in idea with SCV and leverage..

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Peppergrass
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in idea with SCV and leverage..

Post by Peppergrass » Mon Jun 04, 2018 11:22 pm

Hi guys,

wondering your thoughts, as I was listening to an audio with Bill Bernstein in it, where he mentioned some idea some guys came up with if.. I don't know some people wanted to hit their retirement target but couldn't save enough.. they mentioned leveraging the portfolio to achieve obviously a higher level of return..

this got me thinking.. why not just do a whole portfolio of small cap value and leverage it to the max you can, and prey for no depression, or leverage in the fact of an ongoing downmarket although at that point I'm not sure you can or what minimal leverage you could even take, maybe what 5% over a 20 year period to get to zero??

what's wrong in this logic? I mean if you are ok with volatility, if you setup the leverage that yo can take a 50% loss on years..I honestly don't see really a better way of max return if yo can stomach the losses with such concentration and margin.. I mean to me, if you are ok with a SP500 fund, what's better is if you get higher return if once again you can stomach more volatility

I wanted to do this with all my free money I have, as to me.. I asked myself my goal, it was max return, so then I was like, small cap, there is no other magic bullet unless you want to play Roulette with IPO for a 40,000% return over the investment time.

another reason why I thought this was something Bill said, he said over the years, he expects returns to drop a little, so if you are in the riskiest asset class that should theoretically return more then any asset over time, another thing is the dividends on the ETF should be able to pay for a majority of the margin fees, which to me a nice thing vs. say doing this on buffets stock where you might have down years and also have to pay margin interest..

please if anyone has some papers or research or advice or formulas or whatnot, please bring them in, as I am seriously considering this as a long term play on a side account, I aim to put in 150k a year, and fund it with a million to kick it off. Or if you know of another system for max returns I'm all ears as I believe losses don't affect me one bit with this, as it's a mental game of "side money" and I have lost large amounts, also with 2008 I lost not one single night of sleep or even stressed about it once..

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unclescrooge
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Re: in idea with SCV and leverage..

Post by unclescrooge » Mon Jun 04, 2018 11:28 pm

If only investing was as easy as simple as leveraging your riskiest asset classes.

stlutz
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Re: in idea with SCV and leverage..

Post by stlutz » Tue Jun 05, 2018 12:04 am

viewtopic.php?t=5934

It's 29 pages, but reading through the whole thread is worth it.

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whodidntante
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Re: in idea with SCV and leverage..

Post by whodidntante » Tue Jun 05, 2018 12:09 am

The best research paper I know of is the "different approach to asset allocation" thread by markettimer. Markettimer is brilliant, explained himself the whole way down, showed a thick skin, and went down swinging. He had absolutely terrible timing to implement his strategy, which is ironic considering his handle. The bright side is he's doing just fine today.

If I woke up at 58 with very little money, questionable working capital left, and virtually no assets to lose in a bankruptcy, I'm single, no kids, and no dependents, then I would take the gamble, because glamour poor is my best alternative. I would also consider it if I were very young, had nothing to lose, and didn't particularly care about my credit rating.

Personally I would use futures as much as possible, not credit. It's cheaper and you'll have a lower risk of ruin for a given leverage multiple. The downside is you could do EM or small, but probably not small value. Actually that's not much of a downside. You can use your credit to further decrease your risk of ruin.

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alpine_boglehead
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Re: in idea with SCV and leverage..

Post by alpine_boglehead » Tue Jun 05, 2018 12:11 am

stlutz wrote:
Tue Jun 05, 2018 12:04 am
viewtopic.php?t=5934

It's 29 pages, but reading through the whole thread is worth it.
+1, yes that's highly recommended reading for anyone toying with the idea of leverage. Grab a cup of your favorite beverage, and open a chart of the S&P 500 which you should scroll along as your read through the second half of 2008.

Valuethinker
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Re: in idea with SCV and leverage..

Post by Valuethinker » Tue Jun 05, 2018 2:52 am

This was of course "the Bonfire of the Quants" in early August 2007. See Scott Patterson "The Quants".

A major hedge fund (Clifford Asness? I don't know if that has ever been disclosed) had just such a strategy and had to liquidate.

The classic "crowded trade" resulted. As prices of stocks (they all held similar portfolios, the "black box" quant hedge funds used similar stock selection models) their positions lost value and they had to sell more to cover their losses (because they were leveraged).

