PP Inspired Leveraged Portfolios

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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Wed Jul 07, 2021 2:58 pm

hydromod wrote:
Tue Jul 06, 2021 6:27 pm
Kbg wrote:
Tue Jul 06, 2021 5:03 pm
Nice post!

Please don't bank on i or iii. Both are clearly not in the data series. On this board a generally accepted principle/assumption is we can't predict very well and that is always my assumption...but if I were to predict, current economic data suggests 1980-2020 is not in the cards for the next couple of years.
Here's rooting for TMF to maintain (i) negative correlation to equities (or at least near-zero correlation), (ii) similar volatility, and (iii) non-negative returns!
I'm rooting for these TMF things because they make the ride smoother and more profitable. I'm hoping for the flight to treasury safety not to completely disappear during crashes; that's the biggie.

But more realistically, I'm expecting and trying to prepare for a choppy and perhaps net flat upcoming decade (i.e., potentially zero ten-year market returns).
Really, check the data. The correlation expectation flips 180. Bonds (interest rate hikes drive stocks and they are/become correlated.)
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Re: PP Inspired Leveraged Portfolios

Post by D1984 » Thu Jul 08, 2021 9:13 am

Kbg wrote:
Wed Jul 07, 2021 2:58 pm
hydromod wrote:
Tue Jul 06, 2021 6:27 pm
Kbg wrote:
Tue Jul 06, 2021 5:03 pm
Nice post!

Please don't bank on i or iii. Both are clearly not in the data series. On this board a generally accepted principle/assumption is we can't predict very well and that is always my assumption...but if I were to predict, current economic data suggests 1980-2020 is not in the cards for the next couple of years.
Here's rooting for TMF to maintain (i) negative correlation to equities (or at least near-zero correlation), (ii) similar volatility, and (iii) non-negative returns!
I'm rooting for these TMF things because they make the ride smoother and more profitable. I'm hoping for the flight to treasury safety not to completely disappear during crashes; that's the biggie.

But more realistically, I'm expecting and trying to prepare for a choppy and perhaps net flat upcoming decade (i.e., potentially zero ten-year market returns).
Really, check the data. The correlation expectation flips 180. Bonds (interest rate hikes drive stocks and they are/become correlated.)
This to me is the biggest vulnerability of this strategy. If rates rise it will probably hurt stocks and even gold may not be immune (gold does not "like" strongly positive real rates at all; it functions mainly as a hedge against real rates that are less than inflation). I don't think long-term rates will ever be as high (mid-teens) as they were in 1980-81 but I checked the data and 30-year Treasury rates as recently as early 2000 were as high as 6.72% (they went as high as 7.18% in the summer of 1996 and between then and early 2000 they fluctuated between 4.84% at the low and the low 7s at the high). Even in 2002 they hit 5.82 percent and in mid-2004 they briefly rose to 5.46 percent. Heck as recently as the late 2009 to early 2011 rate rise there were several times when long-term rates were between 4.66 and 4.75%.

Even a rise to the levels above (from the current 1.89 or 1.90 percent) would probably absolutely torch TMF....IIRC it has a bit under three times the duration of TLT or VUSTX. The poor returns of the "Hedgefundie" strategy from the early 1960s to 1981 are sobering indeed.....and were almost all due to the simulated TMF getting killed as rates rose. I guess the question is, has anyone simulated what would happen in an environment where rates rose over 3 to 5 years from the current 1.90% to, say, 4.75 or 5%? How badly would it get slammed? How would the simulated UPRO do assuming stocks were up and down but overall lost maybe 2 or 3 percent nominal per year for these three to five years? Maybe including leveraged EM, leveraged EAFE (although the now liquidated DZK's tracking error was horrendous and I'm not sure if EFO's is any better), or even leveraged SCV (using Russell 2000 Value futures since UVT is sadly no more) might help a bit....but I still wouldn't dump a bunch of money into this at once; it seems a strategy like this is best suited to someone like a young(ish) investor who has plenty of human capital to convert into financial assets over the next few decades (i.e. is DCAing regular contributions) so a few years--or even a decade's--temporary swoon just means he/she is buying shares of TMF/UPRO on the super cheap.
Last edited by D1984 on Fri Jul 09, 2021 6:31 am, edited 1 time in total.
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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Thu Jul 08, 2021 9:30 am

The point for me is pretty simple...during periods of secular rising interest rates stocks and bonds become positively correlated. This is crystal clear in the data. The corollary...I think someone who says they could do this strategy during the above conditions for a couple of decades is delusional in the extreme...or they are so young they don't know what it is like to underperform multiple years in a row.

I've no idea if these conditions will repeat themselves, but if they do, very basic economic principles almost guarantee the results/correlations will track history.
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Re: PP Inspired Leveraged Portfolios

Post by D1984 » Thu Jul 08, 2021 9:32 am

hydromod wrote:
Sun Jul 04, 2021 1:22 pm
Without hijacking this thread any further, I just wanted to post a link to a very long entry on my Bogleheads thread where I try to wrap up my observations on the algorithm that I posted above. Comments here were quite useful in clarifying my thoughts. Now I can move on to other things...

The example compares a 1x/2x/3x version of S&P500/NASDAQ/utilities/real estate/long-term treasuries from 1986 to present (the HEDGEFUNDIE bond-bull era) running the identical algorithm for each leverage level. I think that this is a fair apples-to-apples comparison that isolates the effect of leverage. I've done similar things with just low-correlation sector funds and get similar results.

The summary is that the time-averaged portfolio is like a 60/40 allocation that swings from 80/20 to 30/70 at different times, in order to maintain a fixed risk allocation among assets. So total equity leverage with 3x LETFs swings from 0.6 to 2.4, averaging 1.8, not wildly out of line with limits based on historical observations.

I find that the CAGR is proportional to 2.2^L for this particular experiment, where L is the leverage factor, and the standard deviation is proportional to L.

The implication is that the Sharpe ratio increased substantially with increasing leverage, as does the implied optimal leverage. I think this behavior is unexpected for fixed asset allocations.

