WSJ: leveraged portfolios are good for you!

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CletusCaddy
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WSJ: leveraged portfolios are good for you!

Post by CletusCaddy »

The latest from Jason Zweig:

https://www.wsj.com/articles/return-sta ... lead_pos13
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this [Wisdomtree US Efficient Core: NTSX]. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.

“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,” Mr. Schwartz says.
The strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
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Re: WSJ: leveraged portfolios are good for you!

Post by MarkRoulo »

CletusCaddy wrote: Fri Oct 15, 2021 10:28 am The latest from Jason Zweig:

https://www.wsj.com/articles/return-sta ... lead_pos13
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this [Wisdomtree US Efficient Core: NTSX]. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.

“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,” Mr. Schwartz says.
The strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
And the WSJ will get to write some followup articles when we have another case of the leveraged funds losing value at the same time that the inverse leveraged funds lose value!
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Horton
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Re: WSJ: leveraged portfolios are good for you!

Post by Horton »

Two thoughts on NTSX:

1) NTSX is 90% stocks and 10% cash/futures. How much are you paying for that cash/futures position? Well, you can buy VTI for 3 basis points, so, if you do the math, you are paying 173 basis points for the cash/Treasury futures.

2) If you really wanted this type of portfolio, there’s a cheaper way: 90% VTI + 10% EDV. The 10% Treasury futures in NTSX is akin to 6x leverage on intermediate Treasuries. EDV is roughly 5x leverage on intermediate Treasuries due to the longer duration of STRIPS (25 years vs 5 years). Unless you are an investor who wants to target a specific part of the yield curve (e.g., a pension plan or life insurer), this approach should give you about the same result for 15 basis points less and no need to use the derivatives. (Under this approach you can also build the stock portion of the portfolio however you like - SCV, international, emerging markets, etc.)
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Re: WSJ: leveraged portfolios are good for you!

Post by garlandwhizzer »

Using leverage in portfolios typically becomes more popular in the later stages of a long bull market run when backtesting results shine. During severe bear markets and particularly when there are long running multi-year spells of underperformance associated with stagflation for example, the opposite happens. In periods like 1966 - 1982, "the death of equities" which was also the death of bonds especially long duration bonds is a case in point. Even risk embracing investors believe it is utter foolishness to leverage up the portfolio as both bonds and stocks continue to suffer long term. They are enthusiastic about the same strategy at times like now when we've had massive returns on both bonds and stocks for the last 17 years.

Whether a high leverage strategy is going to improve your risk adjusted returns depends less on backtesting data than on your ability to foresee the future in terms of inflation, Fed policy, macro-economic growth background, market valuations, global political, war, and environmental surprises, etc.. All strategies that aim to outperform a balanced portfolio carry the risk of underperformance including this one. Among outperformance strategies, however, I believe leverage of high quality assets like S&P 500 and Treasuries has a better expected risk/reward profile than most.

Personally non-leveraged market risk of my balanced but equity heavy portfolio offers a sufficient level of risk/reward tradeoff for my current taste. I have no problem with those non-risk averse individuals who choose to take on more risk in search of greater gains. I wish them good luck. It is important for them to be aware, however, that the the past 17 years of results is unlikely to replay going forward. The downside of leverage has been invisible for a long time until very recently. How well it will work in the future depends on a lot of inputs, none of which is accurately predictable up front, more so than impressive backtesting results.

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Re: WSJ: leveraged portfolios are good for you!

Post by tomsense76 »

Horton wrote: Fri Oct 15, 2021 12:27 pm Two thoughts on NTSX:

1) NTSX is 90% stocks and 10% cash/futures. How much are you paying for that cash/futures position? Well, you can buy VTI for 3 basis points, so, if you do the math, you are paying 173 basis points for the cash/Treasury futures.

2) If you really wanted this type of portfolio, there’s a cheaper way: 90% VTI + 10% EDV. The 10% Treasury futures in NTSX is akin to 6x leverage on intermediate Treasuries. EDV is roughly 5x leverage on intermediate Treasuries due to the longer duration of STRIPS (25 years vs 5 years). Unless you are an investor who wants to target a specific part of the yield curve (e.g., a pension plan or life insurer), this approach should give you about the same result for 15 basis points less and no need to use the derivatives. (Under this approach you can also build the stock portion of the portfolio however you like - SCV, international, emerging markets, etc.)
That probably would work ok.

Though it is worth noting that NTSX is using a range of different treasury futures as opposed to just one.

It's also worth noting the Sharpe Ratios of leveraged intermediate or short term treasuries tend to be higher than just holding unlevered long treasuries. They are also a bit more responsive to the yield curve.
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skierincolorado
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

Horton wrote: Fri Oct 15, 2021 12:27 pm Two thoughts on NTSX:

1) NTSX is 90% stocks and 10% cash/futures. How much are you paying for that cash/futures position? Well, you can buy VTI for 3 basis points, so, if you do the math, you are paying 173 basis points for the cash/Treasury futures.

2) If you really wanted this type of portfolio, there’s a cheaper way: 90% VTI + 10% EDV. The 10% Treasury futures in NTSX is akin to 6x leverage on intermediate Treasuries. EDV is roughly 5x leverage on intermediate Treasuries due to the longer duration of STRIPS (25 years vs 5 years). Unless you are an investor who wants to target a specific part of the yield curve (e.g., a pension plan or life insurer), this approach should give you about the same result for 15 basis points less and no need to use the derivatives. (Under this approach you can also build the stock portion of the portfolio however you like - SCV, international, emerging markets, etc.)
EDV has 5x the risk of ITT, but it is not even close to 5x the expected return.

For starters just look at interest rates. ITT are 1.1% while the 30y is barely over 2%. If you factor in roll yield, ITT have an expected return of over 2% also.

Holding 10% in EDV gets you .2% (.1*2%) expected CAGR on your whole portfolio. Holding 60% in ITT gets you .6% (.6*1%) expected CAGR. 1.2%(.6*2%) if including roll yield.

The negative correlation with stocks is the same or larger for ITT, so that's a wash.

Any backtest substiting 3-6x as much ITT(VFITX) for EDV will win in a landslide.
Last edited by skierincolorado on Fri Oct 15, 2021 1:44 pm, edited 5 times in total.
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Re: WSJ: leveraged portfolios are good for you!

Post by willthrill81 »

But haven't you heard? Vanguard knows that leveraged funds are so evil that they won't allow intelligent adults to own them in a Vanguard account.
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Re: WSJ: leveraged portfolios are good for you!

Post by tomsense76 »

For those here that are critical of this strategy, I think it is worth reading some of the threads here on HFEA, buying a leveraged balanced portfolio, HFEA with ITT futures, etc. This is really a different approach than say buying stocks on leverage. AIUI their goal is to lever up treasuries until they are about as risky as stocks. IOW they are making two largely uncorrelated bets with equal payoffs. One on stocks and one on treasuries. So their portfolio is in many ways less risky than say a 100% stock portfolio or even more stocks than that.

That all being said, do understand the level of skepticism here. Seeing a bunch of leveraged treasuries with very low bond yields/rates during a time when inflation has been ticking up does give me a bit of a queasy feeling. Just because two things have largely been uncorrelated through history doesn't mean there weren't moments were their correlation increased. Admittedly people have been saying rates must go up for the last decade and have thus far been wrong. It's unclear whether we are at a turning point (my crystal ball is very hazy).

There's also a tendency for a bunch of products to come out right at the moment when a strategy stops working. So this is in the back of my mind as well.

In any event, I wish those pursuing this strategy well. Just feel a bit uncomfortable doing anything like that myself atm for the reasons above.
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Re: WSJ: leveraged portfolios are good for you!

Post by willthrill81 »

tomsense76 wrote: Fri Oct 15, 2021 1:46 pm There's also a tendency for a bunch of products to come out right at the moment when a strategy stops working. So this is in the back of my mind as well.
Maybe, maybe not. Vanguard introduced their SCV fund (VISVX) in mid-1998, and it went on to smoke TSM over the next decade.
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

tomsense76 wrote: Fri Oct 15, 2021 1:46 pm For those here that are critical of this strategy, I think it is worth reading some of the threads here on HFEA, buying a leveraged balanced portfolio, HFEA with ITT futures, etc. This is really a different approach than say buying stocks on leverage. AIUI their goal is to lever up treasuries until they are about as risky as stocks. IOW they are making two largely uncorrelated bets with equal payoffs. One on stocks and one on treasuries. So their portfolio is in many ways less risky than say a 100% stock portfolio or even more stocks than that.

