TuringTrader's Bonds-NOT

Strategy Rules

The operation of Bonds-NOT can be summarized as follows:

• create two independent baskets, each managed by the Universal Investment Strategy
  • basket #1: U.S. Treasuries with shorter maturities and investment-grade corporate bonds
  • basket #2: long-term U.S. Treasuries, U.S. Stocks, Gold, and high-yield bonds
• allocate capital between the two baskets with the Universal Investment Strategy
• rebalance monthly

The Universal Investment Strategy performs an iterative mean-variance optimization of the managed assets. While being CPU-intensive, this method does not require an estimation of future returns or covariances, making it remarkably robust. The two independently managed baskets allow Bonds-NOT to take advantage of negative correlations while limiting the tendency to favor low-volatility assets with poor returns over better-performing investments. Each of the managed baskets has docile characteristics with low volatility, which allows combining them in a tiered approach as a final step. With this 2-tiered approach, Bonds-NOT is technically a meta-strategy, much like our All-Stars Portfolios.

Diversification

Bonds-NOT is primarily a bond strategy. However, unlike investing in the aggregate bond market, the composition of the portfolio is not static. Instead, the strategy continuously selects the best performing bonds of varying maturities and credit ratings. To further boost returns, Bonds-NOT may add exposure to U.S. stocks when conditions to do so are favorable.

Because Bonds-NOT invests in broad indices, it is well diversified for single-company risks. But thanks to its dynamic management, Bonds-NOT is better diversified across asset classes than holding a proxy of the aggregate bond market. Similar to the bond market, the strategy's beta remains close to zero.

Returns & Volatility

In most years, Bonds-NOT beats its benchmark, the aggregate bond market, including those with low bond returns. The portfolio's standard deviation of returns slightly higher than its benchmark, but other risk measures, including maximum drawdown, Ulcer Index, and maximum flat days, are lower. The risk-adjusted returns, notably the Sharpe Ratio and the Ulcer Performance Index, clearly favor Bonds-NOT over the aggregate bond market.

The Monte-Carlo simulation confirms these observations. Bonds-NOT offers a massive upside over the aggregate bond market while at the same time having a significantly lower risk profile.

Account & Tax Considerations

Bonds-NOT trades frequently and regularly triggers taxable events. Investors should not assume that the strategy holds its assets long enough to qualify for long-term treatment of capital gains.

However, it is essential to see this in perspective to holding an ETF representing the aggregate bond market. Over the past three decades, bond yields were declining. This decline resulted in bonds not only paying interest but also accruing capital gains. By holding bonds for sufficiently long periods, investors could defer paying taxes on these capital gains and qualify for long-term treatment of these gains. In 2020 and moving forward, this situation is most likely different. Interest rates have reached historic lows, and with rates staying flat or even increasing, the capital gains of bonds will no longer be a relevant factor. Under these conditions, Bonds-NOT has a very similar tax burden to holding bond ETFs.

Bonds-NOT holds up to six ETFs at a time. To allow for proper position sizing, investors should allocate no less than $10,000 to the strategy.