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 [0:18]

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 [0:37]

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 foundational episodes for this program. And those are episodes 1357, and nine. One of our listeners, Karen, has also reviewed the entire catalog and has additional recommendations as foundational episodes. Ain't nothing wrong with that. And Karen's recommendations are episodes 12, 14, 16, 19, 21, 56, and 82, in addition to the first five that I mentioned. Now, I realize women named Karen get a bad rap these days, but I assure you that all of our listeners are intelligent, thoughtful, and savvy. Yes! And don't forget that the host of this program is named after a hot dog. That's not an improvement.

Mostly Voices [1:41]

Lighten up, Francis.

Mostly Uncle Frank [1:45]

But now onward to episode 193. This is the first episode of season three of Risk Parity Radio. Surely you can't be serious. I am serious. And don't call me Shirley. And boy do we got some fun things planned.

Mostly Voices [2:04]

Real wrath of God type stuff. Human sacrifice, dogs and cats living together, mass hysteria.

Mostly Uncle Frank [2:11]

No one can stop me.

Mostly Voices [2:16]

But in the meantime, I'm intrigued by this, how you say, emails. And?

Mostly Uncle Frank [2:25]

First off, we have an email from My Contact Info.

Mostly Voices [2:30]

Oh, I didn't know you were doing one. Oh, sure.

Mostly Uncle Frank [2:34]

Actually, we have two emails from My Contact Info, but we're going to read them together.

Mostly Voices [2:42]

I think I've improved on your methods a bit, too. And my contact info writes...

Mostly Mary [2:48]

Frank, Jeff Hooke provides some useful commentary on private equity. And then my contact info writes again... Frank, I enjoyed episode 185. Thank you. As you are aware, skill is a controversial term when applied to investing. You know, like, numchuck skills, bow hunting skills, computer hacking skills. Girls only want boyfriends who have great skills. Even if it exists, perhaps rational null hypothesis is that it gets eliminated via brutal gravitational pull of market efficiency. You can't handle the skills.

Mostly Voices [3:30]

Also, Measuring skill is extremely problematic given the non-existence

Mostly Mary [3:35]

of viable asset pricing model. The paradox of skill also makes the assumption that skill is worth paying for a questionable proposition. Thanks again for your wonderful podcasts.

Mostly Uncle Frank [3:47]

Gosh. So now starting with the first email, which is about private equity, and I will link to these things in the show notes. One is a book by Jeff Hook and it's called the Myth of Private Equity and then another is a podcast where Jeff Hook talks about the contents of the book and it's a Meb favor podcast. There are actually a number of lectures and talks Jeff Hook has given that are available on YouTube if you're interested. But Jeff Hook is a former banker hedge fund operator who worked in the private equity space. and basically has written this book to debunk a lot of the myths and beliefs about it. Just a couple of takeaways. One of the things you learn from this is that only about 25% of private equity funds actually beat markets. And I'm talking not only private equity markets, but the S&P 500. And that tends to be very fund specific. But the more important factor in that is that just because a manager has a fund that has ended up in that top quartile. If they have another fund, the chances of that fund beating the market is still just 25%. There is no manager advantage or discernible manager advantage where you can look at some fund that they did before, pick their new fund and think that you're going to perform better. It doesn't work out that way.

Mostly Voices [5:19]

Not going to do it.

Mostly Uncle Frank [5:24]

The other thing, and this is more pertinent for us as do-it-yourself investors, is that private equity takes out very high fees. You may have heard of the 2 and 20 hedge fund fees, but private equity takes out even more depending on how you count it. And what that means is it tends to be a bad deal for do-it-yourself investors. Whether it's in the form of a hedge fund or ETF. The author also says it's actually a bad deal for the people that run the big pension funds and things, who in most cases would be better off without the private equity. But we are certainly not those people. From a risk parity perspective, I think the biggest problem with it is that it's still just equity, whether it's public equity or private equity. So it's not diversified meaningfully from public equity. A private equity business is going to perform just as good or badly in a given economic environment as a public equity business. And just because it's private doesn't make it very special. So as I've said before, this is probably something that we can just stay away from and not worry about. Forget about it.

Mostly Voices [6:38]

It wouldn't be prudent at this juncture.

Mostly Uncle Frank [6:41]

Now your second email is about skill in investing.

Mostly Voices [6:45]

Why don't you have any good skills?

Mostly Uncle Frank [6:49]

Which is a more philosophical topic in many respects.

Mostly Voices [6:52]

Girls only want boyfriends who have great skills.

