If MINVAR is Crap, What Does “Work”?

Let me admit my “mistake” on this. I am using the Lazy Portfolio. Gold, US treasury bills or their equivalent, longer term US Government bonds and the S&P 500.

The mistake is cherry picking a portfolio. Why gold and not silver? Why gold and not a broad commodity index? Why the US stock market? Why not the MSCI World? Why US treasuries and bonds? Why not a basket of world debt?  Should I be including Euro and Swiss short term Govs where the interest rates are currently negative? Should I be looking at constant maturity schemes for longer term bonds rather than conventional approaches?  If its “All Weather” you are looking for then you need to answer these questions and a few more. Don’t cherry pick.  Its a nonsense and in the long term could be extremely damaging.

Think Trump. Think Kim Il Wotsit. Think any number of other nice people who could blow up their countries or economies in the twinkling of an eye. Do you really want to cherry pick? Or should you go as global and as wide as you can. I know my preference. Only you can choose yours.

For my own investment I would choose a basket of commodities, the MSCI World, and world debt. Or at least major economy debt. Would I include Greece, Italy, Portugal and Turkey in my debt basket? Should I? A question for another day perhaps.

Anyway I chose the lazy portfolio because yesterday I trashed the cherished MINVAR approach (using that portfolio) by pointing out it amounts to trend following and can have you “dangerously” exposed to a portfolio consisting at times of 100% stocks. Probably not very bright.

Is there an alternative that appeals to me? Ignoring for the moment my dislike of the Lazy Portfolio.

A useful benchmark is the UCRP – uniform constant rebalanced portfolio. Or equal weighting with constant rebalancing to those of us who don’t go for poncy names.  Instead of constant rebalancing let us assume monthly rebalancing.

Here are the results:

Stat                 UCRP        S&P 500
-------------------  ----------  -----------
Start                1988-01-04  1988-01-04
End                  2016-12-20  2016-12-20
Risk-free rate       0.00%       0.00%

Total Return         665.76%     1593.83%
Daily Sharpe         1.17        0.64
CAGR                 7.28%       10.26%
Max Drawdown         -19.84%     -55.25%
Monthly Vol (ann.)   6.19%       14.27%
 Actually not at all bad, especially in risk adjusted terms. A difficult benchmark to beat and, other than the choice of portfolio itself, pleasantly forecast and parameter free. And of course no 100% exposure to stocks.
Can un-leveraged risk parity improve on that? “Risk Parity” may have been lionised by AQR and Bridgewater but neither Asness nor Dalio invented the concept. CTAs have used it for years to equalise bets in volatility terms between instruments in portfolios containing everything from the three month Eurodollar to metals and stock indices.
Here I present a simple monthly rebalancing with weighting on an inverse volatility basis. There is probably some fancy name for it. Do people call it naive risk parity? Perhaps, but who cares.
Our Cliff and dear old Ray add leverage to increase the returns and indeed this is very easy to do, very effectively, using the futures market.
Either way, it looks more attractive than many other options and preferable to the UCRP. Lower volatility, lower drawdown (potentially!) for a reasonable return. Looks to compare very favourably to pure stocks and Minvar.
Stat                 Inverse Volatility    Benchmark
-------------------  --------------------  -----------
Start                1989-01-04            1989-01-04
End                  2016-12-20            2016-12-20
Risk-free rate       0.00%                 0.00%

Total Return         552.48%               1395.44%
Daily Sharpe         1.56                  0.63
CAGR                 6.94%                 10.16%
Max Drawdown         -12.47%               -55.25%
Monthly Vol (ann.)   4.76%                 14.37%
And here is the area chart for the portfolio over time:
Compared to the highly unsatisfactory and doubtless unstable concentration produced by MINVAR:
Am I making a recommendation here? No I am most certainly not. My partner and I offer software only and not investment advice of any kind. People are merely invited to explore different portfolios, weightings and rebalancing periods for themselves and to draw their own conclusions.
What I will say is that after many years of looking for Eldorado with my friend Dr Pangloss I am convinced most people are completely wasting their time and money in the financial markets. If you want to “invest” do it forcast free and as parameter free as possible.
If you want to “trade” only do so if you have a structural bias in your favour. For Bobby Axelrod and his mates this means inside information. For the HFT brigade it means the bid offered spread and front running. If you can’t think of a structural edge, don’t trade.

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