How it Works

In this post we are going to explore 4 major concepts that are at the bedrock of the Leveraged Portfolio run by Tines Capital. We will not reveal the exact signals of the Leveraged Portfolio, but this post will provide a good example to talk about the concepts it is built on.

To talk about these four major concepts we will look at a simulation of 4 hypothetical portfolios over the years 2000 to 2022 YTD.

  1. Stocks Simulation: For this we will use the return of VFINX which is the Vanguard S&P 500 index fund.
  2. Balanced Simulation: For this we will assume a daily allocation to 70% VFINX and 30% to VUSTX which is the Vanguard Long-Term Treasury Fund.
  3. Balanced with Leverage Simulation: For this we will use the balanced fund but assume we are using 3X leverage daily. Meaning on any given day this portfolio should move up or down by about 3X as much as the balanced portfolio.
  4. Tactical and Balanced with Leverage Simulation: For this simulation we will use the same allocation as the Balanced with Leverage Simulation, but when the S&P 500 has had a negative or flat price appreciation over the last 253 trading days (1 year) we will hold only 30% leveraged stocks and 70% leveraged bonds.

1. Stocks

Historically investing in a large, diversified set of businesses has done very well. This is because people are always working to make their businesses more profitable, invent new things, and find new services that people want. As we can see in the charts below an investment in the S&P 500 has done very well since 2000, turning a $1 into $3.85. However, an investor would have had to endure a lost decade and a drop of 55% from the peak value.

2. Balanced

Since stocks often have periods of low or negative growth, it is wise to diversify with a mix of other assets. US government bonds are a good example. Loaning money to the government via bonds can be a good investment in times of trouble. Plus since the US government has a large tax base and a printing press there is a pretty low chance they default on their plan to pay investors back. We can see that the ratio of return to worst drop improves significantly simply by diversifying into an asset with a negative correlation. Diversification will not lead to higher returns in all scenarios, but it is a wise move in many situations.

3. Balanced with Leverage

When you buy a house with a mortgage you use leverage, and depending on how it is done it can be a powerful wealth building tool. There are of course bad uses of leverage like interest only adjustable rate mortgages when you have little or no income (2008 financial crisis). We highly recommend that investors do not use leverage in markets without the guidance of a professional, because there are many wrong ways to do it. Even when done right it presents significant risk. that being said leveraged ETFs do provide a way from advisors like Tines Capital to provide clients with leverage without the risk of losing more money than they invest. This is significant! Using the balanced portfolio and applying a 3X factor to the daily return results in the growth of $1 into $12.91! Using leverage of course increases the risk and worst drop in value. An investor would have to endure an 83% drop in their investment value. Unfortunately, I think most investors would not be able to handle this. However, the ratio of the return vs the worst drop is still better than the plain stock market over this period.

4. Tactical and Balanced with Leverage

When using leverage it becomes very important to have some sort of active trading system aimed at reducing the drops a portfolio will experience. It is extremely hard to find an active trading mechanism that on its own improves total returns. However, we believe it is not nearly as difficult to find an active trading system that improves the return over maximum drawdown ratio, making for a better overall system. We believe there is a synergistic affect when combining power of investing in business, diversifying into low or negatively correlated assets, judicious leverage, and algorithmic allocation signals.

To bring it all together let’s look at the results of a simulation for a portfolio that uses all these components together. Please keep in mind that Tines Capital does not currently use a portfolio with this exact allocation, and we recommend investors do not use leverage or active trading without the guidance of a professional.

Discussion

We cannot stress enough that investors should not use leverage or active trading without the guidance of a professional or serious research. However, we strongly believe that by combining tactical strategies, leverage, diversification, and the tailwinds of business provide a powerful investment method.

Of course, there are many other crucial factors to consider for an investor such as taxes, advisor fees, time horizon, risk tolerance, and goals. At Tines Capital we take all of this into account because we want your investments to be the best for you. If you would like help investing we encourage you to reach out to Tines Capital for help!

Details

Leveraged ETFs are a main way that Tines Capital utilizes leverage if at all. However, these ETFs were not in wide use until 2009. To simulate the effect of 3X leverage back to the year 2000 the leveraged and a corresponding fee was applied to the VUSTX and VFINX. The calculations are available below.