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. Thank you, Mary, and welcome to Risk Parity Radio.

Mostly Uncle Frank [0:48]

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. Yeah, baby, yeah!

Mostly Voices [0:51]

And the basic foundational episodes are episodes 1, 3,

Mostly Uncle Frank [0:55]

5, 7, and 9. Some of our listeners, including Karen and Chris, have identified additional episodes that you may consider foundational. And those are episodes 12, 14, 16, 19, 21, 56, 82, and 184. And you probably should check those out too because we have the finest podcast audience available. Top drawer, really top drawer, along with a host named after a hot dog.

Mostly Voices [1:35]

Lighten up, Francis.

Mostly Uncle Frank [1:39]

But now onward to episode 230. Today on Risk Parity Radio, it's time for our annual portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com. on the Portfolios page. And we'll also be talking about distributions for January. So we will dispense with emails today. We have lots of numbers to talk about. Most of them you will also find on the website, on the Portfolios page. And so without further ado, 2022 was a year of superlatives and mostly negative superlatives as far as investing was concerned. It was the worst year for the stock market since 2008. It was the worst year for the bond market, perhaps ever. At least that's what I've heard some people say.

Mostly Voices [2:37]

Like anyone can even know that.

Mostly Uncle Frank [2:42]

Certainly since about 1937 is the other date that gets quoted and similar to a couple of years back in the 1970s. And as a consequence, for any portfolio that was composed largely of stocks and bonds, it was a very bad year, including the portfolios on the portfolios page that we have. You know, Quasi-Moto predicted all this.

Mostly Voices [3:06]

Who did what? All these problems, the end of the world. Nostradamus. Quasi-Moto is the hunchback of Notre Dame. Oh, right. Notre Dame. Notre Dame and Notre Dame. It's two different things completely.

Mostly Uncle Frank [3:34]

And so I thought we would go through all the main asset classes and types of funds first, then talk about some reference portfolios, and then do some comparisons with the ones that we track. And then we'll see if we can take away any lessons here.

Mostly Mary [3:41]

That's not how any of this works. First, taking a look at the stock market, the S&P 500 was down 19.

Mostly Uncle Frank [3:50]

44% for the year 2022. The Nasdaq was down 33.1% for the year. Small cap value did a lot better. It was only down 11.38% for the year. And that's looking at the fund VIOV. It was interesting because the best performing factor selection was actually large cap value, which was only down about 2% for the year if you look at something like VTV. So this was a very unusual year.

Mostly Voices [4:22]

Rivers and seas boiling. 40 years of darkness, earthquakes, volcanoes.

Mostly Uncle Frank [4:29]

