Countercyclical Investing

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Kevin K
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Countercyclical Investing

Post by Kevin K »

Most likely there's nothing really new under the sun but I find the approach of this newly-launched ETF intriguing. It kind of seems like an algorithm-driven analogue to Wellesley and Wellington.

It's a fund-of-funds that uses 4-8 mostly Vanguard index ETF's. There's a lot of good info on the FAQ page but here's the basic explanation of what they mean by countercyclical investing:

"Countercyclical Indexing/rebalancing is a strategy that rebalances its investments to reduce the pro-cyclical nature of a portfolio. Essentially, a countercyclical rebalancing methodology seeks to adjust a portfolio’s holdings to account for current market and macroeconomic conditions. In contrast, a standard passively-managed fund (which use pro-cyclical methodologies) will generally hold stocks and bonds in the same percentage allocation (e.g., a standard 60/40 portfolio) regardless of market valuations and macroeconomic conditions. The problem with a fixed approach like this is that it assumes that the 60% stock allocation is always exposed to the same amount of risk, when, in reality, we know that can vary over time. For example, a portfolio with 60% stocks in 2008 faced very different risks than a portfolio with 60% stocks in 2010 and while this approach may be perfectly fine for many investors it may also pose significant behavioral risks to investors who think they're buying a "balanced" fund that actually has very unbalanced exposure to stock and bond risk.
The Discipline Fund rebalances more dynamically than a static fund does which allows the fund to rebalance toward stocks when they appear more attractive and away from stocks when they appear less attractive. This helps better control for behavioral biases by aligning our asset allocation to the potential behavioral risks that the ups and downs of the market expose us to."

The rules state that the permissible range of equities:bonds won't exceed 70:30/30:70. Globally diversified (by market cap) and the bond sleeve strategy also seems pretty well-thought out. Cullen Roche is the founder; he wrote a book called "Pragmatic Capitalism" that is well-reviewed. Curious to hear other's thoughts about this new flavor of All Weather.

https://disciplinefunds.com/what-is-the ... line-fund/
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David Jay
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Re: Countercyclical Investing

Post by David Jay »

Well, according to M* DSCF has been open for one month, has under 10 million in assets and has a .39 ER. That isn't much information.

Not to mention that 70/30 to 30/70 is quite a range, how can they know the risk tolerance of their customers over that range? I have come to the belief that about 85% of investing is behavioral, or as Hersh Shefrin says: "It's not an engineering problem."
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nisiprius
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Re: Countercyclical Investing

Post by nisiprius »

Countercyclical Indexing/rebalancing is a strategy that rebalances its investments to reduce the pro-cyclical nature of a portfolio. Essentially, a countercyclical rebalancing methodology seeks to adjust a portfolio’s holdings to account for current market and macroeconomic conditions.
How is that any different from "tactical asset allocation?"

Unfortunately, "How are the Discipline Funds different from traditional 'tactical allocation' funds" is not apparently a frequently asked question.

Larry Swedroe has written a number of times about tactical asset allocation funds; in 2021, Tactical Asset Allocation versus Static Indexing: Who Wins?
Tactical asset allocation (TAA) is an investment strategy that gained its original popularity in the 1980s. The financial crisis of 2008 led to another surge in demand for funds using TAA as their strategy. The objective of TAA is to provide better than benchmark returns with (possibly) lower volatility. This would be accomplished by forecasting returns of two or more asset classes and varying the exposure (percent allocation) accordingly.
Doesn't that sound exactly like "countercyclical indexing?" It obviously will work exactly as well as your ability to forecast those cycles. Ay, there's the rub. Swedroe continues:
The varying exposure to various asset classes that tactical asset allocation depends on is based on economic and/or market (technical) indicators....

Joseph McCarthy and Edward Tower contribute to the literature with their study "Static Indexing Beats Tactical Asset Allocation," published in The Journal of Index Investing Spring/Summer 2021.... McCarthy and Tower benchmarked the returns of TAA funds against the Vanguard Total Stock Index ETF (VTI), the Vanguard Total International Stock Market ETF (VXUS), the Vanguard Total Bond Index ETF (BND)....

Following is a summary of their findings:
  • TAA funds have higher expense ratios and higher turnover than static index funds.
  • Tactical asset allocation mutual funds and fund-of-fund ETFs substantially under-return static index funds that have the same style.
  • TAA funds typically have higher return fluctuations than do their corresponding benchmarks....
Last edited by nisiprius on Wed Oct 20, 2021 8:09 pm, edited 1 time in total.
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Re: Countercyclical Investing

Post by 000 »

Do you think the 'rebalancing premium' can overcome 0.39% ER?

