Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.

Mostly Mary [0:15]

If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. 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 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! 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 finest podcast audience available. Top drawer, really top drawer. Along with a host named after a hot dog. Lighten up, Francis. But now onward, episode 349. Today on Risk Parity Radio, I have a special treat for you out there. What I know you've all been dying for.

Mostly Voices [1:55]

Ladies and gentlemen, boys and girls, dying times here.

Mostly Uncle Frank [2:06]

Which is another sample portfolio.

Mostly Voices [2:10]

It happens here, and it finishes here. Two men enter, one man leaves.

Mostly Uncle Frank [2:19]

And so let's talk through why we are doing this and what we are doing here. Yes! So the first question is, do we really need another sample portfolio to go with the seven other ones? And the answer is, no, we do not. Forget about it. Most of you are perfectly capable of taking one or more of the samples and modifying them to your specifications.

Mostly Voices [2:45]

That's the fact, Jack!

Mostly Uncle Frank [2:48]

That's the fact, Jack! So why do this at all?

Mostly Voices [2:51]

Let's face it, you can't talk them out of anything!

Mostly Uncle Frank [2:55]

Well, over the past few years that we've been podcasting here about these portfolios, a lot of new information and new ideas have come up. And so I thought it would be interesting to construct a portfolio of sort of the best new ideas, say, in the past decade or so. Because I know a lot of you have been interested in the latest and the greatest things, including using the Avantis funds in particular, incorporating managed futures into a portfolio, and the use of leverage and the use of extended duration bond funds or strips funds. So I thought it might be interesting to put together something that involves a lot of those components. as kind of a thought exercise and a useful new experiment to look at and to think about. But we also wanted to apply the best practices we already know about and the principles that we talk about here, which are the Holy Grail principle about diversification, the macro allocation principle, which looks at the stock bond alternatives mix as a primary driver of performance, and then also the simplicity principle using the simplest tools available to do the job. And so we've come up with a new portfolio of five funds, and I will discuss each of the funds and then talk about the macro allocations and other applications of this new portfolio. So the five funds are going to be UPRO, which is a levered S&P 500 fund, AVGV, which is an Avantis fund that is a fund of funds of all of their value funds, and just came out in the last year or so. On the bond side, we're going to be using GOVZ, which is an extended duration or strips fund. And then for the alternatives, we're going to be using a gold fund, GLDM, which is our standard for the gold side of things, although we could have used IAU M, and then we're going to be using DBMF as a managed futures fund. So what relatively new concepts do each of these funds represent? Well, the first one, UPRO, represents the idea of incorporating leverage into a portfolio. Because we know from academic studies that one way of improving performance of an overall portfolio is to add some leverage to it. And that is the traditional way that hedge funds would use risk parity style portfolios to increase their returns. So why do we pick UPRO? Well, UPRO is the S&P 500, so it's fairly standard as to what it is indexing against. It was originally designed as a short-term trading vehicle, but a lot of people have found that it is useful for a long-term holding because it does not have the kind of decay that you see in a lot of these leveraged funds. It holds not only the S&P 500 itself, but also swaps contracts with various large financial institutions, which is what gives it its levered quality. Now, there are many other leveraged funds out there now, including new ones coming online all the time. But we wanted something here that was going to represent one pure asset for rebalancing purposes, which is why we did not go with a fund like NTSX that we already have in a different portfolio, which combines stocks and bonds. A lot of the newer ones are composite levered funds, which are interesting in their own right, but are actually more difficult to deal with in terms of portfolio construction because they're not representing just one asset class. And of the pure one asset class leveraged funds, UPRO is one of the better behaviors in terms of actually performing the way you would expect a leveraged fund to perform. And we've seen that now over the course about the past 15 years that it's been in existence. So we have a reasonable level of confidence that it will continue to perform as it has over the past 15 years. Now moving to our next fund, AVGV. This is a brand new fund of funds from Avantis. And what it has inside of it is five other Avantis funds. So it's a fund of funds. And what it is intended to represent is a broad selection of all of the value tilted funds that Avantis offers. So it's got US large cap value, US small cap value, international large and small cap value, and also emerging markets with some mid cap value thrown in. It plays out to be about 60% US domestic and about 40% international. I will link to the Morningstar site in the show notes and you can check out the portfolio components. Now over the past few years the Avantis funds have grown in popularity and use by many RIAs and others and are now many of the most highly recommended funds by Paul Mermin and company at his website. So what we were primarily looking for with this fund is something to complement the UPRO, the S&P 500, which is representative of a growth leaning large cap fund. So the most important characteristic for our complement was going to be value tilts. And Avantis gives you some of the best value tilts because they also have a quality overlay, which is particularly meaningful when you're looking at international stocks and emerging market stocks to basically weed out the worst of the worst there. and leave you with better performing funds overall. Now I debated having multiple funds themselves for this because I know some of you like to or want to see an international exposure in addition to a domestic exposure. So we wanted to have that. So that would have been at least two funds here if we wanted to have some domestic value and some international value. There is also a question of whether this should be all small cap value. I could have used a little more cowbell. And now this fund does not have all small cap value. In fact, it's majority large and mid cap. But I am aware of other research recently from Alpha Architect and others that suggests that it really is the value component that is the most important thing here and not the size component. I resolve therefore to make the creature of a gigantic stature.

