A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

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jt4
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A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Fri Sep 20, 2019 4:44 pm

HEDGEFUNDIE has well documented his approach for a risk parity strategy using 3x leveraged ETFs. Some members found the approach interesting and jumped in while others pointed out the risks of leveraged investing.

In this post, I describe a gentle alternative to HEDGEFUNDIE's 3x leveraged ETFs as described below. Of course, some of you will find that this approach is not gentle and a worse alternative... I welcome your (kind) input. :)

What am I trying to do?
I'd like an investment strategy with a risk profile similar to being 100% stocks with a higher expected return. Easy enough, eh?

I'm also young (33) and willing and able to take risk.

What is a 2-year Treasury Future?
A single 2-year treasury futures contract is the equivalent to the return of $200K worth of 2-year treasury notes minus the return of $200K worth of 3-month treasury bills. The return of the 3-month treasury bills is the effective interest rate that you are paying, which is really low ~2%. For no movement in future interest rates, the expected return of 2-year treasury futures would be the spread in the 3-mo and 2-year interest rates. [Note that right now that spread is negative due to the yield curve inversion, but the a key benefit of holding treasury futures, as described below, is that it limits the overall portfolio drawdowns in bad years.]

Proposed Portfolio
66% Total US Stock Market
29% Total International Stock Market
5% cash, held to meet margin requirements for futures
285% 2-year Treasury Futures (\ZT)
385% sum (3.8x leverage)

That's a crazy amount of leverage!
Yes, it's technically 3.8x leverage, BUT this is NOT the same as a leveraged equity portfolio. The max year-to-year drawdown for 2-year treasury futures has been 6.8% since in 1980 (calculated from Simba's spreadsheet). 2-year treasuries are relatively safe and have limited price fluctuations. Their limited price fluctuations are in fact the reason why a large amount of leverage is needed to counteract volatility due to equities in the portfolio.

Why would I do this? (i.e. leveraging is DANGEROUS!)
Historically, 2-Year Treasuries have weak and (for some periods) strongly negative correlation with the US stock market. This weak to negative correlation reduces the overall standard deviation of the portfolio while giving a bump in the expected annual returns (since their expected return is positive).

A Portfolio Comparison by the Numbers
When backtested from 1980 to 2018 using Simba's spreadsheet with yearly rebalancing (available through the Boglehead wiki), we get the following. ---> Of course these numbers will change over different backtesting periods. This is just a representative example. <--
[It goes without saying that the past is not a predictor of the future and that interest rates today are much lower than they were in 1980s.]

Proposed Portfolio vs 100% Total Stock Market Portfolio (1980-2018, Simba spreadsheet)
14.7% vs 11.1% compound annual growth rate (CAGR)
18.2% vs. 16.6% std. deviation
24% vs 37% max drawdown
0.65 vs 0.48 Sharpe ratio
2.64 vs 1.28 Sortino ratio
0.84 vs 1 US Mkt correlation
0.70 vs 0.68 Intl Mkt correlation
(these numbers are calculated on a year-to-year basis, due to limitations of the backtesting spreadsheet)

Proposed Portfolio vs 100% S&P500 (1997-2019, Portfolio Visualizer)
Link to portfolios in Portfolio Visualizer (limited to 1997 due to Total Intl Stock Market dataset)

Image
Image
Image

Looking at these plots, it seems that the greatest benefit of the 2-year treasury futures is limiting the drawdown in bad years. From this perspective, adding leverage with 2-year treasury futures LOWERS overall risk, at least compared to an all-stock portfolio.

Advantages Compared to 3x ETFs
  • no leverage in equities so a large stock market drop won't "wipe out" a stock position
  • no large ~1% expense ratio charged by 3x ETFs
  • no volatility decay (so that my portfolio performance matches that of the underlying assets)
  • minimum capital required for 2-year treasury futures (~$700 margin requirement buys $200K worth of 2-year treasury exposure)
  • futures are tax efficient — income taxed at 60% long-term capital gains + 40% short-term capital gains. Note that typical bond income is taxed as ordinary income (i.e. 100% short-term gains).
Negatives Compared to 3x ETFs
  • initial burden of setting up a futures trading account
  • despite low margin requirements, you need to keep extra cash available to handle the daily mark-to-market adjustments as the futures prices move up or down (if you don't keep a large amount of cash on hand, then you may be subject to a margin call if treasuries fall in price)
  • need to roll treasury futures every 3 months
  • scare factor of leverage
If we can all get over the fact that this portfolio uses leverage, it's makeup is remarkably simple. It's just the total US stock market + Intl market + 2-year treasury futures. I would argue that none of these products are that scary or difficult to understand. [Yes, there is a learning curve to trading futures, just as with trading stocks, but we're big kids here! We can learn new things!]

Overall, I wanted to present this to the community and seek comments and feedback. Overall, I believe that the proposed portfolio is advantageous compared to a 100% stock portfolio, and for those seeking less risk, simply drop the equity and futures exposure and you should still get better risk-adjusted returns compared to a similar portfolio without futures.
______________
--> Now cue the first comment about how Bogleheads don't invest in futures or use leverage!

Elysium
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by Elysium » Fri Sep 20, 2019 4:59 pm

Great, now we are getting into trading leveraged futures contracts. Nice, all we are missing are the posts from semi-retirees considering trading 5x leveraged pork bellies contracts and day trading frontier market penny stocks on 3x leverage, after all what could go wrong with just a 300% leverage when we have TSM/TISM in there somewhere too. Then we can all be certain the next market crash is coming soon. Let the fun begin.
Last edited by Elysium on Fri Sep 20, 2019 5:11 pm, edited 1 time in total.

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Fri Sep 20, 2019 5:10 pm

jt4 wrote:
Fri Sep 20, 2019 4:44 pm
--> Now cue the first comment about how Bogleheads don't invest in futures or use leverage!
Elysium wrote:
Fri Sep 20, 2019 4:59 pm
Great, now we are getting into trading leveraged futures contracts. Nice, all we are missing are the posts from semi-retirees considering trading 5x leveraged pork bellies contracts and day trading frontier market penny stocks on 3x leverage, as a way to boost our net worth. Then we can all be certain the next market crash is coming soon. Let the fun begin.
Right on cue! :D

AHTFY
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by AHTFY » Fri Sep 20, 2019 5:17 pm

Can you test this with pre-1980 data (real or synthetic)? This model is long treasuries in a period with falling rates. How would it perform with rising interest rates?

GrowthSeeker
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by GrowthSeeker » Fri Sep 20, 2019 5:53 pm

Curious (having done options but not futures) as to exactly what contract pair one would get to accomplish this; and for a given contract size, what is the transaction cost.
And wondering how much the bid-ask spread is on such contracts (maybe that's the same thing).
And would this be repeated once every three months; or twice (once for opening and once for closing each position).
Just because you're paranoid doesn't mean they're NOT out to get you.

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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by Tyler Aspect » Fri Sep 20, 2019 5:57 pm

No one knows what will happen to your portfolio. Yes, it has that historical performance and risk adjusted return. None of it matters because that is just the nature of the data mining as a selected output. The leveraging gives it away. What I said before to HEDGEFUNDIE applies here as well. If there is chance that this position could go bust, random chance will ensure it eventually do go bust at an uncertain time. By now it should not be a surprise a hedge fund operator's famous last word could be "my strategy worked very well until it stopped working."

Don't chase performance.
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.

countmein
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by countmein » Fri Sep 20, 2019 6:28 pm

AHTFY wrote:
Fri Sep 20, 2019 5:17 pm
Can you test this with pre-1980 data (real or synthetic)? This model is long treasuries in a period with falling rates. How would it perform with rising interest rates?
This. And also:

- stress test risk of prolonged inverted yield curve
- stress test risk of prolonged positive correlation
- compare against longer treasuries at lower leverage levels (ie why the 2-year?)

