Gyroscopic Investing

So I was curious how much a monthly growth stock pick with trailing stop protection would have done in place of the S&P 500 in the PP since 2000:



There's a slight boost to 6.82% CAGR and MaxDD was significantly reduced to -9.95%. Standard PP was only 6.53% and -15.27% MaxDD. I included trading commissions. This is certainly a valid approach for the very lazy, but I think it would be better to broaden out the stocks picks from just large/mid caps (i.e. liquid enough to be able to recommend to 100,000 subscribers). Note that a maximum of 45 stocks were held at any one time, so empty slots acted as a drag on returns.

It's not as good as using downside risk management on the S&P 500 which as part of the PP returned 8.48% CAGR and -12.90% MaxDD. So, I'm not convinced stock picking is warranted just yet.

And here we see the effect of downside risk management applied only on the S&P 500 within the PP:



Remarkably, there's no reduction in the MaxDD with it being at -25.12%. CAGR is boosted slightly to 8.85% CAGR a gain of about .50% over the Vanilla PP.

Trying another angle, a naive risk parity PP with same downside risk management:



For 9.71% CAGR and -22.17% MaxDD. This is about 1.2% CAGR better than a naive risk parity Vanilla PP and almost 1.5% better than the 25x4 Vanilla PP!

Hey IG, can you do some research and see if the naive risk parity (12m) is indistinguishable from the 1% momemtum asset rotation gain?

Fed clueless as usual. When will we abolish it?



The recession is very, very near:



HFT is dead:



There's also a new stock exchange that just got greenlighted IEX that halts every trade by 350ms or so.

Here's the results of my constant duration (CD) Treasury backtests. EDV is equivalent to CD25; ZROZ is equivalent to CD27. I could not do TLT, TLO or VUSTX CD equivalents because there seems to be a huge, flawed upward bias in the data between 13 and 20 year durations (it's from the government, what do you expect). CD22 is equivalent to current 30-year constant maturity Treasury (CMT). CD8 is close to current IEF. ~TLT is chained TLT+VUSTX+CMT30.

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InsuranceGuy wrote:

MachineGhost wrote:Here's the results of my constant duration (CD) Treasury backtests. EDV is equivalent to CD25; ZROZ is equivalent to CD27. I could not do TLT, TLO or VUSTX CD equivalents because there seems to be a huge, flawed upward bias in the data between 13 and 20 year durations (it's from the government, what do you expect). CD22 is equivalent to current 30-year constant maturity Treasury (CMT). CD8 is close to current IEF. ~TLT is chained TLT+VUSTX+CMT30.

Seems reasonable that longer durations will perform better since the 80s because interest rates have only decreased since then.

Indeed, I didn't find it that informative because there's not enough longer durations available during the critical 70's-80's. So I tried another tack:

The effective duration at the top for 20-year bonds in 1976 before the trough in 1981 for a -20.48% MaxDD was 10 years.

And the effective duration at the top for 20-year bonds in 2008 before the trough in 2009 for a -22.13% MaxDD was 15 years.

Since it took 5 more years worth of duration just to do slightly more damage, it seems clear 1976-1981 was the worst of the two. The political environment was very similar to what we can expect over the next few years as we go through another monetary system crisis.

So thats it for me. 10 max it is.

EDIT: Not so fast! I get a -33% MaxDD for CD10 for 1976-1981. Is there any chance convexity is acting as a brake by decreasing duration more and more during a MaxDD? I believe a ZC wouldn't have any convexity.

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InsuranceGuy wrote:Interesting. In regards to convexity ZC have the highest convexity as the higher the coupon the lower the convexity.

Hmm, for the 20yr bottom in 1976, duration was 10.1 and convexity was 75.5; for the top in 1981, duration was 6.1 and convexity was 33.3.

For the CD10 bottom in 1976, duration was 10.4 and convexity was 79.47; for the top in 1981, duration was 6.42 and convexity was 36.3.

Maximizing the convexity for a same duration target would result in lower losses per unit of yield change, but its marginal.

So nothing to see here, folks! Using duration as a risk target is "good enough".

I think the "accured interest" accounted for in ZC doesn't keep the duration constant after all?

Thinking ahead, it is very likely that a given level of duration will match to a given level of historical volatility, but I'm not going to bother doing that analysis with the poor data from FRED. If you're into risk parity, it could very useful for hedging the equities more precisely.

I cooked up a little quick and dirty quant duration model where you target x years of duration based on any given yield. Of interest is that the model recommends an exposure to 0 years of duration when 10yr Treasury yields are between 1.09% and 1.10% which seems pretty close to craigr's and PS's gut feel.

MachineGhost wrote:I cooked up a little quick and dirty quant duration model where you target x years of duration based on any given yield. Of interest is that the model recommends an exposure to 0 years of duration when 10yr Treasury yields are between 1.09% and 1.10% which seems pretty close to craigr's and PS's gut feel.