Mostly Voices [10:02]

Of course. That would simplify everything. In other words, his veins, his feet, his hands, his organs would all have to be increased in size. Exactly. He would have an enormous schwanzstucker. That goes without saying. So we're going to go with that theory or philosophy in constructing this.

Mostly Uncle Frank [10:26]

If anything, the large cap value will make the fund and the portfolio a little bit more conservative. That's what it tends to do. And that will actually be a nice counterbalance to the leverage being provided by UPRO. So these two funds do appear to work very well together as base stock funds. If you are going to do variations on this, what you might do is take AVGV apart and instead put in your own version of that with your own selections of Avantis funds or DFA funds. And you could get variations on this theme, but we thought we would use the simplicity principle to just keep it very simple for the purposes of a sample portfolio. Now let's move on to the bond fund that we are using GOVZ. Now what GOVZ is, is the most recent entry, if you will, into the world of long-term treasury bond strips ETFs. And there are three similar funds in this category that are commonly used now. One is EDV, which is the oldest one, which is a Vanguard product. Another one is ZROZ, which is a PIMCO fund. And then there is this one, GOVZ, which is an iShares fund. this is the newest of the three of them. It has an expense ratio of only 0.10, which is less than ZROZ, which it pretty much mimics. It is slightly more than EDV, the Vanguard Fund. The reason I picked this one over EDV is this one follows a different index that seems to be more consistent. And I've noticed over the years that EDV has some strange characteristics in terms of distributions in December, whereas this one seems to just be better structured overall. So that is why we picked this one. It's the newest of the three with the best seeming overall characteristics. Now why do we have this kind of fund at all? Well, a lot of you listeners have noticed that you can effectively use this kind of fund to essentially add leverage to your bond side of the portfolio, meaning that you can hold less in the treasury bond world and get the same kind of portfolio effect if you will. And these funds tend to have a implied leverage against something like VGlt or TLT of about 1.5 to 1. So this in effect is a method of adding a little bit of extra leverage to this portfolio. It is also the most diversified bond type that you can have from the stock funds that are in the portfolio. And over the course of the last 30 years, it's been about -0.25 on average. Now that doesn't mean it shows a negative correlation all the time, but when it's most pronounced is when you are in a recession, like 2001 or 2008 or 2020. and so that's why we picked that one. Now moving to our alternative funds, we're going to be using two of them. The first one is an oldie but a goodie, GLDM. We did want to have some gold in this portfolio, and the two cheapest ETFs right now are IAU and GLDM. I think IAU is actually one bop cheaper these days, although they keep trading places to be the cheapest one. So I thought we would just stick with GLDM since it has worked fine in our other portfolios. We didn't need to be that creative with all of these selections. Now the other fund is more creative. It is DBMF, which we've been talking about since 2021. It is a replicator fund. And we first did a deep dive on this all the way back in episodes 55 and 57. At the time, we were wondering how well it would actually perform in terms of following an index and it attempts to replicate what is called the SOC Gen index, CTA index or Managed Futures index. And in fact, what we've seen since then is that it does in fact tend to replicate that index very well. It performed very well in particular in 2022 when everything else was doing very poorly. because it accurately followed the trend in interest rates, currencies, and other things in that instance. And so it has actually become the most popular fund of that nature in the past three years or so, and is now used by many RIAs looking for that kind of exposure, which really was not available in a cost-effective form in the decades prior. But you should go back and listen to the prior episodes where we've discussed this. because it's come up very often and it comes up more and more