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

[moda0306]

Imagine a 100x fund... You invest $1,000:

Day One: the market goes up 3%... you're a genius.

Day Two: the market goes down 1%... you have nothing.


An examply of the effects of "Decay" at its worst.

[MediumTex]

Imagine a 100x fund... You invest $1,000:

Day One: the market goes up 3%... you're a genius.

Day Two: the market goes down 1%... you have nothing.


An examply of the effects of "Decay" at its worst.

Isn't that what Long Term Capital Management did?

If you haven't read "When Genius Failed", it's a nice tale of modern hubris.

[Wonk]

2X PP Update:

This portfolio hit a rebalance band today.  The gold portion is now 35.5% of the whole.  I've been following the "vanilla" 2xPP as well as a couple other variations of the same theme for a while now.  I set it up to track in a Smart Money account dated back to 1.21.10 when UBT was launched.  I'll rebalance all 4 back to 25% and continue the observation until I get bored.  I have none of my own money at stake--observation only.

Here are some details:

Start: 1.21.10
First rebalance: 7.18.11 (about 18 months)
Return since inception: 38.35% (pending close today)
Return of orthodox PP: 18.10%

Other notes:

1. I took a look on days when overall market volatility was high and each vehicle appeared to function as expected for the majority of the time.

2. Tracking error appears correlated with liquidity.  SSO experiences the least amount of tracking error, followed by UGL & UBT.  UBT had substantial liquidations in the past week, dropping the net assets from $25M to $16M and experienced the most tracking error to date.

3. I was on the lookout for decay as mentioned in the articles referenced but did not see it when viewed in terms of the whole 2x portfolio.  Not saying it doesn't exist--especially when comparing the individual leveraged ETFs vs the underlying index over longer periods of time.  However, if the leveraged ETF achieved it's objective with minimal tracking error on a daily basis, the result was almost exactly 200% of the daily move of an orthodox PP, which is interesting.

As I mentioned earlier in this thread, counterparty solvency appears to be the primary risk.  In such a portfolio, you don't own anything other than an obligation to receive payment from another entity.  You own very little actual equities, gold, and bonds.  In the event of a systemic breakdown, I wonder what the outcome might be.  That said, in the event of a systemic breakdown, I wonder what the outcome might be with even an orthodox PP. 

It appears the "break-even" duration of a leveraged PP would be about 4 years, not including opportunity cost.  That is to say, if you invested $1 in a 2xPP instead of an orthodox PP, you would need to survive 4 years without a 100% loss to recoup your initial investment.  If you are including opportunity cost, you would need a shade over 5 years to exceed the expected return of an orthodox PP along with the return of your original investment.  Any returns after that point would be gravy.

It's been an interesting thing to watch.

[Lone Wolf]

Super interesting!  Thanks once again for the update.

I've also been tracking a "Leveraged PP" and a "Leveraged Super PP" (3x33 of the leveraged ETFs, discarding cash.)

I established both portfolios on January 25, 2011.  The "Leveraged PP" (4x25) has so far returned 14.43%.  The "Leveraged Super PP" (3x33) has returned 19.19% (in about 6 months.)

Also, none of this is real money, just a SmartMoney simulation.  All the fun with none of the heartburn!

[moda0306]

Something about me prefers simply taking out a home equity loan with tax-deductible interest, or choosing to go into low/no-interest debt for what I would otherwise buy for consumer items (car, furniture, etc) and invest the rest in the PP, while simultaneously tweaking my PP away from cash and towards stocks, rather than diving into these funds.

I do appreciate the info, though.  Thanks, Clive.

[moda0306]

Yes,

My mistake.

[clacy]

Has anyone tested the PP or variations with futures?  It would be interesting to see a portfolio with $USD, Gold, Bond and S&P futures. With a portfolio north of $100-150k, you could use futures in lieu of ETF's fairly easily. Not sure what the roll over would cost you, but if you're interested in leverage, futures tend to be a much better way to go than levered ETF's, IMO.

[moda0306]

clacy,

I looked at options (futures scare the heck out of me)... the costs seemed to wipe out most of the benefit, but I was looking at pretty aggressive price-move options over 6-months to a year... not these short-term small-move options.

Just FYI.

[clacy]

moda,

The biggest problem that I can see, would be that it would take a very large account (min $500k, possibly more) in order to dial in the 25%'s as all of these contracts represent different dollar amounts.  IIRC, a mini-S&P contract is worth roughly $60k, but gold is worth much more, so unless you're talking about a scale where you had the ability to control several contracts with each allotment, it would be hard to get to an acceptable level of equality in your 3 asset classes (I would probably just use actual cash for that allotment, rather than USD futures).  Or you could just live with some unevenness but that isn't what the HBPP is all about.

