What is the ex-ante reason we should accept sharply rising rates as a serious risk to my strategy? I agree we should base our decisions on ex-ante reasoning, not just backtesting. I've given you my ex-ante reasoning, give me yours.gw wrote: ↑Tue Jun 11, 2019 3:41 pmSuppose that, over the next few years, the 10-year bond rate were to rise from 2.5% to 5% - essentially just returning to 2000-2009 levels. That seems within the realm of possibilities.HEDGEFUNDIE wrote: ↑Tue Jun 11, 2019 10:32 amGW’s objection raises the question: what is it reasonable to expect ex-ante? I submit the following:coingaroo wrote: ↑Tue Jun 11, 2019 10:23 amThank you for one of the most insightful posts in this thread. Of course you will get insane performance by picking the two best performing asset classes and specifications, that maintain some level of diversification and then leverage like crazy.
Gw, what do you think about the idea of equal weight contribution (risk parity) in general? ERC of stocks, treasuries, bonds, commodities, property; leveraged to a target volatility.
1. That the equity premium will persist.
2. That the term premium will persist.
3. That flight to safety will persist.
These are risk-based premia that comprise the fundamental drivers of the financial markets. They don’t need to be “discounted”. By relying on them I am certainly not making a “big bet”. Every BH is relying on them with the 3-fund portfolio.
I make no prediction about interest rates; we have seen in the recon past how that has panned out.
The last time rates doubled was the period 1977-1981. This strategy lost something like 65% over that 4-year period, vs. a 150% gain for the S&P 500.
The previous time rates doubled was the period 1961-1975. This strategy lost something like 50% over that 14-year period, vs. a 200% gain for the S&P 500.
(I'm grabbing those dates and returns by eye from the charts below. YMMV.)
Hedgefundie's argument is that the market conditions of the 60s-70s are a thing of the past. Maybe so. Maybe not. I'm just saying he should recognize the extent to which this strategy's historical performance has been juiced by 40 years of steadily falling interest rates.
My general view of risk parity strategies is similar. One has to worry that it's just an elaborate excuse to justify holding more bonds, discovered after a lengthy period over which bonds were an unexpectedly fabulous investment.
Backtests are cheap, and it's easy to fool yourself.
To the extent that we can form an ex-ante position on interest rates, it's probably that rates will continue to decline or stagnate, given demographic and technology trends.