Usually growth and value are a little bit different, but they are usually not 20 or 30% different. Now, part of that had to do with the extreme outperformance of the energy sector last year, and that was up about 58%, which was the only sector that was up. And when you compare that to the communications sector, consumer discretionary, those were down over 35% each. Real estate was down over 28% in Technology was down over 28% as well. Most of the other sectors were close to flat. But that is also a very unusual environment to have. And I'm not sure that there's ever been an environment where you saw the sectors perform that differently in one year. The dead rising from the grave. Now moving to other asset classes. As I mentioned, bonds had probably the worst year on record. The representative fund, VGLT, or long-term treasuries, correspondingly was down 29.35%, and even intermediate-term bonds were down over 10%. Preferred shares were also down. Our representative fund, PFF, was down 18.18%. As I mentioned, REITs were down too. Our representative fund, R EET, was down 24.07%. But now let's go to the positives, and they were all in alternative sectors. Gold was actually up very slightly. It was up 0.02% for the year. Commodities were up a lot. Our representative fund, PDBC, was up 19.25% for the year. And managed futures were also up a similar amount. Our representative fund, DBMF, was up 21.53% for the year. Some other alternative strategy type funds did well. A fund we've talked about before, BTAL, which is what is called a long short fund. It buys some stocks and sells others. In its case, it was buying mostly value related stocks and selling mostly growth related stocks. It was up 20.47% for the year. And finally, just one other asset class of note. and these are TIPS funds. They actually did worse than nominal bonds, believe it or not. The inflation protection was not very much protection. And so the fund TIP, which is the most representative fund for that, kind of a total market TIPS fund, it was down 12.24% for the year. The long-term TIPS fund, LTPZ, was down 31.68% for the year. And I think that surprised a lot of people. Bing! Because they certainly did not perform as advertised. Bing again! Now let's go through some reference funds for consideration. A typical 60/40 portfolio represented by the fund VBIAx, the Vanguard Balanced Fund, which is basically just a combination of an S&P 500 and a total bond market in a 60/40 ratio. That was down 16.9% for the year. Now, two of Vanguard's commonly held managed funds actually did a bit better. If we look at the Vanguard Wellington Fund, VWENX, that was only down 14.26% for the year. And the Vanguard Wellesley Fund, VWIAX, was only down 9.01% for the year. and those funds really benefited by having large allocations to large cap value. I also took a look at two commercially prepared risk parity funds, RPAR and UPAR. Now both of those are constructed in the kind of traditional way similar to the All Seasons portfolio we have, but they have some leverage put into them. So they're mostly bonds, including some tips, and then the rest being allocations to stocks and commodity related things. Anyway, the less levered one, RPAR, was down 22.8% for the year, and that one has a leverage ratio of about 1.2. The more levered one, UPAR, was down 33.3% for the year. and that one is levered about 1.6 to 1. The leverage in those funds is provided through the use of futures and options contracts. I also went and took a look at a couple of the funds over at AQR Asset Management. AQR is famous for pioneering alternative strategies, basically risk parity on steroids, and they've written a lot of white papers about these topics. many of which you can find over at Risk Parity Chronicles on the resources page. Yeah, baby, yeah! But I took a look at their kind of flagship fund, AQRIX, which is invested in stocks, bonds, and commodities. That one didn't do too bad this year, was down 10.52% for the year. And then I looked at another fund they have, their which is a ticker symbol QDSIX, which is a fund of funds and has just about every strategy you can imagine in it, including managed futures, long/short investing, and straight stocks, bonds, and commodities. That one was actually up for the year based largely on those alternative strategies. It was up 14.69% for the year, which is highly unusual, but it's a highly unusual fund. But now let's take a look at these sample portfolios. The first one is the All Seasons Portfolio. This is a reference portfolio, as I mentioned, designed in that kind of classical risk parity style, similar to the RPAR and UPAR funds only without leverage in it. So it's got 30% in a stock fund, VTI, 55% in intermediate and long-term treasury bonds and the remaining 15% divided into gold and commodities. It was down 19.28% for 2022 and is down 8.06% since inception in July 2020. So that one performed similarly to the commercial risk parity funds that I mentioned, only without the leverage. So it wasn't quite as bad. But as you can imagine, since it was a bond-based portfolio in the supposed worst year on record for bonds, human sacrifice, dogs and cats living together, mass hysteria. It probably had one of its worst years ever. At least for the data we have available. And that's generally true for all of these portfolios. 2022 is kind of a worst case scenario, if you will. Bring out your dead! Bring out your dead! All right, moving to our next one, the Golden Butterfly. This is more comparable to a 60/40 kind of portfolio. And it didn't do too bad all things considered. It was down 13.54%. for the year of 2022. It's up 7.22% since inception in July 2020. And so it did about 3. 5% better than the VBIX 6040 portfolio that I mentioned before. And I should mention what's in it. It is 40% in stocks divided into a total stock market fund and a small cap value fund, 40% in bonds divided into long-term and short-term treasuries and 20% in gold. And what helped it in particular in 2022 was its exposure to 20% in gold along with the small cap value exposure. And the short-term bonds hung in there as well, but you wouldn't expect them to move very much in any given year one way or the other. Moving to our next one, this is the Golden Ratio Portfolio. This one is 42% in stocks, In this sample portfolio, we've divided it into three funds：a large cap growth fund, VUG, a small cap value fund, VIIV, and a low volatility fund, USMV. There's 14% in each one of those. Then we have 26% in a long-term treasury bond fund, VGLT, 16% in gold, GLDM, 10% in a reit fund, R E E T, and 6% in a money market fund. Now this one did slightly worse than the 60/40 portfolio last year. It was down 18.94% for the year. It's up 2.51% since inception in July 2020. I suppose what was most disappointing about the performance of this particular version of this portfolio was the performance of the REITs last year, which were down almost 25%. Now, those are supposed to be something that holds up well in an inflationary environment, but that really was not true last year. So you probably would have been better off with an allocation to something like utilities in that part of it, which were only down about 1.18% for the year. And you would have been even better off if you would have substituted something like the Managed Futures Fund, DBMF in there. And it's also interesting that although the big REIT funds themselves did poorly, particularly the ones with large exposures to tech-related REITs, like data centers and cell towers, but if you would have held some generic REIT like O Realty Income Corp, that one was only down about 15% last year, and that's more of a traditional real estate play. But as I've said in many discussions of REITs, you probably are better off picking individual REITs simply because the REIT funds are over-weighted towards these non-traditional sectors. Now moving to the next portfolio. This is the Risk Parity Ultimate Portfolio. It has 15 funds in it in all sorts of things, but mostly stocks and bonds. It was down 24.73% for the year. And there were several reasons you can see for that. First, most of the stock funds are more growth tilted than value tilted. And there's 5% in a leveraged stock fund, UPRO, which matches the S&P 500. It's unfortunate that we do not have a levered fund that is value tilted, because that's what you would have wanted to have this year. Another fund that performed poorly this year in this portfolio was KBA, which is an investment in Chinese companies. And obviously that was affected by their problems in dealing with COVID Another big disappointment, although it wasn't really a big disappointment because the allocations are only 2% of the portfolio, were the cryptocurrency funds in here, one in Bitcoin and one in Ethereum. And this was kind of a test for that asset class as to whether It was indeed something that was very well diversified from stock funds. And as it turns out, it is not exhibiting that characteristic. It trades very much like a speculative growth or tech company. And it's kind of interesting. The returns of the fang stocks of Bitcoin and of things like Cathie Woods ARK fund are all down in the 60 to 70%. contrast that with actual gold or commodities which were flat to up in this environment. And you can see why you're really not getting much bang for your buck out of cryptocurrency funds because they're really just behaving like small cap growth stocks or leveraged small cap growth stocks if you will. But that being said, it's probably the case that they will recover when the tech sector recovers and small cap growth stocks recover. So it's not unreasonable to continue holding them at least until that recovery occurs, but then probably showing them the door since they do not seem to be helping much in the diversification realm. But that is a basic principle of portfolio management that people usually get backwards. What happens is When you have a rough year like this, there is a tendency to want to make changes. And that's actually the wrong time you should be making changes to your portfolio if you don't have to. The time to actually make the changes to your portfolio is when people don't want to make the changes, which is when the thing has recovered or it's back at some kind of all-time high. And that may take some time, but patience is a virtue in investing. Now it's time for us to look in on these hideous experiments that we call the experimental portfolios.

