Global Macro Trading Journal

Given that high yielding currencies tend to produce returns over low yielding currencies but ocassionally blow up (or produce severe drawdowns like those long the Turkish Lira are finding out), one can even consider that they are kinda like being long high yield bonds or the stock market. Most of the time you get a higher return but occasionally you get hurt really bad. Most people would think its crazy to have 70-80% of their money in the stock market or in high yield bonds but why are they comfortable with 80% of their money in the domestic currency? This might not be such a huge mistake if their country happens be one of those stable high PPP low yield currencies (although, it probably still is a mistake) but if its a high yield country (particularly if its an Emerging Market) then almost surely that its a huge mistake.

When the Turkish scenario happens, the global wealth of the investor will drop like a rock
 
Daal said:
Given that high yielding currencies tend to produce returns over low yielding currencies but ocassionally blow up (or produce severe drawdowns like those long the Turkish Lira are finding out), one can even consider that they are kinda like being long high yield bonds or the stock market. Most of the time you get a higher return but occasionally you get hurt really bad. Most people would think its crazy to have 70-80% of their money in the stock market or in high yield bonds but why are they comfortable with 80% of their money in the domestic currency? This might not be such a huge mistake if their country happens be one of those stable high PPP low yield currencies (although, it probably still is a mistake) but if its a high yield country (particularly if its an Emerging Market) then almost surely that its a huge mistake.

When the Turkish scenario happens, the global wealth of the investor will drop like a rock
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The solution is to not suffer from "home currency illusion". Not measure wealth in terms of the domestic currency but in terms of a stable form of value, like a basket of things that keep their value over-time. There is a certain psychological element to this. It helps to 'train' one self to measure things in terms of a true store of value and not in terms of "confetti currency" like most other fiat currencies (thats why I was avoiding counting interest income from BRL as gains). I was semi aware of these ideas but it all became clear when I saw the Taleb video
Thats why I'm creating this index, so I can measure my results in terms of that. Historically I have done a lot of my measuring (in my head and on spreadsheets) in terms of USD. That's ok as its a stable low yielder but a broader approach with more diversification and less tail risk should be a superior method
 
If one thinks about it, measuring yourself in terms of the domestic currency (specially if its a high risk or medium risk currency) is kinda like measuring yourself in terms of stock market units. Lets say someone puts 50% of their money in fixed income and 50% in stocks. Stocks rise 10%, fixed income returns 5%. No one would say "shit, I gave up 5% in returns by not putting it all in stocks", they would just think "I thought that was appropriate allocation given my risk tolerance and the risks involved". If someone has 50% in the ZAR and 50% in the USD, then the ZAR jumps 10% vs the USD, its wrong to think that the 50% in the USD "lost" 10% vs the ZAR. That loss only happens if you assume the person has a huge risk tolerance and they should measure themselves in terms of high risk units, like the stock market/high yield bonds/high risk currencies that pay a lot of interest.
There is no real loss (or if there is, its much smaller) if you consider that risks that are involved in that portfolio.

This is similar to how you can't consider the 'accumulated profits' of someone who consistently sell OTM options, its 'true profit'. Its true profit is the accumulated profit minus some amount that reflects the risks that were involved with trade. Eventually the tail risks will play out a lot of the profits (perhaps all of it and then some) will be given back if such risky policy continues
 
But of course, this has to be balanced with the 'natural shorts' (the need to pay for food, rent, health care insurance, entertaiment, etc). If you put 100% of your money in the store of value index and your high risk country has a huge boom (like Brazil did from 2003 to 2008), you will get squeezed out in these natural shorts. You might have a difficulty paying for expenses because the domestic currency has soared in value (plus all the interest you could have earned in that currency). So one has to balance the need for safety/store of value with the need for not opening up these 'natural shorts' to a bigger squeeze. That's why I'm keeping 50% of my exposure in the BRL. I suspect the country will have a good run for a while and I dont want to squeeze myself for no reason
 
Taleb is in a situation where he is so wealthy (I estimate he is worth at least $10M USD) that he has his 'natural shorts' covered by so much he doesn't have to be worried about them anymore (specially given that he has book royalty income on top of his assets). He can put all his money (or the vast majority of it) in stores of value. Safety is prioritized over domestic expenses. I'm not in such position yet. I'm already more or less 'retired' (if I convered all my funds to the domestic currency, I could fund all my expenses out of real income from investments and still have money left over) but I dont have those shorts covered many times over (so there is still some risk I could be forced out of 'retirement') or I might be uncovered if I decided to increase my expenses in a big way (like if I decide to move from Brazil to say, Australia). So I have to care about the natural shorts more.

