Refinements to Hedgefundie's excellent approach

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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

The final plot for tonight compares three risk-parity schemes based on volatility (the standard deviation of returns), all with 63-day lookback to calculate volatility and 21-day rebalancing.

Image
  • SD-down calculates volatility with only downward returns (asymmetric calculation)
  • SD-tdd calculates volatility with all returns, but with upward returns set to zero (asymmetric calculation)
  • SD-sym calculates volatility with all returns (symmetric calculation)
These schemes have a similar effect, tightening up the spread in returns and systematically increasing the total return over the reference approach. The asymmetric schemes appear to be slightly better than the symmetric scheme, but all three improve the average 5-year CAGR by around 200 bps. Resetting the weights monthly would have increased average overall returns over the entire duration by almost a factor of two relative to the reference scheme.

Again, the starting day appears to have a larger influence than the scheme.
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Re: Refinements to Hedgefundie's excellent approach

Post by Forester »

In Excel, would you calculate a 63-day lookback with more weight applied to recent data?
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Forester wrote: Tue Sep 03, 2019 3:59 am In Excel, would you calculate a 63-day lookback with more weight applied to recent data?
I haven't yet explicitly looked at the specific question of variable weighting of data. At this point, I personally would keep it simple to minimize the chance of coding errors. I don't think variable weighting will really move the needle much one way or the other, especially over such a long period, so it is really a question of personal taste more than anything else.

My very strong suspicion is that both the duration of lookback and the selective increase in weighting of recent data give systematic effects that are small compared to doing risk parity in the first place. Remember, volatility tends to be correlated over periods of months, and the comparison with different fixed weights shows relatively similar behavior with weights from 30/70 through 60/40.

I've done some previous tests with lookback duration and rebalancing period, and didn't notice dramatic effects from either. I will be putting up some comparisons tonight that will get at this question.

Now that my software is set up better, I intend to generate a series of similar plots to systematically illustrate the effects from a range of risk parity and risk budget schemes, then look at various methods for incorporating market and macroeconomic signals. So far I am finding that the implementation details related to rebalancing and volatility tend to be lost in the noise, and have small influence relative to decisions on how market and macroeconomic information is used to adjust the risk budget between UPRO and TMF.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

The following figure considers combinations of the rebalancing period (1 and 3 months) and volatility lookback period (1 and 3 months) for a standard risk parity model with symmetric volatility, compared to the reference 40/60 scheme with quarterly rebalancing.

Image

Three of the four combinations are clumped with similar expected CAGR.

The combination with 21 days volatility lookback/21 days between rebalancing outperforms the reference scheme to a lesser extent.

The two best combinations are 21/63 and 63/21 days between rebalancing/lookback days.

Based on this comparison, there isn't a compelling reason to select monthly versus quarterly rebalancing or monthly versus quarterly lookback.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

It is more difficult to generate a representative band scheme comparison, because after awhile the different realizations end up in lock step.

Image

In the top left plot, the swath around the total price/nominal line equal to 1 is actually a number of realizations that are moving in lock step with the first realization. The bottom curve ends up in lock step in 2012.

A fuller example might mitigate this tendency to lock step using several approaches, such as randomly adding days to the transition signal or randomly sampling the durations for limiting bands.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

The next figure shows portfolio trajectories assuming a fixed 40/60 UPRO/TMF ratio reset whenever the UPRO fraction moves outside a fixed band. The bands are 5, 10, 15, and 20 percent.

Image

The important takeaway from this case is that the band approach gives comparable or arguably slightly better results than the straight quarterly rebalancing for all of the bands considered.

With 5 percent bands, the average rebalancing frequency would have been approximately bimonthly, with approximately half of the rebalances performed between 10 and 25 days apart (see top plot in the right column) As the tolerance increases, the average duration between rebalances increases substantially.

Looser tolerances appear to increase CAGR slightly (third plot in the right column). I think that this is because the higher-performing asset tends to drift towards a larger allocation, increasing the returns. However, looser tolerances also tend to allow a wider spread in outcomes, both high and low.

As discussed in the previous entry, an analysis with rebalancing based on bands is arguably less representative than an analysis using periodic rebalancing because the trajectories tend to fall into lock step within a few years. So take this analysis with a grain of salt. Nevertheless, the analysis suggests strongly that using rebalance bands would be a viable approach to reducing the total number of rebalances, as has been suggested by others, with the requirement that the portfolio be monitored to some extent.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

The adaptive risk parity case with rebalancing bands is generally consistent with the previous analyses. The risk parity gives a noticeable increase in expected CAGR, at least with the tighter bands, and the coarser bands allow for less frequent rebalances overall.

The benefit from adaptive risk parity disappears for the 20-percent bands, which has an average duration between rebalances of more than 400 days.

Based on this comparison, it would have been satisfactory to defer rebalancing until the UPRO fraction deviated by 10 to 15 percent, which would have been more than a year at times. The tighter bands would have reduced the spread in outcomes due to starting on different days.

Image
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

One more for tonight. This one considers weighting based on variance rather than volatility.

Overall the variance weighting approach tends to reduce the UPRO fraction relative to the volatility weighting, but occasionally the weighting goes up substantially. The variance approach tended to outperform in the periods with low returns. The asymmetric weighting schemes (downward returns only) overall performed better than the symmetric scheme.

The asymmetric variance schemes appear to have outperformed the volatility schemes by approximately 100 bps.

Image
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

In the light of Hedgefundie's switch from 40/60 to 55/45 UPRO/TMF allocation, it's of potential interest to use adaptive risk parity to meet the same overall asset weighting on average while improving the drawdown behavior.

The risk budget approach gives a simple knob to turn. I described this earlier in the thread. In the figures, the b parameter adjusts the UPRO risk budget, with b = 0.5 corresponding to no bias (straight risk parity) and b = 1 corresponding to the case with 100% UPRO.

In the figures, b = 0.7 (the aqua line) would have resulted in a time average of approximately 55/45 UPRO/TMF and has the largest return to risk ratio. The first figure uses symmetric standard deviation (volatility) and the second figure uses downward-only variance.

The figures suggest that performing adaptive risk parity without bias (b = 0.5) would have been expected to boost mean CAGR by 150 to 200 bps. Using downward-only returns to calculate variance would have boosted mean CAGR by 500 bps with b = 0.7.

Increasing b to 0.9 would not have significantly increased mean CAGR further, and would have significantly increased drawdowns.

Image

Image

I suggest that folks might want to consider whether adding the risk budget component to the allocation might be of use. Granted, going forward the boost from LT treasuries is expected to continually decline while interest rates drop, so the benefit may also drop over time.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Returning to the question of volatility lookback period, I offer a comparison using downward-only variance parity to determine nominal weights on a daily frequency. This is the same scheme displayed in the last figure in the previous entry. Unlike the previous example, rebalancing is performed whenever UPRO is above or below a band that is 15 percent above or below the target weights, and when 126 days have passed without rebalancing (semiannual). This allows the rebalancing frequency to arise naturally from accuracy constraints.

The nominal minimum rebalance frequency is 21 days (one month). The actual minimum rebalance frequency is allowed to vary slightly in order to maintain more independent trajectories. Remember, the initial set of trajectories tends to be "captured" into the same rebalance frequency over time. For this analysis, the nominal minimum is allowed to vary by a few days, sampled from a zero-mean Gaussian distribution with a standard deviation of 1 day.

The first figure uses a lookback duration for volatility of 21 days (monthly); the second uses 63 days (quarterly), otherwise the schemes are identical.

Image

Image

The 21-day volatility lookback results in a much choppier asset allocation sequence than the 63-day lookback. The average rebalance frequency is around 30 days with the 21-day lookback and is around quarterly with the 63-day lookback, so the 21-day lookback would generate roughly twice the number of trades. If the minimum rebalance period was 10 days instead of 21 for the 21-day lookback (not shown), the average rebalance frequency would have been about 20 days and the 21-day lookback would have generated roughly three times the number of trades than the 63-day lookback would have generated.