Mostly Voices [18:09]

Tony Stark was able to build this in a cave with a box of scraps.

Mostly Uncle Frank [18:18]

All of these have levered funds in them and unfortunately the kind of levered stock funds they have in them in particular are based on the S&P 500 which has a large cap growth tilt towards it, which makes it perform even worse than it would if it were diversified into value and growth, for instance. And of course, in the worst year for bonds, the levered bond funds don't help, regardless of what kind of bonds they are. I award you no points and may God have mercy on your soul. So the first one of these is the Accelerated Permanent Portfolio. This one is 27.5% in a levered bond fund, TMF. 25% in a leveraged stock fund, UPRO, 25% in PFF, a preferred shares fund, and 22.5% in gold, GLDM. It was down 42.44% for 2022 and is down 23.78% since inception in July 2020. I'm wishing we would have gone with a levered gold fund this year. But it has more than enough leverage already. It's actually levered up to about 208% or over two to one. And so you can estimate that without the leverage in it, it would have been down about 20% or about the same as the stock market was down in 2022. Moving to our most hideous experiment, the aggressive 50/50.

Mostly Voices [19:54]

What happened to your face? It looks like an old catcher's mitt.

Mostly Uncle Frank [19:58]

This one does not have any gold or alternative investments in it. It's only stocks and bonds and so suffered accordingly. It's also got the most leverage in it. It's levered 2.381. And so it's one-third the levered stock fund, UPRO, one-third levered bond fund, TMF, and the remainder divided into a preferred shares fund. PFF and an intermediate treasury bond fund, VGIT. It was down at 51.04% for 2022 and is down 30.72% since inception in July 2020. And that is consistent with the amount of leverage in it. If it were an unlevered portfolio of similar investments, it would have been down about 21% for the year. Now, I know these kinds of portfolios have become very popular in some quarters, and there's a whole website devoted to these kinds of portfolios called Optimized Portfolios that you might want to check out if you're interested in this. But you can see what Leverage does in worst case scenario kind of years. But that's why we run these kind of experiments, so you don't have to.

Mostly Voices [21:09]

Didn't you get that memo?

