Gyroscopic Investing

For a traditional 4x25 HBPP, I'm wondering what's really better between:

- traditional high-beta index e.g. IWM for Russell 2000
- a 3x leveraged ETF e.g. BGU
- individual stocks screened for high beta (and periodically refreshed as beta can dissipate over time)

Thanks

It's not worth doing. IMO. Beta is a rearview mirror measurement. It can only tell you what stocks were more volatile in the past, not how they will work going forward. Also, high beta stocks do have periods of lagging the market (sometimes volatility works the other way, too).

If you wanted to do small cap however to try to capture Beta, I'd be more inclined to use S&P 600 small cap value instead of the Russell because they have better stock screens before letting in a company. iShares has IJS as an example.

Leveraged ETFs are products made to be sold, not bought. I'd avoid all of them.

Overall, the Total Stock Market is the most efficient way to capture market returns in the portfolio. Even Harry Browne gave up the idea of chasing beta and eventually used the S&P 500 index in the portfolio.

Thanks for that tip in the last paragraph. I was not aware HB gave up on beta. I had seen the quote for part of his book where he says you should use high beta for the stock portion. Oh well.

About the ability to predict forward beta, I beg to differ. A few years ago I ran some simple market simulations (using some computer code and end-of-day historical database going back 20 years). I found that any portfolio of the top 10 highest beta among the most liquid (say top 20% in trading volume) stocks over the prior month provides at least a few weeks of very reliable leveraged bet in the same direction as the market. That is the same direction as the future movement - so it gives you leverage, but no predictive power.

I have known this for several years but never been able to put it to good use. Then once 3x leveraged ETFs came out, this seems even less useful. But I'm still wondering if there is some difference in the "quality" of the beta between a 3x ETF and this trading strategy in the context of an HBPP with its buy low / sell high discipline.

I also realize 3x ETFs have their problems with compounding, but that too is not in the context of HBPP rebalancing.

atrchi wrote: Thanks for that tip in the last paragraph. I was not aware HB gave up on beta. I had seen the quote for part of his book where he says you should use high beta for the stock portion. Oh well.

That was part of a discussion I had with his former publisher because this was my own conclusion as well looking at the data that seeking out high beta/alpha returns was not consistently profitable. He concurred. Basically picking funds to have high beta is active stock picking by proxy. When you find out the fund has high beta is about the time it probably is going to start changing. Then again, you can find you have a high beta fund but then it lags the market for protracted periods. I am personally in the camp that a simpler portfolio is more likely to work better over time and capture maximum market returns. I more-or-less agree with John Norstad on this topic of total market investing:

http://www.norstad.org/finance/total.html

Just to add though to not be a wet blanket for you...

If you held a gun to my head and said: "You must try to pick a high beta strategy for the Permanent Portfolio." I would probably say:

Split your stocks 50/50 between Total Stock Market and Small Cap Value and rebalance as you see fit.

BUT, that does not mean it will necessarily outperform. It just means that historically the smaller stocks are more volatile. But again, they may be volatile on the downside as well and if large caps do well for extended periods (as they did during parts of the 80s and 90s) tracking error will be huge.*

* - Plus there are additional costs in transaction fees, higher fund costs and higher taxes that will impact returns.

The more I look, the more comfortable I am becoming with the leveraged ETF's.  I am still no sold on them because on an individual basis they certainly have decay.  However, if used in a portfolio with multiple asset classes such as the PP, and if rebalanced monthly or quarterly, the decay seems to be minimized to large extent, and may be negated by the additional yield from you increased STT holdings.

The next time there is a 15% drawdown for the PP (could be a very long time, or could be right around the corner), I will likely move into a leveraged position.

Possibly something like this:

18% 2x SCV
18% 2x gold
25% EDV (can get close to 2x leveraged results with Zeros, without the borrowing/decay)

The remainder would probably go to:

25% STT (nominal)
14% short term TIPS