Geometric Balancing, Unlevered

The following begins a detailed look into Geometric Balancing. We start with the results of the unlevered portfolio. This portfolio is tuned to target a max 15% drawdown which it does (I will explain in another post how that works. ) Click on any chart to expand it for better clarity.

As discussed in the welcome post the strategy:

• Is long only.  No shorting. 
• Invests in 4 items:  the S&P500, the 30 year US Treasury Bond, Gold, and Cash.
• Re-balances frequently. 
• This strategy does not use leverage.
• Applies cash to the portfolio via the Kelly criterion.
• Uses a “factor of safety” in portfolio construction.
• Does NOT use momentum in any way.

The performance of the strategy:The worst year is 2001 at -3.6%. The Best year was 1995 at 38%. Only 5 years end up losing money. The strategy often slightly lags the S&P 500 in the up years, and greatly outperforms in the down years. Even so, it beat the S&P 500 in 21 of the 41 years.

The following chart shows the geometric balancing vs the S&P 500 and a 60/40 portfolio (re-balanced yearly). You can see the portfolio beats the S&P, while never suffering painful, large drawdowns. Furthermore, geometric balancing handily beats the 60/40 portfolio while still producing much smaller drawdowns. It’s not just the best of both worlds, it’s better than both worlds.

Next is a chart of the drawdown of the portfolio. The worst drawdown happened on September 21st, 2001. Outside of the post 9/11 tragedy, the worst drawdown was 12% in 1984 and 2009. Amazingly the strategy only crossed the 10% drawdown level 6 times in the past 41 years.

Below is the composition of the fund over the last 41 years. A few interesting items:

• The portfolio will go 100% cash, the last time being early 2001
• The portfolio has gone 100% stocks a few times, thought it’s not common. It can happen when bonds and gold are both very volatile.
• The strategy only went full bonds once very briefly, in 1988.
• Gold has never been above 32%. The highest it has ever been was in 2018.
• The historical average is about 50% stocks, 35% bonds, 5% gold, and 10% cash. Although as you can tell actually residing at this average is rare.
• It’s uncanny how the portfolio trades out of stocks leading into major corrections.

Next is what I call the risked drawdown. It is supposed to crudely represent the likely maximum drawdown on the portfolio if I repeated the current portfolio for 40 years. As stated earlier, the strategy tries to limit drawdowns to 15%, therefore chart never falls below 85%.

The portfolio aims for preferred return versus risk. Effectively it’s aiming for a high sharp ratio. At times the strategy will go into “safe” positions trying to meet this optimization. When it does, the risked drawdown rises well above 85%. It has generally been in this “safe” phase for the last 10 years, as seen above. The overall strategy works best when allowing some leverage due to this tendency. Leverage takes the safe portfolios and stretches them out to higher returns when appropriate. However some people are allergic to leverage, and anyway I find it best to evaluate a strategy free of leverage to start. But if you do apply leverage, this strategy produces even lower drawdowns and higher return than posted above.