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

[Reido]

Personally, I'm not worried about the drawdowns one could see with a leveraged PP.  I could tolerate perhaps a 40% drawdown... 

what concerns me is not the severity - its the DURATION.  If you had a 6+ year period, as with stocks, where the account value stayed significantly below it's highs I would find that extremely frustrating.  If I know that in 2 years my account will be restored, then I'm not too concerned.

What concerns me about the 2xPP with leveraged funds is simply that a flat year could easily turn into a down year due to the decay.  I'm not confident that the portfolio would produce 2x the gains consistently enough to be worth the extra losing years...

Just IMO - I know theres really not enough data to say explicitly one way or the other

Since this is part of the VP - I would consider investing in a leveraged PP after a losing year for the regular PP which historically is followed by immense gains!!

[FarmerD]

I constructed a spreadsheet to see how a synthetic 3X HBPP would have performed since 1972.  I used the yearly asset returns data from Craigr’s website then modified the yearly data using the expected etf decay from the Powershares 3X funds prospectus’s. (Page 5 of any of the Proshares 3X funds shows the expected decay)
https://web.archive.org/web/20160324133 ... l-returns/
http://www.proshares.com/funds/#sort=Na ... 2x,ultra3x

Here’s the highlights:
Year                                                  TSM                                                3X HBPP
1972-1979                                        5.6%                                                   63%
1980-2002                                         12.4%                                               7.9%
2002-present                                     4%                                                    19.6%
1980 –present                               11.0%                                                   11.4%
1972 – present                                     9.9%                                                20.2%
Even though the 3X portfolio doubles the return of the TSM, It’s looks like the 3X portfolio goes through extended periods of outperformance and underperformance.  The 3x HBPP returned an incredible 63% CAGR from 1972-1979, then the 3X lagged the TSM next 22 years, then the 3x has again massively outperformed since 2002.  

Note: This analysis assumes annual rebalancing.

[dragoncar]

Consider a 1x that gains 1% each day for 10 days and a 3x that achieves +3% each day for 10 days.

The 1x gains 1.01^10 compared to the 3x gaining 1.03^10 which equals 10.4% versus 34.4%

If the 1x instead declined 1% each day for 10 days and the 3x lost 3% each day for 10 days then that's 0.99^10 for the 1x compared to the 3x 0.97^10 which equals -9.56% compared to -26.25%

I think you may be ignoring that the 26.25% loss of the 3x occurs to a greater base value (after the initial 34.5% gain).  Say you start with:

1x: $100
3x: $100

you get 10 days of 1% gains:

1x: $100 * 1.01^10 = $110.46
3x: $100 * 1.03^10 = $134.39

you get 10 days of 1% losses:

1x: $110.46 * 0.99^10 = $99.90
3x: $134.39 * 0.97^10 = $99.10

Therefore, the 3x has decayed by $0.80.

[FarmerD]

Clive/Dragoncar,
Decay also depends not only on frequency of the gains/losses but their magnitudes.  Consider a 1X versus a 3x ETF that alternates 10% gains or loses for 10 days:

1X: -5%
3X:  -38%

Granted, this is a pretty extreme example but it makes the point.

From the Proshares 3x S&P 500 ETF prospectus (page 5) “The Index’s annualized historical volatility rate for the five year period ended June 30, 2011 was 25.06%. The Index’s highest June to June volatility rate during the five-year period was 45.47% (June 30, 2009).”? Assuming the average volatility over this period (25.06%) would have been about the same historically since 1972, I get the following decay data from their chart:

Index                      3X Fund
-40%                              -82%
-30%                              -72%
-20%                              -58%
-10                                    -40%
0                                      -17%
10%                                  10%
20%                                  43%
30%                                  82%
40%                                  128%

I think this is a reasonable expected return from 3X ETF and is applicable to backtesting historical results using a 3X strategy.  .  Am I missing something?
Statistics was never my strong suit - feel free to correct me. 

