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 [0:39]

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 onward to episode 150. 150 episodes.

Mostly Mary [1:14]

Who would have thunk it? I think I've improved on your methods a bit too.

Mostly Uncle Frank [1:17]

Thank you all for keeping me going with this.

Mostly Voices [1:21]

I do what I'm told.

Mostly Uncle Frank [1:25]

Today on Risk Parity Radio, we will do what we seem to do best here, which is answer listener questions.

Mostly Voices [1:32]

And so without further ado, here I go once again with the email.

Mostly Uncle Frank [1:39]

And first off, first off, we have an email from Steve. Hey, Steve.

Mostly Mary [1:46]

And Steve writes, hi, Frank. Thanks for your great podcast. I have been an avid subscriber slash listener since last April. It's the one I most look forward to each week. I appreciate I appreciate you giving up your retirement to help your listeners. I have two related questions centering around REITs I'm hoping you can help with. One, in your two REIT episodes 19 and 21, you indicate that while you use REET as a generic for risk parity radio sample portfolio calculation purposes, you are more inclined to pick eight to ten individual REITs. Do you have any suggestions for how to go about doing so for investors like me who lean toward index options as opposed to trying to pick individual stocks? because REITs are a supplement to the equity portion of your portfolio, look for REITs with relatively high return potential. What would you say is a reasonable compounded annual growth rate to look for, since equities tend to average around 10% should we look for at least 10% in our REITs as well? C. Diversify across different categories of REITs, each of which is not highly correlated with other REIT categories in your portfolio. And D. Make sure that each hold a multitude of properties for diversification purposes. Do you have any other recommendations that one should keep in mind when selecting individual REITs? Two, one of the things that has frustrated me a bit is that REITs are more difficult to backtest, at least on Portfolio Visualizer, given that Portfolio Visualizer only has REIT data back to January 1994. However, when looking for ways around this, I stumbled upon large cap value as seemingly appropriate substitution for portfolio analysis purposes. Even if its high correlation to US stocks overall don't seem to suggest that it's at all useful in a risk parity portfolio. example, using the Golden Ratio Portfolio as a test, I found that substituting LCV in lieu of REITs leads to compounded annual growth rate, standard deviation, Sharpe/Sortino ratios, and safe/perpetual withdrawal rates that are nearly identical when measured over the same time period, January 1994 to the present. Likewise, when using portfolio charts, which seems to have reached data back to 1970, Substituting LCV for REITs in the Golden Ratio portfolio produces nearly identical compounded annual growth rate and slash standard deviations, length of downturns, depth of downturns, ulcer indices, and safe slash perpetual withdrawal rates. Am I missing something? LCV clearly has a much higher correlation to the US stock market, 0.95 in the correlation analysis I did. So one would think the results would be substantially different, yet they aren't. Does this also suggest that picking individual REITs rather than a generic REIT fund might be important if we're looking for REITs to do something for our portfolio that more stocks, in this case LCV, can't do? Thanks so much, Steve.

Mostly Voices [5:10]

I'll get you a Steve if it's the last thing I do.

Mostly Uncle Frank [5:15]