often. And you can search that at the podcast page at the website at www.riskparityradio.com. So now let's move to the proportions now that we've discussed what the ingredients are. So we wanted to proportion this portfolio so that it would be appropriate for drawing down upon. And what that generally means is to keep your stock allocation between 40 and 70% of the portfolio. Because we are adding leverage to this portfolio, it seemed to make sense to make that closer to the 40 than the 70. So we decided to go with 50% as the overall exposure of the stocks in this levered portfolio. Now, what about the bonds and the alternatives? Well, we thought it would make sense and be symmetrical simply to make those 25% exposures each. Those are reasonable exposures for both of them. And if you look at long-term histories or analyses of portfolios that have the highest safe withdrawal rates, they tend to have somewhere between 15 and 30% in bonds and somewhere between 10 and 25% in alternatives. So our macro allocations are essentially 50% stocks, 25% treasury bonds, and 25% in alternatives as the overall macro exposures. Now how does that translate using the leverage here? As you can imagine, there are kind of infinite ways to combine these things. We thought we would go with something that was simple and symmetrical or relatively symmetrical. So what we went with is 16% in UPRO and that is equivalent to a 48% stock exposure to the S&P 500. For the other stock fund we went with 24% in AVGV and that is our international and value exposures along with domestic value. So you can see that this is a little bit heavy on the S&P 500 side, ordinarily we would go with 50% growth and 50% value. On the other hand, the S&P 500 does have some value to it. It is more of a blend fund and not a pure large cap growth, whereas the AVGV is a very value-oriented fund. So overall, the tilt gets you somewhere on that line that's between value and blend. But if you add together that exposure of 24% with the 48% effective exposure of the UPRO fund, you end up with 72% as the overall exposure to stocks. Now moving on to the bonds. As we mentioned, this kind of strips fund has a net effect in a portfolio of adding leverage to the bond side of things. So, we do not need as much of this in a portfolio like this as you might if you were using a long-term bond fund like TLT or an intermediate-term bond fund like IEF or their Vanguard equivalents. And since we know the exposure of the stocks is 72%, what we really want is a effective exposure to bonds of 36%. So if you divide 36% by 1 1/2, what do you get? You get 24%. And that is our exposure to GOVZ, 24%, which leaves 36% of the portfolio left to allocate, which is also 1/4 of the effective exposures. And so we simply divide that into the gold and the managed futures fund. So those are at 18% each. So we end up with a portfolio that is 16% UPRO, 24% AVGV, 24% GOVZ, 18% GLDM, and 18% DBMF. This gives you an overall exposure in terms of leverage of about 1.44 to 1. So it's based around 144. which is a nice very symmetrical number. I think it is the only number, at least the only low number, that is both a Fibonacci number and a perfect square. For you numerologists out there. You unlock this door with the key of imagination. Beyond it is another dimension. A dimension of sound. A dimension of sight. A dimension of mind. And so we end up with something that looks like 72% in stocks, 36% in long-term treasury bonds and then 18% each in the gold and the managed futures fund. Now, for those of you who are familiar with Corey Hoffstein and his return stack portfolios and that idea, this portfolio is in effect one of those kind of return stack portfolios. A traditional return stack portfolio tends to have 60 to 70% in stocks with the remainder up to 100% in bonds and then stacked on top of that managed futures or other alternatives to somewhere between 20 to 40% or 20 to 50%. And what this portfolio tends to look like is like a 70-30 stock to bond portfolio with the alternative stacked on top of that in a levered manner. Which I thought was nice because this also then is a sample or modeling of that kind of portfolio as well in addition to its other attributes. So what to call this portfolio? Well, I debated all kinds of interesting and funny names because, you know, we got to have some fun around here as well. What do you mean funny? Funny how?

