HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs]

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HEDGEFUNDIE
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Tue Feb 05, 2019 11:46 pm

HomerJ wrote:
Tue Feb 05, 2019 11:41 pm
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
Your return numbers from the backtest are high because of how well Long Treasuries did during that period. You will not get those same numbers starting from this point.

The plan may indeed do very well, but you are highly unlikely to get your $10 million in the same amount of time, because you are NOT starting with 10% Treasuries with falling interest rates.
In Jul 2009 the 30 year Treasury was yielding 4.5%. Today it's yielding 3.0%.

This strategy, as shown in my last post using the actual ETFs, delivered 26% CAGR over this period. Pretty much the same as over the previous 20 years when interest rates dropped from 10%, as you say.

klaus14
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by klaus14 » Wed Feb 06, 2019 12:07 am

HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
What if long term trend reverses and interest rates climb back to 6%? Both stocks AND bonds will do bad. I think you are overfitting.

Topic Author
HEDGEFUNDIE
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Wed Feb 06, 2019 12:11 am

klaus14 wrote:
Wed Feb 06, 2019 12:07 am
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
What if long term trend reverses and interest rates climb back to 6%? Both stocks AND bonds will do bad. I think you are overfitting.
Where is the evidence that rising interest rates are bad for stocks?

https://advisors.vanguard.com/VGApp/iip ... PrStkRtrns

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HomerJ
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HomerJ » Wed Feb 06, 2019 12:30 am

HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:46 pm
In Jul 2009 the 30 year Treasury was yielding 4.5%. Today it's yielding 3.0%.

This strategy, as shown in my last post using the actual ETFs, delivered 26% CAGR over this period. Pretty much the same as over the previous 20 years when interest rates dropped from 10%, as you say.
And stocks went on tear from July 2009.

So right now, Treasuries are yielding less than they did in 2009, AND stocks are highly less likely to return 13% a year for the next 10 years like they just did.

Go for it. At least you're smart enough to keep it at 15% of your money.
The J stands for Jay

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Day9 » Wed Feb 06, 2019 12:40 am

I see OP has the most recent reply on user Rob Bertram's thread Should I use margin to buy a balanced fund?.

OP: To answer your question about when these two assets will fall at the same time, I believe this happens more often when you look at real numbers, not nominal. During stagflation stocks go down and bonds may not go down much nominally, but they lose a lot of real value when there is high inflation.
I'm just a fan of the person I got my user name from

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by fennewaldaj » Wed Feb 06, 2019 1:15 am

HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm


I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
I would say that your main risk is that this relationship breaks down sometime over the period you do this. Its only 15% of your portfolio though so it seems fine to make the moderate gamble that this dynamic continues.

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HEDGEFUNDIE
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Wed Feb 06, 2019 1:22 am

fennewaldaj wrote:
Wed Feb 06, 2019 1:15 am
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm


I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
I would say that your main risk is that this relationship breaks down sometime over the period you do this. Its only 15% of your portfolio though so it seems fine to make the moderate gamble that this dynamic continues.
Bingo, we have a winner.

The supremacy of the US dollar could certainly be challenged, but quite honestly I don’t see it happening in the next 20 years. The Euro, Pound, Yen, RMB all have their respective weaknesses.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Austin_Denizen » Wed Feb 06, 2019 1:27 am

A number of issues with this:

1) Fees and costs will be high. The nearly 1% ER is high to begin with, but inside the funds the manager will be actively trading derivatives such as futures contracts to maintain the leveraged positions. These futures positions inside the ETFs must be rolled over once a quarter, and the position sizes must be adjusted each day to make sure the notional exposure is 3X the assets in the fund. This trading activity will incur commissions and "slippage" that are additional costs not reflected in the ER.

2) The actual performance of these ETFs will not be simply 3X the underlying (ie, the S&P 500 or Bonds). The pricing on the derivatives in the fund (the futures, forwards or whatever other derivatives the managers use) reflects the economic equivalent of a borrowing cost to effect the leverage. Thus, your return for a 3X S&P 500 ETF should be roughly equal to 3X the SP 500 minus: 1) borrowing cost equivalent to that on a notional amount twice the value of the fund, 2) the ER, and 3) the trading costs of the futures program I described above.

3) In addition, because the manager is trying to maintain a 3X leverage position each day, if there is a very large down day in the underlying (SP500 or bonds) then the ETF will sustain a magnified very large loss that is more difficult to recover from. This happened in dramatic fashion with the 3X natural gas ETFs a few months back and with the leveraged inverse VIX products in Feb 2018. By way of example, if the S&P 500 drops 5% one day and then rises 5% the next day, it will still be 0.25% lower than before the down 5% day (100 -5% = 95; 95 + 5% = 99.75). But a 3X leverage ETF that would have a 15% down day followed by a 15% up day would then be 2.25% lower than it had been before the initial down day (100 -15% = 85; 85 + 15% = 97.75), much more than 3X the loss of the index. 5% is a somewhat extreme example, but the same principle will play out with any highly volatile move.

A real life example of this can be seen in the very high volatility environment of Feb 2018. That month, VOO (Vanguard's SP500 ETF) was down 3.73% but UPRO was down 13.53%, about 3.63X the Vanguard product.

The combined effect of these factors can be seen in comparing UPRO's 2018 performance to that of VOO. UPRO's total return for 2018 was -25.11%, while VOO was -4.5%. So UPRO lost 5.5X what VOO did, despite its 3X daily leverage.

