Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer.

Mostly Mary [0:19]

And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:36]

Thank you, Mary, and welcome to Risk Parity Radio. If you are new here and wonder what we are talking about, you may wish to go back and listen to some of the first episodes where we did our introductions of the various topics. And those episodes are episode one, 3, 5, 7, and 9. And so if you go back and listen to those, it will get you up to speed. But now on to episode 137. Today on Risk Parity Radio we are going to go through some listener emails. But before we get to those, I would like to call your attention to a new blog post article put out by Tyler of Portfolio Charts. and he put it out last week. It is called Three Secret Ingredients to the Most Efficient Portfolios. And it is a discussion as to how small cap value stocks, long-term treasury bonds, and gold impact portfolios with some analysis there on a risk reward kind of axis. And I will link to it in the show notes. But I thought it was interesting. This goes all the way back to episode 16 when we were talking about a chocolate cake with vinegar as an ingredient, that oftentimes if you look at asset classes in a vacuum, you get a distorted view as to how they would perform in a portfolio, and that putting things into a portfolio such as gold oftentimes can improve the overall characteristics of the portfolio. Whereas if you looked at that asset class on its own, you would tend to discount or discard it. and this is one of the cardinal sins I see in the portfolio construction world. You'll see somebody asked about a particular portfolio and instead of analyzing the portfolio as a whole, they will go pick at a particular thing in the portfolio and say, oh, I wouldn't want to do that for X, Y, and Z reasons. But if they're doing that, they're not appreciating why somebody might have put that thing in the portfolio and what it's actually doing overall for the whole portfolio. So we need to resist the sort of individualized picking of things because then you end up with kind of a hodgepodge shopping cart full of stuff that isn't well designed to work with the other stuff in your portfolio. And I think this article is a very good explanation as to how that works from a practical point of view because they show, for instance, how bad a hundred percent gold portfolio would be on this risk reward axis. And then you go back and show, well, if you put only this much in, then you're gonna get a much better result that goes all the way to the opposite end of the spectrum. But I will leave that there for you to look at at your leisure. And now, here I go once again with the email. First off, we have an email from Spencer, and Spencer writes, Good morning, Frank.

Mostly Mary [3:46]

My name is Spencer, and I'm a gigantic fan of your podcast. I heard you on Choose FI last year, and it was exactly the type of analysis I was looking for but couldn't find. So my question is regarding a book I read that we will not name in this podcast. The author also has a website. I'll do my best to summarize the principles laid out in the book. First off, it's a monthly rotating investment strategy which utilizes A, one of four separate index fund ETFs, and B, one of two separate bond holdings. Here are the assets from which you choose：Equities 1QQQ, 2SPY, 3IWM, 4MDY, Bonds 1TLT, and 2JNK. His theory is this：utilizing a three-month look-back period, whichever one of the four equity ETFs that has performed best, you allocate 60% of your portfolio. Similarly, utilizing a three-month look back period, whichever the two bond holdings has performed best, you allocate 40% of your portfolio. With one caveat. In the event that during the three-month look back period, all four of the equity ETFs have underperformed SHY, which I believe is a short-term bond fund, you hold 60% SHY for that month. He refers to this as the cash trigger. This method initially seemed appealing to me because he does appear to utilize risk parity principles. The author's claim is that during the backtest period, this portfolio has outperformed the S&P 500 while significantly reducing volatility. The general idea is that this portfolio should perpetually generate 12% returns while reducing volatility. The only weakness I can see is that he's only back tested this method from 2007 forward. I actually held a small experimental portfolio utilizing his methods. However, deep down in my gut, I knew this was most likely a crystal ball type forecasting method. So I switched this experimental portfolio to 50% VIoV and 50% VUG. My question for you is this. Please use your risk parity expertise to poke holes in this form of investing, as I suspect it will not perform as advertised. It looks like he may be changing the way he's evaluating hypothetical past performance of this portfolio, but I can't be certain. Bonus tip. He also advertises a similar but more aggressive investment portfolio called American Muscle that touts super high returns. It utilizes single stocks as part of the portfolio in addition to index funds and the two bond holdings. I used to pay $8 a month for this portfolio, so sue me, to run a separate smaller experimental portfolio. However, I have recently terminated that one as well and switched to a 6040 portfolio utilizing UPRO and TMF with quarterly rebalancing. By the way, love the drops. I went back and rewatched Napoleon Dynamite recently after hearing so many first offs and bow to your senseis. The drops are incredibly effective when juxtaposed with your podcasting style. Thanks for the wonderful information. I cannot get enough of it.