That all being said, do understand the level of skepticism here. Seeing a bunch of leveraged treasuries with very low bond yields/rates during a time when inflation has been ticking up does give me a bit of a queasy feeling. Just because two things have largely been uncorrelated through history doesn't mean there weren't moments were their correlation increased. Admittedly people have been saying rates must go up for the last decade and have thus far been wrong. It's unclear whether we are at a turning point (my crystal ball is very hazy).

There's also a tendency for a bunch of products to come out right at the moment when a strategy stops working. So this is in the back of my mind as well.

In any event, I wish those pursuing this strategy well. Just feel a bit uncomfortable doing anything like that myself atm for the reasons above.
One thing to keep in mind is that while ITT rates are low right now, so are borrowing costs. Those backtests to 1955, 1978, and 1991 I've posted all factor in borrowing costs and were borrowing huge amounts of money (over twice net worth) at 15%+ during the early 1980s. The spread between borrowing costs and current rates is near the historical norm right now.

Another thing to consider is backtests to the 1950s of leveraged ITT. From 1955-1982 100% SPY vs 100% SPY + 100% ITT was a slight net loss (9% CAGR vs 8.5% CAGR). So in a rising rate environment, ITT don't help and can hurt a little. But they didn't hurt a lot. Over a longer holding period of 40+ years they always helped. And the 1980s was a pretty extreme event for bonds.

Last pont I'd make is that the 1.1% YTM on ITT doesn't sound like much, but it's really much more about the steepness of the curve. The curve is pretty steep right now, which provides for substantial yield from rolling down the curve. The return from ITT, including roll yield, is over 2% currently. I don't expect to actually receive over 2%, because I expect that rates will rise, and that this will cut into the 2%+. But it's a lot better than rates rising when the curve is flat already. If the curve stayed the same, ITT would yield over 2%, so that's the starting point really. Now how much do you expect rates to rise? They would have to rise quickly and keep rising at an accelerating rate (ala 1963-1982) in order to reduce the return below zero.
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Re: WSJ: leveraged portfolios are good for you!

Post by tomsense76 »

willthrill81 wrote: Fri Oct 15, 2021 1:54 pm
tomsense76 wrote: Fri Oct 15, 2021 1:46 pm There's also a tendency for a bunch of products to come out right at the moment when a strategy stops working. So this is in the back of my mind as well.
Maybe, maybe not. Vanguard introduced their SCV fund (VISVX) in mid-1998, and it went on to smoke TSM over the next decade.
Yeah that's fair. It's a worry. It might wind up being unfounded.
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Re: WSJ: leveraged portfolios are good for you!

Post by tomsense76 »

skierincolorado wrote: Fri Oct 15, 2021 2:06 pm One thing to keep in mind is that while ITT rates are low right now, so are borrowing costs. Those backtests to 1955, 1978, and 1991 I've posted all factor in borrowing costs and were borrowing huge amounts of money (over twice net worth) at 15%+ during the early 1980s. The spread between borrowing costs and current rates is near the historical norm right now.

Another thing to consider is backtests to the 1950s of leveraged ITT. From 1955-1982 100% SPY vs 100% SPY + 100% ITT was a slight net loss (9% CAGR vs 8.5% CAGR). So in a rising rate environment, ITT don't help and can hurt a little. But they didn't hurt a lot. Over a longer holding period of 40+ years they always helped. And the 1980s was a pretty extreme event for bonds.

Last pont I'd make is that the 1.1% YTM on ITT doesn't sound like much, but it's really much more about the steepness of the curve. The curve is pretty steep right now, which provides for substantial yield from rolling down the curve. The return from ITT, including roll yield, is over 2% currently. I don't expect to actually receive over 2%, because I expect that rates will rise, and that this will cut into the 2%+. But it's a lot better than rates rising when the curve is flat already. If the curve stayed the same, ITT would yield over 2%, so that's the starting point really. Now how much do you expect rates to rise? They would have to rise quickly and keep rising at an accelerating rate (ala 1963-1982) in order to reduce the return below zero.
Yep, at least from what I've read it seems like you have done your homework here. It's totally possible that my worry about this is irrational. Thanks for sharing your analysis.
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Re: WSJ: leveraged portfolios are good for you!

Post by opus360 »

CletusCaddy wrote: Fri Oct 15, 2021 10:28 am The latest from Jason Zweig:

https://www.wsj.com/articles/return-sta ... lead_pos13
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this [Wisdomtree US Efficient Core: NTSX]. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.

“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,” Mr. Schwartz says.
The strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
I am surprised WSJ did not do an article on UPRO instead, 3x leverage on S&P500 index.
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Re: WSJ: leveraged portfolios are good for you!

Post by invest4 »

Different strokes for different folks. As long as people go in with their eyes wide open, make your bets and best of luck!
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

tomsense76 wrote: Fri Oct 15, 2021 2:40 pm
skierincolorado wrote: Fri Oct 15, 2021 2:06 pm One thing to keep in mind is that while ITT rates are low right now, so are borrowing costs. Those backtests to 1955, 1978, and 1991 I've posted all factor in borrowing costs and were borrowing huge amounts of money (over twice net worth) at 15%+ during the early 1980s. The spread between borrowing costs and current rates is near the historical norm right now.

Another thing to consider is backtests to the 1950s of leveraged ITT. From 1955-1982 100% SPY vs 100% SPY + 100% ITT was a slight net loss (9% CAGR vs 8.5% CAGR). So in a rising rate environment, ITT don't help and can hurt a little. But they didn't hurt a lot. Over a longer holding period of 40+ years they always helped. And the 1980s was a pretty extreme event for bonds.

Last pont I'd make is that the 1.1% YTM on ITT doesn't sound like much, but it's really much more about the steepness of the curve. The curve is pretty steep right now, which provides for substantial yield from rolling down the curve. The return from ITT, including roll yield, is over 2% currently. I don't expect to actually receive over 2%, because I expect that rates will rise, and that this will cut into the 2%+. But it's a lot better than rates rising when the curve is flat already. If the curve stayed the same, ITT would yield over 2%, so that's the starting point really. Now how much do you expect rates to rise? They would have to rise quickly and keep rising at an accelerating rate (ala 1963-1982) in order to reduce the return below zero.
Yep, at least from what I've read it seems like you have done your homework here. It's totally possible that my worry about this is irrational. Thanks for sharing your analysis.
I mean not totally irrational, 1955-1982 is a long time to not get any benefit! It's one of the reasons I hold less bonds than the sharpe ratio, especially a sharpe ratio based only on post 1980, would suggest. I hold a bit less than even the 1955-present sharpe ratio. I hold just enough to maximize the 10th percentile of 30 year returns.
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Re: WSJ: leveraged portfolios are good for you!

Post by jarjarM »

opus360 wrote: Fri Oct 15, 2021 2:57 pm
CletusCaddy wrote: Fri Oct 15, 2021 10:28 am The latest from Jason Zweig:

https://www.wsj.com/articles/return-sta ... lead_pos13
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this [Wisdomtree US Efficient Core: NTSX]. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.

“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,” Mr. Schwartz says.
The strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
I am surprised WSJ did not do an article on UPRO instead, 3x leverage on S&P500 index.
I rather they not, it seems to be a jump the shark moment if that happens.
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Re: WSJ: leveraged portfolios are good for you!

Post by nisiprius »

It's important to understand how NTSX is supposed to be used.

When it first began being discussed in the forum, it was presented by WisdomTree as a tool for implementing an "overlay strategy." The document explaining this on their website is blocked from retain investors so I can't consult it any more, but this is one of the illustrations that I captured when the document was still available to me.

Image

You were not supposed to think of NTSX as a way to get 1.5x the moolah by leveraging your whole portfolio 1.5x.