I also don't see any TIPS, SCV, gold, etc. so is this just a traditional stock / nominal bond portfolio with varying AA?
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David Jay
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Re: Countercyclical Investing

Post by David Jay »

Kevin K wrote: Wed Oct 20, 2021 5:55 pmThe Discipline Fund rebalances more dynamically than a static fund does which allows the fund to rebalance toward stocks when they appear more attractive and away from stocks when they appear less attractive.
I especially like this sentence.
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Kenkat
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Re: Countercyclical Investing

Post by Kenkat »

For example, a portfolio with 60% stocks in 2008 faced very different risks than a portfolio with 60% stocks in 2010
The problem is no one thought 2008 was risky until 2009. And no one thought 2010 wasn’t risky until the market went up for the next seven years straight 2011-2017.
sandan
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Re: Countercyclical Investing

Post by sandan »

I do this for a hobby, but it is primarily through individual stocks that usually dominate particular industries. There seem to be quite a few industries like this. Its a fun gamble to see which industries can recover an economic cycle. Many don't.
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Re: Countercyclical Investing

Post by secondopinion »

Kevin K wrote: Wed Oct 20, 2021 5:55 pm Most likely there's nothing really new under the sun but I find the approach of this newly-launched ETF intriguing. It kind of seems like an algorithm-driven analogue to Wellesley and Wellington.

It's a fund-of-funds that uses 4-8 mostly Vanguard index ETF's. There's a lot of good info on the FAQ page but here's the basic explanation of what they mean by countercyclical investing:

"Countercyclical Indexing/rebalancing is a strategy that rebalances its investments to reduce the pro-cyclical nature of a portfolio. Essentially, a countercyclical rebalancing methodology seeks to adjust a portfolio’s holdings to account for current market and macroeconomic conditions. In contrast, a standard passively-managed fund (which use pro-cyclical methodologies) will generally hold stocks and bonds in the same percentage allocation (e.g., a standard 60/40 portfolio) regardless of market valuations and macroeconomic conditions. The problem with a fixed approach like this is that it assumes that the 60% stock allocation is always exposed to the same amount of risk, when, in reality, we know that can vary over time. For example, a portfolio with 60% stocks in 2008 faced very different risks than a portfolio with 60% stocks in 2010 and while this approach may be perfectly fine for many investors it may also pose significant behavioral risks to investors who think they're buying a "balanced" fund that actually has very unbalanced exposure to stock and bond risk.
The Discipline Fund rebalances more dynamically than a static fund does which allows the fund to rebalance toward stocks when they appear more attractive and away from stocks when they appear less attractive. This helps better control for behavioral biases by aligning our asset allocation to the potential behavioral risks that the ups and downs of the market expose us to."

The rules state that the permissible range of equities:bonds won't exceed 70:30/30:70. Globally diversified (by market cap) and the bond sleeve strategy also seems pretty well-thought out. Cullen Roche is the founder; he wrote a book called "Pragmatic Capitalism" that is well-reviewed. Curious to hear other's thoughts about this new flavor of All Weather.

https://disciplinefunds.com/what-is-the ... line-fund/
Define risk.

If they mean volatility, "buying the dip" involves buying when the volatility is higher; "selling high" usually occurs when the volatility is lower. The reverse "controls risk"; that causes panic sells.

If they mean specific macroeconomic risks, do all of them need to be avoid by the investor? Some are perfectly alright to take anyway.

I take the risks that I can afford to take; because of this, what behavior do I need to control?
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vanbogle59
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Re: Countercyclical Investing

Post by vanbogle59 »

Kevin K wrote: Wed Oct 20, 2021 5:55 pm
"... which allows the fund to rebalance toward stocks when they appear more attractive and away from stocks when they appear less attractive."
Gotta love all the different ways to say "crystal ball".
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firebirdparts
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Re: Countercyclical Investing

Post by firebirdparts »

Gonna need a crystal ball for sure. Time machine would be better.
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Kevin K
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Re: Countercyclical Investing

Post by Kevin K »

Thanks very much to all who’ve posted here for nipping my interest in this newfangled sounding approach (that is indeed just tactical asset allocation rebranded) in the bud - with just the right mixture of scalpels and humor. Much-appreciated!
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Re: Countercyclical Investing

Post by nisiprius »

I also wonder if the word "countercyclical" is being misapplied.