Mostly Uncle Frank [21:13]

Now moving to our last portfolio, the Levered Golden Ratio. This one is 35% in a composite S&P 500 and Treasury Bond Fund that is levered up 1.5. It's got 25% in Gold Fund GLDM, 15% in a REIT O, 10% each in a Levered Bond Fund TMF and a Levered Small Cap Fund TNA. and the remaining 5% divided into a volatility fund and a Bitcoin fund. Now overall, this one has leverage in it of about 1.6 to 1. It was down 27.09% for 2022. So is similar to the regular golden ratio portfolio if you were to take out the leverage. In fact, this one performed a little bit better than that one on a Adjusted basis, probably because this one has Realty Income Corp as the REIT O, which is only down 15% compared to the other one, which is using that REIT fund R E E T, which is down 24% last year. This one also suffered because it is kind of growth tilted in a way. The small cap fund in this TNA is based on the Russell 2000 index, and so is a bit growth tilted. It would be better for a portfolio like this if you could find a levered small cap value fund, but such a thing does not exist as far as I know. And then the other major stock component is a slightly levered S&P 500 part of NTSX. So it's very well diversified in terms of large and small, but not as well diversified in terms of growth and value as you might like. And like the other portfolios we've talked about, it would have seemed to have benefited from a better diversification than a REIT fund, which could have been something like utilities or even managed futures. The volatility fund in it was actually pretty much flat for the year, which was a little bit surprising because usually you would expect volatility to have a better year when the stock market is doing badly. But last year was such a strange year that many things did not go as you might have predicted, even if you would have known in advance that there was going to be a war and the Fed was going to raise interest rates over 4% and inflation would persist and not start coming down until near the end of the year. And the allocation to Bitcoin was also a disappointment as it's too similar in terms of correlation to the TNA fund. So it would have been better off with something different there as well. But that does complete walking through the portfolios. I was going to go through the distributions for January, but I think you can just look that up on the website if you're interested. Forget about it. They are all coming out of cash for January because of the year-end distributions from the various funds. So I think I will forego that discussion. Forget about it. And instead just talk a little bit about what we might have learned from this past experience, this unpleasant experience we just went through. It was kind of a worst-case scenario. And I did write down a few points here.

Mostly Voices [24:47]

You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank [24:52]

But I think it's important first to bear in mind what we say in the legal world is that hard cases or difficult cases make bad law. And what that means in this context is it's best not to overreact to some kind of unusual occurrence that may only occur once in a lifetime. And that it would be very premature to declare that we are in some kind of new paradigm here going forward, because one unusual year does not make a paradigm shift. And it'll be more interesting to see what happens after the Fed stops raising rates, which seems to be in the offing in the first part of next year. At least that's what everybody's saying.

Mostly Voices [25:35]

A crystal ball can help you. It can guide you.

Mostly Uncle Frank [25:38]

But let's go through a few points here. I think the first point that we should take from this is that the Fama-French factors are a very important consideration, particularly value versus growth. Now, ordinarily in most years, value and growth perform only slightly differently within a few percentages. But there are occasions where you can see one greatly outperform the other. This year was like that. There were some years like that in the early 2000s, and there were some big years like that in the late 1970s for sure. So having a good mix of both value-oriented funds and growth-oriented funds can be important. I think the next point is that sectors can be very unpredictable. And last year we saw something that almost never occurs. I'm not sure it has ever occurred where you have one sector that is greatly positive where most of the other sectors are negative. And that sector was energy, and it was up nearly 60% last year, energy stocks, that is. Now, of course, we had the unusual situation with a war and a global breakdown in energy supply lines, which you wouldn't have predicted that. Even if you thought that energy might have a good year just due to the inflationary environment that we were going into at the time. Energy usually is a lot more positively correlated with the rest of the stock market, something like an 80% correlation or more. But it was interesting because there were other pockets of subsectors that also did just fine. One of those was property and casualty insurance companies. which seemed to benefit by rising rates. But anyway, those were up about 10% for the year. And other than the energy companies were some of the best performers in the S&P 500 and the Dow. On the negative surprise side was real estate, because you often hear that if there's going to be an inflationary environment, real estate is one of those things that holds up during inflation. That was not true last year. Now, a lot of that did have to do with the Fed raising the interest rates, which raised mortgage rates, which caused a lot of pain in a lot of places in the real estate markets. And part of it also was the fact that it went up like gangbusters in 2021, with a lot of rates being up as much as 40% then. But still, to have your refunds fall 25% and do worse than the overall market, in an inflationary environment seems a bit strange and unpredictable. Moving to our next takeaway. Our next takeaway is that a well-diversified portfolio should have some exposure to alternatives. And those alternatives may include things like gold managed futures, commodities, and long-short strategies. And you saw that any portfolio that had some exposure to those sorts of things did make out better than the ones that didn't. Now, this still is an area where we're trying to find our way and figure out what's the best use of these sorts of things, because other than gold, these other things really have not been around that long, at least as far as availability to do-it-yourself investors is concerned. But some of these funds we've been tracking, like PDVC, the Commodities Fund, or DBMF, the Managed Futures Fund, or BTAL that we've talked about, that's the Long Short Fund. did actually hold up and perform admirably in these sorts of strange environments and did show they were not correlated, or in this case, they were negatively correlated with what the stock and bond markets were doing. Gold also did fine. It was up early in the year and then it was down and then it came back to neutral by the end. But for the portfolios that had it, it was something that could be sold high as they mostly did in the early part of the year to generate distributions. That leads me to my next takeaway, which is that the dollar wrecking ball is real. Now when people talk about the dollar wrecking ball, what they're saying is that when the US dollar shows a lot of strength, it usually means bad things for just about any other asset class. That includes things like stocks, especially international stocks, and it includes gold. Because if you invested in gold last year in any currency other than the dollar, you probably saw a significant increase in the value of that investment, particularly if it was in Euro or Yen. At one point the dollar was up about 20% last year, although I think it only ended up about 8 or 9% over overall for the year. Now, one of the few asset classes that can actually take advantage of something like that is the managed futures asset class because it will trend follow various currencies, including the dollar and other currencies against the dollar. And in that case this year, that resulted in a substantial gain for that asset class. Moving to our next takeaway. Our next takeaway is that all types of bonds do poorly in inflationary environments. especially when the Fed or other central bank is raising interest rates. Now, suppose you would have known how the year would unfold at the beginning of 2022. If you ask a lot of people, they would have said things like, well, go buy some TIPS because those will protect you in an inflationary environment. That turned out to be wrong that because TIPS are bonds, they performed equally badly with other bonds. and pretty much all along the duration curve, just like other bonds of various durations. So the longest dated TIPS performed similarly to the longest dated treasury bonds. In fact, they performed even worse. So you would have been much better off just holding something else, or if you were going to hold bonds, just hold shorter duration bonds. Because while those do not do well in inflationary environments, they do roll over quick enough that they tend to recover and don't go down too much. All that being said, it would certainly be a mistake at this point for someone to sell out of their long-term bonds and buy shorter-term bonds because you're essentially locking in your losses. You still want to be buying low and selling high regardless of the asset class. and how long it takes to recover or go through the complete economic cycle. And now we really haven't seen yet, we have not seen the recession that everybody keeps talking about.