Goldman Sachs lost several hundred million on its internal hedge fund. It was a rout.

About a week in, Goldman announced it was putting more money in, and that restored confidence and stopped the rout.

Unless you can borrow 30 year fixed term, this is a risky strategy. And you have to have an alternative plan to repay the debt, if it does not work in the 30 year time horizon.

Random Walker
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Re: in idea with SCV and leverage..

Post by Random Walker » Tue Jun 05, 2018 9:19 am

I think you’re touching on a great idea POTENTIALLY. One can create a more efficient portfolio with a combination of the riskiest asset classes and the least risky asset classes, then leverage it up to the desired expected return. From what I understand, the only problem for individual investors like us is the price of the leverage.
Many of the alternatives we discuss use leverage, and change the amount of leverage over time to target a certain volatility. They can borrow money more cheaply than we can.

Dave

Jack FFR1846
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Re: in idea with SCV and leverage..

Post by Jack FFR1846 » Tue Jun 05, 2018 9:24 am

There's another futures strategy. Go to Vegas and bet it all on red. It's actually less risky, but could result in the same outcome. You hit red....you win big. You don't? You lose it all and start over again with no debt.
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nisiprius
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Re: in idea with SCV and leverage..

Post by nisiprius » Tue Jun 05, 2018 9:33 am

Peppergrass, there's one interesting upper limit, probably. This is a tricky subject, and it is controversial, and leads to endless discussions. However, no matter how risk-tolerant you are, it is probably irrational to be more than about 140% invested in stocks, i.e. to use more than 0.4-to-1 leverage, because, I've read, that's the ratio set by the "Kelly criterion" for betting, given the statistical bet-like properties of the stock market. The part that is relatively easy to understand about the Kelly criterion is that it is the amount of leverage that maximizes the logarithm of your expected return. People who write about it, however, say that the criterion does not assume anything about your personal utility function, i.e. it is not the result of assuming that you have a logarithmic utility functions. The Kelly criterion--I think!--also takes into account the issue that if you make a repeated series of parlayed bets--i.e. leveraged investments in risky assets where the returns are reinvested--the chances of encountering a run of bad luck that wipes you out or puts you into debt increase over time.
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Re: in idea with SCV and leverage..

Post by Valuethinker » Tue Jun 05, 2018 9:41 am

Hedge funds suffer from the Principal Agent problem.

If the leveraged purchase of SCV stocks works, then the investors share the upside with the HF managers via the fee (say 1.5% p.a.) and the performance fee (say 10-15% of the outperformance).

If it fails, then investors lose their investment. HF managers lose their jobs - but may have been so well compensated that this does not matter. Or they start up again with a new HF with a clean track record.

It's always dangerous to give your money to someone who takes a share in the upside if you win, but don't have the same downside risks that you do.

Valuethinker
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Re: in idea with SCV and leverage..

Post by Valuethinker » Tue Jun 05, 2018 9:43 am

nisiprius wrote:
Tue Jun 05, 2018 9:33 am
Peppergrass, there's one interesting upper limit, probably. This is a tricky subject, and it is controversial, and leads to endless discussions. However, no matter how risk-tolerant you are, it is probably irrational to be more than about 140% invested in stocks, i.e. to use more than 0.4-to-1 leverage, because, I've read, that's the ratio set by the "Kelly criterion" for betting, given the statistical bet-like properties of the stock market. The part that is relatively easy to understand about the Kelly criterion is that it is the amount of leverage that maximizes the logarithm of your expected return. People who write about it, however, say that the criterion does not assume anything about your personal utility function, i.e. it is not the result of assuming that you have a logarithmic utility functions. The Kelly criterion--I think!--also takes into account the issue that if you make a repeated series of parlayed bets--i.e. leveraged investments in risky assets where the returns are reinvested--the chances of encountering a run of bad luck that wipes you out or puts you into debt increase over time.
I don't know anything about this BUT

- it seems to me the key is that the investor can get wiped out, and loses his ability to play the game again.

That possibility of a wipeout from leveraged investing is what is striking. Maybe that's why a strategy appears to pay high returns, because there is the risk of a wipeout.

A bit like putting *all* your money into state lottery tickets. You could wind up with zero return i.e. minus 100%.

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Re: in idea with SCV and leverage..

