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explo

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About explo

  • Rank
    师傅

Profile Information

  • Location :
    Europe

Portfolio

  • Portfolio %
    125% stocks, 250% funds, 0% solars

About Me

My portfolio is focused on risk parity allocation of uncorrelated asset groups in order to enable high return at reasonable risk.

Portfolio Return

The return of the portfolio has been tracked since inception and will be reported here on a quarterly basis.

  • Report date 2017-09-30
  • Inception date 2016-01-01
  • Total return -8.00%
  • Annualized total return -4.66%

Being independent of the length of the tracked period the annualized total return is the most relevant return metric.

Portfolio Risk

Volatility and drawdown measures are used to track risk.

  • Annualized daily volatility 21.70%
  • Maximum drawdown 19.96%
  • Longest drawdown 218 days

Although volatility is the most commonly used risk measure the drawdown profile is probably more relevant.

Asset Groups

The portfolio return is derived from two groups of assets - stocks and funds.

  • Stocks
    • Annualized total return -0.31%
    • Annualized daily volatility 8.82% 
    • Maximum drawdown 9.35%
    • Longest drawdown 571 days
  • Funds
    • Annualized total return -4.34%
    • Annualized daily volatility 17.56% 
    • Maximum drawdown 20.50%
    • Longest drawdown 218 days

The stocks and funds returns are later broken down by their respective components.

Stocks Benchmark

The benchmark consists of a stock index from which the portfolio stocks are picked.

  • Annualized total return -3.18%
  • Annualized daily volatility 6.50% 
  • Maximum drawdown 10.66%
  • Longest drawdown 634 days

The stocks return can be expressed as the excess return to its benchmark and how well it tracks its benchmark.

  • Excess return 2.88%
  • Tracking error 5.43%
  • Information ratio 0.53

A more detailed relationship to the benchmark returns is expressed by the beta value.

  • Beta 1.07

Prior to 2017-08-08 the solar ETF TAN is used as the "index" for the benchmark and after that the ^SP500TR is used. For the benchmark to be as true as possible it uses the same currency as well as daily equity and debt allocation as the portfolio stocks.

Stocks Components

Using the beta value and the annualized risk-free, stocks and benchmark returns the stocks return can be separate into three different components - risk-free, alpha and beta.

  • Risk-free
    • Annualized total return 0.55%
    • Volatility and drawdowns 0%
  • Alpha
    • Annualized total return 3.16%
    • Annualized daily volatility 5.18% 
    • Maximum drawdown 3.96%
    • Longest drawdown 413 days
  • Beta
    • Annualized total return -4.02%
    • Annualized daily volatility 6.64% 
    • Maximum drawdown 12.36%
    • Longest drawdown 633 days

The risk-free and beta returns are passive.

Alpha is the active return. This return is independent of the benchmark return. It is generated by using different stock weights than the benchmark.

Beta is the non-risk-free return achieved by the benchmark. The beta value is the multiplier of this component.

Alpha vs Beta

Alpha is considered valuable because its risk, unlike beta, can be reduced through diversification within an asset class. Alpha is however a zero-sum game. So although it is easy to reduce risk by combining many different alpha sources in a portfolio it is not certain that they will offer positive long-term return.

Beta has a great long-term return benefit in that it, unlike alpha, is not a zero-sum game in a growing economy. Everybody is a winner in the long-term at the expense of substantial short-term risks that cannot be reduced through diversification within an asset class.

A stock index fund is all beta and no alpha. An active mutual stock fund offers both alpha and beta, but managers tend to play it safe and let beta dominate. A long/short equity hedge fund tries to offer more alpha than beta.

When relying on pure beta returns it is important to reduce the portfolio risk by mixing, preferably at risk parity, the primary beta sources - bonds and stocks.

Funds Components

The funds return is derived from two different market exposure strategies - neutral and tactical.

  • Neutral
    • Annualized total return 2.58%
    • Annualized daily volatility 4.18%
    • Maximum drawdown 4.71%
    • Longest drawdown 338 days
  • Tactical
    • Annualized total return -6.92%
    • Annualized daily volatility 16.94%
    • Maximum drawdown 22.21%
    • Longest drawdown 414 days

The returns of the neutral funds are independent of market direction. The returns of the tactical funds are dependent on market direction. Tactical funds take position in multiple asset class markets, e.g. stocks, bonds and currencies. Tactical hedge funds can bet on both directions while tactical mutual funds are limited to asset class weighting of long positions.

Return Charts

2017Q3_return.thumb.PNG.140c72997f14675b29b91d16cdfc1fe5.PNG

Portfolio Allocation

  • Reserve 25%
  • Risk 75%

The portfolio equity is divided into two parts - reserve and risk. The reserve part is at all times required to preserve its inflation adjusted value. The risk part is expected to grow its value.

Risk Allocation

  • Funds 50%
  • Stocks 25%

The allocation requirement is that the maximum drawdown risk should be equal for the two asset groups. This is called risk parity allocation.

Fund Allocation

  • Hedge 35%
    • Relative Value 25%
    • Systematic Macro 10%
  • Mutual 15%
    • Tactical Balance 15%

The high allocation of hedge funds makes the funds group uncorrelated to the stocks group.

Stock Allocation

Each stock can have a light 1%, normal 2% or heavy 3% equity allocation. A stock with less than 20 listing years is considered young and a stock with more than 30 listing years is considered old. Those in between are considered to be in their prime. Allocation details are shown in the pie charts below.

stock_distributions.thumb.PNG.18d317a322402e038b7e596d86c8a39a.PNG

The risk parity allocation of stocks was 5% prior to 2017-08-08. Only solar stocks were held during that period. The sector diversification enabled the risk parity allocation to increase to 25%.

Diversification

The different types of assets used in the portfolio can be classified by how they are exposed to market movements.

  • Risk-free 25%
    • Reserve 25%
  • Neutral 25%
    • Relative Value 25%
  • Tactical 25%
    • Tactical Balance 15%
    • Systematic Macro 10%
  • Fixed 25%
    • Stocks 25%

The neutral and the tactical market exposures, i.e. the two funds components, are uncorrelated and at risk parity. The two different types of tactical market exposures are uncorrelated and at risk parity.

The fixed market exposure, i.e. the stocks, has, as previously discussed, two components - alpha and beta. These are uncorrelated and at volatility risk parity. By definition the beta component follows the stock market and the alpha component moves independently of it.

The two risk balanced asset groups are susceptible to volatility, drawdown and correlation instability, i.e that the future of these properties will differ from the past. Their respective internal diversification into two equally sized and uncorrelated components of diverse market exposure strategies however mitigates concerns about the risk of using past properties as the portfolio construction basis. Each component is further internally well diversified.

Note that there is no explicit allocation to passive market exposure, i.e. to index funds. This is because good alpha sources sometimes already have significant beta components. Allocating part of the equity to pure beta sources would due to its systematic risk not offer any marginal contribution to the risk-adjusted return. The opposite (shorting the index) could actually contribute by reducing the beta component, which has much higher drawdown risk than the other components. Allocating equity to guaranteed negative long-term return just to reduce drawdown risk might however be unwise should the future fail to repeat past alpha returns.

Leverage

The risk allocation is leveraged in order to amplify the return on equity. The same risk lever applies to all assets. The current lever is 5 which results in 5 x 75% = 375% asset allocation. This comes with reasonable risk due to risk parity and lack of correlation between the two asset groups.

The lever has not changed since inception.

 

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