Mostly Uncle Frank [6:56]

And there is a link to a little blog article in the show notes. I will read just a little piece of that. to orient us all to what we're talking about here. And this is from an interview of Michael Mauboussin who is talking about his book, the Success Equation：Untangling Skill and Luck in Business, Sports, and Investing. And he says to the Wall Street Journal, the key is this idea called the paradox of skill. As people become better at an activity, The difference between the best and the average and the best and the worst becomes much narrower. As people become more skillful, luck becomes more important. That's precisely what happens in the world of investing. The reason that luck is so important isn't that investing skill isn't relevant, it's that skill is very high and consistent. That said, over longer periods, skill has a much better chance of shining through. In the short term, you may experience good or bad luck, and that can overwhelm skill, but in the long term, luck tends to even out and skill determines results. Wall Street Journal asks, you, say people generally aren't good at distinguishing the role of luck and skill in investing and other activities. Why not? Mobassan answers, Our minds are really good at linking cause to effect. So if I show you an effect that is success, your mind is naturally going to say that I need a cause for that. And often you are going to attribute it to the individual or skill rather than to luck. Also, humans love narratives. They love stories. An essential element of a story is the notion of causality. This caused that. This person did that. So when you put those two together, we are very poor at discriminating between the relative contributions of skill and luck in outcomes. So the way this applies really in markets is that when you have lots of skillful people participating in some kind of buying and selling in a market, it grinds out to the market efficiency. So the biggest markets with the most players tend to be the most efficient. and the most that are not subject to people coming in with skills and being able to beat them. And people have observed this even in different kinds of stocks, so that stock pickers are much more likely to succeed in areas of small cap stocks or in a particular country's stocks or very kind of niche areas. and much less likely to beat the market when you're talking about big index funds, the S&P 500 and other large indexes. Now, how this relates back to episode 185 that you mentioned, in that episode we were talking about the garden approach of David Stein to constructing portfolios, and I noted that it was in fact a skill-based approach given how many different kinds of assets he had and how specialized they were. And in fact, if you listen to him, he would agree with that, that he likes to focus on small markets where skill is likely to matter. So for instance, he's got a lot of materials on closed-end funds. And what he says, what he likes about closed-end funds is that because those markets are smaller with many fewer players, he feels like he could have an edge over the market itself by studying them closely. And you'll see this to be generally true in, for instance, any kind of business you might be running. If you're skilled at running restaurants, then you're more likely to succeed than somebody who doesn't know what they're doing. Ah, ho there, crusty crab. How can I help you? Pizza? Of course we have pizza. If you are very familiar with the real estate in a particular area, your chances of buying something that is a profitable rental are probably a lot higher than somebody who hasn't been there and hasn't done the work and doesn't know.

Mostly Voices [11:21]

Ah, the sweet smell of an all-day sucker. What guy in a suit? No, it's a tax collector. Hi, SpongeBob. That being said, distinguishing luck from skill, particularly investing, can generally only be done in hindsight.

Mostly Uncle Frank [11:44]

That's why it seems like there are so many skilled practitioners when there's a bull market going on, and then they all seem to disappear when the bear market appears. But this is also the way people can lose a lot of money. So for example, recently we had a lot of Cryptocurrency platforms go bankrupt or fail. But prior to that, say last year, you would find many people out there who profess to have skill in investing in that area recommending those kinds of platforms. And they thought they were skillful because they were making a lot of money at the time. He didn't fall? Inconceivable. That's the illusion. that luck gives you. You give using the word. I do not think it means what you think it means. When I was interviewing for my first big law firm job decades ago, one of the people I interviewed with says, Sometimes it's better to be lucky than good. And that is true more often than we'd like to admit.

Mostly Voices [12:49]

You need somebody watching your back at all times.

Mostly Uncle Frank [12:53]

But as do-it-yourself investors, we can improve our chances by using the statistics and proper diversification and also not having unreasonable expectations for outcomes.

Mostly Voices [13:13]

Well, you have a gambling problem. And then thank you for that email.

Mostly Mary [13:25]

Second off. Second off, we have an email from Chris, and Chris writes, hello Frank. I'm in jail. I'm calling you from jail. Well, that right there may be the reason you've had difficulty finding gainful employment. There have been commentators who suggested increasing leverage after a pullback, switching some SPY to UPRO when the market is down. The problem with that strategy is that you are increasing your risk exposure as the market is getting riskier. On a risk-adjusted basis, it's not a good trade-off. Volatility targeting strategies do the opposite, leveraging up when volatility is low and reducing exposure when it's high. Quantpedia has a decent article on it, an introduction to volatility targeting, and they reference a paper by Campbell Harvey called the Impact of Volatility Targeting. They serve as a good introduction to the concept. I thought you'd find these resources helpful, Chris.

