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HEDGEFUNDIE's excellent adventure

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  • Avatar Phantasos 
    Participant
    Status: Physician
    Posts: 86
    Joined: 01/06/2016

    Which I followed. And all sounded very intelligent. Until it didn’t.

    Click to expand…

    This strategy has had a strong opening, which is surely responsible for some of the publicity it has received.  I think the drama of someone (Hedgefundie) allocating a solid chunk of change ($100k), also contributed to the drama/notoriety.  There is no doubt though, standard deviation of returns, worst years, max drawdowns are all considerably more scary for this type of investment vs plain vanilla S&P500 (see 10-year chart below from portfolio visualizer).

    Initially, this portfolio was started with 40% UPRO and 60% TMF.  It sounds like he underestimated how the out sized performance on back-testing was influence by the decades-long bond bull market.  Recognizing that it would be impossible to achieve similar returns with long treasuries returning what they have been recently, he changed to a 55% UPRO / 45% TMF portfolio.  To be fair, this was after receiving feedback from the Boglehead community over many months and thousands of posts.  His present implementation is 55%  UPRO and 45% TMF.
    I have no plans to invest in websites or syndicated real estate, but I do see the value in having portfolio components with low correlation to the broad US equity market.  Even the 55/45 portfolio has less US market correlation than VNQ (which I own, for that very reason).
    Currently I have zero invested in this strategy.  I have been watching this with interest for some time, I will probably dedicate some Roth space to it at an amount < 5% net worth.  My VNQ is just below 5% right now.
    Portfolio Returns
    Portfolio performance statistics
    Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio US Mkt Correlation
    40%/60% UPRO/TMF $100,000 $1,088,309 28.29% 21.09% 77.04% -12.26% -22.83% 1.27 2.40 0.13
    50%/50% UPRO/TMF $100,000 $1,294,389 30.63% 19.81% 66.09% -13.43% -20.34% 1.44 2.70 0.42
    55%/45% UPRO/TMF $100,000 $1,387,537 31.58% 19.93% 63.14% -14.16% -19.52% 1.47 2.75 0.56
    Vanguard 500 Index Investor $100,000 $321,757 12.97% 12.65% 32.18% -4.52% -16.31% 1.00 1.64 1.00

    "The problem with internet quotes is that you can't always depend on their accuracy" - Abraham Lincoln, 1864

    #239272 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016

    It is intriguing idea and well defended in terms of choices while acknowledging and not minimizing potential weaknesses.  As the OP states, this is a ‘lottery ticket’ using a small portion of investable NW so from an overall risk management standpoint he is not putting himself at substantial risk.

    I also find it ironic this idea is on Bogleheads, given the low cost/indexing mantra predominant on this site, when this is almost the opposite (leverage plus high cost fund ER’s).

    This idea has a couple critical components IMO:

    a.  Execution within a ROTH IRA only.  The leverage/re-balancing component makes it prohibitively expense from a tax standpoint to undertake otherwise IMO.

    b.  Human Behavior aspect.  This idea takes alot of discipline to execute per plan rebalancing while avoiding the almost mccabe fascination of looking at price volatility on a daily/hourly basis.

    Click to expand…

    i wonder if instead of selling UPRO or TMF to “rebalance” you buy some of each to keep the 40/60 ratio, would that get rid of the tax issues…

     

    Click to expand…

    You could do that, but as your account got big those could be pretty massive buys. Somewhat unexpectedly, tax deferred accounts are by far the preferred vehicles to do any kind of real strategy that has trading involved. SVXY is a similar strategy of volatility harvesting but has 1256 tax treatment, which is nice.

    #239273 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016
    Which I followed. And all sounded very intelligent. Until it didn’t. 

    Click to expand…

    This strategy has had a strong opening, which is surely responsible for some of the publicity it has received.  I think the drama of someone (Hedgefundie) allocating a solid chunk of change ($100k), also contributed to the drama/notoriety.  There is no doubt though, standard deviation of returns, worst years, max drawdowns are all considerably more scary for this type of investment vs plain vanilla S&P500 (see 10-year chart below from portfolio visualizer).