4) Your biggest fundamental exposure would be a highly inflationary environment such as occurred in the 70s. Surging interest rates could cause both stock and bond prices to decline and those losses would be magnified by the leverage.

5) Your approach is essentially a "risk parity" approach, and as money has flowed into such strategies it may be that their effectiveness could decline. In fact, I believe this has already begun to happen -- look at how risk parity funds such as AQRIX have performed over recent years compared to a 60/40 portfolio. The Feb 2018 "volpocalypse" and earlier similar taper tantrum moves are examples of what can happen when many investors pile into leveraged strategies that would have worked well in backtesting in the past. Adverse price movements can lead to large losses that cause margin calls for some investors who then need to trade against those positions to reduce risk and the result can be sharp and large adverse movements.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by unclescrooge » Wed Feb 06, 2019 1:40 am

Despite all the criticism, kudos for posting. :beer

I'm curious to see how this pans out over the long run, especially since I rejected a similar idea based on three reasons:

1. Rates may trend higher from here, negatively impact the bonds
2. Leveraged ETFs may no longer work as advertised
3. I'm to chicken to commit a worthwhile amount to this strategy to make it meaningful

gtwhitegold
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by gtwhitegold » Wed Feb 06, 2019 7:24 am

http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html

Above is a list of annual returns for stocks, t-bills, and 10 year treasuries. In only 4 years were the returns negative for both stocks and the 10 year. Also, only one year had a considerable drop in both. Assuming that the returns within a single year are similar, and the investor isn't too risk adverse, this strategy should be executable.

While I agree that stagflation is a real possibility, I don't think that it would cause the behavioral issues of positive correlations.

That being said, I believe that HEDGEFUNDIE should consider international developed and emerging markets stocks as well since there are 3x ETFs for those as well.

Good luck with your experiment.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by rmelvey » Wed Feb 06, 2019 7:30 am

Have you thought about using futures instead of ETFs? You would likely have lower overall expenses and your leverage doesn't reset daily. Definitely takes more of a careful eye to manage though, rolling your contracts each month.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SagaciousTraveler » Wed Feb 06, 2019 7:35 am

Hello,

I noticed both funds do not pay out dividends. Could this strategy be affective in a taxable account? My initial reaction is no because you would still need to rebalance quarterly thus triggering short/long term capital gains.

I ask because I have two different investment plans between taxable and non-taxable. My non-taxable accounts I keep simple with the three fund portfolio. However my taxable account is where i have a small percentage set for 'alternative investments' (stocks, ETFs), which I have yet to invest in anything.

Thank you.

james22
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by james22 » Wed Feb 06, 2019 7:40 am

Waiting for Vanguard's Global Minimum Volatility 3X ETF.

gtwhitegold
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by gtwhitegold » Wed Feb 06, 2019 8:21 am

SagaciousTraveler wrote:
Wed Feb 06, 2019 7:35 am
Hello,

I noticed both funds do not pay out dividends. Could this strategy be affective in a taxable account? My initial reaction is no because you would still need to rebalance quarterly thus triggering short/long term capital gains.

I ask because I have two different investment plans between taxable and non-taxable. My non-taxable accounts I keep simple with the three fund portfolio. However my taxable account is where i have a small percentage set for 'alternative investments' (stocks, ETFs), which I have yet to invest in anything.

Thank you.
You could do it in a taxable account, you would just need a cash buffer if you wanted to rebalance quarterly in your first year without short term captial gains. You could likely use specific lots to tax loss harvest to balance gains during periods of volatility to balance out, but you would only have to do that the first year, since after that you could do long term capital gains after the year mark. Also, if you included international, it would likely give you more opportunities to tax gain / tax lost harvest.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Tanelorn » Wed Feb 06, 2019 8:42 am

There’s nothing like actually trading an idea to see how it works, instead of just backtesting how you imagine it might go. As with any long term, multi-decade experiment, you only live once so you’re either in the experimental group or the control group. Good luck!

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SagaciousTraveler
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SagaciousTraveler » Wed Feb 06, 2019 8:51 am

gtwhitegold wrote:
Wed Feb 06, 2019 8:21 am
SagaciousTraveler wrote:
Wed Feb 06, 2019 7:35 am
Hello,

I noticed both funds do not pay out dividends. Could this strategy be affective in a taxable account? My initial reaction is no because you would still need to rebalance quarterly thus triggering short/long term capital gains.

I ask because I have two different investment plans between taxable and non-taxable. My non-taxable accounts I keep simple with the three fund portfolio. However my taxable account is where i have a small percentage set for 'alternative investments' (stocks, ETFs), which I have yet to invest in anything.

Thank you.
You could do it in a taxable account, you would just need a cash buffer if you wanted to rebalance quarterly in your first year without short term captial gains. You could likely use specific lots to tax loss harvest to balance gains during periods of volatility to balance out, but you would only have to do that the first year, since after that you could do long term capital gains after the year mark. Also, if you included international, it would likely give you more opportunities to tax gain / tax lost harvest.
Perhaps it was the lack of coffee on why this didn't occur to me but it makes perfect sense. Thank you.

