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 [0:36]

Thank you, Mary, and welcome to episode 55 of Risk Parity Radio. Today on Risk Parity Radio, we are going to look at an email from Jason P. with some questions in it. That seemed kind of interesting. I thought I would go over. And then we have a follow-up to our Episode 53, where we were talking about the Dragon Portfolio, and I wanted to talk about a managed futures fund that is relatively new that would fit into that idea of using managed futures as an asset class. And so we'll begin that analysis using our 10 Questions from J. David Stein for analyzing any investment. I don't think we'll get through all of them today. But let's go to this email from Jason and Jason writes, hi Frank, thanks for the podcast. I've been listening for the last couple months and especially look forward to your rant episodes. Keep it up. I have a question regarding margin loans. I have an M1 Plus account. which offers a 2% APR on margin loans. Regardless what I plan to use the loan for, it's important that the portfolio I am using for collateral will：1. Have a likely chance of outpacing the 2% interest rate. 2. Have a low maintenance requirement allowing me to use a large percentage of the capital in the portfolio for collateral. UproTMF have a 75% maintenance requirement versus SPY/VGIT have only 25% and three have reduced volatility to limit likelihood of a margin call. Most of my portfolio is invested in Chris Cauwels ULP Ultimate Liquid Portfolio, which is an extremely conservative risk parity style portfolio made up of 88% VGIT and 12% VTI. I think one of your sample risk parity portfolios might be a better fit that will offer better returns, but still reduce risk of ever getting a margin call. Which of your portfolios do you think would be the best fit? Thanks, Jason. And then a little post script. I would also love to hear your thoughts on the ULP as a way to invest your emergency fund. as well as Hedge Fundies Excellent Adventure, a 55% UPRO/45% TMF from the Bogleheads forums in future posts. Well, that's a lot of material here, and it's kind of interesting. Let's go to this portfolio that you want to use as collateral or to borrow against, if you will. in the M1 account. I think you're right, you would not want to be using leveraged funds or a lot of leveraged funds in such an account, not only due to the maintenance requirements, but also due to the volatility. And I think what probably would work the best for this or would certainly work for this would be to take the Golden Ratio portfolio and modify it slightly to make it, frankly, a little bit more like the golden butterfly. And here's what I might suggest, or you could try, and you should look this up and analyze it. I did do a little portfolio visualizer analysis of it, and I think it will work out well. And so if you look at that golden ratio portfolio, and if you recall that it's 42% stocks, 26% bonds, long-term treasuries, 16% gold, 10% REITs, and 6% in cash. Now, I think the wild card here really is that REIT fund that we're using in that. That's R-E-E-T, and it's both international and domestic. That is a little bit more aggressive than you might want for this kind of portfolio. because that international component of REITs actually has a higher correlation to the stock market than a lot of individual REITs that are domestic. So the easiest solution, I think, would be to go over to the Golden Butterfly portfolio and steal the least volatile component of that. And that would be that short-term bond fund SHY. and if you took that over and substituted both for the REIT fund and the cash, so you made it 16%, you would end up with a portfolio that was 42% stocks, 26% long-term treasuries, 16% gold, and then 16% SHY, which kind of looks like a modified golden butterfly. But it is going to be slightly less volatile, I think, than the Golden Butterfly because the gold component is lower in this modified Golden Ratio portfolio. So I think something like that would actually work out pretty well. And when I ran the analysis, it had a slightly higher sharp ratio than the Golden Butterfly, at least for the past 15 years or so. The other option you might consider is taking that REIT fund and going after some individual REITs that have lower correlations to the overall stock market, because there are some, for instance, O, PSA, which is public storage, and DLR, which is the digital realty REIT. These are very large stable REITs, but they happen to have lower correlations. to the rest of the components in this portfolio. That would be a little bit more on the aggressive side. I think the conservative way to go would be to use that SHY in this kind of setup. And then the only other thing you would have to be cognizant of is making sure that that stock component is not something that's too wild and too volatile in and of itself. If you have a mixture of large cap growth and small cap value and maybe some other little thing in there. If you look at the sample portfolio, it's got a low volatility fund also lined up in there. But I would be also be cognizant of making that sure that that is kind of a basic stock allocation there and is not reaching out for highly volatile growth funds or anything like that. So again, I think that's my best opinion and these are just opinions. This is not financial advice. I'm not a financial advisor and so take my opinions as you will and consult your own advisors before taking any action. But I do think that that kind of portfolio would work for you. I personally do use leverage in an interactive brokers account. and have a more complex portfolio in there that looks like a combination of the golden ratio and the risk parity ultimate portfolios, but also has a lower volatility than probably either one of those. Looking at the next comment here, he says most of his portfolio is invested in this ultimate liquid portfolio, which is 88% VGIT, that's intermediate treasury bond funds, and 12% VTI, which is the total stock market fund from Vanguard. That is a very conservative portfolio. I have not run any analyses on it, but you can obviously do that over at Portfolio Visualizer, and it would be even way more conservative than the all seasons portfolio, which is our most conservative of our sample portfolios. So I'm not sure what the returns on that are going to be, particularly 80% in the intermediate