I thought MT and Craig were referring to 1% LTT yields and not the 10-year Treasury.

buddtholomew wrote:

MachineGhost wrote:I cooked up a little quick and dirty quant duration model where you target x years of duration based on any given yield. Of interest is that the model recommends an exposure to 0 years of duration when 10yr Treasury yields are between 1.09% and 1.10% which seems pretty close to craigr's and PS's gut feel.

I thought MT and Craig were referring to 1% LTT yields and not the 10-year Treasury.

Just up it a bit then.

I spent some time figuring out the optimal Golden Butterfly tilts:



The overall net duration for the portfolio is 3.14 years at current yields. In comparison, the PP is 4.49 years.

Here's the tilts applied to the PP:

Is that optimal in light of current yields or a permanent allocation adjustment?

Man, that's a lot of small-caps. Didn't the original Golden Butterfly come out close to an even split by size? Is this new split part of the duration strategy, too?

Mr Vacuum wrote:Is that optimal in light of current yields or a permanent allocation adjustment?

Man, that's a lot of small-caps. Didn't the original Golden Butterfly come out close to an even split by size? Is this new split part of the duration strategy, too?

The latter and it's nothing to do with yields or duration. It's just a tilt for the best risk/reward ratio. Keep in mind its not small caps per see, but multi-factor value concentrated in small cap zone (i.e. under $2 billion market cap) where there is actually likely to be value since Wall Street doesn't get a gravy train from small caps, so they're not covered by after-the-fact, overpaid analysts. The actual equity split is:

12.50% Total Market
12.50% Large Cap Growth
25.00% Mid Cap Blend
50.00% Small Cap Value

Hopefully Tyler will put up the other sizes and style soon, especially equal weight. I expect there could more revelations to come. For now I am going to apply the above tilt to any/all core domestic equity exposure.

I think this is Charlie's chocolate factory. What your think, KBG?

Hmm... it appears that wide diversification does not improve upon the enhanced Golden Butterfly when applied within an "all weather" portfolio. I certainly wasn't expecting that.

1972:


1985:


2000:

Looks like a good map of it to me. Personally I think top and bottom halves are a bit silly. If one is going to commit to a factor then commit...like top 25 or 10%.

Kbg wrote:Looks like a good map of it to me. Personally I think top and bottom halves are a bit silly. If one is going to commit to a factor then commit...like top 25 or 10%.

What I don't like is the part where they adjust the end results to minimize tracking error to the S&P 500. WTF??? Why go through the sausage factory if only to make it look like what you're trying to avoid. Makes no sense at all. I also checked Goldman's multi-factor ETF which is a lot lower cost and it too does the minimize tracking error thing. So I removed both from my watch portfolio. I'm starting to think maybe the critics are right that this "smart beta" stuff is just "closet indexing in drag" and a way to fleece the public.

These guys aren't stupid (salesmen). They know they can't be too far off the bogey and continue to make a buck.

Assuming this year remains awesome for PP, next year will show renewed enthusiasm for the PP while the previous three years there was little interest. However, if it wasn't for the 2011-2012 interest in PP I wouldn't be here. It's a human thing. Bottom line: They give the customers what they want and falling behind a bull market is not tolerable for many.

Given that future returns on all financial assets have been driven to cash yield levels, this new portfolio is looking rather attractive. The effective duration of the portfolio is 3.854 years.





However, it lacks enough gold:

1972-1980:


1972-1981 (after Volcker steps in);


The only thing that really makes sense right now is cash and gold. We're staring at the exit hole from the Nixon Shock in the distance.

This below was the latest attempt in AmiBroker to imeplement rebalancing bands before I gave up (again):

// --- set rebalancing bands
SetCustomBacktestProc( "" );

if( Status( "action" ) == actionPortfolio )
{
bo = GetBacktesterObject();

bo.PreProcess(); // Initialize backtester

for( bar = 0; bar < BarCount; bar++ )
{
bo.ProcessTradeSignals( bar );

CurEquity = bo.Equity;

for( pos = bo.GetFirstOpenPos(); pos; pos = bo.GetNextOpenPos() )
{
posval = pos.GetPositionValue();

diff = posval - (0.01 * EachPosPercent * CurEquity);
price = pos.GetPrice( bar, "C" );

// rebalance only if difference between desired and
// current position value is greater than 10% of equity
// and greater than price of single share
if( diff != 0 AND
abs( diff ) > (0.10 * CurEquity) AND
abs( diff ) > price ) )

{
bo.ScaleTrade( bar, pos.Symbol, diff < 0, price, abs( diff ) );
}
}
}

bo.PostProcess(); // Finalize backtester
}

This thing is like a tank!