I expect it would likely be easier to just rebalance monthly rather than tracking violation of the bands when using 21-day lookback.

The quarterly lookback has slightly better expected CAGR and the ratio of return to risk is improved for all three risk budget parameter values.

I think that, in this case, the noise in volatility from the shorter lookback period drives a certain amount of spurious rebalancing. The longer lookback period has enough observations that the noise is smoothed out, and the performance improves.

I think that the particular parity measure of downward-only variance may be especially sensitive to noise in the daily returns. A takeaway from this example is that a short lookback period can hurt performance when the changes in volatility create large and frequent changes in the weights. This is not so much an issue when the weighting scheme is less sensitive to volatility.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Volatility limiting is another way to adaptively adjust asset weights. The idea is to define a volatility limit for the risky asset (UPRO in this case). When the lookback volatility of the risky asset is less than the limit, the portfolio is completely set to the risky asset. If the volatility is greater than the limit, the risky asset weight is set to wt = vol/vollim.

The following figure shows the returns with three annualized volatility limits, compared to the original 40/60 quarterly rebalance scheme. The expected CAGR for the scheme is larger than the original method by 200 to 300 bps, and the return/risk ratio is substantially better. Most of the out-performance comes from smaller drawdowns in 2001-2003 and 2008-2009, with slight out-performance since 2008. The volatility limit of 25% would have resulted in better CAGR and risk-adjusted returns than the other two limits. The method triggered relatively few rebalances, usually rebalancing at the default semiannual limit.

Image
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

All of the examples thus far have weights that are based solely on the historical volatility over various periods.

The original Hedgefundie 40/60 weights are based on backfitting over several decades, and the weights are closely tied to a risk parity balance over this period. Other examples have weights based on the volatility over the trailing one to three months. A key assumption in risk parity is that expected return is proportional to risk, with the asset allocation determined to equalize expected risks given the assets in the portfolio. To the extent that asset risks are known, then a pure risk parity is market agnostic once the assets have been selected. The argument for using trailing volatility over a relatively short period, such as a month or quarter, to determine risk is typically that the current market risks are best estimated with recent information.

Some of the examples include tilts to the risk budget for the assets, with the tilts fixed at a constant value. A tilt away from equal risk budget weights serves to emphasize some assets at the cost of others. The emphasized assets might have better growth potential or lower volatility, depending on the desires of the portfolio manager. Setting a risk budget is akin to setting an asset allocation, except with a fixed risk budget the asset allocation changes over time and with a fixed allocation the risk budget changes over time.

There are various ways that one could introduce market timing into a scheme that uses risk parity, such as swapping assets in and out of the portfolio or adaptively adjusting risk budget weights.

The approach I discussed before (using the unemployment rate index) adjusts the risk budget according to the unemployment rate. In this scheme, the risk budget allocated to UPRO is decreased each month that the unemployment rate is increasing and accelerating, and is increased each month that the unemployment rate is decreasing or the increase is decelerating. The risk budget is determined entirely by the macroeconomic indicator.

The next two figures illustrate the adaptive allocation of the risk budget for UPRO between 20 and 90 percent. The UPRO risk budget allocation drops from high to low over a minimum of four months, and increases from low to high over a minimum of 20 months.

Image

Image

In these figures, the timing of the UPRO weight changes is essentially completely determined by the unemployment rate.

As before, the variance-based methods perform slightly better than the volatility-based methods in terms of expected return and risk-adjusted return. The variance methods have approximately 800 bps larger expected CAGR than the 40/60 fixed weighting scheme.

The effect of the limiting budget is shown in the next figure. Widening the UPRO limits tends to increase the overall returns, but exposes the portfolio to increased drawdown from rapid events that are not signalled.

Image
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Re: Refinements to Hedgefundie's excellent approach

Post by AlphaLess »

Interesting thread, and I commend the effort.

Before trying to figure out any sort of dynamic weights (e.g., 100% TMF, or 100% UPRO, or anything in between), do please realize that you are trying to time the SP500 and the Long Bond.

Those are very hard to do. Put another way: if you find ways to time those, then you could *ALSO* apply the exact same techniques to a vanilla stock-treasury portfolio.

Of course, you can find something that 'works' over a period of 5 years, 10 years, or even 15-20 years. But likely, you are just overfitting in-sample.

With TMF+UPRO portfolio you have a bit more nuances factors than just a LongBond+SP500 portfolio (you are basically long LongBond and short the 3-month LIBOR, and you are long SP500 and short the LIBOR), but not much.

If you are going to try to market time and do other exotic stuff, you may as well consider adding Buy-Write and Put-Write concepts to your portfolio.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

AlphaLess wrote: Mon Oct 28, 2019 10:34 pm Interesting thread, and I commend the effort.

Before trying to figure out any sort of dynamic weights (e.g., 100% TMF, or 100% UPRO, or anything in between), do please realize that you are trying to time the SP500 and the Long Bond.

Those are very hard to do. Put another way: if you find ways to time those, then you could *ALSO* apply the exact same techniques to a vanilla stock-treasury portfolio.

Of course, you can find something that 'works' over a period of 5 years, 10 years, or even 15-20 years. But likely, you are just overfitting in-sample.

With TMF+UPRO portfolio you have a bit more nuances factors than just a LongBond+SP500 portfolio (you are basically long LongBond and short the 3-month LIBOR, and you are long SP500 and short the LIBOR), but not much.

If you are going to try to market time and do other exotic stuff, you may as well consider adding Buy-Write and Put-Write concepts to your portfolio.
I appreciate the concerns. This part of the portfolio is only 5 percent of my overall portfolio and I'm not adding to it, so I have a rooting interest but not a keep-the-house interest. The rest of the portfolio is buy and hold; even with this strategy included the overall portfolio is not particularly aggressive.

I have thought considerably about the difficulties with timing. I will not go above 70% UPRO, and I'm basically aiming for a moderate rate of change in the risk budget for UPRO (e.g., completely dropping out of the maximum UPRO position will take at least 4 months). So this is more of a sliding back and forth to tilt the odds than sudden switching based on market twitches.

The timing flag from the unemployment rate has been backtested to the 1950s, so at least that has a record of nearly 70 years.

The next year or two should be very interesting...
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Re: Refinements to Hedgefundie's excellent approach

Post by AlphaLess »

I would focus on a very simply approach:
- portfolio can have 3 different weight schemes, and only 3: (a) tilted towards TMF, (b) balanced, (c) tilted towards UPRO. Keep those tilts close. E.g., balanced can be 50-50, and tilted can be 30-70, or 70-30,
- have VERY simply timing rules, where timing determines which weight scheme you are in. Both SIMPLE, as well as RARE.

#2 potentially limits your in-sample overfit, and trading costs.
#1 ensures that all 3 weight schemes are NOT very far from each other, so there is a LOW penalty from being incorrect (as well as LOW reward from being correct).
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

AlphaLess wrote: Tue Oct 29, 2019 12:14 am I would focus on a very simply approach:
- portfolio can have 3 different weight schemes, and only 3: (a) tilted towards TMF, (b) balanced, (c) tilted towards UPRO. Keep those tilts close. E.g., balanced can be 50-50, and tilted can be 30-70, or 70-30,
- have VERY simply timing rules, where timing determines which weight scheme you are in. Both SIMPLE, as well as RARE.

#2 potentially limits your in-sample overfit, and trading costs.
#1 ensures that all 3 weight schemes are NOT very far from each other, so there is a LOW penalty from being incorrect (as well as LOW reward from being correct).
From my perspective, I don't think that there is a great deal of fitting going on in anything I presented. Others may consider the frequent checking for adaptive allocation to be "fitting" and "market timing", but all it is doing is explicitly maintaining the risk budget in balance (based on the recent market volatility) instead of keeping the allocation constant and allowing the risks to vary over time.

The adaptive allocation risk parity part of the scheme essentially works the way you prefer, but with finer gradations. In my favored approach, the risk budget allocation is based on the last 60 days and checked frequently, but rebalancing only occurs if the current allocation is outside bands. Straight risk parity generally can't send the portfolio to extreme allocations.

