HEDGEFUNDIE's excellent adventure Part II: The next journey

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
caklim00
Posts: 1922
Joined: Mon May 26, 2008 10:09 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by caklim00 » Sun Oct 06, 2019 6:26 pm

305pelusa wrote:
Sun Oct 06, 2019 6:06 pm
rascott wrote:
Sun Oct 06, 2019 5:53 pm
305pelusa wrote:
Sun Oct 06, 2019 5:35 pm
rascott wrote:
Sun Oct 06, 2019 4:56 pm
Why would it need to be 3 month rate? It's only 3 months at the very beginning.... and then drops daily. Pls they are cash settled daily.... so the overnight rate is the applicable one, in my view.
That's because the mispricing of the future contract's implied rate is not assured to reverse over a day; but it is sure to reverse by expiration.

In other words, if the implied rate of the contract is 2.1%, you can borrow overnight at 1.8% and the contract expires in 3 months, it's not actually certain that you'd make a profit by entering and exiting the position over a day. The "implied rate" of the future takes effect over the life of the contract because it's only at the end of the contract that the contract must be worth exactly what the underlying is worth.

Before contract expiration, the contract and the underlying can actually move differently. Similar to how a bond can trade above or below par. It is only once expiration is close that the contract will cost exactly what the underlying does. That's where the arbitrage comes in.

We have 2 and a half months before your December contract expires. So given the above, if you had to guess, what do you think will be closer to the financing cost: The overnight rate or the 3 month rate?
rascott wrote:
Sun Oct 06, 2019 4:56 pm

I read a bunch of papers from CME on this a few months back, and came away comfortable in that the implied repo rate tracks fairly close to the overnight repo rate. Also, there have been several studies that I saw that tested the Treasury futures market. Showing the long- term returns of either 1) holding the underlying bond vs 2) holding the futures contract and investing all the remaining funds in t-bills. The returns were basically identical.... implying to me that the 3 month T bill rate is a good proxy for the implied repo rates of the Treasury futures market.
I'd love to read some of those if you find the time to link them.

Either way, to be blunt, I don't care at all what the financing rate was historically. I don't care what the rate was a decade ago. I only care what it is today.

Thankfully, my previous posts are just the intuition/logic. It's possible (and really easy actually) to calculate the implied rate of future contracts today. I'll save you the trouble; it's 2.1%, identical to the 3 month LIBOR.

It is most definitely NOT the 1.71% (the RFR).

I suppose it's possible it hasn't caught up with the drop in the FFR.... the drop has only been showing up in the Treasury yield curve within the last few days. It may take longer to catch up, who knows..... but historically the 3 month LIBOR has USUALLY matched the Fed Funds rate.


http://www.fedprimerate.com/usprimerate ... -chart.htm
I don't doubt they tend to be similar, historically or otherwise. I'm just making it clear that the financing rate of a futures should be the borrowing rate at the term of the future. If the overnight, T-bill, or anything happens to be that too, that's cool.

Any ways, back to my original question. You're borrowing at 2.1% to invest at 1.5%. Just for the volatility and correlation of the asset.

Out of curiosity, have you calculated what the correlation and/or volatility must be for the above to actually yield a profit? In other words, have you quantified in any way the expected return of this insurance?
Maybe I'm missing something but based on this logic why would anyone invest in something like Vanguard Interm-Term Treasury Inv
VFITX. Current yield is 1.49% and it has 6.1B in assets. This has been its best year since 2011.

User avatar
305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 6:30 pm

caklim00 wrote:
Sun Oct 06, 2019 6:26 pm
305pelusa wrote:
Sun Oct 06, 2019 6:06 pm
rascott wrote:
Sun Oct 06, 2019 5:53 pm
305pelusa wrote:
Sun Oct 06, 2019 5:35 pm
rascott wrote:
Sun Oct 06, 2019 4:56 pm
Why would it need to be 3 month rate? It's only 3 months at the very beginning.... and then drops daily. Pls they are cash settled daily.... so the overnight rate is the applicable one, in my view.
That's because the mispricing of the future contract's implied rate is not assured to reverse over a day; but it is sure to reverse by expiration.

In other words, if the implied rate of the contract is 2.1%, you can borrow overnight at 1.8% and the contract expires in 3 months, it's not actually certain that you'd make a profit by entering and exiting the position over a day. The "implied rate" of the future takes effect over the life of the contract because it's only at the end of the contract that the contract must be worth exactly what the underlying is worth.

Before contract expiration, the contract and the underlying can actually move differently. Similar to how a bond can trade above or below par. It is only once expiration is close that the contract will cost exactly what the underlying does. That's where the arbitrage comes in.

We have 2 and a half months before your December contract expires. So given the above, if you had to guess, what do you think will be closer to the financing cost: The overnight rate or the 3 month rate?
rascott wrote:
Sun Oct 06, 2019 4:56 pm

I read a bunch of papers from CME on this a few months back, and came away comfortable in that the implied repo rate tracks fairly close to the overnight repo rate. Also, there have been several studies that I saw that tested the Treasury futures market. Showing the long- term returns of either 1) holding the underlying bond vs 2) holding the futures contract and investing all the remaining funds in t-bills. The returns were basically identical.... implying to me that the 3 month T bill rate is a good proxy for the implied repo rates of the Treasury futures market.
I'd love to read some of those if you find the time to link them.

Either way, to be blunt, I don't care at all what the financing rate was historically. I don't care what the rate was a decade ago. I only care what it is today.

Thankfully, my previous posts are just the intuition/logic. It's possible (and really easy actually) to calculate the implied rate of future contracts today. I'll save you the trouble; it's 2.1%, identical to the 3 month LIBOR.

It is most definitely NOT the 1.71% (the RFR).

I suppose it's possible it hasn't caught up with the drop in the FFR.... the drop has only been showing up in the Treasury yield curve within the last few days. It may take longer to catch up, who knows..... but historically the 3 month LIBOR has USUALLY matched the Fed Funds rate.


http://www.fedprimerate.com/usprimerate ... -chart.htm
I don't doubt they tend to be similar, historically or otherwise. I'm just making it clear that the financing rate of a futures should be the borrowing rate at the term of the future. If the overnight, T-bill, or anything happens to be that too, that's cool.

Any ways, back to my original question. You're borrowing at 2.1% to invest at 1.5%. Just for the volatility and correlation of the asset.

Out of curiosity, have you calculated what the correlation and/or volatility must be for the above to actually yield a profit? In other words, have you quantified in any way the expected return of this insurance?
Maybe I'm missing something but based on this logic why would anyone invest in something like Vanguard Interm-Term Treasury Inv
VFITX. Current yield is 1.49% and it has 6.1B in assets. This has been its best year since 2011.
You're asking why they would invest in that as opposed to a Money Market (yielding ~2%)?

caklim00
Posts: 1922
Joined: Mon May 26, 2008 10:09 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by caklim00 » Sun Oct 06, 2019 6:35 pm

rascott wrote:
Sun Oct 06, 2019 1:23 pm
caklim00 wrote:
Sun Oct 06, 2019 11:45 am
rascott wrote:
Sun Oct 06, 2019 9:53 am
MotoTrojan wrote:
Sat Oct 05, 2019 2:35 pm
caklim00 wrote:
Sat Oct 05, 2019 2:16 pm

Why just 2 year? I'll admit I'm very inexperienced when it comes to this...

