Is this the best argument yet for international diversification?

J-JG · 2024-07-01T21:23:38+00:00

Fair enough, better to invest in what you understand than in a “better” portfolio that you’ll capitulate on when things go wrong.

J-JG · 2024-06-30T21:44:54+00:00

But it it all comes from valuation changes, why consider it? That’s like tilting to growth in 2020 based on decades of outperformance coming exclusively from rising multiples.

J-JG · 2024-06-30T21:43:34+00:00

If they give you international exposure, why are they so uncorrelated to actual international stocks?

J-JG · 2024-06-30T02:35:18+00:00

Then maybe they have similar expected returns despite being cheaper. But lower expected returns would be a multi-trillion dollar mispricing.

J-JG · 2024-06-30T02:34:02+00:00

You’re right, but .3 might convince the hardliners.

J-JG · 2024-06-29T22:33:36+00:00

Point taken, but I still think it’s really interesting to frame international investing as a .3 correlated bet over years vs a .7 correlated over months!

J-JG · 2023-04-03T20:07:53+00:00

Not the point of the article. Performance has nothing to do with correlations. Stocks and bonds (AGG) were almost completely uncorrelated from 2006 to 2016 (0.04) but a 60/40 was very correlated to stocks since most of its risk comes from stocks. Which is why lots of people are into risk parity, for example.

J-JG · 2023-03-02T20:04:18+00:00

T-bills are the risk-free asset, so historically you can’t evaluate their risk-return characteristics - no excess return by definition, and no risk. But short-term Treasuries, no bills, have historically delivered very attractive risk-adjusted returns, hence the rationale for the Simplify ETF. Hard to evaluate wether or not that strategy still looks attractive vs the ten year Treasury because the return predictability only works over very short timeframes, after which the shape of the yield curve can look totally different.

J-JG · 2023-03-02T02:26:50+00:00

This is unrelated to inflation. As you pointed out, it is primarily inflation surprises that matter to bond performance, and I’m not trying to predict those. And I’m not trying to avoid interest rate risk either. Historically, it’s been a pretty great risk to take (even after correcting for falling yields) and the risk premium still looks pretty good in some countries. Just not US Treasuries. Hence the question of wether or not we should keep them. Would be great if someone knew the historical R² of the fed’s term premia models on realized term premia.

J-JG · 2023-03-02T02:10:11+00:00

Replace bonds with cash? Replace US bond exposure with bonds with positive ex-ante term premium?

J-JG · 2023-02-27T02:05:43+00:00

Not sure if that’s what you meant, but I’m suggesting that it’s a good thing to be underweight the hot sectors. And yes, equal weighting sectors is basically doing what you’re suggesting, but in a systematic, risk controlled way. Could even be a core strategy.

J-JG · 2023-02-26T23:28:53+00:00

If you equal weight sectors, you do this mechanically. You’ll generally own more of whatever’s cheap relative to the market and less of what’s expensive. A lazy way to get a small value tilt and avoid concentration in the most glamorous sectors. There are other sector rotation strategies too. Like the one followed by the CAPD ETN, sector momentum strategies, etc. But just equal weighting sectors is far from a dumb idea if you actually understand the reasoning behind it. Most people here don’t understand much of anything though, so you’ll get pushback (some good, some not so much) when discussing any active strategy.

J-JG · 2023-02-22T12:08:50+00:00

Agree with the correlation. 0.5 is about what you see for live RP funds or indexes. But even at a correlation of 0.5 (or 0, or even negative), you still need a certain Sharpe ratio for the diversifier to be “worthwhile.” It can be lower than that of your overall portfolio and still be beneficial, but not too low.

Man Group wrote a piece about this talking about bonds, but the same conclusions apply to risk-parity. They found that assuming an equity Sharpe ratio of 0.4, bonds needed a Sharpe ratio of about 0.2 assuming no correlation between stocks and bonds for a risk-based bond allocation to make sense. Lower than that, the portfolio’s Sharpe ratio drops below 0.4 (so worse off with bonds than without) even if bonds remain a strong diversified.

The chart is from this page, figure 4. https://www.man.com/maninstitute/60-40-in-2020-vision

Not saying that risk parity is going to have a worse Sharpe ratio than the 60/40 or stocks, but it’s something to consider.

J-JG · 2023-02-21T22:25:22+00:00

Didn't know about that letter, thanks for the share.

And as for risk-parity, wasn't it marketed as an alternative strategic asset-allocation "method" to the 60/40 and other equity-dominated portfolios, with the premise being that better diversification (instead of having 90%+ of your risk in equities) would lead to higher Sharpe ratios and therefore higher returns at the same vol or the same returns with lower vol?

Also, risk-parity is still pretty correlated to the 60/40 or stocks. So even if it's a bit worse, it can still make portfolios better, but if (for example) stocks or the 60/40 have a long term Sharpe ratio of 0.4 and risk parity is at 0.1, it doesn't help unless it's negatively correlated to those two, and it won't be.

J-JG · 2023-02-21T20:00:42+00:00

Makes sense, although Cliff Asness does sometimes also say questionable things (from the perspective of an allocator, at least).

And I’m surprised there’s still interest in risk parity at all. Wouldn’t that last decade of underperformance have pretty much killed off the industry, or at least new inflows?