You were supposed to invest only ⅔ of your portfolio in it, and then use the rest to invest in an undisclosed "alpha strategy." Suggestions were "non-standard risk premia such as real estate or private equity." I got the impression that this had do with something proprietary that you could only learn about or invest in via an advisor. So the idea was "we'd like you to put ⅓ of your money into this 'alpha strategy,' and to help you afford to do that, we have this other thing you can put the other ⅔ of your money into. It will give you the same return from ⅔ of your portfolio you used to get from your whole portfolio, so it's like getting the 'alpha strategy' for free."

In any case, this is what's being described in the WSJ article, except instead of calling it an "overlay strategy" it's now being called "return stacking."

An essential thing to see is that this is not like using leverage to get higher return (i.e. not like HFEA). You leverage a 60/40 portfolio up but then you only use ⅔ as much. You are supposed to undo the leverage. Thus do not experience any more risk, nor do you get any return, than you would from a straight 60/40 portfolio.

What happens depends entirely on what you decide to plug into that other ⅓, that has been freed up by this maneuver.

Unfortunately, I suspect that a lot of investors are not using it that way, but are just going to believe it is an essentially risk-free way to up their returns by 50%.

Is WisdomTree sincere about "overlay strategies" and "return stacking?" Or is this just a fig leaf and, nudge nudge wink wink, they expect you to ignore all that and use it for 1.5X leverage? I wonder.
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Re: WSJ: leveraged portfolios are good for you!

Post by seajay »

garlandwhizzer wrote: Fri Oct 15, 2021 1:06 pm Using leverage in portfolios typically becomes more popular in the later stages of a long bull market run when backtesting results shine. During severe bear markets and particularly when there are long running multi-year spells of underperformance associated with stagflation for example, the opposite happens. In periods like 1966 - 1982, "the death of equities" which was also the death of bonds especially long duration bonds is a case in point. Even risk embracing investors believe it is utter foolishness to leverage up the portfolio as both bonds and stocks continue to suffer long term. They are enthusiastic about the same strategy at times like now when we've had massive returns on both bonds and stocks for the last 17 years.

Whether a high leverage strategy is going to improve your risk adjusted returns depends less on backtesting data than on your ability to foresee the future in terms of inflation, Fed policy, macro-economic growth background, market valuations, global political, war, and environmental surprises, etc.. All strategies that aim to outperform a balanced portfolio carry the risk of underperformance including this one. Among outperformance strategies, however, I believe leverage of high quality assets like S&P 500 and Treasuries has a better expected risk/reward profile than most.

Personally non-leveraged market risk of my balanced but equity heavy portfolio offers a sufficient level of risk/reward tradeoff for my current taste. I have no problem with those non-risk averse individuals who choose to take on more risk in search of greater gains. I wish them good luck. It is important for them to be aware, however, that the the past 17 years of results is unlikely to replay going forward. The downside of leverage has been invisible for a long time until very recently. How well it will work in the future depends on a lot of inputs, none of which is accurately predictable up front, more so than impressive backtesting results.

Garland Whizzer
But the article isn't suggesting to leverage the portfolio,
Imagine you have $3,000. You could stash it all in a balanced fund. Or you could achieve the same result by putting just two-thirds of it in a fund like this [Wisdomtree US Efficient Core: NTSX]. That’s because the fund leverages your money 1.5 to 1. So you can invest less and use the rest of it to buy other assets.

“You get the same exposure for less capital,” says Jeremy Schwartz, global head of research at WisdomTree Investments Inc. in New York, the Efficient Core fund’s sponsor. This way, you still have $1,000 left over, and “that cash option is valuable,”
In their example two thirds 1.5x, or equally you might 50% in 2x where the suggestion is that the remainder 'cash' element has option value.

Leveraging just tends to scale up volatility, broadly compounds to similar rewards. In some respects stocks are 1.5x leveraged as-is, via corporate bonds, hence 67/33 tends to broadly compare to 100% stock, or if stock exposure were held via 2x could be held using 33/67 2x stock/bonds

With 2x generally once/year rebalancing is sufficient to maintain reasonable tracking. With 3x you need to rebalancing every 6 months. With Zvi Bodie 10% in 10x (via Options) you need to rebalance monthly. For 2x once yearly rebalanced 33/67 2x/bonds assuming bonds to be safe then the maximum yearly loss is limited to 33%. And/or the 67% bonds element has optionality.
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Re: WSJ: leveraged portfolios are good for you!

Post by Horton »

skierincolorado wrote: Fri Oct 15, 2021 1:30 pm
Horton wrote: Fri Oct 15, 2021 12:27 pm Two thoughts on NTSX:

1) NTSX is 90% stocks and 10% cash/futures. How much are you paying for that cash/futures position? Well, you can buy VTI for 3 basis points, so, if you do the math, you are paying 173 basis points for the cash/Treasury futures.

2) If you really wanted this type of portfolio, there’s a cheaper way: 90% VTI + 10% EDV. The 10% Treasury futures in NTSX is akin to 6x leverage on intermediate Treasuries. EDV is roughly 5x leverage on intermediate Treasuries due to the longer duration of STRIPS (25 years vs 5 years). Unless you are an investor who wants to target a specific part of the yield curve (e.g., a pension plan or life insurer), this approach should give you about the same result for 15 basis points less and no need to use the derivatives. (Under this approach you can also build the stock portion of the portfolio however you like - SCV, international, emerging markets, etc.)
EDV has 5x the risk of ITT, but it is not even close to 5x the expected return.

For starters just look at interest rates. ITT are 1.1% while the 30y is barely over 2%. If you factor in roll yield, ITT have an expected return of over 2% also.

Holding 10% in EDV gets you .2% (.1*2%) expected CAGR on your whole portfolio. Holding 60% in ITT gets you .6% (.6*1%) expected CAGR. 1.2%(.6*2%) if including roll yield.

The negative correlation with stocks is the same or larger for ITT, so that's a wash.

Any backtest substiting 3-6x as much ITT(VFITX) for EDV will win in a landslide.
There are borrowing costs involved in futures, correct?

Here are a couple quick backtests that I ran. I’m interested in your input.

Backtest 1: portfolio 1 90% US stocks, 30 intermediate Treasuries, and -20% cash vs portfolio 2 90% US stocks and 10% long Treasuries. (I’m adjusting the intermediate Treasuries allocation because PV doesn’t have an option for STRIPS, so I have to use long Treasuries instead.) Results are basically the same for the last 10 years.

Backtest 2: actual performance of NTSX vs 90% VTI / 10% EDV since NTSX inception. NTSX has done slightly better. Why? Don’t know, could be a myriad of reasons - NTSX has more leverage (6x vs 5x), stock composition may be different, rebalancing frequency, changes in shape of yield curve, etc. Will NTSX always be better? I don’t have a clue based on this. My starting position is always to use the cheaper and easier approach (VTI + EDV, in this case) unless there is compelling evidence to support a more complicated approach.
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Re: WSJ: leveraged portfolios are good for you!

Post by BogleFan510 »

More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

Horton wrote: Fri Oct 15, 2021 4:04 pm
skierincolorado wrote: Fri Oct 15, 2021 1:30 pm
Horton wrote: Fri Oct 15, 2021 12:27 pm Two thoughts on NTSX:

1) NTSX is 90% stocks and 10% cash/futures. How much are you paying for that cash/futures position? Well, you can buy VTI for 3 basis points, so, if you do the math, you are paying 173 basis points for the cash/Treasury futures.

2) If you really wanted this type of portfolio, there’s a cheaper way: 90% VTI + 10% EDV. The 10% Treasury futures in NTSX is akin to 6x leverage on intermediate Treasuries. EDV is roughly 5x leverage on intermediate Treasuries due to the longer duration of STRIPS (25 years vs 5 years). Unless you are an investor who wants to target a specific part of the yield curve (e.g., a pension plan or life insurer), this approach should give you about the same result for 15 basis points less and no need to use the derivatives. (Under this approach you can also build the stock portion of the portfolio however you like - SCV, international, emerging markets, etc.)
EDV has 5x the risk of ITT, but it is not even close to 5x the expected return.

For starters just look at interest rates. ITT are 1.1% while the 30y is barely over 2%. If you factor in roll yield, ITT have an expected return of over 2% also.

