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 [0:36]

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.

Mostly Voices [0:52]

Yeah, baby, yeah!

Mostly Uncle Frank [0:56]

And the basic foundational episodes are episodes 1, 3, 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 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. But now onward, episode 317.

Mostly Uncle Frank [1:40]

Today on Risk Parity Radio, we're just going to do what we do best here, which is tend to your emails.

Mostly Voices [1:48]

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

Mostly Uncle Frank [1:56]

And first off, an email from Blake.

Mostly Mary [2:04]

And Blake writes, hi Frank, there's been lots of talk about leveraged ETFs on your podcast as of late. I use them in my own portfolio, so I felt the need to understand their behavior better. You have a gambling problem. I recall you've expressed mixed feelings about them in past episodes and even suggested certain asset classes or implementations may have more merit than others. The way these funds are used seems to matter a great deal. Would you agree that using a leveraged S&P 500 fund to achieve capital efficiency is more defensible than investing at the same nominal value as an unlevered fund? As I see it, There are two entangled issues that need to be disentangled：the daily leverage resets and the volatility drag. I'm sure you agree that volatility drag is not an inherent property of leveraged funds, since anything with volatility impacts its compounded return. Therefore, if an investor puts one-third the capital in a three times leveraged fund, the volatility drag should be fairly similar to investing in an unleveraged fund. Therefore, the main consideration as I see it is the impact of the daily leverage resets. To test this, I built a normally distributed model of daily returns and compared the performance of an underlying index versus a leveraged fund that has been deleveraged by investing a fraction of the capital to achieve the same nominal exposure as to the underlying. From here, I ran a thousand simulations to compare the excess returns of the leveraged fund versus the index. Yeah, baby, yeah! What I found was that the leveraged fund underperforms during the median year but outperforms on average before fees. The reason for this is the convex-like performance of a leveraged fund. When the market is going up in a trending fashion, the fund outperforms on a notional basis because it is constantly buying into the trend to maintain the right leverage mix. Likewise, when the market is going down in a trending fashion, the fund outperforms on a notional basis because it is constantly selling exposure to get back down to target leverage levels. The worst time to own a leveraged fund is in choppy markets, which of course is the median case, but the outliers are so strong it makes up for it. To test this in real life, I compared the performance of a portfolio with one-third TQQQ, a 3x leveraged Nasdaq fund, and two-thirds SHY, short-term bonds, and found the performance closely resembled that of the fund QQQ. The backtest can be found here. I've also linked to an article I wrote summarizing these findings in case you'd like to see the full report. Thanks again for all the great content. Blake C. P.S. Still a Patreon member. The best, Jerry.

Mostly Voices [5:01]

The best.

Mostly Uncle Frank [5:04]

Well, first, thank you for being a Patreon member, and I am sorry I did not get to your email. Sooner. You can't handle the gambling problem.

Mostly Voices [5:13]

Because as a Patreon member, you have the right to go to the front of

Mostly Uncle Frank [5:18]

the line. And I did not make that happen this time.

Mostly Voices [5:22]

That's not an improvement.

Mostly Uncle Frank [5:26]

But just so everybody knows, to the extent you didn't know, this podcast does not have any sponsors or any commercial intent, but it does have a charity. which is the Father McKenna Center, which serves hungry and homeless people in Washington, D.C. And I am on the board of that charity. And so if you donate to that charity, either through the Patreon page or otherwise, you can go to the front of the email line.

Mostly Voices [5:52]

Good seat, sir. You're in the wrong seat, buddy. Come on. Oh, I must be in the front row. And I thank you very much for your support.

