The Dragon Portfolio
The Dragon Portfolio is made up of a diversification of long and short volatility asset classes best to be bought below intrinsic value.
The Dragon Portfolio is made by Christopher Cole . It has resulted on an average of 14.4% Compound Annual Growth Rate (CAGR). The portfolio was formed based on simulations of different portfolios over the past 100 years. As such, comparing traditional portfolios such as 60(stocks)/40(bonds) and many more, He was able to form The Dragon Portfolio.
What is Long Volatility?
Long volatility is basically an asset class that profits from high volatility in the market. A great example would be long straddling the SNP500. Straddling is buying a call and a put option at the same strike price and same expiration date. Other long volatility asset classes includes precious metals (such as Gold, Silver etc.) and Commodity Linked (this is basically stocks that follows the trend of a commodity). For example, Occidental Petroleum(OXY). This company essentially sells oil. As such, with the increase of oil prices in the market, $OXY is able to sell oil at higher prices = higher profits. Similarly, when oil prices of WTI dropped to approximately -$37, it had sell oil a prices significantly lower than the cost of mining the oil itself.
What is Short Volatility?
From long volatility, short volatility is basically an asset class that profits during periods of low volatility in the market. A simple example would be Bonds, short gamma strategies etc. Short Gamma is selling basically options. It can be either through calls or puts.
So how well has THE DRAGON PORTFOLIO performed relative to other investment portfolios?
Based on Christopher Cole’s graph here:
It clearly shows that the dragon portfolio has outperformed tremendously over other common portfolio allocation.
Now WHY is that?
The simplest answer is the power of re-balancing portfolio allocation. You see, the dragon portfolio is made up of asset classes that are negatively correlated to each other. For example, during periods of secular declines, gold performs very well whereas equities would perform badly. As such, I would be able to LEVERAGE INSANELY on BUYING LOW AND SELLING HIGH. This would mean during periods where gold is at all time high, I would start selling and start buying stocks, for example, below intrinsic value.
Here’s his portfolio btw:
Now let’s start with the first asset class, Equity Linked. Equity Linked refers to stocks/equities or assets that correlates to equities. Often we refer to stocks as public companies such as Coca Cola. But private companies are also correlated to stocks as they are both fundamentally in the same asset class. Equity Linked has historically perform very well during period of growth in the economy (Secular Boom).
Other assets that can be categorize as Equity Linked include Real Estate. I think that the majority of people will most likely indulge in stocks and essentially will be doing what Warren Buffett which is Value Investing. Value Investing is essentially buying business or owning shares of companies below intrinsic value. Intrinsic value refers to the true value. There are 2 ways to evaluate intrinsic value. First is known is Net-Nets which essentially taking CURRENT ASSETS AND SUBTRACTING TOTAL LIABILITIES .
This is recommended to be applied to businesses that do not have good management. As such, you can take advantage of the margin between liquidation value (intrinsic value) and market capitalization. This is also known as Margin of Safety. A good guideline for Margin Of Safety is between 30%-50% for this method of evaluating intrinsic value which is known as Cigar-Butt Style. The range depends on how confident you as a value investor are in the company itself.
This method can still be applied to Businesses with good management. The issue is that the very nature of a great business(good management) are often(99.999%) valued significantly above their liquidation value. The reason for this is that the Great business has probably done “greatly” for a very long period of time. If a “GREAT” business does well for a year and declines for 2 years, well that doesn’t sound like a great business to me. An easy method to identify these businesses with bad management would be to look at the most shorted stocks. This does not that all businesses in that list have bad management although they probably will.
The second method in evaluating intrinsic value is the discounted value of the cash that can be taken out of a business during its remaining life. This method essentially means that you use the Discounted Cash Flow Method. This method of evaluating intrinsic value requires using Net Present Value and Discounted Terminal Value.
Net Present Value is the sum of all present value minus the initial investment. By using present value, we are able to project the next 10 years of a company’s owner earnings and discount it back to the present. Hence, the name present value.
Terminal Value is used to project what the company will make at the end of 10 years. As such, with this method, it is more suited towards businesses that have economic M.O.A.Ts, a distinct competitive advantage and/or great management.
The second asset class is Fixed Income. I personally think that you should just buy AAA rated treasury bills or corporate bonds ETF. The reason for this is that I will be focusing on value investing. So the rest would simply be buying ETFs and accept market return which are not so bad.
When should you stop buying bonds?
During periods such as now(9 August 2020) where interest rates are being brought down near zero. For example, the iShares 1–3 Year Treasury Bond ETF (SHY) as of now(9 August 2020) is yielding 1.74%. Fundamentally, the government is trying to achieve 2% CPI which is the government’s metric for inflation. Real inflation is usually more than double. We’ll talk about inflation later on, but let’s get back to what this means. Essentially you are investing in an asset(which the purpose of investing is to make more money) that is making less than the CPI. Jim Grant calls it “return-free risk”
Should you not buy bonds at all?
NO. But, it is stupid to simply allocate your capital based on a arbitrary(made up) allocation only. If bonds are yielding this bad, then you should allocate to assets that are correlated to stocks such as well….. STOCKS XD.
Stocks and Bonds are correlated?
YUP.
The reason why people believe stocks and bonds are not correlated because of recency biased. This is because of the fact that since 2000, Stocks and bonds have shown high anti-correlation. But when you look at the bigger picture, the probability of stocks and bonds being highly correlated is more than double it being highly anti-correlated.
GOLD (Precious Metals)
Gold has shown that it performs immensely well during period of secular decline. One of the main reasons is the perception of safe haven as it has been used over the past 4000 years. Another reason, which is more relevant now than ever, is when recessions do occur, politicians being politicians would promote retarded shit like we should devalue our currency to shit to get short-term political gains(allegedly #dontsueme). Gold also does well in periods of high inflation due to(mainly) the devaluation of currency and not(really) due to appreciation of gold.
Personally, I would add silver as it is a more volatile version of gold and cheaper(i’m poor).
Commodity Trending
Commodity Trending are essentially stocks that reflect the price of the underlying commodity. For example, Warren Buffett recently bought Barrick Gold Corporation ($GOLD) based on his recent 13F filing on 14 August 2020. Barrick Gold Corporation (GOLD) for most of their income, it comes from mining gold. They mine gold and LITERALLY sell them. YUP THAT IS IT. Hence, anyone with half a brain would figure out that if gold prices goes up for example, 2000, 3000, 10000… u get the idea. The higher the profits.
The cost of mining 1 Ounce of Gold is approx. $1000, Currently the price is close to $2000. It is also important to take note that the cost of mining an ounce will probably go up as mining companies use Oil. Currently, the price of oil are extremely low, but in the growth period of the bull market of the commodities sector (which oil is a part of) the cost will probably go up along the price.
Active Long Volatility
Statistically, this asset class has been one of the most under allocated asset class. Long volatility essentially refers to buying options.
Christopher Cole’s strategy is to buy Equity Volatility (options) in the direction of the market after a 5% move upwards or downwards.
An example would be buying a straddle (call and put option) at the same strike price on the SNP500 OR an index fund based on the SNP500 such as $VOO, $SPY etc.
Options are designed to profit tremendously during periods of meltdowns such as 1930s, 1970s etc.
Conclusion
This is the performance of the dragon portfolio relative to the traditional asset allocation such as 60/40 stocks and bonds portfolio.
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