Post by Nate79 » Tue Jun 05, 2018 9:43 am

People mock this idea and then they go and pay their mortgage payment and car payment as they are investing in their 401k/Roth IRA/taxable accounts. From a balance sheet perspective it is the same thing. The main difference are the specific details of the loan (fixed rate, noncallable, etc). So along these lines, while I don't recommend it, you could take out loans against your house or car and invest the money which may be more beneficial than a margin loan.

Valuethinker
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Re: in idea with SCV and leverage..

Post by Valuethinker » Tue Jun 05, 2018 9:44 am

Jack FFR1846 wrote:
Tue Jun 05, 2018 9:24 am
There's another futures strategy. Go to Vegas and bet it all on red. It's actually less risky, but could result in the same outcome. You hit red....you win big. You don't? You lose it all and start over again with no debt.
Thinking the recent Solo: A Star Wars Story. There can be other problems in a casino, too.

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Re: in idea with SCV and leverage..

Post by garlandwhizzer » Tue Jun 05, 2018 8:36 pm

Leverage with a high risk/high potential reward asset like SCV with a large portion of the portfolio is a fine option if you have sufficient safe wealth that you can comfortably afford to lose 60+% of SCV value without panic, and/or you have a high paying job that is totally secure regardless of what the economy does. That is to say it works beautifully if you don't need it at all and you're sufficiently patient. Otherwise it may work beautifully only on paper and in theory. The problem if you may actually need the money is that SCV is expected to tank big time in a severe recession which is also when jobs become less secure. You can get hit with a triple whammy: massive losses due to SCV tanking, multiplication of those loses on the downside by leverage, and then combine that with the real possibility of losing your job/income stream. In that case you can be forced to sell at precisely the point of maximal pain, a real possibility of being totally wiped out. Leverage offers a chance to lose more money than you invested in the first place. This strategy is exceptionally high risk. Working longer, saving more, investing more, and spending less are solutions that, while not sexy short cuts to wealth, have no risk and work reliably.

Garland Whizzer

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whodidntante
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Re: in idea with SCV and leverage..

Post by whodidntante » Tue Jun 05, 2018 8:49 pm

Nate79 wrote:
Tue Jun 05, 2018 9:43 am
People mock this idea and then they go and pay their mortgage payment and car payment as they are investing in their 401k/Roth IRA/taxable accounts. From a balance sheet perspective it is the same thing. The main difference are the specific details of the loan (fixed rate, noncallable, etc). So along these lines, while I don't recommend it, you could take out loans against your house or car and invest the money which may be more beneficial than a margin loan.
I agree that a lot of accumulators here are leveraged in this manner, including myself. I have stated that I am leveraged and precisely what I meant by that before.

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Epsilon Delta
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Re: in idea with SCV and leverage..

Post by Epsilon Delta » Tue Jun 05, 2018 10:55 pm

nisiprius wrote:
Tue Jun 05, 2018 9:33 am
People who write about it, however, say that the criterion does not assume anything about your personal utility function,
Consider the personal utility function where you have $1 and need $10m by Friday or you die. The Kelly criteria does not enter into it, you need to bet enough or failure is certain.

So the Kelly criteria does assume something, probably that you get an infinite number of bets.

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JoMoney
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Re: in idea with SCV and leverage..

Post by JoMoney » Tue Jun 05, 2018 11:50 pm

Peppergrass wrote:
Mon Jun 04, 2018 11:22 pm
...what's wrong in this logic? I mean if you are ok with volatility, if you setup the leverage that yo can take a 50% loss on years..I honestly don't see really a better way of max return if yo can stomach the losses with such concentration and margin.. I mean to me, if you are ok with a SP500 fund, what's better is if you get higher return if once again you can stomach more volatility ...
To me, I have a problem with the conflation of volatility and "risk", which I don't think is the same thing. Among the reasons I use a low-cost, S&P 500 index fund is to simply get a fair share of the markets return and avoid the potentially catastrophic mistakes people are prone to make.
I think the use of leverage, and buying into trading schemes and active strategies are among those mistakes.
Benjamin Graham in The Intelligent Investor wrote:... we have made a basic distinction between two kinds of investors to whom this book was addressed—the “defensive” and the “enterprising.” The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses...

