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 [0:19]

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 61 of Risk Parity Radio. Today on Risk Parity Radio, we're going to do part two of our episode about the ETF NTSX, part one of that episode Part one of this analysis was episode number 59, and you can go back and listen to that. And what we are doing for our analysis is what we do with all of our analyses, which is go through J. David Stein's 10 questions to analyze any investment. And we are on questions 9 and 10 out of 10 for this episode. Questions 1 through 8 we dealt with in the first episode. I did get a nice email from Brandy about that episode. She writes, hi Frank, it was fun listening to your recent episode on NTSX. Thanks for covering this unique ETF. It appears that Wisdom Tree thinks it is a winning strategy. They have filed with the SEC for two more ETFs which copy the NTSX strategy, one with international developed market equities and one with emerging market equities, both using treasury futures in the exact same way slash ratios as in TSX and she provides the links to the SEC filings. She continues on with more things, but that's what she has to say about NTX and I do think it's interesting that this is become a vehicle for Wisdom Tree. Wisdom Tree has a Risk parity, risk parity, Frank Vasquez in the audio. Now, this is an interesting question because if you just look at NTSX in a vacuum, it doesn't seem like it's going to be that useful or interesting to add to a portfolio. And the reason for that is its correlation results. And I'm going to post this correlation analysis in the show notes so you can have a look at it. But what you see from it, and this is from Portfolio Visualizer, I analyzed NTSX against A total stock market fund, a small cap value, long-term treasuries, gold, REITs, commodities, and preferred shares. And what you see is that NTX is in fact 98% correlated with the total stock market fund, has a high correlation with the small cap value fund of 83, 0.83. Then it's negatively correlated with TLT, minor correlation with gold of 0.21. It is highly correlated with REITs and with commodities and is also highly correlated with the preferred shares fund. Now this does only go through the existence of NTSX, which is only since September of 2018. So you do have to take that with some grain of salt. But looking at this, you wouldn't think that this fund would be that useful simply because if you already have a whole bunch of stocks in your portfolio, you wouldn't just want to add something that's highly correlated with them unless you were replacing it because you're not adding to your diversification by adding more things that are more correlated with your portfolio. So if you're going to use this, you probably want to do something different. One comment on this high correlation, it is the same observation that Ray Dalio had back in the 1990s when he was looking at portfolio construction and standard 60/40 stock bond portfolios in particular, you can see from that that almost all of the volatility and risk comes out of the stock portion of those kind of portfolios. And since NTSX is essentially a 60/40 portfolio on steroids with leverage in it to make it more like a 90/60 portfolio, it has the same qualities to it. So I wanted to sort of take it apart and then figure out, well, could you use it on its own with some other components in a risk parity style portfolio, or how could you use it in a risk parity style portfolio? If you take it apart, I mean, what you really have in there is an S&P 500 fund like VOO. which is the Vanguard S&P 500 fund. And then the treasuries work out because they're across the spectrum of treasuries from short term to very long term as almost like an intermediate treasury bond fund. And so if you go and compare NTSX to a leveraged portfolio that is 90% VOO and 60% IEF or VGIT, which are intermediate treasury bond funds, you see that they perform pretty much the same or very close to similar, at least for the time that NTSX has been in existence. And that's not surprising looking at the portfolios, but it does confirm that what WisdomTree is doing with those treasury bond futures that it's got in there do tend to perform like just holding a treasury bond fund. And then it's just a question of which ones and the immediate intermediate term treasuries seem to be on average the same thing. So thinking about that, then you would need to kind of take that apart, do a little algebra, and sort of figure out, well, what else could we match up with that? And in what proportions to really create a risk parity style portfolio that is not 98% correlated with the total stock market. And so I thought, well, what do we have in the most simplified risk parity style portfolios? You could add all sorts of different things to it. But in the most simplified ones, what you have are typically stocks, treasury bonds, and gold. And that is kind of the simplest formulation for them. That is the formulation, for instance, of the golden butterfly portfolio. So I constructed a couple of those just for comparison purposes. What I one of them, I put in 80% NTSX and 20% gold. And I'll link to this in the show notes. And so what that comes out to being kind of like is a portfolio that is 140%, essentially, because the 80% NTSX acts like it was 120% with its 1.5 leverage. And you would divide that 60/40 into stocks and bonds. And then I add 20% in gold, which functions more like 15% in this portfolio. The