I am testing different settings for a Book of two ETF simulations. I’m wondering if there is a consensus from other Book users on the most effective / ‘best practices’ settings when dealing with ETFs in a Book? Specifically, I wonder about these three settings:
General Tab:
Rebalance Tab:
Thanks much in advance for any feedback you can provide!
/Chris
On live books, you can’t rebalance to asset tolerance.
This is an easy flaw to correct, since that feature is available on sim books.
See my feature request here:
[url=https://www.portfolio123.com/feature_request.jsp?featureReqID=1400]https://www.portfolio123.com/feature_request.jsp?featureReqID=1400[/url]
As to your question for book sims, I assume slippage of 0.1%, min rebal transaction at 0.5%, and then test for the best asset tolerance.
I prefer weekly looks to see if assets have drifted past a certain tolerance. I think monthly or quarterly or yearly rebalances are too arbitrary.
When I test for best asset tolerance on a weekly rebal, I typically find there to be an equilibrium point at about 3% most of the time. Tighter tolerances do not allow the mean reversion effect to persist long enough to harvest the gains from that phenomenon. Looser tolerances don’t add much in return and worsen other MPT stats such as drawdown and correlation.
Thanks much, Parker!
I just voted for your Feature Request: https://www.portfolio123.com/feature_request.jsp?featureReqID=1400
In the Request notes, you say,
Can you explain how you would “test for the best tolerance to capture the mean reversion effect?”
Chris
Chris
Ports are great, but ports aren’t “portfolios” in the sense of “portfolio management.” Meaning no one should invest their whole bankroll in any one port.
However, books are “portfolios” in the sense of “portfolio management.” There is tremendous power in blending a set of relatively uncorrelated ports in one book. You can test for port correlation. To me, relatively uncorrelated means max port correlation of 0.80, and the lower the better.
The power of blending uncorrelated ports in a book is derived from the fact that there will be times when a port outperforms the rest of the book, and then falls back to the pack. Likewise, there will be times when a port underperforms the rest of the book, and then catches up. This is mean reversion.
Periodically trimming from winners and adding to losers is “capturing the mean reversion effect.” In other words, we are trying to take profits from winners before they come back to earth, and add to losers before they blast off and catch up to the pack. (This is why rebalancing books every month or quarter or year is too arbitrary. The better way to do it is to examine drift on a weekly basis, and rebalance only when a certain drift tolerance is exceeded).
For any book, you can test for the best tolerance drift to capture this mean reversion effect. Simply re-run the book at different tolerances starting at 0%, 0.5%, 1%, 1.5% etc. going up to 6% or more, and record the results. As I said above, I typically find the optimal drift to be about 3% in the books I have tested (all of which with at least 6 ports in them) but your mileage may vary. You want to consider all the MPT stats in your testing, not just return.
PS It would be really cool if P123 added to the book feature to allow books to choose from a pool of ports based on rules. Maybe someday.
I would love to be able to assign a leverage factor to a book as it is possible with ports. That way for example, I could easier go 150% long a couple of ports, and hedge with 50% an index ETF. Currently, the books fixes the exposures to 100% unless the underlying ports are leveraged. Better would be to be able to leverage at the book level using unleveraged ports.
I totally agree with Miro. The book feature adds 30-50% to my Sharpe Ratios. The trick is to create books with uncorrelated ports. I mostly hedge at the book level.
I also would like to have a formula-based weighted book. I would be fine to use weights based on simple portfolio characteristics-based solution. For example 1/(underlying Portfolio STD), etc. Does not need to be fancy.
An article about the power of blending uncorrelated equity strategies.
[url=http://www.etf.com/sections/index-investor-corner/swedroe-managing-risk-factors?nopaging=1]http://www.etf.com/sections/index-investor-corner/swedroe-managing-risk-factors?nopaging=1[/url]