I'm most familiar with it in the context of stock-picking for an actively-managed portfolios of individual stocks. It is sometimes asserted... e.g. by Investopedia, What Is a Counter-Cyclical Stock?
A counter-cyclical stock refer to the shares of a company that belongs to an industry or niche with financial performance that is typically negatively correlated to the overall state of the economy. As a result, the stock's price will also tend to move in a direction that is opposite to the general economic trend, meaning appreciation occurs during times of recession and depreciations in value occur in times of economic expansion.
If such beasts actually exist, can be identified, continue to be countercyclical after being spotted, and do not also have lower return than cyclical stocks... obviously you could include them in a stock portfolio and cut the risk of the portfolio. Whether that works any better than a bond allocation is... well...

I don't want to go down that particular rabbit hole because that does not seem to be what this fund seeks or claims to do.
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Forester
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Re: Countercyclical Investing

Post by Forester »

The stock-bond allocation varies between 70-30 & 30-70 - but importantly, must overcome the 0.39% fee, so call that 0.3% over and above what Vanguard & iShares offer.
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Re: Countercyclical Investing

Post by Hydromod »

Just for background interest, Allocate Smartly recently had a post on a countercylical trend following approach.

Link to analysis.

Dunno if this is anything similar.
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Re: Countercyclical Investing

Post by secondopinion »

firebirdparts wrote: Wed Oct 20, 2021 10:40 pm Gonna need a crystal ball for sure. Time machine would be better.
Send the money into the past, the past self invests it, and make even more return. Of course, I wonder the impact of inflation of a time machine would have. Let alone how are taxes assessed (and what the IRS would do).
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Kevin K
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Re: Countercyclical Investing

Post by Kevin K »

After having a few more conversations I stand corrected: the Discipline Fund (and countercyclical investing) are not Tactical Investing.

From one knowledgeable commenter:

" This isn't a tactical allocation fund at all. Tactical allocation funds have very high average fees of 1.55%, are tax inefficient and tend to focus on short-term trends to try to make discretionary decisions on how to time the market. The Discipline Fund does none of that. The Discipline Fund has low fees for a global allocation fund, is highly tax efficient and uses a systematic rebalancing processes that are long-term by design. Yes, the fund rebalances more countercyclically than a 60/40 for instance, but why is it necessarily good to rebalance a 60/40 that grows to 70/30 back to a 60/40, but it's bad to rebalance a 50/50 (our benchmark) from 55/45 beyond its original weight to 45/55?

In fact, you could argue that what the Discipline Fund does is way more "passive" than a 60/40 because it is much closer to global cap weighting on average since it holds cap weighted stocks and will remain much closer to the actual market cap of total financial assets (45/55) when compared to something like 60/40, which actually makes huge deviations from global market cap by not owning any foreign stocks or bonds.

Lastly, it's ironic that a Boglehead board is so against this sort of a strategy when John Bogle literally said he used to implement something like this in his own portfolio:"

https://youtu.be/oJynLAvzccc

There's also a new-to-me post in the Q & A part of the Discipline Fund website that specifically addresses the Tactical Asset question:

https://disciplinefunds.com/faqs/

So for me the take away is that Mr. Roche is genuinely trying to do something innovative here in creating an algorithm-based way to implement something that many if not most knowledgeable investors do, albeit not necessarily in a systematic or rules-based way. I'm going to watch the ETF with interest and read his book.
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Re: Countercyclical Investing

Post by secondopinion »

I see a rather interesting statement: "For example, if the stock market declined and a typical passively-managed 50-50 portfolio became a 40-60 stock-bond allocation, it would again be reallocated back to its original 50-50 stock/bond allocation. Whereas, the Discipline Fund may be reallocated to a 60-40 stock-bond allocation to account for the potential that equities often become less risky after they have declined in value."

Have they actually studied the volatility after such dips? On such decreases, the volatility increases; it is not safer but instead is riskier to increase stock allocations.

It is doing a form of concavity investing and it is being described as safer. In reality, the downside risk is greater and the upside potential is lower. Concavity is not a problem if people want it, but it is not safe like it is being made to sound. I do concavity with my allocation; the notion that it is safer (especially in the short-term) is false. Very long-term and it might be true, but how many people are going to believe it when a major dip in stocks continues and continues? Behaviorally, it is entirely opposite of what many people want who are panic selling. They might panic sell the ETF instead.

