Uncle Fred’s Second Coin – The Case for Leveraged Bonds

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MotoTrojan
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan »

coingaroo wrote: Thu Aug 29, 2019 11:56 pm

If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Interestingly the volatility "decay" boosts returns when equities are going steadily up OR down (as they often are) and only really hurts you in a flat market. I don't think the trade-offs are too bad, although the 1% management fee isn't great.

PSLDX or other Pimco StocksPLUS funds are another option which use futures.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

robertmcd wrote: Wed Aug 28, 2019 1:29 pm
MotoTrojan wrote: Wed Aug 28, 2019 1:11 pm
robertmcd wrote: Wed Aug 28, 2019 11:15 am
MotoTrojan wrote: Wed Aug 28, 2019 9:23 am
EfficientInvestor wrote: Wed Aug 28, 2019 6:12 am

As for LTTs, I prefer not to use them due to the additional term risk. I prefer to use shorter term treasuries with additional leverage.
Can you help me understand this? If you leverage 2yr to have the same effective duration as 20yr, how is your risk/performance vastly different?
2 yr has higher sharpe ratio, and it also outperforms during recessions in terms of sharpe ratio when compared to long term. The leverage increases the volatility, thus increasing the returns.

https://www.portfoliovisualizer.com/bac ... sisResults
It has outperformed is what you meant to say. Using futures to leverage the 2yr will expose you to the price change, but not the income, no? I'd rather get the income of EDV or even TMF.
You will earn the spread between the implied financing rate (usually around the 3 mo T bill) and the 2 yr yield, multiplied by your leverage. Right now for example you are earning a negative spread, multiplied by your leverage. It sucks to think about that, but historically it has paid off to have that exposure to the short end of the curve vs. the long end.

Ok... so we just need to wait for the Fed to "fix" the yield curve before jumping in? :sharebeer

I feel I've had this discussion several times on HF's thread (inverted curve messes up these strategies).... but I've been buying into Pimco's Stocks Plus funds as well (Absolute Return & Long Duration). I tend to like the Absolute Return better than the LD in current environment.....but theoretically LD should be better for the long, long term.

I like the DIY approach better than all of it....but still not fully comfortable implementing myself....yet. Upping the leverage on STT is starting to make sense, however.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by robertmcd »

MotoTrojan wrote: Fri Aug 30, 2019 12:43 am
coingaroo wrote: Fri Aug 30, 2019 12:40 am
Tyler Aspect wrote: Fri Aug 30, 2019 12:22 am I agree there are more postings about leveraging this year compared to last year. Unsure about the significance of this trend.
Appetite for leverage linearly increases based on number of years since the last recession.
Leveraged bonds would seem to do well in said recession so kind of counter to that.
Due to recent risk parity outperformance
rascott
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
I guess the first thing to point out is I don't exclusively use short term treasuries. I think there is a good case for them (as laid out earlier in this thread), but there are also times when it is better to be on the longer end of the interest rate curve. If you are having a hard time deciding between using larger amounts of leverage on STT vs small amounts of leverage on LTT, you can split the difference and go with moderate amounts of leverage on ITT. In my case, I do all the above in various accounts because I'm trying to get some real-world experience in investing with all the above.

More specifically, in the case of my wife's small Roth IRA, I'm using IEF over SHY because IEF options are more liquid than SHY (but not much more).
robertmcd
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by robertmcd »

Intermediate term treasuries are also very good to leverage. I think as of right now with the recent drop the 5 yr would have been the best place to be. I can definitely see the merit in having exposure across the curve from 2-30 yrs with less leverage vs. just the 2 yr to mitigate behavioral mistakes.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

EfficientInvestor wrote: Fri Aug 30, 2019 10:38 am
rascott wrote: Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
I guess the first thing to point out is I don't exclusively use short term treasuries. I think there is a good case for them (as laid out earlier in this thread), but there are also times when it is better to be on the longer end of the interest rate curve. If you are having a hard time deciding between using larger amounts of leverage on STT vs small amounts of leverage on LTT, you can split the difference and go with moderate amounts of leverage on ITT. In my case, I do all the above in various accounts because I'm trying to get some real-world experience in investing with all the above.

More specifically, in the case of my wife's small Roth IRA, I'm using IEF over SHY because IEF options are more liquid than SHY (but not much more).
I'm still a ways off from actually implementing this myself to any degree...so just trying to learn the mechanics. The underlying theory makes total sense to me, but actually putting it into action is where I stumble.

1) A Treasury future contract is a $100k position, correct?

2) Is it accurate to say that the financing rate between futures and options are pretty identical? I would just assume any differences that did exist would be arbitraged away.

I still am naive on looking at an option chain and determining the implied interest rate. Also on what leverage ratios determine the effective duration of a position. Still much to learn....and that is before getting into the idea if it's better to leverage the equities vs the bonds. PIMCO leverages the equities.... Wisdom Tree the opposite. PIMCO has to, because they are doing active mgmt on the bond side.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Tyler Aspect »

A long term Treasury ETF is a long term fixed income instrument requiring patience of a holding period lasting 30 to 45 years.

But a 3X leveraged long term Treasury ETF is an entirely different thing all together. This is arguably a short term speculative investment betting on the direction of the long term Treasury yield movement. If the market moves against you, incurring difficult to recover large losses in a very short period of time is entirely possible.
Past result does not predict future performance. Mentioned investments may lose money. Contents are presented "AS IS" and any implied suitability for a particular purpose are disclaimed.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 11:13 am
EfficientInvestor wrote: Fri Aug 30, 2019 10:38 am
rascott wrote: Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
I guess the first thing to point out is I don't exclusively use short term treasuries. I think there is a good case for them (as laid out earlier in this thread), but there are also times when it is better to be on the longer end of the interest rate curve. If you are having a hard time deciding between using larger amounts of leverage on STT vs small amounts of leverage on LTT, you can split the difference and go with moderate amounts of leverage on ITT. In my case, I do all the above in various accounts because I'm trying to get some real-world experience in investing with all the above.