    Initially, this portfolio was started with 40% UPRO and 60% TMF.  It sounds like he underestimated how the out sized performance on back-testing was influence by the decades-long bond bull market.  Recognizing that it would be impossible to achieve similar returns with long treasuries returning what they have been recently, he changed to a 55% UPRO / 45% TMF portfolio.  To be fair, this was after receiving feedback from the Boglehead community over many months and thousands of posts.  His present implementation is 55%  UPRO and 45% TMF.
    I have no plans to invest in websites or syndicated real estate, but I do see the value in having portfolio components with low correlation to the broad US equity market.  Even the 55/45 portfolio has less US market correlation than VNQ (which I own, for that very reason).
    Currently I have zero invested in this strategy.  I have been watching this with interest for some time, I will probably dedicate some Roth space to it at an amount < 5% net worth.  My VNQ is just below 5% right now.
    Portfolio Returns
    Portfolio performance statistics
    Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio US Mkt Correlation
    40%/60% UPRO/TMF $100,000 $1,088,309 28.29% 21.09% 77.04% -12.26% -22.83% 1.27 2.40 0.13
    50%/50% UPRO/TMF $100,000 $1,294,389 30.63% 19.81% 66.09% -13.43% -20.34% 1.44 2.70 0.42
    55%/45% UPRO/TMF $100,000 $1,387,537 31.58% 19.93% 63.14% -14.16% -19.52% 1.47 2.75 0.56
    Vanguard 500 Index Investor $100,000 $321,757 12.97% 12.65% 32.18% -4.52% -16.31% 1.00 1.64 1.00
    Click to expand…

    Hmm…probably shouldnt have tried to overfit/overthink it and just kept it 40/60. Just given the disparity in volatility of bonds/equities on average it makes sense for purposes of being able to hold it. I think the rebalancing helps steady it as well, but overfitting a forward portfolio for past data is always going to lead you astray or at least give you confidence that is undeserved.

     

    #239275 Reply
    Liked by Tim
    fatlittlepig fatlittlepig 
    Participant
    Status: Physician
    Posts: 1195
    Joined: 01/26/2017

    First and foremost theres no reason that bonds and equities have to stay so negatively correlated. That is when stocks go up bonds go down (price) or vice versa. Easily imagined situation is say some sneaky inflation pops up, fed has to increase rates, etc…stocks dive and yields jump, both would be down.

    Its important to understand what you’re really doing with these funds, and its easy to say “duh, you’re leveraged” which is true but you’re really banking on a generally positive return path (path dependency) and fairly low volatility all things considered in major indexes. This is why things like 3x S/P and QQQ generally crush it and return far more than their 3x would make you guess (closer to 10x in reality). Otoh, funds like gold/oil etc…can have years where both the +/-3x fund get crushed since the underlying index doesnt trend and is very volatile compared to the major indexes.

    If you go long these instruments you are essentially shorting volatility, making an explicit bet that the gains/path in the market are going to be higher than the volatility drag of the instrument. I’ve long argued the point there is no magic in 3x fund vs a regular fund like VTI, as it is also leveraged to a factor of 1 and all suffer volatility drag. At what point does it become bad? Well that depends on the volatility mainly. Lower volatility equals higher leverage, this is the very basic premise behind risk parity, not at all rocket science that strategy. Its important to remember you are short volatility, in higher volatility environments you will be destroyed. These would probably be great with a vol filter, but its tough, more timing leads to more whipsaws and mistakes. Maybe some kind of macro filter and tactical allocation would make more sense. That one paper uses the 200d which is as good an arbitrary point as any.

    Simply trying to hold these during rough periods is very hard. I’ve done it, but I’ve mostly failed at it. I did buy some TQQQ in my wifes account monday after brexit and havent touched it, that was sweet (all 10 shares at the time).

    During q4 last yea:

    SPY/QQQ lost 14.33/17.14%

    Triple counterparts:

    UPRO/TQQQ -39.97/-48.23%

    So if you were in the strategy using TQQQ, you lost nearly 50%! Hard to be objective, make great decisions, etc…sizing definitely comes in to play here. You have to find a size big enough to make a difference yet not so big it may keep you up or cause you to act foolishly. For people that can put things on autopilot, never look, etc….this can be a great situation. Honestly I have long planned to go pretty big into these instruments after a recession has been called, etc…

    You also have counterparty risk of course as everyone who traded or even knows about XIV understands, they could back out or screw it up, etc…I think this is a bit more unlikely but I wouldnt be shocked at all during some kind of flash type crash scenario to see these be severely dislocated (but possible for other funds ofc).

