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 episode 46 of Risk Parity Radio. Today on Risk Parity Radio, we are going to answer a listener question about a particular fund from Aptis Funds. But before that, We're going to have our monthly rant. I guess I'll have to cue some music here. I can just find that button. And away we go. And today's rant is about the dishonest marketing of certain kinds of financial products. And oftentimes you can tell that there's going to be some dishonesty involved if you take a look at what these things are called and compare them with what they actually do. Now here's a few names of things that you can find out on the interwebs or have been presented to you at some point. MPI, Wealth Factory, Power of zero, money ripples, infinite banking. What do all these things have in common? What they all have in common is what they're not telling you about how they make their money. These are all fronts for insurance brokers. And you'll notice that none of those titles mentions insurance. They talk about anything else but insurance. And why do they do that? It's because they have a lot to hide and what they're selling is not in your best interests. Usually the pitch runs something like this. They tell you you're a bad person, you shouldn't invest in your 401k or the stock market because you don't want to know what you're doing, you're going to lose all your money. And they try to scare you with that or scare you with some tax argument about some future tax law that they've been claiming is going to appear for the past 20 years and has not appeared. And they particularly hate 401 s and will make up lies about 401 s. You have to understand the reason they do that is because they know that most people have saved a lot of money in 401 s. So they need to get at that money. They need to take that money out of those 401 s and put it down in these insurance products that'll give them those commissions. So I was listening to a little podcast by one of these people last week, and his presentation was completely fraudulent. First he says, well, you know, the stock market has a real return of 7.35% over the past 30 years. Well, why did you use the past 30 years? Why don't you use a longer period as a real return of 8% over the past 50 years? Let's just start there. So that was wrong. And then he doesn't explain what a real return is. Well, we know a real return means it accounts for inflation. The nominal return is higher than that. The nominal return is probably somewhere between 10 and 12%. So what does he do? He does some little calculation and says, all right, well this is how much you would have. And then he says, and then we need to account for inflation. Well, you already accounted for inflation by using a real return. You don't double count inflation. Of course, something's going to look bad if you double count for inflation. And I think he said it was going to be four or 5%, something it hasn't been in 20 years. So he lied. What can we tell about people who lie? Well, there's an analogy. If you order some stew at a restaurant and you start eating it and part of it's rotten, you don't keep eating it. You don't keep picking around the plate looking for good pieces of it. You throw the whole thing away. So one lie is enough. to throw these people out in their ear. But they keep lying. Now let's take a look at what they're actually offering. You have to actually dig to get this information because there's layers and layers of marketing on top of this until they actually get to what they are selling, which is typically a whole life insurance policy with a lot of upfront or early deposits into premiums for it that hopefully will generate some income later. But when you take a look at one of these things, they are God awful as investments. They are God awful. I pulled up one and I'll see if I can link to this. I just took it off a screenshot off somebody's video. I won't mention the name. But anyway, he's saying, well, here's what other Insurance brokers selling these systems are offering, and here's what I'm offering, and isn't it so much better? And they're both just crap. One of them has a commission of 31% in the first year, a 31% commission. No wonder he wants you to buy this thing. He says his is better. It's only got a 29% commission the first year. And that's really the problem with these things. They get behind and they never get ahead. Because the returns on them in their policies are small. They're 4% at best. So you look at these illustrations and you really, anybody's peddling this stuff. The first thing you want to ask them is, let me see an illustration. Let's not waste our time. Let's look at what you're actually offering and not telling me about some mythical benefits of borrowing from it or doing something else with it. But anyway, so the metrics you want to look at, well, how long is it until this thing breaks even? And in these examples, it was six or seven years, six or seven years before you see extra dollar one while all of those commissions are being sucked off. And the opportunity cost is huge. You could be investing that in so many other places. and you know you'd be ahead. But it gets worse over time. It really does because of that opportunity cost and the lack of compounding that you're going to get in something like this compared to a risk parity style portfolio or any kind of portfolio that you could put together without thinking too hard. So I looked at it. The other question I had, well, how long did it take to double your money? And in one of these illustrations, it took 19 years to double your money, 19 years. That's a good chunk of your life. And the other one, it took 20 years to double your money, the one he's recommending. So as you can see, both of these are just bad investments. They're just lousy investments. And then they come back to the pitch, and the pitch is always, Well, you put your money here and then you can borrow against this policy. What they don't tell you is the rates for borrowing against these policies are not good. They're like five or 6%. In today's low interest rate environments, I mean, you can get a mortgage for 3% or less. And then they're going to offer you some other business, real estate, some other scheme for making money. They don't really specify what it is. But it doesn't really matter because this insurance policy thing is completely separate from whatever that is anyway. If that's the greatest thing, just go invest it in. You don't need the insurance policy to invest in it. Now, if you do want to borrow against your portfolio, your investments, there's a very easy way to do it. You don't need an