Diversified Returns: The Case for Risk Parity with Alex Shahidi

Dive into the world of investment strategies with our latest episode focused on risk parity and the innovative ETFs, RPAR and UPAR. Join financial expert Alex Shahidi as he unpacks the evolving landscape of portfolio management, encouraging listeners to reassess their traditional views on asset allocation. The conversation covers the importance of diversification, revealing the limitations of the conventional 60/40 model that many investors continue to favor. 

With insights backed by historical data, we explore how equities, commodities, treasuries, and gold have performed through various market cycles. Shahidi clarifies the concept of risk parity, shedding light on how it can create a resilient investment portfolio that adapts to market fluctuations while aiming for consistent returns. He discusses the potential returns from traditionally lower-risk assets, explaining how leverage can enhance their performance to match or even exceed that of equities. 

Through this engaging discussion, listeners gain a better understanding of how to structure their portfolios for greater stability and consistency. Shahidi also highlights the risks associated with focusing solely on short-term market trends, urging investors to adopt a long-term perspective that prioritizes diversity in their asset allocation. 

As you tune in, consider your own investment approach. Are you gambling by putting all your eggs in one basket, or are you ready to embrace a diverse, strategic framework that stands the test of time? Share your thoughts about risk parity and how it has influenced your financial planning. Your journey to informed investing starts here—demand the answers you need and engage with us! Remember to subscribe and leave a review for more insightful discussions!

DISCLAIMER – PLEASE READ: This is a sponsored episode for which Lead-Lag Publishing, LLC has been paid a fee. Lead-Lag Publishing, LLC does not guarantee the accuracy or completeness of the information provided in the episode or make any representation as to its quality. All statements and expressions provided in this episode are the sole opinion of Evoke Advisors and Lead-Lag Publishing, LLC expressly disclaims any responsibility for action taken in connection with the information provided in the discussion. The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program

 Sign up to The Lead-Lag Report on Substack and get 30% off the annual subscription today by visiting http://theleadlag.report/leadlaglive.

Foodies unite…with HowUdish!

It’s social media with a secret sauce: FOOD! The world’s first network for food enthusiasts. HowUdish connects foodies across the world!

Share kitchen tips and recipe hacks. Discover hidden gem food joints and street food. Find foodies like you, connect, chat and organize meet-ups!

HowUdish makes it simple to connect through food anywhere in the world.

So, how do YOU dish? Download HowUdish on the Apple App Store today: 

Listen on: Apple Podcasts   Spotify

Chapters

• 0:00 Introduction to Risk Parity and ETFs
• 15:55 Understanding Historical Returns and Risk
• 28:14 Why the 60/40 Portfolio May be Risky
• 37:49 The Benefits of a Diversified Portfolio
• 42:35 [Ad] Intelligent Investment Today - The Warren Buffett Way
• 43:08 (Cont.) The Benefits of a Diversified Portfolio
• 49:54 Structuring Asset Allocation for Resilience
• 1:02:34 RPAR vs. UPAR: Key Differences Explained
• 1:13:49 Navigating Market Changes and Returns
• 1:26:44 The Long
• 1:36:58 Concluding Thoughts and Future Outlook

Transcript

Speaker 1: 0:00

Our PAR has been around five years, UPAR about three years. But we can look at these underlying indexes in which those two ETFs invest to have some longer term perspective, which is what I show on this page. So this goes back to January 2000,. So about 25 years. The MSCI World Index, you know, for global equities is averaged a little less than 6% a year, has averaged a little less than 6% a year. Treasuries this is long-term treasuries for the same period has averaged about a percent a year less than global equities. And, by the way, this is after the last few years where global equities were up a lot and treasuries got crushed from 2021 until recently. So, including all that, about 1% a year behind global equities. That's not that big of a difference. And this is without leverage. So if you lever that a little bit you can get to a similar return, as you can see for 25 years, and the average correlation over that period has been slightly negative. So it's been, on average, pretty diversifying.

