What has your hit and miss ratio been?

[DeepState]

Understand dollar cost averaging fully and have the disposition to implement it consistently, then GFC type volatility is actually the sort of event you hope for.

Can I please give you a hug? Damn, where have you been all this time????

 

[DeepState]

Monte Carlo in excel? Ew....

</tangent>

Nah, I meant the single cell calculation for the Combo calc in Excel.

I do my stuff in Matlab.

 

[cynic]

You are welcome. Thankyou for your somewhat more reasoned tone.

You are pointing out a valid scenario which, as per BRTY's single scenario, led to the underperformance of re-bal vs buy-hold. In the extensive simulation, I mentioned that fully 40% failed. Amongst these will be exactly the scenarios you and BRTY have encountered, experienced or imagine might occur.

Re-bal does not claim to be pure arbitrage. I have not claimed it is. The equations, if you were to translate them, don't indicate that either. There is risk of failure as with any strategy you could name other than printing money.

So, given that we have risk of failure, why do it? Because it has positive expectancy and the edge is not trivial even after tax and comm.

Each of the scenarios you have mentioned are real. They can happen. As are a range of great scenarios that favour re-bal. What is missing from this debate is the assignment of probability to these scenarios. I know it sounds vague and all, but perhaps I can explain this via a casino.

Welcome to Cynic-ville Sentosa, a bloody awesome marble walled casino with lights and glamour. You, in your hood with digits running over your face are the Roulette dealer. You have odds stacked in your favour. Now, the kinds of scenarios you are mentioning are like drawing 5x 32s in a row with some punter re-staking that slot each time. The Casino loses. It's a really bad day. But the chances of that are the same as drawing 5x 0 in a row. Or some mix of all the numbers. They are all equally likely. Bad and good scenarios. But when you add it all up, the odds in your favour (re-bal profits) make the casino money through time. You need to assign probability to each scenario and weight it accordingly. At the moment, what you are doing is pointing out the possibility of a bad outcome. No argument from me. They exist. But go on to weight that and all the other ones and you come up with positive expectancy. It's just unnatural to think it terms of these distributions, so I appreciate this is going to be a bit tough. People more naturally think in terms of scenarios as you have done. And, by internal wiring from our ancestors from caveman time, focus more on bad scenarios than good.

There is a note/thesis to So_Cynical (oh, the irony) in the thread "Does Rebalancing Work?" which explains how you can prove it to yourself. It just requires a spreadsheet and a tiny bit of work.

It doesn't need a rocket scientist to see the massive flaw in rebal. They wouldn't see it because they understand this stuff. In fact, I have a friend who actually is a rocket scientist managing portfolio this way. They are in Australia, manage $8bn and are growing like a weed. It just needs a spreadsheet that a high school student could put together in an hour to see that this stuff works in the real world. I hope you have achieved a HS level education and can pull it off. It's no skin of my nose if you don't do this and can't find the truth of it or can't be convinced of it by display of facts, theory or verbal/written obfuscation. Actually, why bother even raising this if you are self-declared closed minded and nailed shut?

Chillax dude.

I have provided an analogy that accurately depicts a significant risk inherent to the rebalancing methodology. One doesn't need to be versed in mathematics, statistics, probability theory, or even casino games to be able to recognise, understand and appreciate said analogy!

As it happens the roullette wheel has been deliberately engineered to more precisely reflect the outcomes that might typically be expected according to probability theory.

Financial markets on the other hand, have not undergone such engineering (their intent, purpose and design are quite different!), hence the casino roullette wheel can hardly be considered a valid comparison. Furthermore, unlike the financial markets, none of the roulette numbers ever go into receivership following a prolonged downturn in fortunes!

Millions upon millions of repetitions are usually required before events can even be expected to conform to the dictates of probability theory, hence any expectancy suggested by such theory could not reasonably be depended upon for investment performance. (The average human life span would only afford a comparatively small event sample - the theoretical expectancy would be unlikely to eventuate!!)

Stocks, commodities, currencies real estate etc. do at times go into prolonged states of decline. History has shown this and continues to do so!
My rainbucket analogy gives ample warning of the perils of rebalancing in respect to such occurences, whereas the roullette wheel has precious little (if anything) to say on such matters!

 

[brty]

RY,

I don't know how some-one types so fast in so many different threads.

Check out Accounting Standard AAS25 for how it's done in the real world with real money with real people who actually understand this stuff

Thankyou for quoting superannuation standards, I have been talking about trading for ones own account, nothing to do with super, but I take it as another parameter you have added.

A person bothers to go through the work on a random portfolio of traded stocks, and in an attempt to maintain your position of how rebal works, just totally fail to acknowledge the simple fact that it will not always work. Plus the fact that there are times where it can be detrimental to a portfolio.