Mostly Uncle Frank [6:00]

Now, I believe you are the same Blake who has been listening for quite a while and who last visited us in episode 286. And I'm glad you are still out there doing all the good work you are doing in research. And especially with these levered funds, which I am very curious about, but also still remain suspicious of, since although they were not designed for long-term holding, at least some of them seem to work just fine for long-term holding. And it's a good question that you asked, as well, why does it seem to work long-term even if it is not designed for that purpose? So if I summarize what you said, it's essentially that these levered funds tend to underperform their multiple in choppy markets, but then tend to outperform in trending markets. And that's just very interesting to me. Makes me wonder why that is the case.

Mostly Voices [7:00]

We don't know. What do we know? You don't know. I don't know. Nobody knows.

Mostly Uncle Frank [7:07]

But I don't really have an answer to that, so I will just leave it alone for now. But I will link to your links in the show notes, which I found to be very interesting. What is also interesting to me is that there is a trend now to create levered funds for long-term holdings with lower expense ratios than you would see in one of these TQQQ or UPRO or any of these three times levered funds. And I'm referring specifically to things like NTSX, which are basically a 60/40 portfolio of S&P 500 and Treasury bonds that's levered up 1.5 to 1, but only has a expense ratio of about 0.2 or 0.25. And others have jumped on that bandwagon with various combinations. The most recent entries are Corey Hoffsteins, which combine things like managed futures and Treasury bonds. And those are pretty much brand new funds as of last year. I will link to that page in the show notes so you can check those out too. But I think this is a developing area, honestly, because we've known theoretically for a long time that this is a potential way of improving market returns, obviously with the same adjusted risk, but for people with long time horizons, that could still make sense. And I will link again to the Ben Felix video about leverage in portfolios because I thought that was also very interesting and basically made the case from an academic perspective. Anyway, you didn't really have a question, just some observations and some links. And I thank you for those and thank you for your email. That was weird, wild stuff. Second off, second off, we have an email from Brown.

Mostly Voices [9:09]

We're gonna be using aliases on this job. Hear your names. Mr. Brown, Mr. White, Mr. Blonde, Mr. Blue, Mr. Orange, Mr. Pink. And Brown writes? Hi, Frank and Mary.

Mostly Uncle Frank [9:27]

Was wondering if you could shed some light on why the S&P 500

Mostly Mary [9:31]

is now fully recovered from the 2022 bear market and back at its all-time high, But the three times leveraged S&P 500 ETF, UPRO, is still way below its all-time high and nowhere close to being fully recovered. Is this due to volatility decay or something else? Does this support the notion that long-term investors should not hold leveraged ETFs such as UPRO and their portfolios? Thank you, Brown.

Mostly Uncle Frank [10:01]

Well, how convenient for you to write this email Just after I got the one from Blake. Ooh, how convenient. Because I think Blake answers your question better than I could, which is that recent performance of the markets has been very choppy and very up and down, which as Blake observed is when levered funds tend to underperform the markets. And then when they are more trending, then they tend to outperform the markets. At least that's what Blake's research shows us, which is a better outcome than you'd expect because in theory, these levered funds should always underperform markets given their expense ratios and their construction, which is based on daily performance and not long-term performance. So I'm always a bit surprised that they work at all because I know that a lot of these kind of levered funds that are based on futures contracts perform very badly over time, particularly those ones that invest in things like oil or volatility contracts have a tendency to just decay. But the ones that are based on swaps contracts like UPRO or very long-term options tend to hold up a lot better. Anyway, I couldn't really answer your question, but I was able to conveniently punt it over to our last Email her. Ooh, how convenient. Which is quite advantageous to me for this audience that listens to this podcast, because you guys are really very knowledgeable. And I learned just as much from you guys as I think you do from me. At least from those of you that have been around for a while.

Mostly Voices [11:46]

You were the bouncers. I am the cooler. All you have to do is watch my back and each other's. Take out the trash.

Mostly Uncle Frank [11:58]

So hopefully that helps a little bit, or at least Blake helps you a little bit. And thank you for your email. Last off, an email from Christian.

Mostly Voices [12:26]

Sister Christian, oh the time has come and you know that you're the only one to say okay. And Christian writes.

