MachineGhost's Research Resort

[MachineGhost]

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Yes, it's a bit tongue in cheek, but this thread will be to centralize all of the fixes to the various flaws I've identified in the Browne PP over the years.  I will be posting in this thread and editing this first post whenever inspiration and a resulting solution strikes.  To that end, here is the latest patch (which I think is the fourth in the series?):

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The stocks should be self-obvious.  Now you can deal with the problematic T-Bonds in two ways.  You can either reduce the weight as proscribed above or you can keep the weight the same and buy a lower duration Treasury.  Depending on what you want to target (6.6 to 10.75 years portfolio duration is the historical "safe zone") that would be 10-year Treasury Note / IEF or a 20-year Treasury Bond.  I would suggest the more conservative target as interest rates did peak at 200% in the late 1800's.   I need to update this with the proper stock duration as well as when the Fed reasserted its monetary policy independence.

Here's the Correlated Risk Parity thread which I believe was the third patch of the series:

http://gyroscopicinvesting.com/forum/pe ... msg122844/

And the fifth patch is the Equal Weight Style Box Portfolio (formerly known as the Equal Weight MarketCap Portfolio):

http://gyroscopicinvesting.com/forum/pe ... #msg146497

[lordmetroid]

I definitely do not understand the table. Could you please explain it?

[Reub]

It looks to me that the data is showing that both stocks and bonds are tremendously overvalued right now by historical standards. Am I correct?

[mathjak107]

not only are you correct but they have  both never been this over valued at the same time with rates so low.  bonds are considered to be far more over valued than stocks . stocks are just a tad more than fully valued.

[iwealth]

Can't say I understand that table either. And I don't see any gold data. Also, still unsure how you calculate duration for anything but bonds. Hope you are willing to explain, I'm sure it's all quite interesting.

[bedraggled]

MG,

If you can explain this post as well as you showed and explained other info, we will all benefit.

Thanks.

[Cortopassi]

Glad to see I was not the only one who did not understand the chart!

[Reub]

Wouldn't a stock duration of 51 years indicate a vastly overpriced equity market?

[MachineGhost]

Whoops, I forgot all about this thread!

The numbers in the chart are the asset class durations.  It was another attempt to manage a PP portfolio to a duration target.  I've since abandoned that for the PP Jr and the Multi-Fortress Portfolio, mostly because I don't know what the heck to do about gold and I'm a long way from official retirement anyway.

So you can see the current PP portfolio duration was 17 years at the time at 25%x4.  If you were more than 17 years to retirement that is okay from that perspective.  But if not, the PP is too risky for you and you should up your cash to get it down.

But to survive a period of rising interest rates, the portfolio should never go past 11 years.

[MachineGhost]

Thanks to the genius Tyler for the inspiration!  I've upgraded the Equal Weight MarketCap Portfolio to the Equal Weight Style Box Portfolio.  Unlike just the size factor before, now risk is equalized (as best as possible) among size, value and growth!



The above exposures are by using these free Schwab ETF's:

SCHB 47.16%
SCHA 29.19%
RSP 13.06%
WMCR 10.59%

[MachineGhost]

Here is the correlated risk parity PP with patch #5 as explained in the previous post:

[img width=800]http://i.imgur.com/KpKCo7B.png[/img]

[img width=800]http://i.imgur.com/Jt08HLK.png[/img]

[img width=800]http://i.imgur.com/ImJfChw.png[/img]

[Laker]

MG, is it me or does 12+2+2+7+3+35+9+20+11= 101? Not being snarky just does not add up.

[Tyler]

MG, is it me or does 12+2+2+7+3+35+9+20+11= 101? Not being snarky just does not add up.

The tools he's using don't display decimals.  It's probably just rounding error. 

[Laker]

Ok, thank you. BTW, love your calculators.

[MachineGhost]

Yeah, its a rounding error.  The exact weights are: 11.79% TM, 1.70% LC blend, 1.52% MC blend, 7.35% SC blend, and 2.65% MC blend.  It takes more funds to use Vanguard's than the free ones available at Schwab.

BTW, for the Correlated Risk Parity PP asset weights used to derive the MaxDD, I ran the correlations for all PP assets back to 1950.  So this is as good risk control as you're ever going to see for the PP until we have a another bond bear market while 30-years T-Bonds exist.  There is a way to estimate what the 30-year yield would have been with linear regression using 20-year T-Bonds and other inputs, but I don't currently have the mental or software setup to do things like that.  Anyone want to take on the job?

Also, I will try my hand once again today at coding up working rebalancing bands (they don't work at the peak2trough backtester with non-orthodox weights).  Annual rebalancing has a risk/reward ratio similar to 30/20 rebalancing bands but with worse risk.

[MachineGhost]

I removed the dynamic correlated risk parity PP weight directions because I realized last night it didn't make any conceptual sense.

If you look at the forward-looking volatility of stocks at the moment, it is higher the average, resulting in a lower weight than normal.  But just scaling that down even further as part of a portfolio isn't the right way to go.  The proper way would be to plug-in these new values into a pre-existing correlation matrix, but that requires complex math and is anything but simple.

You can certainly use the directions to compose a naive risk parity portfolio though, but then that will result in the problem Dalio experienced: too much exposure to interest rate risk.

[MachineGhost]

Venture capital investing didn't take off until 1978 when the Prudent Man Rule reform was instigated under ERISA.  So between that and the forthcoming Regulation CF+, I expect the size anomaly that is only present among microcaps (lowest decile) could completely disappear.

[MachineGhost]

Here's the latest stats on the Browne PP and Correlated Risk Parity PP (CRPPP):

[img width=800]http://i.imgur.com/2PcZ87q.png[/img]

Gold is a whopping 50% of the risk exposure of the Browne PP!  Notice also that forward-looking volatility and trailing-volatility are essentially the same.

Two things have changed.  The London Gold Pool did not collapse until March 1968, so I start on April 1968 from now on when gold starting moving.  1968 to 1977 uses 20-year bonds, then 30-year bonds thereafter (except during the brief discontinuation).  The mismatch in durations bugs me, so I will be redoing this with 20-year bonds all the way through.  I may have already done that before and didn't notice a significant difference, but doubt is the mother of all...

[MachineGhost]

So here we can see that 20-yr T-Bonds are not superior.  I've also accounted for T-Bills to see the Browne PP risk contribution which reduces gold from almost 50% to 38%!  That makes much more sense.

[img width=800]http://i.imgur.com/kVgw8Yl.png[/img]

[MachineGhost]

Here's the latest revision.  Everything on the "to do" list is done short of reblancing bands.  But for now, I rest.

[img width=800]http://i.imgur.com/rDYLCLw.png[/img]

[MachineGhost]

Yep, time for another update!  Any questions? 

[img width=800]http://i.imgur.com/6CcBetc.png[/img]

[InsuranceGuy]

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[MachineGhost]

So you said you are using cleaner data, you mind sharing?  I am curious how the Top3 came out so well.  Are you doing anything different or still just once a year rebalance?  The returns (10.37% vs 8.55%) seems really good as I'm only seeing about a +0.2% increase in return for the Top3 best case in my results.

Nothing different.  The data is better because it is dividend adjusted all the way back to 1950.  Took me 20 years to finally get that and I had to do it myself.  As usual.

[MachineGhost]

That's was a sweet party while it lasted!  Turns out the S&P 500 dividends were in real terms, not nominal.  Corrected.

[img width=800]http://i.imgur.com/iTY2AtP.png[/img]

[InsuranceGuy]

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