LazyOverthinker wrote: ↑Fri Jun 24, 2022 11:10 pm
Wow, finally caught up! Amazing thread, and quite a mental workout
. @comeinvest, I do apologize for changing topics as I don't have an answer to your question...
I'd like to discuss a few possible diversification "tilts" for this strategy's currently-occurring weakness of unexpected inflation and rate-hikes. Firstly, I think a 10% allocation to gold is always worth looking at in any leveraged portfolio... yes, it does not "produce value" in an unleveraged account, but 10% allocation seems to help in every leverage-threatening drawdown.
But gold is actually not a great "direct" inflation hedge for many complicated reasons that we don't have to re-hash here. TIPS, on the other hand, have shown themselves to carry more interest-rate risk than inflation-hedging properties, and we already have plenty of interest-rate risk. Commodities seem to be the only asset that
directly responded to this unexpected inflation in a drawdown-alleviating-capacity, but pure commodities have nauseatingly weak (close to zero) returns as discussed earlier. My suggestion (for a globally diversified portfolio) is to take half of our US-equities allocation and split that amount among commodity-linked sectors: agriculture, energy, and consumer staples (I'm open to any other suggestions that would diversify this "tilt" away from overfitting).
Here is an example - portfolio 2 features the tilts at the bottom:
https://www.portfoliovisualizer.com/bac ... on10_2=3.5
Using only monthly data, you can see it reduced drawdown by 2.5%. Using Google finance's daily data, the real drawdown numbers are closer to 9.3% / 13.8%, with and without sector tilts respectively. An interesting follow-up question for me is "what if stocks tanked 50% instead of 20%?" Then you'd be looking at drawdown differences of 18.5% and 22.5%, which could make or break leverage.
Finally, here's a sloppy attempt at backtesting this to 1998 with "ADM" in place of "FPI" (neither are perfect agriculture diversifiers):
https://www.portfoliovisualizer.com/bac ... on10_2=3.5
Again, this doesn't show how rough 2008 would have actually been. Daily google data shows that having this inflation-resistant tilt would have increased your max drawdown from 16.66~% to 20~%, maybe even 22~%. Perhaps there's a way to refine it so that we can plan around 20% max drawdown in either scenario, or maybe I'm wasting time overfitting for recent events ("wow incredible you saw that oil and food became more expensive when there was a war causing oil and food shortages"). I find it hard to intuit if "commodities as an inflation hedge" can be teased apart from recent events as a whole.
Last but not least, earlier in this thread it was asserted that an Emerging markets + SCV tilt would hold up better during inflation (due to these factors naturally tilting towards commodities), and this has proven to be true with reduced drawdowns in the range of 2-5%. Perhaps we should forget my nonsense about sector tilts and seriously increase emerging + SCV? This definitely would have diminishing returns (I've read that even the Fama-academic types acknowledge 20%~ SCV tilt to be an optimal upper bound), so I still like balancing such an idea with sector tilts. Also, Emerging + SCV would have increased the 2008 drawdown... huh... noticing a pattern here... but there's gotta be a goldilocks zone!
To clarify: I'm trying to optimize for the earlier-discussed "no rebalancing of leverage" strategy mentioned earlier, as I think minimizing volatility decay is one of the main edges mHFEA has over HFEA.