reason I picked that much gold goes back to our gold analyses. in our prior episodes and the one that we looked at from big earnings analysis, which suggests that about 15% gold is probably the optimal amount of gold to have in a risk parity style portfolio. So looking at that, it's a very simple way to construct a risk parity style portfolio with this fund, NTSX would be to take 80% NTSX and add 20% gold. I wanted to compare that with a few things to see what other variations of that would be like. So one of the things I did since we already got some leveraged portfolios is what if we took some of the leveraged funds that we already use in our sample portfolios that you can find at www.riskparadioradio.com? And so one similar proportion portfolio would be 45% UPRO, which is that leveraged S&P 500 fund, 30% TMF, which is the leveraged long-term bond fund. And then we put 25% gold in there because proportionally that comes out to about 15% when you multiply these things all out and do the algebra. And then I wanted to have a sort of a combination of those two portfolios. The reason I wanted to do that is because Typically in our risk parity style portfolios, we want to have some more long-term treasury bonds than intermediate-term treasury bonds. The components of NTSX act more like all intermediates. I thought, well, what if we added a little bit more and tweaked it using these leveraged funds so that it had more of a long-term treasury bond tilt. We did this combination portfolio as our third comparison portfolio in this analysis. And we put 60% in NTX in that. We put 20% in gold, GLD in that. And then we put 5% in UPRO, the leveraged stock fund, and 15% in TMF, the leveraged treasury bond fund. And what that does is it gives it more of a long-term treasury bond tilt. And so we label these things in our analysis. We call our first portfolio NTSX with gold. We call our second one the leveraged fund analog, and we call the third one the combination portfolio. And just looking at the results of those, and they only go back for since September of 2018. So it's not a very long time period because NTSX has only existed for that long. I'll tell you about a longer analysis that I also did after this one. But just looking at this, we see compounded annual growth rates for the NTSX with gold of 16.1%, that leveraged fund analog with just the higher leveraged funds in it at 19.09%, and that combination portfolio at 16.8%, and that all compares to a standard Vanguard 500 Index Invested Fund, S&P 500 fund of 13.5% for this period. Of course, this was a very good period for the stock market. But I think it's more interesting when you look at the drawdowns in the worst years for these things, because the NTSX with Gold portfolio had its worst year in this short period of minus 7.6%. that compares to that leveraged fund analog of 14.8 and then the combination portfolio of -6.9. So that's actually the best one. And that for the max drawdown for the whole period, it's -11. 8 for the NTSX with gold, -14% for the leveraged fund analog, and -6.9 for the combination. So that translates into sharp ratios, which is really the way to compare Risk reward here, since these portfolios are so similar, of 1.02 for the just a plain old NTSX with gold portfolio. The leveraged fund analog has a lower sharp ratio because it has a lot more risk going on in there, even though its growth rate was higher. So it's down at a sharp ratio of 0.81, but the combination portfolio actually does the best. because it's just tilted a little bit more and a little bit more balanced, I think. And so it comes out with a sharp ratio for this period of 1.09. And so I thought that was an interesting way to use this. You can see that it's a usable thing, but you really need to think about what else you have and how do proportion it with your other options, your gold and whatever else you might put in there. I did not go out and start putting REITs or preferred shares or other things in there to see what that would do. I will leave that more for the listener who wants to fiddle with this. But I did do another longer term portfolio where I took the idea of NTSX and put it back farther in time, and we could go back to 2004 with this analysis. So I basically created a synthetic version of this on Portfolio Visualizer, and then we analyzed that both with the equivalent of the three funds that we just talked about, the three portfolios we just talked about here. Let me just pull that up and we'll take a look at that. So I will also link to this in the show notes, the first portfolio in this selection. which goes from, well, this actually only goes from July 2009 to February 2021 because it's got that UPRO in it, which only goes back that far. So the first portfolio, what I call the synthetic NTSX with gold for the synthetic part of NTSX, I use 90% the S&P 500 fund and then 60% in the intermediate treasury bond fund, IEF. and then I put 25% gold in there, which works out to about 15% of the total. And then to balance this out for the purpose of analysis, you have to put a negative cash amount in there. So it's negative 75% on that. So that's the synthetic NTSX portfolio with gold in it. Then I also did that analog, that leveraged fund analog portfolio again with 45% UPRO. 30% TMF and 25% gold in it. And then I did a combination of them as well. So this one has 54% SPY and 26% IEF. That adds up to 80 like we had in the previous example. Then we have 20% in gold, 5% in TMF, the long-term Treasury leveraged