Should I use margin to buy a balanced fund?

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long_gamma
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Re: Should I use margin to buy a balanced fund?

Post by long_gamma » Mon Dec 04, 2017 6:37 pm

Some what relevant article to this thread.

https://blog.thinknewfound.com/2017/12/ ... y-getting/
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Tue Dec 05, 2017 2:05 pm

Awesome read! It is very much in line with this thread.

I really do hope that leveraged portfolios becomes more popular. If one of the robo-advisers would offer leveraged portfolios as an investment option, I would definitely stop my manual stuff and move it over to their service. Rolling futures isn't time consuming, but it does require access to your account. That means I have to plan vacations around my portfolio which is mildly inconvenient.

Swelfie
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Re: Should I use margin to buy a balanced fund?

Post by Swelfie » Tue Dec 05, 2017 3:18 pm

Having been running a similar risk-parity portfolio for over a year now, one thing I was a bit caught off guard by was that, as Rob had discussed earlier in this thread, rising interest rates aren't really all that troublesome to the short term bonds. But what I am seeing in this current market is that combined with a flattening yield curve they are. The last few months interest rates have risen at the 2 year point, but they have risen faster at the 3 month point. This has pushed the implied repo rate up at a rate that my 2 year treasuries have the same expected return as they did 4 months ago, but they have lost a lot of value. My original assessment was that if interest rates rise I would expect to increase future returns, but I hadn't really accounted for the effect curve slope could have as a risk unto itself.

Not that I'm dissatisfied. My portfolio is behaving well overall. I am wondering if there is a diversification path here though. Here is my thought:

VIX doesn't really have any expected future growth, rather it spikes and returns to a baseline. The "insurance" aspect of holding VIX directly against an equity crash causes prices on future volatility to be higher than expected. This puts VIX futures in contago almost always (except during market crashes) and conversely, puts short VIX in near permanent backwardation, making a sliver of ZIV, for instance an attractive investment.

Yield curves have a similar story to VIX in that normally the curve is somewhat steep. At times it shallows or inverts but it later returns to normal (I can't see an economy that persisted in a state where long term investments always pay more than short term.) Since straight-forward investment in a positively sloped yield curve, such as this thread illustrates, is the norm, then insurance against curve flattening is likely at a premium. What is the combination of derivatives then that is shorts a flattening yield curve, as this should also in my mind be in a state of near permanent backwardation?

Rob Bertram
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Re: Should I use margin to buy a balanced fund?

Post by Rob Bertram » Thu Dec 07, 2017 12:20 pm

Yeah, the 2-year note futures have been fairly stagnant. I can check my history, but I believe that they are flat or at a slight loss year to date. Note that they are doing exactly what I want: providing an uncorrelated asset to the portfolio with a positive expected return. And, I agree, the portfolio is doing well which is what should be the ultimate focus.

An inverted yield curve is definitely a concern for a leveraged portfolio. It has happened, but it is a relatively rare event. Outside of keeping leverage within reason, I don't have a portfolio mitigation strategy. I don't want to abandon my total-market framework in order to add assets that are only relevant for a specific black swan event and create drag on the portfolio the rest of the time. I understand your original goal for including VIX futures in your portfolio, but it's not an approach that I would do. As you point out, VIX futures almost always in contango which makes it a losing choice for a buy-and-hold portfolio.

For anyone interested, there is a nice animated graph of the treasury yield curve here: http://stockcharts.com/freecharts/yieldcurve.php

kassad
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Re: Should I use margin to buy a balanced fund?

Post by kassad » Fri Feb 02, 2018 8:48 am

First of all: Kudos to you, Rob for doing this, and opening a thread about it!

Lately I have been thinking about doing the same thing (okay not exactly the same, but something similar), using futures to lever up a balanced portfolio. I haven't yet read through the entire 19 pages of this thread, but I have seen you are also using QUANDL as data source for your futures backtesting. Me too, and I have a problem with it. I am curious how you might have addressed this?