treasury bonds are probably only yielding a little over between 1 and 2% right now. So it would be driven by this 12% part of the stock fund, which is not a whole lot. So that portfolio, I think, would kind of barely yield the 2%. It probably over time would yield 4% or 5% is my guess. So it would not be something that you would, for instance, use for a drawdown portfolio if you were trying to follow a 4% rule because it just doesn't have enough stock market driving it there. But it is very safe. I'll give you that. It's very safe. And you are asking also whether this is a good thing to invest an emergency fund in. I am not that enamored with using real portfolios for a true emergency fund. I think in many cases people just have too large of an emergency fund. and that the idea that I see most people having, or a lot of people having, is that they have these two things. One's an emergency fund and then everything else is a long-term investment. And so one is cash and the other one is 100% equities. What I think makes most sense or more sense for more people is simply to have a smaller emergency fund that is cash and then create an intermediate portfolio for these like three to five year needs or kind of slush fund needs. And that could be a risk parity style portfolio. So you would have instead of just an emergency fund and a long-term investment fund, an intermediate term investment fund. And this is for somebody in their accumulation phase. And you might Use that intermediate term investment fund to save for the house or whatever that large purchase is that you're going to make. Our eldest son actually does use the Golden Ratio portfolio for that purpose. So he's got the emergency fund, which carries over into this intermediate investment fund in a taxable account that's always accessible. And then he's got most of his investments in long-term investments since he's only about 25 years old. He's got a long ways to go. And then the last question or comment, what about Hedge Fundies excellent adventure, which is 55% UPRO and 45% TMF. Those are the leveraged stock fund and the leveraged bond fund. I think that's going to be a really volatile ride and. It has performed well over the past 11 or 12 years that these funds have been in existence. I think that the problem is there is a risk that these things could be correlated for some period of time and it would be highly destructive of that portfolio if there wasn't anything else in it. If you look back to, say, the 1970s, you did see a period or periods in there when long-term bonds and stocks were both going down at the same time. So we haven't seen that in many, many decades, but it can happen. And what really saved portfolios or worked for portfolios in that era was having gold also in those portfolios or some kind of commodities or even certain kinds of stocks that were based in commodities or even your small cap value funds actually did a lot better than the large caps than the large caps or what people called the nifty 50 back in that era. And it really, you know, was Polaroid and Kodak and Xerox and all those fun tech companies of the past. and they did exceptionally well in the sixties and then kind of sucked eggs in the 1970s and you were better off with just a larger, more diversified stock component there. So looking at this 55% UPRO 45% TMF, that's going to be even more volatile than our most volatile risk parity style portfolio, which is our aggressive 50/50, which has 33% of each of those components in it in addition to some intermediate term treasuries and some preferred shares fund. So I don't know that I would want to have something that's that volatile, but maybe if you're young and strong and are interested in experimenting with a little bit of your portfolio, you might try something like that. It's a certainly within the realm of a potential investment, although it's not something that I think I would recommend, at least not for somebody of my age these days. I really do think that these sort of leveraged fund kind of portfolios work better if there is some ballast in there and it is ballast that is uncorrelated to both of the leveraged funds and usually gold comes to mind. as a key component of the rest of that. And now let's talk about this investment in a managed futures strategy ETF. And the ETF we're going to be talking about is the DBMf. That's D as in dog, B as in boy, M as in Marion, F as in as in Frank. And so that comes up in the context of this dragon portfolio that we were talking about a couple of episodes ago. And one of the main components, about one-fifth of that strategy, is supposed to be in managed futures. Those are futures contracts and options on various commodities and other things that you can trade. And usually that is some kind of trend following system. And the criticism or the problem we had with that was simply that there are not good managed futures funds that this has been kind of a major failure in terms of ETFs that have been actually able to implement some kind of strategy and be successful at it. So most of them and have failed. And this is kind of the most recent entry in this area. And so we will use David Stein's 10 Questions to Master Investing to go through these and we'll, I think, do about the first five of them today. All right, the first question, question number one, is what is it? Well, it is something that is complicated. heard about this on a podcast, the Barry Ritholtz Masters in Business podcast, which you can hear every weekend. This one came out a few weeks ago. I will try to link to it in the show notes along with some of these other materials that I pulled off this website about this fund. So anyway, this is an attempt to create an ETF that is managed futures. And the interesting part of it is how they constructed it. And the way they constructed it was by monitoring a whole bunch of hedge funds that invest this way. And you can find these hedge funds, the information is public if you look for it. And so they took all of these hedge funds that were doing these kind of strategies. and then they did some kind of regression analysis to essentially recreate it backwards or re-engineer it backwards saying, well, these are the ways that these things have been performing. How would we create a fund that performs similarly out of managed futures? And so they do this periodically, I think several times a