NTSX holds
US 5YR NOTE (CBT) DEC19 XCBT 2019123112.28%
US 10YR NOTE (CBT)DEC19 XCBT 2019121912.02%
US 10YR ULTRA FUT DEC19 XCBT 2019121911.96%
US LONG BOND(CBT) DEC19 XCBT 2019121911.85%
US 2YR NOTE (CBT) DEC19 XCBT 2019123111.35%

Am I reading this correct that 2 year contract size is 200k? And the others 100k? Are you doing this in taxable or tax deferred?

I'm not sure what you mean by 2 year futures are leveraged to create the same 15x leverage.

This whole idea of leveraging treaturies is reallt interesting since it seems like it in theory is not super risky like leveraged equity.
Wrong. Enough leverage and you can go to ~0% in months in treasuries. This person feels that 2 year bonds have higher sharpe than longer term bonds so instead of 3x 20 year they’re going 15x 2 year. While this has worked historically it’s a near guaranteed loss with an inverted yield curve since the borrowing cost (X 14) is higher than the interest earned on the 15X 2-year bonds.

The US government may not default on your 2-year bond but the NAV can plummet while you still pay the cash portion from borrowing.

By that logic nearly all leveraged treasuries are near guaranteed loss right now.

BTW, my "guaranteed loss" position is up over 6% in the last month.... while equities are down..... doing exactly how it should behave in a risk parity portfolio. The entire point of holding large duration in this exercise is to insure the leveraged equity portfolio.... not to really make money.
Is there any way you could detail how you are purchasing the treatury futures? Like where is the best place to do this? What the costs are? How much you have to hold in cash or other liquid currency? I'm really considering buying a few contracts as potential way to dedge against a drop in the equity market. Any increase in value if the market continues to go up would just be gravy.

I'm using TD Ameritrade. But many brokers offer them. You'll need to open a margin account. TDA charges $2.25 per contract. Other places are cheaper. I may switch over the new Interactive Brokers Lite.

You need to decide how much leverage you actually want/ need.... basically what will your notional exposure be. And that will help determine how much bag cash to set aside in your account to avoid going on margin, and paying interest to your broker.

I'd suggest opening a paper account and buy a few there first to get a feel for it.... without risking any real money.
TGhx, looks like Schwab is $1.50 per contract. I'm betting they have a decent paper account. Will reach out to them to see if they can set me up. To be perfectly honest, I''m not looking to do anything crazy here. Currently sitting at 85/15 stock/bond split and could see moving to 70/30 utilizing futures so I don't have to sell equity. Will probably just do this in taxable as I'd prefer not to take up IRA space for this. I'm basically wanting to just soften the fall if it occurs. Not looking to do risk parity.

caklim00
Posts: 1922
Joined: Mon May 26, 2008 10:09 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by caklim00 » Sun Oct 06, 2019 6:35 pm

rascott wrote:
Sun Oct 06, 2019 1:23 pm
caklim00 wrote:
Sun Oct 06, 2019 11:45 am
rascott wrote:
Sun Oct 06, 2019 9:53 am
MotoTrojan wrote:
Sat Oct 05, 2019 2:35 pm
caklim00 wrote:
Sat Oct 05, 2019 2:16 pm

Why just 2 year? I'll admit I'm very inexperienced when it comes to this...

NTSX holds
US 5YR NOTE (CBT) DEC19 XCBT 2019123112.28%
US 10YR NOTE (CBT)DEC19 XCBT 2019121912.02%
US 10YR ULTRA FUT DEC19 XCBT 2019121911.96%
US LONG BOND(CBT) DEC19 XCBT 2019121911.85%
US 2YR NOTE (CBT) DEC19 XCBT 2019123111.35%

Am I reading this correct that 2 year contract size is 200k? And the others 100k? Are you doing this in taxable or tax deferred?

I'm not sure what you mean by 2 year futures are leveraged to create the same 15x leverage.

This whole idea of leveraging treaturies is reallt interesting since it seems like it in theory is not super risky like leveraged equity.
Wrong. Enough leverage and you can go to ~0% in months in treasuries. This person feels that 2 year bonds have higher sharpe than longer term bonds so instead of 3x 20 year they’re going 15x 2 year. While this has worked historically it’s a near guaranteed loss with an inverted yield curve since the borrowing cost (X 14) is higher than the interest earned on the 15X 2-year bonds.

The US government may not default on your 2-year bond but the NAV can plummet while you still pay the cash portion from borrowing.

By that logic nearly all leveraged treasuries are near guaranteed loss right now.

BTW, my "guaranteed loss" position is up over 6% in the last month.... while equities are down..... doing exactly how it should behave in a risk parity portfolio. The entire point of holding large duration in this exercise is to insure the leveraged equity portfolio.... not to really make money.
Is there any way you could detail how you are purchasing the treatury futures? Like where is the best place to do this? What the costs are? How much you have to hold in cash or other liquid currency? I'm really considering buying a few contracts as potential way to dedge against a drop in the equity market. Any increase in value if the market continues to go up would just be gravy.

I'm using TD Ameritrade. But many brokers offer them. You'll need to open a margin account. TDA charges $2.25 per contract. Other places are cheaper. I may switch over the new Interactive Brokers Lite.

You need to decide how much leverage you actually want/ need.... basically what will your notional exposure be. And that will help determine how much bag cash to set aside in your account to avoid going on margin, and paying interest to your broker.

I'd suggest opening a paper account and buy a few there first to get a feel for it.... without risking any real money.
TGhx, looks like Schwab is $1.50 per contract. I'm betting they have a decent paper account. Will reach out to them to see if they can set me up. To be perfectly honest, I''m not looking to do anything crazy here. Currently sitting at 85/15 stock/bond split and could see moving to 70/30 utilizing futures so I don't have to sell equity. Will probably just do this in taxable as I'd prefer not to take up IRA space for this. I'm basically wanting to just soften the fall if it occurs. Not looking to do risk parity.

rascott
Posts: 1003
Joined: Wed Apr 15, 2015 10:53 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 7:03 pm

305pelusa wrote:
Sun Oct 06, 2019 6:06 pm
rascott wrote:
Sun Oct 06, 2019 5:53 pm
305pelusa wrote:
Sun Oct 06, 2019 5:35 pm
rascott wrote:
Sun Oct 06, 2019 4:56 pm
Why would it need to be 3 month rate? It's only 3 months at the very beginning.... and then drops daily. Pls they are cash settled daily.... so the overnight rate is the applicable one, in my view.
That's because the mispricing of the future contract's implied rate is not assured to reverse over a day; but it is sure to reverse by expiration.

In other words, if the implied rate of the contract is 2.1%, you can borrow overnight at 1.8% and the contract expires in 3 months, it's not actually certain that you'd make a profit by entering and exiting the position over a day. The "implied rate" of the future takes effect over the life of the contract because it's only at the end of the contract that the contract must be worth exactly what the underlying is worth.

Before contract expiration, the contract and the underlying can actually move differently. Similar to how a bond can trade above or below par. It is only once expiration is close that the contract will cost exactly what the underlying does. That's where the arbitrage comes in.

We have 2 and a half months before your December contract expires. So given the above, if you had to guess, what do you think will be closer to the financing cost: The overnight rate or the 3 month rate?
rascott wrote:
Sun Oct 06, 2019 4:56 pm

I read a bunch of papers from CME on this a few months back, and came away comfortable in that the implied repo rate tracks fairly close to the overnight repo rate. Also, there have been several studies that I saw that tested the Treasury futures market. Showing the long- term returns of either 1) holding the underlying bond vs 2) holding the futures contract and investing all the remaining funds in t-bills. The returns were basically identical.... implying to me that the 3 month T bill rate is a good proxy for the implied repo rates of the Treasury futures market.
I'd love to read some of those if you find the time to link them.