Holding 10% in EDV gets you .2% (.1*2%) expected CAGR on your whole portfolio. Holding 60% in ITT gets you .6% (.6*1%) expected CAGR. 1.2%(.6*2%) if including roll yield.

The negative correlation with stocks is the same or larger for ITT, so that's a wash.

Any backtest substiting 3-6x as much ITT(VFITX) for EDV will win in a landslide.
There are borrowing costs involved in futures, correct?

Here are a couple quick backtests that I ran. I’m interested in your input.

Backtest 1: portfolio 1 90% US stocks, 30 intermediate Treasuries, and -20% cash vs portfolio 2 90% US stocks and 10% long Treasuries. (I’m adjusting the intermediate Treasuries allocation because PV doesn’t have an option for STRIPS, so I have to use long Treasuries instead.) Results are basically the same for the last 10 years.

Backtest 2: actual performance of NTSX vs 90% VTI / 10% EDV since NTSX inception. NTSX has done slightly better. Why? Don’t know, could be a myriad of reasons - NTSX has more leverage (6x vs 5x), stock composition may be different, rebalancing frequency, changes in shape of yield curve, etc. Will NTSX always be better? I don’t have a clue based on this. My starting position is always to use the cheaper and easier approach (VTI + EDV, in this case) unless there is compelling evidence to support a more complicated approach.
I took your first backtest and changed nothing, except I swapped VUSTX for VLGSX, VFITX for VSIGX and VFINX for VTSAX. These funds are all nearly identical, and allow us to test back to 1991. We can see the ITT one has lower max-drawdown, higher CAGR, and higher sharpe. I don't think we saw the ITT portfolio win in the shorter time period because VLGSX/VUSTX have much shorter duration than EDV. They're not as bad as EDV, and changes in the yield curve over shorter periods may dominate.

https://www.portfoliovisualizer.com/bac ... tion4_2=10

EDV has been around since 2010, so we can do VTI/EDV vs a simulated NTSX since 2010. The simulated NTSX wins on max-draw, CAGR, and sharpe. The difference in CAGR is substantially more than the difference in fees.
https://www.portfoliovisualizer.com/bac ... tion4_2=10


Your second backtest, the reason NTSX does better is fairly obvious to me. EDV is so bad that even over a short period we are seeing the relative outperformance of NTSX. We've swapped in ITT at a 6:1 ratio because the relative risk is 6:1. But the return of ITT is not 1/6th of EDV, it's more than 1/2. So we end up with more return.

I don't love the fees of NTSX, but it's very likely to outperform 90% VTI + 10% EDV over the long run. Further improvements could be had by using futures.

Yes futures incur a financing cost, but it is the same financing cost implicit in NTSX, and the financing cost is accounted for in the backtest since 1991. The ITT incur much more financing cost than VUSTX, and yet still win substantially.

There's a reason for the underperformance of EDV and VUSTX. Check out the "betting against beta" paper.
Last edited by skierincolorado on Fri Oct 15, 2021 4:42 pm, edited 6 times in total.
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Re: WSJ: leveraged portfolios are good for you!

Post by CletusCaddy »

BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
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Re: WSJ: leveraged portfolios are good for you!

Post by Horton »

skierincolorado wrote: Fri Oct 15, 2021 4:24 pm
I took your first backtest and changed nothing, except I swapped VUSTX for VLGSX, VFITX for VSIGX and VFINX for VTSAX. These funds are all nearly identical, and allow us to test back to 1991. We can see the ITT one has lower max-drawdown, higher CAGR, and higher sharpe. I don't think we saw the ITT portfolio win in the shorter time period because VLGSX/VUSTX have much shorter duration than EDV. They're not as bad as EDV, and changes in the yield curve over shorter periods may dominate.

https://www.portfoliovisualizer.com/bac ... tion4_2=10

EDV has been around since 2010, so we can do VTI/EDV vs a simulated NTSX since 2010. The simulated NTSX wins on max-draw, CAGR, and sharpe. The difference in CAGR is substantially more than the difference in fees.
https://www.portfoliovisualizer.com/bac ... tion4_2=10


Your second backtest, the reason NTSX does better is fairly obvious to me. EDV is so bad that even over a short period we are seeing the relative outperformance of NTSX. We've swapped in ITT at a 6:1 ratio because the relative risk is 6:1. But the return of ITT is not 1/6th of EDV, it's more than 1/2. So we end up with more return.

I don't love the fees of NTSX, but it's very likely to outperform 90% VTI + 10% EDV over the long run. Further improvements could be had by using futures.

Yes futures incur a financing cost, but it is the same financing cost implicit in NTSX, and the financing cost is accounted for in the backtest since 1991. The ITT incur much more financing cost than VUSTX, and yet still win substantially.

There's a reason for the underperformance of EDV and VUSTX. Check out the "betting against beta" paper.
Interesting, thanks. We model the financing costs in PV as short cash. Is that close to what the financing costs would actually be?
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

Horton wrote: Fri Oct 15, 2021 4:53 pm
skierincolorado wrote: Fri Oct 15, 2021 4:24 pm
I took your first backtest and changed nothing, except I swapped VUSTX for VLGSX, VFITX for VSIGX and VFINX for VTSAX. These funds are all nearly identical, and allow us to test back to 1991. We can see the ITT one has lower max-drawdown, higher CAGR, and higher sharpe. I don't think we saw the ITT portfolio win in the shorter time period because VLGSX/VUSTX have much shorter duration than EDV. They're not as bad as EDV, and changes in the yield curve over shorter periods may dominate.

https://www.portfoliovisualizer.com/bac ... tion4_2=10

EDV has been around since 2010, so we can do VTI/EDV vs a simulated NTSX since 2010. The simulated NTSX wins on max-draw, CAGR, and sharpe. The difference in CAGR is substantially more than the difference in fees.
https://www.portfoliovisualizer.com/bac ... tion4_2=10


Your second backtest, the reason NTSX does better is fairly obvious to me. EDV is so bad that even over a short period we are seeing the relative outperformance of NTSX. We've swapped in ITT at a 6:1 ratio because the relative risk is 6:1. But the return of ITT is not 1/6th of EDV, it's more than 1/2. So we end up with more return.

I don't love the fees of NTSX, but it's very likely to outperform 90% VTI + 10% EDV over the long run. Further improvements could be had by using futures.

Yes futures incur a financing cost, but it is the same financing cost implicit in NTSX, and the financing cost is accounted for in the backtest since 1991. The ITT incur much more financing cost than VUSTX, and yet still win substantially.

There's a reason for the underperformance of EDV and VUSTX. Check out the "betting against beta" paper.
Interesting, thanks. We model the financing costs in PV as short cash. Is that close to what the financing costs would actually be?
See figure 5 in link below. Implicit financing of Treasury futures have averaged around .1% over the 3-month T-bill. We could conservatively model this as 20% STT and 80% Cash. https://www.portfoliovisualizer.com/bac ... tion5_1=-4

https://www.financialresearch.gov/brief ... Trades.pdf
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Re: WSJ: leveraged portfolios are good for you!

Post by abc132 »

I highly recommend reading the real life examples section below:

https://www.finra.org/investors/alerts/ ... -investors
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Re: WSJ: leveraged portfolios are good for you!

Post by willthrill81 »

CletusCaddy wrote: Fri Oct 15, 2021 4:30 pm
BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
Many interpret 'bad journalism' to be 'anything that doesn't support my own views'. Hopefully that isn't the case here.
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Re: WSJ: leveraged portfolios are good for you!

Post by Beensabu »

willthrill81 wrote: Fri Oct 15, 2021 8:18 pm
CletusCaddy wrote: Fri Oct 15, 2021 4:30 pm
BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
Many interpret 'bad journalism' to be 'anything that doesn't support my own views'. Hopefully that isn't the case here.
Pretty clear. If it's selling you something, it's advertising, not journalism. He crossed over with "Bogle's monster love-child" at the beginning of the year. A job's a job.
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Re: WSJ: leveraged portfolios are good for you!

Post by nisiprius »

seajay wrote: Fri Oct 15, 2021 3:45 pm...But the article isn't suggesting to leverage the portfolio...
I noted that above myself.

But I worry about the possibility of the "return stacking" strategy being a fig leaf or cover story.