More specifically, in the case of my wife's small Roth IRA, I'm using IEF over SHY because IEF options are more liquid than SHY (but not much more).
I'm still a ways off from actually implementing this myself to any degree...so just trying to learn the mechanics. The underlying theory makes total sense to me, but actually putting it into action is where I stumble.

1) A Treasury future contract is a $100k position, correct?

2) Is it accurate to say that the financing rate between futures and options are pretty identical? I would just assume any differences that did exist would be arbitraged away.

I still am naive on looking at an option chain and determining the implied interest rate. Also on what leverage ratios determine the effective duration of a position. Still much to learn....and that is before getting into the idea if it's better to leverage the equities vs the bonds. PIMCO leverages the equities.... Wisdom Tree the opposite. PIMCO has to, because they are doing active mgmt on the bond side.
1) It depends on the contract. 2-years have a notional value of $200k. All others have a notional value of $100k. See the breakdown here: https://www.cmegroup.com/trading/why-fu ... tures.html

You also have to take into account the price that the contracts are currently trading at. If the 2-year is at 108, your total exposure to 2-year treasuries is 1.08*$200k = $216k.

2) Ultimately, I would say they are pretty close. However, they are different products and you have to consider the differences. With futures, you are just getting directional exposure with leverage. When you buy an option, you are getting directional exposure with leverage AND you are buying insurance. In order for them to be equal, you need to offset the cost of that insurance. If you go far enough in the money (ITM), the cost of insurance almost goes to zero, but you have to deal with lack of liquidity. If your strike price is closer to current price (not as far ITM), you can sell a put to offset the extrinsic value you had to pay for your ITM call, but that brings on other issues because you then have undefined risk on a short position. Instead, if you are buying ITM options that have a decent amount of extrinsic value (insurance premium) that you want to offset, my preference is to buy longer dated calls and then sell shorter dated calls to offset the premium. I find that if I sell one shorter term call for every two longer term calls that I buy, I can just about break even on the daily premium decay (theta).
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Lee_WSP »

Tyler Aspect wrote: Fri Aug 30, 2019 12:42 pm A long term Treasury ETF is a long term fixed income instrument requiring patience of a holding period lasting 30 to 45 years.

But a 3X leveraged long term Treasury ETF is an entirely different thing all together. This is arguably a short term speculative investment betting on the direction of the long term Treasury yield movement. If the market moves against you, incurring difficult to recover large losses in a very short period of time is entirely possible.
So, what's different about that vs any other medium risk/medium reward strategy? With low risk being a TSM fund & no risk being an intermediate bond fund or a bond held to maturity. I'm defining my terms here, not saying that either is actually low or no risk, just putting it in perspective.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

EfficientInvestor wrote: Fri Aug 30, 2019 12:58 pm

2) Ultimately, I would say they are pretty close. However, they are different products and you have to consider the differences. With futures, you are just getting directional exposure with leverage. When you buy an option, you are getting directional exposure with leverage AND you are buying insurance. In order for them to be equal, you need to offset the cost of that insurance. If you go far enough in the money (ITM), the cost of insurance almost goes to zero, but you have to deal with lack of liquidity. If your strike price is closer to current price (not as far ITM), you can sell a put to offset the extrinsic value you had to pay for your ITM call, but that brings on other issues because you then have undefined risk on a short position. Instead, if you are buying ITM options that have a decent amount of extrinsic value (insurance premium) that you want to offset, my preference is to buy longer dated calls and then sell shorter dated calls to offset the premium. I find that if I sell one shorter term call for every two longer term calls that I buy, I can just about break even on the daily premium decay (theta).
Making sure I'm on the same page here....this is effectively the "Poor Man's Covered Call" trade?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 1:49 pm
EfficientInvestor wrote: Fri Aug 30, 2019 12:58 pm

2) Ultimately, I would say they are pretty close. However, they are different products and you have to consider the differences. With futures, you are just getting directional exposure with leverage. When you buy an option, you are getting directional exposure with leverage AND you are buying insurance. In order for them to be equal, you need to offset the cost of that insurance. If you go far enough in the money (ITM), the cost of insurance almost goes to zero, but you have to deal with lack of liquidity. If your strike price is closer to current price (not as far ITM), you can sell a put to offset the extrinsic value you had to pay for your ITM call, but that brings on other issues because you then have undefined risk on a short position. Instead, if you are buying ITM options that have a decent amount of extrinsic value (insurance premium) that you want to offset, my preference is to buy longer dated calls and then sell shorter dated calls to offset the premium. I find that if I sell one shorter term call for every two longer term calls that I buy, I can just about break even on the daily premium decay (theta).
Making sure I'm on the same page here....this is effectively the "Poor Man's Covered Call" trade?
Correct.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
So I figured I would buy a long-term call today on SHY to see what kind of fill I could get. Current price of the underlying is 85.07. I bought the 1/15/21 contract (504 days) at the 81 strike. I was filled at $4.30 per share ($430 total). The current market price for the put option (cost of insurance) for the same strike is $0.05/share. Therefore, you could say I paid $4.07/share in intrinsic value, $0.05/share in insurance premium, and $0.18/share in cost of carry (interest paid - expected dividend). So to get $8,507 exposure to 2-year treasuries (~20x leverage since I am controlling it with $430), I paid $18 upfront in financing and $5 in insurance. $18/$8,507 = 0.21%. But that is for 504 days. If it were just 365 days, that would maybe have been closer to 0.15%. The current spread between the 3 month treasury (borrow/interest rate) and 2 year treasury (dividend) is -0.477%, so I was actually expecting to have to pay more up front in financing. All in all, I'd say long term contracts on SHY are reasonable if you know what you are doing and don't let yourself get taken advantage of by the wide bid/ask spreads.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

Funny, I was just looking at SHY option chain as well.

