danielc wrote: ↑Mon Jan 20, 2020 9:10 pm
It's not luck. I am informing you that my plan is to look at my overall portfolio. The limitations of my 401k force me to slice and dice my portfolio in ways that I wouldn't otherwise. That's not me making buckets; that's the govt and my employer and my 401k provider forcing my hand. But I can still choose to put everything in the same spreadsheet and make decisions about the whole, to the best of my ability.
Having said that, if I do implement hedgefundie's adventure portfolio, I do plan to bucket it because I think that rebalancing between it and the rest of the portfolio is too risky.
That is a mistake. The theory we are applying here is that of Merton's portfolio model, which is a continuous time variant of MPT (MPT optimizes over only a single horizon). According to Mertons portfolio model the optimal portfolio over time is a constant (if we assume constant relative risk aversion). In practice this means that if you allocate 10% to of your portfolio to this adventure and you don't rebalance (it becomes 5%, or 20%), then your portfolio is a violation of Merton's portfolio model.
There can be a good reason to stray from Merton's portfolio model, but in general (99% of the time) I find that it indicates a portfolio construction error.
Now I see your point. Maybe it is better to replace leveraged ITT with unleveraged LTT. I recently discovered
EDV which has a
very long duration. Has a mean duration of 25 years
. Maybe I'll grab that. One advantage of your suggestion is a lower expense ratio, on top of the point you already made that borrowing costs money.
It is not a good idea to use EDV due to a bet-against-beta anomaly in bonds. The longer the duration goes, the less you get compensated for your risk. According to simba's bactesting spreadsheet, ITT7-index has a return of 1.87% per year (+ risk free) and standard deviation of 6.36%. EDV has a return of 3.23% (+ risk free rate) and standard deviation of 24.40%. That is twice the return for 4 times as much risk. According to the same spreadsheet 3x leveraged ITT has higher returns and lower risk than EDV.
I'm not a fan of the target duration approach. Not all durations are created equal. A portfolio with total bond market has a substantially higher sharpe ratio than a portfolio of t-bills and long-term bonds calibrated to the same duration exposure.
danielc wrote: ↑Mon Jan 20, 2020 4:42 pm
1) You and @Uncorrelated are both assuming that I am bucketing my portfolio. I never said that I was or that I plan to. I merely answered @Uncorrelated's question which is whether this is my entire portfolio. I said that it is not part of my portfolio at all, and that I'm thinking of making it maybe 10-20% of my portfolio. This does not mean that I was planning to "bucket" (I was not).
That is what I'd call bucketing your portfolio. But what we call it is not important, the point is that it is impossible to judge your portfolio because you only gave a part of it.
danielc wrote: ↑Mon Jan 20, 2020 4:30 pm
Uncorrelated wrote: ↑Mon Jan 20, 2020 3:25 pm
danielc wrote: ↑Mon Jan 20, 2020 1:16 pm
None of the bonds are long bonds. They are 7-10 year treasuries.
I'm aware of that. You currently have the equivalent exposure of 50% 20-year treasuries and 50% equities, but it would be better to pick 80% equities and 20% long-term treasuries because equities have higher return per unit of risk. (specifically, around 3 times as high).
Can you show me how you derived those numbers? I guess that you are trying to work out the portfolio exposure to equity risk vs term risk. I figure that the leveraged portfolio has roughly the same ratio of equity risk and term risk as the 50/50 equity/LTT portfolio you suggest, but long treasuries aren't exactly equivalent to 2x leveraged intermediate treasuries. The yield curve is not a straight line, and they don't have the same correlation with equities. So maybe it's best if you explain your reasoning instead of me trying to guess.
I used a custom mean-variance optimizer to draw these conclusions, it uses data since 1934 or 1955. This optimizer consistently allocates the majority of it's funds to equities instead of bonds (total bond market or TMF).
The problem with leveraged ITT instead of leveraged LTT is that is it less space efficient. If you use ITT to get the same duration exposure as with LTT you must take on more leveraged funds on the equities side to keep the appropriate ratio of equities and bonds. However, leverage on equities is significantly more expensive than on bonds. Although I have not implemented leveraged ITT in my optimizer I suspect that the optimal allocation would be 0% everywhere along the efficient frontier. I have implemented EDV and unleveraged long term bonds, but my optimizer never chooses those.
If we are talking about non-leveraged funds, total bond market is the best choice in the vast majority of cases.
Uncorrelated wrote: ↑Mon Jan 20, 2020 3:25 pm
It is completely pointless to construct a tangency portfolio unless you have free leverage. There is no convincing reason to optimize for maximum sharpe ratio unless you have free leverage.
Ok. What would be your recommended leveraged portfolio that keeps the 60/40 US/Intl equity exposure of Vanguard balanced funds ?
I don't recommend any particular exposure. A 60/40 ratio is optimal for individuals with high risk aversion, but if you don't have high risk aversion then the optimal ratio is different from 60/40. If you add in leverage or factor funds, the the optimal ratio changes again. If you have human capital left, that also affects the optimal ratio.
I'm sorry that I'm not able to give you a simple answer, once you stray off the beaten path there are no simple answers. At this point I don't even have enough information to say whether you should be considering leveraged funds at all.
Uncorrelated wrote: ↑Mon Jan 20, 2020 3:25 pm
danielc wrote:
Uncorrelated wrote: ↑Mon Jan 20, 2020 10:17 am
Is this your entire portfolio or just a part? It is not a good idea to buy leveraged funds if you are only using it as a part of your portfolio. If you have an emergency fund, you might want to eliminate that too.
Currently it is 0% of my portfolio, but I am currently thinking of putting maybe 10% of my portfolio in HEDGEFUNDIE's adventure portfolio (i.e. risky bet; might win big) and maybe 10-20% of my portfolio in something similar to what I showed here ---- a leveraged portfolio with lower volatility than then unleveraged portfolio that it replaces.
That's a really bad idea. Don't think of your portfolio in buckets, think of your portfolio as a whole. It is likely that your goals are better served by replacing some bonds of your existing portfolio with equities, usage of factor funds, reverse mortgage or replacing one part of your portfolio (say, US stocks) with leveraged equities and keeping the rest the same.
Up to this point I have always treated my entire portfolio as a whole. I don't do buckets, and I haven't made changes yet. Hedgefundie's adventure portfolio is a bit of a gamble and I definitely want to separate it from my main investment; so maybe that's a bucket, or maybe it's "play money".
But I am completely open to looking at everything else as a whole. Now, I don't have a house, and I don't have a lot of bonds that I can practically move to stocks. Most of my bonds are my emergency fund. Even if I had a lot of bonds, I am not sure that replacing bonds with stocks is better than leverage. Bonds (other than very short T-Bills) are themselves risky assets with a relatively low correlation with equities. An optimal portfolio should be the result of finding the right mix of stocks and bonds and then either add T-Bills or leverage to adjust the risk and return.
The optimal portfolio is not a fixed mix of stocks and bonds unless you have free leverage, which you do not have.
It might be useful to read
lifecycle investing (in particular, read the paper) to figure out whether you want any leverage at all. Afterwards we can look at which combinations of funds and/or leverage is most suited for your purpose. Due to the complexities involved most folks seem to get their leverage on the equity side with options.