I have noticed that when I compare the buy and hold performance of the SP500 index (an ETF or US Large Cap in portfoliovisualizer) to the continious SP500 future of the CHRIS database on quandl, they follow each other nicely. However when comparing the same for US long term treasuries (the etf TLT or the cash bond index Long Term Treasuries in portfoliovisualizer) and the continious 30 year bond futures on Quandl, the continious futures vastly underperform (this is true for all the cash bond indexes vs their continious bond futures counterparts that I have tried). To the point that holding the bond futures in the portfolio aren't doing their 'job' well enough. I and up with a few percent more drawdown, and nearly half the CAGR when I put in the 40/60 stock/treasuries futures portfolio on a 1× leverage in amibroker (1982-2017) then what portfolivisualizer works out for the 40/60 index/ETF counterparts. This is a rather dissapointing simulation result.

I have to notice that the continious futures aren't rolled over based on volume or open interest, but are based on spot month calculations (held until expiry) which obviously results in a drag on the performance of futures contracts that are in contango. There is also a huge gap in all the continious bond futures on quandl I have checked from the 21st of Dec 1999 to the 22nd of Dec 1999 (110.84 -> 91.09 in the case of the 30 year treasuries !!!!!).

Did you notice the same problem? How have you gotten round it in your backtesting? Or you don't use the free continious futures at all, and have constructed your own from the individual historical futures using your own rollover rules (I have found various scripts in R and Python that do this, but I myself am not experienced in either programming languages) ?

cavemank
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Re: Should I use margin to buy a balanced fund?

Post by cavemank » Thu Feb 08, 2018 11:47 am

Rob,

I'm really curious as to how your portfolio is doing right now, with bonds and stocks both down a bit.

Finance Doc
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Re: Should I use margin to buy a balanced fund?

Post by Finance Doc » Mon Feb 12, 2018 12:17 am

Rob Bertram wrote:
Fri Dec 02, 2016 6:46 pm
That is a very good question, frejd. Here are my observations:
  • Don't let the pursuit of perfect be the enemy of good: At the core, the model is a 40% total-stock / 60% intermediate-treasury portfolio leveraged to taste. Transforming the bonds from intermediate to short-term was an exercise of keeping the same Sharpe ration and improving the Sortino ratio so as to reduce margin call. There are less complex portfolios with very similar risk/return profiles that you can achieve with a lower starting dollar amount. For example, a 10% stock / 90% short-term treasury portfolio has virtually the same risk profile as 10% stock/ 5% long-term / 85% short-term treasuries (Portfolio Visualizer link). With about $40k, one could get an e-mini S&P contract and 4x 2-year treasury contract. That would be close enough. For lower amounts, you could use leveraged ETFs for stocks (UPRO is 3x S&P 500) and 2-year treasury futures.
  • You don't need to do the insane leverage ratios that I've chosen: I would encourage people just starting out to begin with something much lower as they haven't truly experienced a bear market to understand their risk tolerance.
  • Remember the fundamentals: The top three factors for building wealth are savings rate, time, and keeping costs low. Master those first, then come back to asset allocation and risk/leverage.
I am contemplating doing something similar to what you've done and came across this discussion. A few questions for you:

1) From my cursory reading, you seem to have settled on a 10/90 futures split between s and p 500 / 2 year treasuries? Any other takeaway points to your method? I'm not a market timer at all but starting out with this approach in a market with high stock valuation and low interest rates makes me think twice.

2) Regarding your answer above, 1 e-mini and 4 treasury futures is 530,000 notional value. I don't know the exact details, is maintenance margin for that around 10 to 15 thousand? Leaving a loss of only 25 to 30 thousand to wipe out the position? Max loss maybe as low as 4.7%? I know backtesting predicts that won't happen, but they say, "Past results are no guarantee of future performance" for a reason.