Mostly Voices [32:41]

Sounds like somebody's got a case of the Mondays.

Mostly Uncle Frank [32:44]

Maybe we will next year at some point. The real positive thing about rebalancing into bonds now would be that you're getting higher interest rates going forward. And that's going to do a lot to cover distributions in the future, as well as give an opportunity for capital appreciation at some point. And just going to our last takeaway, our last takeaway is that cryptocurrencies trade like speculative growth tech stocks and are highly correlated with that subsector. And that's true whether it's something very volatile and speculative like the ARK funds, or even just your basic fang stocks. Now, maybe that will change someday, but at this point, I probably would not hold my breath. On the other hand, it is at least a little bit heartening that they haven't really done any worse, at least the main ones, Bitcoin and Ethereum haven't done any worse than speculative growth tech stocks, because they are going through momentous times in terms of fraud, deleveraging, and other fallout. from all the various scandals of the past year. And if they can survive all that, they probably will have a reasonably decent future, at least the main ones, I think. Most of those tokens are going to go to zero. Targets should be clear if you're going low enough. You'll have to decide. You'll have to decide. You'll have to decide. But that is kind of following the typical boom and bust cycle of any technological innovation, going back all the way to railroads and Great Britain in the 1840s. I don't mind going if there's a luncheon provided, but I must be fair, or else I stay at home. But the upshot is that I wouldn't look to that as a very good diversification play going forward. And you would really want to group it or consider it as part of your stock allocation, particularly on the growth side. Hopefully any exposures you've had to it have been relatively minor. But now I see our signal is beginning to fade. Want to wish everybody a happy new year out there? Can't be much worse. Next year than the worst year ever for bond holdings. And the worst year since the 1930s for stock and bond portfolios. Everything that has transpired has done so according to my design. But we have all survived and will live to invest another day. starting Tuesday. 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 and I'll get it that way. If you haven't had a chance to do it, please go to your favorite podcast provider and like, subscribe, give me some stars, a review, That would be great. Mm-kay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [36:17]

I want to welcome all of you to the first meeting of possible investors on this project. Some of you know I've had nine pictures under my subspecies. Four in the South Beach Trumpet series alone. Is the psychiatrist helping? Oh, you know about that, too? So what? There's no stigma these days. The Risk Parity Radio Show is hosted by Frank Vasquez.

Mostly Mary [36:36]

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.