Either way, to be blunt, I don't care at all what the financing rate was historically. I don't care what the rate was a decade ago. I only care what it is today.

Thankfully, my previous posts are just the intuition/logic. It's possible (and really easy actually) to calculate the implied rate of future contracts today. I'll save you the trouble; it's 2.1%, identical to the 3 month LIBOR.

It is most definitely NOT the 1.71% (the RFR).

I suppose it's possible it hasn't caught up with the drop in the FFR.... the drop has only been showing up in the Treasury yield curve within the last few days. It may take longer to catch up, who knows..... but historically the 3 month LIBOR has USUALLY matched the Fed Funds rate.


http://www.fedprimerate.com/usprimerate ... -chart.htm
I don't doubt they tend to be similar, historically or otherwise. I'm just making it clear that the financing rate of a futures should be the borrowing rate at the term of the future. If the overnight, T-bill, or anything happens to be that too, that's cool.

Any ways, back to my original question. You're borrowing at 2.1% to invest at 1.5%. Just for the volatility and correlation of the asset.

Out of curiosity, have you calculated what the correlation and/or volatility must be for the above to actually yield a profit? In other words, have you quantified in any way the expected return of this insurance?

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.

MotoTrojan
Posts: 6580
Joined: Wed Feb 01, 2017 8:39 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by MotoTrojan » Sun Oct 06, 2019 8:04 pm

rascott wrote:
Sun Oct 06, 2019 7:03 pm
305pelusa wrote:
Sun Oct 06, 2019 6:06 pm
rascott wrote:
Sun Oct 06, 2019 5:53 pm
305pelusa wrote:
Sun Oct 06, 2019 5:35 pm
rascott wrote:
Sun Oct 06, 2019 4:56 pm
Why would it need to be 3 month rate? It's only 3 months at the very beginning.... and then drops daily. Pls they are cash settled daily.... so the overnight rate is the applicable one, in my view.
That's because the mispricing of the future contract's implied rate is not assured to reverse over a day; but it is sure to reverse by expiration.

In other words, if the implied rate of the contract is 2.1%, you can borrow overnight at 1.8% and the contract expires in 3 months, it's not actually certain that you'd make a profit by entering and exiting the position over a day. The "implied rate" of the future takes effect over the life of the contract because it's only at the end of the contract that the contract must be worth exactly what the underlying is worth.

Before contract expiration, the contract and the underlying can actually move differently. Similar to how a bond can trade above or below par. It is only once expiration is close that the contract will cost exactly what the underlying does. That's where the arbitrage comes in.

We have 2 and a half months before your December contract expires. So given the above, if you had to guess, what do you think will be closer to the financing cost: The overnight rate or the 3 month rate?
rascott wrote:
Sun Oct 06, 2019 4:56 pm

I read a bunch of papers from CME on this a few months back, and came away comfortable in that the implied repo rate tracks fairly close to the overnight repo rate. Also, there have been several studies that I saw that tested the Treasury futures market. Showing the long- term returns of either 1) holding the underlying bond vs 2) holding the futures contract and investing all the remaining funds in t-bills. The returns were basically identical.... implying to me that the 3 month T bill rate is a good proxy for the implied repo rates of the Treasury futures market.
I'd love to read some of those if you find the time to link them.

Either way, to be blunt, I don't care at all what the financing rate was historically. I don't care what the rate was a decade ago. I only care what it is today.

Thankfully, my previous posts are just the intuition/logic. It's possible (and really easy actually) to calculate the implied rate of future contracts today. I'll save you the trouble; it's 2.1%, identical to the 3 month LIBOR.

It is most definitely NOT the 1.71% (the RFR).

I suppose it's possible it hasn't caught up with the drop in the FFR.... the drop has only been showing up in the Treasury yield curve within the last few days. It may take longer to catch up, who knows..... but historically the 3 month LIBOR has USUALLY matched the Fed Funds rate.


http://www.fedprimerate.com/usprimerate ... -chart.htm
I don't doubt they tend to be similar, historically or otherwise. I'm just making it clear that the financing rate of a futures should be the borrowing rate at the term of the future. If the overnight, T-bill, or anything happens to be that too, that's cool.

Any ways, back to my original question. You're borrowing at 2.1% to invest at 1.5%. Just for the volatility and correlation of the asset.

Out of curiosity, have you calculated what the correlation and/or volatility must be for the above to actually yield a profit? In other words, have you quantified in any way the expected return of this insurance?

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
What was the result from 1955-1982? Don’t recall seeing your backtest. Are you achieving true risk parity throughout history (adjusting to maintain fixed duration)? I’m only at 129% equity but plenty happy with EDV’s ballast, albeit not true risk-parity.

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305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 8:08 pm

rascott wrote:
Sun Oct 06, 2019 7:03 pm

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?

EfficientInvestor
Posts: 235
Joined: Thu Nov 01, 2018 7:02 pm
Location: Alabama

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 8:24 pm

305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?

caklim00
Posts: 1922
Joined: Mon May 26, 2008 10:09 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by caklim00 » Sun Oct 06, 2019 8:33 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
I don't think that's the right question. I think it should be 100% stocks or 100% stocks/90% 2Year treasures/-90%CASH

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305pelusa
Posts: 905
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 8:42 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
Ok, let's try this. I estimate that 100% stocks will.

EfficientInvestor
Posts: 235
Joined: Thu Nov 01, 2018 7:02 pm
Location: Alabama

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 8:46 pm

305pelusa wrote:
Sun Oct 06, 2019 8:42 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
Ok, let's try this. I estimate that 100% stocks will.
Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?

rascott
Posts: 1003
Joined: Wed Apr 15, 2015 10:53 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 8:49 pm

305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
rascott wrote:
Sun Oct 06, 2019 7:03 pm

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?

Your issue seems to be with the entire 'Adventure'...not in the way I'm going about implementing it...which is just buying the effective duration of TMF at a lower cost than TMF (due to a 1% mgmt fee).

This is 10% of my portfolio. All the rest is in 100% stocks. It'll either work or it won't....but it's the route I've decided to take after a lot of thought and research and I am sticking with it....I'm well aware that it is not an ideal time to start it (in the midst of a curve inversion)...but heck, even in the first month, I am up nearly 7% on the futures position...to offset the 4% decline in the equity position. Even with the dreaded inverted curve. Maybe I would have done a little better using much less leverage on a long term bond, maybe not. I haven't checked those.

As to comparing it with just 100% stocks (or 150% stocks)......for a period when interest rates have been basically flat (from 2011 to now.)......how is this for Sharpe?

https://www.portfoliovisualizer.com/bac ... total3=100

User avatar
305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 8:52 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 8:46 pm
305pelusa wrote:
Sun Oct 06, 2019 8:42 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
Ok, let's try this. I estimate that 100% stocks will.
Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?
I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).

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305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 9:02 pm

rascott wrote:
Sun Oct 06, 2019 8:49 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
rascott wrote:
Sun Oct 06, 2019 7:03 pm

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?

Your issue seems to be with the entire 'Adventure'...not in the way I'm going about implementing it...which is just buying the effective duration of TMF at a lower cost than TMF (due to a 1% mgmt fee).

This is 10% of my portfolio. All the rest is in 100% stocks. It'll either work or it won't....but it's the route I've decided to take after a lot of thought and research and I am sticking with it....I'm well aware that it is not an ideal time to start it (in the midst of a curve inversion)...but heck, even in the first month, I am up nearly 7% on the futures position...to offset the 4% decline in the equity position. Even with the dreaded inverted curve. Maybe I would have done a little better using much less leverage on a long term bond, maybe not. I haven't checked those.

