High Beta Stocks Backtest

[MachineGhost]

It's been wondered for some time whether or not high beta stocks would be better in the PP as HB originally recommended high beta mutual funds.  My verdict is no unless you're a gunslinger or use some serious risk reduction techniques (trend following is no good and actually doubles the MaxDD!).  Since 4/1998:

Vanilla PP: 6.52% CAR, -15.24% MaxDD
High Beta Stocks PP: 8.23% CAR, -37.04% MaxDD
Low Beta Stocks PP: 7.53% CAR, -14.02% MaxDD
Momentum Stocks PP: 6.78%, -20.47% MaxDD
Value Stocks PP: 6.25%, -15.79% MaxDD
SmallCap Value Stocks PP: 8.14%, -15.31% MaxDD

Low Beta is a analogy for low volatility which is a known anomaly factor, so its not as strange as it appears.  Whats strange is it actually works within the PP context.  I suspect the volatility capture effect is so minuscle it doesn't win out against the anomaly factors, at least in terms of risk-adjusted gain.

[sophie]

That's quite a performance boost.  Some people might be OK with the increased volatility, which is probably not worse than most standard Boglehead type 70/30 portfolios.

[MachineGhost]

I wouldn't know about the risk of Boglehead portfolios, but keep in mind that a 37.04% MaxDD requires around a 55% gain just back to breakeven.  You could be underwater for years!

[MachineGhost]

I checked the stats, the High Beta PP was underwater for 1,460 trading days, or approximately 5.8 calendar years.

From the looks of it, a lot of high beta stocks were tech stocks.  They got absolutely destroyed post-2000 with a 95.487% maximum drawdown.  This includes delistings.

Wow, if there was a stock torture test for the PP, this sure comes close!

[melveyr]

I think SCV would be a more compelling way to get extra volatility. High beta could actually just be a proxy for the amount of speculative fervor associated with a stock which is kind of a shaky foundation for an equity portfolio. The fact that MG found that high beta was associated with tech in the late 90s might support this hypothesis.

[MachineGhost]

I think SCV would be a more compelling way to get extra volatility. High beta could actually just be a proxy for the amount of speculative fervor associated with a stock which is kind of a shaky foundation for an equity portfolio. The fact that MG found that high beta was associated with tech in the late 90s might support this hypothesis.

Being the size or the value?  Do you want me to backtest it and have you risk public humiliation?

[melveyr]

I think SCV would be a more compelling way to get extra volatility. High beta could actually just be a proxy for the amount of speculative fervor associated with a stock which is kind of a shaky foundation for an equity portfolio. The fact that MG found that high beta was associated with tech in the late 90s might support this hypothesis.

Being the size or the value?  Do you want me to backtest it and have you risk public humiliation?

What do you mean? I was saying that small cap value instead of total stock market makes more sense to me than going high beta. Backtest away...

[MachineGhost]

What do you mean? I was saying that small cap value instead of total stock market makes more sense to me than going high beta. Backtest away...

It was a failed attempt at humor.  And I meant do you believe the higher volatility will come from the small component or from the value component, or in other words, why both together?

EDIT: Since I'm on a roll here, I've updated the OP to show momentum and value stocks.

[melveyr]

What do you mean? I was saying that small cap value instead of total stock market makes more sense to me than going high beta. Backtest away...

It was a failed attempt at humor.  And I meant do you believe the higher volatility will come from the small component or from the value component, or in other words, why both together?

EDIT: Since I'm on a roll here, I've updated the OP to show momentum stocks.

Well it was less about explicitly chasing vol and more about the anomaly that SCV has strong risk adjusted returns. It also has happened to have higher volatility than the stock market so it could work from a volatility harvesting standpoint. I am not sure about the breakdown of what contributes to the volatility (small or value) but I would wager that its both.

[MachineGhost]

Well it was less about explicitly chasing vol and more about the anomaly that SCV has strong risk adjusted returns. It also has happened to have higher volatility than the stock market so it could work from a volatility harvesting standpoint. I am not sure about the breakdown of what contributes to the volatility (small or value) but I would wager that its both.

Okay, I don't have an index for that so I'll use the Vanguard fund.  Pretty interesting!  Is the results pretty much normal for SmallCap Value or is it a temporary outperformance because of the post-2000 climate?

[melveyr]

Well it was less about explicitly chasing vol and more about the anomaly that SCV has strong risk adjusted returns. It also has happened to have higher volatility than the stock market so it could work from a volatility harvesting standpoint. I am not sure about the breakdown of what contributes to the volatility (small or value) but I would wager that its both.

Okay, I don't have an index for that so I'll use the Vanguard fund.  Pretty interesting!  Is the results pretty much normal for SmallCap Value or is it a temporary outperformance because of the post-2000 climate?

MG,

You should check out the Kenneth French data library:
http://mba.tuck.dartmouth.edu/pages/fac ... brary.html

You can get monthly total returns for so many things, most importantly T-Bills, the stock market, and SCV. The data goes WAY back (a lot of it to the 1920s). They often look at excess returns (return - T-Bill return) but you can easily add them back in.

[rocketdog]

It's been wondered for some time whether or not high beta stocks would be better in the PP as HB originally recommended high beta mutual funds.  My verdict is no unless you're a gunslinger or use some serious risk reduction techniques (trend following is no good and actually doubles the MaxDD!). 

