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.

Mostly Mary [0:17]

A different drummer. 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 [0:38]

Thank you, Mary, and welcome to episode 31 of Risk Parity Radio. Today on Risk Parity Radio, we are following up on the email from one of our listeners which spawned this show. And this is from Bill C. He writes, hi Frank, I found your podcast a few weeks ago. and it is very informative. I'm a big fan of the Risk Parity concept. Quick question, have you looked at the RPAR ETF launched in late 2019? If so, what are your thoughts? Well, that's a very good question, and I had not looked at it in detail. I was aware it existed, but now I have done some research on RPAR, and so that is what we are going to talk about today. This seems to be the first real risk parity focused ETF, at least recently. In the past we have seen mutual funds or ETFs devoted to the permanent portfolio concept, but they never quite implemented that in a good way and so only tend to get popular when the price of gold goes up. I mean you can find those just by searching through the mutual funds, but you'll see those. But RPAR is something different and it is really committed to the risk parity concept. I went to their website and they have some very informative slides, presentations there, and a hour long review from the second quarter, which goes through a lot of the features of their It is very similar, as we will find out, to a lot of the sample portfolios that we have at www.riskparityradio.com and so taking a look at what our PAR is comprised of, we see that it follows the same sort of sorting of basic assets for a risk parity style portfolio. And by that I mean, It relies on equities as one of its components, gold as another component, and long-term treasuries as the third component. And those are the largest components of this fund. It is structured in a way that it actually takes a little leverage, so it acts as if it has 120% of what it is composed of. And the way they do that is by in the treasury side of this, the long-term treasuries, instead of owning a fund like TLT, they own treasury futures. I mean, they scale that so that in effect, this behaves as if it were 120% as opposed to 100% of the components. And so the percentages they have adding up to about 120% and in the current Allocation of this fund is 25% global equities, 15% commodity producers, 17.5% gold, 42.5% long-term treasuries, and 20% in TIPS. Now, I wanted to break that down to see exactly what was in it. I thought it was interesting that they took instead of commodities themselves looked at commodity producers in this sector. So I went into the specific holdings which you can find on MarketWatch if you look this up. And basically what you see in there is that the basic stock funds they are using are the Vanguard Total Stock Market Fund, VTI, the Vanguard FTSE Emerging Markets Fund, VWO, and the Vanguard developed markets, ETF, VEA, and that's those comprise the 25% of global equities with about half of it being in VTI and then the other half being in the international funds. They're using BAR, the Grant Shares Gold Trust for their gold holding. There's 10% of that in there, along with GLDM, which we also use in our sample portfolios on the website. So there's 7% of that, so the total of about a little over 17% right now, according to this. And then when you look at these commodity producers, you see a variety of large international companies that are involved in some way in the commodities field. So from the energy side, you see Exxon, Chevron, Valero, which is the Brazilian producer, Totel, which is the French oil producer. And then you see companies that are involved in mining, like BHP Group, Rio Tinto, Southern Copper, Anglo American. And then you also see companies that are involved in the agricultural sector in some way, like Deere and Company is in there, Nutrien, Cortiva, Echo Lab, they also got a wind farm company in their Vestas Wind Systems, which is VWSYF. But all of those are really small holdings from, you know, 0.2% to, I guess, the largest one here is BHP Group, which is 1. 12%, and that adds up to or comprises this commodity side of this fund, which is an interesting way to go about it. There are a couple other features to this fund that I'm not sure I entirely agree with, but they could work out well in the long term. The jury will be out for them. And what they are is that this fund rebalances on a quarterly basis, which is kind of a short-term to be rebalancing a fund like this, it would probably be better off with a longer term rebalancing strategy. But in the financial world, the quarterlys are very important, and so there's a lot of focus on that sort of thing. So it rebalances on a quarterly basis. It also has a variable target allocation. So the target allocation that it has right now is not actually its long-term target allocation. It's long-term target allocation adding to 120% is had to have the global equities be 25%, the commodity producers be 15%, the gold be 10%, the long-term treasuries be 35%, and the TIPS be 35%. And I looked into what happened there and they have a trigger basically when the 10-year Treasury bond goes