The Levered Butterfly Portfolio

This one adds a bit of punch compared to its Golden cousin by adding in leveraged assets. It projects to be one of the best test portfolios: with the highest safe and perpetual withdrawal rates and volatility equivalent to the moderate 80/20 portfolio.

The Levered Butterfly portfolio, October 2022
This portfolio was changed in October, 2022. I put DFAX, the Global ex-US fund in the place of PFF, a preferred shares index ETF. You can see the rationale for the change here. I have left the original text for the explanation, as well as the data tables and back tests.

The Golden Butterfly is such a nice, balanced, and logical portfolio but a bit...well...gentle. Five assets, with perfect symmetry (hence the butterfly name, as the pie chart looks like a butterfly with a golden tail), but lacking in a bit of dynamism. In the Levered Butterfly, we replace the stock and bond assets with leveraged versions to give it a little sting and then add some commodities to the mix to include another non-correlated asset class alongside gold. It doesn’t go all the way, though, as it still includes a solid allocation to short-term treasuries and to stable preferred shares. The end result is a portfolio that uses some leverage to pursue higher returns than the Golden Butterfly while still being relatively stable.

This portfolio has been created and tracked as another case study to test the question: what can we learn from this level of leverage? I targeted the standard deviation of the Bogleheads 80/20 and have used some leverage while still conforming to a pretty conservative asset mix. I’m eager to see how the pieces blend. If you use highly leveraged assets, but still make sure there is a high degree of negative correlation between them and keep the butterfly’s tail of gold and commodities - will these assets lower volatility and compensate for the use of leveraged funds?

Based on backtesting, this portfolio has essentially the same volatility as the Bogleheads 80/20 and the Qian portfolio. The Levered Butterfly projects drawdowns about half as severe as the 80/20 along with a 2% higher return, and projects to outperform the Qian portfolio, as well. The high returns with modest volatility mean this portfolio has the highest projected withdrawal rates of the ten sample portfolios. The profile of this asset mix leads me to think: instead of worrying about whether the safe withdrawal rate is 3.3%, 4%, or 4.5%, we could consider whether portfolios designed along these lines make that conversation less important. The projected safe withdrawal rate for this portfolio is actually 5.9%.

This portfolio also offers a chassis for building your own portfolio with varying amounts of leverage. In this case, the four leveraged assets are at 10% each. If you wanted, you could lower that to 5% and devote more towards PFF, the short-term bonds, or something else. You could also go the other way, and up those to 12.5% each, or even 15% each and cut out PFF and the short-term bonds entirely. Doing that brings up its leverage to +120%, and the resulting portfolio is estimated to have an annual return rate above 11%, with just a little bit more volatility than a 100% equities portfolio. I actually had that more aggressive version as my original leveraged butterfly, but thought it a bit unrealistic to actually put in practice, so made this version to contrast with the Bogleheads 80/20.

Here is the Correlation Matrix (Data from 2009; credit to Portfolio Visualizer):

Correlation Matrix for Levered Butterfly portfolio

And, the Backtest Analysis (Data from 1970; credit to Portfolio Charts):

Backtest for Levered Butterfly portfolio