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Random Musings
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by Random Musings » Fri Sep 20, 2019 10:40 pm

As long at bonds and stocks don't fall a good amount at the same time, or one falls a lot while the other does not rise very much to offset the other or there is a big one day crash or........

Nah, these concepts are too smart to fail. The problem is, high sigma events in the investment arena occur far more than they statistically should. Those damn animal spirits....

RM
I figure the odds be fifty-fifty I just might have something to say. FZ

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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by whodidntante » Fri Sep 20, 2019 11:05 pm

I'm an atypical contributor in that I have no problem with leverage or futures. So like you've asked I will provide gentle feedback on your idea.

I'm not sure I could stand owning something with a negative expected return. If you believe that yields are just as likely to go up as down, then shorting two-year treasury futures would have a positive expected return, nominally. I understand that you think bond price exposure through futures is going to save your bacon in a big drawdown in equities and you're willing to let money fall through your pockets to get this perceived safety. These low yields seem broken to me, so I don't have the same confidence as you that past is prologue. I'm also not sure that the "lower for longer" pop-finance narrative is going to be our reality for the next 30 years. This could be more dangerous than you've calculated.

That said, I think you should do it. No way to learn like putting your hard-earned money where your mouth is. And maybe your model will prove to be correct as in a backtest.

DonIce
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by DonIce » Sat Sep 21, 2019 12:02 am

jt4 wrote:
Fri Sep 20, 2019 4:44 pm
HEDGEFUNDIE has well documented his approach for a risk parity strategy using 3x leveraged ETFs. Some members found the approach interesting and jumped in while others pointed out the risks of leveraged investing.

In this post, I describe a gentle alternative to HEDGEFUNDIE's 3x leveraged ETFs as described below. Of course, some of you will find that this approach is not gentle and a worse alternative... I welcome your (kind) input. :)

I explored this idea in this thread:

viewtopic.php?f=10&t=273666

Although I was mostly looking at 10 year treasury futures. I followed this strategy for 2 quarterly rolls, and made a good chunk of change due to the fall in interest rates since then, but then I sold out. I found that I could not stay the course, primarily because:

Each quarter, rolling from one quarter's contract to the next quarter's contract cost significant money due to the next quarter's contract trading at a higher value than the expiring quarter's contract. This didn't make sense to me. As far as I could understand from theory, the difference between the price of the two quarter's contracts should be the nominal value * (10 year rate - 3 month rate) * 1/4. This would have generally led to small gains each time I rolled, rather than losses, as the yield curve between 10 year and 3 month rates was not inverted at the time.

However, the price did not match this. I suspect that the bond market had continued expectations of rates dropping in the future, which made a contract for 3 months out more valuable than an expiring contract. When more market participants believe that rates will drop in the future than participants that believe rates will fall in the future, I think that must skew the relative price of one quarter's contract relative to the next. What this exercise proved to me was that I don't understand the exact mechanics that dictate the price difference from one quarter's contract to the next well enough, and that my results were not anywhere close to matching what backtests were showing when using PV naively with ETFs that represent similar treasury durations and negative allocations of CASHX.

I'm gonna continue to try to understand this better when I have time to dive deep but it's on the backburner for now. Do let me know if you find out more!

To accurately test this idea I would need to find a reliable source of daily future contract pricing information for real contracts, not back-adjusted continuous futures using various ratio methodologies. Only with the original daily contract data could I figure out what's going on, I think. If anyone has such data I'd love to look at it.

HEDGEFUNDIE
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by HEDGEFUNDIE » Sat Sep 21, 2019 12:39 am

DonIce wrote:
Sat Sep 21, 2019 12:02 am
jt4 wrote:
Fri Sep 20, 2019 4:44 pm
HEDGEFUNDIE has well documented his approach for a risk parity strategy using 3x leveraged ETFs. Some members found the approach interesting and jumped in while others pointed out the risks of leveraged investing.

In this post, I describe a gentle alternative to HEDGEFUNDIE's 3x leveraged ETFs as described below. Of course, some of you will find that this approach is not gentle and a worse alternative... I welcome your (kind) input. :)

I explored this idea in this thread:

viewtopic.php?f=10&t=273666

Although I was mostly looking at 10 year treasury futures. I followed this strategy for 2 quarterly rolls, and made a good chunk of change due to the fall in interest rates since then, but then I sold out. I found that I could not stay the course, primarily because:

Each quarter, rolling from one quarter's contract to the next quarter's contract cost significant money due to the next quarter's contract trading at a higher value than the expiring quarter's contract. This didn't make sense to me. As far as I could understand from theory, the difference between the price of the two quarter's contracts should be the nominal value * (10 year rate - 3 month rate) * 1/4. This would have generally led to small gains each time I rolled, rather than losses, as the yield curve between 10 year and 3 month rates was not inverted at the time.

However, the price did not match this. I suspect that the bond market had continued expectations of rates dropping in the future, which made a contract for 3 months out more valuable than an expiring contract. When more market participants believe that rates will drop in the future than participants that believe rates will fall in the future, I think that must skew the relative price of one quarter's contract relative to the next. What this exercise proved to me was that I don't understand the exact mechanics that dictate the price difference from one quarter's contract to the next well enough, and that my results were not anywhere close to matching what backtests were showing when using PV naively with ETFs that represent similar treasury durations and negative allocations of CASHX.

I'm gonna continue to try to understand this better when I have time to dive deep but it's on the backburner for now. Do let me know if you find out more!

To accurately test this idea I would need to find a reliable source of daily future contract pricing information for real contracts, not back-adjusted continuous futures using various ratio methodologies. Only with the original daily contract data could I figure out what's going on, I think. If anyone has such data I'd love to look at it.
Back to leveraged ETFs it is!

typical.investor
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by typical.investor » Sat Sep 21, 2019 4:14 am

DonIce wrote:
Sat Sep 21, 2019 12:02 am
jt4 wrote:
Fri Sep 20, 2019 4:44 pm
HEDGEFUNDIE has well documented his approach for a risk parity strategy using 3x leveraged ETFs. Some members found the approach interesting and jumped in while others pointed out the risks of leveraged investing.

In this post, I describe a gentle alternative to HEDGEFUNDIE's 3x leveraged ETFs as described below. Of course, some of you will find that this approach is not gentle and a worse alternative... I welcome your (kind) input. :)

I explored this idea in this thread:

viewtopic.php?f=10&t=273666

Although I was mostly looking at 10 year treasury futures. I followed this strategy for 2 quarterly rolls, and made a good chunk of change due to the fall in interest rates since then, but then I sold out. I found that I could not stay the course, primarily because:

Each quarter, rolling from one quarter's contract to the next quarter's contract cost significant money due to the next quarter's contract trading at a higher value than the expiring quarter's contract. This didn't make sense to me. As far as I could understand from theory, the difference between the price of the two quarter's contracts should be the nominal value * (10 year rate - 3 month rate) * 1/4. This would have generally led to small gains each time I rolled, rather than losses, as the yield curve between 10 year and 3 month rates was not inverted at the time.

However, the price did not match this. I suspect that the bond market had continued expectations of rates dropping in the future, which made a contract for 3 months out more valuable than an expiring contract. When more market participants believe that rates will drop in the future than participants that believe rates will fall in the future, I think that must skew the relative price of one quarter's contract relative to the next. What this exercise proved to me was that I don't understand the exact mechanics that dictate the price difference from one quarter's contract to the next well enough, and that my results were not anywhere close to matching what backtests were showing when using PV naively with ETFs that represent similar treasury durations and negative allocations of CASHX.
That's really interesting. You kindly answered my question in the thread you quoted and I almost started on 10 year futures too, but decided I really couldn't understand pricing well enough. The whole cheapest to deliver thing and small difference between the 3 mo and 10 year rates (or whatever turned out to be the cheapest to deliver).