As to comparing it with just 100% stocks (or 150% stocks)......for a period when interest rates have been basically flat (from 2011 to now.)......how is this for Sharpe?

https://www.portfoliovisualizer.com/bac ... total3=100
First, is it actually true that leveraging short term bonds is equivalent to exposure to a long term bond? It seems to me that the yield curve must be linear for that to be the case.

Secondly, as to your link: ST bonds yielded a positive 0.4% term premium over that period. They are currently yielding a negative 0.6% against cash. If 2Y bonds had a positive term premium (like in your link), we wouldn't be having this conversation now would we?

EfficientInvestor
Posts: 235
Joined: Thu Nov 01, 2018 7:02 pm
Location: Alabama

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 9:05 pm

305pelusa wrote:
Sun Oct 06, 2019 8:52 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:46 pm
305pelusa wrote:
Sun Oct 06, 2019 8:42 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?
Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
Ok, let's try this. I estimate that 100% stocks will.
Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?
I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?

rascott
Posts: 1003
Joined: Wed Apr 15, 2015 10:53 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 9:06 pm

MotoTrojan wrote:
Sun Oct 06, 2019 8:04 pm
rascott wrote:
Sun Oct 06, 2019 7:03 pm
305pelusa wrote:
Sun Oct 06, 2019 6:06 pm
rascott wrote:
Sun Oct 06, 2019 5:53 pm
305pelusa wrote:
Sun Oct 06, 2019 5:35 pm


That's because the mispricing of the future contract's implied rate is not assured to reverse over a day; but it is sure to reverse by expiration.

In other words, if the implied rate of the contract is 2.1%, you can borrow overnight at 1.8% and the contract expires in 3 months, it's not actually certain that you'd make a profit by entering and exiting the position over a day. The "implied rate" of the future takes effect over the life of the contract because it's only at the end of the contract that the contract must be worth exactly what the underlying is worth.

Before contract expiration, the contract and the underlying can actually move differently. Similar to how a bond can trade above or below par. It is only once expiration is close that the contract will cost exactly what the underlying does. That's where the arbitrage comes in.

We have 2 and a half months before your December contract expires. So given the above, if you had to guess, what do you think will be closer to the financing cost: The overnight rate or the 3 month rate?



I'd love to read some of those if you find the time to link them.

Either way, to be blunt, I don't care at all what the financing rate was historically. I don't care what the rate was a decade ago. I only care what it is today.

Thankfully, my previous posts are just the intuition/logic. It's possible (and really easy actually) to calculate the implied rate of future contracts today. I'll save you the trouble; it's 2.1%, identical to the 3 month LIBOR.

It is most definitely NOT the 1.71% (the RFR).

I suppose it's possible it hasn't caught up with the drop in the FFR.... the drop has only been showing up in the Treasury yield curve within the last few days. It may take longer to catch up, who knows..... but historically the 3 month LIBOR has USUALLY matched the Fed Funds rate.


http://www.fedprimerate.com/usprimerate ... -chart.htm
I don't doubt they tend to be similar, historically or otherwise. I'm just making it clear that the financing rate of a futures should be the borrowing rate at the term of the future. If the overnight, T-bill, or anything happens to be that too, that's cool.

Any ways, back to my original question. You're borrowing at 2.1% to invest at 1.5%. Just for the volatility and correlation of the asset.

Out of curiosity, have you calculated what the correlation and/or volatility must be for the above to actually yield a profit? In other words, have you quantified in any way the expected return of this insurance?

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
What was the result from 1955-1982? Don’t recall seeing your backtest. Are you achieving true risk parity throughout history (adjusting to maintain fixed duration)? I’m only at 129% equity but plenty happy with EDV’s ballast, albeit not true risk-parity.

I don't think I posted it....but I messed around with different leverage levels for that period (55-82), looking only at the STTs...trying to find one that would have approximated the volatility of equities.

It came out to roughly 5x leverage for that total period to get to about a 7% CAGR/15% st dev combo. I didn't have the data on hand for the monthly SP500 returns for that period...and PV only goes back to 1976...so I couldn't look at returns for a risk-parity like portfolio. I was more interested in just how the leveraged ST Treasuries worked in an era of rising rates. Not real pretty, but still a lot better than LTTs would have done.

rascott
Posts: 1003
Joined: Wed Apr 15, 2015 10:53 am

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 9:12 pm

305pelusa wrote:
Sun Oct 06, 2019 9:02 pm
rascott wrote:
Sun Oct 06, 2019 8:49 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
rascott wrote:
Sun Oct 06, 2019 7:03 pm

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?

Your issue seems to be with the entire 'Adventure'...not in the way I'm going about implementing it...which is just buying the effective duration of TMF at a lower cost than TMF (due to a 1% mgmt fee).

This is 10% of my portfolio. All the rest is in 100% stocks. It'll either work or it won't....but it's the route I've decided to take after a lot of thought and research and I am sticking with it....I'm well aware that it is not an ideal time to start it (in the midst of a curve inversion)...but heck, even in the first month, I am up nearly 7% on the futures position...to offset the 4% decline in the equity position. Even with the dreaded inverted curve. Maybe I would have done a little better using much less leverage on a long term bond, maybe not. I haven't checked those.

As to comparing it with just 100% stocks (or 150% stocks)......for a period when interest rates have been basically flat (from 2011 to now.)......how is this for Sharpe?

https://www.portfoliovisualizer.com/bac ... total3=100
First, is it actually true that leveraging short term bonds is equivalent to exposure to a long term bond? It seems to me that the yield curve must be linear for that to be the case.

Secondly, as to your link: ST bonds yielded a positive 0.4% term premium over that period. They are currently yielding a negative 0.6% against cash. If 2Y bonds had a positive term premium (like in your link), we wouldn't be having this conversation now would we?
I believe that it's "close enough". I am targeting duration that's equivalent to TMF....and in the period I've been tracking them it is really close.

Term premiums were positive in 2018 and Treasury futures would have lost a lot of money. They've been negative for much of 2019 and they have made a lot of money. So maybe it doesn't matter nearly as much as the direction of interest rates.
Last edited by rascott on Sun Oct 06, 2019 9:13 pm, edited 1 time in total.

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305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 9:13 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm
305pelusa wrote:
Sun Oct 06, 2019 8:52 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:46 pm
305pelusa wrote:
Sun Oct 06, 2019 8:42 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:24 pm


Let’s approach this from a different direction...over the next ~10 years, which asset allocation do you think will have a higher sharpe ratio? 100% stock or 10% stock/90% 2-year treasuries?
Ok, let's try this. I estimate that 100% stocks will.
Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?
I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.

User avatar
305pelusa
Posts: 905
Joined: Fri Nov 16, 2018 10:20 pm

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 9:18 pm

rascott wrote:
Sun Oct 06, 2019 9:12 pm
305pelusa wrote:
Sun Oct 06, 2019 9:02 pm
rascott wrote:
Sun Oct 06, 2019 8:49 pm
305pelusa wrote:
Sun Oct 06, 2019 8:08 pm
rascott wrote:
Sun Oct 06, 2019 7:03 pm

Well to be fair... the rate was about 1.8 when I actually bought them.... yeah you can go through this thread and the first one and see I've been bothered by the inverted curve re: levered bonds all year.... but have still gone along with it. And it's worked as it was "supposed" to, to this point. Regardless of the implied financing rate looking like it will be a money loser......

I am only looking for the most efficient way to get the downside protection for holding a 150% equity position. If you have a better idea than this, I'm open to it. This has worked in backtesting for the last 60+ years.. regardless of which direction rates were trending. And yeah there were plenty of inversions along the way like we are in now. I don't expect this to be a permanent situation. But I'm no professional.
Well you're getting an exposure to the market (150%) that's bigger than you're comfortable or believe is optimal. So then you pay money to "insure" it. How about you lower the exposure to something you are comfortable and then get to skip the insurance? That would be my idea.