[stone]

Clive, do those USD index etfs have an inverse correlation to the gold:stocks:LTT part of the PP? Might a smidgen of that provide a more aggressive emergency balancer to the leveraged PP? This is straying way off what I'd ever contemplate doing myself!

[stone]

Perhaps a way to prevent a total loss for the leveraged PP might be had by having a call option for a USD bull index such that you got money if the USD became much stronger but normally just had the option expire worthless as an "insurance expense".

[stone]

Clive, don't the dividends and bond interest play a large part in deciding whether it is worth holding leveraged etfs versus a conventional PP? The dividends on UK stocks are now not to be sniffed at. 

[Reub]

Clive, what do you think about incorporating FSA and FSG into a variable portfolio. FSA is 2x T-Bond Bull/S&P 500 Bear ETF and tracks the difference between 2X LTT and the S & P 500 (-200%).  FSG is 2x Gold Bull/S&P 500 Bear  and tracks the difference between 2X gold and the S&P500 ( -200%).

Both were up considerably on a terrible day for stocks (FSA up 9.31%; FSG up 6.09%).

Any ideas how these could fit into a possible variable portfolio that balances between gold, stocks, cash and bonds?

[blackomen]

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!

Care to share your implementations of the leveraged PP?

[MediumTex]

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!

Care to share your implementations of the leveraged PP?

I think that implementation of this leveraged ETF PP strategy is what started this thread.

Take a look on the first couple of pages.

BTW, I would not recommend it due the decay issue with these funds, but I think several variants were discussed a few pages up.

[Lone Wolf]

Care to share your implementations of the leveraged PP?

Sure thing.  Like MT said, I used the ETFs recommended further up in the thread.

25% SHY = Cash
25% SSO = 2x leveraged S&P 500
25% UBT = 2x leveraged 20+ Year Treasury Bonds
25% UGL = 2x leveraged gold

The "super" version simply throws away the 25% in cash and becomes a 3x33% portfolio.

This is all simulated money, believe me.  Apart from a 529 where I can't implement it, I'm 100% in the Permanent Portfolio (and happy to be there.)

[beafet]

How about:

BGU 33%
TMF 33%
UGLD 33%

[Kel]

On the subject of 20% returns over long periods of time I found the following interesting....

Summary Findings by Mebane Faber in response to Joel Goldbalt's Gothlam Capital supposed 40% returns over 20 years

Before I even begin, here are some findings (I use the CRSP return database which starts January 1, 1926 and runs through December 31, 2010):

* Earning 20%+ returns over very long horizons is for all intent and purposes virtually IMPOSSIBLE(assuming the market experience of the past ~90 years is representative of the future).

* 31.5%+ returns over the 1926 to 2010 period imply that an investor will end up owning over halfof the ENTIRE stock market.

* 33%+ returns imply that an investor will end up owning the ENTIRE STOCK MARKET!

* A 40% return will have you owning the entire stock market in ~60 years–not a bad retirement plan!

* A “doable”? 21.5% a year implies an investor will own .62241% of the market at the end of 2010. With a $16.4 trillion total market value as of December 31, 2010, this would imply a personal stock portfolio worth $102 billion!!!

* Warren Buffett–and perhaps a very select handful of others–have been able to achieve 20%+ returns over very long time periods. These individuals represent some of the richest people on the planet because of this very phenomenon.

* An investor might have an epic run of 20% returns for 5, 10, maybe even 15, or 20 years, but as an investor’s capital base grows exponentially, the capital base slowly becomes ALL capital, and all capital cannot outperform itself!

http://www.mebanefaber.com/2011/10/20/4 ... -20-years/

[MediumTex]

* 33%+ returns imply that an investor will end up owning the ENTIRE STOCK MARKET!

I work with a group of actuaries and I often joke with them about how long it would take using their projected asset return assumptions (normally 8%+ more or less in perpetuity) for the asset they are modeling to swallow up the entire universe.  (Some of them find this amusing and others don't.)

A compounded 8% rate of return turns into a black hole quicker than one would think.

Trees don't grow to the sky and neither do assets in the real world, no matter how skillful the person telling the growth story.