If you had say 10,000 to put in. Perhaps invest 9,000 and use the 1,000 for rebalancing.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Valuethinker » Wed Feb 06, 2019 9:16 am

Tanelorn wrote:
Wed Feb 06, 2019 8:42 am
There’s nothing like actually trading an idea to see how it works, instead of just backtesting how you imagine it might go. As with any long term, multi-decade experiment, you only live once so you’re either in the experimental group or the control group. Good luck!
It feels to me that this strategy worked in a historical sense because:

- both asset classes were in a long term bull market

Therefore leverage works in its favour.

We know that in the long run a large proportion of the returns from holding stocks come from dividends (which makes sense in a theoretical sense - a share is the right to a stream of dividend income at some point in the life of the company). This strategy does not reap that source of return.

It also seems logical that if you buy an option driven product, you are paying the time premium (which diminishes). There is also, of course, the impact of paying management fees.

The usual problem with leveraged strategies is the margin call. At some point the strategy is well out of the money and the investor runs out of time to make it back. From memory Nisiprius calls that a "Martingale Strategy" although I do not fully understand that term.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by sabtastic » Wed Feb 06, 2019 9:16 am

For those that are upset or concerned, is this any different than leveraging real estate? Although it is not exactly the same, if I were to buy a rental property with a traditional loan, that would be roughly 5x leverage, with arguably MORE risk. How would this be any different than OP purchasing a 500k 3bd house to rent out?

I have never had the stones to do this so I am pretty excited. Thank you for documenting this.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Jags4186 » Wed Feb 06, 2019 10:40 am

Valuethinker wrote:
Wed Feb 06, 2019 9:16 am
Tanelorn wrote:
Wed Feb 06, 2019 8:42 am
There’s nothing like actually trading an idea to see how it works, instead of just backtesting how you imagine it might go. As with any long term, multi-decade experiment, you only live once so you’re either in the experimental group or the control group. Good luck!
It feels to me that this strategy worked in a historical sense because:

- both asset classes were in a long term bull market

Therefore leverage works in its favour.

We know that in the long run a large proportion of the returns from holding stocks come from dividends (which makes sense in a theoretical sense - a share is the right to a stream of dividend income at some point in the life of the company). This strategy does not reap that source of return.

It also seems logical that if you buy an option driven product, you are paying the time premium (which diminishes). There is also, of course, the impact of paying management fees.

The usual problem with leveraged strategies is the margin call. At some point the strategy is well out of the money and the investor runs out of time to make it back. From memory Nisiprius calls that a "Martingale Strategy" although I do not fully understand that term.
The Martingdale Strategy refers to a betting strategy where you double each successive wager after a loss until you win. This allows you to win back all of your losses and win the original al amount intended.

Bet 10 and lose
Bet 20 and lose
Bet 40 and lose
Bet 80 and lose
Bet 160 and lose
Bet 320 and win and reset your wager to 10

You can see the problem with this is even if you start your initial bet with 1% of your bankroll ($10 out of $1000) you only get 6 chances before the strategy fails. For anyone who has played blackjack or roulette, I’m sure you’ve been on the receiving end of a losing streak of 6 or more many times.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by BD w/ Kung-Fu Grip » Wed Feb 06, 2019 10:46 am

In for 1k. The commissions may eat my return, but it might be a bit of fun.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by rmelvey » Wed Feb 06, 2019 10:47 am

Jags4186 wrote:
Wed Feb 06, 2019 10:40 am
Valuethinker wrote:
Wed Feb 06, 2019 9:16 am
Tanelorn wrote:
Wed Feb 06, 2019 8:42 am
There’s nothing like actually trading an idea to see how it works, instead of just backtesting how you imagine it might go. As with any long term, multi-decade experiment, you only live once so you’re either in the experimental group or the control group. Good luck!
It feels to me that this strategy worked in a historical sense because:

- both asset classes were in a long term bull market

Therefore leverage works in its favour.

We know that in the long run a large proportion of the returns from holding stocks come from dividends (which makes sense in a theoretical sense - a share is the right to a stream of dividend income at some point in the life of the company). This strategy does not reap that source of return.

It also seems logical that if you buy an option driven product, you are paying the time premium (which diminishes). There is also, of course, the impact of paying management fees.

The usual problem with leveraged strategies is the margin call. At some point the strategy is well out of the money and the investor runs out of time to make it back. From memory Nisiprius calls that a "Martingale Strategy" although I do not fully understand that term.
The Martingdale Strategy refers to a betting strategy where you double each successive wager after a loss until you win. This allows you to win back all of your losses and win the original al amount intended.

Bet 10 and lose
Bet 20 and lose
Bet 40 and lose
Bet 80 and lose
Bet 160 and lose
Bet 320 and win and reset your wager to 10

You can see the problem with this is even if you start your initial bet with 1% of your bankroll ($10 out of $1000) you only get 6 chances before the strategy fails. For anyone who has played blackjack or roulette, I’m sure you’ve been on the receiving end of a losing streak of 6 or more many times.
Daily levered ETFs do the opposite of this. To maintain a constant leverage ratio they sell assets as they fall in value, and buy more as they raise. Rolling a futures contract or buying stocks on margin (and not rebalancing) would be closer to the martingale strategy because your leverage % would increase as the asset falls in value.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Jags4186 » Wed Feb 06, 2019 10:47 am

sabtastic wrote:
Wed Feb 06, 2019 9:16 am
For those that are upset or concerned, is this any different than leveraging real estate? Although it is not exactly the same, if I were to buy a rental property with a traditional loan, that would be roughly 5x leverage, with arguably MORE risk. How would this be any different than OP purchasing a 500k 3bd house to rent out?