I will clearly acknowledge there are times and stocks when averaging down from your winners does work but NOT ALWAYS as you have been suggesting.

Trying to take the actual performance of a group of stocks, as being just one path that could be followed for them from a universe of results that are only theoretical, is disengenious at its best.

Shooting the messenger, that you seem to be an expert at, rather than the obvious that rebal or dollar cost averaging or whatever you want to call it, is not a panacea, is so often found on forums.

Now do it 9,999 times more and let's see what happens

Why? your claims of how this is the best strategy since sliced bread for any portfolio, even those unskilled, didn't stack up. Nobody has 9,999 life times to spend finding those where it works.

How about you start a thread on a portfolio of your selected stocks with the clear easy rules at the beginning, where we walk forward with actual quarterly rebal and see how it pans out. This forum has been around for years. Instead of theory, getinto the real world as some others have done. That way we can see over time how much actual outperformance your strategy delivers.

Are you up to it?

A simple 10 stock selection, quarterly rebal, compared to buy and hold, $50,000/stock start. You didn't like my selected universe so let's walk forward with any you care to name.

 

[craft]

RY,
let's walk forward with any you care to name.

Market Vectors Indices have constructed an equal weight index.



I’m not sure of the construction of the two indexes but it looks like Australian total gross equal weight index has been having a tough time of it compared to the total market over the historical 10year chart.


They have also launched an equal weight ETF in March (Interestingly, RY joined ASF in March– you don’t have anything to disclose do you RY?) So your comparison can easily be tracked on a go forward basis. ASX code MVW.

There is also a white paper on the subject on the Market Vectors site
http://www.marketvectors-australia.com/library/education/
RY has pretty much covered most of it but the References are always useful if anybody wants to read further.

 

[DeepState]

Market Vectors Indices have constructed an equal weight index.

View attachment 57773

I’m not sure of the construction of the two indexes but it looks like Australian total gross equal weight index has been having a tough time of it compared to the total market over the historical 10year chart.


They have also launched an equal weight ETF in March (Interestingly, RY joined ASF in March– you don’t have anything to disclose do you RY?) So your comparison can easily be tracked on a go forward basis. ASX code MVW.

There is also a white paper on the subject on the Market Vectors site
http://www.marketvectors-australia.com/library/education/
RY has pretty much covered most of it but the References are always useful if anybody wants to read further.

First...I hope you are kidding about being an employee of MV and joining at roughly the time of this ETF launch. For avoidance of doubt I am not, and do not endorse or support any of MV's products, its officers, associates or subsidiaries.

This is interesting. I think it compares the MV ETF you described against the ASX 200 or something. The MV ETF construction universe is different by design and this is found in:

http://www.marketvectorsindices.com...utions-licenses-australia-equal-weight-index/

Please note that the universe is different to that of the ASX 200. Secondly, please note that the index contains only 77 names - as if to highlight that further. Whilst it is valid to compare this against any index you want, if it is to be taken as a demonstration of rebal, then the stock universes of the two should be identical. It is not.

 

[craft]

First...I hope you are kidding about being an employee of MV and joining at roughly the time of this ETF launch. For avoidance of doubt I am not, and do not endorse or support any of MV's products, its officers, associates or subsidiaries.

Just probing a coincidence. No offence meant.

This is interesting. I think it compares the MV ETF you described against the ASX 200 or something. The MV ETF construction universe is different by design and this is found in:

http://www.marketvectorsindices.com...utions-licenses-australia-equal-weight-index/

Please note that the universe is different to that of the ASX 200. Secondly, please note that the index contains only 77 names - as if to highlight that further. Whilst it is valid to compare this against any index you want, if it is to be taken as a demonstration of rebal, then the stock universes of the two should be identical. It is not.

As I said I don't know too much about the make up of the indices. the only conclusion I can draw from the historical comparison is that the equally weighted ETF (as its been structured) would not have beaten a whole of market ETF based on market capitalisation.

As for the go forward comparison that BRTY requested this seems an easy and transparent comparison of rebalancing - all that needs to be done is record the buy and hold return of the 77 odd companies and see how MVW performs against that over time. (a long time to allow expectancy to rise above randomness)

 

[DeepState]

RY,

1. I don't know how some-one types so fast in so many different threads.


2. Thankyou for quoting superannuation standards, I have been talking about trading for ones own account, nothing to do with super, but I take it as another parameter you have added.

3. A person bothers to go through the work on a random portfolio of traded stocks, and in an attempt to maintain your position of how rebal works, just totally fail to acknowledge the simple fact that it will not always work. Plus the fact that there are times where it can be detrimental to a portfolio.