My conclusion is that dampening portfolio volatility by (i) simultaneously running several low-correlation assets (with overall positive returns) and (ii) taking advantage of volatility clustering to adjust portfolio allocations would have reduced portfolio volatility decay, thereby allowing compounding growth to be more effective over the period from 1986 to present. More effective compounding disproportionately favors greater leverage levels.

I will say that I am very dubious about growth rates persisting in the next decade or so, and adjustments likely would be necessary if the market enters an extended period of rising rates.
Did you test simulated leveraged utilities from the early 1960s to 1985 as well (either using FKUTX or using the Ken French daily TR data for utilities since it goes all the way back to 1926)? The reason I ask is that utilities (being bond-like stocks) got cut to ribbons from 1965 to 1981; they did worse than the overall S&P 500 as a whole.

Leveraged REITs would've done great from 1965-1972 (I have monthly TR data more or less extending the NAREIT indices back from 1972 all the way to the early 1960s if you would like to see it); REITs even posted positive returns in 1969 when almost everything else was down--but they would've been hurt badly over the 1973-74 bear market (although after that they likely--based on unleveraged REIT returns for this period--wouldn't have had a single negative year until 1987....except maybe 1981; REITs overall returned almost 6 percent that year but leverage costs would've probably meant that actual 2X or 3X leveraged returns would've been slightly negative given rates prevailing at the time) so maybe that would've helped counteract some of the negative returns of leveraged utilities.

Your best performer during this time would've been either 2X or 3X leveraged gold (heck, even unleveraged gold wouldn't have been too shabby) or even just a plain leveraged commodity futures fund (since I don't think there exists any leveraged version of these funds); also, 2X leveraged SCV would've--after being killed in 73-74--have done brilliantly from 1975-1983. I have monthly simulated TIPS data for this period and just a plain unleveraged TIPS fund wouldn't have done half bad either (the same applies even more to I-Bonds given their "heads I win, tails the Treasury loses" features).

Leveraged EAFE and (from what little data I have on EM for this period) leveraged EM would've done pretty well from 1965-1985 (with EAFE killing US TSM or S&P 500 overall for this whole period and with EM doing stunningly from the late 1960s to 1980; losing double digits from 1981-82; having small losses in 83-84, then doing roughly as well as the US and only slightly behind EAFE in 1985)....but I'm not sure how well EDC and especially DZK track their underlying 3X daily; IIRC tracking error is worse for both than for the 3X US ETFs.
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Re: PP Inspired Leveraged Portfolios

Post by StrategyDriven » Thu Jul 08, 2021 10:35 am

vincent_c wrote:
Thu Jul 08, 2021 9:42 am
D1984 wrote:
Thu Jul 08, 2021 9:13 am

This to me is the biggest vulnerability of this strategy.
The biggest vulnerability I believe is the use of a quantitative approach that offers assurance of being "better" than a non-quantitative approach for those who have quantitative skills but do not have fundamental knowledge of how markets work. This gives a false sense of security in that it would have been better than anything they could do themselves without using a quantitative approach.

A quantitative approach is no substitute for sound investing.
If you’re happy picking things to invest in and its working, perfect. However, I find it a bit ignorant an opinion to say you don’t see any benefits to a quantitative approach. I know people who deploy methods who sustainable get improved results by doing so. Maybe you’re too quick to discount something that you don’t fully understand or something that didn’t work for you or somebody you know. I will say, its not for everybody.
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Re: PP Inspired Leveraged Portfolios

Post by StrategyDriven » Thu Jul 08, 2021 12:18 pm

vincent_c wrote:
Thu Jul 08, 2021 11:27 am
Show me a post where I have discounted a quantitative approach.
I was going off what you just posted "A quantitative approach is no substitute for sound investing."

You didn't specify what "sound investing" is, but it certainly sounded as though you were throwing a quantitative approach under the bus. Anyway, no biggie, I simply found it to be a rather irrational comment, doesn't affect me one way or the other.
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Re: PP Inspired Leveraged Portfolios

Post by hydromod » Thu Jul 08, 2021 1:37 pm

A few scattered points:
  • I have very little trust in any model that I didn't develop myself, and not a whole lot in my own. All models are wrong, but some are useful.
  • I try not to trust in any hypothesis about how something works unless I can build a quantitative model to test the hypothesis and build confidence. Failed models are usually the most illuminating.
  • Building a quantitative model can be based on observations or based on principles. One is on firmer ground using the principle-derived model. As an example, the model I presented simply assumes that (i) short-term future volatility patterns can be estimated better than chance based on recent observations and (ii) expected future returns cannot be reliably estimated. Based on those assumptions, all the model does is construct the lowest-volatility portfolio consistent with long-term desired balance of risk among assets.
  • I've only backtested with monthly UPRO/TMF from 1955 through 1986 (example here). There's some heresy in some of these tests; using TMF (-3x LTT) instead of TMV would have worked beautifully 1955-1982, although it's a very open question whether to and how to actually use that information. I haven't gone further yet with other assets, in part because I haven't had an appropriate dataset and in part because I only recently worked out how I wanted to handle more than two assets at once.
  • I looked at the effect of UPRO/TMF correlations 1955-2019 here. I think that the data suggests that inverse correlations between equities and treasuries are all well and good, but they can't overcome falling treasury returns and don't matter with rising equity returns. This means correlations really only matter around equity crashes; and I suspect that automated trading algorithms are well aware of that importance going forward.
  • My model is based on daily total returns, to generate synthetic 3x LETFs, estimate volatilities, and estimate correlations. I can do part of that with monthly returns and monthly estimates of volatility, but would not be able to do much with correlations. So that limits a monthly version of my model to the approximation of zero correlation among assets or a rather poor estimate of correlation.
  • The weak point of my model is that there is no guidance as to what assets to include. However, dramatically failing assets (I'm looking at you 2000 and 2008), have tended to end up with a small hit to the overall portfolio. My hypothesis is that poorly performing assets tend to have high volatility, which cuts their participation. This doesn't work if the asset is a low-volatility dog.
  • I think that a potentially really good way forward would be to combine some of StrategyDriven's approach with mine, by adaptively selecting a number of assets that have prospects of doing well (actually, cutting assets that are likely to be doing poorly in the near future). That might solve the issue of selecting assets that have their day in the sun for a while then fade away. That's not at all permanent portfolio, I know.
  • I'm a bit dubious that several conditions prior to 1986 will repeat, although they make good test cases. I think the gold performance coming off deregulation was an anomalous shock that will be hard-pressed to repeat (other things might mimic this, like crypto, and shocks are endemic to the market). I think the treasury underperformance was likely exacerbated by treasuries being callable (making them very risky), which is no longer the case.
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Re: PP Inspired Leveraged Portfolios