Trading costs are not much of an issue in a Roth account on M1, especially if the trading is less frequent than, say, weekly.

And since the early 1980s, constant allocation at a range from 30/70 to 60/40 would have produced almost the same CAGR (albeit with different volatility). So that's favorable with respect to low penalties as well.

I agree that changing the risk allocation to UPRO based on the unemployment rate behavior is market timing, with almost 70 years of experience, and it will send UPRO to lower and higher extremes than straight risk parity. I'm frankly more concerned about making UPRO too high than too low.
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Re: Refinements to Hedgefundie's excellent approach

Post by Lee_WSP »

What if we only rebalanced into UPRO when UPRO is low? How does that model work?

Ie, only have the TMF as an emergency bailout to reinflate the portfolio. If that makes sense.
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Re: Refinements to Hedgefundie's excellent approach

Post by core4portfolio »

I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
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Re: Refinements to Hedgefundie's excellent approach

Post by MotoTrojan »

core4portfolio wrote: Sat Feb 01, 2020 1:44 am I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
Anywhere between 45-55 UPRO with rest in TMF is reasonable in my view. If you don’t understand this though then may I ask why you’re considering it?

Even hedgefundie himself has posted data showing an expected ~3% outperformance. People should not expect to double the S&P500’s CAGR when it’s 10%.
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Re: Refinements to Hedgefundie's excellent approach

Post by LadyGeek »

^^^ Yes, let me emphasize that point. From: this post
LadyGeek wrote: Sat Jan 25, 2020 8:05 am ^^^ A word of caution. The saying "Never invest in anything you don't understand" applies to newbies and experienced investors alike.

If you're not comfortable with a new strategy, please don't do anything until you fully understand the implications. Be sure you understand the impact of market declines as well as increases. Doing the wrong thing will significantly impact your retirement plans.
In the main discussion, HEDGEFUNDIE's excellent adventure Part II: The next journey, members are not using this approach as their main retirement portfolio. It's limited to 5%, which is the most you can afford to lose and not impact your retirement plans.

I don't know how many members this is, but a strong caution is indicated for investors reading these threads and assume it's something they should do because they're reading about it here. It is not.

Remember this is an investing forum whose members eat this stuff for lunch. We discuss deep-dive investing theory simply because it's fun to do so.

What applies to one investor may not apply to your own situation. Please do your own due diligence and stick with the Bogleheads' approach until you fully understand the details - and - have the willingness, ability, and need to take the risks associated with this approach.
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Re: Refinements to Hedgefundie's excellent approach

Post by core4portfolio »

MotoTrojan wrote: Sat Feb 01, 2020 8:05 am
core4portfolio wrote: Sat Feb 01, 2020 1:44 am I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
Anywhere between 45-55 UPRO with rest in TMF is reasonable in my view. If you don’t understand this though then may I ask why you’re considering it?

Even hedgefundie himself has posted data showing an expected ~3% outperformance. People should not expect to double the S&P500’s CAGR when it’s 10%.
Thanks. I was not going for more than 8% of my entire portfolio.
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Re: Refinements to Hedgefundie's excellent approach

Post by Uncorrelated »

core4portfolio wrote: Sat Feb 01, 2020 11:51 pm
MotoTrojan wrote: Sat Feb 01, 2020 8:05 am
core4portfolio wrote: Sat Feb 01, 2020 1:44 am I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
Anywhere between 45-55 UPRO with rest in TMF is reasonable in my view. If you don’t understand this though then may I ask why you’re considering it?

Even hedgefundie himself has posted data showing an expected ~3% outperformance. People should not expect to double the S&P500’s CAGR when it’s 10%.
Thanks. I was not going for more than 8% of my entire portfolio.
I have mentioned this before but nobody should be using hedgefundie's adventure with 8% of their portfolio. Almost all posts and analysis in that thread are based on the assumption that you allocate 100% of your portfolio to these ETF's. If your portfolio contains other things, such as total stock market or bonds, the ratio of 55/45 is not optimal.

Instead of allocating 8% of your portfolio to these ETF's, is is much more effective to swap some of your existing bonds for equities. Or reducing the size of your emergency fund. Or investing in size/value/low-beta. Or by buying NTSX which has much lower borrowing costs. If neither of those things allow you to reach your financial goals, it might make sense to choose an allocation to UPRO/TMF in addition to all of the things above.
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Re: Refinements to Hedgefundie's excellent approach

Post by core4portfolio »

Uncorrelated wrote: Sun Feb 02, 2020 5:36 am
core4portfolio wrote: Sat Feb 01, 2020 11:51 pm
MotoTrojan wrote: Sat Feb 01, 2020 8:05 am
core4portfolio wrote: Sat Feb 01, 2020 1:44 am I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
Anywhere between 45-55 UPRO with rest in TMF is reasonable in my view. If you don’t understand this though then may I ask why you’re considering it?

Even hedgefundie himself has posted data showing an expected ~3% outperformance. People should not expect to double the S&P500’s CAGR when it’s 10%.
Thanks. I was not going for more than 8% of my entire portfolio.
I have mentioned this before but nobody should be using hedgefundie's adventure with 8% of their portfolio. Almost all posts and analysis in that thread are based on the assumption that you allocate 100% of your portfolio to these ETF's. If your portfolio contains other things, such as total stock market or bonds, the ratio of 55/45 is not optimal.

Instead of allocating 8% of your portfolio to these ETF's, is is much more effective to swap some of your existing bonds for equities. Or reducing the size of your emergency fund. Or investing in size/value/low-beta. Or by buying NTSX which has much lower borrowing costs. If neither of those things allow you to reach your financial goals, it might make sense to choose an allocation to UPRO/TMF in addition to all of the things above.
Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
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Re: Refinements to Hedgefundie's excellent approach

Post by MotoTrojan »

core4portfolio wrote: Sun Feb 02, 2020 8:12 pm
Uncorrelated wrote: Sun Feb 02, 2020 5:36 am
core4portfolio wrote: Sat Feb 01, 2020 11:51 pm
MotoTrojan wrote: Sat Feb 01, 2020 8:05 am
core4portfolio wrote: Sat Feb 01, 2020 1:44 am I dont understood many of these diagrams or explanation terms like risk parity etc
Simple question from me is

1. if I have to put 10k into UPRO/TMF then whats typical allocation will be ?
2. if its dynamic then how to determine what allocation to be set dynamically every month ?
3. I thought of picking 50/50 however since there are many simulation experts.. what STATIC allocation would you be picking ?
Anywhere between 45-55 UPRO with rest in TMF is reasonable in my view. If you don’t understand this though then may I ask why you’re considering it?

Even hedgefundie himself has posted data showing an expected ~3% outperformance. People should not expect to double the S&P500’s CAGR when it’s 10%.
Thanks. I was not going for more than 8% of my entire portfolio.
I have mentioned this before but nobody should be using hedgefundie's adventure with 8% of their portfolio. Almost all posts and analysis in that thread are based on the assumption that you allocate 100% of your portfolio to these ETF's. If your portfolio contains other things, such as total stock market or bonds, the ratio of 55/45 is not optimal.

Instead of allocating 8% of your portfolio to these ETF's, is is much more effective to swap some of your existing bonds for equities. Or reducing the size of your emergency fund. Or investing in size/value/low-beta. Or by buying NTSX which has much lower borrowing costs. If neither of those things allow you to reach your financial goals, it might make sense to choose an allocation to UPRO/TMF in addition to all of the things above.
Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
What does that have to do with the point being made?
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Uncorrelated wrote: Sun Feb 02, 2020 5:36 am I have mentioned this before but nobody should be using hedgefundie's adventure with 8% of their portfolio. Almost all posts and analysis in that thread are based on the assumption that you allocate 100% of your portfolio to these ETF's. If your portfolio contains other things, such as total stock market or bonds, the ratio of 55/45 is not optimal.