Speaker 2: 1:11

For those that are attending that want the CFP credits, I will email after this webinar with details that I need to submit to the CFP board. So just wait to the end of the presentation. I will email you with whatever details are needed on that end and hopefully it'll be good for you guys to get that credit from the CFP board. Let's get started. My name is Michael Guyad. I'm the publisher of the Lead Lag Report. This is a webinar hosted by Evoque Advisors. Well, by me, on behalf of Evoque Advisors, with Al Chidi as the speaker here. If Favoke Advisors, well, by me, on behalf of Favoke Advisors, with Al Chidi as the speaker here. If any of you have questions, we're going to do a Q&A at the end. I will pop in and out as needed, but, like I said, I think you'll all enjoy this presentation on ARCOR and UPAR sort of the framework around risk parity.

Speaker 1: 1:56

So Alex, all yours, great Thanks for having me. I'm very happy to be here, so I'm going to walk through a framework that I've been using as a financial advisor. I've been a financial advisor for 25 years and currently I'm a co-CIO of Evoke Advisors. We manage about $26 billion across about 800 clients. That I learned 20 plus years ago and I've been implementing with my clients for a couple of decades, and five years ago we figured out it'd be more efficient to put it inside of an ETF, so we basically took that philosophy, put it in an ETF, and that's what RPAR and UPAR are.

Speaker 1: 2:36

But it really goes back to the core philosophy and framework of how do you build an asset allocation and what you're trying to do is you're trying to get an attractive return for the risk that you're taking taking risk efficiently more return for the risk. And I'll start with the way most people do it, which I call the conventional framework, which is you have two assets. You have high risk, high return stocks, low risk, low return bonds. If you want more return, you own more stocks, less bonds. If you wanna more return, you own more stocks, less bonds. If you want to manage risk more, you own more bonds and less stocks, and so there's a natural trade off between more return, you have to own more stocks, and the challenge there is you become less diversified because you become more concentrated in a single asset. So that's the typical framework and that's the way most people think about building an asset allocation.

Speaker 1: 3:25

The challenge with that is it's not that well diversified, and what I mean by that is if you just think about the first rule of investing is don't put all your eggs in one basket, and a very simple way to measure that is a 60-40 portfolio that's normally viewed as a moderate risk portfolio. That 60-40 portfolio is 98% correlated to the stock market. So think of it as you're putting all your eggs in the stock market basket, even though only 60% of your dollars is in the stock market basket, and it's because you have the 60%. That's very volatile, goes up and down a lot. You have the 40% that doesn't move very much. I know in 2013 or 2022, it moved a lot, but normally it doesn't move very much and so your total return is dominated by the volatile asset that is also overweighted in that 60-40 allocation. So you're basically betting on the stock market. Stocks do well, you do well, stocks do poorly, you do poorly.

Speaker 1: 4:25

And so one of the challenges in that isn't necessarily that the volatility of stocks which many are familiar with. It's not even the big drawdowns which we've all experienced. It's what I show on this page. It's the long, long periods where you can underperform for 10, 15, 20 years. So here's the S&P 500 going back to 1929. So the average has been about 9% a year over that period. But it goes through long periods where it does way worse than that and long periods where it does a lot better than that.

Speaker 1: 4:58

So from 1929 and 1949, the S&P averaged 0% a year for 20 years. Then it averaged 17% a year for 17 years. Then we had another bear market, 1966 to 82, the S&P averaged 5%, which sounds okay, but cash earned 7%. So you had a 16-year period where you underperformed cash. Then, when investors at that time thought equities had no upside, it earned 20% a year for 17 years 20% average for 17 years, which is pretty phenomenal.

Speaker 1: 5:30

And after that I started my career in the late 90s. I remember people thinking the 2000s would look like the 80s and 90s. Instead it looked more like the Great Depression and we had the weakest rate of growth since the Great Depression and for nine years. The S&P was negative 6% a year for nine years. Then we hit the GFC lows and that started the next bull cycle 16% a year for 16 years.

Speaker 1: 5:53

So if you take a step back and you look at this basket this is the US stock market basket and you're betting on it the average we think about is nine, but about half the time during those bull cycles it's been 18% and about half the time during the bear cycles it's been zero. So that's really important because if you're planning for the next 10, 15, 20 years and you have some expectation of what you expect the stock market to earn and let's say you put in 9%, it's not whether you get nine plus know you know nine plus a little bit, nine plus minus a little bit, or even big swings to get that nine. If you get a zero instead of a nine, that difference is really hard to make up. And again, the challenge is you don't know that if you're in a bullet bear market until years later. So so it's a very risky bet.

