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. 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.

Mostly Voices [1:28]

Top drawer, really top drawer, along with a

Mostly Uncle Frank [1:32]

host named after a hot dog.

Mostly Voices [1:35]

Lighten up, Francis.

Mostly Uncle Frank [1:39]

But now onward to episode 236. Today on Risk Parity Radio, it is time for our weekly portfolio reviews. Of the seven sample portfolios you can find at www.riskparityradio.com on the portfolios page.

Mostly Voices [1:54]

I took the liberty of putting away something in your teeth. What are you talking about? I'm putting you to sleep.

Mostly Uncle Frank [2:02]

But before I put you to sleep with that, I'm intrigued by this, how you say,

Mostly Voices [2:06]

emails.

Mostly Uncle Frank [2:10]

Looks like we have some regulars in the queue here today. Afternoon everybody. Hey, what's happening, Norm? It's a dog-eat-dog world, Sammy, and I'm wearing milkbone underwear. So without further ado. First off. First off, we have an email from Alexi.

Mostly Voices [2:34]

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 [2:42]

And the dude writes, Hey Frank and Mary,

Mostly Mary [2:45]

I really enjoyed your discussion of my volatility experiments on episode 224. Thank you both. But moving forward, did you see this pod? To Survive Disasters, you, Need Smiles, Steve Ho. This is one of the most relevant to risk parity podcasts that I can recall. The Market Huddle website has an accompanying slide deck, which is must save material.

Mostly Voices [3:09]

The best, Jerry, the best.

Mostly Mary [3:12]

In it, Steve Ho discusses the historical performance of various asset classes, sectors and factor tilts in different inflation regimes. Some take homes for us DIY investors. In terms of portfolio inflation hedges, one, utilities more useful than real estate. Two, value and momentum tilts both useful relative to broad market, but momentum better than value and high inflation. Three, healthcare, yutes, consumer staples, best sectors during high inflation. Did you say utes? Yeah, two utes. What is a ute? Four, trend following useful during inflation. Duh. Hope you find this useful, Alexei.

Mostly Uncle Frank [4:03]

Now let's talk about this podcast and this presentation that you identified, and I have mentioned this before this came out. in early December and it is the Market Huddle podcast, but they were interviewing somebody from Bloomberg named Steve Ho who had done a large analysis and created a presentation which is also available there for download. I will be linking to this in the show notes. But it was all about which kinds of assets both in the macro sense and within asset classes tend to perform better or worse in inflationary environments. But first, let's talk about how this relates back to our three principles that we follow here. The macro allocation principle, the Holy Grail principle, and the Simplicity principle. This relates back to what we call the Holy Grail principle. You might want to go back to episode five and listen to an explanation of these things. But this idea comes from Ray Dalio and Bridgewater, which is that if you are able to construct a portfolio of things with positive returns that are uncorrelated or in some circumstances negatively correlated, you will have a much better portfolio that will have better performance characteristics both in terms of what its returns are, overall and what its volatility or drawdowns are likely to be. And why that's important for retirement portfolios is it means you can take more money out of a portfolio like that, which is what we're all about here. Yes. But the theory goes beyond that in terms of thinking about correlations. Correlations are probabilistic. They are not the same all the time between two asset classes. They can be negative or positive. or zero in certain circumstances and in certain environments. But the reason that happens is not random. Things just don't become correlated or uncorrelated for no particular reason. What this is all fundamentally based on is the idea that certain asset classes tend to perform better or worse in certain macroeconomic environments. Generally, those macroeconomic environments are described in a quadrant model. Usually, what you have in the two axes is one talking about whether inflation is increasing or decreasing in the environment, and then on the other axis, whether growth is increasing or decreasing in that particular environment. You end up with four quadrants, and then you can identify which kinds of assets perform well in those circumstances. And then that leads you to portfolio construction and the output, which is the correlation numbers, because if you have assets that reside in different quadrants, they tend to have low or negative correlations with each other. So this presentation you're talking about is very important because it gets at the fundamental nature of these asset classes in inflationary environments. Now you focused on the differences between sectors and factors within the equity asset classes stocks. So you're talking about utilities, real estate, value momentum and other things like consumer staples. But I think you want to step back from that first because what differentiates those things is actually not that great in the big picture. What's more important is what it says on page five of this presentation, which is that equities are generally not great inflation hedges. They're just not. Forget about it.