[Wonk]

Has anyone tested the PP or variations with futures?  It would be interesting to see a portfolio with $USD, Gold, Bond and S&P futures. With a portfolio north of $100-150k, you could use futures in lieu of ETF's fairly easily. Not sure what the roll over would cost you, but if you're interested in leverage, futures tend to be a much better way to go than levered ETF's, IMO.

I don't know the ins and outs of futures markets, so I can't speak with any authority.  But in theory, a small amount of leverage should be harmless while too much will wipe you out.  Leveraged ETFs are 200% of the daily price of their respective indexes.  You can take the max drawdown of the PP--10 to 15% and double it and you're only down 20-30% in a 2008-like event.  What happens if you have 10x leverage in futures?  Would a margin call wipe you out?  I don't know the answer but I would suspect the likelihood is much greater.

[clacy]

Wonk,

I certainly wouldn't want to use 10x leverage.  You could go with 3-4x though and put a much larger percentage of your actual money in cash, and still capture the volatility of the other 3 markets with much less money tied up.  That is just a thought of possible benefits of using that kind of leverage.

A 30 or 40% DD is too much for me, so likely I will never experiment with futures and the HBPP

[Wonk]

any update on this leveraged 4x25 HBPP?

Today is a good day for an update due to the massive volatility.  Here's the rundown:

Permanent Portfolio            2XPP
IVV:    -4.72%                  SSO: -9.42%
TLT:  +3.56%                  UBT: +6.81%
SGOL: -0.47%                  UGL: -1.13%
SHY:  +0.09%                  SHY: +0.09%

Overall for the day, more tracking error than most other days, but not earth shattering.  Here are the returns since 1.21.10:

PP:        19.80%
2xPP:    42.70%
2xPPB:  43.94% (Blended 2x equity: SSO (LB) + SAA (SB)
2xPPSC: 46.43%  (Small Cap equity: SAA)

All three versions of the leveraged PP have hit rebalance bands within the last week or two.  The orthodox PP has not hit a RB yet.  These high-volatility days are getting to be a lot of fun.

[Liz L.]

Very interesting; thanks, Wonk!

[Verto]

It seems the markets are poised to really 'test' the leveraged PP idea.

I think this is a great time to see how it performs.

[AdamA]

if you could borrow 10 million dollars tomorrow and put it into the PP would you do it? How about 100 mil? 1 billion? 100 billion?

From HB:

Rule #7: Don't use leverage.

When someone goes completely broke, it's almost always because he used borrowed money. In many cases, the individual was already quite rich, but he wanted to pyramid his fortune with borrowed money.

Using margin accounts or mortgages (for other than your home) puts you at risk to lose more than your original investment. If you handle all your investments on a cash basis, it's virtually impossible to lose everything—no matter what might happen in the world—especially if you follow the other rules given here.

[Wonk]

Just wanted to say I've been following this leveraged portfolio through the high volatility of the last week or two and it's a helluva lot of fun to watch. 8%-12% daily moves in each ETF are common, although the portfolio as a whole is largely meeting it's directive: roughly 2x the daily move of the underlying assets in a traditional 4x25.  Without a doubt there's been more tracking error, although I've also seen much more tracking error in un-leveraged ETFs such as IVV. 

The orthodox PP has been running as smoothly as a finely tuned Rolls Royce.  The leveraged PP has been running as fast as a Formula One Ferrari.  For the latter, quite frankly I'm surprised the wheels haven't fallen off.  It remains to be seen if it will stay on the road longer term with plenty of bumps and curves ahead. 

[Wonk]

Wonk.

LTT's have a pretty consistent inverse correlation to stocks.

Look at the comparison of TLT and UBT however over the last couple of year and its almost as though UBT had a degree of inverse correlation to TLT.

Clive,

Can you elaborate a bit more on that?  I ran an overlay of TLT and UBT for the past year and it seemed consistent.  UBT's inception date was 1.21.10 and it appeared there was a decent amount of tracking error early that was smoothed out within a few months.  What did you see that I'm missing?

[Wonk]

Weird.  Check out the US version of yahoo finance:

http://finance.yahoo.com/echarts?s=UBT+ ... =undefined

It looks like the UK chart has some sort of glitch in the code.  I used UBT & TBT on the US site to try and replicate:

http://finance.yahoo.com/echarts?s=UBT# ... =undefined

[Verto]

I was very confused seeing the first chart... as the second one is what I see in google as well. Weirddd. Silly yahoo.

[stylo]

It appears the "break-even" duration of a leveraged PP would be about 4 years, not including opportunity cost.  That is to say, if you invested $1 in a 2xPP instead of an orthodox PP, you would need to survive 4 years without a 100% loss to recoup your initial investment.  If you are including opportunity cost, you would need a shade over 5 years to exceed the expected return of an orthodox PP along with the return of your original investment.  Any returns after that point would be gravy.

