for long term investments, why not go 100% emerging markets?

[DcifrThs]

oops, too late to edit, portfolio B after 20% loss is still leveraged only 1:1 (typo)

also, stinkypete, where did you get your info regarding leverage and other stuff you've mentioned in this discussion?

thanks,
Barron

[gull]

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What are some good long term investments other than emerging markets. Id like to have something high return/risk as well as E.M, but obv dont want all eggs in 1 basket.

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Other asset classes with high historical/expected returns are US small value, and foreign small value.

[stinkypete]

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not quite. imagine two portfolios A & B

A: $1000 exposure on $333 leveraged 3:1
B: $1000 exposure on $1000 leveraged 1:1 (i.e. no leverage)

both lose 20%. the result?

A: $800 exposure now on 266.4 leveraged 3:1
B: $800 exposure now on $800 leveraged 3:1


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okay, my explanation sucked and we're both "right" here but the reality is somewhere in between your explanation and your interpretation of my explanation.

when you have $333 and you borrow $667 and you lose $200 of your total $1000 investment, you still have to pay back $667.

$800-$667 = $133. so if you stay in your position you're now leveraged $800/$133 = 6 to 1.

however, if this happens in your 15% sd leveraged 3 times to 45% portfolio, its "equivalent" to a 60% drop in the 45% unleveraged portfolio.

however, to illustrate my point, if you go a little bit further, a 100% drop (3x33.3%) in the 3x leveraged portfolio will generally be far more likely than a 100% drop in the unleveraged portfolio. if that doesn't make sense intuitively and you want to hold on to the fact that those RORs should be the same by the normal distribution model, you should at least realize that the normal distribution is far from accurate since you can't go below a 100% drop.

anyway, i gotta go poop.

[DcifrThs]

[ QUOTE ]
[ QUOTE ]

not quite. imagine two portfolios A & B

A: $1000 exposure on $333 leveraged 3:1
B: $1000 exposure on $1000 leveraged 1:1 (i.e. no leverage)

both lose 20%. the result?

A: $800 exposure now on 266.4 leveraged 3:1
B: $800 exposure now on $800 leveraged 3:1


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okay, my explanation sucked and we're both "right" here but the reality is somewhere in between your explanation and your interpretation of my explanation.

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nope. unfortunately, in this case only reality is correct. and you have not described it.

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when you have $333 and you borrow $667 and you lose $200 of your total $1000 investment, you still have to pay back $667.

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during what time period? you don't owe the $667 when things go wrong...and in effect, you don't have to have 'borrowed' it in the first place.

think of two portfolios

A: $1k investment in the S&P500 index
B: a combination of futures and actual shares of the S&P500 index that invests $500 and gets a $1k exposure. (i.e. leveraged 2:1)

portfolio B hasn't borrowed any money. it has just used less capital to generate a similar exposure.

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$800-$667 = $133. so if you stay in your position you're now leveraged $800/$133 = 6 to 1.

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this is a very silly example since as i mentioned above: leverage doesn't need to have come from actual borrowing.

further, if you play your scenario out through time (where you borrowed $667), you'll still see the way i described it is exactly how it plays out in terms of monthly returns.

if you actually owed the $667, you couldn't have the $800 exposure so you couldn't be leveraged 6:1 (so why would you subtract 667 from 800 lol)

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however, if this happens in your 15% sd leveraged 3 times to 45% portfolio, its "equivalent" to a 60% drop in the 45% unleveraged portfolio.

however, to illustrate my point, if you go a little bit further, a 100% drop (3x33.3%) in the 3x leveraged portfolio will generally be far more likely than a 100% drop in the unleveraged portfolio. if that doesn't make sense intuitively and you want to hold on to the fact that those RORs should be the same by the normal distribution model, you should at least realize that the normal distribution is far from accurate since you can't go below a 100% drop.

anyway, i gotta go poop.

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a portfolio with 1k on leverage and another portfolio with 1k exposure without leverage that are identically invested are almost exactly equally likely to fall by 100%. forget about measuing the expected drops with normal distribution or whatever, the only difference between the leveraged and unleveraged portfolio is how they are invested and a little drift here and there depending on the securities (i.e. futures contracts don't get dividend payments in the S&P 500 excample above)

leverage doesn't need to be acquired through borrowing. you have made some very incorrect statements here so i'd like to know where you are getting this stuff?? have you studied this? read it in a book (if so which book)? constructed portfolios yourself? managed money? or are you just using your own logic to arrive at your conclusions?

thanks,
Barron

[stinkypete]

of course you still owe the $667 when things go wrong. in fact, you owe more because you have to pay interest on it. it's easier to see in the case where you borrow outright, but using futures you end up with the same result, assuming the futures are priced correctly.

with futures, when prices fall, you're going to be dealing with variation margin calls, and if you're going to be funding them with the money you originally invested, the end result is going to be the same.

going with the example from my previous post ($333 leveraged 3 to 1 to $1000), say you invest $333 directly in the underlying and get another $667 exposure through futures.

you experience a 20% drop, and now your direct investment is worth $266.40 and you've lost another $133.4 on your futures (yes, you can consider the futures loss temporary if you want, but you will have to make up these losses through variation margin calls on a daily basis). where's that $133.4 going to come from? well, unless you want to add more money, you're going to have to sell part of your direct investment and you'll be left with only $133 in it. meanwhile, your exposure in the futures market is the same as it was before, and suddenly you're leveraged 6 to 1.

as i showed earlier, the result is the same with borrowing, as would be expected - if that wasn't the case, there'd be arbitrage opportunities.