Mostly Voices [8:02]

So whether you're talking about value versus growth or

Mostly Uncle Frank [8:06]

any of those sectors, you really should not be looking at equities themselves as your inflation fighters in your portfolio. I think the way to think about equities and inflation is generally some sectors are less bad than others, and some factors are less bad than others in an inflationary environment. And the only sectors that seem to do well on the equity side in inflationary environments are those specifically related to commodities, which is not surprising. Last year was a good example if you compare the various factors and sectors across equity performances that you saw growth stocks and tech stocks and consumer discretionary and all of those things tended to perform the worst in an inflationary environment, whereas the value stocks performed a lot less badly. And so the difference was up to 20% differential for those two factors. And the only sector that really did well last year was in fact the energy sector, which is devoted to commodities. I should say that one other niche or subsector that did do well last year was property and casualty insurance companies, but I'm not sure that had as much to do with inflation as it had to do with the Fed raising interest rates, because those kinds of companies seem to perform well in rising interest rate environments as they're able to roll over a lot of short-term debt that they hold. and take advantage of the higher interest rates right away. But I'm not aware of any long term studies of those types of companies in particular, like the one presented in this Bloomberg study. Now, just looking at the other sectors, it seems pretty obvious that the sectors that are in the value camp or more in the value camp, like consumer staples, utilities and health care tended to do better.

Mostly Voices [10:10]

Is it possible to two youths...

Mostly Uncle Frank [10:14]

To what?

Mostly Voices [10:17]

Oh, excuse me, you, Honor. To youths.

Mostly Uncle Frank [10:21]

So I think the takeaway there is value is better than growth in inflationary environments and that the sectors themselves are not really as important, at least when you consider that you don't expect any of them to have positive outcomes. just less bad ones. So in terms of the equity allocations in your risk parity style portfolio, what's really important to focus on is that balance between value and growth overall, which you can do with a lot fewer funds than if you were to try and go sector by sector. And basically that's just an application of the simplicity principle, that if you can do this simply by distinguishing value from growth, there is less need to have to go into the sectors themselves because they're covering the same ground. But that leads us to our next question, which is what actually does well in inflationary environments? And in particular, the environment we saw last year that was not only inflationary, but we also had a central bank steeply raising short-term interest rates to combat that. And the answer is commodities and trend following funds. These are both specialty funds or types of asset classes in the alternative segment. But in a year like last year, they were up about 20% each. Yeah, baby, yeah. So we'll talk a little bit more about that in a minute, but let's talk quickly about some other alleged inflation fighters and how they fared. in this regime. First one is TIPS. We've talked about this before. These are supposedly bonds that you can use to hedge against inflation. You had only one job. That assertion is false and it was proven to be false last year. And the reason for that is because TIPS are bonds and bonds themselves do not do well in inflationary environments. So it's like having a regular bond with an inflation protection layered over it that could be modeled as a swap contract if you wanted to, but it's still a bond and it's still going to perform badly in inflationary environments, particularly as the duration gets longer and its bond characteristics come more to the fore. So you would have to say if inflation fighting is the job of TIPS, they really don't do their job very well. You had only one job.

Mostly Voices [12:50]

They would only be doing their job well as if your entire portfolio

Mostly Uncle Frank [12:54]

was limited to bonds. Then obviously the TIPS would perform better than the nominal bonds, but that doesn't mean they're good or they are helpful when your portfolio is mostly stocks and other things anyway. And what about gold? Well, gold was flat last year overall. It went up at the beginning of the year, then it went down, and then it came back to neutral. But what you really saw there was gold reacting more to the strength of the dollar than anything else. If you were holding gold in a currency other than the dollar, you had a very nice performance in 2022, and we're probably up 15% or more. But a lot of the strength of the dollar had to do with the actions of the central bank, in particular the US central bank, raising interest rates much faster than other central banks were raising them. And now that the US central bank has slowed that down and other central banks are in effect catching up, you've seen the dollar reverse course and has gone down 15% in the past three months or so. So overall, you'd have to say gold is a mediocre inflation hedge. It's a better hedge against a weak currency. But it is kind of like tips in a way that it really does not perform the way the stories say it should. Inconceivable. Because the stories are just wrong. It's more complicated than that. You keep using the word.

Mostly Voices [14:24]

I don't think it means what you think it means.