Speaker 1: 6:41

You can almost think of it as like a coin flip. You know heads you win, tails you lose, and that's just a really risky bets in betting, you know, on that single basket. And then, if you look forward from this point, here you are 16 years into this long bull market. What are the odds that the next 10, 15, 20 years looks like that, versus the odds that it looks more like? You know the bear case. I mean, I don't know if that's going to happen, but you could argue that the coin is tilted or weighted towards the bear side, and so maybe it's over 50, 50 odds that you don't get the 9%. So that's just something to be aware of.

Speaker 1: 7:22

And so then the question becomes well, do you have a choice? You know, it seems that there's a common perspective that if you want returns, you got to get it from stocks, and so if you happen to go through a bear market it's hard to predict then so be it. Everybody's in the same boat and you go through these cycles. It's in some ways inevitable. That's one perspective. Another is well, if there's another way to do it, where you don't have to time these things, if there's a more resilient portfolio that can get you to a similar place over time but doesn't suffer through these long bear markets and maybe it doesn't go up as much during the bull markets, but it's more resilient and it's passive, then maybe that's something that might be a better starting point. So that's something that might be a better starting point. So that's what I think risk parity represents, and it's not really. You don't even have to think of the term risk parity, just think of it as a diversified portfolio. And so what does it really mean to be diversified?

Speaker 1: 8:18

And let me go back to this the reason that the stock market was zero for these 20 years is because you had the roaring 20s. The market was discounting the 30s to look like the 20s, as it often does, and instead you had the Great Depression and that difference in what growth was expected to be economic growth versus what it was was so big that it took 20 years just to break even. Even so big downside growth. Surprise. In the 66 to 82 period, you had a big inflation surprise inflation surprise to the upside. You had a double digit inflation rates that the market was not discounting. That was a terrible environment for stocks. And 2009 was similar to the 1930s. You had strong growth in the 80s and 90s and you had the weakest rate of growth in the 2000s, and that difference caused the S&P to be negative for almost a decade.

Speaker 1: 9:08

So stocks. So the way to think about diversification is what drives these returns. It's not predicting the direction, it's just understanding the cause effect linkage. So stocks have a clear bias to growth and inflation. When growth surprises to the upside versus what was expected, that's positive for stocks, and if it surprises the downside, it's negative for stocks and the opposite is for inflation. If inflation surprises to the upside, like in the 60s and 70s, that's bad for stocks. Surprises to the downside, it's good for stocks. So it has a clear bias to growth and inflation. That bias is fairly reliable. It's fundamental to how equities price. That bias is fairly reliable. It's fundamental to how equities price.

Speaker 1: 9:50

So all you have to do is pick other asset classes that have different biases to growth and inflation and you can effectively diversify that growth and inflation risk. So those asset classes include commodities, tips and treasuries and, as you can see on the screen, they have a very different bias to growth and inflation. Commodities there's two subgroups there's gold and then there's all the other commodities, and the reason gold is separated is because it acts more like a storeholder wealth and a currency than it does an industrial commodity. And so a very simple example is first quarter of 2020, covid hit, the economy collapsed. Gold went up. All the other commodities got crushed. Same thing happened in 2008. Gold was up, all the other ones were down. So they have a very different bias to growth but they're both great inflation hedge assets. So, like in the 1970s, for example, both would have done very well. Tips have the opposite bias to equities. That's one of the reasons they're a good diversifier to equities and then treasuries falling growth, falling inflation.

Speaker 1: 10:46

So you'll notice, between these four asset classes it's a very good starting point for building a well-diversified portfolio, because you own assets that do well in different growth and inflation environments. So that's step one to building a well-balanced portfolio. Step two is this part is a little bit more counterintuitive. In step two, you can actually structure each of these assets to have a similar expected return and risk as equities. So I think conventional wisdom suggests that equities give you returns. These other three they're good diversifiers but they have lower returns. So if you want to increase diversification, you have to give up returns to do so. That's the conventional thinking and it doesn't have to be that way. And the conceptual way to visualize this is that all of these asset classes actually have comparable sharp ratios, meaning return to risk ratios. The reason that these other ones have lower return is because they have lower risk. So all you have to do is own them in a way where the risk is higher and then mathematically you can expect a higher return. So let me walk you through how you can easily do this. For the other asset classes Equities you can just buy the index and you get equity return and risk with these biases With commodities.

