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Discussion Starter #1
The S&P 500 already has very strong performance. But I'll put on my greedy investor hat and ask... can I do better?

Obviously, there's leverage. This boosts the return as well as the risk. There's an exotic ETF called SSO which has been around a long time (since 2006). It's leveraged, 2x the S&P 500 on a daily basis, and over longer periods still gets some leverage effect. Being leveraged, it's insanely volatile. During the last market crash, it fell about 90% in value.

At first glance, I'd say you shouldn't hold SSO, and you shouldn't hold the S&P 500 leveraged (on margin) due to the very sharp drawdowns. It's too much risk.

But what if I told you that you can leverage the S&P 500, passively, without increasing risk? We'll have to ignore the inherent risk in SSO for a moment.

Consider 50% SSO + 50% IEF, a treasury bond fund which acts as a safe haven.
Portfolio analysis at Portfolio Visualizer

Look at what happens now. Going back to SSO inception, the 50/50 mix returns 10.39% with a maximum drawdown of -41.88%.
In comparison, the pure S&P 500 using IVV returns 8.33% with a maximum drawdown of -50.78%

In other words, 50% SSO + 50% IEF produced a significantly higher return but also a milder decline during the market crash! It's a form of volatility harvesting.

If you skip past the crash and start in 2012 (a totally normal year), then the return becomes about the same as the S&P 500, as does the risk. No surprise there.

Over the last year, for example, the SSO/IEF mix returned +20.2% which is significantly higher than pure IVV at +16.6% ... seemingly with no extra risk.

Thoughts? Personally I have trouble holding a derivative-based exotic ETF (SSO) but I find these numbers very interesting.
 

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Discussion Starter #2
And maybe the potential flaw in this idea is that IEF is only working out this nicely because interest rates fell significantly during this period. Perhaps in a prolonged period of rising rates, the effect wouldn't be the same.

Plus, SSO is dangerous in other ways. Being based on derivatives, it could potentially blow up and go to $0.
 

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On the bogleheads forum there is a thread by HEDGEFUNDIE discussing a similar strategy (I believe it uses UPRO = 3X S&P with a leveraged long treasury ETF). The backtest results seem good, but how it would perform in the future is to be seen. It is sort of like leveraging a balanced fund.

I too am a bit leery about using leveraged instruments. There is always a possibility of total failure, a la XIV. If I were to implement such a strategy, my preferred method would be to use futures on the S&P and long bonds. I have been tempted to use the e-minis with long bond and gold futures, which along with the cash in the account, would resemble a leveraged permanent portfolio. The PP seems to blend the best of returns and risk with very small draw downs. I am not sure futures can be traded in an RRSP or TFSA, so taxes will be a burden.

Another method would be using deep in the money calls on SPX or SPY, similar to Life cycle investing. This would be my second choice.
 

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One product that looks interesting is CAPE, an ETN that tracks an index that selects/weights S&P500 sectors by cyclically adjusted valuation. It has generated decent alpha, pretty consistently. Of course, I don't think you would be comfortable with an ETN, james.
 

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Discussion Starter #5
Yeah there's no way I would use an ETN... counterparty risk to the issuer there.

Topo very interesting notes. Right, it's effectively leveraging a balanced fund -- which hedge funds actually do. This is in fact the core concept. You first design a highly diversified (as close to perfect) portfolio with the best risk/reward tradeoff. Then you leverage that up, to your desired level of risk.

The abstract idea is sound and you really can get the same returns as "pure stock market" with less risk than the stock market. The problem is implementing leverage.

The XIV blowup was spectacular. Maybe like you say, futures or some other common derivative are the better way to do this. I have looked at many ways over the years but was never satisfied with the math. I just haven't convinced myself that it's worth doing. The leveraged ETFs are the easiest way, like HEDGEFUNDIE wrote about, but I'm not sure I like those things.

Your idea of leveraging the permanent portfolio is exactly what Risk Parity is, so you might want to look up Bridgewater's notes on that technique. I think it's promising, and I've considered it, but just wasn't comfortable with the implementation of leverage. In the end I decided to go with unleveraged PP / Risk Parity instead, which is actually what Dalio recommends to people himself.

Google Myths and facts about risk parity to see a nice description of the leveraged PP (ideal portfolio) concept.
 