How do you go about setting your limit price for these.... that have such big spreads and little to no volume? Just spilt the difference?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

Also....When just looking at small amounts I could see this working. But say I had a $100k equity portfolio and was wanting 6x SHY. I'd need $600k in exposure....or something like 70 of those contracts. Highly doubt that gets filled. So would have to use futures
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 2:39 pm Also....When just looking at small amounts I could see this working. But say I had a $100k equity portfolio and was wanting 6x SHY. I'd need $600k in exposure....or something like 70 of those contracts. Highly doubt that gets filled. So would have to use futures
A good place to start for setting a limit price for the option is to see what the intrinsic value of the option is. In this case, it was $4.07. I knew it was going to cost at least that much plus the $0.05 for the "insurance premium". So I set my limit at $4.10 to start out with and then bumped it up $0.05 every 30 minutes or so until getting filled at $4.30.

As for your scenario...I would agree that futures probably make more sense.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

EfficientInvestor wrote: Fri Aug 30, 2019 3:01 pm
rascott wrote: Fri Aug 30, 2019 2:39 pm Also....When just looking at small amounts I could see this working. But say I had a $100k equity portfolio and was wanting 6x SHY. I'd need $600k in exposure....or something like 70 of those contracts. Highly doubt that gets filled. So would have to use futures
A good place to start for setting a limit price for the option is to see what the intrinsic value of the option is. In this case, it was $4.07. I knew it was going to cost at least that much plus the $0.05 for the "insurance premium". So I set my limit at $4.10 to start out with and then bumped it up $0.05 every 30 minutes or so until getting filled at $4.30.

As for your scenario...I would agree that futures probably make more sense.
Nice, thank you.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Tyler Aspect »

Lee_WSP wrote: Fri Aug 30, 2019 1:22 pm
Tyler Aspect wrote: Fri Aug 30, 2019 12:42 pm A long term Treasury ETF is a long term fixed income instrument requiring patience of a holding period lasting 30 to 45 years.

But a 3X leveraged long term Treasury ETF is an entirely different thing all together. This is arguably a short term speculative investment betting on the direction of the long term Treasury yield movement. If the market moves against you, incurring difficult to recover large losses in a very short period of time is entirely possible.
So, what's different about that vs any other medium risk/medium reward strategy? With low risk being a TSM fund & no risk being an intermediate bond fund or a bond held to maturity. I'm defining my terms here, not saying that either is actually low or no risk, just putting it in perspective.
https://www.portfoliovisualizer.com/bac ... total3=100

You could use PortfolioVisualizer to compare investments. The above chart showed that a 100% stock allocation had a standard deviation of 13.47%. A 80% stock / 20% bond allocation had a standard deviation of 11.42%. 3X leveraged long term Treasury ETF (TMF) had a standard deviation of 40.80%. You could also see that TMF had a period where it lost 50% of its value within 6 months.

A simple rule of thumb might say not to invest in stuff with standard deviation higher than 13.47%. Now, we know historical record has limited values in that future performance is unknown and it is not a continuation of the past. We have not seen the worst case yet.
Past result does not predict future performance. Mentioned investments may lose money. Contents are presented "AS IS" and any implied suitability for a particular purpose are disclaimed.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

Tyler Aspect wrote: Fri Aug 30, 2019 3:26 pm
Lee_WSP wrote: Fri Aug 30, 2019 1:22 pm
Tyler Aspect wrote: Fri Aug 30, 2019 12:42 pm A long term Treasury ETF is a long term fixed income instrument requiring patience of a holding period lasting 30 to 45 years.

But a 3X leveraged long term Treasury ETF is an entirely different thing all together. This is arguably a short term speculative investment betting on the direction of the long term Treasury yield movement. If the market moves against you, incurring difficult to recover large losses in a very short period of time is entirely possible.
So, what's different about that vs any other medium risk/medium reward strategy? With low risk being a TSM fund & no risk being an intermediate bond fund or a bond held to maturity. I'm defining my terms here, not saying that either is actually low or no risk, just putting it in perspective.
https://www.portfoliovisualizer.com/bac ... total3=100

You could use PortfolioVisualizer to compare investments. The above chart showed that a 100% stock allocation had a standard deviation of 13.47%. A 80% stock / 20% bond allocation had a standard deviation of 11.42%. 3X leveraged long term Treasury ETF (TMF) had a standard deviation of 40.80%. You could also see that TMF had a period where it lost 50% of its value within 6 months.

A simple rule of thumb might say not to invest in stuff with standard deviation higher than 13.47%. Now, we know historical record has limited values in that future performance is unknown and it is not a continuation of the past. We have not seen the worst case yet.
By that rule of thumb we could lever STTs 6-7x, then no...and get equity like risk?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Lee_WSP »

Tyler Aspect wrote: Fri Aug 30, 2019 3:26 pm
Lee_WSP wrote: Fri Aug 30, 2019 1:22 pm
Tyler Aspect wrote: Fri Aug 30, 2019 12:42 pm A long term Treasury ETF is a long term fixed income instrument requiring patience of a holding period lasting 30 to 45 years.

But a 3X leveraged long term Treasury ETF is an entirely different thing all together. This is arguably a short term speculative investment betting on the direction of the long term Treasury yield movement. If the market moves against you, incurring difficult to recover large losses in a very short period of time is entirely possible.
So, what's different about that vs any other medium risk/medium reward strategy? With low risk being a TSM fund & no risk being an intermediate bond fund or a bond held to maturity. I'm defining my terms here, not saying that either is actually low or no risk, just putting it in perspective.
https://www.portfoliovisualizer.com/bac ... total3=100

You could use PortfolioVisualizer to compare investments. The above chart showed that a 100% stock allocation had a standard deviation of 13.47%. A 80% stock / 20% bond allocation had a standard deviation of 11.42%. 3X leveraged long term Treasury ETF (TMF) had a standard deviation of 40.80%. You could also see that TMF had a period where it lost 50% of its value within 6 months.