Mostly Uncle Frank [14:30]

Well, this is a nice observation and paper you've dug up. I'll link to it in the show notes. It does give a nice description of trying to use volatility as a metric for deciding when and what to invest in. And as you say, the observation is that When volatility is high, you generally want to pull back on your investing if you're following one of these sorts of strategies, because what they end up being is what you would also call a momentum strategy, where when things are going well, you are investing more in something. Typically, when things are going badly, that's when the volatility is the highest. You are correct, sir, yes. The trouble with all of these things is that they're very difficult to manage. So I would be careful out there if you are going to venture into these areas. You can't handle the gambling problem. The rest of us will just try to stick with relatively simple portfolios and rebalancing rules to go with them. That is the straight stuff, O' Funkmaster. I also found it a little bit interesting that Campbell Harvey was involved in this kind of research. I don't follow his entire career, but for those who don't know, Campbell Harvey was the first person to observe that an inverted yield curve is a precursor to a recession, and that there's almost 100% correlation to a substantially inverted yield curve and a recession occurring. in the next six months to a couple of years. And he wrote that paper way back when he was getting his PhD. I think this was in the 1980s or something. And it's one of those few things that actually worked moving forward. Usually when somebody finds a correlation like that and writes about it in a paper, in the next 10 years, the whole thing falls apart in his circumstance. he made that statistical observation, and then it has essentially come true or been true ever since then, which is why when the yield curve inverts, you'll see Campbell Harvey get interviewed fairly often. I'll see if I can link to one of his recent interviews, so you can check that out. And thank you for that email. Say hi to mom from jail. I'm in jail. Last off. Last off, we have an email from Andrew. And Andrew writes, hi Frank, how's the health?

Mostly Mary [17:11]

Shaken off the gout? I just listened to Saturday's episode and laughed at your selection of the Dolly Parton song, the perfect rebuttal to that guy's comment. Clearly he listened to two minutes of one episode and went off and invested in the leverage portfolio or something. I am sure you didn't take it too personally as you definitely should not. For my part, I feel super relaxed about my plan and I love dropping it all straight into the Golden Ratio Portfolio. When it goes down, I feel like I am getting the next purchase at a discount. For me, it is helpful to have a coherent justification as to the splits and a good understanding of what I might expect in different economic climates. We had the tools. We had the talent. I dare say you'll get a few more notes like that before this year is out. Just know the rest of us are very appreciative. Cheers, Andy.

Mostly Uncle Frank [18:04]

Well, Andrew, let me first say that I'm glad you're getting a lot out of this podcast and our interactions. The best, Jerry, the best. And I appreciate all of you, too.

Mostly Voices [18:18]

You're gonna end up eating a steady diet of government cheese and living in a van down by the river.

Mostly Uncle Frank [18:27]

Now as to my gout. Fortunately it is under control these days. Got my new medication to reduce the level of acid in the blood and I have not been having gout attacks. So it should be gone for good as long as I stick with the program. Groovy baby. Now your reference to that Dolly Parton song. And this is an episode 186 where I played a little piece of I Never Promised youd A Rose Garden. That is actually not a Dolly Parton song. That is a song by a singer named Lynn Anderson from 1971. Although it sounds a lot like Dolly Parton. It was actually written by another artist named Joe South who had another song that won awards called Games People Play.

Mostly Voices [19:22]

What are the games people play now? Every night and every day now, never meaning what they say now, never saying what they mean. Not that we wouldn't mind playing little Dolly Parton.

Mostly Uncle Frank [19:33]

Working nine to find what a way to make living, Dolly, getting by, it's all taken and no giving. But now I do seem to be meandering far afield from the base topics of this podcast.

Mostly Voices [19:51]

Jolene, Jolene, Jolene, Jolene. I'm begging of you please don't take my man. But you can do that when you're retired. You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank [20:12]

But now I see our signal is beginning to fade. It's time for the grand unveiling of money!

Mostly Voices [20:19]

We will pick up again this weekend with our weekly portfolio reviews

Mostly Uncle Frank [20:23]

of the seven sample portfolios you can find at www.riskparityradio.com on the portfolios page. 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 put your message into the contact form there and I'll get it that way.

Mostly Voices [20:49]

All we need to do is get your confidence back so you can make me more money.

Mostly Uncle Frank [20:56]

If you haven't had a chance to do it, please go to your favorite podcast provider and like, subscribe, give me some stars. That would be great. Okay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio signing off.

Mostly Voices [21:21]

Talking about you to me, the game people play, I wonder can you come out and play?

Mostly Mary [21:37]

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.