Speaker 1: 12:03

Rather than owning commodity futures that have historically had a relatively low return, you can own commodity producer equities. So these are the upstream natural resource companies that are pulling the commodities out of the ground. They're the closest to the underlying commodity, so their price is heavily influenced by the prices of those underlying commodities. So you can own commodity equities and then complement it with gold bullion, and that basket of commodity equities plus gold bullion has an equity-like expect to return and equity-like risk. But it's a good diversifier to equities. So you can see, just with that simple step, instead of just owning equities for returns, you can own equities plus this commodity basket for returns and you've already taken a step towards being more diversified. So you can get just between these two. You can get an equity like expect to return with less risk because it's more diversified than just putting all your eggs in that stock market basket.

Speaker 1: 12:58

Tips and treasuries this one is even more counterintuitive. So tips and treasuries you normally think of them as low risk, low return. You know they're government guaranteed bonds. How can you possibly get the same return out of these as you do with stocks that are far more risky? As I mentioned, the return and risk ratio is comparable to equities over the long run. So all you have to do is raise the risk, and there's two ways to raise the risk with tips and treasuries. All you have to do is raise the risk, and there's two ways to raise the risk with tips and treasuries. One is own longer duration tips and treasuries and then the second is apply a little bit of leverage and then, if you do that, you can actually get the same return from these two asset classes as you do equities. So a very simple example is if you go back 100 years and you look at treasuries versus the S&P 500, if you own long duration treasuries, applied a little bit of leverage, the return from treasuries would be about the same as equities and obviously they're diverse to one another. So another way to think about that is, these asset classes equities and commodities are more volatile than long dated tips, long dated treasuries, so you have to own more of the less volatile assets and less of the more volatileuries. So you have to own more of the less volatile assets and less of the more volatile assets, so you get the equal risk contribution. And if you do that, you can get similar returns on a total portfolio basis across these four assets. So that's the conceptual framework Build a portfolio that's more diverse than a traditional portfolio and then structure them in the way that I just described, and then you just take that framework and you put it inside of an ETF wrapper, which is what RPAR and UPAR are, and you've got something that's interesting.

Speaker 1: 14:36

So for RPAR, you have four diverse asset classes that each individually have an equity-like expected return but are diverse. So the total portfolio has an equity-like expected return over the long run, over a very long period of time, but it's less risky because it's more diverse than equities. It's an index fund, so you're just buying the underlying indexes. You're not timing markets, you have no view, you're not expressing any views about what you think is going to do well, what you think is going to do poorly. You're just buying these index funds, rebalancing automatically every quarter, which is a repeated process of selling whatever's underperformed or selling whatever's outperformed and buying whatever's underperformed Another way of saying buy low, sell high and that can potentially add returns through time as you do that programmatically. And then it's all wrapped in an ETF structure which is, as we all know, is very tax efficient.

Speaker 1: 15:32

So I think of it as two versions. There's RPAR, which launched in 2019, on December 2019, right before the global pandemic. At the portfolio level, it has 20% of leverage. The expense ratios are on the screen 52 gross, 50 basis points net, and it's about a little over 500 million in assets. It tracks this index, the Advanced Research Risk Parity Index, which we created, and so that's kind of that's RPAR. Upar, which launched in January 22, is the same thing as RPAR, same exposure, except it's 40% more levered. So think of it as 1.4x RPAR. So there's 40% more of everything that is in RPAR proportionally, and so we think of it as 40% more risk, 40% more excess return, above, obviously, the financing costs for that extra leverage.

Speaker 1: 16:25

Here is the allocation. For our part, on the left, it's relatively straightforward A quarter of the portfolio goes into the global equities, a quarter into this commodity basket between commodity producer stocks and gold. So 25, 25. And, as I referenced earlier, we can't do 25 long tips, 25 long treasuries, because those two are less volatile than equities and commodities. So you have to own more to get into equal risk exposure. And that's where the diversification comes in, because, as I described each of these asset classes, you see the label here.

Speaker 1: 17:00

But what you should really think about is what is the exposure you get with these asset classes? With equities, you get upside growth exposure and downside inflation exposure. With commodities it's different, right, there's more inflation, upside inflation exposure. Tips is the opposite of equities and treasuries falling growth, falling inflation. So what you want is to diversify those exposures. So you have to risk weight these assets. Own less of the more volatile assets, own more of the less volatile assets so that, as these assets move, no single asset is going to be overly driving the total portfolio return. That's what it really means to be diversified. So 25, 25, 35, 35. And that adds up to 120, which is why there's 20% of leverage at the portfolio level.