Mostly Uncle Frank [7:13]

Well, first of all, you'll note that we edited out the actual names of this person book and their website. Because although I don't mind talking about these things, I do not want to inadvertently promote something like this. You need somebody watching your back at all times. Believe it or not, this is actually worth kind of a mini rant.

Mostly Voices [7:38]

I want you to be nice until it's time to not be nice.

Mostly Uncle Frank [7:46]

And what this mini rant is about is the three card monty played by systems creators who do data mining. Real wrath of God type stuff.

Mostly Voices [7:57]

Now, first of all, what is data mining or data mining?

Mostly Uncle Frank [8:02]

That is the process whereby you look at a past set of data and then you construct a bunch of rules that will optimize for that particular set of data. This is an endemic problem with the financial services industry. And also it's bled over into financial academia. If you listen to the Rational Reminder podcast with Ben Felix, they often talk about this, that a lot of the financial papers that are written now are people who are trying to replicate what Fama and French did when they discovered that small cap value stocks, the small cap component and the value component, tended to give better returns over time. Since then, everybody and their mother has been trying to find other factors and other things that do that. But typically the way they do it is they look at a specific set of data that a specific parameter works for, but it only really works for that set of data. So almost all attempts to come up with a lot of different factors like small cap value that are Significantly better over time have been failures. Everyone in this room is now dumber for having listened to it. Now as to what this author is doing is even more of the carnival barker like atmosphere.

Mostly Voices [9:31]

Danger, Will Robinson, danger.

Mostly Uncle Frank [9:35]

And what's going on here is it's a system creator and people have been creating little systems oftentimes to trade futures and options going all the way back to the 1980s. I could read books about this where people would come out with these systems. Well, you buy here and you sell here and you follow this pattern and that will lead you to the road of riches. And they're always based on some kind of back testing and figuring out, well, this set of rules for this set of data worked in the past. The trouble is that's no guarantee it's going to work in the future. In fact, the more factors you put into this, the less likely it is to work in the future. and that is a consequence of something called the bias variance dilemma, which we have talked about in several earlier episodes. It's a statistical phenomena that if you're looking at a past set of data and trying to pick factors that will work well in the future, you are better off picking fewer of them. The fewer that you pick, the more simple your portfolio is, the more likely it is to repeat past successes. The more rules you stick in there, the less likely it is going to work in the future. That was weird, wild stuff. I did not know that. So this thing looks like this guy took some basic funds, did some back testing with data, came up with this, said, oh, look how well this worked in the past. Now let me see if I can sell it to people. Always be closing. whom I think it might work in the future. Always be closing.

Mostly Voices [11:11]

And so that's what he's doing.

Mostly Uncle Frank [11:18]