Post by StrategyDriven » Thu Jul 08, 2021 2:13 pm

vincent_c wrote:
Thu Jul 08, 2021 12:42 pm
The problem I see is that there are strategies where the focus is on optimizing the quantitative approach when not nearly enough efforts are spent on the fundamental approach. I hoped we would be discussing whether an allocation to the S&P500, NASDAQ, REITS and utilities which are all stocks is an effective approach to diversification. I also see discussions on whether international stocks serve as good diversification. My point is it's far more important to figure these things out rather than just sticking them into a quantitative system.
A problem is that these sort of things are not static, you can't across the board have relationships with 'diversifiers' that behave the same given different circumstances. They may be good diversifiers given the conditions last year or decade, but not necessarily moving forward.
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Re: PP Inspired Leveraged Portfolios

Post by hydromod » Thu Jul 08, 2021 2:40 pm

StrategyDriven wrote:
Thu Jul 08, 2021 2:13 pm
vincent_c wrote:
Thu Jul 08, 2021 12:42 pm
The problem I see is that there are strategies where the focus is on optimizing the quantitative approach when not nearly enough efforts are spent on the fundamental approach. I hoped we would be discussing whether an allocation to the S&P500, NASDAQ, REITS and utilities which are all stocks is an effective approach to diversification. I also see discussions on whether international stocks serve as good diversification. My point is it's far more important to figure these things out rather than just sticking them into a quantitative system.
A problem is that these sort of things are not static, you can't across the board have relationships with 'diversifiers' that behave the same given different circumstances. They may be good diversifiers given the conditions last year or decade, but not necessarily moving forward.
Perhaps we could define precisely what is meant by a diversifier.

For me, a good diversifier has (i) significant positive returns on the whole and (ii) either has a significantly different business cycle than other assets or responds to market forces at a different pace than other assets. Day-to-day fluctuations really don't matter.

One might argue that a store of value asset is a good diversifier as well, although I think of store-of-value as a somewhat different function in practice.
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Re: PP Inspired Leveraged Portfolios

Post by Mark Leavy » Thu Jul 08, 2021 3:25 pm

vincent_c wrote:
Thu Jul 08, 2021 3:18 pm
discussion on diversification
That was just outstanding.

I've never seen it broken down that way. An eye opener.
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Re: PP Inspired Leveraged Portfolios

Post by modeljc » Thu Jul 08, 2021 4:01 pm

Mark Leavy wrote:
Thu Jul 08, 2021 3:25 pm
vincent_c wrote:
Thu Jul 08, 2021 3:18 pm
discussion on diversification
That was just outstanding.

I've never seen it broken down that way. An eye opener.
Wow I agree! Thanks
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Re: PP Inspired Leveraged Portfolios

Post by hydromod » Thu Jul 08, 2021 4:27 pm

Translating for my pea brain:

There are three (maybe four) Platonic ideals for a diversifier: (i) pure credit risk with positive expected return, (ii) pure duration risk with positive expected return, (iii) pure volatility with zero expected real mean return, and (maybe iv) pure volatility with zero expected nominal mean return.

By implication, pure credit risk with negative expected return and pure duration risk with negative expected return exist, but these are not considered diversifiers (anti-diversifiers, maybe?).

Real investments are a mix of these Platonic ideals, because you can't have credit risk without some duration and vice versa.

To clarify, do credit risk and duration risk include volatility as well? Or are these constant for (i) the duration of the credit risk and (ii) each credit source of the duration risk?

Further, how you are conceiving that correlation creeps in? Since the risk sources are uncorrelated...
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Re: PP Inspired Leveraged Portfolios

Post by StrategyDriven » Thu Jul 08, 2021 5:47 pm

vincent_c wrote:
Thu Jul 08, 2021 2:27 pm
StrategyDriven wrote:
Thu Jul 08, 2021 2:13 pm
A problem is that these sort of things are not static, you can't across the board have relationships with 'diversifiers' that behave the same given different circumstances.
How can you say this like it is a fact? At best it is debatable.
What I was referring to is the essentially related to why the Permanent Portfolio was created, it was constructed of different components in order to do ok in inflation, deflation, economic expansion or recession. A component or two are likely to provide returns in different environments, the others maybe down maybe flat. It's a balancing act. When I said that diversifiers are not static across the board, I meant that pick a common diversifier, bonds, utilities, gold, commodities, etc. They will not always be a diversifier depending on the conditions. At times they will move with a tight correlation to the broad markets, other times they will behave well as one would hope when the markets aren't doing well. But they don't always perform in a highly uncorrelated fashion.
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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Thu Jul 08, 2021 5:58 pm

Mark Leavy wrote:
Thu Jul 08, 2021 3:25 pm
vincent_c wrote:
Thu Jul 08, 2021 3:18 pm
discussion on diversification
That was just outstanding.

I've never seen it broken down that way. An eye opener.
Tool for accomplishing the above...long vol
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Re: PP Inspired Leveraged Portfolios

Post by StrategyDriven » Thu Jul 08, 2021 8:01 pm

vincent_c wrote:
Thu Jul 08, 2021 7:54 pm
StrategyDriven wrote:
Thu Jul 08, 2021 5:47 pm
When I said that diversifiers are not static across the board, I meant that pick a common diversifier, bonds, utilities, gold, commodities, etc. They will not always be a diversifier depending on the conditions. At times they will move with a tight correlation to the broad markets, other times they will behave well as one would hope when the markets aren't doing well. But they don't always perform in a highly uncorrelated fashion.
Ok, let's just call it a miscommunication. I never meant to be rude, and I apologize for being defensive. I appreciate your contributions and willingness to defend your points of view.
I clearly offended earlier, my bad on that, I apologize.
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Re: PP Inspired Leveraged Portfolios

Post by vnatale » Thu Jul 08, 2021 8:06 pm

The other night I said to my softball team the other night (and to which they all agreed)..."if there was a sportsmenship award in the league...our team would win it..."