"""
Disparity in risk due to the overweight of the stock market allocation, which contributes a disproportionate quantity of risk to a balanced index fund.
Inefficiencies in capital gains distributions caused by rebalancing.
Bond allocations that do not sufficiently hedge the stock market component.
"""

First, that is dirt simple to fix: reduce stocks.
Second, overbalancing does not cause capital gains? If they are talking about mutual funds, then we can just hold ETFs ourselves.
Third, quality of bonds is something we can control; balance the right combination of treasuries and corporate bonds, and problem solved.
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Re: Countercyclical Investing

Post by loghound »

reviving this thread: Cullen Roche was on Morningstars "the long view" podcast

https://www.morningstar.com/podcasts/the-long-view/144

It was an interesting listen......... I kind of liked his view on trying to avoid behavioral problems..
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Re: Countercyclical Investing

Post by firebirdparts »

well, this old thread was totally about the greatest behavioral problem of all time, which is convincing yourself to get out of the market.

"countercyclical" position feels pretty bad when you're on the sidelines with stonks are going to the moon.

I do think, FWIW, there are some ways that you can try without making a huge error. All these schemes would require you not to be fully invested, and I'm not, but in the end there are long periods where everything brilliant you can do is inferior to the guy who's 100% stocks and doesn't even know it.

I admit it appeals to me to write a rule based on past dips if you like to do that. Necessarily, real people might be adding money while working and then spending it when retired. Fortunately, even wtihout rules, those people pile money into stocks during dips during their working years and then don't sell stocks during dips during the retired years. The ultimate genius, really, and it creates itself if you just act like a know-nothing person with a 60/40 or whatever.
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Re: Countercyclical Investing

Post by Horton »

First, I enjoy reading Cullen Roche’s blog and he’s a engaging speaker. His take on quantitative easing, from the beginning, was contrary to most experts and it seems like he has generally been correct. Lucky or good…I don’t know.

At a glance, this fund appears to implement what he wrote about in this paper:

https://papers.ssrn.com/sol3/papers.cfm ... id=2740027

All that said, the fee of 0.39% is pretty high. As someone mentioned above, you are paying about 0.30% in fees on top of the underlying holdings. There’s likely also some significant bid/ask spreads on the ETF due to its size. It’s probably cheaper than using Mr. Roche’s RIA, but, if desired, you could probably replicate this yourself by looking up the holdings on Morningstar and buying them directly.

IMO, the fund would be more interesting if the fee was 0.20% or less. This would make it comparable in cost to other indexed all-in-one funds.
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Re: Countercyclical Investing

Post by Gaston »

David Jay wrote: Wed Oct 20, 2021 7:00 pm I have come to the belief that about 85% of investing is behavioral, or as Hersh Shefrin says: "It's not an engineering problem."
I tend to agree with you. On some days, I subscribe to the semi-strong version of EMH (efficient markets hypothesis). On others, however, AMH (adaptive markets hypothesis) seems more likely, where emotions and irrationality come into play.

The problem is, neither EMH nor AMH can be used to reliably predict future prices. AMH perhaps is a little better during extreme market dips, if you have the courage to buy when everyone else is panicking.
Last edited by Gaston on Sat Jan 15, 2022 7:54 pm, edited 1 time in total.
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Horton
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Re: Countercyclical Investing

Post by Horton »

Here’s the advisory fee for Mr. Roche’s RIA firm:
Our fee of 0.35% is among the lowest in the asset management business.
https://orcamgroup.com/faqs/

For RIA clients, I wonder if he now uses this ETF or buys the underlying ETFs directly. If the latter, it might be better to use the RIA services, rather than the ETF, because presumably you would get more personalized advice in addition to this strategy.
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Horton
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Re: Countercyclical Investing

Post by Horton »

I also found this statement interesting with the FAQs: [1]
…the Discipline Fund will hold an underlying stock allocation across 3-4 ETFs that closely reflects the global market cap of stocks (as of 2021, that is roughly 45% U.S. stocks and 55% foreign stocks…

I thought the global market was 60% US and 40% non-US? [2]

[1] Source: https://disciplinefunds.com/faqs/
[2] Source: https://www.morningstar.com/etfs/arcx/vt/portfolio
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Gaston
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Re: Countercyclical Investing

Post by Gaston »

Horton wrote: Sat Jan 15, 2022 7:51 pm I thought the global market was 60% US and 40% non-US?
I think you are correct. Vanguard Total World Stock (VT) is at 60% US and 40% non- US.
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