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Rebalancing Frequency

May 23, 2011 Leave a comment

In an attempt to improve the Long Stock and Levered Bond strategy, we decided to sample different rebalancing periods. As the chart below demonstrates, there is almost no difference between a quarterly or monthly rebalancing.  The quarterly rebalancing has a slightly better performance, which is a bonus as it means less slipage and commissions paid as well.

Categories: bonds, hedging, stocks

On Stocks and Bonds

May 22, 2011 Leave a comment

In our last post we discussed the benefits of  a simple long stock portfolio with a levered bond position, and how the combined portfolio had lower drawdowns than just being long stocks.  Deciding to look further under the hood, we were curious what the exact stock/bond return breakdown was during months where stocks fell by more than 2 standard deviations, going back to 1987.

As it turns out, the S&P return component totally dominates the overall portfolio performance, apparently because stocks are a lot more volatile than bonds.  Another way to visualize this is to look at the 12 month rolling correlation between the “just stocks” portfolio and the “stocks + levered bonds” portfolio.

All of this begs the question: why a mix of stocks and bonds in the first place? The whole idea of the combined portfolio, often in a 60/40  allocation, is one of the most common practices on Wall Street. But does it necessarily make sense? There are several ways to approach this question, and as a starting point we’d like to offer the following chart of the rolling 12 month correlation between the S&P 500 and US Treasuries.

Categories: bonds, hedging, stocks

Hedging Equities with a Levered Bond Position

May 19, 2011 Leave a comment

In Steve Drobny’s excellent book “Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money”, Jim Leitner mentions the possibility of using a levered bond position as a hedge for an equity-oriented portfolio.

Unlike a protective put buying strategy or a long position in Vix futures, bonds have positive carry.  The best way to test the merits of a hedging strategy is to compare the individual performances of the market, the hedge, and the combined entity. So we tested the following scenarios:

  1. 100% Allocation to S&P 500
  2. 100% Allocation to US Treasury Bond futures (returns don’t include t-bills)
  3. 100% Allocation to S&P 500 cash and 100% to US Treasury Bond futures rebalanced monthly

Here’s a plot of the returns for each portfolio from 1987 to present.

Here is the statistical breakdown of the results:

(Data source: St Louis Fed FRED Database, Robert Shiller)

Categories: bonds, hedging, stocks