Am I right or am I right or am I right? The fact that he was only charging $8 a month for that other portfolio shows how terrible it probably is because if it was a great system, you wouldn't tell it or show it to anybody. You would use it yourself and make a lot more money that way. Yeah, baby, yeah. Now, the reason this particular system worked since 2007 is kind of obvious, that this was a period of very good equity returns, very steady equity returns. So the chances are something that's worked in the recent past would continue to trend that way in the future. It is essentially a momentum kind of system. Look and see what's the hot thing now and jump into that. Do I feel lucky? I suspect this would be absolutely awful in periods like the early 2000s. Forget about it. Or periods like the 1970s. Forget about it. When you saw things going up and down and what happens then is you get whipsawed. The thing that does well in the past couple of months does poorly in the next few months and so you're constantly buying the thing that is going to be doing the worst. Forget about it. We haven't had that kind of a market in the recent past, but those markets exist. They do come along and we will probably see one in the future. Do I feel lucky? And this system would really fall down on its face in that kind of a market. You can't handle the gambling problem. In order for you to adopt this kind of thing, you would have wanted to see it have worked in real time. over these past years, you would have want to seen this person actually construct this portfolio back in 2007 and have been operating it since then, not back testing from now when you have the hindsight to know what performed the best during that time period. Now, I should also say that this portfolio really does not apply any risk parity principles to it whatsoever. All it's doing is jumping out of some stock and bond asset classes. There's no evaluation of correlations or anything like that. It is simply playing on short-term momentum for these various things that he's chosen. Think McFly, think! Now, I didn't even discuss the tax consequences, which would be horrific if you were using a large amount of money to jump in and out of funds every month or two. you're going to have lots of short-term gains or losses. And to the extent you have gains, you're going to be paying a lot of taxes on them at ordinary income rates in a taxable account. So that's yet another reason you would not want to adopt something like this. Forget about it. But just be mindful, there have always been system sellers in this financial world. There will always be system sellers in this financial world. They are like the three card money guys in the street. You think you know what's going on, but you really don't, and the future is different than the past. A guy don't walk on the lot, lest he wants to buy.

Mostly Voices [14:29]

They're sitting out there waiting to give you their money, or you're gonna take it.

Mostly Uncle Frank [14:34]

So I would take your investing dollars and go elsewhere. Now, just some references for the bias variance dilemma. You'll want to listen to episodes 49, 64 and 66. And I will link to those in the show notes.

Mostly Voices [14:51]

We had the tools, we had the talent. But thank you for that email.

Mostly Uncle Frank [14:54]

We do need to expose yet another dirty corner of the financial services industry. Bow to your sensei.

Mostly Voices [15:02]

Bow to your sensei. Because you know what they want to do. I drink your Milkshake. I drink it up.

Mostly Uncle Frank [15:19]

Second off, we have an email from Hanelore and Hanelore writes, hi Frank, I recently discovered Risk Parity Radio and

Mostly Mary [15:27]

have ever since used every lunch hour to catch up on your show. So much great learning, especially about the negative correlation of long-term treasuries to stocks. As I researched that further, I came across this article on TYA as an alternative to TLT on Seeking Alpha. I would be very interested to hear your thoughts on this. Thanks, Hannelore.

Mostly Uncle Frank [15:51]