So let me get this right, you made money on the futures due to rates dropping. So daily settlement mean cash deposited to your account.

Then when you rolled, the next contract was more expensive. Which you didn't like and so quit. OK, but didn't the daily settlement provide enough return to cover the higher cost of the next contract?

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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sat Sep 21, 2019 10:31 am

I'm running something similar, but much more risk- parity based and with much more leverage.

I honestly don't think 2.8x 2 year treasuries is near enough leverage to really do much of anything when overall rates are this low.

If you are shooting for risk parity you will need something like 10x leverage on a 2 year to equate to the volatility of equities. Don't get caught up in a back test that is only over a very long term where rates started in the stratosphere and came down to 0. When rates are very high you don't need as much leverage for risk parity.... when they are very low, you need a LOT.

In my futures based version of HF's risk parity idea, I'm running:

150% SP500
1500% 2 year notes

MotoTrojan
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by MotoTrojan » Sat Sep 21, 2019 10:35 am

countmein wrote:
Fri Sep 20, 2019 6:28 pm
AHTFY wrote:
Fri Sep 20, 2019 5:17 pm
Can you test this with pre-1980 data (real or synthetic)? This model is long treasuries in a period with falling rates. How would it perform with rising interest rates?
This. And also:

- stress test risk of prolonged inverted yield curve
- stress test risk of prolonged positive correlation
- compare against longer treasuries at lower leverage levels (ie why the 2-year?)
+1. Why not just hold some EDV to counter an equity-rich portfolio and keep it simple.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sat Sep 21, 2019 11:08 am

MotoTrojan wrote:
Sat Sep 21, 2019 10:35 am
countmein wrote:
Fri Sep 20, 2019 6:28 pm
AHTFY wrote:
Fri Sep 20, 2019 5:17 pm
Can you test this with pre-1980 data (real or synthetic)? This model is long treasuries in a period with falling rates. How would it perform with rising interest rates?
This. And also:

- stress test risk of prolonged inverted yield curve
- stress test risk of prolonged positive correlation
- compare against longer treasuries at lower leverage levels (ie why the 2-year?)
+1. Why not just hold some EDV to counter an equity-rich portfolio and keep it simple.

Then you'd need to hold the leverage on the equity side. Either via a LETF and pay the mgmt fee..... or via equity futures and all the volatility that comes into play with those (requires a lot of monitoring).

I think it's simpler in action to lever the bonds and just hold the equities basically straight up (if you don't want more than roughly 100% equity) . This is similar to what the Wisdom Tree fund does.

Which brings me to my next point....OP I think you'd do just as well to buy NTSX if you aren't going to leverage 2 year Treasuries any more than this. A lot simpler.

klaus14
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by klaus14 » Sat Sep 21, 2019 1:48 pm

NTSX+EDV
is simpler.

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ThereAreNoGurus
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by ThereAreNoGurus » Sat Sep 21, 2019 4:37 pm

rascott wrote:
Sat Sep 21, 2019 10:31 am
In my futures based version of HF's risk parity idea, I'm running:
150% SP500
1500% 2 year notes
Each 2 year note Treasury contract is 200K. How many Treasury futures contracts are you holding?
Last edited by ThereAreNoGurus on Sat Sep 21, 2019 4:38 pm, edited 1 time in total.
Trade the news and you will lose.

RandomWord
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by RandomWord » Sat Sep 21, 2019 4:37 pm

Anyone interested in this should probably read through this thread: viewtopic.php?t=143037

Lots of good info there.

My experience from running this strategy for the past few years:
-Futures are hard to understand. They use a lot of strange technical jargon ('backwardization', 'contango', etc) and there's not much in the way of instructions to help regular investors learn about them.
-However, actually using them is quite easy. It's like 5 minutes of work 4 times a year to roll them, and the market for treasury futures is so deep that the spread is negligible. The overall effect is similar to borrowing money to buy bonds on margin.
-The OP's proposed plan is 285% exposure to 2-year notes. That sounds like a lot, but it really isn't. It's not going to give risk parity, if that's what you want. The overall return is still going to be dominated by the equities portion. That's not necessarily a bad thing, just bear in mind this probably won't protect you from a stock market crash.
-The return is *highly* volatile. It's not like regular bonds where you get a slow and steady yield. There's a positive expectation value, but the return for any month (or even year) is dominated by whatever rumors are doing to interest rates. Basically, it's like buying a stock instead of a bond.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sat Sep 21, 2019 6:12 pm

ThereAreNoGurus wrote:
Sat Sep 21, 2019 4:37 pm
rascott wrote:
Sat Sep 21, 2019 10:31 am
In my futures based version of HF's risk parity idea, I'm running:
150% SP500
1500% 2 year notes
Each 2 year note Treasury contract is 200K. How many Treasury futures contracts are you holding?
3... they are roughly 214k each at current prices... margin requirements are roughly $2200 for that exposure. Using straight equity index ETFs, a bit of UPRO pls a micro E-mini to get the 150% equity exposure.

Still fine tuning to define how much I should keep in cash to avoid going on margin.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sat Sep 21, 2019 7:19 pm

RandomWord wrote:
Sat Sep 21, 2019 4:37 pm
Anyone interested in this should probably read through this thread: viewtopic.php?t=143037

Lots of good info there.

My experience from running this strategy for the past few years:
-Futures are hard to understand. They use a lot of strange technical jargon ('backwardization', 'contango', etc) and there's not much in the way of instructions to help regular investors learn about them.
-However, actually using them is quite easy. It's like 5 minutes of work 4 times a year to roll them, and the market for treasury futures is so deep that the spread is negligible. The overall effect is similar to borrowing money to buy bonds on margin.
-The OP's proposed plan is 285% exposure to 2-year notes. That sounds like a lot, but it really isn't. It's not going to give risk parity, if that's what you want. The overall return is still going to be dominated by the equities portion. That's not necessarily a bad thing, just bear in mind this probably won't protect you from a stock market crash.
-The return is *highly* volatile. It's not like regular bonds where you get a slow and steady yield. There's a positive expectation value, but the return for any month (or even year) is dominated by whatever rumors are doing to interest rates. Basically, it's like buying a stock instead of a bond.

Agreed... though 285% 2 year isn't coming close to the volatility of the SP500.

Since 2010, when rates have been zero boundish, 10-12x would give one the volatility of the SP500.

If OP wants something in the range of SP500 volatility/ risk.... he should go 50% SP500, 500% 2-years.

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ThereAreNoGurus
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by ThereAreNoGurus » Sat Sep 21, 2019 7:58 pm

rascott wrote:
Sat Sep 21, 2019 6:12 pm
ThereAreNoGurus wrote:
Sat Sep 21, 2019 4:37 pm
rascott wrote:
Sat Sep 21, 2019 10:31 am
In my futures based version of HF's risk parity idea, I'm running:
150% SP500
1500% 2 year notes
Each 2 year note Treasury contract is 200K. How many Treasury futures contracts are you holding?
3... they are roughly 214k each at current prices... margin requirements are roughly $2200 for that exposure. Using straight equity index ETFs, a bit of UPRO pls a micro E-mini to get the 150% equity exposure.

Still fine tuning to define how much I should keep in cash to avoid going on margin.
Curious how big you are going on this. How many Treasury contracts are you holding?
Trade the news and you will lose.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sat Sep 21, 2019 8:14 pm

ThereAreNoGurus wrote:
Sat Sep 21, 2019 7:58 pm
rascott wrote:
Sat Sep 21, 2019 6:12 pm
ThereAreNoGurus wrote:
Sat Sep 21, 2019 4:37 pm
rascott wrote:
Sat Sep 21, 2019 10:31 am
In my futures based version of HF's risk parity idea, I'm running:
150% SP500
1500% 2 year notes
Each 2 year note Treasury contract is 200K. How many Treasury futures contracts are you holding?
3... they are roughly 214k each at current prices... margin requirements are roughly $2200 for that exposure. Using straight equity index ETFs, a bit of UPRO pls a micro E-mini to get the 150% equity exposure.