A simple rule of thumb might say not to invest in stuff with standard deviation higher than 13.47%. Now, we know historical record has limited values in that future performance is unknown and it is not a continuation of the past. We have not seen the worst case yet.
By that logic 2x ITT is okay.

https://www.portfoliovisualizer.com/bac ... total3=100
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

Here's an article on the topic at hand:

https://www.advisorperspectives.com/art ... sury-bonds

Author recommends leveraging short part of the yield curve when Fed is in a rate cutting cycle. Also says that contrary to what you may think....the inverted curve may signal a good time to leverage.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

rascott wrote: Fri Aug 30, 2019 7:32 pm Here's an article on the topic at hand:

https://www.advisorperspectives.com/art ... sury-bonds

Author recommends leveraging short part of the yield curve when Fed is in a rate cutting cycle. Also says that contrary to what you may think....the inverted curve may signal a good time to leverage.
I would add that when the yield curve inverts, it will need to uninvert at some point. Therefore, either the short term rate needs to drop while the long term rate stays steady or the longer term rates meed to rise while the short term rate stays steady. Either way, I want to be holding the shorter term bonds.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Tyler Aspect »

Lee_WSP wrote: Fri Aug 30, 2019 4:13 pm By that logic 2x ITT is okay.

https://www.portfoliovisualizer.com/bac ... total3=100
That chart showed the ten year return history of 2X leveraged intermediate term Treasury is similar to stock in terms of volatility. I suppose you could make something like this:

60% stock
20% 2X leveraged intermediate term Treasury (1% expense ratio)
20% intermediate term corporate bond

but it could be similar to a not leveraged portfolio of

70% stock
30% bond

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I would summarize it as taking on 80% stock risk, but only getting 70% stock return.

The 2X stock leveraged ETF is considerably risky. Doubling a regular 50% loss of a stock fund makes it nearly a total loss.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Lee_WSP »

70/30 TSM/2x ITT yields a lower Stdev & higher CAGR in your time period.

https://www.portfoliovisualizer.com/bac ... total3=100
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by coingaroo »

robertmcd wrote: Mon Aug 26, 2019 3:22 pm That is why you use leverage to gain duration equivalence. Historically the shorter terms have fallen more on a yields only basis than the longer terms. This is what you are looking for at any point in the curve, then you use leverage to match the volatility of the longer term issues or too achieve risk parity with stocks, etc. For example:

40% VTI & 60% TLT (20+ yr treasuries) - long term risk parity according to hedgefundie's backtests

10% VTI & 90% 2 yr treasuries - risk parity, but my stock allocation and expected return is too low

40% VTI & 60% 2 yr treasury futures leveraged 6x
Is there an ideal duration (e.g. leverage 2 yr more, versus 10 yr) to be leveraging? Should you look at the sharpe ratio?

Or is duration exposure the only thing that matters? I don't understand how there can be such a difference between the sharpes of short term treasuries vs long term ones. Surely there's a gotcha?
Last edited by coingaroo on Sat Aug 31, 2019 1:52 am, edited 1 time in total.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by coingaroo »

Tyler Aspect wrote: Fri Aug 30, 2019 9:06 pm
Lee_WSP wrote: Fri Aug 30, 2019 4:13 pm By that logic 2x ITT is okay.

https://www.portfoliovisualizer.com/bac ... total3=100
That chart showed the ten year return history of 2X leveraged intermediate term Treasury is similar to stock in terms of volatility. I suppose you could make something like this:

60% stock
20% 2X leveraged intermediate term Treasury (1% expense ratio)
20% intermediate term corporate bond

but it could be similar to a not leveraged portfolio of

70% stock
30% bond

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I would summarize it as taking on 80% stock risk, but only getting 70% stock return.

The 2X stock leveraged ETF is considerably risky. Doubling a regular 50% loss of a stock fund makes it nearly a total loss.
You can't compare 60/20/20 with 70/30 because the first portfolio takes on lower risk as measured by volatility.

A 67/33 (33 being 2x ITT) has slightly higher volatility, still much less than the 70/30 portfolio, but with higher CAGR and Sharpe.

https://www.portfoliovisualizer.com/bac ... 0&total3=0
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by skeptic42 »

vineviz wrote: Wed Aug 28, 2019 3:24 pm
EfficientInvestor wrote: Wed Aug 28, 2019 1:10 pm However, as robermcd stated, I still am of the opinion that leveraging the STT (which generally have a higher sharpe ratio) is preferred over using LTT.
I think using leveraged STT is possibly a very reasonable strategy, though it sounds to me very much like an attempt at arbitrage. And I generally am skeptical of arbitrage opportunities unless the limits preventing other market participants from profiting from it are incredibly persuasive. Maybe that's the case here, though, I don't know.

It's not hard to find times in the recent past where STTs had lower Sharpe ratio than LTTs (July 2016 to October 2018, when interest rates were still rising, for instance) which makes me think it's likely to be very period dependent.
Just a thought, the higher Sharpe ratio of STTs compared to LTTs could be due to the aversion to leverage of many investors. IIRC, a similar explanation exists for the low volatility anomaly in stocks.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by coingaroo »

I've red from some other posts, particularly viewtopic.php?f=10&t=287627, that long term treasuries provide diversification benefits against stocks that STTs don't.

I'm not understanding why this is the case. Is there a reason why LTTs diversify more than STTs (on a duration-adjusted level)?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Lee_WSP »

coingaroo wrote: Sat Aug 31, 2019 3:53 am I've red from some other posts, particularly viewtopic.php?f=10&t=287627, that long term treasuries provide diversification benefits against stocks that STTs don't.