Mostly Voices [21:41]

How am I funny?

Mostly Uncle Frank [21:46]

I thought maybe we should do something in the numerology realm because of the 124 and all of the divisors that go into that. Could have called it something like the perfect square portfolio or the fibbo square or something like that.

Mostly Voices [22:05]

You can actually feel the energy from your ball by just putting your hands in and out. Well, I thought that was a little bit too obtuse. Now you can also use the ball to connect to the spirit world.

Mostly Uncle Frank [22:13]

Then I thought, why don't I just call it something that would appeal to our children? Like maybe the Trogdor Portfolio, which is a famous dragon from their childhood.

Mostly Voices [22:28]

You can't handle the Trogdor!

Mostly Uncle Frank [22:34]

And something many people have been laughing about for a couple of decades now, or almost a couple of decades now.

Mostly Voices [22:41]

Okay, starting again, the same way. S, more different S. Close it up real good at the top for his head, and then, using consummate V's, give him teeth, spine to these, and angry eyebrows. And you can add smoke or fire, or maybe some wings. Enough is a wingaling dragon. Let's put one of those beefy arms back on him for good measure. That looks really good. Coming out of the back of his neck there. Now he needs a name. How about... Togdor the Burninator. Oh yeah. Check out all his majesty. But what I landed on was something I thought was equally amusing but in a different way. And it has a nice ring to it.

Mostly Uncle Frank [23:30]

So the name of this portfolio is Optra, O-P-T-R-A, with periods in between each letter. Now, what does that stand for? Well, it's kind of a Lord of the Rings reference.

Mostly Voices [23:46]

Frodo of the nine fingers and the ring of doom. One portfolio to rule all.

Mostly Uncle Frank [24:08]

Optra. Yeah, baby, yeah.

Mostly Voices [24:12]

And yes, that is quite tongue-in-cheek because there is no such thing.

Mostly Uncle Frank [24:16]

It's just another sample portfolio. Forget about it. But it does have all of the nice characteristics we are trying to model here. It conforms with the Holy Grail principle by being maximally diversified across stocks, including value stocks, treasury bonds, and alternatives. It comports with the macro allocation principle by being 50-25-25, which is a good allocation for something you're drawing down on. And it conforms with the simplicity principle. It's only five funds. It could be a few more, but we wanted to make this as simple as possible, even if it was not optimized in another way on the stock side, which you might do by varying those funds a bit. So it does incorporate all the principles we've been talking about these past few years here, and in an interesting way with new and interesting funds. And so I have now put it up on the website. There is also two links there, and I'm using the test full site for these. One is a correlation matrix of the funds in it. I did not include AVGV as a fund for that correlation matrix because it hasn't existed that long. Instead, I used a DFA fund that goes all the way back to the 1990s. I also use the other options in that set up there at test full, which give you a managed futures fund to model all the way back to the 1990s as well. So we have a 30 years of modeling, not only for the correlations, but then also for a back test. And you'll see a back test comparing this portfolio to a 60 40 portfolio and also to just a straight 100% stock portfolio, because this does have the same risk characteristics, if you will, of a 100% stock portfolio. And you'll see it does much better than either one of those over the past 30 years. And in particular, when you compare it against the 100% stock portfolio, you see that its drawdowns are just so much less than the drawdowns of a 100% total market fund, which were up to 55% over the course of the past 30 years. this portfolio is a maximum drawdown, I think, of 29% and so looks better both on its composite annual growth and on its Sharpe and Sortino ratios and all of those metrics. But I will let you check it out for yourself and you can card it over to Portfolio Visualizer and Portfolio Charts and see if you can model it there, although I'm not sure you can model it as well as you can at Test-Full given what is available in terms of databases there. But we're using not only new funds, but a new modeling tool. So it's all very exciting.