4. I will clearly acknowledge there are times and stocks when averaging down from your winners does work but NOT ALWAYS as you have been suggesting.

5. rebal or dollar cost averaging or whatever you want to call it, is not a panacea, is so often found on forums.


6. How about you start a thread on a portfolio of your selected stocks with the clear easy rules at the beginning, where we walk forward with actual quarterly rebal and see how it pans out. This forum has been around for years. Instead of theory, getinto the real world as some others have done. That way we can see over time how much actual outperformance your strategy delivers.

Are you up to it?

A simple 10 stock selection, quarterly rebal, compared to buy and hold, $50,000/stock start. You didn't like my selected universe so let's walk forward with any you care to name.

1. Getting lots of practice.


2. AAS25 was set up to stop charlatans from presenting data in the format that you have done. There are myriad other performance standards for performance measurement. These come from industry groups such as the P-Group and others which mirror this. The same thing applies overseas. Their standards apply to everything that is taxable. Super or non-super. That's why it was set up. Twenty-seven percent underperformance! Surely you must imagine there is something odd about that figure. However, whatever the case, if you want to make a claim about performance without wanting to receive detractions or be accused of being a charlatan, then reference to the P-Group or relevant accounting standards is a good start. They were set up to protect against charlatans and misrepresentation producing figures like this in the past. Thanks for highlighting that you are investing PA. If you were to regard your trading arrangements as being part of your own wider arrangements (ie. BRTY Pty Ltd), then AASB101 82(e)ii will guide you to the same conclusion as per AAS25. You need to recognize unrealized tax When you report comprehensive income in both portfolios when presenting accounts. P-Group says the same thing and they are the performance presentation standard setters on investment matters.

3. BRTY, you keep saying this. You are very locked in the belief that I have said this guarantees outperformance. However, what in the phrase: "This is a probabilistic process whose likelihood of success improves with time" implies certainty of outperformance over any time frame? 'Probablistic' means there is risk...not certainty...of the outcome. Likelihood means 'chance of' - not certainty of. 'Success' means outperformance over buy-hold. 'Improves with time' means it ... improves with time. What about the phrase or any of its subcomponents implies certainty? The whole thing is about not being sure of the outcome.

The simulations displayed 40% FAILURE rate. I presented evidence of FAILURE of the strategy. How is that saying it guarantees success? I actually went to the trouble of not using single scenarios that can easily be selected to paint any picture you like and actually blasted out 10,000 to search for ones that failed miserably...as well as find those which succeeded. It was clearly written and you have even clipped it out for rebuttle - which tells me and everyone you actually saw it. So again, what about that implies certainty of success? How has that not given due credit to scenarios where the re-bal process utterly and dismally underperforms? How many ways can this be said?

How's this for a cut-down version with smaller, perhaps less technical and hence more readily accessible, words: It is not for sure that re-bal works. But it should do better if you give it more time. Even then, it might not work.


4. Please see 3.


5. I understand your reticence about anything touted as a panacea. I don't buy from door knockers or phone dialers. In listening to brokers harping on about the latest and greatest idea, maybe 1% actually makes sense. Perhaps we might have that in common.

I am not saying it is a panacea. It will not guarantee you of a yacht. I never claimed it would. It is just expected to help you get to whatever your financial goals might be and there is a chance it might actually detract from that endeavor. This re-bal stuff is not pure arbitrage. It can, and will, fail a lot of the time. Am I making this clear enough? It can fail... It can fail...* Out of 10k scenarios generated from your stock list, 40% failed. In any other given stock list, this percentage may be higher or lower. In some stock lists that could be selected, the failure rate could be greater than 50% implying negative expectancy for that set of simulations. Is this enough of a surgeon general warning?


6. BRTY, I already do it. My portfolio has over 80 stocks in it, and that's just in Australia and does not include all the other assets that I have in a multi-asset sense which are also being reblanced. I am very happy with it and thought I might share this idea...I would not have guessed that, in doing so, we would be posting backwards and forwards over all sorts of technical issues over something I regard as utterly trivial.

If every person that has disagreed with me, or will disagree with me on anything I have a view on, wanted to challenge ideas by having us posting portfolios in the hope of finding proof of concept I will be updating 100 threads with 80 stock portfolios by next week. Respectfully, yes - respectfully - I shall decline the duel. But nothing stops you from running the experiment out if you are so inclined. Why not use the ASX 20 starting from now. There is no hindsight bias in selecting those stocks because you would be launching from now. Given the ASX 20 membership could almost be regarded as a sell signal on its own, it might turn out to demonstrate how re-bal works in a down market and can - not must - add value to buy-hold in that eventuality. Start rebal at equal weighting which disfavours it. Given you aren't a buyer of the concept of Monte Carlo, the next best thing to getting a fair shake of this is to give it time on a real record. BRTY, we'd have to wait maybe 10 years for this to be achieved to any level that makes sense for a duel and our degree of certainty will improve gradually as we move along. And even then, the statement can only be made that, whatever the outcome, A beat B on this scenario. Your daughter, whom I sincerely hope does well in her PhD studies and moves on to make the life she wants for herself, will be able to assist in appreciating how much weight can be placed on the outcome.