I'd like to know what percentage of the people who buy NTSX are using it as (seemingly) intended--investing only 2/3rds of the their portfolio in it and thereby undoing the leverage, and using the remaining third to go wild with non-traditional without having to displace stocks or bonds--and what percentage are just completely ignoring the theory and investing in NTSX in order to get 1.5x the return of a 60/40 portfolio.

Certainly the discussion upthread about using VTI and EDV is assuming an investor wants to hold a 90/60 portfolio. Not a ⅔(90/60) + ⅓ alts portfolio.

I imagine that WisdomTree doesn't know or care, as long as people buy the ETF.
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Re: WSJ: leveraged portfolios are good for you!

Post by redbarn »

Could you explain how you get an expected return of over 2% on ITT? I have always wanted to read about how to calculate an expected return that factors in the roll return. When I spent some time thinking about this, I tentatively concluded that the expected return on X-yr duration treasury fund factoring in roll return should be the yield on 2*X yr treasury. If true, that means a treasury fund with a 5 yr duration, which should have a current yield of 1.13%, should have an expected return equal to the 10 yr treasury yield, currently at 1.59%. While I am not too confident about this reasoning, I really don't see how the expected return for ITT can be over 2% when even the 30-yr is just over 2%.
skierincolorado wrote: Fri Oct 15, 2021 1:30 pm
EDV has 5x the risk of ITT, but it is not even close to 5x the expected return.

For starters just look at interest rates. ITT are 1.1% while the 30y is barely over 2%. If you factor in roll yield, ITT have an expected return of over 2% also.

Holding 10% in EDV gets you .2% (.1*2%) expected CAGR on your whole portfolio. Holding 60% in ITT gets you .6% (.6*1%) expected CAGR. 1.2%(.6*2%) if including roll yield.

The negative correlation with stocks is the same or larger for ITT, so that's a wash.

Any backtest substiting 3-6x as much ITT(VFITX) for EDV will win in a landslide.
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Re: WSJ: leveraged portfolios are good for you!

Post by 000 »

garlandwhizzer wrote: Fri Oct 15, 2021 1:06 pm Using leverage in portfolios typically becomes more popular in the later stages of a long bull market run when backtesting results shine. During severe bear markets and particularly when there are long running multi-year spells of underperformance associated with stagflation for example, the opposite happens. In periods like 1966 - 1982, "the death of equities" which was also the death of bonds especially long duration bonds is a case in point. Even risk embracing investors believe it is utter foolishness to leverage up the portfolio as both bonds and stocks continue to suffer long term. They are enthusiastic about the same strategy at times like now when we've had massive returns on both bonds and stocks for the last 17 years.
My thoughts exactly.

Seeing risk parity / leveraged stock+bond portfolios wrapped up in ETFs and promoted in the WSJ should be a blaring red warning light.

In time this article may be remembered as yet another exhibit in the upcoming trial of the bulls.
Capitulation of bears is part of the market topping process.
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Re: WSJ: leveraged portfolios are good for you!

Post by Robert T »

.
Just to note the idea in the article (behind NTSX) is not new. Here’s a 1996 article by Asness showing relative back-tested performance from 1927-1993 of a levered 60/40 portfolio. https://www.aqr.com/Insights/Research/J ... --Equities

I am more sympathetic to leverage than some. After all, I implicitly used leverage by holding a mortgage and investment portfolio at the same time, and a small cap value tilted portfolio is a form of ‘return stacking’ (term used in the OP linked article).

However, the level and form of leverage can vastly change the likely dispersion of returns.

For example – the implicit 1.5x leverage of 60:40 S&P500/US treasuries portfolio (similar to NTSX), had relatively good back-tested performance in the 1973-1981 period of high inflation/low growth. The opposite is true with 3x leverage of the individual components as reflected by the performance of 40:60 S&P500 3x: Long-term treasuries x3 [Hedgefundie portfolio]

1973-1981 annualized returns (%) / 1973-74 downside (%)
+8.2 / +15.5 = T-bills
+5.9 / +10.6 = 5-year T-notes
+5.1 / -37.3 = S&P500
+5.9 / -19.6 = 60:40 S&P500 / 5-year T-notes
+8.3 / -28.8 = 60:40 S&P500 / 5-year T-notes (1.5 leverage)
+8.9 / -27.9 = 90% S&P500 / 40% 5-year T-notes / 10% cash (similar to NFTX)

Now compare this to leveraging each component 3 times (and using long-term treasuries)

-9.0 / -54% = 40:60 S&P500 3x:Long-term treasuries 3x [yes that's a minus sign]
viewtopic.php?p=4906671#p4906671

Personally, over time my use of implicit leverage has declined (as mortgage is paid off), although still have the same small cap and value tilt (that some call a form of leverage).

Obviously no guarantees.

Robert
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Re: WSJ: leveraged portfolios are good for you!

Post by namajones »

garlandwhizzer wrote: Fri Oct 15, 2021 1:06 pm Using leverage in portfolios typically becomes more popular in the later stages of a long bull market run when backtesting results shine.
+1. Agree.

Note to OP: Leverage is always a bad idea. Very bad idea.

You don't believe it? You will pay some expensive tuition, courtesy of Mr. Market.

You've been warned.
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Re: WSJ: leveraged portfolios are good for you!

Post by namajones »

willthrill81 wrote: Fri Oct 15, 2021 1:34 pm But haven't you heard? Vanguard knows that leveraged funds are so evil that they won't allow intelligent adults to own them in a Vanguard account.
A very good sign. Ignore it at your own peril.
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Re: WSJ: leveraged portfolios are good for you!

Post by nisiprius »

1) People who use leverage always insist that it is perfectly safe "if you know what you are doing," and love to assert that they are actually reducing risk by using it.

2) The longer a bull market continues, the safer and more predictable assets look. Leverage works by exploiting advantages that can be gained by successfully predicting how assets behave. The more predictable things look, the more attractive leverage looks. And, of course, the cheaper it is to borrow money, the more attractive leverage looks.

3) Nicholas Nassim Taleb testified
Leverage is a direct result of underestimation of the risks of extreme events--and the illusion that these risks are measurable.
I can't find the exact quote, but he has said that academics and economists always favor leverage because if you believe your models are correct, they lead to improvements in efficiency-and they don't perceive the increase in fragility.

4) Charles P. Kindleberger wrote:
Speculative manias gather speed through an expansion of money and credit or perhaps, in some cases, get started because of an initial expansion of money and credit.
All leverage does not in itself cause manias, panics, and crashes, but manias, panics, and crashes are always associated with expansion of leverage. Kindleberger notes that it's hard for a government to control this because
The problem is that “money” is an elusive construct, difficult to pin down and to fix in some desired quantity for the economy... My contention is that the process is endless: fix any M1 and the market will create new forms of money in periods of boom to get around the limit...
(Quotes lifted from a web search that turned up this article.)

5) I'm not going to pile on NTSX except as one of many indicators of a trend. The 50% leverage in NTSX, when used incorrectly simply as a way to make more money, isn't very extreme and probably isn't going to ruin anybody. Measured by standard deviation, the ARK Innovation fund has been twice as risky as NTSX. Triple leveraged is a lot riskier than 50% leveraged. Leveraged 100% stocks is risker than leveraged 60/40.

I think the proposed UPAR ("RPAR Ultra Risk Parity ETF") ETF is scarier, because it takes a financial engineering "risk parity" confection that already uses leverage and applies 160% leverage on top of that. I'm not sure if this is literally "leveraged leverage" but it sounds like it.

6) It's just a symptom. More indicative than either, in terms of the spirit of the age, is the attempt by Direxion to launch a leveraged bitcoin ETF in 2018. And more indicative than that is the 2010 suggestion by two professors that leveraged mutual funds ought to be offered in 401(k) plans.

7) Indeed, one of the things that has bothered me all along about leveraged ETFS is it was leverage that gave investment companies a bad reputation in the 1930s, and strict limitation of leverage was supposed to be one of the protections of the Investment Company Act of 1940. It is supposed to be limited to 33.3%. But where there is a will to avoid regulation, there is a way. The act only restricts mutual funds and ETFs from literally borrowing money. Achieving something similar through the use of derivatives has allowed to mutual funds and ETFs to circumvent the restriction.
Last edited by nisiprius on Sat Oct 16, 2021 7:22 am, edited 5 times in total.
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Re: WSJ: leveraged portfolios are good for you!