Instead of allocating 8% of your portfolio to these ETF's, is is much more effective to swap some of your existing bonds for equities. Or reducing the size of your emergency fund. Or investing in size/value/low-beta. Or by buying NTSX which has much lower borrowing costs. If neither of those things allow you to reach your financial goals, it might make sense to choose an allocation to UPRO/TMF in addition to all of the things above.
The point being made here is that mixing a large amount of an unleveraged portfolio with a small amount of the 3x leveraged portfolio is really a mildly leveraged portfolio. Usually the exposure to equities can be represented entirely by increasing the unleveraged fraction of equities, and accounting for the loss of unleveraged bonds by increasing the exposure to TLT and/or TMF. This is cheaper when you end up with less TMF than the original sum of UPRO and TMF.

I think this requires that (i) the unleveraged portfolio is less than 100 % equities (you need to increase the equities percentage) and (ii) the unleveraged bond component has an effective duration less than TLT (you need to increase the effective duration).

For example, if the unleveraged portfolio is 50/50 VOO/BND (S&P 500/total bond), you can get the same effect of mixing the unleveraged portfolio with the UPRO/TMF portfolio simply by increasing the percentage of VOO and replacing some of the BND with TLT and/or TMF. In many cases one can completely get rid of 3x leveraged funds but have the same effect.

If I understand the process correctly, you can't cut the total amount of 3x funds and get the equivalent mixture if the original portfolio is already VOO/TLT or 100% VOO.

Also, it may be desirable to pay the extra ER if for some reason it isn't easy to transfer funds for rebalancing purposes.

The math was discussed before and after here.
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Uncorrelated
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Re: Refinements to Hedgefundie's excellent approach

Post by Uncorrelated »

core4portfolio wrote: Sun Feb 02, 2020 8:12 pm Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
I'm well aware, that is a mistake.

Half the thread is about determining the optimal ratio of UPRO and TMF, assuming those are the only things in your portfolio, and assuming you are optimizing for max CAGR (logarithmic utility function). Have you seen anyone that matches those assumptions? I have not.
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Uncorrelated wrote: Mon Feb 03, 2020 3:40 am
core4portfolio wrote: Sun Feb 02, 2020 8:12 pm Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
I'm well aware, that is a mistake.

Half the thread is about determining the optimal ratio of UPRO and TMF, assuming those are the only things in your portfolio, and assuming you are optimizing for max CAGR (logarithmic utility function). Have you seen anyone that matches those assumptions? I have not.
In my case, this is not too bad of an approximation. I can only do any leverage in a (currently) small Roth account that is isolated from entry of additional funds for rebalancing, and it is largely intended as a legacy for my kids. It makes sense to consider it as an independent entity because it won’t see any transfers. It will be allowed to grow for at least one or two decades following the strategy.
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Uncorrelated
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Re: Refinements to Hedgefundie's excellent approach

Post by Uncorrelated »

Hydromod wrote: Mon Feb 03, 2020 6:11 am
Uncorrelated wrote: Mon Feb 03, 2020 3:40 am
core4portfolio wrote: Sun Feb 02, 2020 8:12 pm Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
I'm well aware, that is a mistake.

Half the thread is about determining the optimal ratio of UPRO and TMF, assuming those are the only things in your portfolio, and assuming you are optimizing for max CAGR (logarithmic utility function). Have you seen anyone that matches those assumptions? I have not.
In my case, this is not too bad of an approximation. I can only do any leverage in a (currently) small Roth account that is isolated from entry of additional funds for rebalancing, and it is largely intended as a legacy for my kids. It makes sense to consider it as an independent entity because it won’t see any transfers. It will be allowed to grow for at least one or two decades following the strategy.
That is still a bad idea. When the time comes to distribute your inheritance, it doesn't matter from which account it comes. Money is fungible, the only thing you should care about is your total portfolio return and risk. Bucketing up your portfolio and optimizing each part individually just results in inefficiencies.

So many bogleheads are wasting their time with market timing without having the basics down. Use lifecycle investing to determine an approximate dynamic portfolio allocation for you and your kids. Optimize for max utility instead of max CAGR. Solve Metron's equation for multiple asset classes to determine the optimal portfolio allocation. Solve Merton's equation for after-tax returns and/or multiple accounts. Research factor investing. All of these things are simple compared to market timing and collectively have a much greater and much more certain impact on your performance. You'll probably want to apply all the things I mentioned above in your market timing algorithm anyway.
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

Uncorrelated wrote: Tue Feb 04, 2020 4:23 pm
Hydromod wrote: Mon Feb 03, 2020 6:11 am In my case, this is not too bad of an approximation. I can only do any leverage in a (currently) small Roth account that is isolated from entry of additional funds for rebalancing, and it is largely intended as a legacy for my kids. It makes sense to consider it as an independent entity because it won’t see any transfers. It will be allowed to grow for at least one or two decades following the strategy.
That is still a bad idea. When the time comes to distribute your inheritance, it doesn't matter from which account it comes. Money is fungible, the only thing you should care about is your total portfolio return and risk. Bucketing up your portfolio and optimizing each part individually just results in inefficiencies.

So many bogleheads are wasting their time with market timing without having the basics down. Use lifecycle investing to determine an approximate dynamic portfolio allocation for you and your kids. Optimize for max utility instead of max CAGR. Solve Metron's equation for multiple asset classes to determine the optimal portfolio allocation. Solve Merton's equation for after-tax returns and/or multiple accounts. Research factor investing. All of these things are simple compared to market timing and collectively have a much greater and much more certain impact on your performance. You'll probably want to apply all the things I mentioned above in your market timing algorithm anyway.
I'm not arguing the utility of what you are suggesting for an unconstrained optimization scenario, and I appreciate what you are proposing. But in real life, there can be constraints that modify the problem to be solved, and constraints tend to lead to a less efficient solution.

I'm a little puzzled how market timing crept into your wonderful rant though, unless you are referring to adaptive allocation.

In my specific constrained case, I have really do have two buckets to work with, a tiny Roth bucket and a large 403b bucket, and I am constrained by (i) the inability to transfer funds between them, (ii) the inability to transfer funds out of the 403b until retirement, and (iii) the inability to add significantly to the tiny one.

The main portfolio is basically a flavor of the Boglehead philosophy, given the constraints of offerings in the 403b and the investment wishes of DW. Given the moderately short investment time frame before retirement, we consider the main portfolio good enough (as longinvest would say) to handle our retirement needs. I would like to add a cushion, though, for increased travel and inheritance.

The tiny bucket is currently too small to move the needle, but it offers the scarce resource of leverage. Until the tiny bucket grows significantly, I can't see how it much matters whether I optimize separately or together, because only the main portfolio moves the needle. My suspicion is that many of the folks trying the adventure are also constrained in the ability to take advantage of leverage (although clearly there are those that are not...).

Because I can't transfer funds for rebalancing, for the time being it seems preferable to take maximal advantage of the leverage available with the tiny bucket by treating it as an independent 100% leveraged portfolio until it gets big enough to move the needle.

I'd say it starts moving the needle once it rises to 10 to 15 percent of the total portfolio, which may not be until retirement or sometime after. That's when it will make increasing sense to treat the portfolio as a whole.

I'm thinking of this two-bucket approach as basically in line with Taleb's idea of being conservative with 90% of the portfolio and risky with 10%. Although I think that I am underdoing the philosophy a bit.
Busdrvr
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Re: Refinements to Hedgefundie's excellent approach

Post by Busdrvr »

Hydromod wrote: Tue Feb 04, 2020 7:03 pm
Uncorrelated wrote: Tue Feb 04, 2020 4:23 pm
Hydromod wrote: Mon Feb 03, 2020 6:11 am In my case, this is not too bad of an approximation. I can only do any leverage in a (currently) small Roth account that is isolated from entry of additional funds for rebalancing, and it is largely intended as a legacy for my kids. It makes sense to consider it as an independent entity because it won’t see any transfers. It will be allowed to grow for at least one or two decades following the strategy.
That is still a bad idea. When the time comes to distribute your inheritance, it doesn't matter from which account it comes. Money is fungible, the only thing you should care about is your total portfolio return and risk. Bucketing up your portfolio and optimizing each part individually just results in inefficiencies.