BRTY, thanks for the exchange. It's been a challenge but I have learned a thing or two. I'm going to let this thread go now after final responses. It's time to move on. At least for me, life is bigger than a re-bal debate.

All the best with it.


* Re-bal is not pure arbitrage. It can fail. It can lose you money against buy-hold. There are feasible scenarios that the loss relative to buy-hold is such that you will be very very pissed off that you even heard of the idea.

Disclaimer: This is not advice. This is not an effort to solicit for the purchase or sale of securities or any funds or accounts from anyone on this site or elsewhere. Please do your own work and, whatever the outcome, all the best with it. We each make our own way and are free to disagree.

 

[DeepState]

1.Just probing a coincidence. No offence meant.

2. As I said I don't know too much about the make up of the indices. the only conclusion I can draw from the historical comparison is that the equally weighted ETF (as its been structured) would not have beaten a whole of market ETF based on market capitalisation.

3. As for the go forward comparison that BRTY requested this seems an easy and transparent comparison of rebalancing - all that needs to be done is record the buy and hold return of the 77 odd companies and see how MVW performs against that over time. (a long time to allow expectancy to rise above randomness)

1. That's cool. Thought you might be from ASIC or something! Nice spotting of the coincidence though.

2. Agree.

3. Yes, but with knowledge that the composition of the universe will change through time and hence the stocks involved in the mar-cap portfolio would also need to be revised with this. It won't always be the same 77 stocks and might not be 77 stocks but a different number at any given time. You knew this...I'm just doing the lawyer thing.

 

[DeepState]

1. I have provided an analogy that accurately depicts a significant risk inherent to the rebalancing methodology. One doesn't need to be versed in mathematics, statistics, probability theory, or even casino games to be able to recognise, understand and appreciate said analogy!

2. As it happens the roullette wheel has been deliberately engineered to more precisely reflect the outcomes that might typically be expected according to probability theory.

Financial markets on the other hand, have not undergone such engineering (their intent, purpose and design are quite different!), hence the casino roullette wheel can hardly be considered a valid comparison. Furthermore, unlike the financial markets, none of the roulette numbers ever go into receivership following a prolonged downturn in fortunes!

3. Millions upon millions of repetitions are usually required before events can even be expected to conform to the dictates of probability theory, hence any expectancy suggested by such theory could not reasonably be depended upon for investment performance. (The average human life span would only afford a comparatively small event sample - the theoretical expectancy would be unlikely to eventuate!!)

4, Stocks, commodities, currencies real estate etc. do at times go into prolonged states of decline. History has shown this and continues to do so!

5. My rainbucket analogy gives ample warning of the perils of rebalancing in respect to such occurences, whereas the roullette wheel has precious little (if anything) to say on such matters!

1. Totally agree. The scenario is fine. The analogy is very attractive and creative. My point was that that, if you are representing risk to the re-bal process, you also need to couple the scenario with a likelihood. This is not a detraction from your elegant analogy - which could be adapted for many different purposes. It's very cool. Hence I walked into a casino to seek to aid the process of likelihood estimation by illustrative means. It's fine if you don't like the analogy that I chose.


2. Yes, a casino game, if it isn't rigged like LIBOR, has knowable and stable odds in situations like Roulette. That's what makes them good starting points for investments and probability theory.

I just reached out to the first three texts that I have on probability and finance. After blowing the dust off them, they each use games of chance like tossing coins to introduce the idea. These texts deal with probability theory.

Title / Page of first mention of coin toss

a. DeGroot & Schervish, "Probability and Statistics", Fourth Edition / p27 of 890
b. Walpole & Myers, "Probability and Statistics for Engineers and Scientists", Fifth Edition / p11 of 765
c. Rudd & Classing, "Modern Portfolio Theory", Second Edition / p35 of 525.

If these texts alone, which are deep into Probability Theory and it's real world applications, see fit to utilize games of chance to introduce more complex issues, then for a guy who eschews all of it, it seemed reasonable to start there. Do you actually think I think the markets work like a Roulette wheel? No more than I think the markets actually operate like buckets of water where one has a leak.

Probability Theory, by the way, is perfectly applicable to games like Roulette to Poker and Black Jack. But you seem to want to go deeper.