You mean 4 years to be playing with profits only?

I can imagine a nasty fall as gold and tlt tumbles.

[stone]

Clive, might an alternative way, to profit from the volatility of all of the PP assets, be to tweak the rebalance bands of each so that LTT, gold and stocks all hit rebalance bands with equal frequency. Each would be sized up relative to the cash. So perhaps LTT would be kept between 0.95-1.05 (relative to cash being 1), stocks 0.9-1.1 and gold 0.85-1.15 or whatever. That way the basic core assets would still be held around 25:25:25:25 with all the "black swan robustness" advantages that gives.

[stone]

Clive, don't you think it is important to also bear in mind the volatility as seen from a currency that you might need to move to or buy stuff from? Gold may swing around a lot in GBP terms but trimming the gold may make the GBP based PP less robust when converted into USD, Euros, Yen or whatever. If things get really bad, that might be what counts the most. For me, I can imagine that the worst possible economic circumstances would be the time when having savings would become worthwhile.  It was gold that saved the Icelandic PP. I presume a Serbian PP ?!? would be an even more dramatic example.

[stone]

Clive, have you back tested the leveraged PP over the long term with real data? In your link you explain the logic of the leveraged PP based on price movements following brownian motion. My problem with that is that price movements don't follow brownian motion and that the basis of the PP is that they do not. I'm willing to believe that prices do jitter about in a way that is more brownian than many people appreciate but I think reality is a lot less brownian than it would need to be in order to cause the square rule benefit of leveraging up that you describe. As you say, if prices followed brownian motion (ie whether the price goes up or down is not infuenced by what the price is or whether it has just gone up or down) then the PP would in effect be a martingale betting strategy where the distribution of wins and losses was simply shifted by the strategy such that there were frequent small wins and occasional castastrophic losses with no long term benefit. In reality gold, stocks and LTT do not act randomly with respect to each other. A down year for all three together happens less frequently than would be predicted by chance alone (please correct me if I'm wrong). Also prices are influenced by the real economy/central bank etc such that bull and bear markets are genuine empirical facts and not some figment of the gambler's imagination as would be the case if prices followed brownian motion. An extensive survey showed that after a price had a down month, it was more likely to have a subsequent down month than brownian motion would predict ("beware of falling knives" effect). Conversely over a time span of decades, it is important to "buy low". The PP with 15%-35% catches both effects. It isn't clear to me that the leveraged PP wouldn't screw up against those realities.

I also think part of what makes the PP work is that it exploits the mispricing that comes from herd mentality. So be really careful about flitting between which asset to over-weight or under-weight in the "new improved" PP. A few months ago when 50year gilts cost 92p; you were pondering whether it might be better to ditch LTT altogether. Now they are 107p or whatever; you are pondering whether to over-weight them .

I also find it a struggle to follow the PP. I prematurely rebalanced when gold got to $1885 because I got spooked by the pace of increase. I hope that premature rebalancing is the least harmful form of deviance but I suppose in a total currency meltdown it might be the worst. In principle I agree with you that a major economy such as USA, Japan, Germany or UK is unlikely to have an Iceland style hiatus (or worse) but I don't think it is impossible.

[stone]

Clive, if you want to increase rebalancing frequency there is always the option of tightening the bands on a non-leveraged PP (say to 22%-28% or whatever). Wouldn't doing that and cutting down the cash portion on a non-leveraged PP be the same as increasing the cash and having leveraged etfs? In the recent period of jitteryness, there have been many inflection points and that has benefited frequent rebalancing. I thought the 15%-35% bands were chosen so as to avoid multiple rebalancing events during the course of rarer very large swings. So in Iceland 2008 it was better not to rebalance out of gold repeatedly. Perhaps a >80%  crash in stocks or gold might happen next year or whatever. If so; it would be better to have as few rebalancing events into stocks/gold on the way down as possible so as to preserve reserves for a big rebalancing near the bottom. I guess it is a tradeoff between harvesting as much as possible from jittery goofymarket nonsense versus from "big events". The PP is about permanence and so is skewed towards surviving "big events" hence the wide rebalancing bands. Am I in a muddle about this?

[clacy]

Very interesting discussion going on here.

I tend to like the 2x version of the HBPP, because as Clive points out, because of the greater volatility, you're going to have more re-balances, but you still get the overall smoothness of having the 4 key asset classes represented.

I am not running a leveraged PP, but have thought about it in the past.  If you put together a portfolio with 50% cash and the other half divided between 2x gold, 2x spy and 3x LTT's is sounding appealing.

With such a portfolio, your max loss would be 50% (pretty much the entire civilized world would have to melt down to induce that scenario).  And that is still much safer than the stock market, yet could easily produce significantly greater rewards and very likely fairly smooth volatility.