insurance broker. You don't need a contract. You don't need any of this garbage. You just go to a broker like Interactive Brokers with really low margin rates and you invest your money there. And if you want to do it really conservatively, you could just create a 3070 portfolio like an insurance company would invest in or something that looks like one of our risk parity style portfolios, one of the most conservative ones. That all-weather portfolio. And then guess what? You could borrow against it. It's going to be making 5%, 6%, 7% way more than it's going to be making one of these policies. You can borrow against it right now at 1% or less. So if you want to do that, just go do it. Don't talk to one of these jokers. Don't get roped into one of these things. Because the worst thing about it is your money is just tied up in that thing. It's just tied up in that thing. You don't have access to your money. They have your money. You are contractually bound to give them your money and for them to keep your money. Practically, criminally, people are fraudulent. You shouldn't trust them. You shouldn't go to them. You should warn other people about them. All right, enough ranting for today and for the month. Let's calm down a little bit here and take a look at our listener question. This comes from listener Brett, and he writes, Frank, I've become very interested in risk parity in the last couple years and came across your podcast a few weeks ago. I quickly listened to all of them and appreciate you sharing your knowledge. I was wondering what your thoughts were on the Aptos defined risk ETF ticker symbol DRSK. and if it might have a spot in a risk parity portfolio. Thanks. Well, it's an interesting question. I was not familiar with the fund, but I did some research and we will be analyzing this fund using the 10 questions to master investing from J. David Stein, like we always do, and I'll be linking to that in the show notes as well as some of this other material I'm referring to now. And so the first question is, what is it? Now, the Aptis Defined Risk Strategy Fund is an ETF, and it is comprised of a large bond portfolio on top of which there is an options trading strategy. And so when you look inside of this fund, What you see is about 94% of it is invested in a corporate bond ladder that goes about seven years. And those are mostly in bullet shares and I bonds, and they are targeted for the next seven years or so. with the idea that when one expires, you'll go up and put the ladder on the next top. Now, as you can imagine, that's not a very exciting part of this portfolio. It's simply like investing in a corporate bond fund and it would pay those kind of returns on it. Now, what else is in here? The more interesting part is the option strategy. And what they do is they take about 4% of this, 4% or 5%, and they invest it in call options, mostly on large companies, and they've got about 10 of them in here right now. This is the six-month report that I just printed off. And so what they've got in here, call options on Adobe, Alphabet, Amazon, Apple, Bank of America, Broadcom, Facebook, and Home Depot. It's a small selection, but these are all very large, well-known companies, and these are all call options. on these things. And then they've got a secondary strategy to deal with the risk, and that is to buy put options. And so the put options are on QQQs, the Nasdaq ETF, and the S&P 500 index. And they're kind of equally divided into those categories. And as of this report, it comprised 1.7% 27% of the fund. So that's what's in here. All right, question two, is it an investment, a speculation, or a gamble? Well, I would call it an investment. It is got bonds in it that are paying interest, and it's got a strategy with stock options, and they're not, it's not overly saturated with them. It's only a small percentage of the fund, and they will in large part tend to go up as the stock market does and as these companies have historically done pretty well. I don't know whether they'll keep these companies or buy different ones in the future, but that's what they are right now. So it's an investment. What is the upside? The upside is you are getting the interest from the bonds and then you are getting the returns from the call options mostly as they go up. And the put options are end up being a form of insurance. So if the stock market were to decline, then the value of those would go up. But those are not designed as the primary driver here. The primary driver here is to take call options on things that the managers of the fund believe will increase in price. And so that's where the upside comes from. What is the downside? There are a couple of downsides here. Well, the first is you have the drag of the put options. So that's going to reduce the returns of this. I think the second downside is this has a short history. It's only been around for a couple of years since 2018. And I could not find anything that suggested how the companies for the call options were selected. And some of them appear to be correlated. They're big fang stocks. So if there is a decline in these large cap tech stocks, generally, there's a risk here that it's going to lose money. basically what the bet is here is that they can pick stocks that perform better than the overall market. Because if these stocks don't perform better than the overall market, this fund is likely to lag the market. There's also a question of how much volatility is in here and how that is measured. So there's a bit of uncertainty going forward as to whether this fund can perform. So far over the past couple of years, it's making 11 or 12%, seems to be doing okay, but that's not a very long history for the management of one of these things. And you can imagine that if they have a couple of bad years, people will pull money out of the fund, and then you wonder where it's going to be. Question five, who is on the other side of the trade? Well, there really is just the market for the most part. You're not trading with the managers. The managers are just trading options in the stock market. So it's basically dealing with market participants. And these things are all very liquid, very large. So there isn't any real risk there. Question six. What is the investment vehicle? This is structured as an exchange traded fund. So you can just go on the stock market, go to your brokerage and buy the ticker symbol and you'll own it. What does it take to be successful? Well, it's hard to know whether you have confidence in these managers. I don't know the managers. They could be the greatest stock pickers on earth or they could be terrible. And so there is a random factor here. Go back and ask Dirty Harry, do I feel lucky? Do I feel lucky? But if the stock market continues to perform the way it has in the past couple of years, and these companies do as well as they have in the past years, this fund should be relatively decent. Question eight, who is getting a cut? Well, the fund fee on this is 0. 