All right, let's go through some of these questions. Yes. In terms of considerations as to how to pick some individual REITs. Well first, just as a process, what you might do is take a look at one of the big REIT funds like VNQ or you could even look at REET and look at the list of what's in it because it will be a cap-weighted list of a bunch of REITs, a lot of the ones that you want to own. The problem with these funds these days is they are overly concentrated on certain kinds of REITs. so for instance, you look in VNQ, what you'll see is two of the top holdings are American Tower and Crown Castle. Both of those companies work with cell towers and building out that kind of infrastructure. And so you don't need to have both of those. Just one of those is fine. If you're not familiar with the companies and what sort of REITs they are, I'm also going to link to the N-A-R-E-I-T site, which is all about REITs in North America. And it has a section that divides the REITs by category. And those categories are office, industrial, retail, lodging and resorts, residential, timberland, healthcare, self-storage, infrastructure, Data centers diversified as a multi-property specialty and mortgage REITs. If you just took the largest one in all those categories, you'd have a pretty good selection. I don't think you probably need any mortgage REITs. Those are usually more like debt instruments and they're usually leveraged and they do bad things when the market goes down, like in 2008. But other than that, that'll give you a pretty good selection. I think you mostly want to look at the large ones. These are also going to be on that list of what's in VNQ. You'll see things like Realty Inc, which is ticker symbol O, like Warehouser, which is Timberland, which is ticker symbol WY. I'm a lumberjack and I'm okay. I sleep all night, tend to work all day. And I've actually listed a whole bunch of these on that correlation analysis back in those shows because those are mostly the REITs that I happen to own. One thing that is interesting about the REIT category is that what is in there today does not resemble at all what was in there, say, 20 or 30 years ago. Most of the REITs back then were traditional rental property type operations. Most of the large REITs today are in storage, like public storage, or infrastructure, or data centers, these other categories that were really non-existent before the internet or were very small. So mostly I would take the big REITs that are across many different categories of REIT. You will have some that are more correlated with the stock market than others, but that's okay. He's a lumberjack and he's okay. He sleeps all night and he works all day. I think something like Warehousing, which does better in growing environments because it grows trees, is more correlated with the stock market than something like public storage or DLR, which is a data center REIT. But since these are such a small part of your portfolio individually, I wouldn't get too hung up on the exact correlation that they have, especially if you have other ones with very low correlations. So stick with the big ones for the most part. Try to only have one in each category. So you're talking about different kinds of businesses. And then if you've got an interest in a couple smaller ones, you might try those out. I have one called IIPR that rents warehouse and other space to the cannabis industry.

Mostly Voices [9:22]

Is that a joint, man? Like a quarter pounder, man.

Mostly Uncle Frank [9:29]

It's kind of a wild ride, but it's done all right. Mostly Maui Wowie, man.

Mostly Voices [9:33]

Yeah, but it's got some Labrador in it.

Mostly Uncle Frank [9:37]

I have another one called GLPI that is gaming properties, which is not very big, but also has done well.

Mostly Voices [9:45]

Well, you have a gambling problem.

Mostly Uncle Frank [9:48]

But I would only have a couple of those kinds of things around. I would stick mostly with the larger ones for what you're doing.

Mostly Voices [9:55]

You need somebody watching your back at all times.

Mostly Uncle Frank [9:58]

But that's probably enough on picking REITs. Now, as to your question as to why REITs do seem to perform like large cap value in the past and in some data analyses, I'm not sure why that's the case. We don't know. They may have been more similar in the past. If you do look at, say, a large cap value fund like VV and compare it to a bunch of REITs, today, though, you're going to find correlations that are similar between that and a total stock market fund. So I do think that they are a bit different and they are doing something a little different, even if that always doesn't show up in the long-term data. Part of the problem may be that the selection of REITs was certainly way more limited in times past. They have not been around that long as a structure and in the beginning they were more focused on what you would think of as traditional real estate and now they are just a form which could encompass all kinds of businesses that are somehow related to real estate but are not necessarily what you would think of if you were thinking of a REIT. Forget about it. But I will put a couple links in the show notes and thank you for that email.

Mostly Voices [11:15]

Second off.

Mostly Uncle Frank [11:19]

Second off, we have an email from Alexei. Surely you can't be serious. I am serious. And don't call me Shirley. The always prolific Alexei.

Mostly Voices [11:30]

So that's what you call me, you know, that or his dudeness or duder or, you know. Bruce Dickinson. If you're not into the whole brevity thing.

Mostly Uncle Frank [11:38]

And Alexei writes.

Mostly Mary [11:43]

Interesting article on inflation winners and losers. One counterintuitive claim here is that although the value factor is a net winner under inflation, the size factor is a net loser. AZ.

Mostly Uncle Frank [11:55]

Yeah, I will link to this article. I did read it. It confirms what we generally know about inflation and assets that do well in inflationary environments. I think the reason that you may see the value factor so much more predominant than the small factor is that most small companies would be characterized as growth companies. And so if you just take all of them in aggregate, you're getting a lot of growth stocks in there. But I will link to it so people can have a look at it themselves. And thank you for that email. And now our next email comes from the mysterious anonymous emailer My Contact Info.