So many bogleheads are wasting their time with market timing without having the basics down. Use lifecycle investing to determine an approximate dynamic portfolio allocation for you and your kids. Optimize for max utility instead of max CAGR. Solve Metron's equation for multiple asset classes to determine the optimal portfolio allocation. Solve Merton's equation for after-tax returns and/or multiple accounts. Research factor investing. All of these things are simple compared to market timing and collectively have a much greater and much more certain impact on your performance. You'll probably want to apply all the things I mentioned above in your market timing algorithm anyway.
I'm not arguing the utility of what you are suggesting for an unconstrained optimization scenario, and I appreciate what you are proposing. But in real life, there can be constraints that modify the problem to be solved, and constraints tend to lead to a less efficient solution.

I'm a little puzzled how market timing crept into your wonderful rant though, unless you are referring to adaptive allocation.

In my specific constrained case, I have really do have two buckets to work with, a tiny Roth bucket and a large 403b bucket, and I am constrained by (i) the inability to transfer funds between them, (ii) the inability to transfer funds out of the 403b until retirement, and (iii) the inability to add significantly to the tiny one.

The main portfolio is basically a flavor of the Boglehead philosophy, given the constraints of offerings in the 403b and the investment wishes of DW. Given the moderately short investment time frame before retirement, we consider the main portfolio good enough (as longinvest would say) to handle our retirement needs. I would like to add a cushion, though, for increased travel and inheritance.

The tiny bucket is currently too small to move the needle, but it offers the scarce resource of leverage. Until the tiny bucket grows significantly, I can't see how it much matters whether I optimize separately or together, because only the main portfolio moves the needle. My suspicion is that many of the folks trying the adventure are also constrained in the ability to take advantage of leverage (although clearly there are those that are not...).

Because I can't transfer funds for rebalancing, for the time being it seems preferable to take maximal advantage of the leverage available with the tiny bucket by treating it as an independent 100% leveraged portfolio until it gets big enough to move the needle.

I'd say it starts moving the needle once it rises to 10 to 15 percent of the total portfolio, which may not be until retirement or sometime after. That's when it will make increasing sense to treat the portfolio as a whole.

I'm thinking of this two-bucket approach as basically in line with Taleb's idea of being conservative with 90% of the portfolio and risky with 10%. Although I think that I am underdoing the philosophy a bit.
I feel like I'm in the same situation with Roth funds < 1% of total so I would like to see that proportion increase in the 10 years I have left to work. We are setting up and contributing to the kids' Roths, they have yet to complete their schooling, so taking into account all that uncorrelated and others say it seems prudent for them to incorporate leverage at this early stage as well, but for their entire PF.
Waba
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Re: Refinements to Hedgefundie's excellent approach

Post by Waba »

Hydromod wrote: Sat Sep 07, 2019 11:50 pm All of the examples thus far have weights that are based solely on the historical volatility over various periods.
Have you looked at using VIX instead of historic volatility?
dspencer
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Re: Refinements to Hedgefundie's excellent approach

Post by dspencer »

Uncorrelated wrote: Tue Feb 04, 2020 4:23 pm
Hydromod wrote: Mon Feb 03, 2020 6:11 am
Uncorrelated wrote: Mon Feb 03, 2020 3:40 am
core4portfolio wrote: Sun Feb 02, 2020 8:12 pm Even the HEDGEFUNDIE's UPRO/TMF allocation is only 15% and not 100% of portfolio.
So Iam not planning to take more than 10% of portfolio.
I'm well aware, that is a mistake.

Half the thread is about determining the optimal ratio of UPRO and TMF, assuming those are the only things in your portfolio, and assuming you are optimizing for max CAGR (logarithmic utility function). Have you seen anyone that matches those assumptions? I have not.
In my case, this is not too bad of an approximation. I can only do any leverage in a (currently) small Roth account that is isolated from entry of additional funds for rebalancing, and it is largely intended as a legacy for my kids. It makes sense to consider it as an independent entity because it won’t see any transfers. It will be allowed to grow for at least one or two decades following the strategy.
That is still a bad idea. When the time comes to distribute your inheritance, it doesn't matter from which account it comes. Money is fungible, the only thing you should care about is your total portfolio return and risk. Bucketing up your portfolio and optimizing each part individually just results in inefficiencies.

So many bogleheads are wasting their time with market timing without having the basics down. Use lifecycle investing to determine an approximate dynamic portfolio allocation for you and your kids. Optimize for max utility instead of max CAGR. Solve Metron's equation for multiple asset classes to determine the optimal portfolio allocation. Solve Merton's equation for after-tax returns and/or multiple accounts. Research factor investing. All of these things are simple compared to market timing and collectively have a much greater and much more certain impact on your performance. You'll probably want to apply all the things I mentioned above in your market timing algorithm anyway.
Doesn't differing tax treatment mean that money is not fully fungible?
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randyharris
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Re: Refinements to Hedgefundie's excellent approach

Post by randyharris »

Newcomer to Hedgefundie's massive threads, and onto this one. I'm surprised that there hasn't been a post on this thread in the past month and a half... LOTS of activity going on in that time, I'd love to hear some updates from you all who are using related strategies, how's it's working out.

I've tried building a model to do the Adaptive Allocation with Minimum Variance, but can't figure how how as PortfolioVisualizer says that the initial allocations are done on the Timing Period [lookback], and those are adjusted with the realized variance calculations. I've got the realized variance calculations, but can't find anything on how to allocate based on the lookback period, or how to adjust with the realized variance. Would love some help.

Also, I found a file that I thought was going to contain the UPROSIM and TMFSIM data, but I could only find annual and not monthly or daily data in it, would really appreciate finding the daily returns on the 'sim data.
badapu
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Re: Refinements to Hedgefundie's excellent approach

Post by badapu »

Are people already doing this in a brokerage account?

Requesting tips on how would you set this strategy up in Brokerage account (do not have tax advantaged space). I would like to use the current market downturn to invest 100k in 55:45 split. Late 30s with long term time horizon. Would buy in when I can visibly see the strains of the pandemic resolving (agree this involves a component of “market timing” but with a long term time horizon).

Help me understand the implications. I am in the highest tax bracket. The strategy generates approximately 1% in dividends per year (with TMF being qualified dividends). I would pay taxes on that. I feel the 3x UPRO/TMF strategy is better than PSLDX (with its 6% dividend yield) in brokerage.

If rebalancing I would pay taxes on the rebalancing amount (35%). I feel that is still 65% in profits. I would try to buy TMF/UPRO with additional funds (if feasible) rather than rebalance (as long as the funds invested stay <5% of my . The strategy over the 87-18 period would still outperform S&P500 by approximately 4.5% (instead of the 7%) if no additional funds were invested. I would rebalance less frequently. Possibly yearly (with option to rebalance sooner if needed). Anyway to model this in portfolio visualizer?

This is with play money (5% of net worth). More than anything it would be for entertainment value.

Thanks in advance
MotoTrojan
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Re: Refinements to Hedgefundie's excellent approach

Post by MotoTrojan »

badapu wrote: Mon Mar 30, 2020 8:33 pm Are people already doing this in a brokerage account?

Requesting tips on how would you set this strategy up in Brokerage account (do not have tax advantaged space). I would like to use the current market downturn to invest 100k in 55:45 split. Late 30s with long term time horizon. Would buy in when I can visibly see the strains of the pandemic resolving (agree this involves a component of “market timing” but with a long term time horizon).

Help me understand the implications. I am in the highest tax bracket. The strategy generates approximately 1% in dividends per year (with TMF being qualified dividends). I would pay taxes on that. I feel the 3x UPRO/TMF strategy is better than PSLDX (with its 6% dividend yield) in brokerage.