Still fine tuning to define how much I should keep in cash to avoid going on margin.
Curious how big you are going on this. How many Treasury contracts are you holding?
Three. Total account is roughly $40k. So targeting roughly 60k SP500 exposure, $600k 2 year Treasury exposure. And then let it run and see how it goes.

The issue is with their large notional size, it's hard to get the proper allocation set just via the futures contract. So I'll likely still have to use something else to balance it properly when things get out of whack.

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ThereAreNoGurus
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by ThereAreNoGurus » Sat Sep 21, 2019 9:34 pm

rascott wrote:
Sat Sep 21, 2019 8:14 pm
Thx rascott. I enjoy reading these threads, especially when posters have skin in the game.

It will be interesting to see how these various portfolios pan out over the years. I hope you and others stick around and continue to give updates on your portfolios (ie., returns, changes in weights, leverage, etc.).

(I bought an HF Adventure Pass in May. :D )
Trade the news and you will lose.

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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by uberdoc » Sat Sep 21, 2019 10:00 pm

Y’all getting rich quick using 3x leverage, factor, momentum and all clever tricks making me feel a dumb with a three fund portfolio. It’s depressing watching money pass by.

typical.investor
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by typical.investor » Sat Sep 21, 2019 10:09 pm

uberdoc wrote:
Sat Sep 21, 2019 10:00 pm
Y’all getting rich quick using 3x leverage, factor, momentum and all clever tricks making me feel a dumb with a three fund portfolio. It’s depressing watching money pass by.
FOMO is unhealthy.

None of that stuff is tried-and-proven. Value investing is suffering! King of the factors right!

3X leverage in a sideways market ... nobody really knows how it will actually turn out. Index could be up with actual negative 3X fund returns.

Which Momentum fund? iShares has been great. AQR - not so much. Fund implementation makes a crucial difference in this stuff and it’s hard to know what’s best in advance.

Did you get that promotion at work you wanted? If not, what about thinking about that. If yes, what about the next one?

Getting more money in via contribution is tried-and-true!

RandomWord
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by RandomWord » Sat Sep 21, 2019 10:57 pm

DonIce wrote:
Sat Sep 21, 2019 12:02 am
jt4 wrote:
Fri Sep 20, 2019 4:44 pm
HEDGEFUNDIE has well documented his approach for a risk parity strategy using 3x leveraged ETFs. Some members found the approach interesting and jumped in while others pointed out the risks of leveraged investing.

In this post, I describe a gentle alternative to HEDGEFUNDIE's 3x leveraged ETFs as described below. Of course, some of you will find that this approach is not gentle and a worse alternative... I welcome your (kind) input. :)

I explored this idea in this thread:

viewtopic.php?f=10&t=273666

Although I was mostly looking at 10 year treasury futures. I followed this strategy for 2 quarterly rolls, and made a good chunk of change due to the fall in interest rates since then, but then I sold out. I found that I could not stay the course, primarily because:

Each quarter, rolling from one quarter's contract to the next quarter's contract cost significant money due to the next quarter's contract trading at a higher value than the expiring quarter's contract. This didn't make sense to me. As far as I could understand from theory, the difference between the price of the two quarter's contracts should be the nominal value * (10 year rate - 3 month rate) * 1/4. This would have generally led to small gains each time I rolled, rather than losses, as the yield curve between 10 year and 3 month rates was not inverted at the time.

However, the price did not match this. I suspect that the bond market had continued expectations of rates dropping in the future, which made a contract for 3 months out more valuable than an expiring contract. When more market participants believe that rates will drop in the future than participants that believe rates will fall in the future, I think that must skew the relative price of one quarter's contract relative to the next. What this exercise proved to me was that I don't understand the exact mechanics that dictate the price difference from one quarter's contract to the next well enough, and that my results were not anywhere close to matching what backtests were showing when using PV naively with ETFs that represent similar treasury durations and negative allocations of CASHX.

I'm gonna continue to try to understand this better when I have time to dive deep but it's on the backburner for now. Do let me know if you find out more!

To accurately test this idea I would need to find a reliable source of daily future contract pricing information for real contracts, not back-adjusted continuous futures using various ratio methodologies. Only with the original daily contract data could I figure out what's going on, I think. If anyone has such data I'd love to look at it.
I'm confused.

Rolling from one contract to another doesn't actually net you anything. All that matters is the price movements while you actually have the contract open. EG, you could close a contract on silver (currently around 18) and open one for gold (currently around 1500) and you wouldn't lose any money except the commission for the contract.

Like you said, they are priced differently because of speculation about how interest rates might move in the future, but all that really affects you is how the interest rates *do* move.

Quandl has some actual futures data (https://www.quandl.com/data/SRF-Reference-Futures) although you have to pay for most of it. I have some limited data from the past three years, if you really want to take a look at it.

ThrustVectoring
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by ThrustVectoring » Sun Sep 22, 2019 12:17 am

jt4 wrote:
Fri Sep 20, 2019 4:44 pm

Proposed Portfolio
66% Total US Stock Market
29% Total International Stock Market
5% cash, held to meet margin requirements for futures
285% 2-year Treasury Futures (\ZT)
385% sum (3.8x leverage)
That's probably not using enough leverage and interest rate exposure for an aggressive portfolio. Futures have inter-commodity spread tables, which tell you the ratios of different contracts to hold to get a partial discount on required capital due to the market movements of the different items being negatively correlated. The S&P 500 and two-year treasury future have a ratio of 1:50, which when converted to cash amounts is roughly 1:13 (the full S&P 500 contract is significantly larger than the two-year treasury future).

This isn't to say that this is the ratio you necessarily should be using, but it is the point where market institutions believe that the negatively correlated risks in the two products roughly cancel out. Sanity checking those sorts of numbers seem roughly okay - your overall duration would be something like 26 years, so similar to just running long-term bonds but with worse convexity (and short-term rates tend to be more volatile, too).

Also, you don't need the 5% cash. Cash in brokerage accounts pays 1% if you're lucky, 0% if you're not, compared to the 2% you could easily be getting in a high yield savings account. This amounts to a 5 to 10 bps management fee on your entire account. In a taxable account, you can meet margin requirements through taking on a limited amount of margin debt, and is very likely significantly cheaper than holding a bunch of cash for no reason.

Finally, adding straight treasury futures to a near-100% equity strategy is going to increase risk. You're just going to be getting paid far more efficiently for the risk. I'd suggest dropping the equity percentage to something like 60% to make it far easier to sleep at night. Make up the difference with intermediate or long-term TIPS.

My rough proposal:
825% 2-year Treasury Futures
37.5% Total US Stock Market
25% Total International Stock Market
37.5% Long-term TIPS

NB: I haven't pulled the trigger on this yet, taxable savings are 100% cash because I'm getting married soon and my SO is considering nursing school. And I'm not doing anything this heterodox in my retirement accounts, those are staying 100% stock and getting left alone. But if I were to do treasury futures, this is roughly the size of the position I'd take.
Current portfolio: 60% VTI / 40% VXUS

rhe
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rhe » Sun Sep 22, 2019 7:17 am

I held a portfolio quite similar to this for the past two years, but toned it down a couple of weeks ago because I was getting worried. Over those two years my bond positions contributed about 6% growth to my total account value, so I disagree with those people who think the proposed bond position is "small". I do agree that on an average day the positions do not move very much, but in the past couple years there have been some very bad days for the stock market, and on some of those days bonds went down substantially as well. This portfolio is no fun to hold on those days, because you have to decide when you are going to start selling into losses.

