MichaelDickens

MichaelDickens's Comments

How Much Leverage Should Altruists Use?

I don't know much about emerging market bonds so I can't make any confident claims, but I can say how I am thinking out it for my personal portfolio. I considered holding emerging market bonds because the yield spread between them and and developed-market bonds is unusually high. I decided not to hold them because I don't think they provide enough diversification benefit in the tails. Since I invest with leverage, it doesn't necessarily make sense for me to maximally diversify, I only hold assets if I think the benefit overcomes the extra cost of leverage. But I do believe it might make sense to hold emerging bonds for someone with a less leveraged, more diversified portfolio. That said, I would consider them a "risky" asset, not a "safe" asset, and plan accordingly.

How Much Leverage Should Altruists Use?

Yeah I think it probably makes sense not to hold bonds if you're using leverage and you can't get leverage at close to the risk-free rate. I personally don't hold any long-only bonds. But the argument for holding bonds is that they might be negatively correlated with stocks, in which case a negative expected return might still be worth it. Historically they've had close to 0 correlation, not a negative correlation, so I don't find this argument that persuasive.

For commodities, their returns are much harder to project than bonds (where you can just look at the yield), so it's hard to say whether they're worth it. I personally don't hold any long-only commodities.

How Much Leverage Should Altruists Use?

This is a totally reasonable objection, and I will try my best to respond. Sorry if this reply is a little disjointed/hard to follow.

And as a result the 8x leverage recommendation is insane

To be clear, 8x leverage is not a recommendation; it is the result of a particular analysis with many limitations—I tried to cover the important ones in Caveats. In light of these caveats, 8x leverage does not seem reasonable.

That said, I disagree that the projected returns are insane. I agree that they look insane, and when I was writing this, I had some tension between trying to sound sane and representing my true beliefs, and I decided that the latter was more important.

I don't overly trust backtests, but I trust the process behind VMOT, which is (part of the) reason to believe the cited backtest is reflective of the strategy's long-term performance.[2] VMOT projected returns were based on a 20-year backtest, but you can find similar numbers by looking at much longer data series (e.g., Value and Momentum Everywhere). VMOT backtest gives higher expected returns than generic value/momentum backtests[1], and I believe this is not due to data-mining, but I don't think there's really an efficient way for me to justify this belief other than to say read the books (Quantitative Momentum and Quantitative Value), which explain why the authors believe their particular implementations of momentum and value have (slightly) better expected return. If you assume VMOT will have returns commensurate with a generic value/momentum strategy, you might get a lower expected return than 9%, but note that Research Affiliates' estimates for generic value/momentum are still on par with my assumption for VMOT's return (I think RAFI is about 1-2% too optimistic, and VMOT's improved methodology adds about an extra 1-2% expected return).

I admit that I kind of made up the returns for managed futures, but it is worth noting that the paper I cited (with a 100-year backtest, not 20-year) found a historical performance for managed futures far higher than my made-up forward-looking return estimate.

Explaining why we should expect these strategies to outperform the market is much harder, and I can't really present a convincing argument in this comment, but the OP linked to a lot of sources that provide their own arguments.

This is not directly relevant to the investment strategies I talked about above, but if you use the really simple (and well-supported) expected return model of earnings growth plus dividends plus P/E mean reversion and plug in the current numbers for emerging markets, you get 9-11% real return (Research Affiliates gives 9%, I've seen other sources give 11%). This is not a highly concentrated investment of 50 stocks—it's an entire asset class. So I don't think expecting a 9% return is insane.

VMOT is down 20% in the last 3 years. This estimate would expect returns of 27% +- 20% over that period, so you're like 2.4 standard deviations down.

This is only 2.4 standard deviations assuming returns follow a normal distribution, which they don't. By the same argument, you could look at the S&P's recent 30% decline over a one-month period (the historical monthly standard deviation is about 5%) and conclude that our 95% confidence interval for the S&P's monthly return is [-40%, -20%].

I am not disputing that VMOT has performed particularly badly in the recent past, and that this sucks if you're investing in it (which I am)—value and trendfollowing have both performed poorly over the past three years, which explains VMOT's underperformance. Value, momentum, and trendfollowing have each had many historical periods of long underperformance (often much longer than three years), which is probably part of the reason why they're all still unpopular.

[1] In brief:

  • Quantitative Value uses EBIT/EV instead of more commonly used value metrics like P/E or P/B, and there are theoretical and empirical reasons to expect EBIT/EV to work better
  • Quantitative Value screens companies on quality as well as value, I'm not really convinced this helps but I doubt it hurts. The literature on the quality factor is promising but not as robust as on value or momentum
  • Quantitative Momentum looks for smooth returns as well as strong momentum, and there are theoretical and empirical reasons to expect smooth-return momentum to work better than "sharp" momentum

[2] This actually raises some interesting epistemological questions about when backtests (or limited empirical data in general) should be trusted, it's something I need to think about more.

(Edited to clean up a bit and add footnote)

How Much Leverage Should Altruists Use?

My estimates came from the book Global Asset Allocation by Meb Faber. I expect it's less rigorous than the paper you link to, so I suppose we should trust the paper more.

The data in /Global Asset Allocation/ came from Global Financial Data. I don't know the details of how GFD's data is constructed, but I've seen it used by quite a few papers and a lot of institutions use it, so I assume it's pretty reliable. Without having read it, I don't expect the Doeswijk paper is unreliable either—they probably get different results because (1) they use different time horizons and (2) they don't include the same countries in their samples (I think Doeswijk includes more).

