Pumping Vol in Swiss Retirement Portfolios

The following post details my experiences in getting VIAC, a Swiss provider of third pillar retirement portfolios, to do weekly rebalancing. It’s a repost of what I’d already contributed to Reddit and LinkedIn, so it’s written for a wider audience and you find it a bit too detailed in parts.

The Background

Over the past few years I’ve been digesting a number of books and academic papers on investing, with a particular interest in ideas originally rooted in sports betting and later applied to financial markets - particularly Shannon’s Demon, the Kelly Criterion, and Parrondo’s paradox. Some of you might be reminded of Poundstone’s great book “Fortune’s Formula”, and you wouldn’t be far off.

The long and short of these is that it should be possible to 1) generate returns in otherwise flat markets, 2) there exists an asset allocation so as to maximize the expected log returns of wealth (in other words, maximize wealth growth over time) and that 3) returns can be extracted not just in flat / sideways markets, but also with negative expectation trades, e.g. in environments where both stocks and bonds are expected to sink in the near term

Why is this possible?

A good definition comes from the EDHEC Business School:

The potential source of additional performance because of the simple act of resetting portfolio weights back to the original weights is referred as the rebalancing premium. It is also sometimes known as the volatility pumping effect or diversification bonus because volatility and diversification turn out to be key components of the rebalancing premium

How can this be applied to Pillar 3a?

VIAC doesn’t exactly let you click a button to do weekly rebalancing. What can be done instead is setting up a weekly recurring standing order to invest into your portfolios (you have more than one, right?).

I’m currently filling up #3 of 4, maybe 5, and have been sending money in on a weekly basis ever since Q1/2022 into that third portfolio. As such, the first two portfolios did not see active contributions for most of the year.

Until I realized I could just get my bank to transfer 1,00 CHF into each of them - as any inflow is enough to trigger a rebalance free of charge.

And as the current market environment is somewhat volatile - both for stock, real estate and foreign exchange markets - this should be as good a time as any.

I’ve since created a reporting for the Sunday before the start of this, and the Monday before initially writing up these experiences.

What stands out:

  1. With the filled-up and otherwise inactive portfolios, the “rebalancing premium” is about 1.45% and 1.72%, respectively. I calculate this by multiplying the difference in fund counts with the current fund price and dividing by the portfolio sum.
  2. Typically, an inflow of 1 CHF triggers rebalancing transactions of between 66 and 150 CHF. Those are free of charge, as VIAC pools and nets all internal transactions between its customers - so the effective volume of funds traded is orders of magnitude lower than the gross volumes.
  3. With the third portfolio that’s currently being filled, there’s a slight loss (-0.05%) versus contributions. I chalk that up to 2022 being a “down market” (-20% at its worst), which I’m using to “average down” - one of the few instances where Dollar-Cost Averaging excels.

One caveat: fund counts shown in the manual reporting may or may not be as precise as their internal weights. So some of the slippage detailed above might just arise from differences in rounding.

With that, I’m hoping to inspires more of you to try out exotic strategies in the Third Pillar investment scheme.

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First, what kind of assets allocation you are talking about? And which investment horizon?

All these premia will look insignificant once the bull run starts and you are not in max stocks. MSCI provide historical data for MSCI world index from 1970, feel free to backtest your allocation strategy.

I did some tests with finpension. The results are: sell and buy transaction prices are the same (the same fund, buying in one portfolio, selling in another portfolio) but it is off from NAV by the issue or redemption spread as indicated in the fund’s factsheet. For me it means that they book transactions in both directions at the price they effectively transacted with the fund issuer, and it was mostly buying.

Feel free to test your assumption.

@Dr.PI
First, what kind of assets allocation you are talking about? And which investment horizon?

Both do not matter, the only assumption is that the allocation stays stable across time. Obviously, if you start early, you’ll benefit of the additional CAGR for longer.

@Dr.PI
All these premia will look insignificant once the bull run starts and you are not in max stocks. MSCI provide historical data for MSCI world index from 1970, feel free to backtest your allocation strategy.

You can apply them to a 99% stocks strategy. The only thing required for harvesting rebalancing premiums / pumping volatility is fluctuating assets.

@Dr.PI
I did some tests with finpension. The results are: sell and buy transaction prices are the same (the same fund, buying in one portfolio, selling in another portfolio) but it is off from NAV by the issue or redemption spread as indicated in the fund’s factsheet.

Score one for VIAC then. :wink:

To obtain the “What stands out” section, I looked at fund counts first and prices second. Assume you don’t touch a VIAC portfolio after the first two years, those counts would stay stable across time (unless seriously out of whack). Now add weekly additions of CHF 1,00 to trigger rebalancing, and do that for a few months. Then count those funds again. Compare what’s in your portfolio now at current prices, vs. what would have been, also at current prices.

Thank you very much. It’s really cool that we can implement Shannon’s demon without transaction costs!

You can apply them to a 99% stocks strategy. The only thing required for harvesting rebalancing premiums / pumping volatility is fluctuating assets.

Well, my intuition would say that the rebalancing premium is very small if all the assets in the portfolio have high correlation to each other (as would be the case if the portfolio is 99% stocks). Would you agree?

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@tartufo:
Well, my intuition would say that the rebalancing premium is very small if all the assets in the portfolio have high correlation to each other (as would be the case if the portfolio is 99% stocks). Would you agree?

It would indeed work better with negatively or uncorrelated assets. In two out of three portfolios I added the maximum amount of gold I could (7% I believe) to achieve that. I’ve switched to 1% cash for the time being, will give this a spin until April and then consider a higher cash allocation.

From the best paper I’ve read so far on the subject [1]:

We have established the surprising result that these strategies generate port-
folio growth rates in excess of the individual asset growth rates, provided
some volatility is present. As a consequence, even if the growth rates of the
individual securities all have mean zero, the value of a fixed-mix portfolio
tends to infinity with probability one

I also found your old post on Why we rebalance and other tales about volatility. Great stuff, I’ve been reading Hollerbach / Abdelmessih / Eifert for years and may or may not have got an inspiration or three from The Great Age of Rebalancing Begins… Birds of a feather, and all that.

So I’ll leave you with a related paper from the absolute goats MacLean, Ziemba & Li [2] that may be a little more immediately useful for financial independence & early retirement than pumping vol in 3a pillars you cannot reach for some decades:

A dynamic Bayesian fractional Kelly strategy, where the investor
rebalances the portfolio based on the performance to date, is shown to be optimal
assuming that the risky assets are jointly lognormally distributed. The strategy
minimizes the expected time to reach a wealth goal while maintaining a high
probability of reaching that goal before falling to a subsistence level of wealth.

[1] Dempster, Evstigneev, Schenk-Hoppé: Growing Wealth with Fixed-Mix Strategies (2009)

[2] Maclean, Ziemba, Li: Time to wealth goals in capital accumulation (2005)

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