Since you have espoused the term Probability Theory and are talking about sample size and parameter stability, you must be versed or making it up. I'll give you the benefit of the doubt. If you believe that a Roulette wheel is engineered (yes, it is) and thus is not a valid comparison with markets, then you will need to explain why the moment generating function of the sum of lognormal returns being security price returns, drawn from an unknown and flexible distribution, will not asymptote to the same description for higher moments as the one drawn from draws from a game of Roulette. But...it does. Cynic, this is the same stuff that is the bedrock of options pricing using binomial models. The entire options market disagrees with your statement.

As for Roulette numbers going into receivership. That's absolutely true. But they don't need to. The scenario of effective bankruptcy is where there are several draws in a row where the house loses. You can give the house starting capital and let it - uh - roll. The house can bankrupt under Roulette conditions even with positive expectancy. This is the same as saying that re-bal can lose you tonnes of money relative to buy-hold. It can and will happen. Casinos will go bust under certain scenarios. Re-bal will lose (a lot of) money under certain scenarios.


3. Where did you get this from? Early in my career, I was Head of Risk for a $12bn balance sheet which traded global equities, global bonds and credit, FFX and options and this statement surprises me greatly. I must have missed the memo that said I couldn't estimate risk! But what do I know? Perhaps you can call someone who knows better than me and produces risk management engines for - not millions and millions - but trillions and trillions of dollars.

The Head of Research at MSCI Barra and the CEO of Northfield would be good places to start. They don't have millions and millions of observations to draw from either. Yet, surprisingly, their stuff produces risk estimates that pass all statistical tests - Yes, from Probability Theory - and is incredibly valuable given the sensitivity to which portfolio settings are held.

Seemed to work alright in my lifetime. And that included the periods like LTCM, Russia/Asia Crisis, Tech Wreck, Iraq and GFC.

I would guess, because I cannot ever know for sure when we're talking Probability Theory, that you have probably no real concept of convergence and how fast it occurs and how it can be further stabilized.


4. Yes they do. No argument here. Please see Post #73, Item 4. Where I ran re-bal for portfolios that were composed entirely of stocks that went down. It demonstrated that rebal has positive expectancy under these conditions. Re-bal doesn't care if stocks are going up or down. All that matters is how they move relative to one another. The underlying idea behind this re-bal stuff comes directly from Probability Theory and from that, the positive expectancy just falls out. Much of this debate arises because people can't work through the maths or, failing that, won't take the time to run a basic Monte Carlo simulation to get a feel for it. I'm done with this debate. Please just do the work to figure it out. I'm not here to be your pillar of abuse or punching bag. I could care less.


5. Your analogy is a great one, describing a horrible scenario for re-bal. The Roulette wheel spinning 32 ten times in a row with some punter re-staking that number is also a horrible analogous scenario for re-bal.


All the best, I'm signing off. Any further correspondence can be directed to the site that Craft has provided.


Disclaimer: I am not endorsing or suggesting that you should purchase or utilize risk models or any other material from MSCI Barra or Northfield. I am not encouraging you to play Roulette or toss coins. I am not encouraging you to put holes in any buckets you have either. Be amply warned. Re-bal can and will underperform buy-hold in certain scenarios most of which are highly plausible. Some of these outcomes can be very bad indeed. This statement would apply for any investment strategy you might attempt except for pure arbitrage. Please do your own work and figure it out for yourself.

 

[DeepState]

1. Gut instinct would have me think a fair bit of rebalance performance over indexes has to do with initial equal weight effect.

2. Sometimes you just need a break - you may find that also in time..


3. What it takes to harvest one edge doesn't necessarily add to another - and in fact trying to do so can cause damage to the original edge. That's not a discussion for 12:30am but a mighty good topic for one rainy day and could probably go a long way to reconcile the different angles you and BRTY might be coming from.


4. Care to detail your data source(total return by quarters -nice) and back testing engines? They appear pretty impressive.

Hi Craft

1. That's true. There is a certain optimal portfolio that re-bal works best for relative to buy-hold. That's not an equally weighted portfolio and requires some matrix inversion to obtain. Anything away from that lowers expectancy. At the extreme, if the initial portfolio consists of one stock, re-bal doesn't work. But beyond that, there is positive expectancy at some level. Just less than the maximum that could probablistically be achieved.

2. Yep, I'm retired mate! Also, on the receipt of your advice, I am taking a permanent break from this thread after this note.

3. Very cool. Yes, you are right. Net edge is not the sum of all edges, it must be adjusted for the covariance (or deeper structure) of the expected portfolio of edges.

I think the difference with BRTY goes a fair way beyond this. But I'll let this pass.

