Mutant PP Implementation?

[cnh]

I recently implemented a "pure" 4X25 PP in one of my accounts and I'll be happy to watch it work, but I'm hesitating to do so in a larger account.  Here's why.  After some backtesting covering a 40-year period, I find that a portfolio of 65% Vanguard Wellesley, 10% long treasuries, 10% short treasuries and 15% gold outperforms a comparable pure implementation on CAGR, SDEV, Sharpe and max draw-down (very slightly).  I acknowledge the active management risk inherent in Wellesley, but I may be willing to accept it based on the track record.

Am I failing to consider an attribute of a pure implementation?  Should cost perhaps be the deciding factor?

[craigr]

"Past performance does not guarantee future results."

Wellesley is a fine fund, and perhaps even something to consider stand alone (or mixed with some gold). But the confluence of the active managers with the passive components could cause issues. It's hard to say how the managers will position their funds ahead of time and whether that positioning could be good or bad going forward.

[iwealth]

I recently implemented a "pure" 4X25 PP in one of my accounts and I'll be happy to watch it work, but I'm hesitating to do so in a larger account.  Here's why.  After some backtesting covering a 40-year period, I find that a portfolio of 65% Vanguard Wellesley, 10% long treasuries, 10% short treasuries and 15% gold outperforms a comparable pure implementation on CAGR, SDEV, Sharpe and max draw-down (very slightly).  I acknowledge the active management risk inherent in Wellesley, but I may be willing to accept it based on the track record.

Am I failing to consider an attribute of a pure implementation?  Should cost perhaps be the deciding factor?

It's very easy to find combinations that have worked better than the PP in the past. Wellesley is just a large cap stock/intermediate bond mix. To give you an example, using Simba's backtesting spreadsheet, I find that 46% large cap value and 54% 5-yr treasuries gives me a higher return with  lower "down" and higher "up" standard deviation than 100% Wellesley from 1972-2011.

And playing with the numbers a little more, I see that 32.5% LCV, 32.5% 5-yr treasuries, 10% LTT, 10% STT, and 15% gold slightly outperformed your portfolio from 1972-2011. And no management risk. I'm not recommending such a thing, just pointing out that you can always find something that has a higher CAGR and lower standard deviation that the PP when looking backward.

I'd just focus more on whether or not you feel whatever portfolio you choose will help you sleep at night given an uncertain future. Not trying to say that's the PP. Just that the PP's biggest advantage isn't a numeric backtesting performance that destroys every other combination imaginable.

Just have to love that a portfolio can perform so amazingly well over time with equal allocations of 4 very distinct assets.

[Pointedstick]

I'd just focus more on whether or not you feel whatever portfolio you choose will help you sleep at night given an uncertain future. Not trying to say that's the PP. Just that the PP's biggest advantage isn't a numeric backtesting performance that destroys every other combination imaginable.

This is so true. If you base your portfolio purely on backtesting, you'll still have the urge to tinker, because there's always something that did better in the past and will do better in the future. The beauty of the PP, in my mind, is how its components combine so well on theoretical and macroeconomic grounds. We don't hold assets because of how much they returned in the past, but because of how they must behave in given situations, past, present, and future.

To that effect, the only real debates concern worries that parts of the PP might not serve their functions well enough well enough (gold having higher volatility than LTTs and stocks) or that they might not going into the future ("with rates this low, how do LTTs make any sense?"). There are plenty of tweaks we can make while still acknowledging the macroeconomic realities that make the PP work. Even for someone who uses a different portfolio, understanding these realities is the key to being happy with your portfolio, in my mind. You won't know what the markets will do in the future, but you can be reasonably sure of how your portfolio will react, even if you're 100% in triple-leveraged Nigerian credit default swaps.