20% annual returns over 40 years...interested?

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account. In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[Kbg]

.

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange/broker are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account on a daily basis...to ensure you have adequate cash on hand to meet your contract's settlement amount. Additionally, the overnight margin per contract is based on what the exchange calculates as a normal extreme daily move which can and will be adjusted up during periods of high volatility. For example, the mini S&P 500 contract's overnight margin right now is equal to about a 5% move.

In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[dragoncar]

That's amazing. There's still counterparty risk, of course, but I see why it's relatively insignificant

[MachineGhost]

Generally, the rule of thumb is to have an account size 3x to 4x the historical MaxDD (absolute dollars) to be able to survive. That has held up in every situation I recall when backtesting futures trading systems.

Also, I think you're confusing the exchanges/brokers with the clearinghouses which are pre-Federal Reserve-style associations owned by the exchanges. The clearinghouses are who guarantee the derivative contracts. The ruckus about off exchange derivatives being brought on exchange via Frank-Dodd Act after the subprime collapse -- they had no clearinghouses by definition so it was direct counterparty risk with each other. Very, very bad! You simply cannot trust a counterparty, especially investment banks as their whole modus operandi is front-running your trades and ripping your muppet face off.

Another lynchpin of the futures industry is that customer funds may not actually be segregated off the broker's balance sheet as that recent futures brokerage collapse and suicide of its owner indicated... PFG was it? Perengine Financial Group?

[Kbg]

Check out who the clearing houses are...

Securities must be segregated. Cash, not so much. Stay loaded up with ST T-Bills to the max possible.

The moral of the story, don't go with small firms that offer a sketchy amount of leverage. Go large with lots of retail customers who will light up their local Congressman's office, good automated risk control and lots of assets. Fidelity, Schwab, Vanguard, IB and TDW should be just fine.

But again, short of major catastrophe, these are all some of the most liquid contracts on the face of the planet.

[Kbg]

For a 100K portfolio...

2.5x means 250K equivalent/25% each to SHY, TMF, UGLD, and SPXL/25K SHY and 225K (75K x3) equivalent everything else

2x means 200K equivalent/16.667 each to the above and 50% to SHY/50K SHY and 150K (50K x3) equivalent everything else

1.5x means 150K equivalent/8.333% each to the above and 75% to SHY/75K SHY and 75K (25K x3) equivalent everything else

1x means 100K/25% each to SHY, TLT, GLD, SPY

Purchase price was at the close 12/31/15 through the close on 7/29/16

2.5x = 43.07%/-5.76%DD

2x = 29.12%/-4.31%DD

1.5x = 15.20%/-2.51%DD

1x = 13.62%/-1.62%DD

Futures: +3.74% since 7/12/16. 1.9 percentage points separates gold from LTT so no need to rebalance.

Personal mix = 35.33%

Comment: The port is now at an all time (backtest) high again. In my personal mix I'm +6.5 percentage points vs. my tracking bogey due to timely rebalancing. We also had our worst DD for the year thus far in July before rebounding to a new high.

[Indexinvestor]

Hi all,

My first post :-)
I am new to this forum and invested in the HBPP using ETF's since a couple of years back.
I think I read this thread from start to finish about 3 times now....and I am hooked to say the least. Thank you for all your contributions and a special thanks to KBG!
I am in my "asset growth years" so to speak and I am contemplating doing the 3xETF version that KBG is talking about: 50% SHY, 16.7% SPXL, 16.7% TMF, 16.7% UGLD ie the 2x.
As I understand it backtests quite well and if a total meltdown is coming I will still be standing with 50% cash.
My dilemma is how much of my total portfolio I should allocate to the above? I am not thinking of doing it only as a VP but to a greater extent...