I have never had the stones to do this so I am pretty excited. Thank you for documenting this.
No margin calls in real estate in the United States.

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vineviz
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by vineviz » Wed Feb 06, 2019 11:18 am

Time2Quit wrote:
Tue Feb 05, 2019 10:28 pm
I am not doubting or being negative, I am just want to know what conditions would need to be present for this strategy outperform the market?
It basically only takes two conditions for a daily leveraged strategy like this to outperform the market.

1) The underlying assets need to produce a modestly positive average return (i.e roughly 0.28% per month or better).
2) The underlying assets need to have slightly more up days than down days on average (i.e. at least one more up day per month than down days).

It's definitely true that a string of unfavorable months can definitely take a bite out this strategy: going back to 1970 a daily 3x leverage strategy like this would have produced three drawdowns greater than 50% (1972-74, 1977-1981, and 2007-2009) versus just one for an unleveraged stock portfolio.

Even so, this kind of leverage doesn't magnify the downside risk nearly as much as people tend to assume. The 3x 40/60 portfolio proposed here. Since 1970, the 20 worst months for large cap U.S. stocks have had an average return of -10.35%. During those same 20 worst months, this strategy would have had an average return of -13.47%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by samsdad » Wed Feb 06, 2019 11:24 am

I think in all fairness we need to see the simulated data set upon which this experiment is based on, at least in part. I think there's a way to cut and paste the data in a response here.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by aj76er » Wed Feb 06, 2019 11:43 am

I think that the use of leverage to create a more efficient portfolio is an interesting one. Here's a link to PV that looks at three portfolios:
  • 25% 3x leverage S&P and 75% Inter US Treas
  • 37.5% 2x leverage S&P and 62.5% Inter US Treas
  • 75% S&P and 25% Inter US Treas
https://www.portfoliovisualizer.com/bac ... tion4_3=25

The portfolio efficiency (and CAGR) increases monotonically with increased leverage.

On paper, there's not much to dislike about this methodology. However, it does raise some questions:

* Can the leveraged ETFs be wiped out in a market crash? SSO (2x leveraged S&P) was in existence during 2008 and only dropped 81% while unleveraged S&P dropped 50%. I would have thought SSO would have been wiped out. Or does the leveraging only asymtotically approach zero?
* Will the uncorrelated behavior of US treasuries and S&P persist? There is an increased reliance on the flight to quality behavior to US Treasuries with these types of portfolios.
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SagaciousTraveler » Wed Feb 06, 2019 11:55 am

Jags4186 wrote:
Wed Feb 06, 2019 10:47 am
sabtastic wrote:
Wed Feb 06, 2019 9:16 am
For those that are upset or concerned, is this any different than leveraging real estate? Although it is not exactly the same, if I were to buy a rental property with a traditional loan, that would be roughly 5x leverage, with arguably MORE risk. How would this be any different than OP purchasing a 500k 3bd house to rent out?

I have never had the stones to do this so I am pretty excited. Thank you for documenting this.
No margin calls in real estate in the United States.
HedgeFundie isn't using margin.

With that said, I would hope Bogleheads wouldn't use margin to buy leveraged ETFs.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by garlandwhizzer » Wed Feb 06, 2019 12:06 pm

Interesting strategy, HEDGEFUNDIE. It worked quite well over the last 30 years. I do not however believe that backtesting the past defines the future in any precise way. We are in quite a different macroeconomic environment now especially so relative to the 1980s, 1990s which had high economic growth, high inflation, high bond yields, robust labor productivity growth, a manufacturing rather than a service/information based economy, and much lower total debt levels. That is pretty much the opposite of what we have now. It will be interesting to see how this adventure works out. Please keep us updated with your results. I wish you good luck.

Garland Whizzer

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by EfficientInvestor » Wed Feb 06, 2019 12:10 pm

samsdad wrote:
Wed Feb 06, 2019 11:24 am
I think in all fairness we need to see the simulated data set upon which this experiment is based on, at least in part. I think there's a way to cut and paste the data in a response here.
samsdad - The article at the link below provides step-by-step instruction on how to pull the daily data and upload it to Portfolio Visualizer for use in a backtest. This is the method that was used to develop the data that HEDGEFUNDIE used. The article uses the Nasdaq instead of S&P 500, but you can pull data for ^GSPC to match what HEDGEFUNDIE has shown for UPRO.

https://theleveragedindexer.com/2018/11 ... -backtest/

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Tanelorn » Wed Feb 06, 2019 12:25 pm

SagaciousTraveler wrote:
Wed Feb 06, 2019 11:55 am
HedgeFundie isn't using margin.

With that said, I would hope Bogleheads wouldn't use margin to buy leveraged ETFs.
The SEC increased the margin requirements on leveraged ETFs years ago, so you don’t get much if any margin on them even if you wanted.

https://www.finra.org/sites/default/fil ... 119906.pdf

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by vineviz » Wed Feb 06, 2019 12:47 pm

aj76er wrote:
Wed Feb 06, 2019 11:43 am
* Can the leveraged ETFs be wiped out in a market crash? SSO (2x leveraged S&P) was in existence during 2008 and only dropped 81% while unleveraged S&P dropped 50%. I would have thought SSO would have been wiped out. Or does the leveraging only asymtotically approach zero?
Because the leverage on these ETFs resets daily they don't get wiped out due to market movements. If you took the five worst days for the S&P 500 from 1923 to present and experienced them in an uninterrupted streak a 3x daily leveraged ETF would lose only 91% of its value.

