Author Topic: Anyone played with the "All-Weather" portfolio?  (Read 2467 times)

jjcamembert

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Anyone played with the "All-Weather" portfolio?
« on: November 27, 2017, 02:15:57 PM »
I just discovered this today: https://www.bridgewater.com/resources/our-thoughts-about-risk-parity-and-all-weather.pdf

Basically a simple stocks and bonds portfolio but leveraging up on bonds to match stock volatility. What are your thoughts?

"To understand  the  concept, imagine  that  you expect  stocks  to  have a higher  return than
bonds, but  you don't want  to  bet  everything  on  stocks  because  you could  be  wrong,  so you
 want  to  have  a diversified  portfolio  of stocks and bonds.  You might think that putting half
of your money in each would do the trick, but that's not true because the stocks dominate  the
portfolio because they will move up and down by about twice as much as the bonds.   Doing that 
would also lower  your  expected  return because you expect  bonds to  have a lower  expected
return than stocks.

That was the dilemma faced by most investors before risk parity.  On the other hand, if you lever
up the bonds to have a similar volatility, both the expected risks and the expected returns of the
bonds would increase to be more like  the  expected  risks  and  returns  of  stocks.   Doing that 
levering  would  raise  the  expected  return  of  bonds because  bonds have a expected return that
is greater  than cash so that borrowing cash to  buy more bonds will give more of that profitable
spread.  So, by doing that and by putting 50% of your money into stocks and 50% of your  money into
levered bonds (which would be analogous  to putting about 50% of your  risk and 50%  of your
expected return in each), you would be betting like amounts on each.  While that leveraging up
creates increased volatility  in the  bond  piece of the portfolio, that  increased  risk in bonds
can be used  to  reduce the risk  of  your portfolio."

ChpBstrd

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Re: Anyone played with the "All-Weather" portfolio?
« Reply #1 on: November 29, 2017, 12:47:55 PM »
1) They don't tell how they plan to borrow (obtaining leverage) for less than the yield on the bonds they are buying with the borrowed funds. To do so profitably, their credit risk would have to be lower than the credit risk of the companies they are investing in, which is simply risk arbitrage.  Are they using options or futures to control more bonds than cash alone would control? Several closed ended funds offer cheap leverage (see cefconnect.com), but I don't know how leverage could work for low-risk assets like treasuries. E.g. I would gladly borrow millions of dollars at 2% if I could reinvest them in treasuries yielding 2.7%. But who's going to loan to me at 2% when they could loan to the more-creditworthy US government at a higher yield?

2) The objective of diversification is to have the ability to rebalance, e.g. selling 1 unit of what went up to buy 2 units of what went down. As economic cycles occur, rebalancing approaches result in selling high and buying low to the extent returns on different assets like stocks and bonds oscillate. The 60/40 portfolio they contrast with does that. But it's not clear how what they describe rebalances differently.

3) Returns of equities and bonds have historically counter-oscilated. When equities did well, rates were increased, harming existing bonds. When equities did poorly, rates were cut, helping existing bonds. However, we are now at a weird place where both equity valuations and bond valuations are high. Will they fall together if inflation and higher rates appear?

4) Lots of talk, but little about the mechanics or math of the plan. Is the objective to inform or to sell?

ILikeDividends

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Re: Anyone played with the "All-Weather" portfolio?
« Reply #2 on: November 29, 2017, 01:49:16 PM »
1) They don't tell how they plan to borrow (obtaining leverage) for less than the yield on the bonds they are buying with the borrowed funds.
I had the same question, and did a little digging.

I'm assuming they're using something like this:

"Leveraged Bonds ETFs. Leveraged Bonds ETFs provide magnified exposure to popular fixed income benchmarks. These ETFs are designed to generate amplified returns, compared to their non-leveraged bond index counterparts, through the use of financial instruments including swaps, futures, and other derivatives."

The few I looked into were re-balanced daily, and I'm a little leery about what that might mean for a long-term position.
« Last Edit: November 29, 2017, 01:54:22 PM by ILikeDividends »

ChpBstrd

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Re: Anyone played with the "All-Weather" portfolio?
« Reply #3 on: November 29, 2017, 03:49:53 PM »
So the equivalent of buying call options on TLT or futures on zero-coupon bonds which would in theory rise rapidly in the event of a correction.

Makes sense, but no wonder they don't emphasize it. Derivatives markets are known to go illiquid in the event of a crisis.

ILikeDividends

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Re: Anyone played with the "All-Weather" portfolio?
« Reply #4 on: November 29, 2017, 03:52:59 PM »
So the equivalent of buying call options on TLT or futures on zero-coupon bonds which would in theory rise rapidly in the event of a correction.

Makes sense, but no wonder they don't emphasize it. Derivatives markets are known to go illiquid in the event of a crisis.
My assumption was that they were buying the leveraged bond ETF outright, rather than playing options against it.  But yeah, there's a big glaring hole in their very long write-up that raises more questions than it answers. So who really knows whether they're outright long or rolling calls or synthetic stock (or even borrowing cash to buy bonds, for that matter)?
« Last Edit: November 29, 2017, 04:05:43 PM by ILikeDividends »

jjcamembert

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Re: Anyone played with the "All-Weather" portfolio?
« Reply #5 on: November 29, 2017, 04:10:05 PM »
Agree with all of your points ChpBstrd. Those were some of my questions as well, such as how to get the leverage? I wouldn't want to use a leveraged ETF due to the drag, so I'd probably use futures and/or options so that would require at least minimal management rolling contracts. Especially if you're talking long time periods, volatility changes so you would have to rebalance your stock to bonds ratios on occasion just like any portfolio.

When I did more searching, apparently Tony Robbins popularized the portfolio but doesn't use leverage which makes it just a standard, low-risk, low-reward allocation model. (https://www.washingtonpost.com/business/get-there/why-the-all-weather-portfolio-is-a-wash-out/2014/12/05/ca580a2e-7be3-11e4-9a27-6fdbc612bff8_story.html)