In that same spirit I nominate both "vincent_c" and "StrategyDriven" to each get the "Un-divisive" Award!

They have each set sterling examples for all of us to follow.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: PP Inspired Leveraged Portfolios

Post by D1984 » Fri Jul 09, 2021 1:31 am

hydromod wrote:
Thu Jul 08, 2021 1:37 pm
A few scattered points:
  • I have very little trust in any model that I didn't develop myself, and not a whole lot in my own. All models are wrong, but some are useful.
  • I try not to trust in any hypothesis about how something works unless I can build a quantitative model to test the hypothesis and build confidence. Failed models are usually the most illuminating.
  • Building a quantitative model can be based on observations or based on principles. One is on firmer ground using the principle-derived model. As an example, the model I presented simply assumes that (i) short-term future volatility patterns can be estimated better than chance based on recent observations and (ii) expected future returns cannot be reliably estimated. Based on those assumptions, all the model does is construct the lowest-volatility portfolio consistent with long-term desired balance of risk among assets.
  • I've only backtested with monthly UPRO/TMF from 1955 through 1986 (example here). There's some heresy in some of these tests; using TMF (-3x LTT) instead of TMV would have worked beautifully 1955-1982, although it's a very open question whether to and how to actually use that information. I haven't gone further yet with other assets, in part because I haven't had an appropriate dataset and in part because I only recently worked out how I wanted to handle more than two assets at once.
  • I looked at the effect of UPRO/TMF correlations 1955-2019 here. I think that the data suggests that inverse correlations between equities and treasuries are all well and good, but they can't overcome falling treasury returns and don't matter with rising equity returns. This means correlations really only matter around equity crashes; and I suspect that automated trading algorithms are well aware of that importance going forward.
  • My model is based on daily total returns, to generate synthetic 3x LETFs, estimate volatilities, and estimate correlations. I can do part of that with monthly returns and monthly estimates of volatility, but would not be able to do much with correlations. So that limits a monthly version of my model to the approximation of zero correlation among assets or a rather poor estimate of correlation.
  • The weak point of my model is that there is no guidance as to what assets to include. However, dramatically failing assets (I'm looking at you 2000 and 2008), have tended to end up with a small hit to the overall portfolio. My hypothesis is that poorly performing assets tend to have high volatility, which cuts their participation. This doesn't work if the asset is a low-volatility dog.
  • I think that a potentially really good way forward would be to combine some of StrategyDriven's approach with mine, by adaptively selecting a number of assets that have prospects of doing well (actually, cutting assets that are likely to be doing poorly in the near future). That might solve the issue of selecting assets that have their day in the sun for a while then fade away. That's not at all permanent portfolio, I know.
  • I'm a bit dubious that several conditions prior to 1986 will repeat, although they make good test cases. I think the gold performance coming off deregulation was an anomalous shock that will be hard-pressed to repeat (other things might mimic this, like crypto, and shocks are endemic to the market). I think the treasury underperformance was likely exacerbated by treasuries being callable (making them very risky), which is no longer the case.
Gold from, say, 1970 to year-end 1974 does present a conundrum since it did indeed have a huge spurt in price as it went off the regulated $35 an ounce price level and this can only happen once; probably what happened was some of the gains that would've accrued from, say, 1964 to 1968 or 1969 instead all got bunched into these years (along with the actual regular gains that would've happened...after all, 1972 through 1974 were boom years for all sorts of commodity prices). I've done a crude simulation of an "alternate gold" using a mixture of 1/3rd broad commodity prices (since they would also be expected to increase in price during a period of strong inflation....especially one where real rates were negative during some of said inflation), 1/3rd silver prices (since silver is the precious metal that has the highest correlation to gold despite silver still having some characteristics of an industrial metal as well whereas gold is almost a purely monetary/store of value precious metal), and 1/3rd "leveraged TIPS" (the Kothari synthetic ITT TIPS simulated data leveraged by either the actual 1 year Treasury rate or actual 5-year rate and leveraged at such a level that their stddev and vol were approximately similar to that of gold from 1968-2020) and this approach yielded the following annual returns (with 1/3rd in each of the asset classes as above and rebalanced at the end of each year; I chose to do a leveraged version of TIPS since gold is a hedge against negative real rates and leveraging TIPS by nominal rates is a sort of simulation of this characteristic of an asset class):

1970 = 6.12%

1971 = 1.70%

1972 = 30.84%

1973 = 54.15%

1974 = 38.55%

So even though this hypothetical "simulated gold" still wouldn't have done as well as actual gold I still think gold from 1970-1974--had it been freely traded and fully free market priced rather than coming off a fixed regulated price--still would've done pretty decently during the inflationary early 1970s period.

Oh, and when it comes to LTTs doing poorly from 1955-1981 due to them being callable during this period....that dog doesn't really hunt. Some (though far from all) LTTs issued during this time frame were callable but even those that were callable were either callable after 25 years (for bonds issued with an original maturity of 30 years) or sometimes callable after 20 years (for bonds issued with an original maturity of 25, 27, or 28 years). It wasn't like corporate long-term bonds where the callable ones can be called in only a few years after they are issued. By the time any of these LTTs were anywhere close enough to the call date to seriously affect their performance as long-term bonds a fund like VUSTX, TLT, or TMF wouldn't hold them anyway as they would be below 19.5 or 20 years until maturity.

For some examples see the following:

https://www.treasurydirect.gov/ftp/opd/opdm121955.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121958.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121965.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121967.pdf

These are for all the US public debt securities outstanding as of year-end 1955, 1958, 1965, and 1967 respectively.