Any and all advice regarding your approach would be appreciated.

long_gamma
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Re: Should I use margin to buy a balanced fund?

Post by long_gamma » Mon Feb 12, 2018 1:18 pm

Finance Doc wrote:
Mon Feb 12, 2018 12:17 am
2) Regarding your answer above, 1 e-mini and 4 treasury futures is 530,000 notional value. I don't know the exact details, is maintenance margin for that around 10 to 15 thousand? Leaving a loss of only 25 to 30 thousand to wipe out the position? Max loss maybe as low as 4.7%? I know backtesting predicts that won't happen, but they say, "Past results are no guarantee of future performance" for a reason.
Your notional value calculation looks wrong. 2 year treasury note face amount is $200,000. At current values of 2 year note and ES emini, notional value is close to $1 million.

I am all for leverage, but the leverage applied here is crazy for my taste.
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

jw50
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Re: Should I use margin to buy a balanced fund?

Post by jw50 » Mon Feb 12, 2018 3:18 pm

Too many posts to read through.

For simpleton like me, the two main considerations are:
-the differential between the expected return and the margin interest rate
-the potential of margin call, been a forced seller

Therefore I will have only stocks in the portion of my portfolio bought with margin; and use maximum of 20% margin.

Finance Doc
Posts: 12
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Re: Should I use margin to buy a balanced fund?

Post by Finance Doc » Mon Feb 12, 2018 5:48 pm

long_gamma wrote:
Mon Feb 12, 2018 1:18 pm
Finance Doc wrote:
Mon Feb 12, 2018 12:17 am
2) Regarding your answer above, 1 e-mini and 4 treasury futures is 530,000 notional value. I don't know the exact details, is maintenance margin for that around 10 to 15 thousand? Leaving a loss of only 25 to 30 thousand to wipe out the position? Max loss maybe as low as 4.7%? I know backtesting predicts that won't happen, but they say, "Past results are no guarantee of future performance" for a reason.
Your notional value calculation looks wrong. 2 year treasury note face amount is $200,000. At current values of 2 year note and ES emini, notional value is close to $1 million.

I am all for leverage, but the leverage applied here is crazy for my taste.
Okay, I must have had the specs wrong. Even worse.

bmritz
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Re: Should I use margin to buy a balanced fund?

Post by bmritz » Mon Feb 12, 2018 6:20 pm

jw50 wrote:
Mon Feb 12, 2018 3:18 pm
Too many posts to read through.

For simpleton like me, the two main considerations are:
-the differential between the expected return and the margin interest rate
-the potential of margin call, been a forced seller

Therefore I will have only stocks in the portion of my portfolio bought with margin; and use maximum of 20% margin.
Isn't the buying power of the margin fungible though? So if you use any margin on anything on a portfolio you are effectively levering the entire portfolio? That's how I always thought of it. So the relevant measure of your first consideration would be the expected return of your entire portfolio vs the margin rate.

bmritz
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Re: Should I use margin to buy a balanced fund?

Post by bmritz » Tue Feb 13, 2018 7:45 pm

cavemank wrote:
Thu Feb 08, 2018 11:47 am
Rob,

I'm really curious as to how your portfolio is doing right now, with bonds and stocks both down a bit.
I was also curious how this portfolio performed during the recent “correction.”

Last I could follow, the portfolio was: 10% S&P 500, 5% Long Term Treasuries, 85% Short Term Treasuries Leveraged 26x via futures.

Returns between close of Jan. 26 and close of Feb. 8:

Code: Select all

VOO (Vanguard S&P 500 ETF):                  -10.09%  (Jan 26: 263.36 Feb 8: 236.79)
VGLT (Vanguard Long-Term Treasury ETF):      -3.77%   (Jan 26: 75.88  Feb 8: 73.02)
VGSH (Vanguard Short-Term Treasury ETF):     +0.00%   (Jan 26: 60.09  Feb 8: 60.09)
By naively multiplying the portfolio weights by the returns, the total unlevered portfolio decreased by 1.20%.
Levered 26x, the account funds decreased by 31.13%.

