whodidntante wrote: ↑Sun Aug 28, 2016 11:24 am

How did you implement your leveraged portfolio, and what benefits did you realize? If you stopped, why did you stop? Post your success stories so we can learn from them.

I started a leveraged indexing portfolio a year ago in Nov 2017. The long term goal is to outperform the stock market by a factor of 2-3 while maintaining similar downside as the stock market. In other words, I'm aiming for a 20-30% CAGR and a max drawdown of -50%. Not the best results so far, but that's more due to the nature of the markets this year and not so much due to the leverage. I believe in the leveraged indexing concept and I'm sticking with it. My leveraged indexing concept is based around 2 rules:

1. Develop a diversified asset allocation that provides an optimal return/risk ratio.

2. Apply leverage, according to your risk tolerance, using the best source of leverage available.

In my opinion, a good starting point for Rule 1 is to develop an "all-weather" portfolio similar to that of the Ray Dalio variety. For the sake of simplicity and available data, let's use 35% S&P 500, 50% long term treasury, and 15% gold. Since 1987, this blend returned 8.3% CAGR with a max drawdown of -14.0%. Over this same time, the S&P returned 10.2% CAGR with max drawdown of -51%. This backtest was during a period of falling interest rates. Therefore, I don't necessarily expect this all-weather portfolio to continue to get 8% returns going forward. However, I would expect the all-weather diversified portfolio to remain a much more efficient investment in terms of sharpe ratio (return/risk).

Once a diversified asset allocation is determined, leverage can be applied per Rule 2. The first part of Rule 2 is to determine amount of leverage. I have a long investing horizon and can take on the risk of a potential 50% drawdown, similar to being in 100% stock. Therefore, if I would have used 3x leverage on this all-weather portfolio over the last 30 years, the max drawdown would have been -42% minus borrowing costs and volatility drag. Therefore, let's assume the max drawdown would have been somewhere around -50%.

The second part of Rule 2 is to determine your type of leverage. In my opinion, leveraged ETFs are currently the best form of leverage available due to ease of use, relatively low cost of use, and you never have to worry about margin calls. A 3x ETF version of the all-weather portfolio mentioned above would result in the following allocation:

35% UPRO, 50% TMF, 15% UGLD

You do have to contend with volatility drag due to the daily resetting of leverage. For instance, the volatility drag is definitely working against me this year as my current return is around -18.9% when the unleveraged version is around -4.1%. However, the daily resetting of leverage is actually a benefit in down years because the individual ETFs cannot lose more than 100% will likely be capped at a max loss around -90%. Also, in an up year, the daily resetting will lead to overperformance of the target. For instance, UPRO (SPY 3X) did 71.3% in 2017 while SPY did 21.3%. Therefore, UPRO overperformed 3X SPY for the year due to the daily resetting of leverage.

While these funds haven't been around beyond 2009, the daily data for their indexes or for mutual funds that track the indexes have been. Therefore, you can pull daily data for these indexes, perform daily 3X calculations, and create your own proxy funds at PortfolioVisualizer.com to show what the leveraged funds would have done in the past. For my daily calculations, I subtract 1%/250 to account for the expense ratio. That is 1% expense ratio split over 250 trading days in a year. Also, to account for dividends, I create a weighted average of the daily close value and daily adjusted close value (includes dividends) to find the right blend of the two that matches the actual performance of the leveraged ETF. I then compare my proxy fund to the actual fund over the time period the actual fund has been around. For example, here is my proxy TMF (portfolio 2) vs the actual TMF (portfolio 1):

Once I create proxy funds that match the actual 3X ETF funds, I can apply the backtest further back in history. My limiting factor is how far back I can get daily data. In the case of S&P 500, long term treasury, and gold, I am able to go back to 1987. My 3X portfolio backtest to 1987, using the same 35/50/10 split, resulted in a CAGR of 21.0% and a max drawdown of -40.9% (in 1987). The max drawdown during 2008 was -38.8%. If you get a little more aggressive and use TQQQ (3X Nasdaq) instead of UPRO, the results are even better. Over the same time period a blend of 35% TQQQ, 50% TMF, 15% UGLD would have returned 29.3% CAGR with a max drawdown of -50.2%. So you would have had almost triple the return of the S&P with the same max drawdown. While this is all theoretical, I would still call it a "success story" that you may be interested in.

Please note that the allocations mentioned in this post are for illustration purposes. My actual portfolio is a blend of TQQQ (15%), RETL (10%), LABU (10%), DRN (15%), TMF (40%), and UGLD (10%). The data on some of these funds are limited and I can't backtest them as far. However, my overall concept is to use stock funds that generally have the highest returns (tech, consumer discretionary, and biotech as opposed to indexes like S&P 500 that include utilities and consumer staples) and use the bonds that do the best when stocks are doing poorly (long term bonds). Gold is included for protection against inflation and a REIT fund is included for additional diversification.