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Discussion Starter #6 (Edited)
By the way, if you want to experiment with leveraging the PP, you might want to look into ways to leverage the asset classes by using higher beta versions of each asset.

For example, small caps instead of the S&P 500. And for bonds, go farther on the yield curve.

Start with the regular PP which let's say is
25% S&P 500
25% long treasury bond [22y]
25% gold
25% cash

First transformation, collapse the fixed income portion. You end up with, equivalent:
25% S&P 500
50% the 10 year treasury bond
25% gold

In the link below, this is Portfolio 1; the regular PP. Now you can amp up the stocks and bonds:

25% small caps (implied leverage)
50% long treasury bond (implied leverage)
25% gold

So now you've leveraged the PP without resorting to exotic instruments! In the 41 year backtest, CAGR has increased by 0.93% with very little increase in risk.

Link to portfolio visualizer with these examples

In my view, this is the most plausible avenue. No derivatives, no borrowing... just higher beta alternatives. The "leverage" effect is rather mild, though.

But still, I think that implied leverage helps. The modified portfolio is showing about 1% CAGR improvement in more recent timeframes. In fact, if you shift it just a wee bit towards stocks and less gold, you can actually match traditional 60/40 performance... with less risk of course.

Kind of funny, isn't it? That with just a little bit of effort, one can make a totally passive portfolio that performs on par with 60/40, but with far less downside (less drawdown). And yet, very few people bother... and investment professionals almost universally balk at the idea.
 

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One thing that holds me back from using leverage is that I see my unleveraged portfolio returns as adequate for my retirement goals. I don't want to risk the money I need, to get extra returns that I don't need (although I would certainly be very happy to eat a free lunch if there is one out there). I could do a similar strategy with a small portion of my portfolio, but then the extra return may not make it worthwhile. For example 5% outperformance on 10% of one's portfolio adds 50 bps to the total return.
 

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Discussion Starter #8
I agree. I also see my current portfolio's returns as adequate, and I don't think it's a good idea to take the additional risks of leverage.

Topo, not sure if you're aware that my asset allocation is very similar to the permanent portfolio. It's 30% stocks, 50% high grade bonds, 20% gold... basically the same as PP (see my previous post above) but with 5% shifted from gold to stocks.

US long-term backtest shows 5% real return and a worst year of -5% which is the same return as a 50/50 balanced fund but with more consistent annual returns

More relevant, performance in CAD of the portfolio has been 4.6% real return

I'm happy with this real return. Beating inflation by 4.6% with minimal volatility is a "good deal" in my eyes. Yes, it's not as high as 60/40 performance but that's not a big deal either. For me, there is value in maintaining good performance during stock slumps (like 2001-2011) which my allocation and PP can do, but 60/40 does not.

I don't feel compelled to complicate the situation by using leverage or anything exotic.
 

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I've published this before but here goes again. If you want to supercharge your returns and cut your risk investing in the S&P buy an ETF that mimics the S&P and do the following.

Look at a weekly chart of the S&P with a 10 week and 50 week moving average

When the 10 crosses over the 50, buy

When the 10 crosses under the 50, sell

If you did this you would only have made 4 or 5 trades in the last 20 years but you would have increased your returns from 8 or 9% to over 12% and you would have missed the big drawdowns in 2001 and 2008.

lnk.php.png S&P MA cross.jpg
 

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Discussion Starter #10
Thanks Rusty. I agree it looks nice on S&P 500 but I tried it on the TSX and the results are uncertain. It frequently gets shaken out. I agree it does buy in near the start of each bull market, which is awesome, but it also gets shaken out along the way during market corrections. I didn't calculate the net result... perhaps it does better than buy & hold on TSX.

That would be worth calculating. If it works on both the S&P 500 and TSX, you'd know it's not just a fluke or data fitting exercise unique to the S&P 500
 

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I agree. I also see my current portfolio's returns as adequate, and I don't think it's a good idea to take the additional risks of leverage.

Topo, not sure if you're aware that my asset allocation is very similar to the permanent portfolio. It's 30% stocks, 50% high grade bonds, 20% gold... basically the same as PP (see my previous post above) but with 5% shifted from gold to stocks.