    I think right now is a pretty sketchy time to get involved with these as no one and no instrument seems to have a stable take on whats happening in the world. However, it may just be another great buying opportunity. The definite best way to get a handle on these things is to simply trade them. Size appropriately, get a feel for it and if you can handle it. I have been so so at handling it, too involved. Have been working on being more apathetic and letting things run, only focusing on the big stuff.

    What will you do in a recession if this is down 90+% from where you bought it? Abandon it, think it was dumb to consider? Etc….thats the big issue this late in the game, even if we havent peaked yet, we’re far closer to that time.

    Oddly enough over time the optimized leverage for the SP has been about 3, for the Nasdaq its been around 2, due to its higher volatility.

    Sorry I dont think I did a good job making it short or simple. Basically, they are incredibly hard to hold which can lead to poor decisions (impossible to understand the state you’ll be in during a massive draw down until your there) and now isnt really the best time to be jumping in maybe but obviously thats a market call which are prone to being dead wrong. Maybe wade in a bit. I certainly think leveraged funds should be used by more people more strategically, as auggie mentioned to get a bit more exposure with less.

    Click to expand…

    So the main drawback is that your portfolio values will oscillate and be volatile? It seems to me that it would be “easier” psychologically to “buy low” a leveraged index fund that has fallen 25% than a stock that has fallen 25%. Does that make sense?

    #239276 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016

    First and foremost theres no reason that bonds and equities have to stay so negatively correlated. That is when stocks go up bonds go down (price) or vice versa. Easily imagined situation is say some sneaky inflation pops up, fed has to increase rates, etc…stocks dive and yields jump, both would be down.

    Its important to understand what you’re really doing with these funds, and its easy to say “duh, you’re leveraged” which is true but you’re really banking on a generally positive return path (path dependency) and fairly low volatility all things considered in major indexes. This is why things like 3x S/P and QQQ generally crush it and return far more than their 3x would make you guess (closer to 10x in reality). Otoh, funds like gold/oil etc…can have years where both the +/-3x fund get crushed since the underlying index doesnt trend and is very volatile compared to the major indexes.

    If you go long these instruments you are essentially shorting volatility, making an explicit bet that the gains/path in the market are going to be higher than the volatility drag of the instrument. I’ve long argued the point there is no magic in 3x fund vs a regular fund like VTI, as it is also leveraged to a factor of 1 and all suffer volatility drag. At what point does it become bad? Well that depends on the volatility mainly. Lower volatility equals higher leverage, this is the very basic premise behind risk parity, not at all rocket science that strategy. Its important to remember you are short volatility, in higher volatility environments you will be destroyed. These would probably be great with a vol filter, but its tough, more timing leads to more whipsaws and mistakes. Maybe some kind of macro filter and tactical allocation would make more sense. That one paper uses the 200d which is as good an arbitrary point as any.

    Simply trying to hold these during rough periods is very hard. I’ve done it, but I’ve mostly failed at it. I did buy some TQQQ in my wifes account monday after brexit and havent touched it, that was sweet (all 10 shares at the time).

    During q4 last yea:

    SPY/QQQ lost 14.33/17.14%

    Triple counterparts:

    UPRO/TQQQ -39.97/-48.23%

    So if you were in the strategy using TQQQ, you lost nearly 50%! Hard to be objective, make great decisions, etc…sizing definitely comes in to play here. You have to find a size big enough to make a difference yet not so big it may keep you up or cause you to act foolishly. For people that can put things on autopilot, never look, etc….this can be a great situation. Honestly I have long planned to go pretty big into these instruments after a recession has been called, etc…

    You also have counterparty risk of course as everyone who traded or even knows about XIV understands, they could back out or screw it up, etc…I think this is a bit more unlikely but I wouldnt be shocked at all during some kind of flash type crash scenario to see these be severely dislocated (but possible for other funds ofc).

    I think right now is a pretty sketchy time to get involved with these as no one and no instrument seems to have a stable take on whats happening in the world. However, it may just be another great buying opportunity. The definite best way to get a handle on these things is to simply trade them. Size appropriately, get a feel for it and if you can handle it. I have been so so at handling it, too involved. Have been working on being more apathetic and letting things run, only focusing on the big stuff.

    What will you do in a recession if this is down 90+% from where you bought it? Abandon it, think it was dumb to consider? Etc….thats the big issue this late in the game, even if we havent peaked yet, we’re far closer to that time.