Mostly Mary [12:42]

And My Contact Info writes：Thank you for discussing the article by William Bernstein that I mentioned. I also like that he has a scientific background. Since you are aware of Professor Lowe, I thought I would mention a book he recently published, see below. I recently finished it and in particular found the discussions about what constitutes a perfect portfolio interesting. The book features interviews of Markowitz, Sharpe, Fama, and Bogle, among others. Key takeaway, there's no such thing as a perfect portfolio. I continue to enjoy the sound bites. These and actual portfolio monitoring make your podcast superior.

Mostly Voices [13:14]

The best, Jerry, the best.

Mostly Uncle Frank [13:17]

And just so everyone knows what we're talking about, this article referenced is from episode 147 by William Bernstein. And I misstated that he was a surgeon. I thought he was a neurosurgeon. At least that's what I had in my mind. William Bernstein is actually a neurologist, but he's still an MD nevertheless.

Mostly Voices [13:37]

Groovy baby!

Mostly Uncle Frank [13:41]

Now as for this book by Professor Lowe about the perfect portfolio, I did pick it up. I read the summary part of it at the end and some other parts of it so far. It is a great summary of kind of the evolution of finances and portfolio construction methods.

Mostly Voices [13:59]

Real wrath of God type stuff.

Mostly Uncle Frank [14:03]

And the big takeaways from the book, I found some of them on pages 309 and 310, where Professor Lowe writes that thanks to Markowitz, we now understand diversification is the key to constructing the perfect portfolio. And he also calls it the holy grail of investing. We have been charged by God with a sacred quest. And then on page 310, he says that we should use this not only within asset classes like stocks, but across asset classes that might include stocks, bonds, real estate, commodities, and other things. And then he goes on to say that history should be your guide for assessing returns, variations, and correlations.

Mostly Voices [14:52]

You are correct, sir. Yes.

Mostly Uncle Frank [14:56]

What was maybe more interesting was on page 320, after going through summaries of all 10 of the famous economists and investors, on page 320 he said that Markowitz's idea of diversification is universally accepted but is the only thing that these experts agree upon. And then he goes on to talk about the various differences and how they are influenced by the temperaments of the individuals involved. Where this comes out or where it relates to this podcast is that one of our guiding principles here is the Holy Grail principle. And what this podcast seeks to do is to elevate that principle up much further in the portfolio construction, decision-making framework than most people put it at. There can be only one. And so after looking at the basic return characteristics of an asset, our next step generally is to look at correlation so that we can apply the Holy Grail principle of diversification in a way that makes sense and is based on numbers and not feelings or narratives about investments that may not be diversified in reality, even though they seem like they should be in one's mind. You are talking about the nonsensical ravings of a lunatic mind. And I think this book is further confirmation that as do-it-yourself investors, we really need to take on the task of analyzing our portfolios for their correlation characteristics and how that affects the overall portfolio in terms of volatility, drawdowns and returns. We use the Buddy system. No more flying solo. But it's nice to confirm that we're moving in the right direction. So thank you very much for that email and that book reference. I will Continue reading it until I've read all of the summaries of all the individuals involved. Mass hysteria. And now... Last off. Last off, we have an email from Brandon, and Brandon writes... Great show.

Mostly Mary [17:22]

I discovered Risk Parity Portfolios after reading the book entitled Risk Parity published last year, and then found your podcast and have been learning a lot more. My question is why you use the preferred shares fund PFF in several of your sample portfolios. I heard you say in one episode it's because it's supposed to function as an asset class in between common stocks and bonds. However, a naive look at the historical performance of PFF shows that net depreciating even over the last 10-year stock bull market and subject to sharp drawdowns along with the rest of the overall stock market. So it seems like it has the disadvantage of stocks and bonds with little upside other than having low correlations. probably because it hardly changes in value at all over the past decade or so. But I suspect that I might be missing something.