79%, the expense ratio, which is not that high for something like this when you're talking about an options strategy. So it's reasonable for what it is. It would be difficult for an individual to construct this and would require a lot of effort. And of course, you have to know how to pick call options and deal with managing that. So it's not a terribly high fee, but it's not a cheap fee either. All right, now the more, most interesting question, at least the one I find the most interesting, is how would it impact your portfolio? Now to think about this, we need to think about a couple of metrics, and I've done a asset correlation analysis that I'll link to in the show notes for you to take a look at. I've taken this fund, DRSK, and put it in a matrix with three Vanguard funds, VTI, which is the total stock market, VUG, which is large cap growth, VIIV, which is small cap value, a long-term treasury fund, TLT, some gold, GLD, a REIT, VNQ, and a preferred shares fund, PFF. and these are a variety of funds that you may already be holding in your risk parity style portfolio. So the question is how would you fit this new fund in there if you're going to fit it in there? Now, as I mentioned, it does have an annualized return over the past couple of years, and it says it's 11.89%, so it's not bad there. It seems to be along the lines of another stock fund or stock market component the way it performs because really its basic performance is going to be tied to the stock market and to the performance of those particular companies and their call options, which is the main driver of the returns for this. And if you look at this correlation analysis, you see the Aptis Defined Risk Fund is positively correlated with all of these, but not to a necessarily very high degree. It is positively correlated with the Total Stock Market Fund at a rate of 0.6. And remember, this is a scale from negative 1 to positive 1. With the Large Cap Growth Fund, the correlation is 0.66. With the Small Cap Value, it's 0.46. with the long-term treasury fund TLT, it's uncorrelated, it's 0.04. I found that interesting that it's not actually negatively correlated as other stock funds would be. With gold, the correlation is 0.33 with the REIT fund, the correlation is 0.56, and with the preferred shares fund PFF, the correlation is 0.52. Now these are limited in the data set because this fund has only been around since September of 2018. You can't take these as gospel because they are not based on that much data, but it is interesting to see what these correlations are for this. So you can see that this could have a place in a risk parity style portfolio. as a substitute for one of your stock funds or in addition to one of your stock funds because it would play nicely with the rest of the stock funds and you would expect it to have positive returns when the stock market is going up and not be too bad when the stock market is going down due to the put insurance it's got built into it. Now, I did not attempt to run any back tests on this simply because there's just not enough data for it to be meaningful. But if you were to incorporate it, you would incorporate it as probably part of your stock component or something that might replace REITs or preferred shares or one of those stock related type funds. And now we get to question 10. Should you invest? Should you make this part of your risk parity style portfolio? I think for me the answer is probably no, not at this point. Not because it's a bad fund or it's a bad idea. It's actually very similar in some ways to the options trading strategy that Big Earn uses that we talked about in an earlier episode that I can also link to in the show notes. In his version, he's got a lot of municipal bond funds and some preferred shares, and then he's got an options trading strategy that involves selling puts, which is also bullish in terms of the stock market. This is just a different type of stock option trading strategy that's also layered over a large pool of bonds. So this is actually not that unusual for a fund to employ, or at least a hedge fund to employ. The main problem that I have with it is simply it just does not have much of a track record. So there is a large random component here. You could ask yourself a question, do I feel lucky? And it's difficult to know whether these managers can sustain a good performance over a long period of time because you are really dependent on their ability to pick the correct call options for the correct period. Stock picking is going on here, and so you really need to have a lot of confidence in these particular managers. They don't appear to have a particular system, at least not the one I could see in the materials that they provided, but they are actually just doing this based on their own research at the time, I guess. So unless you knew something about the managers having some kind of a good track record for being able to do this over the course of a decade or so, it would be hard to recommend this fund at this point. It may be something to watch because it might be something you would want to invest in the future if they can sustain a good performance even through a bad year or two, and that's what you'd really want to see. is to see what their performance would be like in a year where their stock picks go badly or some of them go badly, and that just has not happened over the past couple of years given what they're holding. But now I see our signal is beginning to fade. I want to thank Brett for that excellent question and suggestion. It's always interesting to look at various investments and then think about how they might work or not work in your risk parity style portfolio. Because there are a lot of options out there and in the ETF world you can buy just about anything in an ETF these days. If you'd like to send a question or comment to me, you can send me an email at frank@riskparityradio.com that's frank@riskparityradio.com Or you can go to the website www.riskparadioradio.com and fill out the contact form there and I will get it that way. We will be resuming this weekend with our weekly portfolio review of the portfolios that you can also find at www.riskparadioradio.com on the portfolios page. Thank you for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [25:52]

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.