[stinkypete]

yes, i've studied this stuff. no, i don't have a specific book i can refer you to.

i went through all my posts, and while some of the stuff i said may not be explained particularly clearly, i don't see any mistakes, so if you'd like to point out anything in particular, i can explain why it's correct.

[DcifrThs]

pete,

a few things:

we are way off track here in terms of the point of this thread.

second, your point above leverage is definitely correct. the main point though is that intelligent use of leverage (i.e. NOT 3:1 and extremem numbers i mentioned as instructive examples) is a good thing and can increase portfolio efficiency.

if the value of the underlying increases, you are less levered, but if it falls, you are more highly levered. on average, your total leverage will remain fairly close to your target without much adjustment (though some is necessary from time to time).

the statement "a 100% drop in a levered portfolio is more likely than in a non-levered portfolio" is correct and i was way off there. when you deal with this in practice though, there are some major differences:

first, you aren't levering the riskier parts of the portfolio. in fact, you do the exact opposite. you want to increase exposure to the least volatile (least correlated, and lower returning) assets to maximize your sharpe ratio and create the most efficient portfolio. these less risky asset classes are faaaaarrrrrrrr less likely to experience huge moves that cause anywhere near 20% losses in any amount of time (thus contributing to my statement that a levered portfolio is just as exposed to a non levered one. i was thinking of the ideal portfolio and applying to an equity only one which was wrong).

second, the amount of leverage is very small on average. it is nowhere near 3:1. more like 1.3 or 1.5:1 for ideal portfolio efficiency.

when you combine those two facts, you get that the best portfolio still is created via leverage and that leverage is overall fairly harmless when used in that manner.

so for being an ass with respect to the leverage argument, i have to apologize and hope you'll forgive.

the statements you made that were very incorrect were:

1) that timing of returns don't matter, and
2) that the best portfolio in the long run "usually" won't be one that maximizes your sharpe ratio

my whole point in this thread is pretty similar to what i mention here a lot: the best portfolio should have leverage (a small amount on the underutilized asset classes), the best portfolio is very well diversified, and (possibly a repeat of #2 there) any portfolio that invests in one single asset class or asset is problematic and can be dominated by many other portfolios (and crushed by the "best" one)

Barron

[stinkypete]

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2) that the best portfolio in the long run "usually" won't be one that maximizes your sharpe ratio

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the point i was trying to make was that if you start building your portfolio with the primary goal of diversifying fully and maximizing your sharpe ratio, expecting that you can then leverage it to meet your return goals, you might end up disappointed because leverage can be hard to obtain/implement.

in a lot of cases it might be a lot more feasible to build your portfolio concentrating more on the riskier assets, as suggested in the OP.

there might be cases where you can only assemble an "optimal" portfolio expecting to return 7-8% using your method because the leverage isn't accessible, while you could expect to earn 10-12% concentrating on riskier assets with a slightly lower sharpe ratio. if you're on a 20-30+ year time horizon, you'd probably be better off with the latter.

how's the portfolio you discussed a few months ago coming along? how are you obtaining your leverage?

[DcifrThs]

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2) that the best portfolio in the long run "usually" won't be one that maximizes your sharpe ratio

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the point i was trying to make was that if you start building your portfolio with the primary goal of diversifying fully and maximizing your sharpe ratio, expecting that you can then leverage it to meet your return goals, you might end up disappointed because leverage can be hard to obtain/implement.

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in every case i can think of (so likely almost every case) you know your constraints before yous tart building your portfolio.

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in a lot of cases it might be a lot more feasible to build your portfolio concentrating more on the riskier assets, as suggested in the OP.

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that is true, and if you don't have leverage, you can have an equity/EM heavy portfolio. but you should still diversify away from those two riskier & higher returning holdings

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there might be cases where you can only assemble an "optimal" portfolio expecting to return 7-8% using your method because the leverage isn't accessible, while you could expect to earn 10-12% concentrating on riskier assets with a slightly lower sharpe ratio. if you're on a 20-30+ year time horizon, you'd probably be better off with the latter.

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as you mentioned that is feasible, but just sticking everything in 1 or 2 asset classes isn't a good idea (which is what i was initially responding to)

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how's the portfolio you discussed a few months ago coming along? how are you obtaining your leverage?

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i don't have one ofthose yet. i invested my money before i knew about this in illiquid-yet high returning- investments (i.e. some undeveloped land at below market rate in auctions, very high end real estate at great prices-even at todays levels, and a few private companies).

my friend from my old job however, does have the portfolio (or an equity heavy version of it) and it is doing well. the leveraged bonds (from interactive brokers) have done great in this tumultuous period.

Barron