Mostly Mary [12:41]

Hi Frank, first of all, thank you for providing such a useful resource to do-it-yourself investors. I've listened to every episode and have learned a great deal from your podcast. My question today concerns holding gold in a taxable account. My current portfolio is similar in spirit to the Golden Ratio and includes GLDM and tax advantaged accounts. I'd like to move this gold position into my taxable account in order to move out tax inefficient assets like long-term Treasuries and reduce my income for ACA purposes. I'm not too worried about the higher collectibles tax rate, as this would be a long-term holding with few transactions. What I am worried about, though, is the ongoing tax filing complexity. My understanding is that physical gold ETFs like GLDM are structured as grantor trusts, which pass their income and expenses through to the investor. The fund generates capital gains or losses every month when it sells little bits of gold to pay for its expenses. and the investor is on the hook to calculate and file taxes on their pro rata share of these little transactions, even if their number of shares in the fund doesn't change. These same transactions also constantly change your cost basis because your shares represent declining amounts of actual gold, which you need to manually calculate and track as well for any future sales. I'm including links to a recent example tax reporting statement for GLDM along with the fund's prospectus. But looking through forms at places like TurboTax seems to confirm that all of this overhead can be a real nightmare. Like you, I don't think I'd like another job. Looks like you've been missing a lot of work lately.

Mostly Voices [14:26]

I wouldn't say I've been missing it, Bob.

Mostly Mary [14:30]

Is holding a gold ETF like GLDM in a taxable account really this complicated when it comes to filing your taxes? Should I be considering any creative alternatives like ETNs, CEFs, Gold mining stocks, futures, or something else I haven't heard of for my gold exposure? The absence of taxable distributions from gold is appealing, so I'd love to find a workaround. Thanks, Christian.

Mostly Uncle Frank [15:08]

Well, I guess your basic question is, is holding a gold ETF like GLDM in a taxable account really this complicated when it comes to filing your taxes? And the answer is no. I've held GLDM both in an interactive brokers taxable account and in Fidelity taxable accounts for a number of years now and it does not cause any particular trouble in filing taxes. It's interesting, the Fidelity account does report on its 1099 all of these little one or two cent transactions occasionally, whereas Interactive Brokers does not report those on its 1099. I don't know why, but if you want a better 1099, go to Interactive Brokers. So I can say, in either case, it's not that big of a deal. Mostly because when you have a holding in gold, GLDM, or otherwise, you're really not making that many transactions and most of the time it's just sitting there. So I don't know what TurboTax does with these sorts of things, but it shouldn't be that complicated and no, it's not a reporting problem. You might want to go back and re-listen to episode 303 of this podcast. and look at the links there too. Because if you are interested, there is another gold ETF which is called PHYS, which because of its holding structure does at least according to itself and its proponent qualify it for ordinary treatment under capital gains rules. But that article is there. I don't need to repeat all of that, but you should check that out. And it is the case with all of these things now that there's probably at least seven or eight different ETFs that you can invest in gold in. I think the new low price leader right now is IAUm, which has an expense ratio of 0.09. which I think is now one tick below GLDM's 0. 10% expense ratio. So it's getting cheaper and more efficient all the time, which is the advantage of ETFs and competition. I will put your links in the show notes, but I do commend you to go back and listen to episode 303 and look at the links that are attached to that podcast, because I think that will Give you the information you need here. Hopefully that helps and thank you for your email. But now I see our signal is beginning to fade. Yeah, I know this was a short podcast, but hey, I'm still mentally on vacation in Peru. What can I say?

Mostly Voices [18:24]

It's kind of helpful when one emailer

Mostly Uncle Frank [18:28]

answers the question for another emailer. Ooh, how convenient! Anyway, 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, 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. Okay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [19:24]

Sister Christian, know the time has come and you know that you're the only one to save okay, put your motor in. Yeah, M.

Mostly Mary [20:02]

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.