I'm not understanding why this is the case. Is there a reason why LTTs diversify more than STTs (on a duration-adjusted level)?
STTs are very similar to holding cash, so they mostly provide ballast to a portfolio. Dry powder if you will.

LTTs being much more sensitive to interest rate changes provide uncorrelated movements to the portfolio. Ideally when one goes down the other will not also go down and hopefully go up, but this is not always the case, but being uncorrelated, the likelihood is good that both will not drop at the same time.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Kevin M »

Lee_WSP wrote: Sat Aug 31, 2019 10:54 am
coingaroo wrote: Sat Aug 31, 2019 3:53 am I've red from some other posts, particularly viewtopic.php?f=10&t=287627, that long term treasuries provide diversification benefits against stocks that STTs don't.

I'm not understanding why this is the case. Is there a reason why LTTs diversify more than STTs (on a duration-adjusted level)?
STTs are very similar to holding cash, so they mostly provide ballast to a portfolio. Dry powder if you will.

LTTs being much more sensitive to interest rate changes provide uncorrelated movements to the portfolio. Ideally when one goes down the other will not also go down and hopefully go up, but this is not always the case, but being uncorrelated, the likelihood is good that both will not drop at the same time.
This isn't addressing the use of leverage to essentially get LTT duration exposure with leveraged STTs, which is one of the key features of OP's approach. Holding leveraged STTs definitely is not similar to holding cash. I think the OP argument is that sufficiently leveraged STTs offer similar portfolio benefits as un-leveraged or less-leveraged LTTs, perhaps with even higher portfolio Sharpe ratio.

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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

I hope some others have some input on this....as the idea is quite interesting. I have a few play accounts (roughly 10% of my portfolio) that I've allocated to higher risk strategies....and thinking ST Treasury futures may have a part in one of these.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan »

rascott wrote: Sat Aug 31, 2019 5:14 pm I hope some others have some input on this....as the idea is quite interesting. I have a few play accounts (roughly 10% of my portfolio) that I've allocated to higher risk strategies....and thinking ST Treasury futures may have a part in one of these.
I’d love to see more info too. So far it seems like over-fitting to the GFC. For me if I can get sufficient duration exposure for my goals, without leverage (EDV for example), then the simplicity of avoiding futures wins out against a potential to arbitrage some spread, which also can work against me.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

MotoTrojan wrote: Sun Sep 01, 2019 10:51 am
rascott wrote: Sat Aug 31, 2019 5:14 pm I hope some others have some input on this....as the idea is quite interesting. I have a few play accounts (roughly 10% of my portfolio) that I've allocated to higher risk strategies....and thinking ST Treasury futures may have a part in one of these.
I’d love to see more info too. So far it seems like over-fitting to the GFC. For me if I can get sufficient duration exposure for my goals, without leverage (EDV for example), then the simplicity of avoiding futures wins out against a potential to arbitrage some spread, which also can work against me.
Can you clarify what you mean by over-fitting to the GFC?

I would like to get the data set used for this simulation to mess around with it....how/where would that be? The simba spreadsheet has annual returns for STTs.... but not in a monthly/quarterly format to load into PV.

As discussed above, options could be used for smaller portfolios....but will only take you so far due the low volume of options on STT ETFs.

Also I'm not clear on effective duration and term risk. Is there some tangible difference between getting the effective duration of a LTT via leveraged STT that is superior to just something like EDV? The OP indicates that there is....that term risk is reduced....but is it really?
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Kevin M »

EfficientInvestor wrote: Mon Aug 26, 2019 6:40 am <snip>
One of my favorite investing books is William Bernstein’s, The Intelligent Asset Allocator. If you haven’t read the book, I highly recommend you grab a copy. In the book, Bernstein introduces us to Uncle Fred and his coin that determines the annual return of an investment. He then shows how if you have two identical coins that have similar but uncorrelated return and risk profiles, you receive a diversification benefit that results in better risk-adjusted returns.

<snip>

So now you are probably thinking, “I really like this concept in theory, but what asset could represent the second coin.” If we do a quick overview of various asset types, we can see that there isn’t really anything else that provides the same kind of returns as the stock market while being completely uncorrelated.
<snip>
Bonds lack correlation with stocks, but they don’t generally have the same kind of return potential.
<snip>
It just so happens that if you apply leverage to bonds (via the use of futures, options, leveraged ETFs, etc.), you can approximate the return and risk profile of stocks.
I just wanted to say that I really appreciate and enjoy the way you present this. I also second your recommendation to ask Bill Bernstein about this on the Bogleheads podcast.

However, at MotoTrojan has pointed out, there are actually bonds that can have high returns, high volatility, and low correlation to stocks (without leverage): long duration bonds. One way to get the most duration exposure is with an extended duration Treasury fund, such as EDV, which for the period available in Portfolio Visualizer, Feb 2008 - Aug 2019, had higher return and higher standard deviation that SPY (S&P 500). A 40/60 SPY/EDV portfolio had higher return, lower SD, and higher Sharpe ratio than 100% SPY, which illustrates the coin flip analogy as well.

Image

Portfolio 1 = SPY
Portfolio 2 = EDV
Portfolio 3 = 40/60 SPY/EDV

Source: PV backtest.

However, it's also important to note that the 20y Treasury yield dropped from 4.35% at the beginning of the period to 1.78% at the end, and the 30y dropped from 4.35% to 1.96%. So this is why EDV returned 9.37% instead of something closer to 4.4% if yields had not changed.

I was going to say that yield curve rolldown return might have been expected to add to the return even with a static yield curve, but since the 20y and 30y yields were the same at the beginning of the period, there might not have been any rolldown component of return in that maturity range, since there was no positively-sloped yield curve to roll down.

