Buffett's secret: being levered long low beta high quality stocks http://www.econ.yale.edu/~af227/pdf/Buffett's Alpha - Frazzini, Kabiller and Pedersen.pdf This seems like the holy grail for portfolio construction when combined Ray Dailo all-whether portfolio An excellent way to build a portfolio for a macro trader IMO is: Stocks+Bonds+Gold+Cash The stock part is mostly Buffett like strategies of buying low beta stocks with a long-track records with global exposure (this is key here US focused business can add significant risk). Bonds can be a general index like the Barclays Agg or something like that (a global index is probably even better). Gold the best way is whatever way defers the most taxes and cash is just a money market fund or FDIC guaranteed CDs or something along those lines With that base a macro portfolio will generate a baseline return every year (theoretically, in practice sometimes you will lose) in a low volatility basis. Then post that portfolio as margin to make macro trades when the right "pitch" shows up. This removes pressure to perform because you know you will get paid 5-10% a year even if you do nothing (again theoretically over the long-term at any given year who knows what will happen) I'm currently long BRKB in the stock part of my portfolio but I'm thinking of adding KO and/or PG I wrote about them recently http://seekingalpha.com/article/1081971-buffett-style-valuation-of-the-coca-cola-company http://seekingalpha.com/article/1092801-buffett-style-valuation-of-the-procter-gamble-co
It's also interesting that lots of people, including Buffett, cry about how volatility is not equal to risk yet these low beta stocks have historically been the least risky and the high beta ones have been the most risky to own. So market measures of volatility CAN be used as an input for how much risk is being taken, especially for people that are not market professionals. Yes, there are cases where the market is completely wrong (like on CDOs pre-crash) but most people will be completely wrong even more often that that
Forgot to mention TIPS. Probably a good addition as well. So there would be 5 categories for investment, the particular weights would depend on the individual situation. A hedge fund that is subject to withdraws might have to have less in stocks and gold, an individual investing his savings might have more stocks Unfortunately Buffett's advantage of getting cheap leverage can't be easily replicated. A few options are -Own gold through Single Stock Futures, this might create bigger tax liabilities for some -Own stocks through SSFs, same
TIPS are problematic in some scenarios, due to the risk of the government altering the inflation-proofing in an era of high inflation (i.e. when their diversifying nature is most needed). Gold should be sufficient inflation-hedging, and in a 1970s environment it will almost always have spectacular returns so high that no TIPS are needed to inflation-protect the total portfolio. TIPS are like 'half-bonds, half gold' - they hedge a bit against recession, and hedge a bit against inflation. Treasuries + gold will hedge against both but should have superior overall portfolio return, due to the inverse correlation. Harry Browne wrote quite a bit about this. The point is that it's about portfolio construction, NOT the individual return of the component assets. TIPS are good as an individual asset, but are inferior to a blend of Treasuries + gold in terms of contribution to total portfolio return and volatility. In the opposite way, gold sucks as an individual asset, but is excellent at contributing to portfolio returns due to its low correlation (and, in high inflation times, inverse correlation). Another asset that is worth having is real estate. If you own a house with a mortgage, then you probably already have ample real estate exposure. If you are rich then having at least 20% of assets in prime location real estate is probably a good idea, along with some farmland. One big advantage over financial assets is that real title is harder to confiscate, politically - it would outrage too many sections of society. Whereas siphoning away capital via inflation or taxation of stocks/bonds/income is, in many political environments, acceptable or even popular. Land is one of the few things that will still be there after a war, a coup, a 'squeeze the rich' society, socialism etc. If you aren't rich enough to manage rental property, then owning REITs is a reasonable substitute. So, a sample diversified portfolio would be something like this: 20% real estate/REITs 20% domestic stocks 20% foreign stocks 20% treasuries 20% gold This is a relatively high-return, medium-risk portfolio. 