Investing - Theory, News & General • More Evidence Against Factor Investing

Leverage can be achieved in a brokerage account at near zero cost and near risk-free rates these days, so no private equity needed for that purpose. Infrastructure I have via some publicly listed companies and partnerships.

Thanks again, your asset allocation is intriguing and there is nothing wrong with it, and you obviously put a lot of thought into it; I would think its expected risk and return are probably not measurably worse than the equity index in the long run; probably a tie, but at slightly higher expense ratio. But I think it's too complicated, over-thought and over-engineered, and it might have exposure to unintended biases and risks like sector tilts, while some of the perceived additional diversification attributes might be illusions. Smart people tend to outsmart themselves in finance. Due to the nature of unknown probability spaces and the unknown future, it's naturally hard to "prove" anything or to argue with backtesting; but with the information at hand, I personally would rather go with a leveraged equity index (perhaps with some equity "factor" sprinkles) + intermediate-term and short-term treasuries portfolio, basically mHFEA, with leverage on a glidepath. When I say equity index I mean global equity markets, which I think is a free diversification lunch (other major discussion in the international thread).

Just on this. I meant to say, I would feel exposed having anything approaching 25% of my net worth exposed to a derivative instrument on a brokerage account (being that that's the kind of leverage they typically offer). There are usually hidden costs – so the cost of a margin loan is often in Junk debt territory. Stop Losses aren't guaranteed, unless you want to pay a lot for insurance (so you can owe unlimited amounts).

Retail investors leveraging trades on platforms with 80% loss rates are not going to get intra-bank-like lending rates, by a long shot. And I wouldn't like a large allocation to a Daily leveraged ETF – a) because they can go bankrupt; and b) because the daily leverage maths is a wildcard. The wrong sequence of returns can leverage you the wrong way, and that's the kind of tail risk you need to know about.

Sorry for the delay as I was offline.
I use futures and box credit spreads for leverage. No hidden cost, and yes my cost of leverage is near intra-bank lending rates and near the risk-free rates (T-bills, term SOFR).
The daily leverage of LETFs is manageable and not a measurable detractor from returns; read the mHFEA thread to understand the details why. The main problem with LETFs is the fee. I don't use them.
I don't need complex and fee-laden products, let alone investment classes like private equity, just for leverage.

With Private Equity and Infrastructure, they're getting deals on leverage retail investors will never get. They're investing a lot in risk management and insurance (whole sectors rely on these funds not imploding). You can spread risk across funds and firms. And they tend to leverage on very long-term contracts – in the case of infrastructure, a lot of these funds were set up when we had near-zero rates, and are leveraged on those terms for the next 20+ years .. An additional benefit is that I'm not just leveraging the market exposure I've already got – so if there's another Tech crash, I'm not leveraged on the downside. My VWRL will drop, but my leveraged funds are in different businesses and sectors .. Also, I don't consider public stocks of infrastructure firms to be quite such effective diversifiers. We may have had 20 years of them producing similar returns, but they are ultimately different types of asset with different risks and terms.

"they're getting deals on leverage retail investors will never get" - they would have to get rates below the risk-free rate, which is doubtful.
"You [they] can spread risk across funds and firms" - I too. My entire diversified asset portfolio backs the options (or futures) implied loan debt.
"they tend to leverage on very long-term contracts" - That would imply a large negative duration exposure, which comes with a large negative term premium, and relatively higher long-term risk-free rates (plus a spread). May or may not be advantageous depending on the target asset allocation. I have something similar via my home mortgage.
"I don't consider public stocks of infrastructure firms to be quite such effective diversifiers. We may have had 20 years of them producing similar returns, but they are ultimately different types of asset with different risks and terms." - Depending on initial public equity valuations, returns will probably be different in the short and medium term (not necessarily worse for public equities, for example with currently low public vs. private real estate valuations). Until I see evidence to the contrary, I assume that long-term NAV returns will be similar.

I want to say that I don't mean to destroy your belief in your asset allocation and asset choices. I'm just saying, a lot of what you are saying sounds similar to what I read my entire life in "glossy brochures" of product vendors and asset management firms; the language is generic and lacking factual details, making it hard to pinpoint the potential defects. I don't believe in any suggested benefits until I see substantiated evidence, which appears to be hard to come by.

I'd perhaps say the same for you advocating futures. I.e. interest costs are advertised as low, but you have to have enough cash to cover losses leveraged to the downside (which means having a cash drag on your leveraged market exposure), or a certain loss loses you all your capital (making it a bet), or you use Options to protect your position (where you're back to being hit on costs, usually with spreads).

I'm just not aware of a 'free lunch' with leverage. Someone's taking on the risk, and there is a market rate for that risk. The risk of getting the equivalent of a margin call is your enhanced tail risk. Otherwise you need to be able to cover the maximum loss, which is either going to be a drag on returns, or a more expensive form of hedging.

Afaic, daily leveraged ETFs are for day trading. It's not the friction costs, it's that the maths of daily leverage are a tail risk. So if you get a sequence of returns that skews larger returns on (say) down days, you can get situations where the market going up actually leverages losses to the downside. And it's not the mathematical outlier some suggest it is. It happened with a daily leveraged Chinese ETF not too long ago .. And again, if I'm running a large, leveraged portfolio, it's always the outlier risks that take those portfolios down. I felt the risk management side of the mHFEA thread was a disaster waiting to happen. And the fact (?) that strategy imploded so badly, so quickly after the thread was created (with stock bond correlations outside the range of the woefully inadequate period of market data HF decided to use) is the Sod's Law of investing. At every level, that was an appallingly bad strategy (even before the implementation – daily leveraged ETFs are not for serious people). LTCM is the case study. If you don't calculate your tail risk properly, it's just a matter of time until you implode .. The difference with institutional-grade private equity and infrastructure is they've got very serious incentive to model risk properly.

Statistics: Posted by comeinvest — Tue Apr 02, 2024 1:04 pm — Replies 655 — Views 47933