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'hedgefundie Portfolio' and wisdom tree leveraged ETFs?

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rat_race2021
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Hi ERN,

Curious if any specific thoughts around the 'hedgefundie' portfolio and the wisdom tree leveraged etfs (NTSX, ITSX, ETSX).  The hedgefundie portfolio https://www.bogleheads.org/forum/viewtopic.php?t=288192 is a very large thread on bogleheads that implements a ~60/40 split of UPRO and TMF (3x leveraged SPY & TLT).  The wisdom tree etfs are 90/60 stock/bond etfs for USA/Developed/Emerging all paired with treasuries.  The hedgefundie portfolio would be managed by m1 finance with their easy to use rebalancing functions.

 

I enjoyed your topic on 'lower risk through leverage' and the accompanying google sheet.   It seems that these approaches make sense mathematically and that someone would stand to gain from them? Despite being more complex.  

I'm guessing you already mentioned this in your previous post on leverage, so maybe I am just not getting it. If the wisdom tree ETFs are interesting, do some of them make more sense than others? For example, is the International 90/60 better than in comparison to an intl fund more so than NTSX (USA 90/60) is vs VTI?

 

 

 

 

 

 

 

 

 

19 Replies
earlyretirementnow.com
Posts: 250
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Excellent question. During the accumulation phase, especially early on, it makes sense to go 100% equities or potentially even >100% equities, or maybe a leveraged S/B portfolio with more overall volatility target than a 100% equity portfolio, just like that hedgefundie portfolio.

If you plot the efficient frontier, you'll notice that somewhere around 30/70 to 40/60 is the max-Sharpe-Ratio portfolio. Not a bad idea to lever that up, as I have outlined in my post back then (Lower risk through leverage).

I find it a bit troubling that people on Bogleheads are now trying to pump up the equity portion, though. They seem to forget the whole rationale behind it (i.e., max Sharpe + leverage gets you to the left of the efficient frontier).

Also, if you do this with regular rebalancing you will generate a boatload of short-term gains. Transaction costs might be a headache too. Even at M1 where you don't have a commission, you still lose on the b/s spread. It's best to implement this with a futures portfolio. Section 1256 contracts!

But if you're constrained by ETF implementation, pick the ones that have the lowest expense ratios.

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9 Replies
nmg
 nmg
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@earlyretirementnowcom ERN, 55 $UPRO/45 $TMF is actually the 3x leverage of the tangency portfolio on the efficient frontier.

 

40/60 Stocks/Bonds might be tangency for treasury bonds in general, but the hedgefundie portfolio explicitly uses 20+ year US treasury bonds (i.e. $TLT) leveraged 3x ($TMF).

 

See:

 

https://www.portfoliovisualizer.com/efficient-frontier?s=y&type=1&mode=2&startYear=1972&endYear=2021&robustOptimization=false&groupConstraints=false&geometric=false&minimumVarianceFrontier=false&fromOrigin=false&symbol1=SPY&symbol2=TLT

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earlyretirementnow.com
(@earlyretirementnowcom)
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@nmg   Good point.

But: It may be. Or may not be. The EF based on long-term historical data is not that useful. You have to input today's expected equity returns, today's 30y yields, today's cash yield, and today's expected VCV. (i.e., volatility and correlation). We ran a strategy like this at BNY Mellon, and believe me, this is a lot more complicated than just plugging in a historical return series and historical tangency portfolio. 🙂

But you're right. Because the 30y has a much longer duration and more risk you will get a lower bond weight on the efficient frontier. So, the SPY/TLT may indeed look more like a 50/50 or even 55/45 using today's data. But it all depends on your inputs. 

The reason why I normally work with the 10Y is that I have a longer return data window (1871-now) and the 10y Treasury Future is the most liquid contract.

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nmg
 nmg
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@earlyretirementnowcom full disclosure, I am an engineer by training and can't claim to know what I am talking about (but am interested to learn). Do you have any book recommendations that goes into some of these technical topics (e.g. modern portfolio theory) in greater detail?

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earlyretirementnow.com
(@earlyretirementnowcom)
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@nmg I like this one:

https://www.amazon.com/Practitioners-Guide-Asset-Allocation-Finance/dp/1119397804/ref=pd_bxgy_img_1/143-1341640-4622754?pd_rd_w=GIzdI&pf_rd_p=c64372fa-c41c-422e-990d-9e034f73989b&pf_rd_r=HP01HKABC44AWQA5GMRV&pd_rd_r=859fe893-626e-426e-ae44-eaeef57c08c4&pd_rd_wg=EOIbp&pd_rd_i=1119397804&psc=1

 

But caution: a theoretical model is only as good as the inputs. The best example is the Efficient Frontier calculation. The theory is trivial (basically a quadratic programming optimization), but coming up with the inputs is the challenge. Especially equity expected returns and forward-looking S/B correlations. 🙂

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figuy1
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@earlyretirementnowcom I've been thinking, why don't people lever up more early in their earning years, then once they think they have enough equities to retire on, spend the rest of their earning years to deleverage until retirement.