[Kbg]

Please, consider it a VP and not a PP. Personally, I would start out small and wait for a really bad drawdown to see if you actually can take the volatility...and I highly recommend you not look at the individual elements, just look at the portfolio bottom line ups and downs

[Indexinvestor]

Hi KBG...thanks for a quick response.
For me the individual asset classes do not matter at all...why should they? Its like having a portfolio of stocks and rank the overall performance on the least performing stock?
I definately can take the volatility....have done so some years ago with a 100% stock portfolio..
Contrary to my previous portfolios I like the max drawdown aspect and yet a considerable upside.

[Cortopassi]

Indexinvestor,

Don't do it! If you have researched the 2x/3x enough you'll see things like below, and will have read about decay.

YTD, woo hoo, look at that NUGT go! (Miners 3x). Looks like a great deal, right?



Then look at 5 year. Both are near zero from the starting level

[iwealth]

Also keep in mind that a falling 3x leveraged instrument will approach zero rather quickly so if the underlying asset rebounds, you will not participate in proportionate gains.

Quick example:

If the underlying asset price is 100 and it falls 30% to 70 then rises 50% to 105.
The 3x ETF is 100 and it falls 90% to 10 then rises 150% to only 25.

The only way you can track a 2x PP is if you frequently rebalance the 3x ETFs and keep them at 50% of your total portfolio. And if the 3x ETFs are all falling at the same time, you will be eating into your cash pile rather quickly.

[Cortopassi]

Good example.

What I tried once and made minimal money, not worth the effort, was to short two competing instruments. So you could short DUST and NUGT and take advantage of the decay. But many of these are not available for shorting, or if they are have shorting fees/expenses, so those costs ate into profits.

I did it with UCO and SCO. And found I could make a little. but eventually they get unbalanced, so you still have to watch too closely for my taste.

AND, you also need to start out when the funds are fresh or split to make them more even. Doing this strategy now with DUST at $5 and NUGT at $154, well, they are already severely unbalanced.

Go to the casino or track instead, at least you'll enjoy yourself for a while as you are losing money.

[mukramesh]

Hasn't kbg already shown that for trending non/inversely correlated assets, the decay actually works in your favor? I'd be most worried when all PP assets are in a sideways market.

[iwealth]

Hasn't kbg already shown that for trending non/inversely correlated assets, the decay actually works in your favor? I'd be most worried when all PP assets are in a sideways market.

The problem is that these correlations are not consistent and positive correlations between assets can last for extended periods of time.

I can assure you that there will be extended periods where 2 of 3 or all 3 volatile asset classes rise and fall at the same time.

[Kbg]

Cartopassi, interesting, but not really relevant. A totally different asset. Again, for like the 1000th time, it is the portfolio composition that matters most. Not, repeat not for the 1000th time, the individual assets.

But hey just for fun...let's toss UGLD and go with NUGT as our gold element. In other words, 16.66% goes to NUGT every year instead of UGLD

1/1/12 to yesterday

UGLD: CAGR 9.21/MDD -16.62
NUGT: 15.54/-31.92

2012,13,15 not impressive...this year the NUGT port is up 98.9%. Having noted this, the portfolio performance CAGR was -.5 on 12/31/16. I doubt most people would hang for that kind of performance.

CAGR of NUGT Port based on start date and ending on 12/13/15
2011: 1.95
2012: -.50
2013: -2.84
2014: -2.56
2015: -16.85

PPs 2012-2016 CAGR/TotRtn/MaxDD

1x 4.80/24.20/-7.97
3x 9.21/50.29/-16.62
NUGT 15.54/95.00/-31.92

And my personal favorite: 75% cash and 8.33% to the rest...5.08/25.74/-8.47. I have zero doubt in my mind this version is a better and safer version than the original. It is literally impossible for this portfolio to have a worse annual return than the PP's full backtest history if rebalanced annually. Not to mention 75% could be sitting in STTs.

