Thanks Denny!!!
Tom,
As always, thanks for the great advice. The tax feature, and the improved dynamic hedging Book capabilities would be great.
A simple approach to the dynamic hedging book might be to combine multiple hedges in a book simulation. For example, include your favorite system, and include 2 TLT systems. Each TLT system buys and sells under different conditions. Adjust the percent contribution of each TLT system in your book. The problem with this is that the book holds back cash for each TLT system that is out of the market.
Before Book was available, I had created my own version of Book using excel. Exact same concept as the book, except when systems go out of the market it puts the resulting cash back into systems that are still in the market. I could dust it off if interested.
Best Regards,
Stu
Stu - here is an ETF port that I believe captures the essence of what you are trying to do (hedging not included).
https://www.portfolio123.com/port_summary.jsp?portid=1346994
The performance isn’t great but slightly outperforms the S&P 500 equal weight benchmark. I would have to put a lot of hours in on this to get better performance and I don’t have the time.
Losses are cut short so you can write them off against winners in other ports. The winning trades are held greater than 366 days. You would have to do your own hedge to cover the 2008 bear market. I did a 10 year run because there aren’t that many ETFs prior to 2005.
If anyone comes up with an improvement to this port then perhaps they can share/make it public.
Thanks
Steve
Steve,
I made a few mods to your ETF Test Sim. Here is my mod Sim .
I moves your Taxonomy buy rule to a custom universe so I could play with Rank rules.
I added RankPos < 4 to your first sell rule and removed the GainPct>60 requirement.
I added a simple bench buy rule requiring the 6 month bench return to be > 0% or the 1 month bench to be > 10%.
The annual return = 16%, the max DD = 20%, and the % winners increased to over 50% from 30%.
1/2 of the holdings were held for over 1 year and all of the rest were sold with loses between -4.4% & -13.6%.
Thanks Denny - the issue I have with you mod is that the improvements have to do with market timing, whereas I think Stu wants to keep his hedging separate?
Year-by-year performance
Steve 19.08 21.97 12.47 -41.27 35.84 14.82 3.23 10.64 36.69 18.44
Denny 19.08 19.09 6.31 2.39 37.53 16.82 -0.08 13.49 28.98 17.41
Steve
Steve and Denny.
Nice work. A consideration is that this etf systems performance will change based on which provider is chosen for a starting universe (try putting in the other etf providers) as well as the type of etfs that are added to that providers universe.
Tom,
It would be great to be able to create a post-tax backtest. This might encourage development of a tax efficient category within r2go. I would also like to see leverage at the book level as you suggest.
Alan,
The backdoor traditional to roth ira conversion is a great way to diversify your tax risk and is underutilized. The mega backdoor ira conversion is difficult to implement unless you meet certain well defined criteria.
All,
The etn, vqt (switches between spy and vix), is a reasonable tax efficient replacement for a portion of a bond portfolio.
Scott
Scott - I haven’t tested Denny’s version but mine gives similar results for iSHARES (in addition to the original SPDR). Both of these providers have 80+ long equity ETFs and a lot of the ETFs have a narrow focus i.e. specific industry/sector. The ranking system demands the strongest performance over the last 1-2 years in order to be picked and then sells a year or more later with large % gain. This is why one needs the narrow focus, very difficult to do this with a broad ETF. The rules are not suitable for other asset classes such as Fixed Income or mixed assets, I’m not sure about commodities.
Steve
Steve and Denny, thank you! I need to spend more time reviewing both systems.
Here is something I put together quickly as an example of what I’m thinking. This needs work as it is not diversified enough, and the hedge needs work. Additional hedge systems could/should be included in the mix. Unfortunately, the overall return assumes only 80% cash invested in the market when the hedge is out of the market. This needs to be fixed as a book option. I wish I had more time to experiment.
Buy and hold with hedge example
–Stu
Hi Denny,
[quote]
I added RankPos < 4 to your first sell rule and removed the GainPct>60 requirement.
[/quote]With the rule “RankPos<4” you are selling the etf if it is in the top 3 ranked etfs. Is there any reason for this or did you mean “RankPos>4”?