Mostly Voices [27:14]

I told you homeboy, you can't touch this. Yeah, that's how we living in, you know, you can't touch this. Look at my eyes, man. You can't touch this. Here, let me bust the funky lyrics. So I actually bought the funds.

Mostly Uncle Frank [27:34]

last Friday before market close, probably should have done it at market close since they went down in value in the couple hours at the end of the last trading day in June, but I wanted to have the portfolio up and running on July 1st. As of Tuesday, it had gotten back to its starting point. We'll see how it goes from there. In terms of the management of it, We'll be doing one kind of standard thing and then one kind of unusual or different thing. The standard thing is what we could be withdrawing from this portfolio on a monthly basis taking from the best performer recently and that'll be at a 6% annualized rate to start. And if it drops below 80% of its current value, starting at $10,000, we'll drop the distribution rate to 5%. would never go below that. And then I thought I would do something completely experimental on the rebalancing side, because I've read or heard discussed a couple ideas over the past few years that I wanted to kind of implement this with this, even though I'm not sure how they're going to work out just on an experimental basis. And one of those was the idea that maybe you shouldn't rebalance your portfolio very much at all. I know people like Rick Ferri have said, well, maybe you shouldn't be rebalancing at all. And I've heard other people mention that, that even rebalancing once a year maybe isn't that optimal. If you're just taking from the best performers anyway, there's a kind of rebalance that's constantly going on as you distribute from the portfolio. But another idea that I've heard floated is that you see the biggest shifts in the economy, the macro economy, if you will, when you see the Fed reverse course on whether it's been raising rates or reducing rates. So I thought it'd be fun and interesting to time rebalancing to that because it doesn't even occur every year. It's usually a multi-year cycle we're talking about. So this portfolio will only be rebalanced whenever the Fed changes course on raising or lowering the federal funds rate. And we'll be doing no rebalancing if the Fed is going the same direction it has been going or is not moving the federal funds rate at all. So in this circumstance, that bias or that pattern most recently has been to raise rates. The Fed has stopped doing that when the Fed starts reducing rates, if it starts reducing rates, at that point we would rebalance the portfolio. And then after that we would only rebalance the portfolio if the Fed started raising rates again. In theory, that should capture large economic cycles over a period of years, because the Fed is mostly trying to react to macroeconomic forces itself. It's not always very good at it, but it's probably just as good or better than most pundits out there, if you will. But as far as I know, nobody's ever actually modeled something like this, and I haven't been able to find any modeling of it. But I thought it was a reasonable choice on an experimental basis. And we'll see how it goes. Could be very interesting. We shall see. But now I see our signal is beginning to fade. I've recovered from my trip to Milwaukee with some old friends, lots of baseball, German food, and... Bloody Marys with a ham's beer chaser. But now we're gonna be having some family visit for the 4th of July weekend, so I do not know if I'm going to be able to get on another podcast until next week. It's not that I'm lazy, it's that I just don't care. Although I will try to update the website, including the new Optera portfolio. And then we will get back to answering your emails, all in due course and in good time. Looks like you've been missing a lot of work lately. I wouldn't say I've been missing it, Bob. In the meantime, if you do 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 follow or a view. That would be great. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [32:29]

Tractor strikes again. Tractor! Tractor was a man. I mean, he was a dragon man. Maybe he was just a dragon. But he was still dragon! Burninating the countryside, burninating the peasants, burninating all the people, and that's true, that's true, that's true, that's true. And the truck door comes in the night.

Mostly Mary [33:28]

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.