But to be clear, I've never said this (50%/16.66%) was a safe leveraged version of the PP. I do believe it has a good chance of returning stock like returns with less Max DD. Using PortViz data I have a rolling 10 year (1971 start date) return max of 26.41, avg of 18.16, and min of 12.84. As of 12/31/15 the rolling 10 year return was 13.83%. The worst annual DD was -12.3%. But of course this is not intraday MaxDD. I had a ~18% DD in 2015.

This compares with a 100% stock port that had a max 10 year rolling of 16.90, an average of 9.16, and a min of -1% whose max annual DD was 38.5. Intraday was at least 57%. If we do a 60 stock/40 10Y Ts the rolling stats are 16.46/10.77/3.16. The worst annual Max DD was -14.74%.

Now tell me, objectively, which is the better portfolio of the three?

[iwealth]

Good example.
AND, you also need to start out when the funds are fresh or split to make them more even. Doing this strategy now with DUST at $5 and NUGT at $154, well, they are already severely unbalanced.

Due to the nature of these instruments, this should not matter as long as you buy equivalent monetary amounts.

[Kbg]

The problem is that these correlations are not consistent and positive correlations between assets can last for extended periods of time.

I can assure you that there will be extended periods where 2 of 3 or all 3 volatile asset classes rise and fall at the same time.

Correlation has nothing to do with the decay factor which absolutely is real.

The issue, above all, for decay is trendiness. All three of the PP assets trend well which is why they are in the portfolio in the first place. For the same reason HB stuck them in the port, we are counting on the ability to trend well. I'm not going to post this again (though I just did), but if you look at the actual data vs. the crap you read somewhere you will see that with this particular portfolio the trendiness is such that it can overcome the decay. Read carefully...I'm not discounting decay. I'm saying these assets can overcome/make up for it when they trend. On average, the real portfolio has come very close to it's advertised 2x leverage factor. The data also indicates we ARE getting nicked a bit for decay, but it's quite minor.

I've also mentioned this before, but if one is actually going to attempt this they really should take the eye poking time required to understand the math behind these ETFs and what it means from a practical stand point. It's on the internet and at the ETF sponsoring company websites. If one does this, they will understand why a short 3x ETF and shorting these ETFs in general is not a particularly good idea.

But folks, do me/us all a favor...don't knock this portfolio for attributes you praise on other parts of the board. Leverage, decay, derivatives, fair game. Negative/low correlations, volatility, all-weather attributes...isn't that why you are here and not so much? If the latter are your concerns then the standard PP isn't good for you either.

[Cortopassi]

Cartopassi, interesting, but not really relevant. A totally different asset. Again, for like the 1000th time, it is the portfolio composition that matters most. Not, repeat not for the 1000th time, the individual assets.
Now tell me, objectively, which is the better portfolio of the three?

And from before: If one can't keep their eyes off a component's bottom line vs. the portfolio's bottom line, then absolutely do not put a dime in this.

----------------

I am in the bolded boat. That would kill me. I love to see the day to day interplay of stocks vs. bonds vs. gold. But to watch one or more of those 3x ETFs go to zero while the other zoomed is not for me, regardless if the bottom line is higher.

I appreciate all the math and work you've put into this. 15 years ago, I probably would have tried it. Not now though.

[stuper1]

Kbg,

I apologize, because I think I've asked this before, but could you please tell me again. If someone wanted to run one of these portfolios, like the 75/8/8/8 or the 50/17/17/17, how often would they need to check in on things and potentially do a re-balance? Is this something you have to check on weekly or monthly? Or is it more like the PP where you don't have to worry even if you only check in every year or so?

Also, can you give us a feel for how many rebalancing transactions per year might be required, so we can have a feel for potential transaction costs?

[Kbg]

With regard to decay...as board members may have noticed I mentioned in an earlier post that I'm paper tracking a futures based version of the portfolio. This will effectively eliminate decay as an issue but requires more work to maintain. Currently, this port is up over 2% since mid-July on a min size port of around $48K. I am not accounting for any returns from the pure cash balance in this study. The one issue I've ran into is the MGC mini gold future. Supposedly it expires on the 29th, but it appears to effectively have stopped trading on the 1st.

