skierincolorado wrote: ↑Thu Oct 07, 2021 12:22 pm
kbourgu wrote: ↑Thu Oct 07, 2021 10:52 am
Can anyone present any insights into the current state of TMF/TLT? Stocks seem to be recovering but looks like the bond portion is back in a downtrend.
The whole reason this works so well is that stocks and bonds are negatively correlated (would more accurately be described as uncorrelated). For the last few weeks they were positively correlated, so it's good to see the correlation reduced again. And as DMoogle said, this is a long-term strategy, short terms things like this should be completely ignored. I wouldn't even biggen to evaluate this strategy on any time horizon less than 10 years, preferably 20.
The more correct phrase would be that equities and treasuries have "negative tail dependence." When times are good they don't really move together, but when sh*t hits the fan, they go sharply in opposite directions. That's why the strategy works so much better with treasuries than something like corporate bonds or muni bonds. In normal times, they are uncorrelated with equities, but they can crash together.
That's why it's so useful to think of the non-equity component as crash insurance and then thinking about the options in terms of:
"deductible" -- how bad do things need to be for a negative correlation. High deductible means things have to get bad before the negative correlation starts. Low deductibles are better.
"coverage limit" -- how negatively correlated are they in a crash. High coverage limit means they are really negatively correlated in very bad times. HIgher coverage limit is better.
"premium" -- expected return on investment if there is no crash. Negative premium means positive expected return, zero premium means 0 expected return, positive premium means negative expected return. Lower (ideally negative) premiums are better.
"interest rate risk" -- if interest rates go up, how does that impact your insurance value (this is a common problem in life insurance)? Note that it also means that your premiums go down by more if interest rates go down (which is one reason TMF dominates in backtests). Low interest rate risk is better.
For instance:
- TMF: High deductible, high coverage limit, positive premium, highest interest rate risk.
- TYD: High deductible, medium coverage limit, slightly higher premium than TMF, medium-low interest rate risk.
- EDV: High deductible, medium coverage limit, negative premium, medium interest rate risk.
- cash: Low deductible, low coverage limit, zero premium, zero interest rate risk.
- long short-term vol: zero deductible, highest coverage limit, very high premium, zero interest rate risk.
- long medium-term vol: low deductible, high coverage limit, high premium, zero interest rate risk.
- SPY puts: zero deductible, extremely high coverage, very high premium, zero interest rate risk.
- gold: medium deductible, medium coverage limit, medium premium, negative interest rate risk.
The main questions then are:
- How comfortable am I with "non-crash" drawdowns (like 2018)?
- How worried am I about interest rates?
- How high of a premium am I willing to pay?