As has been pointed out, transaction costs are very important. I was not happy rolling the treasury futures, and switched to eurodollars instead. With a two year eurodollar strip, you only have to roll an eighth of your position each quarter, and you can do it basically anytime you want, because the front contract barely moves at all and settles to cash.

DonIce
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by DonIce » Sun Sep 22, 2019 4:02 pm

RandomWord wrote:
Sat Sep 21, 2019 10:57 pm
I'm confused.

Rolling from one contract to another doesn't actually net you anything. All that matters is the price movements while you actually have the contract open. EG, you could close a contract on silver (currently around 18) and open one for gold (currently around 1500) and you wouldn't lose any money except the commission for the contract.

Like you said, they are priced differently because of speculation about how interest rates might move in the future, but all that really affects you is how the interest rates *do* move.

Quandl has some actual futures data (https://www.quandl.com/data/SRF-Reference-Futures) although you have to pay for most of it. I have some limited data from the past three years, if you really want to take a look at it.
Thanks, you are probably right and I was probably thinking about it wrong. Selling a contract with a notional value of say $120k to buy one with a notional value of say $123k seemed like I would be losing money, but you are right that I wasn't actually losing or gaining any money in the roll transaction, since I am just putting up the collateral, which generally remains unchanged from quarter to quarter.

The free data at Quandl doesn't include treasury note or treasury bond futures as far as I could find, though it does offer some data sets for some commodities for free. If you have data over the past three years for treasuries I'd definitely be interested!

DonIce
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by DonIce » Sun Sep 22, 2019 4:07 pm

rascott wrote:
Sat Sep 21, 2019 10:31 am
If you are shooting for risk parity you will need something like 10x leverage on a 2 year to equate to the volatility of equities. Don't get caught up in a back test that is only over a very long term where rates started in the stratosphere and came down to 0. When rates are very high you don't need as much leverage for risk parity.... when they are very low, you need a LOT.
Can you elaborate on this in a more mathematical way? What is the relationship you are describing between prevalent interest rates and treasury note futures volatility?

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Sun Sep 22, 2019 4:44 pm

DonIce wrote:
Sun Sep 22, 2019 4:07 pm
rascott wrote:
Sat Sep 21, 2019 10:31 am
If you are shooting for risk parity you will need something like 10x leverage on a 2 year to equate to the volatility of equities. Don't get caught up in a back test that is only over a very long term where rates started in the stratosphere and came down to 0. When rates are very high you don't need as much leverage for risk parity.... when they are very low, you need a LOT.
Can you elaborate on this in a more mathematical way? What is the relationship you are describing between prevalent interest rates and treasury note futures volatility?


I cannot (or at least have not tried) but EfficientInvestor did some regression analysis based upon the volatility of short term treasuries under different interest rate environments and leverage levels.

He has posted the chart in a couple threads - including in the HF Adventure thread recently. It had matched up to what I came up to separately..... when trying to define how much one would need to leverage STTs to equate to the volatility of LTTs. I did this just multiplying the duration of SHY to equate to TLT.

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Sun Sep 22, 2019 10:10 pm

Thanks for all these comments. I'd like to address a couple of points.

(1) Leverage. For those of you against leverage. Leveraging different types of assets are NOT equal. As a simple example, consider leveraging a (fictional) 10x position in 3-month treasury futures (these don't really exist). This would be similar to borrowing cash and investing that cash at nearly the same rate. In general, such a situation wouldn't make much sense as there would be little to gain, but I hope it's clear that there would also be little risk. Similarly, for the same amount of leverage 2-year treasuries are about 10x less "risky" as compared to treasury bonds, such as TLT with an effective duration of 18 years. A 1% change in interest rates (across all durations) would cause a 2% change in the price of a 2-year treasury note whereas an investment in TLT would experience an 18% change.

(2) Risk parity. It's interesting to me that some people immediately think that the proposed portfolio is too leveraged whereas others think it should be 3x more leveraged! I'm not necessarily trying to achieve pure risk parity (whereas each asset held has the same risk profile). Instead, I'm trying to achieve a profile that I would call S&P 500 "Plus". Such a portfolio would give me an average return similar to (and hopefully a little greater than) the S&P 500, but that is hedged to limit drawdowns during market downturns. (The best of both worlds, eh? Not too much to ask for?)

(3) NTSX. There have been a couple of suggestions about the use of NTSX -- Wisdom Tree's 90/60 balanced fund that directly invests 90% in the SP500 and the other 10% in a treasury ladder (i.e. all treasury durations from 2-year to 30-year) for a 60% total exposure to treasuries. I am indeed invested in NTSX for my US equity positions, and I really like the makeup of the fund and it's reasonable expense ratio of 0.2%. The biggest negative is the low volume (and large spread), which can be overcome by placing a limit order halfway between the bid-ask price and being patient. I was worried about the low assets under management for this fund (and possible risk of closure), but it looks like a single investor (or institution) moved $20M into the fund on 9/9, so that it's AUM are now $36M. Hopefully, at this level of assets, it's worthwhile to Wisdom Tree to keep it alive.

(4) Falling/rising interest rates. This article suggests that only 1/3 of the total return from holding eurodollar futures (very, very similiar to holding 2-year treasuries) from 1994 to 2014 can be attributed to interest rate changes whereas "roughly two-thirds of the total gain on a Eurodollar carry portfolio was explained by risk premium, carry, or riding the yield curve." Rising interest rates will hurt returns, but given an effective duration of 285% x 2-year, a 5% increase in interest rates will hit my portfolio by 15%. While this wouldn't be fun, the hope is that the yield-carry curve return and the negative correlation to the US market would still make holding the treasuries valuable to the portfolio construction as a whole.

(5) Why 2-year treasury futures? The same article as above points out a better Sharpe ratio for 2-year treasuries as compared to longer duration bonds. Several theories have suggested why this might be, but in practice, it suggests it better (from a historic risk/return perspective) to hold leveraged 2-year treasuries over something like EDV. In this case you would leverage the 2-year treasuries to get the same effective duration. Of course you could equally hold eurodollars, which as the article shows, have nearly identical results as 2-year treasuries.

____________

In the proposed proposal I choose ~285% 2-year treasuries because (in the backtesting from 1970 to 2018, I believe this was correct) there was a minimum in the std. deviation around this level of exposure. Depsite the logical advice that I give above about 2-year futures having substantially less risk than a similar sized position in EDV, a 8x to 15x leverage as some have suggested seems a little scary to me. While this amount might make the most sense mathematically, there are some practical issues in terms of how much cash you need to have set aside to deal with mark-to-market for such a position.

@EfficientInvestor could you summarize (or point us to) your analysis on the volatility of short term treasuries under different interest rate environments and leverage levels? (In practice, I worry about my own implementation of this in such a way that it doesn't become "market timing" of different leverages.)

@rhe Have you found any disadvantages to trading eurodollar future as compared to US treasuries?

rhe
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rhe » Mon Sep 23, 2019 3:30 am

jt4 wrote:
Sun Sep 22, 2019 10:10 pm
@rhe Have you found any disadvantages to trading eurodollar future as compared to US treasuries?
As far as I can see, eurodollar futures are perfect if your plan is just to hold the first eight contracts. My strategy was actually slightly more complex, because I would try to hold the part of the yield curve with the greatest positive slope. This is usually the front of the yield curve, but right now it is actually several years out (both for usd and most other currencies). This generated some trading costs that I didn't like.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Mon Sep 23, 2019 5:42 am

jt4 wrote:
Sun Sep 22, 2019 10:10 pm


(2) Risk parity. It's interesting to me that some people immediately think that the proposed portfolio is too leveraged whereas others think it should be 3x more leveraged! I'm not necessarily trying to achieve pure risk parity (whereas each asset held has the same risk profile). Instead, I'm trying to achieve a profile that I would call S&P 500 "Plus". Such a portfolio would give me an average return similar to (and hopefully a little greater than) the S&P 500, but that is hedged to limit drawdowns during market downturns. (The best of both worlds, eh? Not too much to ask for?)