If rebalancing I would pay taxes on the rebalancing amount (35%). I feel that is still 65% in profits. I would try to buy TMF/UPRO with additional funds (if feasible) rather than rebalance (as long as the funds invested stay <5% of my . The strategy over the 87-18 period would still outperform S&P500 by approximately 4.5% (instead of the 7%) if no additional funds were invested. I would rebalance less frequently. Possibly yearly (with option to rebalance sooner if needed). Anyway to model this in portfolio visualizer?

This is with play money (5% of net worth). More than anything it would be for entertainment value.

Thanks in advance
The 87-18 period is essentially impossible to repeat. Do more research first.

This is a risk parity strategy, don’t add market timing too.
shoehead
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Re: Refinements to Hedgefundie's excellent approach

Post by shoehead »

This month’s rebalance for me was interesting. I believe at the very beginning of May UPRO had a -8% day or something wild. With a target of 25% std, my model gave me a UPRO allocation of 30-40% (can’t remember) for the month of June. Without that day, however, the allocation was over 100% for UPRO. I decided to chalk it up to an outlier and went with a 70/30 UPRO/TMF split....so far it was the right move. As far as I know my model replicates the volatility targeting model in PV.

Anybody have strategies for addressing crazy outlier? I use a 21-day lookback and monthly rebalancing.
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Lee_WSP
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Re: Refinements to Hedgefundie's excellent approach

Post by Lee_WSP »

shoehead wrote: Tue Jun 09, 2020 5:09 pm This month’s rebalance for me was interesting. I believe at the very beginning of May UPRO had a -8% day or something wild. With a target of 25% std, my model gave me a UPRO allocation of 30-40% (can’t remember) for the month of June. Without that day, however, the allocation was over 100% for UPRO. I decided to chalk it up to an outlier and went with a 70/30 UPRO/TMF split....so far it was the right move. As far as I know my model replicates the volatility targeting model in PV.

Anybody have strategies for addressing crazy outlier? I use a 21-day lookback and monthly rebalancing.
Manually cull the data point.
Mickelous
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Re: Refinements to Hedgefundie's excellent approach

Post by Mickelous »

badapu wrote: Mon Mar 30, 2020 8:33 pm Are people already doing this in a brokerage account?

Requesting tips on how would you set this strategy up in Brokerage account (do not have tax advantaged space). I would like to use the current market downturn to invest 100k in 55:45 split. Late 30s with long term time horizon. Would buy in when I can visibly see the strains of the pandemic resolving (agree this involves a component of “market timing” but with a long term time horizon).

Help me understand the implications. I am in the highest tax bracket. The strategy generates approximately 1% in dividends per year (with TMF being qualified dividends). I would pay taxes on that. I feel the 3x UPRO/TMF strategy is better than PSLDX (with its 6% dividend yield) in brokerage.

If rebalancing I would pay taxes on the rebalancing amount (35%). I feel that is still 65% in profits. I would try to buy TMF/UPRO with additional funds (if feasible) rather than rebalance (as long as the funds invested stay <5% of my . The strategy over the 87-18 period would still outperform S&P500 by approximately 4.5% (instead of the 7%) if no additional funds were invested. I would rebalance less frequently. Possibly yearly (with option to rebalance sooner if needed). Anyway to model this in portfolio visualizer?

This is with play money (5% of net worth). More than anything it would be for entertainment value.

Thanks in advance
Check your brokerage and which method of selling your shares they use, first in first out, lowest tax, etc. as that will determine your approximately 4 per year rebalancing taxable events. There was a chart in the main thread on quarterly rebalancing and the best method, lowest tax I believe, came out to 1.x% per year more expenses. So you would have your total costs at the 1% expense ratio, the 1.x% taxes on rebalancing, and I believe dividends in addition as I'm not sure those were factored in if your brokerage has that method of selling shares. I'm not an expert just a guy who's read through a couple hundred pages of posts on HF Adventure.
occambogle
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Re: Refinements to Hedgefundie's excellent approach

Post by occambogle »

Re: an adventure in taxable... There's some info here in this post and the replies to it:

viewtopic.php?t=288192&start=4850#p5259971

The other option is to do something milder such as 35% UPRO 65% EDV, but I don't know whether the tax implications would be better or not.
sf1988
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Re: Refinements to Hedgefundie's excellent approach

Post by sf1988 »

Anyone use google sheets to set this up? I'm working on trying out the AA minimum variance, but am seeing different weights created as compared to the PV allocations during the backtest.

Volatility for each: I did STDEV(21 day returns)*SQRT(252)

Correlation: I took the 6 month (126 trading days) correlation of TMF TQQQ

for the wreights, I found a formula online, but not sure if I should do something else.
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danyboy7
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Re: Refinements to Hedgefundie's excellent approach

Post by danyboy7 »

Hydromod wrote: Tue Jul 09, 2019 10:37 pm
siamond wrote: Tue Jul 09, 2019 6:59 pm
Hydromod wrote: Tue Jul 09, 2019 3:03 pm
MotoTrojan wrote: Tue Jul 09, 2019 2:16 pm Sorry, both TMF and TMV gained in value during the same month frequently?
At my quick glance it appeared to occur fairly often. I will double-check tonight to make sure I'm stating this correctly though.
Huh? This doesn't seem quite right? Sometimes, the monthly returns are really low and the borrowing costs are going in the same direction, which could explain what you've seen, but I am quite surprised you would have even noticed those rare situations. I took a quick look, comparing the +3x model with the -3x model, and I don't see anything like that happening 'frequently'. Am I missing something?
Yes, it seemed out of place. It's been bothering me all day so I went through the math to understand. It's actually pretty neat how the formulas fall into place.

And it turns out that in my rush I managed to cut and paste names to the wrong column in the spreadsheet I uploaded to portfolio visualizer at some point. The results I showed were with inverse x3 S&P 500 instead of inverse x3 LTT.

You might say that it was an "out of sample" test of the methodology...

The revised figures follow. I double-checked the file, cleared out all of the assets in portfolio visualizer, and reloaded them. All of the numbers look good now.

The dual-momentum case looks even better with the correct inputs.

Image

The relative strength model does better up until the last decade, then the prior model accelerates past.

Image

Sorry about the confusion and inadvertently casting shade on Siamond. It was all on my fumble fingers.

At least I understand the spreadsheet and its math better now. And there is some confirmation that the methodology is somewhat robust.
Hydromod,could I ask to provide an accessible PV link to all of us :confused ? Your previous and only link is not consultabile due to "private dataset" and honestly I'm having a hard time to analyze this strategy based on 1 screenshot.
"So what to do with an environment with long-term rising interest rates? Switch from TMF to TMV, maybe " this a your previous quote,is this switch included in your strategy ? I would like to comprehend if you portfolio has an exit option for rising interest rates scenario and/or stock market tanking for years.Or if it's the umpteenth "hedgefundie" version that would be absolute annihilated in the scenarios described above.
I have seen the light
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

danyboy7 wrote: Thu Jul 30, 2020 2:05 am Hydromod,could I ask to provide an accessible PV link to all of us :confused ? Your previous and only link is not consultabile due to "private dataset" and honestly I'm having a hard time to analyze this strategy based on 1 screenshot.
"So what to do with an environment with long-term rising interest rates? Switch from TMF to TMV, maybe " this a your previous quote,is this switch included in your strategy ? I would like to comprehend if you portfolio has an exit option for rising interest rates scenario and/or stock market tanking for years.Or if it's the umpteenth "hedgefundie" version that would be absolute annihilated in the scenarios described above.
The private dataset is my externally calculated set of UPRO/TMF combinations based on Siamond's monthly dataset.

The PV business model requires at least a basic subscription to upload data sets at this point (when I did the analyses it was free), so I've stopped using PV for such analyses. That's partly why I went to the effort of doing a bunch of Matlab coding.

If you want to use PV for the analyses and have a subscription, you can upload your own spreadsheet with the estimated monthly returns for UPRO, TMF, and TMV; you should be able to construct various weightings yourself. That would give you flexibility to calculate your own weights (40/60 vs 55/45) and rebalance periods. If you don't have these already, I should be able to find these three estimated monthly sequences in a spreadsheet and provide a link.