...An elementary requirement for the intelligent investor is an ability
to resist the blandishments of salesmen... [Graham mentions IPO's in bull markets, but I would suggest this applies to mutual funds too]

...the majority of security owners should elect the defensive classification... They should therefore be satisfied with the excellent return now obtainable from a defensive portfolio (and with even less), and they should stoutly resist the recurrent temptation to increase this return by deviating into other paths...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Valuethinker
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Re: in idea with SCV and leverage..

Post by Valuethinker » Wed Jun 06, 2018 3:05 am

Nate79 wrote:
Tue Jun 05, 2018 9:43 am
People mock this idea and then they go and pay their mortgage payment and car payment as they are investing in their 401k/Roth IRA/taxable accounts. From a balance sheet perspective it is the same thing. The main difference are the specific details of the loan (fixed rate, noncallable, etc). So along these lines, while I don't recommend it, you could take out loans against your house or car and invest the money which may be more beneficial than a margin loan.
You cannot be margin called on a car loan or mortgage? Fluctuations in the value of the associated asset do not lead to withdrawal of credit facilities? If your house price drops 50%, but you still make your payments, you can keep living in your house?

That's the key. The limit to speculation (leverage) is the margin call. You have to be able to borrow for at least as long as it takes the market to recover, whereas conventional margin accounts are marked-to-market at least daily, and so there can be a forced liquidation.

It's how Buffett does it. He has a huge supply of loaned funds (insurance premiums - the "float"). He invests it long term in low volatility companies (both quoted and unquoted). But he cannot be margin called-- in fact, liquidity crises *benefit* him, because he can function as a last resort provider of liquidity.

Long Term Capital Management, by contrast, had strategies that would have paid off, but became overextended and faced margin calls. Hence its collapse. Lehman Brothers was, in essence, a highly leveraged bet of a similar nature, and experienced the margin call of all margin calls (a c. $480bn balance sheet of securities they could no longer finance via money markets).

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pezblanco
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Re: in idea with SCV and leverage..

Post by pezblanco » Wed Jun 06, 2018 8:44 am

Epsilon Delta wrote:
Tue Jun 05, 2018 10:55 pm
nisiprius wrote:
Tue Jun 05, 2018 9:33 am
People who write about it, however, say that the criterion does not assume anything about your personal utility function,
Consider the personal utility function where you have $1 and need $10m by Friday or you die. The Kelly criteria does not enter into it, you need to bet enough or failure is certain.

So the Kelly criteria does assume something, probably that you get an infinite number of bets.
Yes, it does.

In this thread there is a short synopsis of what the Kelly criterion optimizes ....

viewtopic.php?f=10&t=237430&p=3711263#p3711263

onourway
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Re: in idea with SCV and leverage..

Post by onourway » Wed Jun 06, 2018 10:34 am

Nate79 wrote:
Tue Jun 05, 2018 9:43 am
People mock this idea and then they go and pay their mortgage payment and car payment as they are investing in their 401k/Roth IRA/taxable accounts. From a balance sheet perspective it is the same thing. The main difference are the specific details of the loan (fixed rate, noncallable, etc). So along these lines, while I don't recommend it, you could take out loans against your house or car and invest the money which may be more beneficial than a margin loan.
Valuethinker already wrote on this, but the big difference between a mortgage and other forms of investment leverage is that I cannot be wiped out by leveraging my mortgage. Schwab has some surprisingly straightforward literature on margin borrowing. I suggest you read them. https://www.schwab.com/public/file?cmsi ... 11478&cv17 (PDF) and https://www.schwab.com/public/file?cmsid=P-270109&cv17

Leveraging my mortgage does not include risks such as:
Your downside is not limited to the collateral value in your margin
account.
Schwab may initiate the sale of any securities in your account, without
contacting you, to meet a margin call.
Schwab may increase its “house” maintenance margin requirements
at any time and is not required to provide you with advance written
notice.
You are not entitled to an extension of time on a margin call.

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Re: in idea with SCV and leverage..

Post by ThrustVectoring » Wed Jun 06, 2018 4:19 pm

Small-cap value has higher beta, if you don't have binding leverage constraints then you shouldn't invest there. It'll tend to get over-crowded by people who have leverage limits and so search for more risk per unit capital.

