Hey r/shares buddies,
I not too long ago backtested a “volatility managed technique” from Alan Moreira and Tyler Muir’s 2017 paper “Volatility Managed Portfolios”. My outcomes present that following their methodology for a little bit over the previous decade would have considerably outperformed the market.
Particularly, ranging from 2010, the volatility managed technique noticed a complete return that was greater than 4 occasions larger than the purchase and maintain technique. Put in different phrases, $100 invested in mentioned technique in 2010 would have became greater than $1700 at present, whereas $100 invested in a purchase and maintain technique would have became simply $480. Even higher, this technique seems to be comparatively accessible to a retail dealer by means of the ETFs: SPY, UPRO, & VGSH.
Backtest outcomes: https://i.imgur.com/kzHv5Av.jpg
TLDR
The final thought behind the technique is to weave out and in of SPY (ETF for the S&P 500) based mostly on market volatility. If the market is risky, we keep in secure US authorities bonds (VGSH, ETF for brief time period US treasuries), and if the market is calm, we purchase into SPY with leverage.
The explanation this works is that the US inventory market typically goes up, particularly in low volatility intervals, and low volatility additionally considerably reduces the price of leverage.
We will measure market volatility by calculating the latest variance of the worth of SPY.
Right here’s a excessive stage abstract of the method:
Diving Only a Bit Deeper
Of their paper, Moreira & Muir recommend that over the previous ~100 years, buyers would have been in a position to obtain optimistic alpha of their portfolio by commonly adjusting their fairness publicity as realized volatility fluctuates. In low volatility intervals, you wish to be invested within the S&P 500 and with leverage (low volatility means cheaper and safer leverage) and in excessive volatility intervals, shelter in secure US treasuries.
Our backtest confirmed that more often than not, utilizing this technique, you would be leveraged in S&P 500. It is because volatility prior to now decade has been terribly low.
This paper was written in 2017 but the technique they put forth labored extremely effectively throughout COVID. The technique shifted publicity virtually completely into US treasuries originally of the pandemic and remained there till round June earlier than returning to its regular leveraged place which allowed it to make the most of the bull run that occurred within the again half of that 12 months.
To place this in observe and make it simply accessible for a retail investor, we selected to make use of the three ETFs: SPY, UPRO, and VGSH. For affordable and easy leverage with S&P 500, who use a mixture of SPY and UPRO (3x leveraged S&P 500 ETF). Nonetheless, this additionally means you could leverage as much as solely 3x however this ought to be sufficient.
This sensible technique tracked the perfect technique within the paper fairly intently and solely barely underperformed.
Full Evaluation and Replication Directions
I am unable to submit pics in self posts on this subreddit so it is arduous to share the backtest outcomes (formulation used, charts and so forth.). I’ve linked the complete evaluation and technique replication directions under within the feedback.
I hope you have discovered this evaluation informative and useful!