60% is long risk. For more conservative returns, I would go to 10% RE, drop the stock portion a bit, and boost the treasuries and gold to 25% each, or bring in some cash. If you can add alpha then go to say 30% hand-picked domestic stocks and 30% picked foreign stocks, and add in 20% short positions also, for a 120/20 portfolio - higher return and lower risk. However, personally I hate the idea of 'investment shorts', even as a portfolio diversifier - it is just too hard to come up with 4-5 great shorts per year IMO. I prefer to short only tactically, when true slam dunks come up and have a catalyst to make you confident you won't see a 25%+ rally in your face. Bear in mind that active stock-picking investment adds considerable risk. You could easily have a value portfolio that goes down 10% while the market as a whole rises 10%, for a 20% underperformance, and lots of psychological pressure to throw in the towel. This happened to a lot of value guys in 1999. Or a 2008 can come along and fuck up active non-index strategies. You have to ask, if you have say 40% in stocks, do you really want to do all the work, and have all the psychological pressure, of trying to ape Buffett, just to make say 5-6% a year instead of 3-4% on the stock portion? A 2-3% advantage that you grind out for 5 years can easily be cancelled out by one bad macro trade, or one missed great macro trade. In my opinion, it is better to accept the lower return, in exchange for only having to spend 3-4 hours per annum on the portfolio, and freeing up your time and focus to seek out the 3-6 macro trades per year that can really juice your returns. It is also more tax efficient and far less paperwork. On a similar note, I question the wisdom of taking too much risk in a passive portfolio. Imagine if you have a good year of trading, making 20-30% on your macro bets. But your portfolio runs into a 1973-74, or 2008, or 1937, and it drops 20-30%. Or, even worse, your portfolio gets screwed the same year your trading sucks. If you are unable to earn alpha, then 20-30% drawdowns every decade or two are the price you have to pay in order to earn respectable investment returns. Over 30 years, 7% per annum makes a lot more dough than 4% per annum - the latter could leave you eating tinned soup in social housing during retirement. But if you can make respectable returns from trading, then you simply don't need to take much risk - your focus should be on (real) capital preservation. The trading part is what will earn your returns, the investment part should just be to beat inflation by a bit each year, whilst minimising taxes, expenses, workload, and risk/stress. Is it worth taking that big drawdown risk to chase 7-8% per annum, instead of minimising losses and settling for 5%? If you can't make an extra 3%+ per annum by macro trading, you are fucked anyway. So, my advice would be to lower the risky portion of the portfolio, by holding plenty of short/medium-term bonds, or (superior IMO) a mix of cash and long-dated Treasuries. This conservative approach has two great advantages: it means you are one of the only people who won't get fucked in an economic crash; and it means you are one of the only people who is unfazed when risk assets have been crushed and are dirt cheap, thus allowing you to aggressively step up and invest when periodic bear markets reach their climax. If you look at all the benefits of a conservative passive portfolio, they are considerable: much lower risk; almost zero effort; tax efficiency; psychological & financial staying power in deep bear markets; optimal focus on the trading side. All this in return for earning, at worst, 1-3% less per annum. So, a cautious portfolio could be something like this: Real estate 10% Domestic stocks 15% Foreign stocks 15% Long-dated Treasuries 20% Cash/short-dated Treasuries 20% Gold 20% This puts 40% into high return assets, 40% into relatively safe assets, and 20% into a hedge against high inflation/monetary debasement and political collapse. Expected returns over the long-run might be something like 7-8% for the stocks, 5% for RE, 3% for bonds, 1% for cash and zero for gold, plus 0.5-1% for the rebalancing bonus. Total about 4.5% per year with minimal risk of permanent capital loss. In the depths of major bear markets you can shift to a more aggressive portfolio, something like 20% RE, 50% stocks, 10% bonds 10% cash 10% gold. This could easily raise the long-term return to 10-15% per annum on the index portfolio side. Anyway, that's how I would play it.