It is possible (and in fact, not very hard) to figure out if this strategy yields a higher risk-adjusted return than just 100% in stocks. It's possible to determine the correlation and volatility 2Y treasuries must display such that your strategy of paying for insurance on 150% stocks delivers higher returns than, say, 100% in stocks. Since 2Y treasuries are not really insurance (at best the correlation is like -0.2... certainly far from a true -1.0 hedge), and the price is really high (-0.6% on 200k+ exposure is quite a bit), I would make an educated guess that the numbers aren't looking good. But I haven't calculated it. One can use Sharpe's equations to do so:
https://web.stanford.edu/~wfsharpe/mia/ ... #imperfect

Regardless, I just told you that your borrowing cost is a whooping 0.4% higher than you thought (tripling the spread from -0.2% to -0.6%) and it doesn't seem to phase you. So I can only imagine you haven't done that no?

Rascott don't you think it's a little imprudent to just use a certain portfolio based on its great results in the past 60 years? Especially when conditions back then were, for the most part, quite a bit different?

Your issue seems to be with the entire 'Adventure'...not in the way I'm going about implementing it...which is just buying the effective duration of TMF at a lower cost than TMF (due to a 1% mgmt fee).

This is 10% of my portfolio. All the rest is in 100% stocks. It'll either work or it won't....but it's the route I've decided to take after a lot of thought and research and I am sticking with it....I'm well aware that it is not an ideal time to start it (in the midst of a curve inversion)...but heck, even in the first month, I am up nearly 7% on the futures position...to offset the 4% decline in the equity position. Even with the dreaded inverted curve. Maybe I would have done a little better using much less leverage on a long term bond, maybe not. I haven't checked those.

As to comparing it with just 100% stocks (or 150% stocks)......for a period when interest rates have been basically flat (from 2011 to now.)......how is this for Sharpe?

https://www.portfoliovisualizer.com/bac ... total3=100
First, is it actually true that leveraging short term bonds is equivalent to exposure to a long term bond? It seems to me that the yield curve must be linear for that to be the case.

Secondly, as to your link: ST bonds yielded a positive 0.4% term premium over that period. They are currently yielding a negative 0.6% against cash. If 2Y bonds had a positive term premium (like in your link), we wouldn't be having this conversation now would we?
I believe that it's "close enough". I am targeting duration that's equivalent to TMF....and in the period I've been tracking them it is really close.

Term premiums were positive in 2018 and Treasury futures would have lost a lot of money. They've been negative for much of 2019 and they have made a lot of money. So maybe it doesn't matter nearly as much as the direction of interest rates.
How do you mean "in the period I've been tracking them it is really close"? Please enlighten me, I literally have no idea why leveraging short term bonds would have the same "effective duration". They certainly don't have the same returns so I don't follow this equivalence.

BTW, yes, what rates do is clearly more important. But since we don't know what they will do (random walk), we could ignore them and just focus on fundamentals. That said, you bring up a great point: If you knew this is how things would go, then you did right. I'm assuming you did not know this is what would happen to rates, so the results can only be attributed to luck thus far.

Also, I ran some numbers and approximations and I find 2Y treasuries need a correlation of around -0.9 to stocks for the portfolio to have a similar Sharpe to 100% stocks. Seeing as how historical correlation has been around 0, this does not seem prudent in the current climate.

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Location: Alabama

Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 9:38 pm

305pelusa wrote:
Sun Oct 06, 2019 9:13 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm
305pelusa wrote:
Sun Oct 06, 2019 8:52 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:46 pm
305pelusa wrote:
Sun Oct 06, 2019 8:42 pm


Ok, let's try this. I estimate that 100% stocks will.
Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?
I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 10:02 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm
305pelusa wrote:
Sun Oct 06, 2019 8:52 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 8:46 pm


Ok...how about 100% stock vs 40% stock/60% long term treasuries? Or anything in between? Or do you think that 100% stock will have a higher sharpe ratio than any portfolio containing treasury bonds?
I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 10:17 pm

305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm
305pelusa wrote:
Sun Oct 06, 2019 8:52 pm


I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.
The rationale is similar to the rationale you are using to invest in leveraged stocks despite a historic bull market run and elevated evaluations. In short...you can’t time the market. Just because stocks may be overvalued, that doesn’t mean you should stop investing. In the same way...just because the yield curve is inverted, that doesn’t mean I should stop investing in leveraged bonds. In both scenarios, the market will always dictate and I will never be able to know what is coming next. All I know is that over the long run, I will receive a return above the risk free rate for taking on risk. And if I’m going to take on risk, I would rather diversify beyond just equity risk.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Sun Oct 06, 2019 10:31 pm

305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.
I’ll add that I view investing like flips of a coin. You never know what the next flip will be. The next flip could be that stocks stay flat/up, the yield curve stays inverted for the next year and I lose money or don’t make as much as I could have. Or it could be that stocks tank due to a variety of reasons, the fed lowers rates back to zero, and the levered bonds save the day. I don’t know what will happen next, so I prefer to keep the risk parity.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 10:49 pm

305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm
305pelusa wrote:
Sun Oct 06, 2019 8:52 pm


I estimate that 40/60 stocks/30Y bonds should have a slightly higher expected Sharpe (within rounding error).
Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Last edited by rascott on Sun Oct 06, 2019 10:54 pm, edited 2 times in total.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 10:51 pm

EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
The rationale is similar to the rationale you are using to invest in leveraged stocks despite a historic bull market run and elevated evaluations.
Nonsense. Equity valuations, while high, still point to a positive expected future return well above the RFR. Valuations would have to go well past 200 times earnings before this wasn't the case. They're currently around 30. But yes, if the S&P were selling at 200 times earnings, I would not leverage stocks either. It sounds like you would, which is absolutely bananas.
EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
In both scenarios, the market will always dictate and I will never be able to know what is coming next. All I know is that over the long run, I will receive a return above the risk free rate for taking on risk. And if I’m going to take on risk, I would rather diversify beyond just equity risk.
Dude, you've already said this to me before. You just take risk on, even when the market is priced to not reward you for it, hoping that it somehow does. We've already discussed this in your previous thread.

I really thought you were going somewhere interesting by asking me about predicted Sharpes. Evidently not. I'm not really sure there's much to discuss here.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 10:59 pm

rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:05 pm


Ok...what about something even closer to being a risk parity portfolio like 30% stock, 60% ITT, and 10% gold?
I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 11:05 pm

305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm


I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.
Well then you need to also convince everyone else in here that is holding TMF that they are wrong as well... and they all should have bailed on it once the curve inverted.

Yes if the curve stays inverted forever it will be a failed idea.

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HEDGEFUNDIE
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by HEDGEFUNDIE » Sun Oct 06, 2019 11:07 pm

The 30 years have not inverted against the 1 month or the 3 month. So leave TMF out of it.
rascott wrote:
Sun Oct 06, 2019 11:05 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm


If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.
Well then you need to also convince everyone else in here that is holding TMF that they are wrong as well... and they all should have bailed on it once the curve inverted. Have a good night.

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 11:15 pm

305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm
305pelusa wrote:
Sun Oct 06, 2019 9:13 pm


I estimate that will have a slightly lower Sharpe than 100% stocks. Seriously, what's your point? I'm kinda tired of solving math equations.
If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 11:15 pm

rascott wrote:
Sun Oct 06, 2019 11:05 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm


If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.
Well then you need to also convince everyone else in here that is holding TMF that they are wrong as well... and they all should have bailed on it once the curve inverted.

