Global Macro Trading Journal

[Daal]

But how huge a buy where Greek bonds after the reestructuring? I need to get more familiar with EU markets and fundamentals, that was a huge opportunity. In 2012 they switched those Greek law bonds to English law, cut down domestic debt to GDP dramatically (the paper talks about a €100B gift to Greek tax payers, 50% of GDP) but more importantly, they changed the mix of Greek debt holders massively. Now the ones hold the bag are the ECB and EFSF, private bondholders own a small % of the debt.

Any future reestructuring will have to involve the EFSF but especially the ECB. This arseholes was sparred 100% while pension funds and people living on incomes (during a depression!) had to suffer a big loss.

In the future, I doubt private bondholders will be down with any bs reestructuring, the ECB and the EU (and the IMF) better prepare because they will be the ones involved in the haircuts in the future. Private bondholders can probably try some refuge under English law arguing unfair treatment due the ECB being protected against losses while everyone takes on the chin

Since 2012 Greek bondholders more than double their money, it was one hell of a buy

 

[Daal]

According to the central bank data, the 30y Greek bond was yielding 16% by the end of March 2012 (after the debt reestructuring). Assuming a expected low inflation rate of 1%, these bonds were paying 15% real for 30 years
€100,000 invested in these bonds would turn into €6.6M after 30 years, all returns above inflation. Even if there was some expectations of default, you were getting so much in interest that it wouldn't take that long to get your capital back. And whats crazier, these bonds went down after they started to trade! The yield went as high as 23% (22% real for 30 years)
By year end people started to wise up and the yield collapsed to 11%, buyers who stepped in were compensated with a huge capital gain

 

[Daal]

This was such a sweet setup for anyone in Europe looking to retire. I dont care how scared they were, if you got something like €500K, in situations like this, it pays to close your eyes and buy (putting something like €75K). If you are wrong, you lose maybe half your money, if you are right, you retire in 10-20 years or so. The payoff is so ridiculous you just have to get involved
Plus in depressions usually risk premiums are too high anyway, its all positive expected value

 

[Daal]

Is it too late to get involved in Greece? In the bond market, maybe, yields are now at 7%, still a decent return but its more balanced with the risk now. There is probably still some room (since these bonds are far from a popular investment and depressions bring risk premiums up as people need liquidity and are scared) but if there is any place that could run is in equities. I got a 1.5% position there (nothing major) but inflation, GDP and other stats have improved. Any debt reestructuring should fall to the offshore public sector (the EU and IMF) and if they pull out of the EUR (and the new drachma plunges), that would be a good thing as I would get the chance to buy more and ride up for a huge reflation boom. At least, that's my thesis

 

[Daal]

€100,000 invested in these bonds would turn into €6.6M after 30 years

Of course, that's assuming one can reinvest the coupons at the same interest rate which is as it turn out, didn't happen. But even a lower reinvestment rate would still produce an attractive final return

 

[Daal]

Looks like Pabrai is not doing so well ever since he got famous and increased his AUM

https://www.dropbox.com/s/p2h51kc4i7ybl4c/Pabrai Funds 2015 Annual Letter.pdf?dl=0

And by his statements he lost more in 2016. That's always an annoying risk to HF investors. To find a fund that you like but that loses performance right at the moment when you find it (because the fact that you found means other have found it and the AUM popped)
Pabrai even says he sucks on investments that go above the 4.9% stake level, says he never makes any money on it. So it looks like he has issues scaling up his strategy

 

[Daal]

Read an important paper that talks about the dangers of using Compounded Rates of Return to make investment decisions

http://www.bfjlaward.com/pdf/25968/65-76_Chambers_JPM_0719.pdf

"The expected compound rate of return is a misunderstood
measure of performance, because it focuses
on rates and creates an illusion that volatility “punishes”
expected growth (not just growth rates)."

"A focus on average compounded rates
leads to the misconception that the asset does not offer
any expected long-term growth."

"Expected portfolio values are governed
by arithmetic means, not geometric means or
volatility."

He also talks about rebalancing

"A clearer description of the effect of rebalancing is
to describe the effect on return as “rebalancing return”
and to note that rebalancing return should generally be
positive when asset prices are mean-reverting and negative
when asset prices are trending."

"However, portfolio rebalancing can serve as an effective
mean-reverting strategy. When underlying returns
are mean-reverting, rebalancing offers a free dessert. It
does so through allocating away from previously highperforming
assets toward previously low-performing
assets, not through diversification or volatility reduction.
The expected gains of rebalancing mean-reverting
assets come from the expected losses of other traders who
are implementing trending strategies, not from turning
water into wine."

One has to be careful when dealing with compounded growth rates, expected value is more related to Arithmetic returns rather than Geometric returns

He also talks about how rebalancing decreases volatility (dispersion) and increases returns (assuming assets are not completetly uncorrelated, yes, total lack of correlation is bad for rebalancing). But diversification does not add to returns (it only reduces volatility).
I happen to think that diversification "adds" to returns in a relative sense. If you owned 100% in Russian equities in 1917 you lost 100% or close to it. But if you owned 50% Russian and 50% UK, you kept half of your money. So in that sense, diversification 'added' to the returns by removing tail risks/risk of ruin

 

[Daal]

A rule that can be derived from that paper is to make sure you look at both expected arithmetic and geometric returns (as well as historical) before making an invesment decision. As well as understanding the differences between both. There might be discrepancies that will lead to a poor decision if one only looks at one of them (like the bank CD example he gives). The rule can prevent such issue

 

[Daal]

Thought I run an additional test with Greek returns. The effect of adding cash as an 'asset class' at the rule of thumb 15% allocation (and the returns are the inverse of the inflation rate). Its an idea that I suspect Dalio implements in his All-weather fund (he talks about how they monitor central banks to override the system if they think the returns of cash over assets will be superior for a period of time. Its also something that El-Erian advocates as a form of a 'barbell strategy', he is 30% cash right now.

I tested a cash allocation right at the start of the period to make it simple but I don't think it would make a huge difference if I added it later (when signs of trouble emerged to make it 'realistic')

the 'month' word is there by mistake

-45.2% real versus

-53% Without cash. And this with the harsher S&P data.
Without rebalancing the result is -42% vs -50%. So it would have helped but still, its hard to salvage investors from a decent sized loss with such a hard macro period

 

[Daal]

I'm building a 'dynamic' excel backtester that will be able to run tests (with rebalancing or not) on pretty much any return(s) stream quickly. It will adjust almost automatically to new data with just a few manual inputs. This will make the process for backtesting new data (new countries, or different time frames) very quickly for me. I'm trying to do it right so I don't ever have to do it again. With that it will be pretty interesting the different tests I will be able to run.
Then it comes the other part of the challenge, getting the data, often its the most difficult