year, and modify the holdings in this fund. And so what do you end up with this in this fund? It varies over time, but it has a wide range of things in it. Right now, as of the fourth quarter of 2020, the top five holdings are a Japanese to US dollar currency futures, the Euro to US dollar currency futures. some futures in emerging markets, some futures contracts on the S&P 500, and some futures contracts on short-term treasury bonds. And those are the top five items. Let me see if I can find the list of the other ones. Some of the other things that you find in this fund as of actually February 9th, 2021 are crude oil futures. I mentioned the Euros and the S&P. There are gold futures in there, emerging market futures, other foreign stock futures, and there are actually futures on two-year notes, 10-year notes, and the long bond, and some on commodity futures. So it's a wide variety of things that they've got in here. In addition to that, that is ballast. They keep most of the money in T-bills that's not being invested in these futures contracts. So it is one of the most complicated structures that I've seen in an ETF, but it's interesting the way they construct it simply because it is mechanically derived, even though it's very complicated. They use a program to analyze these other funds and then reconstruct a fund that would perform as those other funds are performing. All right, now that we know what it is, it is an ETF that you can buy and sell on regular markets, by the way. The next question, question two, is, is it an investment, a speculation, or a gamble? Well, I don't think it's a gamble. It does have positive returns, and it is well structured in a way that you would expect it to have a positive yield over time. It is kind of a cross, though, between an investment and a speculation, depending on what is in these funds. Futures contracts and options by their nature are a bit speculative because you're not holding them long term for most of the time. The underlying assets also could be speculations, for instance. the investment in gold or the investment in currencies. Those are not things that have a yield and they are not businesses. So those would be speculations. On the other hand, the futures that are tied to indexes in stock markets are more of an investment. So it is a cross here between an investment and a speculation is probably the best way to describe it. All right, what is the upside? Well, the upside, it's kind of a little bit muted, at least the way it's performed over the past about 18 months. This has only been around since May of 2019. It's a brand new thing. So in 2019, it did have a six-month return or seven month return there. I guess that's eight months. And it came out to 10.76% for that year. In 2020, it was up and down and it came out with a final performance of 1.84% for that year. So since inception, it has a return of 7. 54% And so the upside is you're going to get these profits generated by these strategies in these futures, and they do seem to be reasonably profitable. And I also note that they don't appear to be terribly volatile. I do see that the highest return was in 2019 in August of 7.52%. and then the worst month was in May of 2020 so far, and when it was down 3.22%. What I thought was interesting is when you look at it in March or April of 2020, which were highly volatile times for stock and bond markets, this was very muted. It was up 1.03% in March. It was up 1.84% in April of 2020. It was down 1.84% in February of 2020. So this does appear to have a low correlation to other things and a lower volatility, which is helpful and is good for the upside when we get to talking about how it might fit in a risk parity style portfolio. All right, number four, what is the downside? The downsides are kind of a little bit unknown with respect to this because it has not been around that long and we don't really know how well this method of constructing a fund will work over time. It could work just fine. I'm sure they've back tested it and it has performed well in the past, otherwise they wouldn't have constructed it the way that they did. But the proof will be in the pudding. and there could be some serious drawdowns at some point just on random factors. So the downside is mainly the uncertainty of this. If we look at other factors, there is a total expense ratio in this fund of 0. 85%, which is high for an index fund, but it's not that high for something of this complication that you would expect to be paying somewhere between 0.75 and 1% for something like this. That's another little bit of a downside to this fund. All right, question number five, which is the last one we'll do today. Who is on the other side of this trade? Well, when you think about it, The fund is just traded out in open markets. So in terms of buying or selling the fund, you just get out there and buy or sell it. It does not have incredible liquidity, but it doesn't have bad liquidity either. So it's not like you'll be having trouble to get in or out of it. On the components of it, obviously, they are trading against other hedge funds and banks and large institutions that may be hedging various things, and also your small traders. So it's the whole gamut of institutions and people that trade commodities and futures. But I think that is probably enough for today on this. We will pick this up next week actually. We won't be discussing this fund on questions six through ten until a week from today or the next week. So I do see our signal beginning to fade now and we will pick this up with our next episode which will be our portfolio reviews of the six sample portfolios that you can find at www.riskparityradio.com. www.riskparityradio.com and come back to this fun next week. If you would like to leave me a message or a question or something for me to comment upon, I promise not to rant on your email, but you can send that to frank@riskparityradio.com by email. That's frank@riskparityradio.com or you can just go to the website www.riskparityradio.com fill out the little contact form and I will get your message that way. We are up to almost 6,000 downloads for this little hobby podcast of mine and I appreciate all of you who are listening in. I hope you get something of value out of it. And thank you for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [26:54]

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.