Mostly Uncle Frank [18:12]

All right, let's talk about PFF, which we also reviewed in excruciating detail in episode nine. If you want to go back and listen to that one. This is a preferred shares fund. It tends to have about half of the volatility of the stock market. Over time, it tends to yield about 5%. almost all of its yield is paid out as qualified dividend income. So the price of it doesn't go up and down very much. I think you may have been missing the income component of this. If you want to go to somewhere like Portfolio Visualizer and put in PFF, you can see its performance as if the dividends were reinvested. And so you can see the growth there over time. So why do we use this in some of our sample portfolios? When we look at the accelerated permanent portfolio, which is one of the ones we use it in, remember that that portfolio is based on Harry Brown's original permanent portfolio. His original permanent portfolio was one quarter stocks, one quarter long-term treasuries, one quarter gold and one quarter cash or money markets, short-term bonds, things like that. We decided in this version since we're sort of ramping things up that we would replace the cash with something with a little more oomph to it. And so instead of using cash or a money market there we used PFF for that portfolio. But relative to the other components it still has very low volatility and low returns like what Harry Brown had in there to begin with. Now the next portfolio we use this in is also one of the experimental portfolios. This is the aggressive 50/50. And the idea of that portfolio was to construct a leveraged stock bond portfolio based on a simple 50/50 stock bond mix. Now we did not want to put too much leverage in that so we kept the levered parts of it, which are a leveraged stock fund, a UPRO and a leveraged bond fund, TMF. Those are two-thirds of the portfolio. The rest of the portfolio we had to divide into stocks and bonds, but I wanted it to be really muted on that side of it, so that part of the portfolio would just function as ballast. So that part of the portfolio just has 17% in PFF, which is the stock-like component in it, and then it's got 17% in VGIT and Intermediate Treasury Bond Fund. And the idea of those two funds was just to act as 50/50 placeholders, essentially, in the portfolio because the action is going to be on the side of the leveraged funds. Now, the third portfolio we put this in is the Risk Parity Ultimate Portfolio. I believe it's got 10% of PFF in it. Now the purpose of that portfolio was to try and model something that had the kitchen sink in it. We view that as having probably too many funds in it, but we didn't want to have many, many different sample portfolios. It was easier to construct this one with the kitchen sink in it, which includes PFF. And then the real challenge of that portfolio was to balance out the allocations in the various components to come up with something that was reasonable and would perform comparably to, say, a 60/40 portfolio. Now, I agree with you that most people are not going to have a use for this kind of fund in their portfolio. The kinds of people who use this in real life are like Rick Ferri, Mr. Boglehead. In his personal portfolio, he wanted to have an income Generating component in his taxable side and what's in that is part PFF and part municipal bonds because he's trying to reduce the tax liability from that. And that I believe is the most likely use of it for somebody in a higher tax bracket that doesn't want to pay high ordinary income but wants to have some income and pay the long-term capital gains tax rate on it. For most people, this is not going to be an issue they need to worry about. Forget about it. But for some people, it will be a useful arrow in their quiver or golf club in their bag, if you will. Top drawer.

Mostly Mary [22:46]

Really top drawer. But thank you for that email.

Mostly Uncle Frank [22:50]

It is good to review these asset classes and remind ourselves what we were doing with them when we put them where we did put them, because sometimes you end up making changes based on that. But now I see our signal is beginning to fade. It's time for me to fetch a bottle of wine so that Mary and I can celebrate episode 150. No one can stop me.

Mostly Voices [23:17]

I want to thank all your listeners again for your excellent support and

Mostly Uncle Frank [23:21]

excellent questions. It is more than gratifying to have this kind of audience. This is Ken Dorfman.

Mostly Voices [23:28]

He's a legacy from Harrisburg.

Mostly Uncle Frank [23:32]

We will be picking up this weekend with our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com on the portfolios page. And maybe we'll get to some emails for February. I think we've just finished January. If you haven't had A chance to do it. Please go like, subscribe, give us some stars, a review, and please do that at your favorite podcast provider. That would be great. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio signing off. The smell of fresh cut timber.

Mostly Voices [24:12]

The crash of mighty trees. I cut down trees, I wear a hill suspenders and a brass. I wish I'd been a girly, just like my dear Papa. I cut down trees, I wear a hill suspenders and a brass. I wish I'd been a girly, just like my dear Papa. Oh, fathers. The Risk Parity Radio show is hosted by Frank Vasquez.

Mostly Mary [24:43]

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.