4. My data aggregation platform is FactSet. My manipulation engine is MatLab. What I have now just blows mouse farts relative to the hyper-sonic thruster stuff of the past. But, it'll do me.

Cheers

 

[DeepState]

1. It is a small part, what other similarly simple strategies do you think give investors an edge?


2. This is fine if your focus is on total returns.

For people who invest to provide passive income to meet expenses, retire or follow other passions, the income component is more important.

Sorry TPI, I signed off too soon.

1. I think you are looking to low turnover strategies. If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market. Things like deep value which is screened for credit worthiness, buying small caps. You may have heard of Low Vol. That's achievable but more intense and needs valuation and earnings quality overrides. You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere. All that is simple.

The above is heavily mined so the basic strategies are not going to be super-profit makers any more. Unfortunately, simple stuff produces fairly simple returns in this type of scenario.

Otherwise, you get rich by not losing money. Watch for tax. Knowing your tax rate, you should either tilt to or away from dividend payers. Watch comm. There is massive excess turnover. Just doing nothing is often better than watching screens. Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it. This really adds up over time.

You sound like an adviser or planner. You would be aware of the horrible record of mistiming markets in retail (let along insto). So a huge part of this is simply sticking to the game plan. But, it's hard because you don't know if your game plan is busted. To me, you invest in a way that allows for really bad scenarios but not the extreme ones. When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.

That's the simple truth of it.

2. Actually, you can build a portfolio with an income focus and add re-bal on top. The concept works anyway. It would, for example, work on a portfolio of bonds.


Cheers

 

[KnowThePast]

Sorry TPI, I signed off too soon.

1. I think you are looking to low turnover strategies. If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market. Things like deep value which is screened for credit worthiness, buying small caps. You may have heard of Low Vol. That's achievable but more intense and needs valuation and earnings quality overrides. You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere. All that is simple.

The above is heavily mined so the basic strategies are not going to be super-profit makers any more. Unfortunately, simple stuff produces fairly simple returns in this type of scenario.

Otherwise, you get rich by not losing money. Watch for tax. Knowing your tax rate, you should either tilt to or away from dividend payers. Watch comm. There is massive excess turnover. Just doing nothing is often better than watching screens. Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it. This really adds up over time.

You sound like an adviser or planner. You would be aware of the horrible record of mistiming markets in retail (let along insto). So a huge part of this is simply sticking to the game plan. But, it's hard because you don't know if your game plan is busted. To me, you invest in a way that allows for really bad scenarios but not the extreme ones. When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.

That's the simple truth of it.

2. Actually, you can build a portfolio with an income focus and add re-bal on top. The concept works anyway. It would, for example, work on a portfolio of bonds.


Cheers

Hey RY,

I am really enjoying your contributions to this forum, you have already given me enough ideas to research and play around with for a long time. Thank you.

If I could please keep you signed in to this thread for a little bit longer..

What are your thoughts on black swan events? A system may have a positive expectancy, but a significant enough chance of a total meltdown. And the longer you run the system, the greater chance of running into one eventually.

Australian market is an interesting example at the moment. A lot of value strategies, at the moment would be almost totally invested in mining services companies. Chance of a catastrophic event for a portfolio is thus significantly higher, as it only needs to happen in one industry.

What are your thoughts on controlling systems to lower this risk, what kind of manual overrides to allow, and how to not let those overrides be abused?

 

[cynic]

1. Totally agree. The scenario is fine. The analogy is very attractive and creative. My point was that that, if you are representing risk to the re-bal process, you also need to couple the scenario with a likelihood.

No problem! My trading experience accompanied with observations of others tells me that the likelihood for an ardent trader is extremely high!

2. Yes, a casino game, if it isn't rigged like LIBOR, has knowable and stable odds in situations like Roulette. That's what makes them good starting points for investments and probability theory.

For probability theory perhaps , but certainly not for investments!!!

I just reached out to the first three texts that I have on probability and finance. After blowing the dust off them, they each use games of chance like tossing coins to introduce the idea. These texts deal with probability theory.

Well bully for you! I have some authoritative texts at my disposal also! Better still, I actually take the time to read and understand them!

Title / Page of first mention of coin toss

a. DeGroot & Schervish, "Probability and Statistics", Fourth Edition / p27 of 890
b. Walpole & Myers, "Probability and Statistics for Engineers and Scientists", Fifth Edition / p11 of 765
c. Rudd & Classing, "Modern Portfolio Theory", Second Edition / p35 of 525.

If these texts alone, which are deep into Probability Theory and it's real world applications, see fit to utilize games of chance to introduce more complex issues, then for a guy who eschews all of it, it seemed reasonable to start there. Do you actually think I think the markets work like a Roulette wheel? No more than I think the markets actually operate like buckets of water where one has a leak.