Low Beta is a analogy for low volatility which is a known anomaly factor, so its not as strange as it appears.  Whats strange is it actually works within the PP context.  I suspect the volatility capture effect is so minuscle it doesn't win out against the anomaly factors, at least in terms of risk-adjusted gain.

Thanks for looking into that.  I've been wondering the same thing for some time.  My current game plan is to gradually shift the stock portion of my PP from having a small value tilt towards having a low volatility tilt once I hit retirement.  As time dwindles on my expected lifespan, I will have less time to recover from high volatility so I'm hoping this will dampen any major swings. 

Now all I need to do is find a couple of good low volatility gold and LTT funds! 

[Pointedstick]

Now all I need to do is find a couple of good low volatility gold and LTT funds! 

Check out the last couple of posts in http://gyroscopicinvesting.com/forum/in ... g66279#new

TLH has lower-duration bonds than TLT (and is therefore lower in volatility) and you can kinda-sorta have a lower-volatility gold-like thing by swapping some of the gold out for TIPS. Not a great solution, I know. But the combination seems to backtest well.

[KevinW]

IMO, if one wants a different risk/reward profile than the vanilla PP, mixing in a VP is safer and better than tampering with individual PP assets. The 4x25 is a well-oiled machine of interdependent parts. If you want less risk/reward, add a VP of cash. If you want more, add a broad market or small cap value index fund.

[MachineGhost]

TLH has lower-duration bonds than TLT (and is therefore lower in volatility) and you can kinda-sorta have a lower-volatility gold-like thing by swapping some of the gold out for TIPS. Not a great solution, I know. But the combination seems to backtest well.

I think your TIPS suggestion is actually a reasonable idea for lowering the portfolio risk except for the reason we own gold.  TIPS are certainly part of the AWP portfolio that I've been questioning of late.

In theory, with less risky stocks, you wouldn't need such long duration bonds.  Do they really serve any other purpose but to hedge the stocks?

I've been pondering if the the PP is actually right for me.  There's no doubt I believe in the clustering correlations of the assets, the problem is I still find the portfolio risk to be so out of whack with the return offered when other portfolio approaches (such as rental real estate, municipal bonds, dividend growers) are far superior with less risk so long as you ignore the gold buggerism and MR.

[Pointedstick]

I've been pondering if the the PP is actually right for me.  There's no doubt I believe in the clustering correlations of the assets, the problem is I still find the portfolio risk to be so out of whack with the return offered when other portfolio approaches (such as rental real estate, municipal bonds, dividend growers) are far superior with less risk so long as you ignore the gold buggerism and MR.

I've noticed.  Thing is, I think you may be underestimating the risks of alternative investment strategies.

Rental real estate is horribly risky unless you own multiple properties in different geographical locations; even an apartment complex in one city can be entirely leveled by a tornado or fire or something. And it's a ton of work, too. Much more like a job than an investment strategy. If you're not a big people person and don't like construction, forget it.

Munis are risky not only due to their default and call risks, but they share with all fixed income products a major implementation risk that you'll buy in during a period of ultra-low rates (like right now). A fixed-income heavy strategy that relies on coupon payments seems like a terrible investment on its own at this point in time. You wanted to buy those bonds in 2009. Or 2000.

Same for dividend growers; we're in the middle of a stock boom. The time to buy into the nice fat dividend growing companies was before 2012 IMHO.

So what are we left with? A 50/50 Boglehead portfolio? That's doing well right now because the stock market is on fire, but it'll crash terribly due to all the corporate bonds. A 30-year treasury bond ladder? Good luck deriving much income from it, and it'll deliver really poor capital appreciation. International stocks or bonds? There's even more risk there, without necessarily more return attached. Annuities? Personally, those make my head spin. I can barely understand a thing about them.

I don't necessarily disagree with you, MG, but it looks to me like the PP is the best choice we have without having to dive deep in the the world of Wall Street financial engineering. Don't let the perfect be the enemy of the good!

[rocketdog]

IMO, if one wants a different risk/reward profile than the vanilla PP, mixing in a VP is safer and better than tampering with individual PP assets. The 4x25 is a well-oiled machine of interdependent parts. If you want less risk/reward, add a VP of cash. If you want more, add a broad market or small cap value index fund.

That's my intent.  My PP is the same percentage of my portfolio as my age, and my VP makes up the rest.  So I will always have a VP... at least until I turn 100, that is! 

[KevinW]

I'm confused, I thought you said

My current game plan is to gradually shift the stock portion of my PP from having a small value tilt towards having a low volatility tilt once I hit retirement.

Now all I need to do is find a couple of good low volatility gold and LTT funds! 

[rocketdog]

I'm confused, I thought you said

My current game plan is to gradually shift the stock portion of my PP from having a small value tilt towards having a low volatility tilt once I hit retirement.

Now all I need to do is find a couple of good low volatility gold and LTT funds! 

I did say that.  Does it not make sense?  If not I'll be happy to clarify, but give me specifics. 

[KevinW]

Well on one hand you agree that the vanilla PP should be left as-is with no tampering, and then on the other you say you are using low volatility stocks instead of a TSM index. And wish for lower-volatility bonds and gold. Those things seem contradictory.