Yep, nothing wrong from what I see in your analysis. For me, I'd probably just buy the PIMCO Stocks Plus funds and let them deal with it....(I actually do some of that too). It's not really the same thing as you are talking about (they use more credit risk in a 100/100, 2x leverage setup) , but likely will end up in the same place, or pretty darn close to it. These aren't good funds for taxable accounts, however.

I'm only using futures in a separate, highly leveraged risk- parity portfolio. Which may well blow up entirely. :D I'm well aware I'm taking a gamble, as educated as it may be. I've made a variety of higher risk investments than this over time, some work great, some blow up.

Also.... don't know what portfolio size you are working with... but a drawback to your idea is that the 2 year contracts are so large ($200k each).... it's gonna be hard to keep your allocations in line. And isn't a Eurodollar contract $1m? So even less suitable.


BTW....I also read that paper a while back... I had in my head long been thinking that holding Treasury futures contracts is much like acting like a bank (borrowing ultra- short and lending longer). When they said basically the same thing (and showed the math behind it) , it was helpful to confirm my thoughts. Also should make it clear why bankers get really antsy about inverted yield curves. :happy
Last edited by rascott on Mon Sep 23, 2019 6:11 am, edited 5 times in total.

BlueOrange10
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by BlueOrange10 » Mon Sep 23, 2019 5:47 am

The lower you go in duration, the closer this gets to timing the market :D

EfficientInvestor
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by EfficientInvestor » Mon Sep 23, 2019 6:42 am

jt4 wrote:
Sun Sep 22, 2019 10:10 pm
@EfficientInvestor could you summarize (or point us to) your analysis on the volatility of short term treasuries under different interest rate environments and leverage levels? (In practice, I worry about my own implementation of this in such a way that it doesn't become "market timing" of different leverages.)
Let me first state that there are many ways to analyze the volatility vs leverage of short term treasuries (STT). I somewhat arbitrarily chose to look at the 5-year standard deviation of annual returns. It may be helpful to also look at standard deviation of monthly returns over a 12-month period, especially if you decide to rebalance annually (and reset leverage annually).

The data in the chart below represents the 5-year standard deviation of annual returns of STT with various amounts of leverage vs the fed fund rate at the beginning of year 1. In other words...given today's fed fund rate, what kind of volatility could I expect over the next 5 years if I set my leverage today and left it like that for 5 years. Take note that I probably should have used the 3-month treasury instead of the Fed Fund rate, but I called it close enough for now. The leveraged return calculations use the CASHX risk-free rate from Portfolio Visualizer, but I used the Fed Fund rate as my x-axis variable.

The black line in the chart represents the 5-year standard deviation of the S&P 500. Interestingly enough, the average is around 15% regardless of the Fed Fund rate. All the other lines are the 5-year standard deviations of STT with various amounts of leverage. To determine the amount of leverage to use to achieve risk parity with the S&P 500, find the line that intersects with the black line at the current interest rate. Currently, that would be the orange line that represents a 10X leverage.

Please keep in mind that this chart is based on data from 1955 - present. Just because there was a positive correlation between fed fund rate and volatility of leveraged STT over the time period doesn't mean the trend will continue. That being said...I think the trend makes sense. With leveraged STT, the leverage has a big impact due to the amount you need to use. As cost of leverage increases, that means you have to have an even larger return in a given year to offset that cost of leverage. The price you pay to achieve those higher returns is higher volatility.

A final note...because the S&P 500 volatility stays constant, my assumption is that this is due to companies ramping down their borrowing as borrowing rates increase in order to maintain their risk. Then they ramp it up when borrowing rates are low. In the same way, shouldn't we also do this with out short term bond exposures?

Image

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Mon Sep 23, 2019 7:26 am

EfficientInvestor wrote:
Mon Sep 23, 2019 6:42 am
A final note...because the S&P 500 volatility stays constant, my assumption is that this is due to companies ramping down their borrowing as borrowing rates increase in order to maintain their risk. Then they ramp it up when borrowing rates are low. In the same way, shouldn't we also do this with out short term bond exposures?
Ah yes, I remember that plot that you posted. Thanks for reposting!

(1) @EfficientInvestor: What are your own criticisms with changing your treasury leverage to match SP500 volatility?

(2) Regarding the SP500 companies — do we really think they changed their debt by a factor of 5x (or more?) as interest rates went from near 0% to 2%? [I don't know, I'm really asking!]

EfficientInvestor
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by EfficientInvestor » Mon Sep 23, 2019 8:20 am

jt4 wrote:
Mon Sep 23, 2019 7:26 am
EfficientInvestor wrote:
Mon Sep 23, 2019 6:42 am
A final note...because the S&P 500 volatility stays constant, my assumption is that this is due to companies ramping down their borrowing as borrowing rates increase in order to maintain their risk. Then they ramp it up when borrowing rates are low. In the same way, shouldn't we also do this with out short term bond exposures?
Ah yes, I remember that plot that you posted. Thanks for reposting!

(1) @EfficientInvestor: What are your own criticisms with changing your treasury leverage to match SP500 volatility?

(2) Regarding the SP500 companies — do we really think they changed their debt by a factor of 5x (or more?) as interest rates went from near 0% to 2%? [I don't know, I'm really asking!]
I can't really criticize the data. It is what it is and the positive correlation between borrowing rate and volatility of leverage STT makes sense (at least to me) and I would expect it to continue. The biggest criticism would be regarding the implementation and whether an investor could establish rules and stick to them. Using that much leverage can be a hard pill to swallow and you really need to be convinced of the data to use 10x leverage.

Fortunately, borrowing 10X at the moment only equates to about 10 x 2% = 20%. Since 1955, STT have not had a single year with a negative return. Therefore, let's assume a worst year scenario of a 0% return. If you are leveraged by a factor of 10 and have to pay out 20% for your borrow cost and then get a return of 0%, you are looking at a worst case scenario of having a -20% return. I'm ok with that. But if borrow costs go up, you need to reduce leverage to maintain your worst case scenario.

Regarding S&P 500 companies and leverage...your guess is as good as mine. I was just making an assumption about what they are doing given the constant volatility. I imagine there is data out there about the average debt of S&P 500 companies over time and you can compare that against the borrowing rate.

RandomWord
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by RandomWord » Mon Sep 23, 2019 5:10 pm

rhe wrote:
Sun Sep 22, 2019 7:17 am
I held a portfolio quite similar to this for the past two years, but toned it down a couple of weeks ago because I was getting worried. Over those two years my bond positions contributed about 6% growth to my total account value, so I disagree with those people who think the proposed bond position is "small". I do agree that on an average day the positions do not move very much, but in the past couple years there have been some very bad days for the stock market, and on some of those days bonds went down substantially as well. This portfolio is no fun to hold on those days, because you have to decide when you are going to start selling into losses.

As has been pointed out, transaction costs are very important. I was not happy rolling the treasury futures, and switched to eurodollars instead. With a two year eurodollar strip, you only have to roll an eighth of your position each quarter, and you can do it basically anytime you want, because the front contract barely moves at all and settles to cash.
Can you go into detail on the cost savings for eurodollars vs treasury futures? Because it doesn't seem like it should be very much. Assuming you're trading the front contract, you should be able to pay just one tick on the spread, so 1/256 * 2000, or slightly less than $8. Call it $10 per contract with the commission. I guess every dollar counts, but I don't see how eurodollars would save enough to really matter much.