Post by Forester »

How sure can we be of how a levered 60/40 would have actually performed in the 1970s? I'd be wary of that. And with the remaining third of the portfolio, if an investor buys short term corporates or some Frankenstein commodity fund; they're likely going to be spinning wheels versus the simpler portfolio.
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Re: WSJ: leveraged portfolios are good for you!

Post by nisiprius »

CletusCaddy wrote: Fri Oct 15, 2021 10:28 amThe strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
Double-take. No, these strategies are not HFEA and are not "along the same spectrum." The only commonality is the use of a leveraged ETF. But this is not the WSJ giving the seal of approval to leveraged ETFs. This is the WSJ giving the seal of approval to a specific strategy. The use of leverage in this strategy doesn't increase risk, not because of predicted relationships between assets in the future, but simply because of brute force dilution. NTSX is riskier but you use less of it.

The strategy described in the article is, conceptually:

a) Start with 60/40 as an entire portfolio. All stocks and bonds, all traditional securities. Conceptually, imagine that your entire portfolio is an investment in the Vanguard Balanced Index Fund.

b) You wish you could put ⅓ of your portfolio into some spiffy alternative--like "real estate" or "private equity" in their blurb. But you don't want to do it by displacing stocks and and you don't want to do it by displacing bonds.

c) So you compress that Balanced Index fund so that it only takes up ⅔ of your portfolio by leveraging it up 50% Notice that there is an exact balance: you are leveraging it up 50% but you are only using ⅔ as much of it and ⅔ of 150% = 100%. In theory, if you devoted the other ⅓ of your portfolio to cash and in theory if you could borrow interest-free, you have done nothing at all. A portfolio of ⅔ (150% Balanced Index) + ⅓ cash exactly the same as 100% Balanced Index. In real life all you've done is to introduce friction and enrich whomever you've borrowing the money from.

But now, instead of using that freed-up third of the portfolio for cash, you can use it for your advisor's favorite alternative. And because your original Balanced Index holding has been concentrated rather than reduced, it is still going to make the same amount of money for you, so your alternative no longer needs to be very profitable. If it's uncorrelated with stocks and bonds it will be able to reduce portfolio risk without dragging down portfolio return. And if it does makes a profit, you make more money that you would have with all Balanced Index. Sheer financial magic!

See the diagram in my posting above.

Without knowing what specific things advisors using "return stacking" are suggesting for that "alpha strategy," it's hard to say but I would guess that in most cases the whole portfolio will have about the same risk as the original straight 60/40. NTSX won't increase the risk because it's only ⅔ of the portfolio. So it boils down to how much risk the "alpha strategy" turns out to have, going forward, and how correlated it turns out to be with NTSX.

That's the proposition, and it is not at all like either HFEA or PSLDX, which have an explicit goal of using leverage to Make More :moneybag :dollar :greedy

My skepticism of the strategy presented in the WSJ article is not that "leverage is risky." It is a) skepticism that NTSX truly will always be--under all conditions--virtually identical to 150% leverage at zero cost, b) skepticism that the stuff your advisor is suggesting you put into the third of your portfolio that's been freed up is really all that great, and c) general distrust of financial complexity.
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Re: WSJ: leveraged portfolios are good for you!

Post by Random Walker »

My understanding of leverage is that the expected return (simple average) goes up proportionate to the leverage factor, but the variance drain increases disproportionately because it is a function of SD^2. So the increased “expected return” should really not be as big as people think. The drag caused by volatility is especially high for super equity heavy investments.

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Re: WSJ: leveraged portfolios are good for you!

Post by Horton »

nisiprius wrote: Sat Oct 16, 2021 7:42 am Without knowing what specific things advisors using "return stacking" are suggesting for that "alpha strategy," it's hard to say but I would guess that in most cases the whole portfolio will have about the same risk as the original straight 60/40. NTSX won't increase the risk because it's only ⅔ of the portfolio. So it boils down to how much risk the "alpha strategy" turns out to have, going forward, and how correlated it turns out to be with NTSX.

That's the proposition, and it is not at all like either HFEA or PSLDX, which have an explicit goal of using leverage to Make More :moneybag :dollar :greedy

My skepticism of the strategy presented in the WSJ article is not that "leverage is risky." It is a) skepticism that NTSX truly will always be--under all conditions--virtually identical to 150% leverage at zero cost, b) skepticism that the stuff your advisor is suggesting you put into the third of your portfolio that's been freed up is really all that great, and c) general distrust of financial complexity.
See the links below for an idea of what products you might expect:

https://www.rcmalternatives.com/2021/09 ... -stacking/
https://investresolve.com/return-stacki ... onment-lp/

It probably comes as no surprise that those promoting the strategy are also the ones offering products in this sphere. Marketing at its finest. :beer
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Re: WSJ: leveraged portfolios are good for you!

Post by nisiprius »

Horton wrote: Sat Oct 16, 2021 9:13 am See the links below for an idea of what products you might expect:

https://www.rcmalternatives.com/2021/09 ... -stacking/
https://investresolve.com/return-stacki ... onment-lp/

It probably comes as no surprise that those promoting the strategy are also the ones offering products in this sphere. Marketing at its finest. :beer
Well, at least now I know where the phrase "return stacking" came from. I think this is exactly the same thing as WisdomTree was calling an "overlay strategy."
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Re: WSJ: leveraged portfolios are good for you!

Post by zkn »

Random Walker wrote: Sat Oct 16, 2021 8:46 am My understanding of leverage is that the expected return (simple average) goes up proportionate to the leverage factor, but the variance drain increases disproportionately because it is a function of SD^2. So the increased “expected return” should really not be as big as people think. The drag caused by volatility is especially high for super equity heavy investments.

Dave
I think this is right. We often use the geometric return or compounded annual growth rate (CAGR) to better describe an investor's experience than the arithmetic mean. The CAGR can be approximated as CAGR ~= M - 0.5 * SD^2, where M is the arithmetic mean and SD is the standard deviation. I guess the second term corresponds to what you mean by "variance drain". So even if we had free leverage so we could multiply our M and SD by our leverage factor, the second term will grow faster than the first and the CAGR will increase by a factor less than our leverage factor. At some point our CAGR should decrease with increasing leverage.
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Re: WSJ: leveraged portfolios are good for you!

Post by JackoC »

redbarn wrote: Fri Oct 15, 2021 11:40 pm Could you explain how you get an expected return of over 2% on ITT? I have always wanted to read about how to calculate an expected return that factors in the roll return. When I spent some time thinking about this, I tentatively concluded that the expected return on X-yr duration treasury fund factoring in roll return should be the yield on 2*X yr treasury. If true, that means a treasury fund with a 5 yr duration, which should have a current yield of 1.13%, should have an expected return equal to the 10 yr treasury yield, currently at 1.59%. While I am not too confident about this reasoning, I really don't see how the expected return for ITT can be over 2% when even the 30-yr is just over 2%.
'Roll return' is a function of the term premium*, not the slope of the yield curve. You can calculate a 'roll return' assuming the 'yield curve does not move' (ie. in a year from now the 2yr, 5yr, 10yr rates will be same as now's) but that's making an arbitrary assumption about the term premium depending how steep today's curve is. But the NY Fed's ACM model estimates the term premium, which is not directly visible, as now about zero out to 10 yrs. Other models which not agreeing exactly tend to show a similar trend to lower term premium. And if the expected term premium is zero, the best estimate of the expected return of an intermediate treasury fund is the yield, so 1.1% if that's the yield on ITT. This is another of the many potential pitfalls of 'backtesting' to determine future strategies. The realized term premium *was* positive. But if there's other evidence the expected term premium is basically zero... Some people will even 'backtest' to estimate the raw expected return of bonds in the future. Most of us can see that's ridiculous, ie. if bonds returned a certain amount as yields fell from high levels they obviously won't replicate that if yields stay at their much lower level now. It's not as obvious when one is making the same mistake by assuming that the past realized values of secondary variables like the term premium (or realized vols or correlations) is the best estimate of their future expected value. There might be specific evidence that it isn't.
https://www.newyorkfed.org/research/dat ... remia.html

