holding if you were 35 had an 8 year old. Had $85k for her education and had 10 years to make sure it got to $200? Bonds aren't going to do it.
Why discourage things like international small which also have low correlation with USA stocks. Why discourage natural resources, energy, REITs, gold, commodities, EM bonds, all low correlation?


International small - This is true, but the problem is that most international small cap funds are really international midcap funds at best. To truly get local exposure, you've got to pay ERs out the nose (well above 1%) and risk active management. Note, even DFA's is not a true ISV fund for many of its largest holdings.

Natural resources, [Precious metals equity], Energy, REITs - all are stock sectors or industries. REITs are a bit different, with the tax structure, but they still add complexity and TSM has a 3-4% slug.

Gold and Commodities - 0% real return, with the main returns being speculative/political/event. You get storage costs and horrible tax treatment for gold and implementation problems/crowding with commodities.

EM Bonds - You've got an investability problem here. Do you pick USD Emerging bonds, which don't suffer currency problems on your end but are more likely to default (historically having a lower credit rating) or do you pick local currency bonds, which may have better credit but subject you to currency fluctuations that can easily outstrip the bonds' expected return.

Moreover, with the exception of Gold, all of these assets tend to gain correlation in times of economic panic, such as the depression or 2008. Gold's actually not that great for inflation either.

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