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Mon Sep 23, 2019 8:47 pm

jt4 wrote:
Sun Sep 22, 2019 10:10 pm

In the proposed proposal I choose ~285% 2-year treasuries because (in the backtesting from 1970 to 2018, I believe this was correct) there was a minimum in the std. deviation around this level of exposure. Depsite the logical advice that I give above about 2-year futures having substantially less risk than a similar sized position in EDV, a 8x to 15x leverage as some have suggested seems a little scary to me. While this amount might make the most sense mathematically, there are some practical issues in terms of how much cash you need to have set aside to deal with mark-to-market for such a position.

Curious....how exactly do you propose structuring your positions to get 285% exposure. Unless you have a very large starting portfolio balance, a $200k (actually about $214k at current prices) contract is not real flexible. And then how are you going to maintain that ratio when your equity balances change over time?

And yes, you need to do some cash management at higher leverage.....but this thing isn't going to go off the charts on you in a matter of a day. The worst thing that would happen is you go on margin and have to pay margin interest until you get to your cash balances resolved.

rhe
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rhe » Mon Sep 23, 2019 9:22 pm

RandomWord wrote:
Mon Sep 23, 2019 5:10 pm
Can you go into detail on the cost savings for eurodollars vs treasury futures? Because it doesn't seem like it should be very much. Assuming you're trading the front contract, you should be able to pay just one tick on the spread, so 1/256 * 2000, or slightly less than $8. Call it $10 per contract with the commission. I guess every dollar counts, but I don't see how eurodollars would save enough to really matter much.
I think the tick size changed last year, so it may not be as big of an issue now. Treasury futures settle to treasuries, so you pay half a tick when you buy and half a tick when you sell. If you think the term premium is 50bps (which doesn't show up in the yield curve right now), then that's 25bps per year. If you only pay one tick for each roll, then you're right that this doesn't cut into profit that much. On the other hand, right now it looks like the spread is two ticks. The thing that I didn't like about trading treasury futures was that I had to put the roll on my calendar and remember to trade on certain days. With the eurodollars I can trade whenever I want to.

RandomWord
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by RandomWord » Mon Sep 23, 2019 10:35 pm

rhe wrote:
Mon Sep 23, 2019 9:22 pm
RandomWord wrote:
Mon Sep 23, 2019 5:10 pm
Can you go into detail on the cost savings for eurodollars vs treasury futures? Because it doesn't seem like it should be very much. Assuming you're trading the front contract, you should be able to pay just one tick on the spread, so 1/256 * 2000, or slightly less than $8. Call it $10 per contract with the commission. I guess every dollar counts, but I don't see how eurodollars would save enough to really matter much.
I think the tick size changed last year, so it may not be as big of an issue now. Treasury futures settle to treasuries, so you pay half a tick when you buy and half a tick when you sell. If you think the term premium is 50bps (which doesn't show up in the yield curve right now), then that's 25bps per year. If you only pay one tick for each roll, then you're right that this doesn't cut into profit that much. On the other hand, right now it looks like the spread is two ticks. The thing that I didn't like about trading treasury futures was that I had to put the roll on my calendar and remember to trade on certain days. With the eurodollars I can trade whenever I want to.
Sure, I totally understand wanting something that's convenient. I wish there was a contract for 100 years out so we could just buy that and forget about it.

But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.

DonIce
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by DonIce » Mon Sep 23, 2019 10:44 pm

RandomWord wrote:
Mon Sep 23, 2019 10:35 pm
But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.
The notional value isn't really important, just the potential returns or potential volatility, right? Over the course of a year the 2 year futures contract usually moves around 1% or so, so that's about $2000. And $50 is 2.5% out of that $2k of movement.

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Tue Sep 24, 2019 8:19 am

DonIce wrote:
Mon Sep 23, 2019 10:44 pm
RandomWord wrote:
Mon Sep 23, 2019 10:35 pm
But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.
The notional value isn't really important, just the potential returns or potential volatility, right? Over the course of a year the 2 year futures contract usually moves around 1% or so, so that's about $2000. And $50 is 2.5% out of that $2k of movement.
The notional value is not important when you're trying to determine how much to hold for risk parity to a given asset (i.e. the notional values you hold of 2-yr and 10-yr treasuries will be different by roughly a factor of 5x so we can't look at notional value alone...)

BUT, I do think the notional value is important because it allows me to determine the effective expense ratio for holding the futures. To meaningfully compare the effective expense ratios for these two different types of investments, I need to make an apples-to-apples comparison.

Premise: I have $1M that I wish to invest in 2-yr treasuries. Let's compare expense ratios for different investment methods.

(Case 1) Hold 2-yr treasuries directly (without leverage) by buying ETF. The most popular ETF is SHY (iShares 1-3 Year Treasury Bond ETF) with an expense ratio of 0.15%. So if I hold $1M in treasuries in that fund, I pay $1500/year in expenses.

(Case 2) Hold 2-yr treasury futures and buy 3-mo T-bills to offset borrowing cost. For comparison, assume that I hold $1M in 2-yr treasury futures (which costs little out-of-pocket) and offset the borrowing costs implied in the futures contract by also purchasing $1M worth of 3-month T-bills at auction (assuming no transaction fees). The effective expense ratio for rolling the treasury futures (ignoring other costs at this point) is equal to the transaction fees (sell 5 contracts + buy 5 contracts every quarter = 40 future contract trades/yr ==> $115/yr at my TDA transaction cost of $2.87/contract including exchange and regulatory fees) + spread (1 tick/trade x 40 trades/yr x $7.81/tick = $312/yr) giving a total yearly cost of $427 ==> 0.042% expense ratio.

Also, by using limit orders, you may be able to make the argument that you don't pay the spread, reducing the effective expense ratio to 0.0115%.

(Case 3) Buy 2-yr treasury notes at auction. (Also a possibility, but we'll ignore it for this comparison.)

_______________________

I partly do this analysis to convince myself that $115/yr in trading fees isn't really that much in the scheme of things because it only translates to a 0.0115% expense ratio, which I would consider miniscule for any other ETF or fund.

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Tue Sep 24, 2019 8:38 am

rascott wrote:
Mon Sep 23, 2019 8:47 pm
jt4 wrote:
Sun Sep 22, 2019 10:10 pm

In the proposed proposal I choose ~285% 2-year treasuries because (in the backtesting from 1970 to 2018, I believe this was correct) there was a minimum in the std. deviation around this level of exposure. Depsite the logical advice that I give above about 2-year futures having substantially less risk than a similar sized position in EDV, a 8x to 15x leverage as some have suggested seems a little scary to me. While this amount might make the most sense mathematically, there are some practical issues in terms of how much cash you need to have set aside to deal with mark-to-market for such a position.

Curious....how exactly do you propose structuring your positions to get 285% exposure. Unless you have a very large starting portfolio balance, a $200k (actually about $214k at current prices) contract is not real flexible. And then how are you going to maintain that ratio when your equity balances change over time?

And yes, you need to do some cash management at higher leverage.....but this thing isn't going to go off the charts on you in a matter of a day. The worst thing that would happen is you go on margin and have to pay margin interest until you get to your cash balances resolved.
:) The reason why I picked 285% exposure to 2-yr treasuries is because it equaled a whole number of contracts.

In practice, the exposure will drift from 285% and I will rebalance only when it's dropped low enough that I can add another contract to boost it back up to 285% or has gone high enough that I will sell a contract to bring the exposure back down.

In using portfolio visualizer, I tested the impact of this on the returns and it has very, very little overall impact.