While I don't doubt the specific historical results in the paper, in general I would expect the global market portfolio to outperform every individual asset class (on a risk-adjusted basis) in the long run, although it's expected that some asset classes will outperform GMP for multiple decades in a row. (Faber actually discusses this in Global Asset Allocation!) I agree it's plausible that the paper happened to pick a good time for equities.

How Much Leverage Should Altruists Use?

RE international equities, I wrote about this here to explain why I think most people should underweight US equities.

Looking at historical data it seems that international equities have underperformed

First, if EMH is true, there is no reason to expect US equities to have a higher Sharpe ratio than international equities.

Second, US outperformance is only a recent phenomenon (see this tweet and its replies), and the outperformance is pretty marginal if you look over a long time horizon.

Third, the recent US outperformance is the exact reason why Research Affiliates (RAFI) projects worse returns in the future. The US stock market has outpaced its economic growth, so RAFI is counting on valuations to revert to the mean. There's a lot of historical evidence that markets tend to mean revert like this over sufficiently long time horizons (3-5 years or longer). I haven't read any of the primary research on long-term mean reversion, but apparently the original source was Jegadeesh and Titman (1993), and data is available from the Ken French Data Library (see "6 Portfolios Formed on Size and Long-Term Reversal").

(I cited RAFI for expected return projections, but the analysis is pretty easy to replicate. Just use the discounted dividend model and add in an assumption that P/E ratios will partially mean revert.)

I don't see where RAFI recommends holding 0% exposure to US equities?

Long-term investment fund at Founders Pledge

I recently wrote about how altruistic investing differs from regular investing, with some ideas about how altruists might want to invest their money. It's just some preliminary ideas and it's targeted at retail investors, but most of it is relevant to your situation. It includes some ideas that I do not commonly see discussed in EA circles or in investing circles.

How Much Leverage Should Altruists Use?

There are a few ways to get something close to the global market portfolio, although they all require making small compromises. Betterment and Wealthfront will give you something like the global market, but each have skews that push them somewhat away from it. The ETF GAA holds the global market portfolio with small tilts toward value and momentum—I happen to think these tilts are a good idea, but it does move it somewhat away from a truly agnostic portfolio.

You could also buy a combination of VT, BND, and BNDX, which will give you the total market in stocks and bonds, although this does exclude smaller asset classes like gold.

Out of these options, I personally would probably invest in GAA, but which is best depends on which compromises you're most willing to make. (I personally don't invest in the global market portfolio, I just invest in VMOT and EQCHX, as discussed in OP.)

RE government bonds: in theory, if you want to increase risk, you should hold equities and bonds in proportion to the global market portfolio and then apply leverage as desired. But this theory assumes you can borrow money at the risk-free rate, which is false. To use leverage, you will probably end up having to pay about 1% on top of short-term interest rates, and given how small the spread is between short- and long-term rates, holding bonds with leverage guarantees you a negative long-run return. For that reason, I personally do not hold any bonds.

But note that it's still possible to make positive return with bonds in the short run. For example, bonds have returned >10% over the past few months, so holding stocks+bonds with leverage would have worked out better than just holding stocks.

RE your last point on special opportunities: I think that's a really important question, and I don't know how to answer it. I don't know how to reconcile the general observation that almost everybody fails to beat the market with certain special cases, e.g., bitcoin like you mentioned. You invested in bitcoin in 2011; I considered investing around the same time, but didn't, in short because I didn't expect to be able to beat the market. Clearly I should have invested in bitcoin, but I don't know of any general strategy that would have led to me investing in bitcoin but wouldn't have led to me making a bunch of other stupid investing decisions. How do you think it is that you have invested in 2-3 money-making special opportunities? What distinguishes those from other, similar-looking opportunities that failed? Have you made any special investments that didn't pan out?

How Much Leverage Should Altruists Use?

Private equity is indeed a part of the global market portfolio, so on priors, it makes sense to invest in private equity. I don't know much about it, but my understanding is that the existing private equity ETFs don't do a good job of tracking the market—private equity is, well, private, so you can't really index it.

EA Forum 2.0 Initial Announcement

Can you elaborate on how you turned off karma display? I would love to use your code if you're willing to share it. I strongly dislike posting on the EA Forum because of how the karma system works, and and my experience would be vastly improved if I couldn't see post/comment karma.

How Much Leverage Should Altruists Use?

Both are correct. The claim made by Lifecycle Investing is not that increasing stock exposure decreases risk in general. The claim is that by increasing stock exposure early in life and decreasing late in life, while keeping net lifetime exposure the same, you decrease risk.

The argument for this claim is that you have more dollars when you're older, therefore market swings in later years have a bigger effect on your portfolio than in earlier years. But you can negate this effect by using leverage when you're young, thus effectively increasing how much money you're investing with, and holding more bonds/cash when you're older.

Simplified example: suppose you have $100 today and will get another $100 next year. If you invest all your money in stocks during both years, then you are exposing $100 to equity risk this year, but $200 next year. If instead you invest with 1.5:1 leverage this year, and then next year you only invest 75% of your money, that means you're exposing $150 to equity risk during both years. Either way, you're investing $150 per year on average. But in the former scenario, you are taking twice as much risk in year 2, whereas in the latter scenario, you take the same amount of risk both years, which is better.

I'm not sure I'm explaining it well, so let me know if that doesn't make sense.

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