US long-term backtest shows 5% real return and a worst year of -5% which is the same return as a 50/50 balanced fund but with more consistent annual returns

More relevant, performance in CAD of the portfolio has been 4.6% real return

I'm happy with this real return. Beating inflation by 4.6% with minimal volatility is a "good deal" in my eyes. Yes, it's not as high as 60/40 performance but that's not a big deal either. For me, there is value in maintaining good performance during stock slumps (like 2001-2011) which my allocation and PP can do, but 60/40 does not.

I don't feel compelled to complicate the situation by using leverage or anything exotic.
I am thinking about adding an allocation of gold to my portfolio. I'm looking for a better entry point, maybe in the 1300 range. It reacts well to inflation and deflation, and with interest rates so low, there is a lower hurdle to overcome.
 

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Thanks Rusty. I agree it looks nice on S&P 500 but I tried it on the TSX and the results are uncertain. It frequently gets shaken out. I agree it does buy in near the start of each bull market, which is awesome, but it also gets shaken out along the way during market corrections. I didn't calculate the net result... perhaps it does better than buy & hold on TSX.

That would be worth calculating. If it works on both the S&P 500 and TSX, you'd know it's not just a fluke or data fitting exercise unique to the S&P 500
You would have gotten shaken out of the S&P a couple of times too. But when you can get back in for a $7 commission it seems like an acceptable risk to avoid a major drawdown. After all you pay a fire insurance premium on your house and don't get all bummed out when it doesn't burn down and the premium is wasted.

I went over the chart in my favorite trading platform and calculated as accurately as possible what would have happened had I followed the rules, that is where I got the 8% vs 12% figures.

The big advantage is missing the big drawdowns. It's not a day trading strategy. Moving averages have been used this way at least since the fifties, Jack Dreyfuss talked of using a weekly moving average as one of his main trading tools. But it has been left behind by more recent developments. That doesn't mean it still doesn't work. To me one of the big advantages is, it lets you stop worrying about a market drop.
 

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You would have gotten shaken out of the S&P a couple of times too. But when you can get back in for a $7 commission it seems like an acceptable risk to avoid a major drawdown. After all you pay a fire insurance premium on your house and don't get all bummed out when it doesn't burn down and the premium is wasted.

I went over the chart in my favorite trading platform and calculated as accurately as possible what would have happened had I followed the rules, that is where I got the 8% vs 12% figures.

The big advantage is missing the big drawdowns. It's not a day trading strategy. Moving averages have been used this way at least since the fifties, Jack Dreyfuss talked of using a weekly moving average as one of his main trading tools. But it has been left behind by more recent developments. That doesn't mean it still doesn't work. To me one of the big advantages is, it lets you stop worrying about a market drop.
I find the concept interesting. I always think about the possibility of a drawn-out bear market, where there may be a lot of volatility, but the market basically goes nowhere (sort of like the 70s or the aughts). One way to mitigate the effects would be using other asset classes or subclasses (REITs, small cap value, gold, etc). Bonds could be better than equities in these kind of scenarios (depending on inflation), but given that interest rates will be low, one may have to substantially eat into principal.

But what if one could allocate portion of their portfolio to a strategy that would harvest the volatility with less risk (or different risk) than buy-and-hold? Maybe a moving average or trend following strategy.
 

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But what if one could allocate portion of their portfolio to a strategy that would harvest the volatility with less risk (or different risk) than buy-and-hold? Maybe a moving average or trend following strategy.
There is a whole paper written on this a while back called "Quantitative Approach to Tactical Asset Allocation" by Faber.
A search here should bring up previous discussions on it.
 

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Discussion Starter #15
I have my own proprietary technical approach to avoiding those drawdowns, which has similarities to what Rusty posted. It's been working well -- I actually avoided the late 2018 stock declines. And now the strategy is back up to all time highs, mirroring the broad index. I use this for part of my equity within my asset allocation plan. Kind of like trading around the basic asset allocation of 30% equities, so I'm not always at 30%. If my technical method gets me out, I might drop to more like 25%.

Here's my take on it: the technical methods can work. The difficulty is in implementation, and sticking with the method (in other words it's a behavioural challenge, not technical). How many people can consistently follow a technical approach involving constant monitoring and updates over 10 years? 30 years? What happens when you have children who are sick, too much work to do, other priorities like health that take precedence. And what happens when you -- inevitably -- underperform the index for a few years. Do you decide your strategy is broken, and abandon it?

I think these are the real reasons that passive asset allocation and indexing win in the long term. Here's a great article on this topic: Why Isn’t Everyone Beating the Market?
 