Notice that the long-term bonds (20 years or greater to maturity) shown are either not callable at all (i.e. for 1955 and 1958 the ones due in 1985, 1990, 1995) or callable so far in the future that the call provision had negligible impact on their performance in response to rates (due in 1983 but callable in 1978; by 1955 or 1958 this bond's coupon rate would've been below market rates at almost all times and wouldn't be seen as being at risk of call...and even if it was briefly at risk of call--say a month or two in mid-1955--when LTT market rates were at around 2.7% and this bond carried a 3% coupon--it wasn't like the Treasury could call it then and there; at the VERY earliest they'd have to wait until mid-1978; this would've still given this bond a period until maturity or first call of circa 23 years which meant it still would've effectively been an LTT and functioned as one in response to interest rate changes...there wasn't a huge difference in 30-year and 23-year rates on the yield curve at that time ). In any event, after this one brief period there wasn't a time when a 3% coupon bond was in any real risk of call as market rates were always higher than 3% at any time after that (they got pretty close in May 1958 when they hit 3.06 or 3.07% but they never got at or below 3% again until the late 2000s at which point this bond would've been ancient history anyway).

Much the same as the above applies to 1965 (the ones not callable but that were due in 1985, 1990, 1995, plus one issued in 1960 that was due in 1998 and not callable; the 1978 callable-1983 due one wouldn't have been an LTT by this point and so wouldn't be in an LTT fund to begin with) and to the ones due in 92, 93, and 94 but callable in 87, 88, and 89 respectively; this also applies to late 1967 (the one due in 1985 wouldn't be an LTT at that point; the ones due in 1990, 1995, and 1998 weren't callable, and by this point the ones callable in the early 1990s were at coupons so far below then-current market rates they weren't in any risk of being called anyhow).

The poor LTT performance during this period was mostly due to rates rising from 2.9 or 3.0 percent to circa 15 percent; call provisions had little to do with it.
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Re: PP Inspired Leveraged Portfolios

Post by hydromod » Fri Jul 09, 2021 9:17 am

D1984 wrote:
Fri Jul 09, 2021 1:31 am

Gold from, say, 1970 to year-end 1974 does present a conundrum since it did indeed have a huge spurt in price as it went off the regulated $35 an ounce price level and this can only happen once; probably what happened was some of the gains that would've accrued from, say, 1964 to 1968 or 1969 instead all got bunched into these years (along with the actual regular gains that would've happened...after all, 1972 through 1974 were boom years for all sorts of commodity prices). I've done a crude simulation of an "alternate gold" using a mixture of 1/3rd broad commodity prices (since they would also be expected to increase in price during a period of strong inflation....especially one where real rates were negative during some of said inflation), 1/3rd silver prices (since silver is the precious metal that has the highest correlation to gold despite silver still having some characteristics of an industrial metal as well whereas gold is almost a purely monetary/store of value precious metal), and 1/3rd "leveraged TIPS" (the Kothari synthetic ITT TIPS simulated data leveraged by either the actual 1 year Treasury rate or actual 5-year rate and leveraged at such a level that their stddev and vol were approximately similar to that of gold from 1968-2020) and this approach yielded the following annual returns (with 1/3rd in each of the asset classes as above and rebalanced at the end of each year; I chose to do a leveraged version of TIPS since gold is a hedge against negative real rates and leveraging TIPS by nominal rates is a sort of simulation of this characteristic of an asset class):

1970 = 6.12%

1971 = 1.70%

1972 = 30.84%

1973 = 54.15%

1974 = 38.55%

So even though this hypothetical "simulated gold" still wouldn't have done as well as actual gold I still think gold from 1970-1974--had it been freely traded and fully free market priced rather than coming off a fixed regulated price--still would've done pretty decently during the inflationary early 1970s period.

A question asked in ignorance: my understanding is that the economy is becoming less manufacturing-dominated and more information-dominated. Is that relevant and correct? What implications would that have for commodities in the future?

Oh, and when it comes to LTTs doing poorly from 1955-1981 due to them being callable during this period....that dog doesn't really hunt. Some (though far from all) LTTs issued during this time frame were callable but even those that were callable were either callable after 25 years (for bonds issued with an original maturity of 30 years) or sometimes callable after 20 years (for bonds issued with an original maturity of 25, 27, or 28 years). It wasn't like corporate long-term bonds where the callable ones can be called in only a few years after they are issued. By the time any of these LTTs were anywhere close enough to the call date to seriously affect their performance as long-term bonds a fund like VUSTX, TLT, or TMF wouldn't hold them anyway as they would be below 19.5 or 20 years until maturity.

For some examples see the following:

https://www.treasurydirect.gov/ftp/opd/opdm121955.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121958.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121965.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121967.pdf

These are for all the US public debt securities outstanding as of year-end 1955, 1958, 1965, and 1967 respectively.

Notice that the long-term bonds (20 years or greater to maturity) shown are either not callable at all (i.e. for 1955 and 1958 the ones due in 1985, 1990, 1995) or callable so far in the future that the call provision had negligible impact on their performance in response to rates (due in 1983 but callable in 1978; by 1955 or 1958 this bond's coupon rate would've been below market rates at almost all times and wouldn't be seen as being at risk of call...and even if it was briefly at risk of call--say a month or two in mid-1955--when LTT market rates were at around 2.7% and this bond carried a 3% coupon--it wasn't like the Treasury could call it then and there; at the VERY earliest they'd have to wait until mid-1978; this would've still given this bond a period until maturity or first call of circa 23 years which meant it still would've effectively been an LTT and functioned as one in response to interest rate changes...there wasn't a huge difference in 30-year and 23-year rates on the yield curve at that time ). In any event, after this one brief period there wasn't a time when a 3% coupon bond was in any real risk of call as market rates were always higher than 3% at any time after that (they got pretty close in May 1958 when they hit 3.06 or 3.07% but they never got at or below 3% again until the late 2000s at which point this bond would've been ancient history anyway).

Much the same as the above applies to 1965 (the ones not callable but that were due in 1985, 1990, 1995, plus one issued in 1960 that was due in 1998 and not callable; the 1978 callable-1983 due one wouldn't have been an LTT by this point and so wouldn't be in an LTT fund to begin with) and to the ones due in 92, 93, and 94 but callable in 87, 88, and 89 respectively; this also applies to late 1967 (the one due in 1985 wouldn't be an LTT at that point; the ones due in 1990, 1995, and 1998 weren't callable, and by this point the ones callable in the early 1990s were at coupons so far below then-current market rates they weren't in any risk of being called anyhow).