Mostly Uncle Frank [14:28]

So now let's go back and talk about the real inflation fighters here. The real inflation fighters are commodities and trend following systems or trend following funds. So if you thought every year was going to be like last year, or you had a crystal ball that said that inflation was going to be high and higher for some period of time. A crystal ball can help you. It can guide you. Which many people in their crystal balls seem to be claiming these days. You can actually feel the energy from your ball by just putting your hands in and out. You would want a higher allocation to things like commodities and trend following systems. Now, it's pretty obvious why commodities perform well in inflationary environments because they essentially define inflationary environments. Inflation is measured largely by the price of commodities. Hello, hello, anybody home? Now, why do managed futures or trend following funds also work well in these kind of environments? Probably for a couple reasons. Part of what they invest in is in fact commodities and they chase commodities going up in a trend following manner. But the other factor at play there is that managed futures funds can also invest in essentially the direction of interest rates and go the opposite way that bonds would go in a rising interest rate environment and profit from it. They can also invest in currency pairs. And so last year they both followed the interest rate rising, which was good for managed futures funds, and the dollar strengthening, which was also good for managed futures funds. That is the straight stuff, O Funk Master. So does that mean now we should go out and load up on these sorts of alternative investments? Do you want a chocolate?

Mostly Voices [16:27]

Get excited about the inflation crystal balls out there and go

Mostly Uncle Frank [16:32]

whole hog on the hogs or pork bellies.

Mostly Voices [16:39]

We are here to try to explain to you what it is we do here. We are commodities brokers, William. Now, what are commodities? Commodities are agricultural products like coffee that you had for breakfast. wheat, which is used to make bread, pork bellies, which is used to make bacon, which you might find in a bacon and lettuce and tomato sandwich. I'm happier than a pig in slop. And the answer is no, of course not.

Mostly Uncle Frank [17:09]

And for a couple of reasons. The first reason is you shouldn't be running around chasing whatever did the best last year. If you do that, you're just fund hopping. Not going to do it. Wouldn't be prudent at this juncture. Because the likelihood of having spectacular performances two years in a row is pretty small for any investment. And so it's really bad portfolio management to sell the things you have that have done poorly recently and buy things that have done well recently. You're essentially selling low and buying high if you're doing that. Are you stupid or something? The time to make a shift is when your portfolio recovers, is at or near an all-time high, and then you can reassess whether you want to add some other alternative investment or make some other change in your portfolio, at least if you have a reasonably well-constructed portfolio to begin with. If half of your portfolio is in a few tech stocks and they all tanked at once, you may have a different problem. You have a gambling problem. Because yes, that is another form of gambling, folks. You just don't realize it till it blows up on you. It's a disgrace to you, me, and the entire gym state. But the bigger overarching reason why you don't want to overload on these kind of alternative inflation fighting investments is on page 18 of this presentation. And what this is talking about is that there is a trade-off here that a lot of these kinds of investments, particularly the commodities ones, just don't have a good long-term track record in terms of return profile, and they have a lot of volatility, and so will drag down the overall performance of your portfolio. So there is a trade-off here. The more inflation fighters you stick in a portfolio, the less likely it is to perform well over time and have a high return profile. So the real question then becomes how much of your portfolio do you want to devote to these kinds of assets, given what else you're holding? And there is no clear answer to that with respect to things like commodities and managed futures funds. With commodities, I think it's somewhere between zero and 10% if I had to throw out a guess. Which means I'm not sure that you are better off with them or not over a long period of time, although you're certainly better off if you have a year like last year or if you have a crystal ball that says that we're going to have lots of inflation in the future. Fire and brimstone coming down from the skies. Rivers and seas boiling.

Mostly Voices [19:57]

40 years of darkness, earthquakes, volcanoes.