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Discussion Starter #16
I am thinking about adding an allocation of gold to my portfolio. I'm looking for a better entry point, maybe in the 1300 range. It reacts well to inflation and deflation, and with interest rates so low, there is a lower hurdle to overcome.
Remember though, reacting the inflation is one angle. Another angle of gold (perhaps just as important) is the low correlation with both stocks & bonds. This lets you create a better diversified portfolio, smoothing over volatility. That has value, whether or not you're buying gold at a low level.

This creates an interesting situation where two things are simultaneously true:

(1) all assets (stocks, bonds, gold) are quite high on a multi-year scale. It's hard to buy any of them and feel good about the entry price

(2) a diversified, multi-asset portfolio is generally safer and less volatile. It will probably grow in a more reliable way, no matter the entry point


Topo, I would appreciate your thoughts on this as I struggle with this on a daily basis! I am under-invested currently, have too much cash. The ideal theory of (2) says that I shouldn't overthink it, and just invest everything. But then I keep coming up against (1), which is what you also mentioned in your post.
 

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Remember though, reacting the inflation is one angle. Another angle of gold (perhaps just as important) is the low correlation with both stocks & bonds. This lets you create a better diversified portfolio, smoothing over volatility. That has value, whether or not you're buying gold at a low level.

This creates an interesting situation where two things are simultaneously true:

(1) all assets (stocks, bonds, gold) are quite high on a multi-year scale. It's hard to buy any of them and feel good about the entry price

(2) a diversified, multi-asset portfolio is generally safer and less volatile. It will probably grow in a more reliable way, no matter the entry point


Topo, I would appreciate your thoughts on this as I struggle with this on a daily basis! I am under-invested currently, have too much cash. The ideal theory of (2) says that I shouldn't overthink it, and just invest everything. But then I keep coming up against (1), which is what you also mentioned in your post.
I completely agree with you that a holistic approach to portfolio construction is the best approach. This would lead me to suggest that the decision should not be overthought and buy into your asset allocation as you have originally contemplated.

I guess when it comes to gold, I am putting my trader hat on more than my investor hat. It goes back to how I originally constructed my portfolio long time ago, starting with all equities and then gradually adding bonds recently. So I don't feel gold will be necessary for my portfolio, but it would be a good addition at the right price. I won't mind missing a 20% upswing, but would prefer not to take a 20% hair cut in the short term.
 

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I have my own proprietary technical approach to avoiding those drawdowns, which has similarities to what Rusty posted. It's been working well -- I actually avoided the late 2018 stock declines. And now the strategy is back up to all time highs, mirroring the broad index. I use this for part of my equity within my asset allocation plan. Kind of like trading around the basic asset allocation of 30% equities, so I'm not always at 30%. If my technical method gets me out, I might drop to more like 25%.

Here's my take on it: the technical methods can work. The difficulty is in implementation, and sticking with the method (in other words it's a behavioural challenge, not technical). How many people can consistently follow a technical approach involving constant monitoring and updates over 10 years? 30 years? What happens when you have children who are sick, too much work to do, other priorities like health that take precedence. And what happens when you -- inevitably -- underperform the index for a few years. Do you decide your strategy is broken, and abandon it?

I think these are the real reasons that passive asset allocation and indexing win in the long term. Here's a great article on this topic: Why Isn’t Everyone Beating the Market?
Reviewing the Meb Faber paper, he has some data on a leveraged SMA-following portfolio showing an 18.8% return. He, however, warns against using margin or leveraged ETFs.
 

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Discussion Starter #19
Reviewing the Meb Faber paper, he has some data on a leveraged SMA-following portfolio showing an 18.8% return. He, however, warns against using margin or leveraged ETFs.
I do mine non leveraged, plain vanilla ETF, based on simple moving averages and a few principles I borrowed from electrical engineering (switch de-bouncing & hysteresis) to improve stability and create fewer trades. My system sends me a text message daily, sometimes instructing me to make a trade.
 

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I looked at a 5 year chart of UPRO with SMA-200 overlay. It captures 2017 very well, but there is substantial whipsawing going on in 2018 and 2019. SPY looks better. So maybe one could use SPY SMA-200 as the signal and then implement with UPRO. One could do this in a tax-sheltered account to minimize taxes.
 
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