I'm trying to follow the argument but I've never looked at such information directly and I'm having trouble with nomenclature. I tried looking at the 1965 one and I'm not sure what I'm looking at exactly. Is redeemable the same as callable? Could you pick out a page and line that show one of these, maybe the one due in 92 and callable in 87?

The poor LTT performance during this period was mostly due to rates rising from 2.9 or 3.0 percent to circa 15 percent; call provisions had little to do with it.
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Re: PP Inspired Leveraged Portfolios

Post by D1984 » Thu Jul 15, 2021 11:16 am

hydromod wrote:
Fri Jul 09, 2021 9:17 am
D1984 wrote:
Fri Jul 09, 2021 1:31 am

Gold from, say, 1970 to year-end 1974 does present a conundrum since it did indeed have a huge spurt in price as it went off the regulated $35 an ounce price level and this can only happen once; probably what happened was some of the gains that would've accrued from, say, 1964 to 1968 or 1969 instead all got bunched into these years (along with the actual regular gains that would've happened...after all, 1972 through 1974 were boom years for all sorts of commodity prices). I've done a crude simulation of an "alternate gold" using a mixture of 1/3rd broad commodity prices (since they would also be expected to increase in price during a period of strong inflation....especially one where real rates were negative during some of said inflation), 1/3rd silver prices (since silver is the precious metal that has the highest correlation to gold despite silver still having some characteristics of an industrial metal as well whereas gold is almost a purely monetary/store of value precious metal), and 1/3rd "leveraged TIPS" (the Kothari synthetic ITT TIPS simulated data leveraged by either the actual 1 year Treasury rate or actual 5-year rate and leveraged at such a level that their stddev and vol were approximately similar to that of gold from 1968-2020) and this approach yielded the following annual returns (with 1/3rd in each of the asset classes as above and rebalanced at the end of each year; I chose to do a leveraged version of TIPS since gold is a hedge against negative real rates and leveraging TIPS by nominal rates is a sort of simulation of this characteristic of an asset class):

1970 = 6.12%

1971 = 1.70%

1972 = 30.84%

1973 = 54.15%

1974 = 38.55%

So even though this hypothetical "simulated gold" still wouldn't have done as well as actual gold I still think gold from 1970-1974--had it been freely traded and fully free market priced rather than coming off a fixed regulated price--still would've done pretty decently during the inflationary early 1970s period.

A question asked in ignorance: my understanding is that the economy is becoming less manufacturing-dominated and more information-dominated. Is that relevant and correct? What implications would that have for commodities in the future?

Oh, and when it comes to LTTs doing poorly from 1955-1981 due to them being callable during this period....that dog doesn't really hunt. Some (though far from all) LTTs issued during this time frame were callable but even those that were callable were either callable after 25 years (for bonds issued with an original maturity of 30 years) or sometimes callable after 20 years (for bonds issued with an original maturity of 25, 27, or 28 years). It wasn't like corporate long-term bonds where the callable ones can be called in only a few years after they are issued. By the time any of these LTTs were anywhere close enough to the call date to seriously affect their performance as long-term bonds a fund like VUSTX, TLT, or TMF wouldn't hold them anyway as they would be below 19.5 or 20 years until maturity.

For some examples see the following:

https://www.treasurydirect.gov/ftp/opd/opdm121955.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121958.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121965.pdf

https://www.treasurydirect.gov/ftp/opd/opdm121967.pdf

These are for all the US public debt securities outstanding as of year-end 1955, 1958, 1965, and 1967 respectively.

Notice that the long-term bonds (20 years or greater to maturity) shown are either not callable at all (i.e. for 1955 and 1958 the ones due in 1985, 1990, 1995) or callable so far in the future that the call provision had negligible impact on their performance in response to rates (due in 1983 but callable in 1978; by 1955 or 1958 this bond's coupon rate would've been below market rates at almost all times and wouldn't be seen as being at risk of call...and even if it was briefly at risk of call--say a month or two in mid-1955--when LTT market rates were at around 2.7% and this bond carried a 3% coupon--it wasn't like the Treasury could call it then and there; at the VERY earliest they'd have to wait until mid-1978; this would've still given this bond a period until maturity or first call of circa 23 years which meant it still would've effectively been an LTT and functioned as one in response to interest rate changes...there wasn't a huge difference in 30-year and 23-year rates on the yield curve at that time ). In any event, after this one brief period there wasn't a time when a 3% coupon bond was in any real risk of call as market rates were always higher than 3% at any time after that (they got pretty close in May 1958 when they hit 3.06 or 3.07% but they never got at or below 3% again until the late 2000s at which point this bond would've been ancient history anyway).

Much the same as the above applies to 1965 (the ones not callable but that were due in 1985, 1990, 1995, plus one issued in 1960 that was due in 1998 and not callable; the 1978 callable-1983 due one wouldn't have been an LTT by this point and so wouldn't be in an LTT fund to begin with) and to the ones due in 92, 93, and 94 but callable in 87, 88, and 89 respectively; this also applies to late 1967 (the one due in 1985 wouldn't be an LTT at that point; the ones due in 1990, 1995, and 1998 weren't callable, and by this point the ones callable in the early 1990s were at coupons so far below then-current market rates they weren't in any risk of being called anyhow).

I'm trying to follow the argument but I've never looked at such information directly and I'm having trouble with nomenclature. I tried looking at the 1965 one and I'm not sure what I'm looking at exactly. Is redeemable the same as callable? Could you pick out a page and line that show one of these, maybe the one due in 92 and callable in 87?

The poor LTT performance during this period was mostly due to rates rising from 2.9 or 3.0 percent to circa 15 percent; call provisions had little to do with it.
1. In regards to gold/commodities:

I can't exactly say what implications that would have for commodities. The economy may be becoming less manufacturing-dominated and more service dominated but regardless, people still need food, lumber/other building materials, energy of some kind (be that fossil, nuclear, solar, etc), clothing, medical care, transportation, etc....and since we still have to live in the physical world (you can't eat virtual food, or live in a virtual house, or take virtual medicine, etc) production of those will still require commodities of some kind. Just a thought experiment: the economy is far larger (in both total and per capita GDP terms) and far less manufacturing dominated than it was in, say, 1920 or 1950....but people in the US today probably consume more commodities per person (in absolute terms) than people in the US 100 or 70 years ago even though spending on physical goods is less in percentage terms (since we spend so much more on personal services and on digital goods/services) than it was back then.