On back and forth about Wisdom Tree Core Efficient, NTSX, (if it were your portfolio) being leveraged, yes it is. Leverage doesn't mean a stock allocation >100%, it simply means you borrow (explicitly or implicitly via futures, etc) to buy assets. This fund does that, it's leveraged. By convention 'leverage' doesn't generally include the leverage public stock companies take on on your behalf with *their* borrowing. However a statement like "leverage is always a bad idea. Very bad idea" isn't sensible in the broadest terms which would have to recognize that stocks are an ownership stake in (generally) *leveraged* corporate assets, as well as the simpler example of a mortgage on a house or rental property. Never having any leverage in the narrower sense of NTSX's is a fail safe: you won't blow yourself up because you didn't add to the leverage contained in your stocks or as a result of your mortgage. However the statement 'all leverage is a very bad idea', is contradicted by almost everyone's holdings. Whether NTSX is a good idea is more subtle than a simplistic statement like that. FWIW I'm not enthusiastic about 'risk parity' and it's mainly because I don't like the outlook *now* for correlation in particular and term premium as a secondary thing. Color graphs of past results will not convince me I'm wrong. :happy However I recognize that that's an opinion. In first paragraph though I do point out a sloppy assumption, that the term premium which would result in 'yield curve stays the same' and a 'roll return' calculated on that assumption, is anything other than wholly arbitrary.

*the term premium in X years can be defined as the difference in expected return between locking in the rate at time 0 to X years vs investing in a series of short term instruments (doesn't really matter how short, assume 3 months if you need a fixed mental picture of it) rolling one to the next for X years. A positive term premium is where locking in the rate to X yrs gives higher expected return, a negative term premium is where rolling over the short investment gives a higher expected return. At zero term premium there's no 'roll return'.
seajay
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Re: WSJ: leveraged portfolios are good for you!

Post by seajay »

nisiprius wrote: Fri Oct 15, 2021 9:06 pm
seajay wrote: Fri Oct 15, 2021 3:45 pm...But the article isn't suggesting to leverage the portfolio...
I noted that above myself.

I'd like to know what percentage of the people who buy NTSX are using it as (seemingly) intended--investing only 2/3rds of the their portfolio in it and thereby undoing the leverage, and using the remaining third to go wild with non-traditional without having to displace stocks or bonds--and what percentage are just completely ignoring the theory and investing in NTSX in order to get 1.5x the return of a 60/40 portfolio.
Broadly (full cycles) and 2x LETF will tend to yield similar reward to 1x, generally only the volatility is scaled. I suspect the likes of HFEA are having their zig day (period) that sooner or later will zag and see its popularity fade. Equally however half in 2x, half in bonds to near mirror 100% 1x seems to indicate that to beat the index you just have to beat LIBOR. However in practice that is easier said than done. For instance I've backtested such using Investment Trusts/absolute return funds that target beating LIBOR as a partner to LETF's and broadly again the rewards still come out at much around the same on a risk adjusted basis. Broadly both are pointless and it distils down to LETF's being more appropriate for rotational/momentum type plays - but there again that can just wash.

I do hold LETF's (have been buying/holding such for over 5 years now), but more for a case of tax efficiencies purposes. Leveraged Total Return Swaps are a means to reduce taxation compared to if dividends were being received/paid. I do also apply elements of rotational/dynamics such as using a Dow/Gold ratio stochastic (*A) along with modest potential scaling (1.2x maximum). I know you hate gold (along with many others that pipe in to say they dislike/hold-no gold despite the OP specifically asking to refrain from such comments) but personally I prefer it to bonds

*A : Along the lines of 1 lower, 50 upper with yearly reviews using a stochastic of current (Dow/Gold ratio) - lower / upper - lower ... so for instance back in the early 1980's when Dow/Gold was near 1.0 very little gold would have been held for that year, whilst in the late 1990's when the Dow/Gold was up at 40 levels relatively high levels of gold would have been held.
L2F
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Re: WSJ: leveraged portfolios are good for you!

Post by L2F »

nisiprius wrote: Sat Oct 16, 2021 7:42 am Double-take. No, these strategies are not HFEA and are not "along the same spectrum." The only commonality is the use of a leveraged ETF. But this is not the WSJ giving the seal of approval to leveraged ETFs. This is the WSJ giving the seal of approval to a specific strategy. The use of leverage in this strategy doesn't increase risk, not because of predicted relationships between assets in the future, but simply because of brute force dilution. NTSX is riskier but you use less of it.

The strategy described in the article is, conceptually:

a) Start with 60/40 as an entire portfolio. All stocks and bonds, all traditional securities. Conceptually, imagine that your entire portfolio is an investment in the Vanguard Balanced Index Fund.

b) You wish you could put ⅓ of your portfolio into some spiffy alternative--like "real estate" or "private equity" in their blurb. But you don't want to do it by displacing stocks and and you don't want to do it by displacing bonds.

c) So you compress that Balanced Index fund so that it only takes up ⅔ of your portfolio by leveraging it up 50% Notice that there is an exact balance: you are leveraging it up 50% but you are only using ⅔ as much of it and ⅔ of 150% = 100%. In theory, if you devoted the other ⅓ of your portfolio to cash and in theory if you could borrow interest-free, you have done nothing at all. A portfolio of ⅔ (150% Balanced Index) + ⅓ cash exactly the same as 100% Balanced Index. In real life all you've done is to introduce friction and enrich whomever you've borrowing the money from.

But now, instead of using that freed-up third of the portfolio for cash, you can use it for your advisor's favorite alternative. And because your original Balanced Index holding has been concentrated rather than reduced, it is still going to make the same amount of money for you, so your alternative no longer needs to be very profitable. If it's uncorrelated with stocks and bonds it will be able to reduce portfolio risk without dragging down portfolio return. And if it does makes a profit, you make more money that you would have with all Balanced Index. Sheer financial magic!

See the diagram in my posting above.

Without knowing what specific things advisors using "return stacking" are suggesting for that "alpha strategy," it's hard to say but I would guess that in most cases the whole portfolio will have about the same risk as the original straight 60/40. NTSX won't increase the risk because it's only ⅔ of the portfolio. So it boils down to how much risk the "alpha strategy" turns out to have, going forward, and how correlated it turns out to be with NTSX.

That's the proposition, and it is not at all like either HFEA or PSLDX, which have an explicit goal of using leverage to Make More :moneybag :dollar :greedy

My skepticism of the strategy presented in the WSJ article is not that "leverage is risky." It is a) skepticism that NTSX truly will always be--under all conditions--virtually identical to 150% leverage at zero cost, b) skepticism that the stuff your advisor is suggesting you put into the third of your portfolio that's been freed up is really all that great, and c) general distrust of financial complexity.
That's basically buying this "alpha strategy" on margin using 60/40 portfolio as collateral.
How you can be so sure it doesn't increase risk?
Last edited by L2F on Sat Oct 16, 2021 2:56 pm, edited 1 time in total.
Random Walker
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Re: WSJ: leveraged portfolios are good for you!

Post by Random Walker »

zkn wrote: Sat Oct 16, 2021 9:45 am
Random Walker wrote: Sat Oct 16, 2021 8:46 am My understanding of leverage is that the expected return (simple average) goes up proportionate to the leverage factor, but the variance drain increases disproportionately because it is a function of SD^2. So the increased “expected return” should really not be as big as people think. The drag caused by volatility is especially high for super equity heavy investments.

Dave
I think this is right. We often use the geometric return or compounded annual growth rate (CAGR) to better describe an investor's experience than the arithmetic mean. The CAGR can be approximated as CAGR ~= M - 0.5 * SD^2, where M is the arithmetic mean and SD is the standard deviation. I guess the second term corresponds to what you mean by "variance drain". So even if we had free leverage so we could multiply our M and SD by our leverage factor, the second term will grow faster than the first and the CAGR will increase by a factor less than our leverage factor. At some point our CAGR should decrease with increasing leverage.
And abc132 emphasized this point in his post above:
I highly recommend reading the real life examples section below:

https://www.finra.org/investors/alerts/ ... -investors

Dave
sc9182
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Re: WSJ: leveraged portfolios are good for you!