below 1%, they go to the current allocation, which has more gold and more treasuries in it on the theory or grounds that a low yield on treasuries implies a deflationary or bad environment, which is usually true, but not always true, I would say. And so they do have this sort of 1% trigger in them. wondering as the Treasury inches back up to about 1% where it is right now, how they're going to deal with that either on a rebalancing basis or if it goes above and then comes back, how are they going to deal with that in their fund? I'm not sure that they may have thought all of that through because it could involve some churning or whipsawing of this fund. changing allocations like that based on some metric out in the marketplace. So again, I'm not sure that that method of managing this fund is entirely the best. On the other hand, this fund has performed quite well this year, partially based on that mechanism of shifting in the second quarter or the end of the first quarter, they shifted into more Treasuries and more gold, which did quite well then. And so it is up over 12% this year, which is a good performance for a fund like this. And I will be linking to these pages in the show notes where you can find this information both from their website and from the Market Watch website. But I wanted also to see, since it has only been in existence since the end of last year, how a risk parity style portfolio like this one might have performed in the past and how it would compare to one of our sample portfolios. So I went ahead and went over to Portfolio Visualizer and created an analysis for this, which I'll also link to in the show notes. And I needed to change a little bit to make it more proportional to add up to 100% instead of 120%. but you can multiply it times 1.2 when we get to the returns and volatility statistics and get an idea for what that is. So in order to do that, I looked at the portion that was going to be stock funds and I put it together as the Vanguard Total Stock Market 10%, the Vanguard Developed Markets Index at 6%, and the Vanguard Emerging Markets Stock Index at 6%. To deal with these commodity producers, I looked at what sectors they were in, and they really are mostly the largest companies in the sectors that are the energy sector, the industrial sector, and the material sector. So I took out three sector funds to represent those XLE, XLI, and XLB, and put those in proportion. They each get 4%. of the total for that. So it's 12% to that. Then proportionally the treasury bonds, we went with TLT and that's 29%. We went with TIP, the general tips fund, at another 25% of the portfolio. And then for the gold, proportionally that comes out at 8%. And I was using the long term projections for the allocations given by the RPAR managers. I'm not using what they're using now, but using what they say are their long-term projections for that. So that became Portfolio 1 in this analysis. And then to compare that, I used a version of the Golden Ratio portfolio that you can find at our sample portfolios at www.riskparityradio.com. and made it a very simplified version of that. I put 42% in the Vanguard Total Stock Market, 26% in TLT, 16% in GLD, the gold fund, and 10% in VNQ for the real estate for that, and 6% in cash. And so ran this comparison. Now it only goes back to 2004 because that's when you had the gold ETF come online. But it is 16 years of data, which is much better than one year of data, which is all we have right now for the fund itself. And looking at this, the returns are actually quite similar. The performance overall is quite similar to these two portfolios. The RPAR reference portfolio here had a compounded annual growth rate of 7.2%. compared with the compounded annual growth rate of the golden ratio at 8.76%. But you also need to gross up that 7.2%. So because since they're using leverage in their portfolio, you would get a higher return. So if you multiply that 7.2 times 1.2, what you get is 8.64, which is very close to the golden ratio's performance of 8.76. The RPAR reference portfolio here had a best year of 16.1%, a worst year of 5.6%, and a maximum drawdown of 16%. Again, if you grossed up those numbers, they are going to look closer to what the Golden Ratio has, which is the best year of 22%, the worst year of -9.5%, and a maximum drawdown of minus 22.8%. Overall, the Sharpe ratios are very comparable. The golden ratio for this period was 0.86%, and the RPAR reference portfolio that we put together has a Sharpe ratio of 0.81%. So it has a very similar risk reward ratio to it. And just looking at a couple more metrics from this portfolio visualizer analysis, we see that the Correlation of each of these portfolios, the RPAR style portfolio has a correlation with the market of only 0.59, and the Golden Ratio portfolio has a market correlation of 0.77%. So the RPAR style portfolio is less correlated with the overall market. And then looking at the perpetual withdrawal rate calculated for this period going back to 2004, It is 5.12% as a what you could reasonably take out of it perpetually from the RPAR style portfolio and 6.55% for the Golden Ratio portfolio for this period. But again, if you multiply that times 1.2, they're going