Finally, gold especially is not a pure commodity like almost every other commodity since most of it is used for monetary/store of value/jewelry purposes rather than "consumed" like copper, iron, coal, oil, lumber, wool, cotton, cocoa, beef, and the like. Silver and platinum do exhibit some of this "store of value" effect as well but gold is a purer play on that than either of those two metals since it has much fewer industrial uses than either silver or platinum. Given that gold is nonrenewable and that it has this store of value property, it (along with silver and platinum to an extent...and even oil and gas to some extent as well; they are nonrenewable so even though they aren't stores of value they would be effected by negative real rates as well to some degree) should at least somewhat subject to Hotelling effects that vary based on how positive or negative prevailing real rates are. I just included commodities (including silver) in my crude sim of gold model in my post precisely because at least some commodities do behave this way in respect to negative real rates.


2. In regards to LTTs:

OK, for the 1965 document:

Go to page 6; at the top of said page it should say: TABLE X--STATEMENT OF THE PUBLIC DEBT, DECEMBER 31, 1965

Now, go down to the section on that page titled Treasury Bonds.

Go down to the bond listed as "4-1/4% 1987-92 (Effective Rate 4.2340%)". The "Date of Issue" for this one was 8/15/62; this was the day the US Treasury originally went to the bond market and issued this bond (i.e. the day that it borrowed the money and issued the bond in return for said money). The "redeemable" date for this particular bond is 8/15/87; "redeemable" means that the Treasury could call it in on that date or any time after up to its 8/15/92 maturity date (which would be the date it would mature and you'd get your original money back....this was a 30-year bond as it was issued in Aug 1962 and matured in Aug 1992 if it wasn't called) which means that yes, in this case redeemable is the same thing as callable. The "Feb 15-Aug 15" in the "Interest Payable" column for this bond just means that it pays its interest coupon twice yearly; once In February and again in August (so if you had this bond paying 4.25% the total interest on a $100,000 investment would be $4250; $2,125 of this would be paid in February and $2,125 of it would be paid in August). The other columns are just showing the total amounts issued and outstanding. This was a 30-year bond but if you were going by "period until first call or maturity" it would technically trade as a 25-year bond (since it was callable any time 25 years or more after issue); as a practical matter this wouldn't mean much since by the time this bond was in the period between 25 years to first call (summer of 1962) and 20 years to first call (summer of 1967) and/or 20 years to maturity (summer of 1972)--by which point it would cease being a LTT so a PP'er (or an LTT index fund like TLT or VUSTX) wouldn't hold it anyway since it would cease being a true LTT at that point--rates were so much higher than when it was issued the threat of call was basically nonexistent; the Treasury is not going to call in a long-term bond paying 4.25% with some twenty years left on it when it would have to go right back out and borrow the same money at 5 or 6 or 8 or 9 percent.
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Re: PP Inspired Leveraged Portfolios

Post by usermane » Sun Jul 18, 2021 2:54 pm

Most of the discussion here has been centered about 2x or 3x leverage. That's too much for me. Sharpe ratio calculations don't adequately account for rare events, since they assume Gaussian distributions, so 2x or 3x is almost certainly too much leverage. But it does suggest that some amount of leverage is optimal for the long term. Smaller leverage is also cheaper, since your lenders have less risk.

I can think of three easy ways to lever bonds. Leveraging bonds is easier than leveraging stock and that shows up in cheaper expense ratios. So this is the low hanging fruit. The most important factor in a treasury bond fund is the duration, so if you can match the duration of the Permanent Portfolio's bonds (about 9), I'd say that's a pretty good approximation. You can also use simple ETFs to do it, which is important for those of us who are more lazy than greedy.

I'm going to be considering two portfolios for examples here. The first is your classic Permanent Portfolio
25% US Stock
25% Long Term Treasuries
25% Short Term Treasuries
25% Gold
and the other is a Golden Butterfly Variant which is
20% US Stock
20% International Stock
20% LTT
20% STT
20% Gold
Why not Small Cap Value? You'll see when we get there. Percentages are also going to be rougher after this.

1. Don't hold Cash. Take the cash portion of the portfolio and buy the other things. Since borrowing money is theoretically the same as shorting cash, this is the easiest thing to do. It has liquidity risk and your portfolio will be considerably more volatile, but this is appropriate if you have an emergency fund and are considering your other investments. People say that the Permanent Portfolio considers your emergency fund part of your investments, so just take that part out.

2. Zero Coupon Bonds. Sell the coupons on your LTT, get more duration per unit. EDV has a 24.6 year duration, as opposed to VGLT's 18, so it effectively gets 1.35 the duration per unit. It has an expense ratio of .07, unlevered treasuries expense at .05, so this may be the cheapest leverage on the market.
So if you replace VGLT with EDV, you get an effective permanent portfolio of
US: 26.67
Gold: 26.67
Cash: 26.66
EDV: 20
Leverage Ratio: 1.067
and a Golden Butterfly of
US: 21.2
International: 21.2
Gold: 21.2
Cash: 21.2
EDV: 15.2
Leverage: 1.05

3. NTSX, NTSI, NTSE are interesting choices as well. These hold the stock portion of your portfolio directly and buy treasury futures to achieve a .9 stock, .6 treasury exposure for every 1 dollar. Expense ratios are .20, .26, and .32 respectively.

Duration of NTSX is trickier. It buys a ladder of 2, 5, 10, and 30 year bonds, but they have coupons. If they were zeros, they would have:
47/4 = 11.75
duration, but they do yield something, even if it is low. Worse, as interest rates change, the duration will shift as well. This month's starting yield curve was
2 Y 5 Y 10 Y 30 Y
0.25 1.24 1.48 2.07

Which gives Macaulay Bond Durations of
1.971 4.790 9.139 22.634

So the Futures Portion of NTSI has a duration of 9.6335 or a little over our target. Very convenient, but that won't hold as interest rates shift. But you get a 6x leveraged, intermediate duration ETF stapled to a normal large cap index fund. That is a lot of leverage in a small package, plus futures are tax advantaged relative to bond funds if you are doing this is taxable space.