fund, and 5% in UPRO, the long-term S&P Leverage Fund and this one needs negative 20% in cash to make it balance out. But you can see from this is how you would need to actually go in there and sort of tweak these numbers to match up with your other things and do a little algebra to construct these in a way that makes sense. So looking at the results of this, we see that the synthetic NTSX with gold actually has a compounded annual growth rate of 17.54%, the leveraged fund analog, which is more leveraged, is up at about 23.96% compounded annual growth rate for this period. The combination fund is actually lower at 15.03%. But then when you go over and look at the worst years and maximum drawdowns, you see that the first and third portfolios are much more diversified and less volatile. So that first synthetic NTsX with gold portfolio is a worst year of minus 5.37% and a maximum drawdown of 13.2. The leverage fund analog, the more risky one, is negative 15.1 for its worst year and negative 19.97 for its maximum drawdown. And then the combination is the best in terms of lower volatility. It has a worst year of negative 5.87%. I should say that's a little bit more than the worst year for the NTSX with gold, but its maximum drawdown is the lowest at negative 10.99%. That all compares to the S&P 500 or Vanguard 500 index during this period with a worst year of negative 4.5 and a maximum drawdown of 19.6%. which is similar to that of the Leverage Fund analog, but that only had a compound annual growth rate of 15.15% for the period. What this all translates into is you can see similar results on a risk reward balanced metric using that Sharpe ratio. We see that the synthetic NTSX portfolio with the gold in it has a sharp ratio of 1.31, which is high. The Leverage Fund Analog, which had the highest compounded annual growth rate, actually has a lower sharp ratio of 1.25 for it. And then the combination portfolio does better than the other two. It's at 1.35. So it's the best of the three, but they're all sort of within striking distance. But then when you compare that with the total stock market, the Vanguard 500 Index Investor, that was down at 1.05. So any of the leveraged portfolios with NTX or analogs to it do better than the total stock market for this period with less volatility. So coming back to the question as to how does this impact your portfolio? It could improve the performance of your portfolio is the answer, but you do have to make some manual adjustments in your portfolio. to accommodate this and its specific characteristics so that you can take what your ordinary projected risk parity style portfolio might be like, take this and make some modifications to it, and you'll get a little leverage and you may get, you probably will get some better performance at a slightly higher risk, but it may be worth the risk if you do it right. So, question 10, should you invest in NTSX? And the answer is a qualified maybe that it could be a useful way to get some leverage and construct a risk parity style portfolio, but it comes with a health warning on it that it is leveraged, you get more risk out of that, and you do need to do a little bit more work to figure out how it's going to balance or work out with the other components in your portfolio. I do know that because it has a relatively low expense ratio of 0. 2 and for something with futures and leverage in it, that as low as you're probably going to get in an expense ratio, and it should cover that. So that's a positive for it, but it does carry some risk to it. I will note that in my conversations with Andy Cole of Laminar Investments that I mentioned in episode 59, he said that he does use this and help investors construct risk parity style portfolios with it, also incorporating some international ETFs and things like that. I won't tell you exactly what he does just because it's his business and if you want to talk to him, you can go look him up and talk to him. But he says that as one of the simple solutions, if he's just going to give you some ideas and you're going to pay him for that, this would be something that he would use as a one of those options. I do not get compensated for anything that he gets. I do not get compensated for anything for doing this. This is a hobby podcast and I am an amateur investor just with a lot of experience. But now I see our signal is beginning to fade. I wanted to thank Andy and Brandy again for bringing this fun to my attention because it looks like it could be something that is useful for risk parity style investors. I'm not sure I plan on using it myself, but knowing that it's out there is useful in and itself just for recommendation purposes and ideas moving forward. If you have questions or comments You can send them to frank@riskparityradio.com that's frank@riskparityradio.com or you can go to the website www.riskparityradio.com and put them in the comment box or contact form and I will get your message that way. We will be picking up this weekend with our weekly portfolio reviews of the sample portfolios you can find on the Portfolio's page at www.riskparadioradio.com and I suppose I also owe some of you a monthly rant since I know that some of you like that. I will come up with something by then. I haven't felt like ranting too much this week, but we will fulfill that purpose or role. Thank you for tuning in. This is Frank Vasquez. with Risk Parity Radio. Signing off.

Mostly Mary [22:31]

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.