Mostly Uncle Frank [20:01]

Managed futures is much more promising in my view, and the right amount is probably somewhere between 10 and 15%. The main problem we've had with managed futures in the past is that they really have not been very investable for do-it-yourself investors because you either had to do the work of managing a portfolio of futures and options, which is a lot of work. I don't think I'd like another job. Or you were forced to buy funds that had very high fees and not very good performance. That's not an improvement. at least that has been their history. It's only been in the past few years that we now have funds like DBMF that have low enough expense fees and index fund like characteristics that I think an average do-it-yourself investor can consider to use in these kind of portfolios. Because unlike straight commodities funds, these managed futures funds do do more things for you seem to have really a zero correlation with stocks, whereas commodities and stocks are positively correlated in many environments, having to do whether it's a high growth or low growth environment. And managed futures funds have a history of having a reasonable return themselves. It's not as high as the stock market itself, but it's more in the up to 7% range. you're thinking that stocks are 8 to 10%, commodities are more like 2 or 3%. All of this is very interesting to me because these are relatively recent developments. This has only been possible in the past few years. So it will be something we think about implementing going forward. For right now, though, as I said before, you would not be jumping into these kinds of funds after you've been walloped by the markets last year. Right now it's just time to wait for portfolios to recover because you never really want to rush into anything or make rash decisions or moves with your portfolios. But if you are interested in these topics, you really should download this presentation that we've been talking about. Because it really is valuable in terms of using data to decide what assets do well in inflationary environments as opposed to listening to people tell stories about what they think performs well because those two things do not line up in the present day. Wrong! Wrong? Wrong! Right?

Mostly Voices [22:41]

Wrong! And so I think this makes an excellent reference tool for the future.

Mostly Uncle Frank [22:49]

But that's probably enough on that for one sitting. So bold strategy, Cotton.

Mostly Voices [22:52]

Let's see if it pays off for him.

Mostly Uncle Frank [22:56]

Thank you very much for that email, though. Take it easy, dude. Oh, yeah. I know that you will.

Mostly Voices [23:04]

Yeah, well, the do the binds.

Mostly Uncle Frank [23:07]

And because I spent so much time on that, I think we're just gonna do one more email today. And so, Last off. Last off, we have an email from Spencer, and Spencer writes：Good morning, Frank.

Mostly Mary [23:24]

I've never heard mid-cap index funds discussed on the show. I'm assuming they're useless in the context of constructing risk parity portfolios. Would you care to elaborate on why this is? I've always been curious. Thank you, sir. Spencer S.

Mostly Uncle Frank [23:39]

Well, funny you brought this up. We just talked about it in episode 234. What this gets at is what people call the factor zoo or factor mania. And this has a lot to do with a lot of academic research and people writing papers for their PhDs. Basically, ever since Fama and French first discovered factors and factor differentiation for constructing portfolios back in the 80s and 1990s when they wrote their famous papers, people have been looking for other and more factors that would be meaningful ways of constructing portfolios or investing. And so hundreds of factors have been looked at with all kinds of names, and they call this the factor zoo. And in 95% of the circumstances, the factor turns out to be not meaningful for the purposes of investing. or in a lot of the circumstances that the academics are looking at, it's not investable in that it would require too many transactions or investing in illiquid things or problems like that. And so with that backdrop, getting to your question, yes, mid-caps fall into that non-useful or non-meaningful characteristic. So just knowing that something's a mid-cap fund does not tell you anything in particular about its performance in relation to the overall market. What would be more important is whether it's value or growth, whether it is in a particular sector, and using things like the profitability or momentum factor if you can apply them. So when we are constructing portfolios and we are applying the simplicity principle, one of the corollaries to that is not investing in funds that have meaningless characteristics because they just take up space and then we have to go back and look at their actual meaningful characteristics in terms of things like growth and value to determine how they fit in the overall portfolio. So it just adds on layers of confusion without adding any meaningful differences or diversification. And so the simplest kinds of portfolios only focus on the most meaningful factors. Since mid-cap is not a meaningful factor, there's no reason to have a fund that is focused on mid-cap stocks in particular.

Mostly Voices [26:07]

That's not how it works. That's not how any of this works. It's for that same reason.

Mostly Uncle Frank [26:15]