My own strategy is currently to track around 60 different combinations of adaptive schemes and lookback periods (4/8/12 weeks) in Google sheets, find the average weighting that the schemes provide, and rebalance when the weights are more than 10 or 15 percent out of balance. The sheet allows one to select any two funds that GOOGLEFINANCE will return, but is only based on price.

I went from UPRO/TMF to UPRO/TQQQ/TMF last fall, then switched to TQQQ/TMF and have stayed put (aside from an ill-fated few weeks with SPXU starting the day that the market turned).

I'm prepared to switch over to TMV if it looks like we've entered a rising interest rates environment. IMO significant positive returns and moderately positive correlation is more important than negative returns with moderately negative correlation.

I'm still mulling over exit strategies for a long-term market flatline; this is such a small portion of my total portfolio that I'm inclined to just let it ride for a while, but that's not a decision that needs to be made in a hurry.
ljford7
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Re: Refinements to Hedgefundie's excellent approach

Post by ljford7 »

Hydromod wrote: Thu Jul 30, 2020 10:12 am I'm prepared to switch over to TMV if it looks like we've entered a rising interest rates environment. IMO significant positive returns and moderately positive correlation is more important than negative returns with moderately negative correlation.

I'm still mulling over exit strategies for a long-term market flatline; this is such a small portion of my total portfolio that I'm inclined to just let it ride for a while, but that's not a decision that needs to be made in a hurry.
Very interesting thread and I learned quite a bit. Just curious, with TMF getting beat up pretty badly lately, did you ever make headway into a system to make the switch to TMV if needed?
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

ljford7 wrote: Tue Feb 23, 2021 3:17 pm
Hydromod wrote: Thu Jul 30, 2020 10:12 am I'm prepared to switch over to TMV if it looks like we've entered a rising interest rates environment. IMO significant positive returns and moderately positive correlation is more important than negative returns with moderately negative correlation.

I'm still mulling over exit strategies for a long-term market flatline; this is such a small portion of my total portfolio that I'm inclined to just let it ride for a while, but that's not a decision that needs to be made in a hurry.
Very interesting thread and I learned quite a bit. Just curious, with TMF getting beat up pretty badly lately, did you ever make headway into a system to make the switch to TMV if needed?
Not yet, but it’s starting to be something that is ticking a little bit.
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RovenSkyfall
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Re: Refinements to Hedgefundie's excellent approach

Post by RovenSkyfall »

Hydromod wrote: Tue Feb 23, 2021 4:09 pm
ljford7 wrote: Tue Feb 23, 2021 3:17 pm
Hydromod wrote: Thu Jul 30, 2020 10:12 am I'm prepared to switch over to TMV if it looks like we've entered a rising interest rates environment. IMO significant positive returns and moderately positive correlation is more important than negative returns with moderately negative correlation.

I'm still mulling over exit strategies for a long-term market flatline; this is such a small portion of my total portfolio that I'm inclined to just let it ride for a while, but that's not a decision that needs to be made in a hurry.
Very interesting thread and I learned quite a bit. Just curious, with TMF getting beat up pretty badly lately, did you ever make headway into a system to make the switch to TMV if needed?
Not yet, but it’s starting to be something that is ticking a little bit.
After seeing this paper: https://papers.ssrn.com/sol3/papers.cfm ... id=2741701, I have been stuck on the idea that maybe a UPRO/TMF 200DMA is the best way to avoid losses of TMF, but use it in a downturn. Your prior PV simulations looked to use end of month data, but that doesnt seem specific enough to test the 200dMA. Any thoughts on running this in Matlab with daily data?
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

RovenSkyfall wrote: Thu Mar 18, 2021 2:54 pm After seeing this paper: https://papers.ssrn.com/sol3/papers.cfm ... id=2741701, I have been stuck on the idea that maybe a UPRO/TMF 200DMA is the best way to avoid losses of TMF, but use it in a downturn. Your prior PV simulations looked to use end of month data, but that doesnt seem specific enough to test the 200dMA. Any thoughts on running this in Matlab with daily data?
I'm not quite at a point to test this just yet in detail with my current code set.

I've looked at moving averages a bit in the past. I haven't been able to make it work very well for most funds other than S&P and NASDAQ, which makes me suspicious. It seems like a bit hit or miss to use this as an in/out signal going forward, because the volatility structure seems to have sped up in the last few years and the timing is now off; I blame lots of algorithmic trading.

I'd be more inclined to use indicators to set the relative volatility weight of UPRO vs TMF (say 80 or 90% volatility to UPRO in favorable conditions and 20 or 30% volatility to UPRO in unfavorable conditions).

One idea that I've seen is to use a volatility-weighted moving average, where the moving average is up to 252 days with low volatility and down to 50 days with high volatility. That reacts slowly when there aren't big bumps and quickly when there are big changes, so you reduce whipsaws. I'm probably going to test that pretty soon as well.

I just think that we are going to see a lot of ups and downs for the next 5 to 10 years, with a relatively flat overall market, so we should be trying to handle that kind of scenario.
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

This entry copies the entry here in the Are 3x leveraged ETFs the long-term winning strategy? thread. I'm copying it to keep the information fairly compact for easier cross reference.

Okay, I cobbled together a few plots to get some ideas across. The Matlab code isn't really in shape to share, it's pretty much exploratory at this point. Caveat emptor on the results. Usual disclaimers about investing advice, the future isn't the past, etc., etc.

This approach is not at all my idea, I'm just trying to illustrate ideas I've picked up here and there that seem useful.

I am not using fixed portfolio weights for individual assets. With a fixed portfolio weight, the risk fraction for each asset bounces around over time as it becomes more and less volatile. Instead, I'm assigning a fixed risk fraction to each asset category (using volatility as a surrogate for risk) and rebalancing the portfolio to match the assigned risk fraction. This is a mild type of tactical asset allocation strategy.

All of these plots rebalance every 21 trading days (not end of month) and use volatility calculated over the past 42 trading days to recalculate weights for each rebalance. All of them start with a unit portfolio value with no additions. All of them randomly sample the trade values between low and high during the day and include a bid-ask spread.

First figure is plain ol' unleveraged QQQ and TLT, extended with ^NDX and Siamond's daily values. The ex in the label indicates that the earlier part is simulated. I use the borrowing formula with overnight LIBOR and present-day ER; probably there is some underestimate of drag during the simulated part, so returns for the simulated part are probably too large. What I consider more important is how bouncy the portfolio is in the earlier part, especially around 2000 and 2008-2009.

Top plot shows the portfolio value (gray) and the amount assigned to each asset. The lines go with the label having the same color.

Middle plot shows the moving 3-yr CAGR for the portfolio and the raw assets. Notice that the huge drop in QQQ after 2000 was compensated by having only a small fraction of the portfolio in QQQ. This would not have occurred for the one-day crash in 1987!

Bottom plot shows the fraction of the portfolio assigned to each asset.

Image

Second figure replaces TLT with TMF, still holding QQQ. This option might be for those that don't want leveraged equities, but are willing to have a fraction of the portfolio as insurance in leveraged treasuries. Concentrated insurance allows the QQQ to occupy a large fraction of the portfolio.

Image

Third figure is now completely 3x LETF. The allocations should be essentially identical to the QQQ/TLT allocations.

Image

Fourth figure is approximately a leveraged Golden Butterfly, which is supposedly 20/20/20/20/20 in S&P/SCV/LTT/STT/GLD (SCV is small cap value, LTT is long term treasuries, STT is short term treasuries, and GLD is gold). The TYD is an approximate LTT/STT blend. Note that the UGL fraction is usually smaller than 20%; it should be larger, on average, because it's the only 2x LETF and needs larger space to balance its risk share, but I assigned a smaller risk fraction to gold. Notice the tailing off in the last 8-10 years as interest rates approach zero; this is also evident with TMF. The Golden Butterfly has historically shown disproportionately large safe/permanent withdrawal rates compared to its CAGR, because it is not very volatile and has relative small sequence of returns risk, which makes it attractive as a potential retirement portfolio. Looking at this figure, even the 3x version seems pretty stable.