Yes if the curve stays inverted forever it will be a failed idea.
Again, LT bonds still yield positive returns above RFR. TMF's fees are high enough that they nullify much of that but it's not as bad as -0.6%.

As to the curve inversion: So then why wouldn't you just wait until it "straightens" back up and THEN establish your position with a positive expected return? This is the part I'm missing.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 11:16 pm

rascott wrote:
Sun Oct 06, 2019 11:15 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 9:38 pm


If you truly believe that 100% stocks will have the highest sharpe ratios in the future, I have nothing more to say. You should lever up whatever portfolio you think will be the most efficient in the future. However, I personally believe a more diversified portfolio will always have a higher sharpe ratio over the long run due to the diversification benefit.
Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.
Do you know how to calculate a Sharpe ratio?

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 11:20 pm

HEDGEFUNDIE wrote:
Sun Oct 06, 2019 11:07 pm
The 30 years have not inverted against the 1 month or the 3 month. So leave TMF out of it.
rascott wrote:
Sun Oct 06, 2019 11:05 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm


Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.
Well then you need to also convince everyone else in here that is holding TMF that they are wrong as well... and they all should have bailed on it once the curve inverted. Have a good night.
It did in August. And TMF is not the 30 yr.... it's 20+ year... think the weighted avg is about 25 years.

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Sun Oct 06, 2019 11:21 pm

305pelusa wrote:
Sun Oct 06, 2019 11:16 pm
rascott wrote:
Sun Oct 06, 2019 11:15 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm
305pelusa wrote:
Sun Oct 06, 2019 10:02 pm


Huh I thought you were going somewhere with it. Any ways, I definitely cannot rationalize adding a negative Sharpe ratio asset in my portfolio. Call me conventional I guess. Adding assets with a negative Sharpe could, maybe, lead to a higher overall portfolio Sharpe. But it's very unlikely and I estimate it won't here.

I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.
Do you know how to calculate a Sharpe ratio?

Yes, what's your point?

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Sun Oct 06, 2019 11:24 pm

rascott wrote:
Sun Oct 06, 2019 11:21 pm
305pelusa wrote:
Sun Oct 06, 2019 11:16 pm
rascott wrote:
Sun Oct 06, 2019 11:15 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm
rascott wrote:
Sun Oct 06, 2019 10:49 pm



I don't understand how you come up with a lower expected Shape ratio for 10% VFINX/90% STT than 100% VFINX.

Since ultra low rates have been the norm... and have been more or less flat:

https://www.portfoliovisualizer.com/bac ... 0&total3=0

I'm taking that portfolio and leveraging it 15x. Why would this be expected to have a worse Sharpe than just 100% stocks
Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.
Do you know how to calculate a Sharpe ratio?

Yes, what's your point?
That the return on cash is very relevant to the calculation of Sharpe ratios as well.

samsdad
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by samsdad » Mon Oct 07, 2019 7:01 am

rascott wrote:
Sun Oct 06, 2019 11:20 pm
It did in August. And TMF is not the 30 yr.... it's 20+ year... think the weighted avg is about 25 years.
Good thing it returned 35.11% in August then.

caklim00
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by caklim00 » Mon Oct 07, 2019 9:13 am

Current rates

Code: Select all

Date		1 Mo	2 Mo	3 Mo	6 Mo	1 Yr	2 Yr	3 Yr	5 Yr	7 Yr	10 Yr	20 Yr	30 Yr
10/01/19	1.79	1.77	1.82	1.81	1.73	1.56	1.51	1.51	1.59	1.65	1.93	2.11
10/02/19	1.75	1.75	1.79	1.75	1.67	1.48	1.43	1.43	1.53	1.60	1.90	2.09
10/03/19	1.78	1.75	1.70	1.66	1.58	1.39	1.34	1.34	1.45	1.54	1.85	2.04
10/04/19	1.73	1.74	1.71	1.65	1.58	1.40	1.35	1.34	1.43	1.52	1.81	2.01
I think my idea of buying ZN futures (10 YR) might not be the best idea (current yield 1.52). I wonder if Wisdomtree NTSX does any sort of changes based on this or if they just continue to split their holdings across the various futures lengths.

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Mon Oct 07, 2019 9:44 am

caklim00 wrote:
Mon Oct 07, 2019 9:13 am
Current rates

Code: Select all

Date		1 Mo	2 Mo	3 Mo	6 Mo	1 Yr	2 Yr	3 Yr	5 Yr	7 Yr	10 Yr	20 Yr	30 Yr
10/01/19	1.79	1.77	1.82	1.81	1.73	1.56	1.51	1.51	1.59	1.65	1.93	2.11
10/02/19	1.75	1.75	1.79	1.75	1.67	1.48	1.43	1.43	1.53	1.60	1.90	2.09
10/03/19	1.78	1.75	1.70	1.66	1.58	1.39	1.34	1.34	1.45	1.54	1.85	2.04
10/04/19	1.73	1.74	1.71	1.65	1.58	1.40	1.35	1.34	1.43	1.52	1.81	2.01
I think my idea of buying ZN futures (10 YR) might not be the best idea (current yield 1.52). I wonder if Wisdomtree NTSX does any sort of changes based on this or if they just continue to split their holdings across the various futures lengths.

No changes.... they hold them all in equal weight.

https://www.wisdomtree.com/etfs/asset-allocation/ntsx

rascott
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by rascott » Mon Oct 07, 2019 12:06 pm

305pelusa wrote:
Sun Oct 06, 2019 11:24 pm
rascott wrote:
Sun Oct 06, 2019 11:21 pm
305pelusa wrote:
Sun Oct 06, 2019 11:16 pm
rascott wrote:
Sun Oct 06, 2019 11:15 pm
305pelusa wrote:
Sun Oct 06, 2019 10:59 pm


Dude Rascott, if I see one more backtest from you where 2Y treasuries yield more than cash, Imma lose my mind broski.

And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.
Do you know how to calculate a Sharpe ratio?

Yes, what's your point?
That the return on cash is very relevant to the calculation of Sharpe ratios as well.

Yeah... and one can only calculate Sharpe ratios in the rear view mirror. One would have thought that the "expected" Sharpe of 2 years notes was negative throughout 2007 as well when we were last inverted... but the actual results were the opposite of that.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Mon Oct 07, 2019 12:27 pm

305pelusa wrote:
Sun Oct 06, 2019 10:51 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
The rationale is similar to the rationale you are using to invest in leveraged stocks despite a historic bull market run and elevated evaluations.
Nonsense. Equity valuations, while high, still point to a positive expected future return well above the RFR. Valuations would have to go well past 200 times earnings before this wasn't the case. They're currently around 30. But yes, if the S&P were selling at 200 times earnings, I would not leverage stocks either. It sounds like you would, which is absolutely bananas.
EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
In both scenarios, the market will always dictate and I will never be able to know what is coming next. All I know is that over the long run, I will receive a return above the risk free rate for taking on risk. And if I’m going to take on risk, I would rather diversify beyond just equity risk.
Dude, you've already said this to me before. You just take risk on, even when the market is priced to not reward you for it, hoping that it somehow does. We've already discussed this in your previous thread.