Instead, leverage should be applied to low volatility stocks and shorter-term bonds. So take a minimum volatility stock fund, and then crank up the returns by applying leverage. Similarly, if you want your bond portfolio to have a duration of 10 years, you'll tend to be better off leveraging up 2-year treasury futures by a factor of 5 than by buying 10-year treasuries outright.

FWIW, I'm not convinced enough of this approach to actually go for it - I'm happy enough to get the market average results via 100% VTSAX/VTIAX.
Current portfolio: 60% VTI / 40% VXUS

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Re: in idea with SCV and leverage..

Post by alpine_boglehead » Thu Jun 07, 2018 12:12 pm

Cross-referencing this current thread about the psychology of money. It's about a superb article about investor behavior. And this quote sums up the idea of using (too much) leverage.
The idea is that you have to take risk to get ahead, but no risk that could wipe you out is ever worth taking.

Peppergrass
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Re: in idea with SCV and leverage..

Post by Peppergrass » Thu Jun 07, 2018 7:28 pm

thank you guys for the comments, I will read that thread when I have a chance tonight..


I'm not sure how much that guy was leveraged?? but I'll look,

it makes me think and have thought about toying with the idea on this, of playing with the margin in certain scenarios.. here's one for example.. run a pure 100% SCV, when it hits a 35% downfall, leverage in at ... lets just say 20%, it hits down to 40-50, you leverage in again to 50%, this of course is betting we don't hit a depression, then you get wiped out, game over.. but with this theory, you cannot know the future, but you know when there is a drop, which is scary and painful to most. most people are predicting what the market will do, but I have come to think waiting for a drop is easier then thinking what market does.. because once a drop happens it's known.. the two variables with this is obviously.. how far she drops, and is she going to go into Great Depression mode.. two things we can't say but timing of a max 50% drop, would make you some very serious gains when it recovers if you are planing there is no depression and or larger drop then 50%.. I would say most would be willing to bet on these two not happening??

then you say dump leverage at 100% gain, to then 10% leverage to a set time point, three years out, as apparently that is the tie between most bull to bear markets... this of course loses you to what we have been experiencing which is at over 8 years up.. in this scenario you would be hurting to play max roulette if you didn't leverage out and watched the gains disappear...

it's an idea I have been toying with.. once again this is play money, nothing more..I can lose it and not care, as I have enough for family and already have my kid very well funded.


just some thoughts... I'm a gambler by nature though, and makes me wonder how to get more. some people introduced a good idea, futures, there is also LEAPS too.. the Kelly criterion has one author who has made 800 million in leaps... granted he is a mathematician and I'm sure a great deal smarter then I will ever be.. maybe luck was on his side, maybe it was all purely brains.. I don't know, I have tried to find more to his method and analysis of using LEAPS, but can't really find any more then he recommended the average user invest SP500......

Theoretical
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Re: in idea with SCV and leverage..

Post by Theoretical » Thu Jun 07, 2018 8:35 pm

here's one for example.. run a pure 100% SCV, when it hits a 35% downfall, leverage in at ... lets just say 20%, it hits down to 40-50, you leverage in again to 50%, this of course is betting we don't hit a depression, then you get wiped out, game over.. but with this theory, you cannot know the future, but you know when there is a drop, which is scary and painful to most. most people are predicting what the market will do, but I have come to think waiting for a drop is easier then thinking what market does.. because once a drop happens it's known.. the two variables with this is obviously.. how far she drops, and is she going to go into Great Depression mode.. two things we can't say but timing of a max 50% drop, would make you some very serious gains when it recovers if you are planing there is no depression and or larger drop then 50%.. I would say most would be willing to bet on these two not happening??

then you say dump leverage at 100% gain, to then 10% leverage to a set time point, three years out, as apparently that is the tie between most bull to bear markets... this of course loses you to what we have been experiencing which is at over 8 years up.. in this scenario you would be hurting to play max roulette if you didn't leverage out and watched the gains disappear...
Absolutely horrible, horrible idea. Margin calls WILL wipe you out here, especially because you're all on a single roulette number (the riskiest slice of equities - triply so if you're US only). Remember, SCV are typically highly leveraged companies INTERNALLY so you do not want leverage squared. There are plenty of risks involved with the suggested highly leveraged 2 year treasury futures, but they're exponentially safer than this strategy.

100% SCV can be a brutal ride, but won't send you to zero. This kind of leverage will in a hurry, especially in a down market

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