Post by sc9182 »

For our portfolio filled with ultra-low index ETFs ; there is one leak however: expense ratios of 0.93% leverage ETFs by ProShares.

Since 2009 - we may have directly and/or indirectly paid nearly $20k annually towards ProShares ETF expense ratios. If one thing certain - the fund management made bucket loads of “guaranteed monies” from us. Then again, not complaining - we made monies with bigger shovel (multiple 10x 20x baggers of ProShares long leveraged ETFs in portfolios). We do: cautiously and strictly monitor/maintain asset allocation and leverage ratio.

During C‘VID drawdown - some recent lots allowed tax loss harvesting opportunities; then, by late March, we was back into ProShares long ETFs.

Over the past decade+ , markets been kind/great, including to long leverage funds/ETFs.
Last edited by sc9182 on Sat Oct 16, 2021 12:59 pm, edited 2 times in total.
BogleFan510
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Re: WSJ: leveraged portfolios are good for you!

Post by BogleFan510 »

CletusCaddy wrote: Fri Oct 15, 2021 4:30 pm
BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
One only has to read the first two sentences. Classic fearmongering. Market close to all time highs (scary). Except that it always is, normally as it grows constantly.

Nowhere to run, no where to hide...as if something is different this time and the past methods no longer work. Absolute BS.

A false strawman followed by a pitch for a complex financial product. Right out of the classic whole life insurance or managed portfolio sales pitches.

Because of these false worry signals, invest in something that drains 1% in fees, in a market where 1% is pretty close to the risk adjusted safe return of capital. Of course for a few basis points one can buy into the most efficient, diversified investment vehicles ever invented. But thats old news and boring.
Stay the course, ignore the Financial Press noise. But I will say, this is my opinion and that people are free to disagree with it.

But if you want to go leveraged, your nickle. How would this strategy do in 1990 Japan or in a 2009 scenario, without the internet/tech/biotech and IT productivity gains juicing the market back? I am happy those that went this route were not burned, but the US market has been on a 20 year bull run, with a few blips. Lots of gains to hide higher fees draining money. A flat or down market will make this a scary bet.
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Re: WSJ: leveraged portfolios are good for you!

Post by mikejuss »

The drift of this article, and of the news that Vanguard is adding a private-equity position to their target-date funds, is to normalize riskier and riskier behavior in search of added yield for those who, frankly, have not saved adequately for their retirement. It's all pretty depressing. I can only hope that by saving and living below my means today I won't have to go searching for leveraged bets to afford my retirement tomorrow.
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Re: WSJ: leveraged portfolios are good for you!

Post by willthrill81 »

BogleFan510 wrote: Sat Oct 16, 2021 12:00 pm
CletusCaddy wrote: Fri Oct 15, 2021 4:30 pm
BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
One only has to read the first two sentences. Classic fearmongering. Market close to all time highs (scary). Except that it always is, normally as it grows constantly.

Nowhere to run, no where to hide...as if something is different this time and the past methods no longer work. Absolute BS.
I definitely get your point and agree that the tactics and perhaps the motivations of the author are highly questionable.

But at the same time, we haven't been in a position where valuations (as measured by metrics like CAPE) have been this high combined with interest rates being this low. We truly are in uncharted waters. And considering that valuations have generally portended low stock returns, and starting bond yields have been very indicative of future returns, the mid-term future might not turn out so great for many investors.

OTOH, we're always in uncharted waters by some metric. As Heraclitus said, "You cannot step in the river in the same place twice."

No guarantees, and YMMV.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

nisiprius wrote: Sat Oct 16, 2021 7:42 am
CletusCaddy wrote: Fri Oct 15, 2021 10:28 amThe strategies he mentions should be no surprise to Bogleheads: NTSX, PSLDX. Not quite HFEA but along the same spectrum.

Pleasantly surprised these strategies are getting attention and the seal of approval from a national newspaper.
Double-take. No, these strategies are not HFEA and are not "along the same spectrum." The only commonality is the use of a leveraged ETF. But this is not the WSJ giving the seal of approval to leveraged ETFs. This is the WSJ giving the seal of approval to a specific strategy. The use of leverage in this strategy doesn't increase risk, not because of predicted relationships between assets in the future, but simply because of brute force dilution. NTSX is riskier but you use less of it.

The strategy described in the article is, conceptually:

a) Start with 60/40 as an entire portfolio. All stocks and bonds, all traditional securities. Conceptually, imagine that your entire portfolio is an investment in the Vanguard Balanced Index Fund.

b) You wish you could put ⅓ of your portfolio into some spiffy alternative--like "real estate" or "private equity" in their blurb. But you don't want to do it by displacing stocks and and you don't want to do it by displacing bonds.

c) So you compress that Balanced Index fund so that it only takes up ⅔ of your portfolio by leveraging it up 50% Notice that there is an exact balance: you are leveraging it up 50% but you are only using ⅔ as much of it and ⅔ of 150% = 100%. In theory, if you devoted the other ⅓ of your portfolio to cash and in theory if you could borrow interest-free, you have done nothing at all. A portfolio of ⅔ (150% Balanced Index) + ⅓ cash exactly the same as 100% Balanced Index. In real life all you've done is to introduce friction and enrich whomever you've borrowing the money from.

But now, instead of using that freed-up third of the portfolio for cash, you can use it for your advisor's favorite alternative. And because your original Balanced Index holding has been concentrated rather than reduced, it is still going to make the same amount of money for you, so your alternative no longer needs to be very profitable. If it's uncorrelated with stocks and bonds it will be able to reduce portfolio risk without dragging down portfolio return. And if it does makes a profit, you make more money that you would have with all Balanced Index. Sheer financial magic!

See the diagram in my posting above.

Without knowing what specific things advisors using "return stacking" are suggesting for that "alpha strategy," it's hard to say but I would guess that in most cases the whole portfolio will have about the same risk as the original straight 60/40. NTSX won't increase the risk because it's only ⅔ of the portfolio. So it boils down to how much risk the "alpha strategy" turns out to have, going forward, and how correlated it turns out to be with NTSX.

That's the proposition, and it is not at all like either HFEA or PSLDX, which have an explicit goal of using leverage to Make More :moneybag :dollar :greedy

My skepticism of the strategy presented in the WSJ article is not that "leverage is risky." It is a) skepticism that NTSX truly will always be--under all conditions--virtually identical to 150% leverage at zero cost, b) skepticism that the stuff your advisor is suggesting you put into the third of your portfolio that's been freed up is really all that great, and c) general distrust of financial complexity.
Unless the other 1/3 is in cash, it's a leveraged strategy.
skierincolorado
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Re: WSJ: leveraged portfolios are good for you!

Post by skierincolorado »

BogleFan510 wrote: Sat Oct 16, 2021 12:00 pm
CletusCaddy wrote: Fri Oct 15, 2021 4:30 pm
BogleFan510 wrote: Fri Oct 15, 2021 4:22 pm More bad journalism from the WSJ, likely born from advertiser conflicts of interest. Ignore the financial media noise and stay the course.
What exactly in the article do you find to be “bad journalism”?
One only has to read the first two sentences. Classic fearmongering. Market close to all time highs (scary). Except that it always is, normally as it grows constantly.

Nowhere to run, no where to hide...as if something is different this time and the past methods no longer work. Absolute BS.

A false strawman followed by a pitch for a complex financial product. Right out of the classic whole life insurance or managed portfolio sales pitches.

Because of these false worry signals, invest in something that drains 1% in fees, in a market where 1% is pretty close to the risk adjusted safe return of capital. Of course for a few basis points one can buy into the most efficient, diversified investment vehicles ever invented. But thats old news and boring.
Stay the course, ignore the Financial Press noise. But I will say, this is my opinion and that people are free to disagree with it.

But if you want to go leveraged, your nickle. How would this strategy do in 1990 Japan or in a 2009 scenario, without the internet/tech/biotech and IT productivity gains juicing the market back? I am happy those that went this route were not burned, but the US market has been on a 20 year bull run, with a few blips. Lots of gains to hide higher fees draining money. A flat or down market will make this a scary bet.
Aren't the fees on NTSX 0.2%? Still on the higher side, but not close to 1%.
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