    Oddly enough over time the optimized leverage for the SP has been about 3, for the Nasdaq its been around 2, due to its higher volatility.

    Sorry I dont think I did a good job making it short or simple. Basically, they are incredibly hard to hold which can lead to poor decisions (impossible to understand the state you’ll be in during a massive draw down until your there) and now isnt really the best time to be jumping in maybe but obviously thats a market call which are prone to being dead wrong. Maybe wade in a bit. I certainly think leveraged funds should be used by more people more strategically, as auggie mentioned to get a bit more exposure with less.

    Click to expand…

    So the main drawback is that your portfolio values will oscillate and be volatile? It seems to me that it would be “easier” psychologically to “buy low” a leveraged index fund that has fallen 25% than a stock that has fallen 25%. Does that make sense?

    Click to expand…

    Yes and yes.

    This is what I was talking about with “volatility harvesting”. I did this in the new year this year for example, instead of tax loss harvesting since I was in a deferred account (but no reason you cant use these as partners) I bought TQQQ as my equity component and built up a position in TLT for an anchor and as my ‘safe’ position.

    I would love to nail down this strategy more, though I find the transitioning to a less leveraged fund after some gains portion much more difficult to define. Most of the time I clip my wings and should have held on anyways, but you have to pick something. I usually run a trailing % stop loss, which is inevitably too tight. I’ve moved to starting a position with one, but then just changing it to discrete levels as you win to help it run.

    #239278 Reply
    Avatar antheus 
    Participant
    Status: Resident, Physician
    Posts: 96
    Joined: 04/18/2017

    I’m not considering this but it was a really interesting read. What’s the biggest downside? Is it that, in a sustained recession, because the fund is leveraged it could potentially go under in which case you wind up with 0 vs. investing in the market?

    #239298 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016

    I’m not considering this but it was a really interesting read. What’s the biggest downside? Is it that, in a sustained recession, because the fund is leveraged it could potentially go under in which case you wind up with 0 vs. investing in the market?

    Click to expand…

    It wouldnt go under as in goes to zero, but it could easily lose 90+%. Holding is difficult. Dollar cost averaging could help here.

    The fund could lose investors and shut down, but not really a big deal and one of the greatest benefits of these funds is that it is extremely cheap access to leverage, and your losses stop at zero. Thats pretty huge.

    #239300 Reply
    Avatar Phantasos 
    Participant
    Status: Physician
    Posts: 86
    Joined: 01/06/2016
    It wouldnt go under as in goes to zero, but it could easily lose 90+%. Holding is difficult. Dollar cost averaging could help here.

    Click to expand…

    Most of us have some type of bond fund in our portfolios, at some level, because it is a safer asset class with less correlation to the US equity market.

    Part of the theory for this strategy (if you read the first post on Bogleheads) is that long treasuries are “the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash.”

    Individually, the 3x ETFs UPRO and TMF certainly have the level of risk Zaphod is warning about.  In order for the strategy to fail (lose 90% of the portfolio), you would have to experience UPRO AND TMF crashing at the same time.  If you look at graphs of UPRO and TMF together you see very elegantly how they zig-zag opposite of one another.

    If you look at the performance of these UPRO/TMF portfolios in portfolio visualizer, you will see that they definitely have high max draw downs, but 90% is not historical (past performance does not…)

    "The problem with internet quotes is that you can't always depend on their accuracy" - Abraham Lincoln, 1864

    #239412 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016
    It wouldnt go under as in goes to zero, but it could easily lose 90+%. Holding is difficult. Dollar cost averaging could help here. 

    Click to expand…

    Most of us have some type of bond fund in our portfolios, at some level, because it is a safer asset class with less correlation to the US equity market.

    Part of the theory for this strategy (if you read the first post on Bogleheads) is that long treasuries are “the ultimate global flight-to-safety asset, the asset that reliably surges when stocks crash.”

    Individually, the 3x ETFs UPRO and TMF certainly have the level of risk Zaphod is warning about.  In order for the strategy to fail (lose 90% of the portfolio), you would have to experience UPRO AND TMF crashing at the same time.  If you look at graphs of UPRO and TMF together you see very elegantly how they zig-zag opposite of one another.