There's no reason to have a fund that focuses in particular on dividend paying stocks, because that's not a meaningful factor either. Surely you can't be serious. I am serious. And don't call me Shirley. People often get confused by that because a lot of dividend paying stocks happen to also be value tilted stocks. But although those characteristics overlap, one happens to be meaningful and the other one is not. The easiest way to understand that is to take a look at something like Berkshire Hathaway, which is a well-known value tilted stock that does not pay a dividend. and you will see it has very similar performance characteristics to a lot of other value tilted stocks, probably because it happens to own a lot of them. But that's just another example. If you have a dividend fund, I do invite you to go compare it to a large cap value fund like VTV and see if they don't look awfully similar in performance over long periods of time. The main difference in what they're holding is likely to be VTV has a large allocation to Berkshire Hathaway, whereas your dividend fund does not. But anyway, we have nothing against mid-cap stocks in particular here, but there's no reason to focus a particular fund or investment on them. So hopefully that explanation helps and thank you for your email. And now for something completely different. And the something completely different is our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparriyrader.com on the portfolios page. Not much ultimately happened last week. Most of the markets were pretty flat and most of the portfolios were pretty flat. So just whipping through this, the S&P 500 was down 0.66% for the week. The NASDAQ was up 0.55% for the week. Small cap value represented by the fund VIoV was down 0.86% for the week. Gold was up again. That's gold, Jerry, gold. Gold was up 0. 23% for the week. Long-term treasury bonds represented by the fund VGLT were down 0.35% for the week. Our representative REIT fund, our EET, was up 0.17% for the week. Commodities were up 1.14% for the week for our representative fund, PDBC. Preferred shares were also up. They looked like the big winner last week, up all of 1.29% for our representative fund, PFF. And managed futures represented by the fund, DBMF, were up 0.21% for the week. Now, moving to our portfolios. First one's this all seasons portfolio that is a reference portfolio. It's 30% in stocks in a total stock market fund, 55% in treasury bonds intermediate and long term, and 15% divided into gold and commodities, GLDM and PBDC. It was down 0.2% for the week. It is up 4.57% year to date and down 3.85% since inception in July 2020. Moving to our three Bread and butter kind of portfolios. First one is this golden butterfly. 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, GLDM. It was down 0.26% for the week. It is up 4.81% year to date and 12.38% since inception in July 2020. Next one is the Golden Ratio. This one's 42% in stocks, in three funds, 26% in long-term treasuries, 16% in gold, 10% in REITs, and 6% in a money market fund. It was down 0.27% for the week. It is up 5.15% year to date and up 7.79% since inception in July 2020. Moving to the third one of these, the Risk Parity Ultimate. This one has 15 funds in it. I won't go through them all. This one was actually up last week. It was up 0. 03% for the week, or all of $3 in terms of actual dollar value. It is up 6.25% year to date and 0.41% since inception in July 2020. Now moving to these experimental portfolios involving levered funds, they were not nearly as volatile this week as they usually are. First one is the Accelerated Permanent Portfolio, this one is 27.5% in a leveraged 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 0.84% for the week. It is up 11% year to date and down 15.39% since inception in July 2020, having quite a year so far. Next one is the aggressive 50/50, our most levered and the least diversified portfolio. It is one third in a levered stock fund, UPRO, one third in a levered bond fund, TMF, and the remaining third divided into a preferred shares fund, PFF, and an intermediate treasury bond fund, VGIT. It was down 1. 31% for the week. It is up 11.39% year to date in 2023 and is down 22.82% since inception in July 2020. And our last one is a lever to golden ratio. This one is 35% in a composite fund called NTSX. That's S&P 500 and treasury bonds levered up 1.5 to 1. 25% in a gold fund, GLDM, 15% in a REIT O, 10% each in a levered stock fund, small cap fund, TNA, and a levered bond fund, TMF, and the remainder in a volatility fund and a Bitcoin fund. It was down 0.44% for the week. It is up 7.20% year to date and down 17.93% since inception in July 2021. It's a year younger than the other ones. And you can check all those out at the website at your leisure. But now I see our signal is beginning to fade. Just one announcement for the season.

Mostly Voices [32:57]

Duck season. Rabbit season. Duck season. Rabbit season. This is Economy Conference Season.

Mostly Uncle Frank [33:11]

I'm living on the air in Cincinnati, which is a conference run by my friend Diana Merriam in Cincinnati, Ohio on the weekend of March 17th. And I will be doing a little breakout session there on withdrawal strategies. And so I hope to see some of you there.

Mostly Voices [33:28]

You on the motorcycle. You two girls. Tell your friends. Free parking. Free parking. Mary will be there too.

Mostly Uncle Frank [33:50]

I will link to that in the show notes so you can check it out. 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. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off. I'm hoping.

Mostly Voices [34:34]

Here's the deal and I'm talking. When you and me, I'm hoping. Then you come back to me. I'm longing. As I can be, I'm waiting for your company. I'm hoping. Then you come back to me.

Mostly Mary [34:50]

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.