Needless to say, the odds of the S&P 500 dropping by 50% in five days is insanely low: I think the worst week in stock market history is a drop of less than 20%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by rmelvey » Wed Feb 06, 2019 12:47 pm

aj76er wrote:
Wed Feb 06, 2019 11:43 am
I think that the use of leverage to create a more efficient portfolio is an interesting one. Here's a link to PV that looks at three portfolios:
  • 25% 3x leverage S&P and 75% Inter US Treas
  • 37.5% 2x leverage S&P and 62.5% Inter US Treas
  • 75% S&P and 25% Inter US Treas
https://www.portfoliovisualizer.com/bac ... tion4_3=25

The portfolio efficiency (and CAGR) increases monotonically with increased leverage.

On paper, there's not much to dislike about this methodology. However, it does raise some questions:

* Can the leveraged ETFs be wiped out in a market crash? SSO (2x leveraged S&P) was in existence during 2008 and only dropped 81% while unleveraged S&P dropped 50%. I would have thought SSO would have been wiped out. Or does the leveraging only asymtotically approach zero?
* Will the uncorrelated behavior of US treasuries and S&P persist? There is an increased reliance on the flight to quality behavior to US Treasuries with these types of portfolios.
These leveraged ETFs reset their leverage daily. The S&P500 would need to drop 50% in a single day for the fund to get completely wiped out.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by EfficientInvestor » Wed Feb 06, 2019 12:57 pm

HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
HEDGEFUNDIE - Have you considered the use of TYD (3X 7-10 year treasuries) instead of TMF (3X 20 year treasuries)? While TMF will likely provide better protection when stocks crash, TYD won't be as susceptible to losses due to rising interest rates. Since 2015, a portfolio with TYD instead of TMF would have performed better, but when the inevitable stock crash comes, you will likely wish you were holding TMF instead of TYD.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SagaciousTraveler » Wed Feb 06, 2019 12:58 pm

Tanelorn wrote:
Wed Feb 06, 2019 12:25 pm
SagaciousTraveler wrote:
Wed Feb 06, 2019 11:55 am
HedgeFundie isn't using margin.

With that said, I would hope Bogleheads wouldn't use margin to buy leveraged ETFs.
The SEC increased the margin requirements on leveraged ETFs years ago, so you don’t get much if any margin on them even if you wanted.

https://www.finra.org/sites/default/fil ... 119906.pdf
Thank you.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by finite_difference » Wed Feb 06, 2019 1:04 pm

rmelvey wrote:
Wed Feb 06, 2019 12:47 pm
aj76er wrote:
Wed Feb 06, 2019 11:43 am
I think that the use of leverage to create a more efficient portfolio is an interesting one. Here's a link to PV that looks at three portfolios:
  • 25% 3x leverage S&P and 75% Inter US Treas
  • 37.5% 2x leverage S&P and 62.5% Inter US Treas
  • 75% S&P and 25% Inter US Treas
https://www.portfoliovisualizer.com/bac ... tion4_3=25

The portfolio efficiency (and CAGR) increases monotonically with increased leverage.

On paper, there's not much to dislike about this methodology. However, it does raise some questions:

* Can the leveraged ETFs be wiped out in a market crash? SSO (2x leveraged S&P) was in existence during 2008 and only dropped 81% while unleveraged S&P dropped 50%. I would have thought SSO would have been wiped out. Or does the leveraging only asymtotically approach zero?
* Will the uncorrelated behavior of US treasuries and S&P persist? There is an increased reliance on the flight to quality behavior to US Treasuries with these types of portfolios.
These leveraged ETFs reset their leverage daily. The S&P500 would need to drop 50% in a single day for the fund to get completely wiped out.
Does anything below 50% not matter, e.g. would a 23% drop have any impact? I would think they’d halt trading if it went below 30% in a single day. So that offers some protection?

So 15% of your portfolio will be using this leverage strategy — what are you doing for the other 85% of your portfolio? I feel like it’s the total portfolio performance that really matters.

Is the rest of your portfolio S&P 500 and you are simply looking for additional performance?

So 85% S&P 500 and 15% leverage strategy. And the hope is that such a portfolio will beat 100% S&P 500?

Don’t forget the maxim that more money has been lost reaching for yield than at the point of a gun.
The most precious gift we can offer anyone is our attention. - Thich Nhat Hanh

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Wed Feb 06, 2019 2:05 pm

EfficientInvestor wrote:
Wed Feb 06, 2019 12:57 pm
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
HEDGEFUNDIE - Have you considered the use of TYD (3X 7-10 year treasuries) instead of TMF (3X 20 year treasuries)? While TMF will likely provide better protection when stocks crash, TYD won't be as susceptible to losses due to rising interest rates. Since 2015, a portfolio with TYD instead of TMF would have performed better, but when the inevitable stock crash comes, you will likely wish you were holding TMF instead of TYD.
My strategy is interest rate agnostic (and more generally speaking, market timing agnostic). I don't believe anyone can say for sure that interest rates will rise meaningfully from here. And even if they do rise, over the 20 year timeframe of the strategy, reinvestment risk should cancel out the interest rate risk.