    If you look at the performance of these UPRO/TMF portfolios in portfolio visualizer, you will see that they definitely have high max draw downs, but 90% is not historical (past performance does not…)

    Click to expand…

    Sorry, when I say 90+% Im mostly referring to triple leveraged equity funds in general. Though I can easily see a scenario (in theory) where inflation rises, causing rates to drastically reverse course, which would also likely crash the stock market at some point, and both would fall bigly. Im not sure the portfolio construction of a 50/50ish +/-10% either way would lose 90%, but everyone reading isnt likely thinking of the whole portfolio construction in the grand scheme.

    I think EDV is an interesting idea for the bond side as its got great duration/convexity exposure but is super cheap and technically not leveraged. Somewhere in the zillions of posts they were talking about it and it makes a lot of sense from a simplicity standpoint.

    #239417 Reply
    Avatar Dont_know_mind 
    Participant
    Status: Physician
    Posts: 951
    Joined: 11/21/2017

    The traditional way to get around path dependency is to have a collateralised loan – eg mortgage on your house and use that for investment.

    Smoother returns are a marketing ploy, but if you’re an individual investor and not trying to market a fund, who cares ?

    3 parameters will matter – were you right ? Your sizing when you were right and your return.

    Nothing else really matters.

    How does anyone buy an asset that appreciates and holds onto it ?

    A 3X leveraged fund is very different to the way I invest. I love investments with a lot of runway and where time is the risk, not price.

    3X funds seem like an elegant way of implementing leverage. I used to think leverage was important. But now I don’t. To me it’s a hindrance. You can internalise the leverage and I’ve found that is more robust. But maybe I’m missing out on some returns. I’m comfortable with my returns though.

    Everyone has different beliefs, so it boils down to what you really believe, whether you can hold onto that strategy and whether that proves correct. You can have a system where you have belief and no correctional facility such as full indexing (and belief in EMH) or a correctional facility that makes you prone to behavioural errors.

    ‘Everything about the game is logical and common sense and elementary. All the figures and the mathematics and the mechanics can be understood by a child in junior-high school. But the game is decked out in an endless number of minor contradictions and open switches and deadfall traps, in order to lure the average player into doing everything wrong.’~ Robert L. BaconIf

    #239447 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 6186
    Joined: 01/12/2016

    There are also 2x leveraged and a few less leveraged ones, dont have to try your hand with fire of course.

    #239448 Reply
    triad triad 
    Participant
    Status: Dentist, Small Business Owner
    Posts: 276
    Joined: 04/29/2016

    I’ll be completely honest, Fatlittlepig is very intrigued and has been following this thread and considering participating.

    Click to expand…

    Did you decide to try this strategy?  I’m considering doing it in my roth which is about 5% of my portfolio

    #240456 Reply
    Lordosis Lordosis 
    Participant
    Status: Physician
    Posts: 1847
    Joined: 02/11/2019

    What are the tax implications of leveraged funds?  Would there be a huge difference in tax protected space?  Or just a marginal benefit? That roth space is valuable and I am not sure I would use it for my “play money” unless it made a big difference.

    I heard Vanguard does not let you buy them so if you have your RIRA there you are out of luck.

    “Never let your sense of morals prevent you from doing what is right.”

    #240461 Reply
    triad triad 
    Participant
    Status: Dentist, Small Business Owner
    Posts: 276
    Joined: 04/29/2016

    What are the tax implications of leveraged funds?  Would there be a huge difference in tax protected space?  Or just a marginal benefit? That roth space is valuable and I am not sure I would use it for my “play money” unless it made a big difference.

    I heard Vanguard does not let you buy them so if you have your RIRA there you are out of luck.

    Click to expand…

    short term cap gains when rebalancing.  I think you can buy etfs in vanguard.  there is a $7/transaction fee

    #240481 Reply
    fatlittlepig fatlittlepig 
    Participant
    Status: Physician
    Posts: 1195
    Joined: 01/26/2017

    I’ll be completely honest, Fatlittlepig is very intrigued and has been following this thread and considering participating.

    Click to expand…

    Did you decide to try this strategy?  I’m considering doing it in my roth which is about 5% of my portfolio

    Click to expand…

    Yes but only a small amount about a week or so ago, I want to add to it overtime and not have to sell to rebalance if that makes sense.

    Upro is up 8% tmf is down 5%

     

    #240511 Reply
    Liked by Zaphod, triad

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