The downside is that this is package deal. You get S&P 500, International Developed, and Emerging Market exposure. Which is why the Golden Butterfly Variant we're looking at invests internationally, not in Small Cap Value.

I would count the synthetic bond fund in VSTX as a 1/2 Cash 1/2 Long Term Treasuries. So you get an effective permanent portfolio of
NTSX: 32.25
Gold: 29.05
Cash: 19.35
LTT: 19.35
Leverage Ratio: 1.16
and a Golden Butterfly of
NTSX: 28.56
NTSI: 28.56
Gold: 25.70
Cash: 8.56
LTT: 8.56
Leverage: 1.253

NTS is a lot more efficient with Golden Butterly Style Portfolios because they have so many more stocks, which come with 6x leverage bonds.

4. Combining Choices
Levering cheaply is nice, let's put these together. First, we're doing a Golden Butterfly, because this is about efficiency. Next, replace LTT with EDV for additional duration.
NTSX: 29.20
NTSI: 29.20
Gold: 26.29
Cash: 8.75
EDV: 6.48
Leverage: 1.314

Finally, dropping the Cash can save you space. You still have ~2/3rds of your "cash" from the futures, what you're really doing is shifting your bond fund further up in duration.
NTSX: 31.9
NTSI: 31.9
Gold: 29.00
EDV: 7.2
Leverage: 1.45
Notice that we have now exceeded the leverage of some of the individual components. Leverage multiplies through a portfolio, that is why it is so easy to unbalance your ratio. But we're about halfway to the 2x levered etfs with an expense ratio just under .20, using SGOL for our gold ETF. That's a lot more efficient.

Who is this good for? Well, leverage has diminishing returns so you are now more likely to be on the safe side of the Kelly Criterion. Your only counterparty for the futures is the CME group, all stocks in the ETFs are as secure as ETFs can be. So BelangP types who want to lever can do it this way. If the CME group defaults, your gold will be in the palm of your hand. You could also replace the bonds with a bond like asset, like utility stocks. Moral of the story is that leveraging bonds is cheaper than leveraging stocks, so if you don't want to go to the max, focus on the cheap parts first.
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Re: PP Inspired Leveraged Portfolios

Post by usermane » Sun Jul 18, 2021 7:57 pm

The long end of the yield curve is normally bid up by fund managers trying to do exactly this trick. This is the duration equivalent of the AQR's low beta anomaly. Fund managers are leverage constrained, so they want the most duration per dollar and will pay a premium for it. For instance
Lever_to_Long.png
Lever_to_Long.png (60.77 KiB) Viewed 7764 times
Levering long bonds to match EDV's duration gets you very similar returns with much less volatility. But that's with "no strings attached" leverage, which not all managers have access to. But we are private investors and can't fire ourselves, so we don't have to worry about the extra volatility. We just pay fees for the margin.

Since the longest parts of the curve are disproportionately valuable, intermediate term treasuries probably offer better returns from a risk/reward perspective. They aren't as useful from a whole portfolio perspective and there are a bunch of complications in using them. Plus you would have to lever them up to match the risk, which is complicated if you don't have the couple hundred grand needed to be a real futures trader. WisdomTree will do it for you, if you buy their funds, and I'm more than happy to let them get me better duration exposure. Of course, I don't want to buy the S&P and large cap developed at the moment, since I can't buy much else in the TSP, but it is the principle of the thing.
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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Mon Oct 11, 2021 11:55 am

It has been a minute since I posted a performance update…so here its is.

UST/TQQQ/VGSH 70/20/10 (The Bullet)

VGSH/TQQQ/TMF/DGP 44/25/12.5/18.5 (The barbell)

VGSH 35%, UST 30%, TQQQ 25%, DGP 5%, VIXY 5% (The Newbie)

70% BND/25% TQQQ/5% VIXY (Personal mix)

1/1/21 - 9/30/21; quarterly rebalance

Bullet: 1.62%

Barbell: 2.65%

Newbie: 1.98%

Personal: 3.88% (backtest) 7.59% (account)

A continued ho hum year for this system. The outperformance over my personal version is due to an option selling overlay I use. In a good year it should add 5% to the top line which it is on track to do by end of year.
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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Thu Oct 21, 2021 10:52 am

There are some really good threads on Bogleheads going on with regard to the title of this thread. This one in particular really has me rethinking my approach.

https://www.bogleheads.org/forum/viewto ... 0&t=357281

It get's pretty dense at times and you can blow by most of it, but look for various allocation ratios

If you aren't interested in leverage then ignore completely.
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Re: PP Inspired Leveraged Portfolios

Post by I Shrugged » Thu Oct 21, 2021 2:47 pm

vincent_c wrote:
Thu Oct 21, 2021 11:23 am
Just scanned it.

It seems to be talking about similar concepts as just a levered PP. The allocations may be different but the assets being suggested are pretty much the same (gold, stocks, LTT).

I did notice that they assumed that LTTs were going to be a losing investment in the long run. I personally cannot make this assumption but I think this may be fundamental to whether the HBPP is broken or not with ZIRP.
The more time that passes, the less I feel that the PP is being broken by ZIRP. More like, we need to move all of our nominal return benchmarks downward. We meaning everyone, everywhere. And it had been a big concern of mine.

But ZIRP combined with inflation, now that makes my butt hurt.
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Re: PP Inspired Leveraged Portfolios

Post by Kbg » Thu Oct 21, 2021 5:55 pm

vincent_c wrote:
Thu Oct 21, 2021 11:23 am
Just scanned it.

It seems to be talking about similar concepts as just a levered PP. The allocations may be different but the assets being suggested are pretty much the same (gold, stocks, LTT).

I did notice that they assumed that LTTs were going to be a losing investment in the long run. I personally cannot make this assumption but I think this may be fundamental to whether the HBPP is broken or not with ZIRP.
If you have some time to read more the main topic is leveraging bonds to chill (and improve) risk adjusted returns. Unfortunately the nuggets of the main idea are buried in the minutiae of treasury futures pricing.
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