MachineGhost

Stress Testing Your Portfolio

> but I am hoping that the 3SD worst estimate is still a good
> measure. Basically, we are saying that we plan for a really bad
> (<1/1000) event while ignoring autocorrelation/corre

A normal bell curve suggests .13% probability for -3SD, actual market (S&P 500) history is .49% probability at -3SD. You have to go all the way down to -6SD at .10% probability to be equivalent. Using -3SD is false assurance in a retirement planning product!

The problem with all models is GIGO. Garbage in, garbage out. Garbage such as using a heuristic short cut instead of sampling the actual returns distribution. Especially in combination with a short sampling period.

Informed traders/investors don't even bother with standard deviations. Instead, they are concerned with historical maximum drawdowns. That's the absolute worst case scenario, until it is surpassed in the future. Many stocks have up to 80%-90% drawdowns in previous bear markets.

There is a Sharpe Ratio analog that takes into consideration the probabilities of such drawdowns and their underwater equity time. It is called the Ulcer Performance Index It is superior to Sharpe Ratio, but as with standard deviation, you still have the risk being hidden as who knows what the actual probability and magnitude of the next drawdown would be?

I don't like probabilities on my worst case scenario other than 100%. If you plan for that, everything else is gravy.

Tactical Asset Allocation, Part I

Vernl, downside risk only measures the standard deviation below the mean. In the real world, a loss is a peak-to-trough drawdown, so standard deviation is inherently superior as it is the probability weighted maximum point above the mean to the minimum point below the mean. If the maximum historical drawdown is what one is worried about, then a simple heuristic ( 1 / maximum drawdown in % ) can be used to allocate.

More Thoughts on Mohamed El-Erian's 'When Markets Collide'

The portfolio total is 98%. Where is the other 2%?

A Practical Demonstration of the Value of Portfolio Theory

User 149047: Sharpe is a naive ivory-tower academic, not a hedge fund manager. After excluding inherited wealth out of the *public* Forbes 400 list we are left mostly with *public* individuals that relied on investment timing for business opportunities or real estate (i.e. Sam Zell bought at the bottom of the real estate market and sold out at the top of the real estate market). Timing *is* everything. The skill is hardly "elusive", but the will and discipline to acquire it is.

An Endowment Portfolio From Publicly-Traded Vehicles

For the average investor, Swensen recommends in his book 30% domestic equity, 15% developed market, 5% emerging market, 15% U.S. long-term Treasury bonds, 15% TIPS/I-BONDS (Swensen wasn't aware, but I-BONDS have superior deflation protection to TIPS) and 20% real estate.

I've been walk forwarding (using timing) both the Harvard and Yale endowment allocations using my idea of "best of breed" ETF's/CEF's where available, less the Absolute Return allocation as I'm unsatisfied with the limited amount of performance data on those vehicles so far. However, it was unclear to me until reading this thread if HSGFX was considered to be an Absolute Return asset as opposed to Domestic Equity. Does any disagree?

My verdict so far is these two portfolios are not that much better returning or less risky than Swensen's average investor portfolio and certainly won't get you to the promised land of a high Sharpe ratio. Performance is very likely to be worse without timing for reducing peak to trough drawdowns. Performance may also be woefully sub-par because Absolute Return is resting in cash. (If that really were to be the case, why bother with other asset classes? Just stay in cash and allocate the minimium out to Absolute Return strategies to achieve your target level of a yearly return. With managed forex trading accounts returning, say 5% a month average, why take on more non-systematic risk than necessary? Sometimes I fear asset allocation has become Wall Street B.S. to sell more and more asset classes, but I digress.) Anway, I suspect as more capital flows out of overvalued asset classes into more alternative, undervalued asset classes, total portfolio returns will likely stay commensurate with what was experienced over the past 30 years with the traditional institutional allocations.

Does anyone know of software that features an automated, volatility &amp; co-variance (R2) optimal portfolio generator? That is something I'd dearly like to see let loose on 10,000 securities.

HARVARD:
15% Domestic Stocks [DEF/STH/PZI]
10% Foreign Stocks [50% EEN, 50% EEB/JSC]
11% Domestic Bonds [AGG]
6% Inflation-indexed Bonds [TIP]
5% Foreign Bonds [GIM]
5% Junk Bonds [DSU]
13% Commodities [DBC/GSG]
10% Real Estate [IGR/RWX]
13% Private Equity [PSP]
12% Absolute Return (hedge fund)

YALE:
12% Domestic Equity [DEF/STH/PZI]
15% Foreign Equity [50% EEN, 50% EEB/JSC]
4% Fixed Income [GIM]
27% Real Assets (Real Estate, Oil, Gas, Timberland) [IGR/RWX, EPD/KMP, PCL/RYN]
17% Private Equity [PSP]
25% Absolute Returns (50% Event-Driven, 50% Hedged Value Driven)

Lazy ETF Portfolios Inspired By The Gurus

It seems reasonable enough to rebalance at the end of April before the seasonally negative 6-month period for equities.

Lazy ETF Portfolios Inspired By The Gurus

The long-term Treasuries are there to act as protection against deflation and financial crisis, such as what occured briefly around Feb 27, 2007. Also, I-Bonds will not be allowed to go under the starting principal in a deflation as opposed to TIPS, so that gives them an added advantage at cost of liquidity.

With PowerShares' new Private Listed Equity ETF and Rydex's Managed Futures, Hedge Fund and Long/Short mutual funds, it's easier to emulate the Yale Endowment than ever before. The last major shortcoming is there is not yet a Real Asset ETF/fund focused on providing current income (inflation protection). I don't relish the work of managing numerous MLP's, Canadian royalty trusts, REIT's, etc..

Lazy ETF Portfolios Inspired By The Gurus

Indeed, Swensen recommended 30% domestic equity, 15% developed market, 5% emerging market, 15% U.S. long-term Treasury bonds, 15% TIPS/I-BONDS and 20% real estate, so the Swenson model as currently presented is totally incorrect.