So again, that leaves the stock-crash-protection as the rationale for the TMF holding, and as you point out TMF is the best tool for that purpose.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Wed Feb 06, 2019 2:10 pm

SagaciousTraveler wrote:
Wed Feb 06, 2019 7:35 am
I noticed both funds do not pay out dividends.
Valuethinker wrote:
Wed Feb 06, 2019 9:16 am
We know that in the long run a large proportion of the returns from holding stocks come from dividends (which makes sense in a theoretical sense - a share is the right to a stream of dividend income at some point in the life of the company). This strategy does not reap that source of return.
Both funds DO pay dividends...

http://www.proshares.com/funds/upro_distributions.html

http://www.direxioninvestments.com/prod ... stribution

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by MotoTrojan » Wed Feb 06, 2019 2:11 pm

Would be harder to back-test but I wonder if there are any ways to combine this with trend-following or valuation based allocations between the leveraged equities and treasuries.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SagaciousTraveler » Wed Feb 06, 2019 2:28 pm

HEDGEFUNDIE wrote:
Wed Feb 06, 2019 2:10 pm
SagaciousTraveler wrote:
Wed Feb 06, 2019 7:35 am
I noticed both funds do not pay out dividends.
Valuethinker wrote:
Wed Feb 06, 2019 9:16 am
We know that in the long run a large proportion of the returns from holding stocks come from dividends (which makes sense in a theoretical sense - a share is the right to a stream of dividend income at some point in the life of the company). This strategy does not reap that source of return.
Both funds DO pay dividends...

http://www.proshares.com/funds/upro_distributions.html

http://www.direxioninvestments.com/prod ... stribution
Bad assumption by me. Fidelity did not have a % list for SEC Yield. Should have dug deeper.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by EfficientInvestor » Wed Feb 06, 2019 2:46 pm

HEDGEFUNDIE wrote:
Wed Feb 06, 2019 2:05 pm
EfficientInvestor wrote:
Wed Feb 06, 2019 12:57 pm
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:36 pm
HomerJ wrote:
Tue Feb 05, 2019 11:15 pm
Jags4186 wrote:
Tue Feb 05, 2019 4:49 pm
So what jumps at me whenever I see a great backtested strategy are the following:

1). What conditions occurred that allowed these great returns
2). Where are we today and how does it compare to the starting point at the beginning of the back test?
3). What would lead this strategy to fail miserably vs following a 40/60 unleveraged strategy.
Backtest for 1987-2018.

Long Treasuries did AMAZING through most of that period, as interest rates dropped

Today's conditions for Long Treasuries are not the same.
I have said this before, I'll say it again. The reason the Long Treasuries are there is NOT because of their expected return. It's because of their status as the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash. This dynamic, along with regular rebalancing, is the key to the strategy, and why it has held up over the past 30 years.
HEDGEFUNDIE - Have you considered the use of TYD (3X 7-10 year treasuries) instead of TMF (3X 20 year treasuries)? While TMF will likely provide better protection when stocks crash, TYD won't be as susceptible to losses due to rising interest rates. Since 2015, a portfolio with TYD instead of TMF would have performed better, but when the inevitable stock crash comes, you will likely wish you were holding TMF instead of TYD.
My strategy is interest rate agnostic (and more generally speaking, market timing agnostic). I don't believe anyone can say for sure that interest rates will rise meaningfully from here. And even if they do rise, over the 20 year timeframe of the strategy, reinvestment risk should cancel out the interest rate risk.

So again, that leaves the stock-crash-protection as the rationale for the TMF holding, and as you point out TMF is the best tool for that purpose.
I figured that would be your response. I use TMF for the same reason. I mainly just wanted to point out the option for folks that are more concerned about rising interest rates. Now that the FED raised rates several times and have gotten further away from 0%, I like to think that the worst is behind us. If rates continue to rise, I would think that a portfolio with TYD would outperform a portfolio with TMF. However, I prefer to peel of 10% from TMF and put it towards 3X gold (UGLD). If rates continue to rise from here, it will likely be due to higher inflation. Therefore, UGLD can serve as the inflation hedge while TMF serves as the hedge against a stock crash.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by HEDGEFUNDIE » Wed Feb 06, 2019 3:11 pm

HomerJ wrote:
Wed Feb 06, 2019 12:30 am
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 11:46 pm
In Jul 2009 the 30 year Treasury was yielding 4.5%. Today it's yielding 3.0%.

This strategy, as shown in my last post using the actual ETFs, delivered 26% CAGR over this period. Pretty much the same as over the previous 20 years when interest rates dropped from 10%, as you say.
And stocks went on tear from July 2009.

So right now, Treasuries are yielding less than they did in 2009, AND stocks are highly less likely to return 13% a year for the next 10 years like they just did.

Go for it. At least you're smart enough to keep it at 15% of your money.
This brings up an interesting historical question. In the history of the stock and bond markets, how often were both the stock market and the bond market simultaneously in a bear market?