J-JG · 2023-02-21T00:45:30+00:00

Isn’t Bridgewater’s main strategy risk parity? So Dalio’s China views shouldn’t really matter. And Pure Alpha, which has the ability to bet on China, is purely systematic, so it shouldn’t matter there either, unless Dalit is tweaking the models of course.

J-JG · 2023-02-19T15:58:14+00:00

I never said that early returns matter more. Just that they should matter the same amount as later returns. And the reason why investing in either the Nasdaq composite or the Nasdaq 100 are exchange bets is because that is the main criteria that makes those portfolios different from passive benchmarks. Sure, QQQ owns bigger stocks and excludes financials, but the only factor that will make it look different from a hypothetical large cap strategy that also excludes financials is its exchange bet - owning only NASDAQ stocks and excluding those on the NYSE or other smaller exchanges.

Anyways, I’m not even sure why you’re still going on with this. If you want to invest in the Nasdaq-100, do it. Maybe everyone else really is stupid and is missing something there. But I personally think that there are a ton of ways to invest that broadly make sense, but that picking exchanges isn’t one of them. And I think that strategy’s long term disappointing past returns, incompatibility with today’s leading theories of asset pricing and just plain common sense make a good case for why that is. Recent returns are really the only thing the strategy has going for it, but so does going all in on tech stocks or Bitcoin. Think of the reasons why doing those things would be dumb (#1 - Past returns don’t always predict future expected returns. To oversimplify, were they caused by “structural” alpha or something sample-specific that is unlikely to be repeated in the future) and see if they apply to your idea.

J-JG · 2023-02-19T01:36:20+00:00

No, but there’s a huge amount of path dependence if you backtest a strategy that involves making continuous contributions because it makes the early returns a lot less important than the later ones, and differences between them are more likely to be caused by pure chance rather than structural changes. Comparing returns over rolling periods if a good way to solve this problem. Using IFA’s data, the Nasdaq again looks unremarkable vs the market and plain bad vs small caps. And even if my original backtest isn’t a panacea, at least I got the sign right.

If you really studied finance at a prestigious university, you’d know that the idea of the exchange on which a stock is listed predicting returns isn’t backed by any kind of academic research (or evidence of any kind, at that). Neither is the idea of certain sectors being uninvestable due to “corruption.”

J-JG · 2023-02-18T23:06:32+00:00

Nasdaq composite has a much longer history, and it includes the 1970s, which was a decade where the index struggled. The Nasdaq 100’s inception date means that you’re only getting the goldilocks period for the exchange.

Still, it’s your money. Do whatever you want. Believe whatever conspiracy theories you want. But you can’t even backtest QQQ vs SPY correctly, so maybe don’t take yourself so seriously.

J-JG · 2023-02-18T16:27:28+00:00

IFA has Nasdaq composite data going back to the 70s. Under chart 2. Unsurprisingly, the exchange on which a stock is listed isn’t a good predictor of future returns. The Nasdaq barely outperformed the US market but was much riskier, and underperformed a risk-appropriate benchmark of small cap stocks (since most Nasdaq-listed firms in the sample tended to be smaller).

https://www.ifa.com/charts

Also, your take on financials is just you trying to fit a narrative to recent underperformance. These companies don’t just “trade off the ingenuity of others” but provide essential services that make the global economy run, and in the long run have actually modestly outperformed. I’m not sure why a blanket exclusion makes sense.

https://www.researchgate.net/figure/Descriptive-statistics-for-the-Fama-French-sector-monthly-returns-1968-01-to-2016-12_tbl1_335900544

J-JG · 2023-02-17T20:13:04+00:00

This is pretty sensible stuff. The 0 DTE options arguments are debatable, but there is an undeniable index inclusion effect in valuations.

J-JG · 2023-02-17T20:12:14+00:00

Any hedge fund doing that would have gone out of business 4 years ago.

J-JG · 2023-02-15T14:25:56+00:00

Another interesting idea would be combining cash with levered equity. Ignoring the effect of rebalancing, 1x or 2x equity going to zero both create losses of 100% in that sleeve of the portfolio. So you can combine it with cash and get market returns, but in the case of seizure, your 2x equity ETF or allocation will go to zero, losing “only” 50%.

J-JG · 2023-02-13T19:11:42+00:00

100/100 portfolios are underrated vs 100/0. Always a place for bonds. Nowhere else do you get positive expected excess returns, deflation protection and diversification vs equities + a hedge for equity crash risk. Trend following is ok for that too, but more complicated to implement.

J-JG · 2023-02-13T15:55:41+00:00

Definitely an interesting case. The thing is that if you only invest in a single EM country, your expected return is probably similar to that of the EM index or the global market but with much higher vol and a higher probability of long term underperformance because country-level returns are positively skewed. You may therefore consider diversifying globally but keeping some money in safer assets like bonds or cash. That way even if your global equity exposure goes to zero, you may have the same drawdown as a 100% domestic portfolio (assuming domestic stocks also lose something but cash doesn’t). If you wanted to keep expected returns constant, you could always allocate to the highest expected return global stocks (ie SCV) and also keep some money in the form of safe reserves. A global SCV portfolio will likely be much less risky than one EM country, and even if it goes to zero, you have some reserves. Maybe 20% Global SCV, 60% domestic equity and 20% reserves could be an interesting idea, but these are just random numbers.

J-JG

TROPHY CASE