Right now I'm unbalanced on my barbell, I had 55% in equities last week but today I bought another stock (will post about it soon). So its more like 60%, plus 5% in REITs (although that is extremely low risk since I'm not a homeowner). And of the 40% of my safe some of that is in cash being held as margin against risk strategies (day, swing trading). So I'm unbalanced, but I'm aware of it and I'm doing because I see good opportunities. As these opportunites change, I will try to increase my safe allocation bucket. Right now, in that safe allocation, between duration US bonds, gold and cash, cash is probably not a bad choice. Its returns are increasing (as the Fed hikes) and one can dodge the downside volatility of the bond and gold market while retaining the 'drawdown anchor' properties that a safe asset needs to have
By cash I mean, either ~1y US T-Bills, or cash USD balances held at IB (with pay now 0.41% a year, without the need to pay for the spread and commissions of T-bills)
With a 60% safe (cash, bonds, gold) 40% risk (EM stocks) vs 100% SPY, what can you expect? As a very rough proxy, lets use the earnings yield as the expected return of stocks. So SPY has a 5.1% expected return (19.5 PE) VWO (EM stocks) have a 7.8% expected return (~12.8 PE) The safe allocation probably have a 2% expected return (it keeps up with inflation but that's it). So the 100% index guys gets 5.1% but the barbell guy gets 0.4 * 7.8 + 0.6 * 2 = 3.12+1.2 = 4.32% a year He gives up a little less than 1% but he gets so much for it. Drawdowns will be drastically lower (in fact, its unlikely to go over 25%), the index guy can lose 50% without much problem. In 2008 that barbell would have outperformed by a big amount (S&P lost 37%, EMs lost a bit more but gold and bonds went up). There is a lot less tail risks with the barbell too (under a depression scenario, the index guy can get hurt massively like Ben Graham did) So, on the surface, it appears that the person is taking reckless risks by getting involved with EMs, small caps, tech companies etc, but when you consider the other side of the barbell (the drawdown anchors) and the overall strategy, its the other guy that is taking reckeless risks
And this even ignores that EM stocks are likely to return even more as its easier to have 1 huge gainer in there (as EMs improve and become developed) as compared to developed, since the benefits of those markets are already widely recognized (so there is likely to be more convexity there, over the long-term). In other words, its easier to get 'lucky' and have a huge gain in EMs as compared to developed markets
But this safe + lot of risk portfolio can get really fun if its build in a way that is so historically resilient that one can safely leverage it (up to a point) that it might actually beat the returns of the index guy, while still retaining the downside risk limitations. That's when you will beat the index guy (or at least match him) while having small drawdowns realtive to him (and a lot less tail risks). Thats when you have your cake and eat it too. So in a way, that's sort of what I'm doing by increasing the risk bucket to more than 30%. Its similar to levering up a 70/30 barbell. If you lever up a 70/30 barbell portfolio by 2-1, the risk bucket becomes 60% and the safe 140%. I'm only increasing my risk bucket but I'm not increasing my safe hedges at the same time (I'm light on bonds and normal on gold now). That is an 'unhedged' sort of exposure but I got my doubts bonds will be a great hedge at this point in time, maybe even gold will struggle. I could buy futures and increase that safety, its something that I think about, I still haven't made up my mind if its worth it but its an idea to consider. I'm worried that cash will actually do better than duration bonds and gold (that is, bonds and gold will fall). There is no need for futures if that is the case (there is no futures for cash)
I suppose the 'futures of cash' are Eurodollars and Fed funds futures. They are the price of cash so they affect the supply and demand for short-term cash. I"m short Fed funds futures now, so I'm exposed to the return of cash dropping. When would the return of cash drop? If the economy started to suck, if there is a terrorist attack, global risk aversion etc (that would hurt my risk allocation as well). In that case, I better react quickly and protect myself through the purchase a fair amount of 10y UST bond futures. And that will be my risk management plan to protect my capital and deal with my unbalanced barbell
I guess what I'm saying is that inherent in a 'risk-parity' 'all-weather' 'diverisified portfolio' is the tendency towards the barbell portfolio. They are pretty much the same even though it doesn't look like it. The all weather stuff sounds all fancy and deep, but all it does is to build a barbell by looking at history and distributing stocks, bonds, cash and gold in a way that makes sense. That leads to a barbell style portfolio, which is one of the best ways to produce great risk adjusted returns
When analyzing portfolios, things can get tricky when one adds trading/timing skills to the mix. Take my EWZ exposure, its high convexity/risk. But I do have a stop/exit plan, the 60/220 MA crossover I mentioned. So I will lose 20-30% at most but I can make an exponential amount. Therefore when barbelling this, I don't need as much safe assets in the other side because there is a 'natural hedge' coming from timing skills. Similarly with OAK because its a low risk MLP, there is no need to barbell it as much. So a typical 70 safe 30 risk can get tricky when nuances kick in Indeed when I run historical tests with annual data (as opposed to monthly data), this smoothens the vol of stocks and the best risk-adjusted portfolios respond by having more stocks (usually 40-50%). Stocks look less risky on annual data so one can own more of it. Timing/Trading skills replicate that. These are sort of advanced portfolio construction techniques that books don't talk about it, maybe I will write a mini-book on this some day, call it 'Advanced Portfolio Techniques', probably no one will read it but it would be nice to have this out
I started to receive The Economist print edition. This thing is great, I should have subscribed years ago, I would be a lot better informed and probably would have made a lot more money from trade ideas coming from it. This week's edition has a great article on the Fed hikes. Also, pretty good article on the 'syncronized' growth theory from Tepper. Seems that they picked up on it after he went on CNBC
With people worried about whether Trump got votes to do this or that, one has to remember that he is likely to pickup support in 2018 Lots of Democrats with their job on the line on states that Trump won. So I will let ZeroHedge cheerlead every 10 point drop in the ES, but long-term this market is likely to have some good buying pressure the lower it goes