Riding the HEDGEFUNDIE Adventure (UPRO/TMF) on M1 Finance

Here we dive into the famous “Excellent Adventure” from Hedgefundie and how to implement it on M1 Finance.

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In a hurry? Here are the highlights:

• Hedgefundie is a member of the Bogleheads forum.
• Hedgefundie created a thread in February 2019 proposing a 3x leveraged ETF investing strategy based on risk parity using the S&P 500 index (UPRO) and long-term treasury bonds (TMF) held in a 40/60 allocation.
• Hedgefundie later updated the strategy’s asset allocation in August 2019 to 55/45 UPRO/TMF.
• Extensive backtesting, discussion, and analysis within the thread by members of the Bogleheads forum supports the validity and potential market outperformance of the strategy.
• The proposed strategy calls for quarterly rebalancing.
• Several different protocols/variations of the strategy emerged in the Excellent Adventure thread, including monthly rebalancing, rebalancing bands, and volatility targeting with various lookback periods.
• Some users have added a dash of TQQQ (3x the NASDAQ 100 index) for a minor tech tilt, as Big Tech has had a stellar run recently.
• It is recommended to implement the strategy within a Roth IRA on M1 Finance, to avoid tax implications and to make regular rebalancing seamless and easy.

Disclaimer:  While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or transact in any of the products mentioned. Do your own due diligence. Read my lengthier disclaimer here.

Who is Hedgefundie?

Hedgefundie is a member of the Bogleheads forum who created a now-famous thread on the forum proposing a 3x leveraged ETF strategy.

What is the Hedgefundie Strategy?

The Hedgefundie strategy – the wild ride of which has become known as “Hedgefundie’s Excellent Adventure” – is based on a risk parity allocation of leveraged stocks (3x the S&P 500 index via UPRO) and leveraged long-term treasury bonds (3x the ICE U.S. Treasury 20+ Year Bond Index via TMF).

Risk parity is a portfolio allocation strategy in which, consistent with Modern Portfolio Theory (MPT), risk is spread evenly among assets within the portfolio by looking at the volatility contributed by each asset, thereby attempting to optimize returns per unit of risk (Sharpe).

The Hedgefundie strategy relies heavily on the negative correlation (or at least, uncorrelation) between stocks and long-term treasury bonds, wherein the bonds provide a buffer during stock drawdowns. Long-term treasuries are chosen precisely because they are more volatile than shorter-duration bonds and because of their degree of negative correlation to stocks, in order to sufficiently counteract the downward movement of a 3x leveraged stocks position. This concept is based on the simple historical principle of improving risk-adjusted return (Sharpe) over long periods by holding uncorrelated assets, such as a traditional 60/40 stocks/bonds portfolio, as opposed to 100% stocks.

Consistent with the idea of Lifecycle Investing, this heavily-leveraged strategy is better suited for young investors with a long time horizon who can afford to be risky early in their investment horizon. Hedgefundie advocates for treating this strategy like a “lottery ticket” and not using it with a significant portion of your total portfolio value.

Critics and naysayers reflexively exclaim the oft-cited, overblown, platitudinous “Leveraged ETF’s aren’t meant to be held long-term because of volatility decay,” but, in short, that doesn’t concern me. Moreover, that same volatility decay can actually help when upward movement with positive momentum is occurring. I would also argue that as long as you can stomach the volatility, a major drop should [eventually] be followed by a major rebound; 3x hurts on the way down but helps on the way up. UPRO from ProShares and TMF from Direxion were chosen due to their low tracking error and high volume; again, we’re getting 300% exposure to the S&P 500 and long-term treasury bonds, respectively.

The proposed strategy calls for quarterly rebalancing. Several different protocols/variations of the strategy emerged as the Excellent Adventure thread progressed, including monthly rebalancing, rebalancing using bands, and volatility targeting with various lookback periods. It is recommended to implement the strategy within a Roth IRA on M1 Finance, to avoid tax implications and to make regular rebalancing seamless and easy.

Utilizing a traditional, unleveraged 40/60 stocks/bonds portfolio, compared to an all-equities portfolio, has relatively low volatility and should produce higher risk-adjusted return (Sharpe) over long time periods, but would also likely underperform an all-equities portfolio in terms of total return. The solution, Hedgefundie maintains, is applying leverage. We’re attempting to accept a risk profile similar to that of the S&P 500, but with much higher returns.