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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan »

rascott wrote: Sun Sep 01, 2019 1:30 pm
MotoTrojan wrote: Sun Sep 01, 2019 10:51 am
rascott wrote: Sat Aug 31, 2019 5:14 pm I hope some others have some input on this....as the idea is quite interesting. I have a few play accounts (roughly 10% of my portfolio) that I've allocated to higher risk strategies....and thinking ST Treasury futures may have a part in one of these.
I’d love to see more info too. So far it seems like over-fitting to the GFC. For me if I can get sufficient duration exposure for my goals, without leverage (EDV for example), then the simplicity of avoiding futures wins out against a potential to arbitrage some spread, which also can work against me.
Can you clarify what you mean by over-fitting to the GFC?

I would like to get the data set used for this simulation to mess around with it....how/where would that be? The simba spreadsheet has annual returns for STTs.... but not in a monthly/quarterly format to load into PV.

As discussed above, options could be used for smaller portfolios....but will only take you so far due the low volume of options on STT ETFs.

Also I'm not clear on effective duration and term risk. Is there some tangible difference between getting the effective duration of a LTT via leveraged STT that is superior to just something like EDV? The OP indicates that there is....that term risk is reduced....but is it really?
Just saying the global financial crisis is only one event and just because leveraged short bonds beat unleveraged long bonds (via Sharpe) of equal duration doesn’t prove anything. I’d want to see more evidence over broader time periods.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Tyler Aspect »

Kevin M wrote: Sat Aug 31, 2019 4:55 pm
This isn't addressing the use of leverage to essentially get LTT duration exposure with leveraged STTs, which is one of the key features of OP's approach. Holding leveraged STTs definitely is not similar to holding cash. I think the OP argument is that sufficiently leveraged STTs offer similar portfolio benefits as un-leveraged or less-leveraged LTTs, perhaps with even higher portfolio Sharpe ratio.

Kevin
I am naturally suspicious of leveraged strategies. From what I see of 20% allocation to 2X leveraged intermediate term Treasury there was a reduction of volatility and slight increase of return during the period from 2010 to 2019. This is not too remarkable by itself; the return difference was only of the range of 10% stock. This time range was a bond bull market, and levering it 2X should represent the best case situation. What about when the bond market reverts to a bear market situation? It might become a drag on performance of the range of 10% stock.

Its expense ratio is not that good. Also the use of swaps might present problems when the market seizes up.

ProShares and Direxion are not exactly big names. None of the big name fund suppliers are willing to brand themselves as leveraged fund suppliers. Vanguard recently banned leveraged ETFs from their trading platforms.

These are my perspectives for caution.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan »

Tyler Aspect wrote: Sun Sep 01, 2019 3:26 pm
Kevin M wrote: Sat Aug 31, 2019 4:55 pm
This isn't addressing the use of leverage to essentially get LTT duration exposure with leveraged STTs, which is one of the key features of OP's approach. Holding leveraged STTs definitely is not similar to holding cash. I think the OP argument is that sufficiently leveraged STTs offer similar portfolio benefits as un-leveraged or less-leveraged LTTs, perhaps with even higher portfolio Sharpe ratio.

Kevin
I am naturally suspicious of leveraged strategies. From what I see of 20% allocation to 2X leveraged intermediate term Treasury there was a reduction of volatility and slight increase of return during the period from 2010 to 2019. This is not too remarkable by itself; the return difference was only of the range of 10% stock. This time range was a bond bull market, and levering it 2X should represent the best case situation. What about when the bond market reverts to a bear market situation? It might become a drag on performance of the range of 10% stock.

Its expense ratio is not that good. Also the use of swaps might present problems when the market seizes up.

ProShares and Direxion are not exactly big names. None of the big name fund suppliers are willing to brand themselves as leveraged fund suppliers. Vanguard recently banned leveraged ETFs from their trading platforms.

These are my perspectives for caution.
Futures are most commonly used to leverage STT since 2-3x isn’t enough to get much effective duration. No volatility decay to worry about from daily rebalancing.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

Tyler Aspect wrote: Sun Sep 01, 2019 3:26 pm
Kevin M wrote: Sat Aug 31, 2019 4:55 pm
This isn't addressing the use of leverage to essentially get LTT duration exposure with leveraged STTs, which is one of the key features of OP's approach. Holding leveraged STTs definitely is not similar to holding cash. I think the OP argument is that sufficiently leveraged STTs offer similar portfolio benefits as un-leveraged or less-leveraged LTTs, perhaps with even higher portfolio Sharpe ratio.

Kevin
I am naturally suspicious of leveraged strategies. From what I see of 20% allocation to 2X leveraged intermediate term Treasury there was a reduction of volatility and slight increase of return during the period from 2010 to 2019. This is not too remarkable by itself; the return difference was only of the range of 10% stock. This time range was a bond bull market, and levering it 2X should represent the best case situation. What about when the bond market reverts to a bear market situation? It might become a drag on performance of the range of 10% stock.

Its expense ratio is not that good. Also the use of swaps might present problems when the market seizes up.

ProShares and Direxion are not exactly big names. None of the big name fund suppliers are willing to brand themselves as leveraged fund suppliers. Vanguard recently banned leveraged ETFs from their trading platforms.

These are my perspectives for caution.


This thread was discussing the use of futures (or possibly options for small portfoilos) on STTs (not intermediate)....and provided test data back to 1955. And at much higher leverage levels. A 2x LETF isn't going to come close to that....not enough leverage pls the drag of the ER (and possibly volatility decay).
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Kevin M »

Tyler Aspect wrote: Sun Sep 01, 2019 3:26 pm
Kevin M wrote: Sat Aug 31, 2019 4:55 pm This isn't addressing the use of leverage to essentially get LTT duration exposure with leveraged STTs, which is one of the key features of OP's approach. Holding leveraged STTs definitely is not similar to holding cash. I think the OP argument is that sufficiently leveraged STTs offer similar portfolio benefits as un-leveraged or less-leveraged LTTs, perhaps with even higher portfolio Sharpe ratio.