Speaker 1: 17:48

Another way to think about this is you have this pie chart here in the middle. You could go to the left and have another pie chart which is an unlevered risk parity portfolio. So you own 20% less of everything. The pie chart will look the same, just the numbers will be a little bit lower and that portfolio doesn't need any leverage. It's equally diversified, it has a similar return to risk ratio. It just has a lower expected return. So think of a unlevered RPAR as having a 60-40 type of expected return with less risk than 60-40 because it's more efficient. You move to the right and you have RPAR which is 20% levered relative to that unlevered RPAR. You're basically levering each of those components and that portfolio has an equity-like expected return with risk that's comparable to 60-40 risk. And then if you go one step to the right and you lever RPAR 40% more, you get UPAR Same pie chart, just everything is levered up 40% more and that has an equity-like expected risk with an expected return that's gonna be higher than equities. Rpar has been around five years, upar about three years.

Speaker 1: 19:34

But we can look at these underlying indexes in which those two ETFs invest to have some longer term perspective, which is what I show on this page. So this goes back to January 2000,. So about 25 years. The MSCI World Index for global equities has averaged a little less than 6% a year. Treasuries this is, long-term treasuries for the same period has averaged about a percent a year less than global equities. And, by the way, this is after the last few years where global equities were up a lot and treasuries got crushed from 2021 until recently. So, including all that, about 1% a year behind global equities that's not that big of a difference. And this is without leverage. So if you lever that a little bit you can get to a similar return as you can see for 25 years. And the average correlation over that period has been slightly negative. So it's been, on average, pretty diversifying Tips 5.5% a year long data tips, so barely behind equities, and tips have also been in a terrible bear market the last few years. So, including that bear market, almost the exact same return as equities with low correlation. Uh, commodity equities this index started in December 2002, about 8% a year. Uh, over that time period, uh, it's. I think equities are similar to that over that exact same time period. Uh, but diversifying to equities, um, and then gold, uh, has actually been the winner the last 25 years. Uh, uh, over 9% a year on average over the last 25 years and the correlation has been close to zero.

Speaker 1: 21:11

The numbers that I just showed you are repeated on the right here. So these are the 25 year returns and then to the left we have returns by five year blocks, because you get very different environments over these periods. You can even look at them over 10 year decades. You know, if you combine these two blocks, so for the first decade equities were about zero for the entire decade. You know, if you combine these two blocks, so for the first decade equities were about zero for the entire decade. You know, minus two for the first five years, plus two the next five years annualized, so that was a lost decade. So if you were 50 and you want to retire at 60, when you're assuming stocks get you nine for the next 10 years and they get you zero. That's a big difference and that you and that's compounding over a decade. That's really hard to make up and so that's the risk of putting all your eggs in that basket. But if you were diversified across all these indexes and this is just a simple average of those indexes you average almost 10% a year over that decade and so you took obviously a lot less risk, more diversified. The risk of the loss decade is much lower when you're more diversified.

Speaker 1: 22:15

Then the 2010s and 2015 period stocks were the best. They went from the worst to the best. But if you were diversified across all of them, even though you did much better in the previous period, you still did fine during this period. You know 6.6 and 5.8% respectively, and then the last five years balanced portfolio is about 5%. This is equally weighting and that includes two assets that were negative over that time period Treasury is minus 5% a year, tips minus 2% a year and gold was the best, and the number that I think is really interesting is this 7.4%. So this is if all you did in the last 25 years it just equally weighted these assets, rebalanced once a quarter, no leverage you would have earned 7.4% a year, and this is without timing anything. This is just buying these indexes, rebalancing and forgetting all the news and all the prognostications about the future. You would have earned 7.4% a year. Equities earn 5.8%a year. So you had to beat equities by over a percent and a half a year, with less volatility, no loss decades and just much greater consistency. So to summarize all that, and just much greater consistency. So to summarize all that.