Hedgefundie updated the approach 6 months after posting the original strategy, opting to move to a 55/45 UPRO/TMF allocation from the previous 40/60 risk parity allocation. Hedgefundie’s reasons are laid out here, based primarily on the premise that the stocks portion of the strategy is the primary driver of the strategy’s returns and that the main purpose of holding the treasury bonds is essentially as “insurance” in case of a stock market crash.

Intrinsically, we’re relying on US stocks and long-term treasuries not crashing in tandem. At the time of writing, these assets have a seemingly reliably negative correlation close to -0.5. A key fundamental assumption of this strategy that Hedgefundie proposes is that the US will not return to pre-Volcker (pre-1982) monetary policy. That is, we’ll be able to significantly mitigate or altogether avoid hyperinflationary periods like the late 1970’s, during which time bonds suffered greatly.

Stocks and long-term treasury bonds do not have a perfect -1 correlation. Sometimes they move in the same direction. This is actually a good thing. Historically, when these assets moved in the same direction, it was usually up. On days when stocks dropped, long-term treasuries fairly reliably rose significantly to mitigate the total loss.

Simulated returns going back to 1987 look like this:

Here are the rolling returns:

Below are the drawdowns. Notice the smaller drawdowns in most cases compared to the S&P 500:

I agree with Hedgefundie’s assertion that extremely volatile assets like gold, commodities, small caps, etc. would suffer worse from volatility decay and would not improve the strategy’s diversification and return. International developed markets may be a viable option to include, but Boglehead member siamond found issues with the DZK ETF.

Some users have added a dash of TQQQ (3x the NASDAQ 100 index) for a minor tech tilt, as Big Tech has had a stellar run recently.

Make no mistake that this is a risky strategy by its very nature. Read up on leverage and the nature of leveraged ETF’s before employing this strategy. Do not put your entire portfolio in this strategy.

Read more details and nuances of the strategy on the original thread here. If you’ve got the time, there’s a lot of learning to be had throughout the entire thread. The thread has expanded into a Part II here.

Alternative Options to the Hedgefundie Portfolio

If you want to utilize a leveraged strategy similar to that proposed by Hedgefundie but be completely hands off, PIMCO has been doing something similar for years with their StocksPLUS Long Duration Fund (PSLDX) since 2007. Read more about the fund here. Note that you can only access this fund through certain brokers, and it may have a minimum investment requirement. Those details are beyond the scope of this post; ask your broker if it’s available to you.

Similarly, if you’re doing this with a small portion of your portfolio or if you want to employ a leveraged strategy in a taxable account, WisdomTree’s NTSX may be a suitable option, effectively providing 1.5x leverage on a traditional 60/40 stocks/bonds portfolio. It holds 90% straight S&P 500 stocks and 10% treasury futures to achieve effective exposure of 90/60 stocks/bonds. Read more about the fund here.

Bogleheads user MotoTrojan proposed a variant by which you can match the volatility of Hedgefundie’s 55/45 UPRO/TMF and save some on the expense ratio of TMF by utilizing Vanguard’s Extended Duration Treasury ETF (EDV) in a ratio of 43/57 UPRO/EDV. Here’s an M1 pie for that.

A leveraged All Weather Portfolio may also appeal to you.

The Hedgefundie Portfolio ETF Pie for M1 Finance (UPRO/TMF)

Again, most users are utilizing M1 Finance to deploy the Hedgefundie strategy due to its dynamic rebalancing with new deposits, zero transaction fees, and its simple, 1-click rebalance that you can do quarterly. It takes no more than 30 seconds every 3 months. I wrote a comprehensive review of M1 Finance here.

The risk parity 40/60 portfolio would be this pie which looks like this:

• 40% UPRO
• 60% TMF

To add this pie to your portfolio on M1 Finance, just click this link and then click “Save to my account.”

The updated 55/45 portfolio would be this pie which looks like this:

• 55% UPRO
• 45% TMF

To add this pie to your portfolio on M1 Finance, just click this link and then click “Save to my account.”

Disclosures: I am long PSLDX, NTSX, UPRO, and TMF.

Disclaimer:  While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or transact in any of the products mentioned. Do your own due diligence. Read my lengthier disclaimer here.