I really thought you were going somewhere interesting by asking me about predicted Sharpes. Evidently not. I'm not really sure there's much to discuss here.
Well, I was trying to do some deductive reasoning, but it didn't quite work. Since you believe that 100% stock will have a better Sharpe ratio over the next ~10 years than a 10% stock/90% STT, there isn't much sense in continuing the thought experiment. My claim is that a more diversified portfolio should always have a higher Sharpe ratio over an extended period of time due to the diversification benefit. Yes, there will be shorter periods of time when this doesn't hold true (see rampant rising interest rates of the 70s). Yes, the curve is inverted at the moment, but that doesn't mean it will be for the next 10 years. It could uninvert by the end of the year. Consider the figure below. Since 1977, the 2-year has inverted with the Fed Fund Rate several times.

Image

Now, consider the backtest below, also since 1977. This shows 100% stock vs 10% stock/90% STT. Over the time period, the Sharpe ratio of 100% stock was 0.48. For the 10/90 portfolio, it was 0.64. Therefore, if you had levered up the 10/90 portfolio to the same 15% SD of stock over the time period, you could have achieved an overperformance above 100% stocks of 15*(0.64 - 0.48) = 2.4% per year on average (theoretically, assuming you had used futures and incurred minimal slippage due to cost of leverage). As shown in the image above, there were multiple times when the curve would have inverted and your logic (which I can appreciate) would have told you to get out of STT. However, if I need to defy short term logic to achieve long term overperformance, that is a trade off I am willing to make. While I differ from most Bogleheads in my use of leverage, I am still a Boglehead in the sense that I am a passive investor and I don't try to time the market. I am making investing decisions based on very long term trends and I am not going to jump in and out of a strategy based on yield curve inversions.

https://www.portfoliovisualizer.com/bac ... 0&total3=0

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Mon Oct 07, 2019 12:37 pm

rascott wrote:
Mon Oct 07, 2019 12:06 pm
305pelusa wrote:
Sun Oct 06, 2019 11:24 pm
rascott wrote:
Sun Oct 06, 2019 11:21 pm
305pelusa wrote:
Sun Oct 06, 2019 11:16 pm
rascott wrote:
Sun Oct 06, 2019 11:15 pm



And that was a non leveraged portfolio to ask you about your claims on Sharpe ratios..... the cash rate is irrelevant to that.
Do you know how to calculate a Sharpe ratio?

Yes, what's your point?
That the return on cash is very relevant to the calculation of Sharpe ratios as well.

Yeah... and one can only calculate Sharpe ratios in the rear view mirror. One would have thought that the "expected" Sharpe of 2 years notes was negative throughout 2007 as well when we were last inverted... but the actual results were the opposite of that.
Don't mix up "expected value" and "realized value". Only over many observations will those converge.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Mon Oct 07, 2019 12:42 pm

EfficientInvestor wrote:
Mon Oct 07, 2019 12:27 pm
305pelusa wrote:
Sun Oct 06, 2019 10:51 pm
EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
The rationale is similar to the rationale you are using to invest in leveraged stocks despite a historic bull market run and elevated evaluations.
Nonsense. Equity valuations, while high, still point to a positive expected future return well above the RFR. Valuations would have to go well past 200 times earnings before this wasn't the case. They're currently around 30. But yes, if the S&P were selling at 200 times earnings, I would not leverage stocks either. It sounds like you would, which is absolutely bananas.
EfficientInvestor wrote:
Sun Oct 06, 2019 10:17 pm
In both scenarios, the market will always dictate and I will never be able to know what is coming next. All I know is that over the long run, I will receive a return above the risk free rate for taking on risk. And if I’m going to take on risk, I would rather diversify beyond just equity risk.
Dude, you've already said this to me before. You just take risk on, even when the market is priced to not reward you for it, hoping that it somehow does. We've already discussed this in your previous thread.

I really thought you were going somewhere interesting by asking me about predicted Sharpes. Evidently not. I'm not really sure there's much to discuss here.
Well, I was trying to do some deductive reasoning, but it didn't quite work. Since you believe that 100% stock will have a better Sharpe ratio over the next ~10 years than a 10% stock/90% STT, there isn't much sense in continuing the thought experiment. My claim is that a more diversified portfolio should always have a higher Sharpe ratio over an extended period of time due to the diversification benefit. Yes, there will be shorter periods of time when this doesn't hold true (see rampant rising interest rates of the 70s). Yes, the curve is inverted at the moment, but that doesn't mean it will be for the next 10 years. It could uninvert by the end of the year. Consider the figure below. Since 1977, the 2-year has inverted with the Fed Fund Rate several times.

Image

Now, consider the backtest below, also since 1977. This shows 100% stock vs 10% stock/90% STT. Over the time period, the Sharpe ratio of 100% stock was 0.48. For the 10/90 portfolio, it was 0.64. Therefore, if you had levered up the 10/90 portfolio to the same 15% SD of stock over the time period, you could have achieved an overperformance above 100% stocks of 15*(0.64 - 0.48) = 2.4% per year on average (theoretically, assuming you had used futures and incurred minimal slippage due to cost of leverage). As shown in the image above, there were multiple times when the curve would have inverted and your logic (which I can appreciate) would have told you to get out of STT. However, if I need to defy short term logic to achieve long term overperformance, that is a trade off I am willing to make. While I differ from most Bogleheads in my use of leverage, I am still a Boglehead in the sense that I am a passive investor and I don't try to time the market. I am making investing decisions based on very long term trends and I am not going to jump in and out of a strategy based on yield curve inversions.

https://www.portfoliovisualizer.com/bac ... 0&total3=0
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Mon Oct 07, 2019 1:00 pm

305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Mon Oct 07, 2019 1:07 pm

EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by RandomWord » Mon Oct 07, 2019 1:30 pm

305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I don't think that's true. "everyone" expects rates to go down, because the fed keeps talking as if they're going to cut rates. Maybe "everyone" is wrong, but it's a lot more likely for them to go down than go up right now.

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Mon Oct 07, 2019 1:57 pm

305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I would say 1.5% would be a reasonable expected return.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Mon Oct 07, 2019 2:07 pm

EfficientInvestor wrote:
Mon Oct 07, 2019 1:57 pm
305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I would say 1.5% would be a reasonable expected return.
Right. Let's do the same for the 3 month Treasury (the cash rate). Given our assumption about the random walk nature of rates, then the current 1.7% yield would be our expected return for cash for the upcoming decade as well.

Given that our expected return on 2Y treasuries is 1.5% and our expected return of cash is 1.7%, then the expected/average/mean Sharpe ratio is negative.

3) I don't really believe the 2Y treasury Sharpe will likely be negative for the next decade. I don't think you believe so either. So what assumption have we made the we might want to revisit? Hint: Back to Q1

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Mon Oct 07, 2019 2:22 pm

305pelusa wrote:
Mon Oct 07, 2019 2:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:57 pm
305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I would say 1.5% would be a reasonable expected return.
Right. Let's do the same for the 3 month Treasury (the cash rate). Given our assumption about the random walk nature of rates, then the current 1.7% yield would be our expected return for cash for the upcoming decade as well.

Given that our expected return on 2Y treasuries is 1.5% and our expected return of cash is 1.7%, then the expected/average/mean Sharpe ratio is negative.

3) I don't really believe the 2Y treasury Sharpe will likely be negative for the next decade. I don't think you believe so either. So what assumption have we made the we might want to revisit? Hint: Back to Q1
I agree with your conclusions. I have done the same analysis in the past and have wrestled with the logic. My conclusion is that the expected return of cash over a long period of time isn't necessarily the current yield. As you suggest, we need to go back to the first question. While I'm of the opinion that the market is random, I don't think the fed is random in how they set their policy. The 2-year rate is mostly random because it is dictated by the market more than it is the fed. The further you go out on the yield curve, the less you are pinned to the fed rate and the more you are affected by the market. The cash rate is not as random because it is more dictated by the fed than the market. As you stated, I don't think the fed will ever allow the curve to stay inverted for a whole decade. It may last a few years at times, but the inversion tends to correct itself one way or another.