Something like this with a 15 year contribution phase:

Year 0-5: 175%-225% equities

Year 6-10 125-175% equities

Year 11-15: 75-125% equities and glide to desired equities allocation by year 15

Basically, if you think you need about 250 units of S&P 500 index, save until you have that amount leveraged (say $550k for 2x leverage at current price), then use your future contributions to gradually deleverage until you get to something like 70-80% equities at retirement.  Seems like you'd get to retirement much faster without that much more risk if you're continually periodically investing each month.  If you're planning on buying a certain amount of equities anyway, why not buy most of them in year 0-5 rather than waiting until years 6-15 to buy them.

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schmeljones
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@figuy1 This is the thesis of the "Lifecycle Investing" book from Ayres and Nalebuff and is the subject of much discussion at Bogleheads - e.g. https://www.bogleheads.org/forum/viewtopic.php?t=274390

I'm about 10 years from FIRE and reading that book was the final push for me to go 100% equities last summer and not pay off my mortgage a day earlier than necessary. I'm also using LEAPS plus covered calls in my Roth IRA and BigErn's put selling in an after-tax account.

Functionally, that means I'm at roughly 1.2x leverage across accounts (~2x leverage if you include mortgage). Going to try to stay around 1.2x by balancing new leveraged contributions with paying off the mortgage and will chart out a deleveraging/bond-buying glidepath a few years from now when the FIRE picture is more in focus. 

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earlyretirementnow.com
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@schmeljones I generally support that view. Leverage early in life is OK because you got a lot of "runway" ahead of you in case things move against you. It's certainly a good way of dealing with the sequence of return risk for savers, i.e., good returns early on and then weaker returns later in life. 

Unfortunately, this gain falls into the category "mathematically correct, but hard to sell from a psychological point of view"   

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figuy1
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@earlyretirementnowcom Yeah you're definitely right about the  psychological point of view.  You have to be able to stomach 80%+ drawdowns which is very difficult if you're a new investor.

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figuy1
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@schmeljones Wow there's a lot on the topic at bogleheads.  I've never spent much time over there because I assumed most of the talk is geared towards more conservative traditional retirees, but looks likes there's more to it.

They have a good point about factoring in mortgage into your leverage ratio.  Someone who has or plans to take out a big mortgage should probably use less leverage than someone who has a small or no mortgage.  One relatively low risk way to have leverage earlier in your savings phase is to just wait to pay down mortgage and own bonds like you're doing.

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earlyretirementnow.com
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And of course, the cautionary tale. This portfolio would have sucked in the 1960s-1980s!

 

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3 Replies
figuy1
(@figuy1)
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@earlyretirementnowcom Great point! In a inflationary environment with low real stock returns, this portfolio would get smoked compared to simple buy and hold equities portfolio.

How did you generate that back test? It looks like portfolio visualizer but I thought they only had data back to the 1970's.  Do you have a premium subscription or something?

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figuy1
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I may have answered my own question.  It looks like they have a custom data import feature. I'm guessing you imported your own return data from Robert Shiller?

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earlyretirementnow.com
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@figuy1 I think this is just one of the pics that someone posted on bogleheads. 🙂

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figuy1
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Is it just me or have way more people been talking about using leverage to have >100% equities exposure in the past 1-2 months?

I don't remember anything like this since 2007.

Obviously in hindsight it would've been great to own more equities in this bull run but I'd be very weary to go from <=100% equities to >100% equities now. 

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schmeljones
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It's not just you - IBKR announced a doubling of margin loan balance from last year in their recent Q2 earnings. https://twitter.com/Bonecondor/status/1417617179613274113?s=20  

Always hard to call a bubble as it happens but at some point you have to wonder...

That being said I'm still comfortable at 1.2x equity equivalents with a 50% savings rate and total assets 5x annual savings at age 31 (20s were mostly graduate school).

FWIW, there's no way I'd be doing this with a higher asset/savings ratio, I'm counting on substantial dollar-cost averaging through contributions to ride out a repeat of 2000-2001 or 2007-2009 psychologically and financially since I wasn't investing during either.

I also have the potential for a significant payout from stock options in the next 18-24 months. While I don't count on that money as a sure thing at all, it certainly factors into my investing risk appetite.

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