Looking At Leverage

The Monday email from Finominal looked at whether there is any added benefit to leveraging up investment portfolios. My use of the word up is not fair, really the idea is whether using leverage for better diversification is additive. The following is what they studied.

We can't go back 100 years on testfol.io but I think we can go far enough back to be useful.

The result for 90/60 being better than straight S&P 500 is consistent with the backtesting done by WisdomTree to support their NTSX ETF. The next image adjusts the growth rates for inflation. 

A real return of 5% is a common target for endowments. Portfolio 4 obviously has the lowest growth rate but it also has the lowest volatility by far and a pretty small max drawdown when you think about all the crazy things that have happened since 1988 and the beta is only 0.18. All good but the differences in compounding is meaningful. Portfolio 4 has grown to $224,000 while simple 60/40 is $335,000. Yes 100% equities did much better than both but someone really needs to look themselves in the mirror about going 100% equities and being able to hold on no matter what. 

Someone could put it all in NTSX, so levered up, but that would have meant being down almost 30% in 2022 versus 18-19% for SPY/IEF. The math checks out of course but enduring 30% requires enduing 30%. There's not a tidy this is best for everyone answer here. We talk frequently about understanding our own emotional limits for our investment portfolio as well as the tradeoffs to whatever we decide. Going full NTSX should result in a better long term result but with more pain along the way. Portfolio 4 is very unlikely to keep up with the others but I would expect very little anguish along the way. 

Where this exercise is quadrant inspired, the Permanent Portfolio Fund PRPFX compounded at 7.08% for the period studied with a volatility of 8.94%. I feel like most of the investment industry would consider the permanent portfolio idea to be valid but clearly not always optimal but then nothing is always optimal. 

I don't think it is that difficult to assess the pros and cons of most of the portfolios we explore here. With today's example, a portfolio with a 25% weight to equities might be all weatherish, I would say Portfolio 4 fits that bill, it's not going to keep up with a portfolio that is 60% equities. 

The other day, we used a Twitter fight as an opportunity to look at a new (to us) ETF that fits in with some of other funds that we've looked at over the last few weeks. Over the weekend, the Twitter fight drew a lot more attention, really a lot. I think this screenshot gives some context of how the instigator engages on Twitter.

The Hedgeye company that McCullough runs is a research shop, they have some ETFs and there is a very active trading service. Hedgeye's runs a lot of ads about learning their process which includes a universe of 140 ETFs that allows them to "go anywhere, not everywhere." 

Based on all the back and forth I read over the weekend (I couldn't help it!), the success is very questionable but there are plenty of people (or bots maybe, I don't know) that were very supportive of Hedgeye. But the 140 ETFs and I also believe there are individual stocks involved too, is interesting to me. 

The trading appears to be very active and if they exercise all 140 ETFs frequently, that is going to be hard to keep track of. This all helped me crystalize a couple of things we do here that I hope are productive for readers but that I know helps me.

You have probably noticed that when we explore portfolio theory we use a much narrower universe of funds. I am very much a believer in holding long term when possible. By using far fewer funds for blogging purposes I think it creates the effect for regular readers to get a sense how these funds do through various events. I first started writing about SHRIX for cat bonds three years ago. Cat bonds are a core holding, the weighting is small though, and most portfolios we experiment with include SHRIX. Love the idea or hate it, if you're reading this blog regularly you are getting a sense of how they do. 

There are others too of course, cat bonds is just an easy example. Clients own EMPIX, not SHRIX, SHRIX has a much longer track record which makes for better backtesting. EMPIX is managed to have even less volatility than SHRIX which is why I prefer that one. 

The continuity makes it much easier to learn versus being all over the place with very frequent trading changes. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.