Speaker 1: 23:34

I think the key question is what drives these asset class returns, and it really it's three things. It's growth surprises, inflation surprises and then something that we call the attractiveness of cash, or periods where cash is king. Growth surprises and inflation surprises are easily diversifiable risks. Most people don't diversify those risks but they're easily diversifiable. You don't really get paid to take those risks because they're easily diversifiable and you diversify by owning these diverse asset classes. The last one the attractiveness of cash is not that easily diversifiable, is not that easily diversifiable.

Speaker 1: 24:09

And the rationale there is as an investor, your starting point is I can just hold cash, take no risk and get whatever the yield the cash provides Over the very long run. It's about 3% or 4%. For a long time it was 0%. Today it's a little over 4%. But you can take no risk and get whatever cash offers. But the alternative is I want more returns than what cash offers. But the alternative is I want more returns than what cash offers. So I want to invest in risky asset classes. So they offer a premium above cash.

Speaker 1: 24:38

You know the stock market. You know over the 100 years it might be 5% above cash, 4 to 6% depending on your starting at any point above cash. And so when cash is zero, that is very different than when cash is 5%, right? So when cash is zero, that is very different than when cash is 5%. So if cash is zero and you're thinking of cash plus five, that's a 5% return. But if cash all of a sudden goes from zero to five, then you're not going to be happy with a 5% return from a risky asset. When cash is all of a sudden yielding five, you need maybe 10. You need stocks to be priced for 10 to take that risk, to warrant the risk.

Speaker 1: 25:14

And so when the challenge with environments where cash suddenly goes from a low amount to a high amount in a short period of time and was completely unexpected, meaning the market was not discounting it that poses a headwind for all assets at the same time, and that's mechanical in a way, because as an investor, your alternative is risk-free cash, and so that's what happened in 2022. The market all of a sudden discounted that cash was going from zero to 5%, and so headwind for all assets at the same time. It's tough to diversify against that because they all face that same bias against the big movement in cash when cash is king. And so in periods like that, risk parity and a balanced, diversified portfolio is probably not going to do well. It's understandable. It's not a surprise. It's hard to predict when those periods start and when they end.

Speaker 1: 26:05

You had a very similar type of experience in the early 80s when Paul Volcker rapidly hiked interest rates. That surprised the market, and so that's what the risk is. It's not growth surprises, it's not inflation surprises, it's not the 1970s, it's not COVID happening, it's cash all of a sudden becoming king. And so that's what you're left with when you diversify growth and inflation surprises. So here are some examples of that. So if we go back over, you know, since 2000, over the last 25 years, you've had four distinct periods where you had a big drop in growth. You had a negative growth surprise, pretty significant the 2000 dot-com crash, 2008, gfc, 2011 Eurozone crisis and then the global pandemic. That just lasted. The shock only lasted about three months.

Speaker 1: 26:58

So what happened in those periods? The stock market fell a lot, from peak to trough, somewhere between 20 and 50%. It fell. Bonds went up a little bit. The US aggregate went up a little bit. It's not that volatile, so it doesn't go up a lot. That's why the more volatile is actually more diversifying. This 29% that's cumulative over about two years, so it's not a lot. And so you'll notice 60-40 didn't do that well during those periods because stocks went down a lot, bonds went up a little bit. There's more in stocks than bonds, so big drawdown. If you look at the underlying asset classes in risk parity equities and commodities as you would expect, all did poorly during those periods. But the other assets were actually in a bull market, generally speaking, during those periods and so if you just average that, just to keep the math simple, you really didn't have massive drawdowns. Into the 2000 dot-com crash, the stock market fell almost 50%. This balanced portfolio up about nine. The GFC crisis a little bit more challenging because you actually had deflation for a period, so tips were slightly negative minus 14. Eurozone crisis about flat. And then the global pandemic minus four percent in that quarter when stocks fell 21 and our part was actually live at that time and it was down about that that amount. So that's falling growth.

Speaker 1: 28:48

Uh, inflation is is a little bit more challenging to show you examples because even though we had a very short bout of inflation, uh, post-covid, it didn't last very long. Inflation expectations over the long term didn't really last very long. Inflation expectations over the long-term didn't really change very much. So we have to go back to the 70s to get a good example. So in that period gold was up 31% a year. Commodity futures just commodity prices were up over 20%. Inflation averaged over 7% in that decade.