Probability Theory, by the way, is perfectly applicable to games like Roulette to Poker and Black Jack. But you seem to want to go deeper.

Since you have espoused the term Probability Theory and are talking about sample size and parameter stability, you must be versed or making it up. I'll give you the benefit of the doubt. If you believe that a Roulette wheel is engineered (yes, it is) and thus is not a valid comparison with markets, then you will need to explain why the moment generating function of the sum of lognormal returns being security price returns, drawn from an unknown and flexible distribution, will not asymptote to the same description for higher moments as the one drawn from draws from a game of Roulette. But...it does. Cynic, this is the same stuff that is the bedrock of options pricing using binomial models. The entire options market disagrees with your statement.

Not according to Lawrence G. MacMillan (You do know who he is don't you!!!). I suggest you acquaint yourself with the contents of his chapter on stock price distribution (chapter 38, "Options as a Strategic Investment", 4th edition) where he demonstrates that stock prices (and by extension options) do not conform to normal and/or lognormal distributions!

As for Roulette numbers going into receivership. That's absolutely true. But they don't need to. The scenario of effective bankruptcy is where there are several draws in a row where the house loses. You can give the house starting capital and let it - uh - roll. The house can bankrupt under Roulette conditions even with positive expectancy. This is the same as saying that re-bal can lose you tonnes of money relative to buy-hold. It can and will happen. Casinos will go bust under certain scenarios. Re-bal will lose (a lot of) money under certain scenarios.

As I've already mentioned, Casino games are simply not a valid comparison to the financial markets!
Incidentally, the behaviour of the options market happens to agree with me on this! I often trade (profitably I might add) using instruments that are priced in accordance with the Black Scholes model.

3. Where did you get this from?

Third year high school maths class! Were you asleep in that class?

Seemed to work alright in my lifetime. And that included the periods like LTCM, Russia/Asia Crisis, Tech Wreck, Iraq and GFC.

Good for you ! Were you trading for a living with your own capital (and no other income) at that time?

I would guess, because I cannot ever know for sure when we're talking Probability Theory, that you have probably no real concept of convergence and how fast it occurs and how it can be further stabilized.

Well it's a good thing that you're not reliant upon the accuracy of your guesses for income then, isn't it?!!
I find experience gives me a more accurate picture of what can realistically be expected. Fanciful theories work well in theoretical worlds, however, such worlds are distinctly different from the one we live and trade in!

4. Yes they do. No argument here. Please see Post #73, Item 4. Where I ran re-bal for portfolios that were composed entirely of stocks that went down.

Well what was the point of that!
Such a portfolio would be even less probable than one with stocks that only go up!!

The adverse impact of rebalancing could be expected to be greatest when applied to a portfolio comprising a mixture of winners and losers! Incidentally, such mixed portfolios are far more likely to occur in the real world of trading where the future of any given investment is usually uncertain!

It demonstrated that rebal has positive expectancy under these conditions. Re-bal doesn't care if stocks are going up or down. All that matters is how they move relative to one another. The underlying idea behind this re-bal stuff comes directly from Probability Theory and from that, the positive expectancy just falls out.
Much of this debate arises because people can't work through the maths or, failing that, won't take the time to run a basic Monte Carlo simulation to get a feel for it.

On the contrary, much of this debate is occurring because some here are able to easily discern the issues with this theory despite your inept efforts to obscure them with mathematical sleight of hand.

I'm done with this debate. Please just do the work to figure it out. I'm not here to be your pillar of abuse or punching bag. I could care less.

Good to hear! Enjoy your retirement!

 

[hhse]

Forgive my ignorance, but what is the point of rebalancing your share portfolio (in general, they head the same direction as the overall market), all you are effectively doing is either reducing the speed at which your portfolio goes down (or up). In that case, why not just buy an ETF and save on commissions?

To me, in simple terms 'rebalancing' only makes sense in terms of removing 'one type of risk' but taking on board another type of risk to make money.

e.g.

Rebalancing options portfolio to remove directional risk by having bullish and bearish trades, and you taking on 'volatility' risk and profiting from either an expansion or collapse in volatility in the product.


However, in your example, you are effectively trying to slow down your porftfolio's directional movement and yet you are trying to collect money from its movement ... I don't understand this... just buy an ETF.

I can understand people picking companies because they feel its undervalued, but I don't see how regular rebalancing comes into play.

 

[TPI]

Sorry TPI, I signed off too soon.

1. I think you are looking to low turnover strategies.

Yes that is definitely my preference, low turnover and also low time involvement.

If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market. Things like deep value which is screened for credit worthiness, buying small caps. You may have heard of Low Vol. That's achievable but more intense and needs valuation and earnings quality overrides. You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere. All that is simple.