This discussion of how best to trade whilst investing is pretty interesting. There are really three options for anyone who likes to trade: 1. solo trading to pay your bills and grow capital 2. being employed to trade at a financial institution, earning an income, and getting a bonus as a % of your trading returns 3. doing some other kind of work, and trading/investing on the side The first option has a couple of major problems. Firstly, you are a solo operator, so you have inferior motivation, idea-generation, networking, support, data etc compared to working in a group of professionals. Secondly, you have to earn your nut each year to pay expenses, after taxes. In the first world this can be considerable e.g. 100k a year in NYC or London is not much, you will never grow capital at this rate. Third, flat or down years become losing or devastating blows because your expenses take a bite as well as the market loss. It can also affect your trading, as there is pressure to earn money every month or quarter, and definitely every year. This can either make you gun-shy or make you trade too big, depending on your psychology. The advantage of the solo approach is freedom and privacy, this plays to the 'daytrade in bermuda shorts from the beach, while being sucked off by 3rd world prostitutes' fantasy that is popular with many. To avoid the downsides, you probably need at least 2 million capital, and ideally more; you should also rent a small office and find 1 or two collaborators to exchange ideas and keep motivated, even if you don't get involved commercially with them. The second option is probably best for financial gains. You have zero risk - worst case is you get paid a lot then fired at the end of the year, and return to what you would have done if you had not been hired in the first place. And you have good upside if you do well. That's a nice skewed bet in your favour. You also benefit from talking with other clued-up market pros, and have the structure and pressure to stay disciplined and competitive. It is no coincidence that most of the top market performers have done so in trading firms, trading branches or banks, hedge funds, investment funds, and so on. For every Dan Zanger there are 1000 David Tepper/George Soros/David Einhorn type successes in the institutional world. However, one should note that these successful players usually end up doing silly things like buying sports teams, installing ludicrous art works in their front gardens, or being milked for political contributions, which suggests that being a financial markets tycoon is not sufficiently satisfying as one's life work to avoid existential angst. If even Paul Tudor Jones says "no one will remember me" and thinks his job is meaningless, then chances are that you aren't going to find soul-stirring fulfilment even if you hit the big time. Still, if financial security and life independence are the goal, this is a good option if you have the ability and discipline to pursue it well. The third option is for those who don't have the ability, energy, ambition, or connections to get into the industry trading for a living, or who simply find the idea of being a financial-sector employee to be mind-numbingly boring, meaningless, and restrictive. The disadvantage is you cannot/will not focus on trading full-time, so you will miss the type of opportunities that are thrown up by the hard work of researching ideas and markets. You will be restricted to the more obvious headline-grabbing opportunities. Your edge then, must come from superior judgement and timing, rather than more meticulous research or other institutional edges. This approach requires having an external income (either things like real estate income, passive income from capital, or income from a job), so that you do not rely on trading returns to pay your bills. Saving and reinvesting your external income will also juice returns considerably compared to relying purely on capital gains from the markets, and gives you infinite patience in waiting for the very best trades to come along. You also do not have to ferret around 50 hours a week to find slight inefficiencies to generate a trading income - you can focus solely on the fat pitches each year. Trading is relatively abstract and impersonal and so there can be benefits to having other activities involving more human contact and 'meaning'. For example, a doctor who passive index invests, and makes selected bets when a new market for growth appears, or some deep value is thrown up by market crashes. Overall I would say that option 2 is best to start out, and remains best if getting super-rich is your main goal in life; and option 1 or 3 is better in the long-run (e.g. once you have a good trading skill set and experience, say after 5-10 years) for people who want a more autonomous and rounded life. Option 1 is most precarious, option 3 is safest but potentially most limiting in terms of performance.