Portfolio Visualizer Results (from 1/1997 to 12/2018

Annual rebalancing
Band rebalancing when absolute deviation of exposure is 33% (which is equal to one contract for my portfolio)

Code: Select all

Portfolio           	Intial Bal	Final Bal	CAGR	Stdev	Best Yr	Worst Yr	Max. Drawdown	Sharpe Ratio	Sortino Ratio	US Mkt Correlation
Annual Rebalancing	$10,000		$99,374 	11.00% 	13.52%	36.14%	-22.44%		-37.05% 	0.69		1.06		0.91
Band Rebalancing	$10,000		$99,336 	11.00% 	13.55%	35.35%	-25.21%		-38.51% 	0.69		1.05		0.91

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Tue Sep 24, 2019 8:52 am

rhe wrote:
Sun Sep 22, 2019 7:17 am
I held a portfolio quite similar to this for the past two years, but toned it down a couple of weeks ago because I was getting worried. Over those two years my bond positions contributed about 6% growth to my total account value, so I disagree with those people who think the proposed bond position is "small". I do agree that on an average day the positions do not move very much, but in the past couple years there have been some very bad days for the stock market, and on some of those days bonds went down substantially as well. This portfolio is no fun to hold on those days, because you have to decide when you are going to start selling into losses.

As has been pointed out, transaction costs are very important. I was not happy rolling the treasury futures, and switched to eurodollars instead. With a two year eurodollar strip, you only have to roll an eighth of your position each quarter, and you can do it basically anytime you want, because the front contract barely moves at all and settles to cash.
@rhe I understand that eurodollar strips track treasuries quite well over the long term, but I recently came across the plot below that shows TED — the spread between the 3-mo treasury and 3-mo LIBOR (upon which the eurodollar is based).

Image

In the 2008 great recession, the T-bill rate dropped to nearly zero due to government intervention while the LIBOR rate shot up to 5% as the financial market tightened and banks stopped lending. I recognize that this plot only compares 3-mo rates, but it suggests that holding treasuries would be significantly more advantageous than holding eurodollars in times of distress. After all, we want treasuries to be negatively correlated with the stock market for the most benefit.

Topic Author
jt4
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by jt4 » Tue Sep 24, 2019 9:00 am

ThrustVectoring wrote:
Sun Sep 22, 2019 12:17 am
jt4 wrote:
Fri Sep 20, 2019 4:44 pm

Proposed Portfolio
66% Total US Stock Market
29% Total International Stock Market
5% cash, held to meet margin requirements for futures
285% 2-year Treasury Futures (\ZT)
385% sum (3.8x leverage)
That's probably not using enough leverage and interest rate exposure for an aggressive portfolio. Futures have inter-commodity spread tables, which tell you the ratios of different contracts to hold to get a partial discount on required capital due to the market movements of the different items being negatively correlated. The S&P 500 and two-year treasury future have a ratio of 1:50, which when converted to cash amounts is roughly 1:13 (the full S&P 500 contract is significantly larger than the two-year treasury future).

This isn't to say that this is the ratio you necessarily should be using, but it is the point where market institutions believe that the negatively correlated risks in the two products roughly cancel out. Sanity checking those sorts of numbers seem roughly okay - your overall duration would be something like 26 years, so similar to just running long-term bonds but with worse convexity (and short-term rates tend to be more volatile, too).

Also, you don't need the 5% cash. Cash in brokerage accounts pays 1% if you're lucky, 0% if you're not, compared to the 2% you could easily be getting in a high yield savings account. This amounts to a 5 to 10 bps management fee on your entire account. In a taxable account, you can meet margin requirements through taking on a limited amount of margin debt, and is very likely significantly cheaper than holding a bunch of cash for no reason.

Finally, adding straight treasury futures to a near-100% equity strategy is going to increase risk. You're just going to be getting paid far more efficiently for the risk. I'd suggest dropping the equity percentage to something like 60% to make it far easier to sleep at night. Make up the difference with intermediate or long-term TIPS.

My rough proposal:
825% 2-year Treasury Futures
37.5% Total US Stock Market
25% Total International Stock Market
37.5% Long-term TIPS

NB: I haven't pulled the trigger on this yet, taxable savings are 100% cash because I'm getting married soon and my SO is considering nursing school. And I'm not doing anything this heterodox in my retirement accounts, those are staying 100% stock and getting left alone. But if I were to do treasury futures, this is roughly the size of the position I'd take.
@ThrustVectoring: thanks for this feedback — it's insightful.

I agree that the 5% cash provides a drag on the returns, but I don't want to worry about frequent transactions to cover the daily mark-to-market. In this case, the futures are in an IRA so I can't move money back and forth. I could also invest part of that cash in ultra-short-term bond funds, but once again, the more aggressive I am with this, the more I have to monitor the account daily.

RandomWord
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by RandomWord » Tue Sep 24, 2019 12:52 pm

DonIce wrote:
Mon Sep 23, 2019 10:44 pm
RandomWord wrote:
Mon Sep 23, 2019 10:35 pm
But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.
The notional value isn't really important, just the potential returns or potential volatility, right? Over the course of a year the 2 year futures contract usually moves around 1% or so, so that's about $2000. And $50 is 2.5% out of that $2k of movement.
Well then, just to make this apples to apples, how much are you paying per year for a eurodollar futures contract? And what kind of returns do you expect from them?

rascott
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Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by rascott » Tue Sep 24, 2019 6:15 pm

DonIce wrote:
Mon Sep 23, 2019 10:44 pm
RandomWord wrote:
Mon Sep 23, 2019 10:35 pm
But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.
The notional value isn't really important, just the potential returns or potential volatility, right? Over the course of a year the 2 year futures contract usually moves around 1% or so, so that's about $2000. And $50 is 2.5% out of that $2k of movement.


This doesn't seem right to me.... that's like saying the expense ratio of a fund is based upon its volatility/ expected return. Every bond fund in existence would have probably worse numbers than this.

The correct comparison is trading costs to notional value.... that's the effective ER of this strategy.

DonIce
Posts: 699
Joined: Thu Feb 21, 2019 6:44 pm

Re: A gentle alternative to HEDGEFUNDIE's excellent adventure with 2-Year Treasury Futures

Post by DonIce » Tue Sep 24, 2019 8:08 pm

rascott wrote:
Tue Sep 24, 2019 6:15 pm
DonIce wrote:
Mon Sep 23, 2019 10:44 pm
RandomWord wrote:
Mon Sep 23, 2019 10:35 pm
But I also think it's important to keep in mind the scale. The leverage on these things is so large that it's easy to lose track of the big picture. I don't think $50 per year or whatever on a $200,000 notional value is worth worrying about it. Now, if there's some reason why eurodollars should deliver a larger return than treasury futures, that could be worth way more than $50 a year. But it would be strange if the market allowed such an inefficiency to persist, when these are both so heavily traded.
The notional value isn't really important, just the potential returns or potential volatility, right? Over the course of a year the 2 year futures contract usually moves around 1% or so, so that's about $2000. And $50 is 2.5% out of that $2k of movement.


This doesn't seem right to me.... that's like saying the expense ratio of a fund is based upon its volatility/ expected return. Every bond fund in existence would have probably worse numbers than this.

The correct comparison is trading costs to notional value.... that's the effective ER of this strategy.
Think about for example 5 year futures vs 10 year futures. To get roughly the same behavior with 5 year futures, you would need to hold 2 times the notional value, and so trade 2x as many contracts, and so have 2x the costs. The two positions should behave almost identically (2 5 year contracts vs 1 10 year contract). Which has the higher ER? If you think about it in terms of notional, they have the same ER. But if you think about it based on the cost you pay for the effect that you get, 2 5 years has a 2x higher ER. At least, that's how I've been thinking about it. Am I making a mistake somewhere?

Also, how are ERs defined for leveraged funds? I think its based on the value invested, not the value controlled by the leverage? For example, if you put $1000 into a 3x leveraged fund with an expense ratio of 1%, that's because its expenses are $10 on the $1000 that you put in, not $30 on the $3000 that your investment nominally controls.

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