Kevin
I am naturally suspicious of leveraged strategies.
I wasn't promoting leverage, but simply pointing out that you can get similar duration exposure as LTTs by leveraging STTs, and this was in answering a question about duration of STTs vs. LTTs in the context of this thread (which requires leverage for the STTs). If you'd quoted the entire exchange, the context would've been clear (I hope).

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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by siamond »

EfficientInvestor wrote: Mon Aug 26, 2019 4:40 pm
Kevin M wrote: Mon Aug 26, 2019 3:16 pm
EfficientInvestor wrote: Mon Aug 26, 2019 1:37 pm To get data going back to 1955, I uploaded monthly return data to PV and made my own ticker symbols.
What is your data source for short-term Treasuries (STT) back to 1955? I assume you're using simulated returns of some sort for the older returns. I know we have simulated annual STT returns back further than that in the Simba/siamond backtest spreadsheet, which rely on longinvest's simulated 2-4 year bond ladder prior to 1976.
Kevin
I am using data from siamond and I believe it is based on longinvest’s models, as you suggested. I believe it is the same data that was used as the basis for the 3x Leveraged ETFs that are the basis for Hedgefundie’s backtest.
Nothing to do with Longinvest's annual model. This is coming from the monthly dataset we assembled for Hedgefundie’s thread and the corresponding modeling effort. For STTs, this was derived from the CMT/FRB rates (1-3 yrs maturity) you suggested, Kevin! :wink:

PS for the OP: intriguing concept! I second the idea of asking Dr. Bernstein about it, instead of rehashing the usual topics...
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott »

siamond wrote: Sun Sep 01, 2019 8:26 pm
EfficientInvestor wrote: Mon Aug 26, 2019 4:40 pm
Kevin M wrote: Mon Aug 26, 2019 3:16 pm
EfficientInvestor wrote: Mon Aug 26, 2019 1:37 pm To get data going back to 1955, I uploaded monthly return data to PV and made my own ticker symbols.
What is your data source for short-term Treasuries (STT) back to 1955? I assume you're using simulated returns of some sort for the older returns. I know we have simulated annual STT returns back further than that in the Simba/siamond backtest spreadsheet, which rely on longinvest's simulated 2-4 year bond ladder prior to 1976.
Kevin
I am using data from siamond and I believe it is based on longinvest’s models, as you suggested. I believe it is the same data that was used as the basis for the 3x Leveraged ETFs that are the basis for Hedgefundie’s backtest.
Nothing to do with Longinvest's annual model. This is coming from the monthly dataset we assembled for Hedgefundie’s thread and the corresponding modeling effort. For STTs, this was derived from the CMT/FRB rates (1-3 yrs maturity) you suggested, Kevin! :wink:

PS for the OP: intriguing concept! I second the idea of asking Dr. Bernstein about it, instead of rehashing the usual topics...
Is there a link to that data set (monthly STTs?)

Thanks!
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

Kevin M wrote: Sun Sep 01, 2019 3:12 pm I just wanted to say that I really appreciate and enjoy the way you present this. I also second your recommendation to ask Bill Bernstein about this on the Bogleheads podcast.

However, at MotoTrojan has pointed out, there are actually bonds that can have high returns, high volatility, and low correlation to stocks (without leverage): long duration bonds. One way to get the most duration exposure is with an extended duration Treasury fund, such as EDV, which for the period available in Portfolio Visualizer, Feb 2008 - Aug 2019, had higher return and higher standard deviation that SPY (S&P 500). A 40/60 SPY/EDV portfolio had higher return, lower SD, and higher Sharpe ratio than 100% SPY, which illustrates the coin flip analogy as well.

Image

Portfolio 1 = SPY
Portfolio 2 = EDV
Portfolio 3 = 40/60 SPY/EDV

Source: PV backtest.

However, it's also important to note that the 20y Treasury yield dropped from 4.35% at the beginning of the period to 1.78% at the end, and the 30y dropped from 4.35% to 1.96%. So this is why EDV returned 9.37% instead of something closer to 4.4% if yields had not changed.

I was going to say that yield curve rolldown return might have been expected to add to the return even with a static yield curve, but since the 20y and 30y yields were the same at the beginning of the period, there might not have been any rolldown component of return in that maturity range, since there was no positively-sloped yield curve to roll down.

Kevin
Thanks for the reply. What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX. See results below. As you said, with the extended duration bonds, you are relying on interest rates dropping to get big returns. Alternatively, with leveraged STT, you are counting on the spread between STT and fed rate staying in your favor. Or, in an instance when that spread is negative (like right now), you are counting on short term rates dropping enough to make up for that negative spread. Overall, results have shown so far that leveraging up the STT has worked better than just getting extended duration exposure.

https://www.portfoliovisualizer.com/bac ... 0&total3=0

Image

A big question that remains is "what is the correct amount of leverage?" In the backtest above, I use 12X leverage instead of the 6X I used in my original post. This is because I large portion of this backtest period had a 0% fed fund rate and really low rates on STTs. Because the performance of leveraged STT is dependent upon the rate at which you are borrowing money, I decided to try to figure out the correlation between the standard deviation of leveraged STT vs the fed fund rate (risk-free return rate). The image below shows the 5-year standard deviation of returns vs the initial risk-free return rate (fed fund rate in year 1 of the 5-year period). I created a separate plot of points for various amounts of leverage and added in at straight-line fit of the data for each amount of leverage. As expected, there was a high correlation between borrowing rate and volatility. I also added in a plot of the rolling 5-year standard deviation of the S&P 500. As expected, this hovered around 15% regardless what the fed fund rate was doing. My assumption is that companies borrow more money when the rate is low and borrow less money when the rate is high. Overall, they always end up around a 15% volatility. Likewise, in order to maintain comparable volatility with leveraged bonds, you should lever up when rates are low and reduce leverage when rates are high. To determine what amount of leverage to use at any time, you could see which leverage line intersects with the current fed fund rate and the S&P 500 line. Since the current fed fund rate is 2%, this means (based on historical data), you may want to use 10X leverage on STT to maintain comparable volatility to stocks. I only used 6% in my original post on this thread because it is the long term average.