...

Otherwise, you get rich by not losing money. Watch for tax. Knowing your tax rate, you should either tilt to or away from dividend payers. Watch comm. There is massive excess turnover. Just doing nothing is often better than watching screens. Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it. This really adds up over time.

You sound like an adviser or planner. You would be aware of the horrible record of mistiming markets in retail (let along insto). So a huge part of this is simply sticking to the game plan. But, it's hard because you don't know if your game plan is busted. To me, you invest in a way that allows for really bad scenarios but not the extreme ones. When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.

That's the simple truth of it.

Well put, that sounds more like my style.

Though I'm not currently an adviser or planner, and work mostly in a non-related field.

2. Actually, you can build a portfolio with an income focus and add re-bal on top.

Yes perhaps this is true.

Though I think this also depends on how much capital you have to invest.

If you have a lot of capital, then you can generate more than enough income to live off very conservatively using cash/term deposits/bonds, and invest the rest more aggressively with a total return focus.

At a lower end eg. <$1M of capital, you may not be able to put everything into cash/term deposits/bonds and generate a sufficient income on which to live off, and one that keeps up with inflation over a potentially very long retirement period.

As such your exposure to risk assets (eg. commercial property, shares) may need to be greater in order to meet your basic income requirements, and the "tilt" of those risk assets I feel should generally be more towards yield (and more passive strategies as in the long-term actively managing money may become a lower priority).

Re-balancing at this level may make creating a regular, reliable and predictable income stream which you can use to pay your bills and expenses a bit more complicated.

Each time you do this you sell one source of income (eg. a stock) and replace it with another (ie. another stock), but in doing so the income streams (ie. the dividends generated by the old stock vs. the new stock) won't necessarily match, but your living expenses will be the same, and you may end up worse off from an income point of view.

Hence why I feel that for the retail investor, who is mostly trying to generate sufficient income on which to live off, this re-balancing process is more hassle than it's worth.

Once their basic income requirements are more than adequately met though, any excess capital could be directed towards a portfolio with such strategies involved.

 

[DeepState]

Hey RY,

I am really enjoying your contributions to this forum, you have already given me enough ideas to research and play around with for a long time. Thank you.

If I could please keep you signed in to this thread for a little bit longer..

What are your thoughts on black swan events? A system may have a positive expectancy, but a significant enough chance of a total meltdown. And the longer you run the system, the greater chance of running into one eventually.

Australian market is an interesting example at the moment. A lot of value strategies, at the moment would be almost totally invested in mining services companies. Chance of a catastrophic event for a portfolio is thus significantly higher, as it only needs to happen in one industry.

What are your thoughts on controlling systems to lower this risk, what kind of manual overrides to allow, and how to not let those overrides be abused?

Hi KTP, just responded to you via new thread under Derivatives / Return Distributions. Cheers

 

[brty]

While I wont change my tune about the dangers of rebal on stock portfolios, I have done a little preliminary research on an area where rebal should ALWAYS work.

This being in the field of ETFs. Taking any of our long term well managed ETFs, say AFI, MLT, WAM, STW etc and using just a couple of them with at least $100k in each, by rebalancing when they deviate from each other by a certain percent, only 2-3%, because they do correlate very well as you would expect, then it might be possible to add .5% or so to the overall performance per annum over the long term.

When I get the time in a couple of weeks, I'll have ago at doing that to see what I come up with. Of course I'll still be a charlatan by showing an area where it works.

 

[sinner]

I have made pretty much this identical post before, but it's relevant again...for anyone who wants to actually see some research rather than just arguing mindlessly back and forth...

http://gestaltu.blogspot.com.au/2012/02/volatility-harvesting-and-importance-of.html - "Volatility Harvesting and the Importance Of Rebalancing "

Practical application in the Permanent Portfolio (US):

http://gestaltu.blogspot.com.au/2012/08/permanent-portfolio-shakedown-part-1.html
http://gestaltu.blogspot.com.au/2012/08/permanent-portfolio-shakedown-part-ii.html

...and Japan too (i.e. a market where stocks have been going down for decades and the economy is in deflation):

http://gestaltu.blogspot.com.au/2012/09/the-permanent-portfolio-turns-japanese.html

 

[TPI]

While I wont change my tune about the dangers of rebal on stock portfolios, I have done a little preliminary research on an area where rebal should ALWAYS work.

This being in the field of ETFs. Taking any of our long term well managed ETFs, say AFI, MLT, WAM, STW etc

brty, AFI, MLT and WAM are actually LICs (listed investment companies) not ETFs.

STW is an ETF though, but not really actively "managed" as such as it is a passive index tracker.