I suspect that for the vast majority of the period 1927-2018 (a starting point that I've seen used often), at least one of the two markets was in bull mode, which bodes well for my strategy.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by samsdad » Wed Feb 06, 2019 4:10 pm

EfficientInvestor wrote:
Wed Feb 06, 2019 12:10 pm
samsdad wrote:
Wed Feb 06, 2019 11:24 am
I think in all fairness we need to see the simulated data set upon which this experiment is based on, at least in part. I think there's a way to cut and paste the data in a response here.
samsdad - The article at the link below provides step-by-step instruction on how to pull the daily data and upload it to Portfolio Visualizer for use in a backtest. This is the method that was used to develop the data that HEDGEFUNDIE used. The article uses the Nasdaq instead of S&P 500, but you can pull data for ^GSPC to match what HEDGEFUNDIE has shown for UPRO.

https://theleveragedindexer.com/2018/11 ... -backtest/
That looks like a lot of work. After getting the raw data for ^GSPC (btw, what's the TMF data based on?), then you have to really labor:
Now that you have your raw data in place, the first step is to calculate the daily return of the base fund. This is done by subtracting the current day close from the previous day close and then dividing by the previous day close. This formula is shown in Figure 2.
{Figure 2 shows a formula in excel such as column I3=F3-F2/F2 where F3 equals the adjusted close of day X and F2 is the adjusted close of day X-1.}
Fig. 2 – Close Daily % Formula

The next step is to calculate the daily performance of the leveraged fund based on the daily performance of the base index. For TQQQ, I multiplied the base index daily % by a factor of 3 and then subtracted a small amount each day to account for the expense ratio of the fund. This is equal to the 1% expense ratio divided by 250 trading days in a year. This formula can be seen in Figure 3.
{Figure 3 shows a formula in excel such as column J3=I3*3-0.01/250}
Fig. 3 – TQQQ Daily % Formula

Once you have written both of these formulas you can copy them down to all the dates in the spreadsheet. After that, you should open a new Excel file and copy the Date and TQQQ columns over to the new file and save it as a .csv file. It should look like the two columns shown in Figure 4.
A couple of questions:

1. Can't someone here just copy and paste the spreadsheet data for UPRO and TMF that they already have worked on? I'd venture that'd just be the column J information. The date information can be obtained easily enough from Yahoo. I'm not familiar enough with excel to try to figure out some way of automating the information into columns I and J. Doing it manually for 30*250*2 days looks like about 15000 formula entries for each fund.

2. Are we entirely sure that the formula in Fig. 3, which "multiplie(s) the base index daily % by a factor of 3 and then subtract(s) a small amount each day to account for the expense ratio of the fund. This is equal to the 1% expense ratio divided by 250 trading days in a year" reflects how these funds operate in real life? I'm trying to avoid the GIGO problem.

No. 1 might seem like asking someone else to do my work for me, but really, we're here to discuss and analyze this objectively. It's kinda hard to just take one's word for it. A few errors in the data or the formula approach mentioned above might change the information drastically. I think it'd be great if some of the math dorks around here put their eyeballs on it too.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by UnderWater » Wed Feb 06, 2019 4:14 pm

HEDGEFUNDIE wrote:
Tue Feb 05, 2019 2:56 pm
Here is how 60% TMF & 40% UPRO, rebalanced quarterly, would have performed over 1987-2018, as compared to the S&P 500:
Image
[ quote formatted by admin LadyGeek]

I seem to be missing something very basic. When I run a 23.75% CAGR on a $10k initial investment, I wind up with $709k after 20 years. To hit the $10MM or so mark, you'd need a CAGR north of 40%?

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Jags4186 » Wed Feb 06, 2019 4:21 pm

UnderWater wrote:
Wed Feb 06, 2019 4:14 pm
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 2:56 pm
Here is how 60% TMF & 40% UPRO, rebalanced quarterly, would have performed over 1987-2018, as compared to the S&P 500:
Image
[ quote formatted by admin LadyGeek]

I seem to be missing something very basic. When I run a 23.75% CAGR on a $10k initial investment, I wind up with $709k after 20 years. To hit the $10MM or so mark, you'd need a CAGR north of 40%?
1987-2018 is 32 years

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by UnderWater » Wed Feb 06, 2019 4:34 pm

Jags4186 wrote:
Wed Feb 06, 2019 4:21 pm
UnderWater wrote:
Wed Feb 06, 2019 4:14 pm
HEDGEFUNDIE wrote:
Tue Feb 05, 2019 2:56 pm
Here is how 60% TMF & 40% UPRO, rebalanced quarterly, would have performed over 1987-2018, as compared to the S&P 500:
Image
[ quote formatted by admin LadyGeek]

I seem to be missing something very basic. When I run a 23.75% CAGR on a $10k initial investment, I wind up with $709k after 20 years. To hit the $10MM or so mark, you'd need a CAGR north of 40%?
1987-2018 is 32 years
Yes, that would the something very basic that I was missing. Latched onto HEDGEFUNDIE's 20-yr time horizon I guess.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by Oicuryy » Wed Feb 06, 2019 4:59 pm

Image

Could someone please explain Morningstar's alpha value to me? The screenshot shows Morningstar's MPT statistics for UPRO. I understand the beta of 3. If the index goes up 1% one day the etf will go up 3*1%. But do I then subtract 4 percentage points of alpha? 3*1%−4% = −1% for the day?

HEDGEFUNDIE, how did you adjust your simulated returns for the negative alpha?

Ron
Money is fungible | Abbreviations and Acronyms

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by GrowthSeeker » Wed Feb 06, 2019 5:29 pm

Thank you for posting this. It is always exciting to see the possibility of a huge CAGR. Other leveraged ETFs I have seen have provided expected leveraged results only short term, not long term, so I cannot figure out how UPRO and TMF are doing it long term. It is tempting,
but then several thoughts come to mind:
- if it looks too good to be true ...
- past results ...
- what surprises are hiding in the prospectus ...