Image
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by HEDGEFUNDIE »

EfficientInvestor wrote: Sun Sep 01, 2019 10:38 pm What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by siamond »

rascott wrote: Sun Sep 01, 2019 9:55 pmIs there a link to that data set (monthly STTs?)
Please contact EfficientInvestor by private message.
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor »

HEDGEFUNDIE wrote: Sun Sep 01, 2019 10:46 pm
EfficientInvestor wrote: Sun Sep 01, 2019 10:38 pm What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
I agree with that statement overall. However, in this case, you can leverage STT up even further to get similar volatility as PEDIX and have better returns than PEDIX. But the big question is how to know when to leverage up and how much to leverage up. The backtest below shows 50 SPY/50 PEDIX vs 50 SPY/600 STT vs 50 SPY/350 SHY. Portfolio 2 would be like using 12X leverage and would have been the best option. Portfolio 3 would be like using 7X leverage on STT (which is what the 5% fed fund rate in 2007, before the crash, would have told me to do based on the chart in my previous post). Portfolio 3 would have had less drawdown during 2008 than Portfolio 1, but would have had less return overall over the time period.

https://www.portfoliovisualizer.com/bac ... total3=100

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coingaroo
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by coingaroo »

HEDGEFUNDIE wrote: Sun Sep 01, 2019 10:46 pm
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
This is not exactly accurate.

Asset A has sharpe of 1 and stdev of 5%

Asset B has sharpe of 0.1 and stdev of 50%

You would rather choose asset B? (assume RFR=0)

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There surely must be a reason why STT has a higher sharpe ratio than LTT. I don't buy the "aversion to leverage" explanation as that's exactly what hedge funds would do to capture arbitrage profits. STT *is* literally the most liquid instrument in the world, and you simply do not get a 0.4 sharpe differential on the most liquid instrument in the world.

Are there any academic papers that explore and explain this anormality?
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vineviz
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by vineviz »

coingaroo wrote: Mon Sep 02, 2019 7:10 am
HEDGEFUNDIE wrote: Sun Sep 01, 2019 10:46 pm
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
This is not exactly accurate.

Asset A has sharpe of 1 and stdev of 5%

Asset B has sharpe of 0.1 and stdev of 50%

You would rather choose asset B? (assume RFR=0)
The point that I think that HEDGEFUNDIE was trying to convey is that it's not appropriate to apply the Sharpe Ratio to an asset, only to the total portfolio of assets.

The Sharpe ratios of STT or LTT in isolation are irrelevant: all that matters is the performance of the combined portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
robertmcd
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by robertmcd »

HEDGEFUNDIE wrote: Sun Sep 01, 2019 10:46 pm
EfficientInvestor wrote: Sun Sep 01, 2019 10:38 pm What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
Leveraged short term treasuries would have done better than PEDIX during the GFC. Rates dropped much more on the short end of the curve, and the leverage made up for the lack of duration.
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Steve Reading
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by Steve Reading »

EfficientInvestor wrote: Fri Aug 30, 2019 2:15 pm
rascott wrote: Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote: Fri Aug 30, 2019 6:13 am
coingaroo wrote: Thu Aug 29, 2019 11:56 pm If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
So I figured I would buy a long-term call today on SHY to see what kind of fill I could get. Current price of the underlying is 85.07. I bought the 1/15/21 contract (504 days) at the 81 strike. I was filled at $4.30 per share ($430 total). The current market price for the put option (cost of insurance) for the same strike is $0.05/share. Therefore, you could say I paid $4.07/share in intrinsic value, $0.05/share in insurance premium, and $0.18/share in cost of carry (interest paid - expected dividend). So to get $8,507 exposure to 2-year treasuries (~20x leverage since I am controlling it with $430), I paid $18 upfront in financing and $5 in insurance. $18/$8,507 = 0.21%. But that is for 504 days. If it were just 365 days, that would maybe have been closer to 0.15%. The current spread between the 3 month treasury (borrow/interest rate) and 2 year treasury (dividend) is -0.477%, so I was actually expecting to have to pay more up front in financing. All in all, I'd say long term contracts on SHY are reasonable if you know what you are doing and don't let yourself get taken advantage of by the wide bid/ask spreads.
I just calculated your implied borrowing costs and it's around 2.7%. I don't think you're taking dividends into account.

Here's how I calculate it (back of the envelope). You paid 4.3 for the right to buy SHY at 81. So what you're borrowing is 81 dollars. You can pay 81 today to get the share, or delay until 2021 so that's the quantity you're being allowed to borrow.

You could buy SHY today for 85. Instead, you're paying 4.3 + all of the dividends (since you won't get them, it's like paying for them). It's around 2.6 in dividends until January 2021. You get to purchase at 81 though. So overall, you'll overpay on this position by 4.3 + 2.6 - 4 (difference between market price and strike) = 2.9. You could buy SHY today for 85 (and get it's dividends), but you're choosing to overpay by 0.3 (extrinsic value of options) AND forfeit dividends instead. So your extra cost is 2.9 effectively.

You'll pay 2.9 bucks to borrow 81 bucks for 16 months. That's 2.9/81*12/16 = 2.68%.

If you don't take dividends into account, it's just 0.3/81*12/16 =0.2%. Which is around what you got.

Anyone feel free to correct me if I'm wrong.
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson
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