Wild ride indeed.

For a little context, excluding dividends, YTD the unlevered portfolio is down 0.59%, while the levered portfolio is down 15.42%.

95% of that 15.42% loss came from decreased NAV in the bond portion of the portfolio. This thing is sensitive to interest rates.

jw50
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Joined: Thu Jul 27, 2017 2:00 pm

Re: Should I use margin to buy a balanced fund?

Post by jw50 » Thu Feb 15, 2018 5:52 am

An interesting article on leverage:
http://www.morningstar.com/articles/849 ... erage.html

long_gamma
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Re: Should I use margin to buy a balanced fund?

Post by long_gamma » Thu Feb 15, 2018 7:14 am

I have problem with his initial assumptions.
Real-World Costs
Of course …money is never free. I then raided the Federal Reserve Bank of St. Louis’s database (FRED), downloaded the monthly federal-funds interest rate, and simulated three borrowing costs. I permitted institutions to borrow at the fed-funds rate plus 2 percentage points; larger retail investors ($1 million), at fed-funds plus 4 points; and small retail buyers at fed-funds plus 6 points. (I couldn’t find a database that listed historical margin-account interest rates, but based on current quotes, those assumptions seem roughly correct.)
He has two links (FRED & IB) which doesn't justify the rates he is quoting.

FRED rate 1.42%
IB rates varies from 2.04% to 2.92%

So for very small retail buyer he is assuming 1.42%+6% = 7.42% which is nowhere near 2.92%.

There is other option, retail investors can borrow using futures and options at much lower rate. Implicit cost of borrowing using futures and options is less than 2.5%.

It doesn't take genius to figure out, when expected returns are around 6 to 7% and if one is borrowing at 7.42% then leverage doesn't work.
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

n00b590
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Re: Should I use margin to buy a balanced fund?

Post by n00b590 » Thu Feb 15, 2018 4:17 pm

long_gamma wrote:
Thu Feb 15, 2018 7:14 am
I have problem with his initial assumptions.
Real-World Costs
Of course …money is never free. I then raided the Federal Reserve Bank of St. Louis’s database (FRED), downloaded the monthly federal-funds interest rate, and simulated three borrowing costs. I permitted institutions to borrow at the fed-funds rate plus 2 percentage points; larger retail investors ($1 million), at fed-funds plus 4 points; and small retail buyers at fed-funds plus 6 points. (I couldn’t find a database that listed historical margin-account interest rates, but based on current quotes, those assumptions seem roughly correct.)
He has two links (FRED & IB) which doesn't justify the rates he is quoting.

FRED rate 1.42%
IB rates varies from 2.04% to 2.92%

So for very small retail buyer he is assuming 1.42%+6% = 7.42% which is nowhere near 2.92%.

There is other option, retail investors can borrow using futures and options at much lower rate. Implicit cost of borrowing using futures and options is less than 2.5%.

It doesn't take genius to figure out, when expected returns are around 6 to 7% and if one is borrowing at 7.42% then leverage doesn't work.
+1

redstar
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Re: Should I use margin to buy a balanced fund?

Post by redstar » Mon Apr 23, 2018 11:31 pm

Rob Bertram wrote:
Tue Apr 14, 2015 12:03 pm
I was thinking about how to start a leveraged portfolio with about $10k (which is the minimum to open a margin account). Do you plan on keeping the 10/90 asset allocation as you continue to contribute cash, or is it only a transitional point due to the size of the futures contract? If you do plan on transitioning, would you be willing to share your plan?
Rob, thanks for this thread. It’s fascinating. Do you have estimates on the portfolio that would make sense to start using low amounts of leverage with a small amount of capital? I’m not sure I would do it, but I’m curious what it looks like.

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