Image

Fifth figure is the same except TMF instead of TYD. A bit better returns but a bit wobblier.

Image

Sixth figure takes out the gold. Not very different, slightly better returns.

Image

Final figure is for those who really don't want to predict what sectors might outperform in the future. Some of these LETFs have not done well during this interval, some have. The funds are not all that strongly correlated, which is a useful feature. The history is a bit noisy. Yet the overall portfolio has delivered reasonably steady returns throughout.

Image

This approach is not at all a buy and hold approach, and would be wildly impractical in a taxable account. I don't consider it market timing (some will) because I'm not attempting to predict peaks and valleys or exit and entry points. In this version I'm not even adding and subtracting funds, as many tactical asset allocation strategies do, although I must admit that I'm thinking about how that might be done reasonably.

One key takeaway is that the portfolio construction approach of diversification is even more important with LETFs. You can get away with a single 3x LETF for a while, even do really well, but it may crash. With the diversified portfolio, you won't ever get the great concentrated burst (it will take great discipline not to chase it) but you have a good shot at mitigating a great concentrated death spiral.

I hope y'all find this interesting and thought provoking. I really don't have much more to say on it.
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Hydromod
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

I was asked about how the weighting is calculated. It's basically the same thing I first discussed here, where the standard risk parity approach has a risk weighting added.

The vanilla risk parity approach simply weights each fund according to its inverse volatility, weighted by the sum of all inverse volatilities: w_i = (1/V_i)^m / (sum_j (1/V_i)^m), where V is variance calculated over a trailing period. The m exponent is 0.5 for risk parity with volatility and 1 for risk parity with variance. More sophisticated approaches account for correlation, but it requires matrix algebra. However, I think the vanilla formulation should be correct when each pair of funds has a correlation coefficient of 1 (perfectly correlated) or 0 (perfectly uncorrelated).

The budget formulation for risk parity is w_i = (b_i/V_i)^m / (sum_j (b_j/V_j)^m). Here b_i is the risk budget assigned to fund i. It's cleanest when (0 <= b <= 1 and sum_i b_i = 1).

Using the vanilla approach corresponds to each b = 1/N. With just UPRO and TMF, b = 0.5 for both.

Say I wanted to combine UPRO, TQQQ, and TMF. In this case, b is 1/3 for all of them. So equities now have 2/3 of the risk budget. Add a few more equities, and TMF has little impact any more.

The way I keep the risk allocation under control is to assign a risk budget for asset classes. It seems to work pretty well to combine things that are fairly well correlated into groups, especially if the groups are relatively uncorrelated with each other. I've tentatively settled on groups for equities, REITs, gold, treasuries/bonds, and commodities (only useful if I'm looking at 1x funds).

It seems to work pretty well to have the weight decline somewhat from equities to treasuries, then drop quite a bit to gold and REITs.

So if I want to have UPRO, TQQQ, and TMF, I'd set the equities weight to 0.6 (say) and treasuries weight to 0.4. The equities share the class weight evenly, so the final risk budget is 0.3/0.3/0.4 for UPRO/TQQQ/TMF.

Not unlike the portfolio weights that people are using. Except that each month I would recalculate w_i, which is the actual portfolio weight. For comparison, the original HEDGEFUNDIE 40/60 portfolio fraction for UPRO/TMF is actually pretty close to a 50/50 risk weight over long durations.

It's pretty easy to do the calculations in Google Sheets, it's just a little annoying that the current day doesn't always show up when requesting a fund history.

Hope this helps.
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Re: Refinements to Hedgefundie's excellent approach

Post by Hydromod »

To my mind, a good use for risk parity is for assigning allocations to long-only funds in order to balance volatility. My goal is to maintain a relatively smooth return over a few years; the moving 3-year CAGR is about the right duration for assessing performance for my purposes.

The figure below is my attempt at developing a risk parity portfolio. It's basically minimum variance except that the risk assigned to equities is 60 percent in aggregate and to LTT is 40 percent; minimum variance would assign equal risk to each component. This method does not include return estimates when developing weights.

Each month the portfolio weights are recalculated with a two-month lookback for the correlation matrix. Note that the average weight for LTT is roughly 50 percent, but it bounced around considerably.

Image

I have 4 equities (S&P 500, NASDAQ, utilities, and real estate) plus long-term treasuries.
  • The top plot shows the portfolio value, adjusted to 1 at the start, and the components adjusted to their fraction of the portfolio.
  • The second plot shows the moving 3-year CAGR.
  • The third plot shows the allocation for each fund.
  • The fourth plot shows the ulcer index for the components and the portfolio.
The portfolio only roughly follows the components; it does not track the peak performer. However, it does back down the allocations of components that are not doing well. Over this period the CAGR was 10 percent.

Exactly the same method is used for 2x LETFs in the next figure. The early part of some LETFs are synthetic, based on leveraging the corresponding fund in the first figure, and may be optimistic with respect to expenses. All of the LETFs start before 2/2007 except UBT (2010).

Image

The key here is that the funds again balanced out very nicely, even though some of the individual 2x funds had bad patches. The calculated CAGR for the period was 19 percent, again probably a bit optimistic from the first few years. The portfolio oscillations are a bit bigger than the unleveraged version.

I find that the 3x version also behaved nearly as smoothly, but all funds are synthetic prior to 2009 and the synthetic versions are probably quite optimistic so I'm not showing it. The CAGR from 2009 on was roughly 25-30 percent.

As a bit further backtest, the following figure does just the 2x S&P500 and NASDAQ, and 3x LTT. These have synthetic daily data, although the values are increasingly questionable the further back in time. However, UOPIX was actually in existence starting in 1998, so it gives an idea of responses during the 2000 period and the 2008 period. The 3x LTT has a proportionately smaller fraction of the portfolio than a 2x LTT would occupy (but the same risk fraction), so overall returns are a bit bigger than a pure 2x-only portfolio.

Image

I've delayed posting this until now, because I wanted to verify the behavior accounting for correlations. It turns out that I don't see a very big difference in returns and volatility using the minimum variance approach (considering the correlations) or just inverse variance weighting, even though the weights vary somewhat. I expect that picking funds that have relatively low correlations probably is partly responsible, and probably explicitly assigning risk fractions to each fund also is partly responsible. I realize that the correlations are not very accurate, but (i) recalculating correlations each month also will tend to even out estimation errors from one month to the next and (ii) the results aren't sensitive to the correlation matrix anyway.

I've tried other funds and combinations, in particular considering TNA/URTY, UMDD, CURE, SOXL, EDC, EURL, UGL, commodities, and TYD. I don't see any particular benefit to adding these other funds, but the methodology seems to work pretty well. I discarded 2x LETFs and TYD because they need too much of the portfolio in order to balance volatility. I discarded commodities, EDC, and EURL for low returns. I discarded TNA/URT, UMDD, CURE, and SOXL mainly for simplicity.

I am not currently using the unemployment index as an indicator, which I had discussed before. I think that it won't be useful until the COVID shock has worked its way out of the system.

I am still considering the possibility of using TMV instead of TMF if there comes a time with steadily rising interest rates, such as the period from 1955 to 1982.

I've done some backtesting trying to predict market movements based on moving averages and volatility. In common with much that I've read, I wasn't able to see any predictive capability in these indicators, so I will not be using them.

This is the type of strategy that I will be following with my HEDGEFUNDIE adventure going forward. It's only practical in tax protected, because of the monthly rebalancing. I'm planning to test drive this for at least five years with five percent of my current portfolio, and consider a larger fraction if it goes well (especially if it goes well under adverse conditions).
jarjarM
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Re: Refinements to Hedgefundie's excellent approach

Post by jarjarM »

Hydromod wrote: Tue Apr 27, 2021 9:50 pm
Thanks for the interesting post. Have you look at the look back window sensitivity? I saw you're doing 2 months but wondering if you see any improvement by going shorter look back since you're dealing with LETFs that tend to be more volatile. Thanks.
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