[stone]

Negative real interest rates make all kinds of leverage induced wackyness seem plausible on paper. I guess as the various supposidly 20%+ per year leveraged schemes lock horns; the market will gyrate wildly to ensure that sufficient calamities occur to keep arithmetic obeyed. I guess the situation will unravel as it sucks a bigger and bigger proportion of the economy into ever more complex financialization until the productive kernal of the real economy withers away to nothing.

[Lone Wolf]

* An investor might have an epic run of 20% returns for 5, 10, maybe even 15, or 20 years, but as an investor’s capital base grows exponentially, the capital base slowly becomes ALL capital, and all capital cannot outperform itself!

This has a few interesting implications.

UBT's market cap is only $33 million.  This means that a "Supercharged" Permanent Portfolio of $132 million would own all of UBT. 

At 20% growth per year, we'd expect our investment to increase 1470x over 40 years.  (!)  That means that if we start up a $90,000 Leveraged Permanent Portfolio, we'll hit our $132 million target in 40 years.  UBT would be ours!

Sadly, UBT's market cap would of course increase in the intervening years, but it's fun to think about.  It seems to clearly illustrate that something in here is going to fail dramatically well before such a bizarre outcome can take place.  Whatever it is, I'll watch it unfold from the safety and comfort of my "play money" portfolio.

Or does this all mean I should be starting up a $900 Leveraged PP now for the chance to collect $1.32 mill in 40 years? 

[beafet]

How about:

BGU 33%
TMF 33%
UGLD 33%

FYI, this portfolio is up 4.55% in one day.

[Reub]

And how much was it down last week?

[beafet]

No clue, I just set it up to be tracked on Sunday.

[Wonk]

Should be interesting to see when or if this experiment will blow up.  After nearly 2 years, it's still on track.  As of today:

1xPP: 26.49% (no rebalance)

2xPP: 61.06% (2 rebalance events)
2xSCPP: 64.18% (2 rebalance events)

After learning of the 3x gold ETN, I decided to add a 3xPP using the 3x funds mentioned above.  UGLD is a baby, so I had to start it at Oct 24, 2011.  Let's see a Lehman-style event and find out what happens.

3xPP: 5.09%

[stone]

Isn't it true that the Ranaissance Technologies Medallion Fund has had a 30% CAGR for decades? I think Ranaissance Technologies talk about each fund strategy having a certain maximum fund size. So the Medallion Fund has long been closed to new entrants (it is just for employees) and although the holders are employees they charge themselves massive (>30%) "management fees" so as to avoid outgrowing the strategy.

[slk23]

Clive: isn't a 33 day period too small of a sample to make conclusions from?  The 2x PP (DGP, UBT, SSO) has done pretty well over almost two years: 77% compared to 38% from GLD, TLT, VTI (no rebalancing).

[stone]

Clive regarding high beta stock holdings, are you familiar with BRSC? From what I can see, the discount increases when the market falls and vice versa. Surely that must add to potential rebalancing gains? I've got my stocks as equal parts BRSC, CTY and TEMIT.
Silver on the face of it does not seem like "high beta gold" to me. The lows of silver seem to mirror the lows of stocks whilst the highs of silver seem to mirror the highs of gold. So it doesn't help if, as with the UK PP at the end of 2008, you want to use gold to rebalance into stocks.

[stone]

Clive, within the context of a PP, I think the discount/premium does have a very strong tendency to swing things in the way you want. Discounts increase at the stock lows and tighten/change to premiums at the highs. I've been really puzzled why that hasn't led to closed-end funds being a part of the standard PP prescription

[MachineGhost]

Trading, not investing.

Isn't it true that the Ranaissance Technologies Medallion Fund has had a 30% CAGR for decades? I think Ranaissance Technologies talk about each fund strategy having a certain maximum fund size. So the Medallion Fund has long been closed to new entrants (it is just for employees) and although the holders are employees they charge themselves massive (>30%) "management fees" so as to avoid outgrowing the strategy.