Someone who is just starting out saving and investing probably should care about the domestic currency (and the natural shorts) even more. So I think there is a relationship between someone's wealth size and how much they should keep in stores of value vs domestic currencies. People who live in countries with stable histories (the ones in the store of value index) are in a privilege position because they can make the mistake of over concentrating in the domestic currency vs stores of value and still not be punished by it. People in emerging markets routinely get wiped out when they balance that relantionship incorrectly
 
So there are two balances that one needs to get right:
1)How much domestic currency to own vs store of value currences
2)How much of each store of value (and which ones) to own

The 2nd one sounds simple but silver is so volatile that it might make sense to weight it down. I got to run some tests on its historical vol vs gold, etc. There also might be some correlations between the domestic currency and the store of value currency (SEK and DKK, CAD and USD, etc). I dont think one needs to be super perfect on that store of value allocation (1/4 CHF 1/4 DKK 1/4 AUD 1/4 gold is probably going to do a fine job or some other combination of stores of value) but I like the theory behind trying to do a 'better' or almost perfect allocation (from a tail risk minimization perspective). I think I can learn alot by trying to figure that out
 
There are perhaps three main approaches that one can take with the idea of reduced tail risks through FX diversification:

-The Taleb method. He owns the actual bonds and currencies with the bulk of his portfolio. Those positions are cash-like, he is just trying to keep up with inflation and not produce significant returns

-The Dalio method. Dalio doesn't want cash because cash will lose to assets most of the time over the long-run. But he is also all for reducing the risk of ruin and diversifying away risks. So in a portfolio, he would allocate a certain percentage (say 30-40%) of the underlying categories (stocks, bonds, etc) to foreign assets of those categories. So his 30% stock allocation could be 15% US 10% Developed 5% Emerging. Or something along those lines

-And the third method, which is the method that I have been using quite a bit. Which is to own most of my assets in USD and 'redonominate' them into the currencies that I want to own because I believe they are appropriate given the state of the world and my risk preferences. Back a few years ago when I wasn't aware that I could just buy BRL futures and roll over them (for some reason everytime I would pull up the liquidity was shit and I would think they sucked) I decided to use the AUD, NZD, CAD and NOK (commodity currencies) as proxies for the BRL, I did it on Oanda. So most of my assets where in short-term UST bonds but they were 'redenomitated' in those currencies. I would get the interest from the US bonds, plus the positive carry from those currencies (which back during the commodity boom were paying pretty good interest). When 2008 hit and commodities started to plunge, I changed the weightings a bit to focus more on defensive countries. So I added the CHF to the basket (and IIRC, the JPY as well), etc. It was a way to 'outperform' the BRL and produce am extra return. When things stabilized in 2009/2010 I was back in the commodity currencies full on and even implemented a 'beta' component to reflect that the BRL moves more and pays more interest than the AUD, NZD, CAD, NOK. So I used some leverage to 'beta weight' my basket.

Not that this sorts of interventions are recommended, I did it because I just can't help it sometimes. But the overall idea is to own assets in a Dalio like fashion (a balanced approach) but redonominate them into the appropriate currencies that are likely to reward owners and avoid currencies that are about to be devalued.

This third method is a bit more complex but I think its a good idea as an additional tool in the toolbox for a trader/investor/money manager
 
The third approach can work without interventions as well. One can own a portfolio of assets then redenominate the assets to the desired currencies (balancing the need to protect against big moves in the domestic currency but also protect one self against governments by having some stores of value/safe haven currencies). This redenomination can be a bit tricky these days because the FX brokers blew up and got hurt bad since the CHF peg black swan in early 2015.

The pairs are paying less interest and costing more, they are also not SPIC insured so there is extra risk. Futures are an option but it can be hard to position size with them unless you have an account value that is very big (or if the futures size is small like in the case of the BRL, only $31K each). ETFs aren't ideal because if you short them, you got to pay the dividend/interest AND the borrow rate. I still like some FX pairs, one just have to be careful about the costs associated with the trade. The golden age for the bucket shops is gone and they are out to cheat customers now
 
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Oanda for instance, charges -1.5% a year to long the CHF. Its just suicide to own this. Back in the day the reason I had an account there was because they had pretty good interest rates compared to IB and other places. These days its hard to own anything there
 
One cool trick is that at IB, the first 100K CHF one can own without having to pay the negative rates. The cost to own is 0% now for the first 100K
 
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