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305pelusa
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by 305pelusa » Mon Oct 07, 2019 2:35 pm

EfficientInvestor wrote:
Mon Oct 07, 2019 2:22 pm
305pelusa wrote:
Mon Oct 07, 2019 2:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:57 pm
305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm


Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I would say 1.5% would be a reasonable expected return.
Right. Let's do the same for the 3 month Treasury (the cash rate). Given our assumption about the random walk nature of rates, then the current 1.7% yield would be our expected return for cash for the upcoming decade as well.

Given that our expected return on 2Y treasuries is 1.5% and our expected return of cash is 1.7%, then the expected/average/mean Sharpe ratio is negative.

3) I don't really believe the 2Y treasury Sharpe will likely be negative for the next decade. I don't think you believe so either. So what assumption have we made the we might want to revisit? Hint: Back to Q1
I agree with your conclusions. I have done the same analysis in the past and have wrestled with the logic. My conclusion is that the expected return of cash over a long period of time isn't necessarily the current yield. As you suggest, we need to go back to the first question. While I'm of the opinion that the market is random, I don't think the fed is random in how they set their policy. The 2-year rate is random because it is dictated by the market more than it is the fed. The further you go out on the yield curve, the less you are pinned to the fed rate and the more you are affected by the market. The cash rate is not as random because it is more dictated by the fed than the market. As you stated, I don't think the fed will ever allow the curve to stay inverted for a whole decade. It may last a few years at times, but the inversion tends to correct itself one way or another.
Ok good. This is all in retrospect pretty obvious right? If we are to believe that 2Y treasuries will likely have a positive Sharpe then, given that it's currently on track to a negative Sharpe, we believe it is more likely that the curve "straightens" back up than further inverts. Whether that's from Fed policy or otherwise does not actually matter.


4) If we (and the market) have a very reasonable expectation that the Fed will cut its rate (and everyone thinks so), this would explain a piling into the 2Y treasuries. So from a return perspective for the upcoming 2 years, what is riskier? Buying and holding 2Y bonds or investing in cash and reinvesting every 3 months. Which one is less likely to produce its expected return (1.5% for one and 1.7% for the other).

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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by Lee_WSP » Mon Oct 07, 2019 3:06 pm

RandomWord wrote:
Mon Oct 07, 2019 1:30 pm
305pelusa wrote:
Mon Oct 07, 2019 1:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:00 pm
305pelusa wrote:
Mon Oct 07, 2019 12:42 pm
Let's try my thought experiment. Let's forget about historical data. For a million and one reasons, it could lead you astray. Let's just start baby steps:

1) Do you truly believe rates follow a random walk? Like they're coin flips? As in "rates are as likely to go up than down"?
Before I answer the question, I want to address historical data. I completely agree that it can lead you astray. However, it is all we have to go off of to draw conclusions about what may happen in the future. You seem to be in the camp that says "since the yield curve is inverted, I should not apply leverage to bonds because the expected return of bonds is less than the current borrowing rate". However, 40+ year data that I showed in my previous post shows that there would have been many times over the 40 year period when you would have borrowed at a higher rate to invest in bonds. Despite that, the levered 10/90 portfolio would have overperformed. I'm not trying to claim that the levered 10/90 portfolio will overperform over the next 10 years. I'm trying to point out that it is a real possibility to contrast your claim that you shouldn't invest in leveraged bonds when the curve is inverted.

Now, to answer your question, I would generally say yes. I don't know if rates will be up or down in the future, so it is a random walk.
To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I don't think that's true. "everyone" expects rates to go down, because the fed keeps talking as if they're going to cut rates. Maybe "everyone" is wrong, but it's a lot more likely for them to go down than go up right now.
I agree with Random. Market fluctuations are not random, but they are unknowable.

EfficientInvestor
Posts: 235
Joined: Thu Nov 01, 2018 7:02 pm
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Re: HEDGEFUNDIE's excellent adventure Part II: The next journey

Post by EfficientInvestor » Mon Oct 07, 2019 4:11 pm

305pelusa wrote:
Mon Oct 07, 2019 2:35 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 2:22 pm
305pelusa wrote:
Mon Oct 07, 2019 2:07 pm
EfficientInvestor wrote:
Mon Oct 07, 2019 1:57 pm
305pelusa wrote:
Mon Oct 07, 2019 1:07 pm


To your first point: Yes I understand and I hear you. I didn't just straight up ignore your post haha. You'll see my point in a moment.

Let's continue:
2) Right now, 2Y treasuries yield 1.5%. Given that rates are as likely to go up as down, what would you say is the mean/average/expected return for 2Y treasury bonds for the next decade.

Hint: For the next 2 years, if held to maturity (like a B&Her such as yourself will), you will get 1.5% return on average. Then reinvest it 2 years at the 2Y treasury rate of 2021. And then 2023, etc until 2029. If rates are as likely to go up as down, what is the average/mean/expected rate at which you'll reinvest in those future dates
I would say 1.5% would be a reasonable expected return.
Right. Let's do the same for the 3 month Treasury (the cash rate). Given our assumption about the random walk nature of rates, then the current 1.7% yield would be our expected return for cash for the upcoming decade as well.

Given that our expected return on 2Y treasuries is 1.5% and our expected return of cash is 1.7%, then the expected/average/mean Sharpe ratio is negative.

3) I don't really believe the 2Y treasury Sharpe will likely be negative for the next decade. I don't think you believe so either. So what assumption have we made the we might want to revisit? Hint: Back to Q1
I agree with your conclusions. I have done the same analysis in the past and have wrestled with the logic. My conclusion is that the expected return of cash over a long period of time isn't necessarily the current yield. As you suggest, we need to go back to the first question. While I'm of the opinion that the market is random, I don't think the fed is random in how they set their policy. The 2-year rate is random because it is dictated by the market more than it is the fed. The further you go out on the yield curve, the less you are pinned to the fed rate and the more you are affected by the market. The cash rate is not as random because it is more dictated by the fed than the market. As you stated, I don't think the fed will ever allow the curve to stay inverted for a whole decade. It may last a few years at times, but the inversion tends to correct itself one way or another.
Ok good. This is all in retrospect pretty obvious right? If we are to believe that 2Y treasuries will likely have a positive Sharpe then, given that it's currently on track to a negative Sharpe, we believe it is more likely that the curve "straightens" back up than further inverts. Whether that's from Fed policy or otherwise does not actually matter.


4) If we (and the market) have a very reasonable expectation that the Fed will cut its rate (and everyone thinks so), this would explain a piling into the 2Y treasuries. So from a return perspective for the upcoming 2 years, what is riskier? Buying and holding 2Y bonds or investing in cash and reinvesting every 3 months. Which one is less likely to produce its expected return (1.5% for one and 1.7% for the other).
If I were to place all my money in a single investment, I agree that putting it in cash at the moment makes the most sense. However, I'm not placing all of my money in a single investment. I am trying to implement a 2 coin flip scenario as described in my post at the link below. If I were to put half my risk in stocks and half my risk in cash, I would just have a 50% diluted stock portfolio. It is very possible that my leveraged bond coin will flip negative returns over the next couple years due to the inversion, but that doesn't mean I should go back to flipping just a single coin (i.e. stocks). While the odds may be a little less due to the inversion, there is still a very real possibility that the leveraged bond coin will continue to flip positive over the next couple years. That is why I continue to flip two coins...you never know what will come next.

https://theleveragedindexer.com/2019/08 ... ged-bonds/

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