All right, thank you for bringing this up. This has to do with a new family of funds called the Simplify ETFs. Most of them have just been around for a couple of years now. This one has only been around for a couple of months. But there are some interesting things in these Simplify ETFs. A lot of them are lined up to fulfill specific roles in portfolios like this one, which is a long-term treasury component for a portfolio. There are other ones over there that have volatility components to them and some other commodities related things that look pretty interesting. and I will be interested to see how well they do perform. One of the biggest problems we have with these ETFs right now is they just haven't been around that long. So in particular, this one, it's only been around two months. I'd like to see it at least perform for a year before really thinking about it too hard. If you look at it, what it's doing is this. It is taking intermediate treasury bonds and then levering those up to create a synthetic Long term treasury bond, essentially. So it is designed to have the same risk characteristics as a long term treasury bond like TLT with the idea that it will perform a little better. And we'll talk about why that is with the next email. Actually, it was interesting. These emails came in the same day, but that is what this article speaks to that you found. And I will link to this in the show notes. The idea there is that Intermediate term treasury bonds are actually a little bit underbought when compared to long term treasury bonds. So you're essentially getting a better deal if you can use intermediate treasury bonds. The problem being is they don't have the same characteristics as long term treasury bonds in terms of the negative correlation and diversification from stocks. So the way to get around that is to lever them up. The idea should be a little bit better. Now, as I mentioned, this fund TYA had not been around that long. However, I did find another fund TYD, which has been around longer, and that is a three times leveraged intermediate treasury bond fund. It is actually in the same family with TMF, that leveraged long-term treasury bond fund we used. And I had not looked at this before simply because it has a expense ratio of 0.95, which is pretty high. So I would have thought that it would not perform as well as TLT in a portfolio with that kind of expense ratio. But I thought, well, let's go and run this in an actual portfolio. No, not by itself, but in an actual portfolio to see what it would have looked like and how it compared to TLT, at least for the period that it existed, which is since 2009. And so I ran this at Portfolio Visualizer. I will link to this in the show notes, but it did show that the portfolio, and I use a golden ratio style portfolio for each one, one with TYD and one with TLT in it, and it did show that the one with the TYD in it did perform a little bit better than the one with the TLT in it. It had a compounded annual growth rate over this period of 12.26 versus 11. 62 for the one with TLT in it. Its worst year was a little bit better at -4 compared to -4.63. Its best year was a little bit better, 23.44 compared to 22.46. And its max drawdown was less compared to the one with the TLT in it. So its sharp ratio was 1.36 compared to the sharp ratio of the golden ratio with the TLT in it of 1.33 for this period going back to 2009. So assuming this new fund TYA, which only has an expense ratio of about 0.25 or 0.15, while it's still new, performs like the TYD, it may be a good option. I think we should wait to see whether it does or not. It is based on their ability to manage some futures contracts and options contracts, but it could be a good option going forward assuming that it performs. as advertised. Another interesting and useful thing you could use it for though is also if you are tax loss harvesting out of TLT and need to buy something else, you could easily jump into this TYA as something that performs the same but is not exactly the same, so would not run afoul of a wash sale rule. So that's another thing that you could use this for. I think this is a good example of why I call this the golden age of investing. The Inquisition, want to show the Inquisition, here we go. That we are seeing many more useful ETFs come online that are of specific kinds of assets that we might use or not use in a risk parity style portfolio. And since they are specifically designed to cover a specific asset class, that makes them very useful in terms of portfolio construction. As do-it-yourself investors, we are going to have a lot more options in the future in terms of being able to construct nice risk parity style portfolios with these things. Thank you very much for that email. Yes. Our next email comes from Keith, and Keith writes：Uncle Frank, I know you are familiar with Hedge Fund E's excellent

Mostly Mary [21:22]

adventure, which uses UPRO and TMF to create a leveraged stock and bond portfolio. Have you been reading about the modified version introduced by Bogleheads forum member Skier in Colorado? Skier proposes some compelling arguments for replacing long-term treasuries with a larger position in intermediate-term treasuries. The resulting portfolios have higher Sharpe ratios, so they have better returns, assuming they are levered up to the same risk level. The hypothesis is that leverage constrained investors Bid up the prices of high beta assets in a quest for better returns. That makes the lower beta assets a better deal per unit of risk. The inspiration for this comes from a paper titled Bet Against Beta. The Bogleheads who are discussing this idea are using futures contracts to lever up five-year treasuries so that they have a volatility similar to your beloved TMF. I've gone one step further toward a risk parity portfolio using futures for stocks, bonds, and gold. Over the last six months, it has performed similarly to the models on Portfolio Visualizer. Futures might be beyond the scope of a podcast for DIY investors.

Mostly Voices [22:35]

It is real wrath of God stuff.

Mostly Mary [22:44]

Fire and brimstone coming down from the skies, rivers and seas boiling, 40 years of darkness, earthquakes, volcanoes, the dead rising from the grave.