to be very close to the same. So what does all that mean? Where do I come out on this? I think this is a very interesting fund and I'll be interested to see how it develops going forward. What I'm not sure about is whether the additional complications with it and the additional management of it are actually going to make it have better performance long term. It does have an expense ratio of 0.5%, which is not bad actually for a fund with all of this management going on in it. And it's hard to argue with the performance so far at 12%, which is very good and is in part due to this extra management. It would be difficult for a do-it-yourself investor to reconstruct a portfolio like this simply because you have to manage those futures contracts. And then if you are going to buy individual companies to represent that commodity sector, you're looking at another 20 companies that you need to buy and then you need to proportion those in some way to match some kind of index or something you would have to come up with. So where it comes down, if you think of our three principles, which are the Holy Grail principle about choosing investments with lower correlation, it checks that box. If you look at the macro allocation principle that says that most of the returns are due to the macro allocations, it also checks that box. It really does not try to be a big stock picking kind of fund or picking odd things. It basically picks most of the things sort of in the square of the allocation it wants to be. you look at those Vanguard funds in there and they are low cost and cover the entire market pretty well. And the same for some of these other funds with the exception of this commodities area, which is a little bit different. I think where it maybe falls down a little bit is on the third principle, the simplicity principle, that it just may be more complicated than you really need for this. I think part of that is to inject a bit of this leverage into the fund to get it to that 120% kind of performance. But on the other hand, as we've seen, you could probably do about as well, at least for the long-term aspects of this, with one of the risk parity style portfolios, let's sample portfolios that we have on our page, like the golden ratio or golden butterfly or the risk parity ultimate if you wanted to make it a little more complicated there. But I don't think I would criticize anyone for investing in this ETF. It is a interesting way to do this without having to do anything in the way of management at all. There is kind of a question as to where you would put it in a overall portfolio because the way the risk parity works, it's, it's really designed for all of your assets and putting the matching them all together. So having this as some kind of separate portfolio doesn't actually make a whole lot of sense. They were asked this question on their little webinar, which you can watch, and they said it kind of goes in as an alternative asset class. And I suppose you could characterize it as that. It does have a relatively low correlation with the overall stock market if most of your investments were in an overall stock market. I could see somebody using this though as kind of an intermediate term fund because that's also a very good use for risk parity style investing. That if you were saving for a house or something in five years or something like that, perhaps you would put your money into this to get a better risk reward ratio. than the overall stock market, which would be a lot more volatile because I do think that this portfolio is likely to have a pretty smooth ride and its drawdowns are not likely to go on for more than a couple of years, which is typical for these risk parity style portfolios. I will be interested to see if there are more ETFs that come online that are oriented towards the risk parity style as this one is, and whether some of them will have even lower expense ratios than this, although I have to say that 0.5% for something like this is really good. But with that, I see our signal is beginning to fade. I want to thank again our listener Bill C for sending in this question. I thought it was an excellent question and it made for a very good show as we explore all of the variations and varieties of investments in the Risk Parity Rubric, if you will. If you have a question or comment or suggestion, you can send them to me by email at frank@riskparityradio.com or fill out the contact form on the website if you don't want to use email. and the website is www.riskparadioradio.com. We will be picking up again this weekend with our weekly portfolio review, and it was another interesting week in the market, so we'll see what that yields in terms of our sample portfolios. I can tell you that at least partway through the week, we have divergences with some of the sample portfolios doing better in this environment and some of them doing a little worse in this environment. But it's something new, and I think we'll see that there is a dampening of volatility overall with all of these risk parity style portfolios. Thank you for tuning in.

Mostly Mary [21:27]

This is Frank Vasquez with Risk Parity Radio, signing off. 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.