"This is a relatively high-return, medium-risk portfolio. 60% is long risk. For more conservative returns, I would go to 10% RE, drop the stock portion a bit, and boost the treasuries and gold to 25% each, or bring in some cash. " I agree on REITs. It seems that over the long-term they don't correlate with stocks much so they provide some diversification and should have a higher returns than just owning a house (I believe the real return in housing over the long-term is 0%) http://www.jpmorganinstitutional.co...goBlobs&blobwhere=1321487763107&ssbinary=true "If you can add alpha then go to say 30% hand-picked domestic stocks and 30% picked foreign stocks, and add in 20% short positions also, for a 120/20 portfolio - higher return and lower risk. However, personally I hate the idea of 'investment shorts', even as a portfolio diversifier - it is just too hard to come up with 4-5 great shorts per year IMO. I prefer to short only tactically, when true slam dunks come up and have a catalyst to make you confident you won't see a 25%+ rally in your face. Bear in mind that active stock-picking investment adds considerable risk. You could easily have a value portfolio that goes down 10% while the market as a whole rises 10%, for a 20% underperformance, and lots of psychological pressure to throw in the towel. This happened to a lot of value guys in 1999. Or a 2008 can come along and fuck up active non-index strategies." I consider stock picking an investment "strategy". In my view it is inevitable to use a "strategy" no matter what you do. If you buy SPY you are using a "strategy" of loading up on high market cap stocks while having less exposure to smaller market cap stocks. Simply because other people are doing that and using as a reference for their performance it doesn't mean it is a good idea to do that in someone's portfolio (exception: people that are managing OPM and are subject to withdraws) Why not buy a price weighted index? Or the equal weight S&P500 or a fundamentally weighted index or a basket of safe low beta stocks with great history? Since one will be forced to make a guess as to which strategy will be a better place to put their savings I rather do my homework and make my best guess based on the evidence rather than just follow the crowd and buy SPY or something (again the exception if you are running OPM). "You have to ask, if you have say 40% in stocks, do you really want to do all the work, and have all the psychological pressure, of trying to ape Buffett, just to make say 5-6% a year instead of 3-4% on the stock portion? A 2-3% advantage that you grind out for 5 years can easily be cancelled out by one bad macro trade, or one missed great macro trade. In my opinion, it is better to accept the lower return, in exchange for only having to spend 3-4 hours per annum on the portfolio, and freeing up your time and focus to seek out the 3-6 macro trades per year that can really juice your returns. It is also more tax efficient and far less paperwork." "On a similar note, I question the wisdom of taking too much risk in a passive portfolio. Imagine if you have a good year of trading, making 20-30% on your macro bets. But your portfolio runs into a 1973-74, or 2008, or 1937, and it drops 20-30%. Or, even worse, your portfolio gets screwed the same year your trading sucks. If you are unable to earn alpha, then 20-30% drawdowns every decade or two are the price you have to pay in order to earn respectable investment returns. Over 30 years, 7% per annum makes a lot more dough than 4% per annum - the latter could leave you eating tinned soup in social housing during retirement. But if you can make respectable returns from trading, then you simply don't need to take much risk - your focus should be on (real) capital preservation. The trading part is what will earn your returns, the investment part should just be to beat inflation by a bit each year, whilst minimising taxes, expenses, workload, and risk/stress. Is it worth taking that big drawdown risk to chase 7-8% per annum, instead of minimising losses and settling for 5%? If you can't make an extra 3%+ per annum by macro trading, you are fucked anyway. So, my advice would be to lower the risky portion of the portfolio, by holding plenty of short/medium-term bonds, or (superior IMO) a mix of cash and long-dated Treasuries. " I would say that this depends on the individual risk tolerance, age, # of sources of income, total wealth etc. It seems that you would have no problem giving up 2-3% in order to have a smaller drawdown. I would have a problem with that for a number of reasons: -The 2-3% compounded will add up to a higher high that is significantly higher than in the safe strategy as a result when the 20-30% drawdown comes you might actually still be ok compared to the safe strategy. -Caring too much about annual returns is a form of 'mental accounting' that you have criticized in the past. I know that in 10 years that riskier portfolio is highly likely to have produced more money than the safe one, why should I care about financial snapshot of returns taken every 31 of December? Because other people do that? I rather have more money and work in my mental game so I decrease my sensitivity to groupthink and concerns about what was my % returned on Dec 31. That said I can understand when someone is older they should decrease the riskiness of the portfolio because they are not expected to live that much longer and getting hit with a large drawdown might hurt them in ways that the additional 2-3% a year would not compensate (being unable to afford medical costs, having his living standards decreased due a lawsuit and not being able to work to get it back, etc) I can