KJ
Wow! KJ you caught a random typing error. Missing the > key and Hitting the < key instead sure makes a BIG difference. That is what happens when I only spend a few minutes trying various rules. The mistake significantly improved the results so I just went on and didn’t recheck the rule. Since the Sim only traded 29 ETFs over the full time period, a random goof can make a big difference where if the Sim traded hundreds of stocks it would have made the results worse.
This is a good example of why we must understand why a change made an improvement and not simply accept every change that improves a Sim. Although selling the stocks ranked 1 through 3 and keeping stocks ranked 4 & 5 improved this Sim, I see no reason to believe that will work going forward. Data mining at its finest!
Stu,
Try using a leveraged ETF in your book so you do not have a 20% cash drag (leveraged x 3 will cut it to 6.7%) when the hedge is out of the market.
Scott
Denny,
I see a reason that your random typing error might work going forward. In a word (okay 4 words): reversion to the mean. There is good reason to think that the ETFs that have performed the best over a long time period (i.e., best one and two year sortino ratios in this case) will revert to the mean (in a negative way).
I run no ETF sims but excluding stocks that have performed exceptionally well over a long period does lead to a mild improvement in my stock sims.
For stocks at least, I have found this to be too dependent on market conditions to be useful.
Thanks Scott.
My thoughts exactly. The current hedge shorts SSO which is a 2x leverage S&P500 ETF.
My general assumptions…
Speaking in rough numbers, assuming 100% invested cash when hedge is out of the market (instead of 80% invested cash using the Book…please fix), I believe the return would increase about 2% to around 13% in this systems example. I believe in my tax bracket, the equivalent annual return using a system with short term cap gains would need to be roughly 40% higher or 13%/.6=21%. A system using 1 year hold time qualifying for long term capital gains would need a return roughly 20% higher (15% fed, 5% state) or 13%/.8=16%
BR,
Stu
Stu / Scott - I’m not really following your trail of thought. For tax purposes, you pay capital gains the year you sell a security. (I assume that is how it works in the USA). So if you short sell, then this presents a problem because you will have to buy back the ETF at or before the end of the year, thus incurring short term capital gains, what you were trying to avoid.
Steve
[quote]
I see a reason that your random typing error might work going forward. In a word (okay 4 words): reversion to the mean. There is good reason to think that the ETFs that have performed the best over a long time period (i.e., best one and two year sortino ratios in this case) will revert to the mean (in a negative way).
[/quote] Jim,
While that may be true, you cannot have two competing philosophies in buy and sell rules. Your buy rules are buying the highest ranked etfs (assuming they will go up) while your sell rules are selling the top ranked etfs (assuming they are done going up).
KJ
KJ,
Yep. Better ways to do the sim I’m sure. Finding why a typo works would just be a start. And as I said in my post, the improvement–even when the buy and sell rules match up–is not that impressive for a stock sim.
Steve,
I’m willing to incur a tax burden when shorting in exchange for decreased portfolio losses. Thoughts?
–Stu
Stu - the stock market could possibly go down for up to 3 years (as in 2000-2002). The strategy is OK provided you don’t start using it at the beginning of such a bear market. If the hedge makes money for the first three years then you would be incurring significant short term gains for three years.
In any case, if you are making money on your hedge, why not be selling your losers in your “buy and hold” strategy in the same year?
Now if the hedge loses money, then you have to kick in more money for the hedge the next year. So presumably you will be selling some of your “buy-and-hold forever” holdings?
Steve
Thanks Steve,
I’m interested in creating more of a passive portfolio using ETF’s with added hedging. The passive part should be well diversified in order to minimize volatility except when the market dictates using the hedge. I would include this approach as part of the overall short-term, long-term bucket investing Tom suggests. Having said that, I am very open to your suggestions, and especially systems you may develop that provide a good balance between return, volatility, liquidity, and tax efficiency.
Regards,
Stu
Stu - I was just curious because you were focused on minimizing taxes then at the end you threw in this short term hedge which kind of muddies the situation. Interesting stuff though.
Steve