Mostly Uncle Frank [22:51]

I wouldn't want you to violate the simplicity principle, but I'm sure you will find the Bogleheads discussion very interesting. Best wishes, Keith. So yes, this is very interesting and it is exactly what we were just talking about with Hanelore, that in theory, if you take a leveraged intermediate term treasury, you may get a better result in terms of performance than a long-term treasury or a comparable long-term treasury using leverage on the intermediate term treasuries. So I will link to the Bogleheads Forum page in the show notes that you mentioned and also this article that you mentioned. the Bet Against Beta article, which is also getting at this idea that since intermediate treasuries are underbought or underused compared to long-term treasuries and portfolios, that buying the intermediate term treasuries gives you a better deal than you get on long-term treasuries. And if you can lever them up, you should have a better performing asset overall. As for using futures contracts, yes, if you are capable of doing that, that is a good way of creating leverage in a portfolio. Tony Stark was able to build this in a cave with a box of scraps. It does kind of go beyond what we talk about here in this podcast, because it requires some advanced knowledge in terms of management and also in position sizing, which can be very difficult to figure out with options and futures if you're not familiar with them. Man's got to know his limitations. But I would anticipate that a portfolio composed of futures and options contracts, at least in the very liquid things like the total stock market or S&P 500, treasury bonds and gold is going to perform similarly to risk parity style portfolios composed of ETFs. And this is in fact what the hedge funds were trying to do when they originally constructed these risk parity style portfolios to take something conservative, add leverage to it and hopefully get a better risk reward performance than you would by simply investing in the stock market. And so thank you for that email. It's very interesting reading and it demonstrates that there is more than one way to skin this cat and apply risk parity principles to these kinds of assets. I'll be honest, fellas, it was sounding great, but I could have used a little

Mostly Voices [25:08]

more cowbell. And now, Last off.

Mostly Uncle Frank [25:12]

Last off, we have an email from Claire, and Claire writes, Hey, I'd like to advertise on your podcast.

Mostly Mary [25:19]

I run advertising for an unnamed app. I'm trying to get the word out and I'm willing to spend. I'm reaching out to you because my research suggests your pod is in the top 1.5% of all podcasts in the world. Just let me know. Thanks. Well, first of all, I'd like to thank all of our listeners for making this podcast one of the top 1.5% in all the podcasts in the world.

Mostly Uncle Frank [25:50]

Groovy, baby! I think that what that is actually saying is that the popularity of podcasts is a fractal construction arranged on a power law such that you have most of the podcasts in the world down with only a few listens, and then as you get to the right, if you will, you see a few podcasts with hundreds of listens and even fewer with thousands of listens like this one. And then you get up to the really popular ones, which have millions of listens, and I'm sure they're in the top 0.1% when you get there. But in any event, I'm very grateful for all of you listeners. The best, Jerry, the best. As for advertising. Degrade myself, huh? Homie don't play that. No, it would just create a lot more work for me and then I would feel compromised by whatever I was advertising. I don't think that's worth it at this stage.

Mostly Voices [26:40]

Forget about it.

Mostly Uncle Frank [26:44]

So I will just stick to advertising our charity, the Father McKenna Center, which you can support by going to the support page for Risk Parity Radio, www.riskparityradio.com/support Click on support. But thank you for the email anyway. It's nice to know how we're doing here. But now I see our signal is beginning to fade. We will pick up this weekend after Christmas with our weekly portfolio reviews of the seven sample portfolios that you can find at www.riskparityradio.com on the portfolios page. And we'll probably also get through some more emails. If you have comments or questions for me, please send them to frank@riskparityradio.com that email is frank@riskparityradio.com or you can go to the website www.riskparityradio.com and fill out the contact form and I'll get your message that way. If you haven't had a chance to do it, please go to your podcast provider and like, subscribe, give it some stars, so on and so forth. That would be great. Okay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio, signing off. No one can stop me.

Mostly Mary [28:00]

The Risk Parity Radio show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial, investment, tax, or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here. Making sure to take into account your own personal circumstances.