also understand that if someone is already wealthy they might accept lower returns because the additional utility of that money might not be worth it (I say might because I read some interesting research showing that more money do create happiness even at higher levels, particularly if the person spent the money in charitable activities) I would agree with your point if we were talking about 60/40 style portfolios. But the whole idea of the All-Weather portfolio is that the drawdowns are already limited As a trader I already have to deal with losses constantly I rather take that 2-3% a year and work on the mental side so I stop caring about 1 year returns and mental accounting traps "This conservative approach has two great advantages: it means you are one of the only people who won't get fucked in an economic crash; and it means you are one of the only people who is unfazed when risk assets have been crushed and are dirt cheap, thus allowing you to aggressively step up and invest when periodic bear markets reach their climax. " "If you look at all the benefits of a conservative passive portfolio, they are considerable: much lower risk; almost zero effort; tax efficiency; psychological & financial staying power in deep bear markets; optimal focus on the trading side. All this in return for earning, at worst, 1-3% less per annum." Agreed that is has lower risk. As far as the zero effort part I believe that is an illusion simply because the person decided to join the crowd and buy the index strategies that others are doing without research "So, a cautious portfolio could be something like this: Real estate 10% Domestic stocks 15% Foreign stocks 15% Long-dated Treasuries 20% Cash/short-dated Treasuries 20% Gold 20% This puts 40% into high return assets, 40% into relatively safe assets, and 20% into a hedge against high inflation/monetary debasement and political collapse. Expected returns over the long-run might be something like 7-8% for the stocks, 5% for RE, 3% for bonds, 1% for cash and zero for gold, plus 0.5-1% for the rebalancing bonus. Total about 4.5% per year with minimal risk of permanent capital loss. In the depths of major bear markets you can shift to a more aggressive portfolio, something like 20% RE, 50% stocks, 10% bonds 10% cash 10% gold. This could easily raise the long-term return to 10-15% per annum on the index portfolio side. Anyway, that's how I would play it."
http://www.advisorperspectives.com/newsletters12/pdfs/Why_a_60-40_Portfolio_isnt_Diversified.pdf This portfolio worst drawdown outside the depression was -15% with 8.1% compounded per year against 8.2% for the 60/40 In the depression it dropped 53% but I believe this was mostly because it did not had gold in it but rather commodities in general. Had it had gold the portfolio would have dropped much less Lets say it would dropped 30% in the 30's. I simply can't justify "spending" 2-3% a year in forgone returns in order to hedge against a great depression scenario due a number of reasons -It is an 1 in a century event -My views on the Fed makes me believe it is much more likely they would recreate the 70's rather than the 30's -It is possible to protect against this by having more global exposure. The whole world got clobbered in the 30's but having global exposure protects you against a local depression (like Greek investors had to face)
NCT got a piece of the big BAC MSR sale yesterday. Did a secondary to raise money for the purchase and upped the size and the price! Also spinning off its Excess MSRs and will issue stock to investors. Stock has more than doubled in the last year and still cheap (assuming no RE crash). Even with the stock motoring, $0.22 quarterly divvie still pays nearly 10% on current buys. http://seekingalpha.com/currents/post/747841
I agree that option 2 is best to accumulate capital, the issue is that it is not easy to get a job in these financial institutions, in Brazil if you don't have an engineering, math or at LEAST a business bachelors degree from a reputable university they won't even interview you and even then the selection process is not easy. I'm told it is similar in the US. So the nice income you get gets diluted by the time spent in the university (5 years for engineering, 4 for business and everybody and their mothers have a business degree) plus another year needed to actually get in these universities (exams are though in the government universities). If you have to pay for that education in the private universities then that dilutes that income and free call option even more. So anyone wanting that path is looking at 1 year of study then 2-3 years in the uni until they can apply for an internship, then who knows how many years till they give you money to manage. Unless they already have the degree, if they do, it is a no brainer to apply and accumulate some capital over a few years working 12 hour days. Then go on your own I don't agree with $2M in capital being needed for option 1. Depends on where you live of course but I live in Sao Paulo which the last time I checked was on the top ten list of most expensive places to live. I can live comfortably spending $20K a year (My rent is $400 USD a month, I live in a small apartment but for $600 I could certainly get a bigger one) and the includes health insurance. I'm not a big spender but even $30K should be fine, anything more than that and the person almost certainly is blowing money in crap they don't need (unless they have children, in which case the person might have joint income) With option 3 I certainly think these diversified portfolios are the way to go. With option 1 I believe it makes sense to twist the portfolios to try to add some alpha