It is interesting that yesterday, 2/5/2018, was the One Year Anniversary of the Death of XIV, the VelocityShares Daily Inverse VIX Short-Term ETN. This was behaving like the inverse of the VIX until suddenly, one day, it wasn't. Apparently part of the strategy of this ETN involved buying VIX futures at times as a hedge, but apparently the liquidity of VIX futures is not infinite. This allowed for occasional spikes in VIX futures prices. There was a clause in the prospectus that said they could declare an "acceleration event" if the share price of XIV dropped far enough and fast enough, meaning they could just shut it down: a sudden 80-90% drop in one day, much of it in after hours trading.

It was discussed on the BH site Inverse VIX ETN down 80% after hours, among others.
And here is a story at Barron's about it.

My worry is that they might "Melvin" me.
Last edited by GrowthSeeker on Wed Feb 06, 2019 5:35 pm, edited 2 times in total.
Just because you're paranoid doesn't mean they're NOT out to get you.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by SlowMovingInvestor » Wed Feb 06, 2019 5:33 pm

GrowthSeeker wrote:
Wed Feb 06, 2019 5:29 pm
It is interesting that yesterday, 2/5/2018, was the One Year Anniversary of the Death of XIV, the VelocityShares Daily Inverse VIX Short-Term ETN. This was behaving like the inverse of the VIX until suddenly, one day, it wasn't. Apparently part of the strategy of this ETN involved buying VIX futures at times as a hedge, but apparently the liquidity of VIX futures is not infinite. This allowed for occasional spikes in VIX futures prices. There was a clause in the prospectus that said they could declare an "acceleration event" if the share price of XIV dropped far enough and fast enough, meaning they could just shut it down: a sudden 80-90% drop in one day, much of it in after hours trading.
That was an ETN, not a ETF, so it would be more vulnerable, right ? It can't be redeemed for a 'basket'.

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by GrowthSeeker » Wed Feb 06, 2019 5:36 pm

SlowMovingInvestor wrote:
Wed Feb 06, 2019 5:33 pm
GrowthSeeker wrote:
Wed Feb 06, 2019 5:29 pm
It is interesting that yesterday, 2/5/2018, was the One Year Anniversary of the Death of XIV, the VelocityShares Daily Inverse VIX Short-Term ETN. This was behaving like the inverse of the VIX until suddenly, one day, it wasn't. Apparently part of the strategy of this ETN involved buying VIX futures at times as a hedge, but apparently the liquidity of VIX futures is not infinite. This allowed for occasional spikes in VIX futures prices. There was a clause in the prospectus that said they could declare an "acceleration event" if the share price of XIV dropped far enough and fast enough, meaning they could just shut it down: a sudden 80-90% drop in one day, much of it in after hours trading.
That was an ETN, not a ETF, so it would be more vulnerable, right ? It can't be redeemed for a 'basket'.
I believe you are correct, but I don't really know how to quantify the risk. Basically the risk of something most investors would not even think could happen.
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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by EfficientInvestor » Wed Feb 06, 2019 5:47 pm

Oicuryy wrote:
Wed Feb 06, 2019 4:59 pm
Image

Could someone please explain Morningstar's alpha value to me? The screenshot shows Morningstar's MPT statistics for UPRO. I understand the beta of 3. If the index goes up 1% one day the etf will go up 3*1%. But do I then subtract 4 percentage points of alpha? 3*1%−4% = −1% for the day?

HEDGEFUNDIE, how did you adjust your simulated returns for the negative alpha?

Ron
The short answer is that it is negative because the risk-adjusted return of holding UPRO by itself is poor relative to the S&P 500. See the equation for alpha at the article below.

https://corporatefinanceinstitute.com/r ... nce/alpha/

Then, see the 5-year backtest below from Feb 2014 - Jan 2019. If we assume that the ETF, GSY, approximates the risk free rate, then the following equation should approximate alpha for UPRO over the last 5 years:

Alpha = 24.94 - 1.67 - 3*(10.8 - 1.67) = -4.12 (close enough to the -4.06 that Morningstar shows)

https://www.portfoliovisualizer.com/bac ... ion3_3=100

Note that I have included a 40% UPRO/60% TMF portfolio as Portfolio 2. Portfolio Visualizer calculates the Alpha for that blend over the last 5 years as being 7% (see the metrics tab).

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Re: HEDGEFUNDIE's excellent adventure [3x leveraged ETF strategy]

Post by vineviz » Wed Feb 06, 2019 5:55 pm

Oicuryy wrote:
Wed Feb 06, 2019 4:59 pm
Image

Could someone please explain Morningstar's alpha value to me? The screenshot shows Morningstar's MPT statistics for UPRO. I understand the beta of 3. If the index goes up 1% one day the etf will go up 3*1%. But do I then subtract 4 percentage points of alpha? 3*1%−4% = −1% for the day?

HEDGEFUNDIE, how did you adjust your simulated returns for the negative alpha?

Ron
The alpha is an annualized number, so the negative alpha would be a 4% drag on annual returns not daily returns.

The 4% includes the effect of the expense ratio, the cost of the trading costs for the stocks and swaps, and the effect of volatility drag during the measured period. Depending on the period, the regression might apportion those costs differently between beta and alpha (i.e. you could get a lower beta and a positive alpha).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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