Anyone ever traded this future? I'm confused.

[Kbg]

Kbg,

I apologize, because I think I've asked this before, but could you please tell me again. If someone wanted to run one of these portfolios, like the 75/8/8/8 or the 50/17/17/17, how often would they need to check in on things and potentially do a re-balance? Is this something you have to check on weekly or monthly? Or is it more like the PP where you don't have to worry even if you only check in every year or so?

Also, can you give us a feel for how many rebalancing transactions per year might be required, so we can have a feel for potential transaction costs?

On the first, I'd spend the same amount of time as you would the standard version. You could pretty much forget about it if that is your style. Personally, I would rebalance annually as that enables you to monetize the volatility of the assets. If you use bands to rebalance then assuming you are going to do the standard 15-35 then of course that means 5 and 11.67.

With the second one that is a little more difficult. I actively manage it and rebalance on major dives in an asset. Whether that ends up being a good idea or not, IDK. Last year it would have and this year thus far it has been a good idea. However, if something is trending down hard for a good fundamental reason I'd probably wait to rebalance...but I'm more of an active vice passive investor. If you are passive, then once a year. Once a year is what I post the stats on for performance and DD.

Please realize, if you go the more aggressive route you are in fact investing/trading a leveraged portfolio with the good and evil that comes with it. A tight money situation is going to suck even worse for this portfolio than a standard PP. Also, as I've posted a couple of times if you can't handle an asset going to zero this is MOST DEFINITELY NOT for you. The history shows this is a relatively frequent occurrence. So the standard this is for information/education purposes only; I am not a registered advisor and investors should seek professional assistance; Historical returns are no guarantee of future returns; apply.

Also, realize you can dial the cash to leverage at whatever level is comfortable/appropriate to your situation. I categorically do not recommend anything above 2x and I heartily recommend a large cash balance for volatility dampening and a pool of reserves for buying. If one wants to dial in leverage more specifically to their risk tolerance then the numbers are as follows:

Lev % 3xETF
1.00 - 8.33
1.25 - 10.42
1.33 - 11.11
1.50 - 12.5
1.67 - 13.92
1.75 - 14.59
2.00 - 16.67

2012-2016 Performance in order of the above
5.12/-8.48
6.20/-10.57
6.55/-11.27
7.25/-12.62
7.96/-14.00
8.29/-14.63
9.29/-16.60

Standard PP 4.84/-7.97

[Kbg]

I'll be the first to say this is not a PP, just a PP inspired VP. I wish I could fast forward 5 more years to see how the 75% cash version does. The end of 2016 will be 5 full years.

[mukramesh]

kbg, does your personal mix still include XIV? If so, can you describe how much what this is supposed to add to the leveraged PP?
I'm sure you've already explained this but I am having a hard time finding the post in this thread...

[Kbg]

M,

I have 5% of my personal mix in XIV and it comes out of the 50% cash. So cash is actually at 45%. Other options would be to nick the other three 1.67% or take it from the stock allocation. The latter would be most apples to apples but really XIV is a completely different risk premium (carry) as it is effectively continuous put selling.

I really debated pulling it from the port as most likely the short VIX selling type of strategies have seen their best days. The market in VIX futures has become WAY more efficient than the early days. XIV/SVXY are highly correlated with stocks and the leverage is roughly around a 3x ETF so one could make some very sound arguments that there isn't much value added over SPXL/UPRO. I would not debate that viewpoint strenuously. I have a small piece of it for the carry premium diversity and because it does very well in a flat choppy market (like now) whereas nothing else really does. So it gives just a tiny bit of diversification. Another more mellow option is ZIV or somewhere in between with both XIV and ZIV.

Note: XIV is highly risky stuff in a market that continues to evolve, be careful out there.