Speaker 1: 29:19

Cash was a little over 6%. Equities underperformed cash underperforming inflation for a decade. And then long treasuries did very poorly as you had a big move in interest rates. Tips did not exist at the time, but our guess is they would have done well as they pay you inflation and real interest rates actually fell, so they had a tailwind of falling real rates. So if you could see, you know, without putting it all together, that if you owned just stocks and bonds you probably did very poorly. If you had a component of gold, commodities and tips in your portfolio, you probably held up much better.

Speaker 1: 29:55

And then there are periods that don't happen very often where cash is king. So for that we go back about 45 years to capture five periods where cash was king the 2022, 23,. We had a massive tightening, so this is fresh in all our memories. Stocks were slightly up, so they faced a major headwind because of the big move in interest rates but the net was slightly positive because that was supported by good growth, particularly US stocks. Everything else took a big drawdown and what's interesting about these drawdowns is they're usually followed by significant drawups. So you have a period where cash is king, everything kind of sells off, and then you get some sort of a policy response, oftentimes an easing and then everything rallies. So you get big underperformance on the downside and then you get big outperformance on the upside and then you kind of go back to those more normal periods. So we saw that in the 22-23 tightening Big drawdown, big recovery During COVID this was just a three-month period.

Speaker 1: 31:04

Big drawdown, big recovery. Global financial crisis the drawdowns were pretty significant. Big recovery the 1994 tightening when the Fed aggressively hiked interest rates. The market was not expecting it. You got a drawdown and then a big recovery. And then the 80 to 82 tightening is probably the closest to the 22 to 23 tightening. You saw this big move. And then, by the way, the global finance crisis and COVID. Those were not necessarily tightenings where the Fed was hiking interest rates. Those were more panic periods, which is another type of environment where cash could be king, where people just panic. They don't care about anything, they just want to hold cash. Those are even more rare than the tightenings and they last even shorter time because there's almost always a policy response, which you saw during the COVID crisis and also during the GFC. So if we look at RPAR since we started in 2019, you've actually seen quite a number of types of environments. So when we started, I mentioned this was right before COVID.

Speaker 1: 32:09

When COVID hit, the economy collapsed. We had this period of very weak growth. Stocks were down quite a bit. Our par was up about 2% in three months. So it's almost normal returns, nothing unusual. Then you had a period of pure panic that lasted about two weeks. Everything sold off. Our part was down 16%. You had a market response. They threw the kitchen sink at the problem. You had a big recovery, up 31%. So part of being balanced is you're trying to minimize the big drawdowns, but it's important to understand when those might occur and what usually happens after. So if you didn't panic when everybody else was panicking and you had a big drawdown, you were rewarded with a big draw up. Then kind of all of that faded and then growth was strong and our power is up 9% in 14 months.

Speaker 1: 32:59

Average returns. That strong growth and all the stimulus fueled inflation. And all of a sudden inflation started to surge, stocks fell, the inflation hedge assets did well. Our power is up 2% in five months, perfectly normal. And then you had the surprise tightening, which was a significant move, and so it lasted about 19 months. Rpar fell 26% and then, once that tightening ended, you had a 25% recovery In Q4, there was a short period of tightening. It's already. We've already seen easing since then. So you had a minus AIDS and RPAR this year is up about 5% or so. So you're already starting to see a recovery there. So that's kind of basically the environments that we've lived through and to kind of sum it up and obviously happy to take any questions.

Speaker 1: 33:53

So then the question is what is the risk? You know, anytime I, as an advisor, look at investments, I ask, I always try to find the answer to well, what is the risk? What can go wrong? And so it's not really growth surprises, it's not inflation surprises. You're pretty diversified to that. I showed you examples. Cash is king is a risk. It doesn't happen often, but it does happen occasionally. So the key there is be aware of it when it's happening so you don't overreact. Recognize that oftentimes you get a rebound, so wait for that, don't sell low. And so those are not really risks. I guess there is a risk that you sell low.

Speaker 1: 34:31

I think the bigger risk is what I call the risk of zooming in. So if we were all zoomed out and we're looking at it over, you know 20, 30, 40 year period, you can think of risk parity as this green line where it's a more steady line to get to a similar place as a stock market over time. And the stock market is more volatile, it's obviously less diversified, so it's going to go through bigger swings and so if you're zoomed out, it's clear you want to be on the green line versus the blue line. So that's obvious. But but we live in a world where it's constantly forcing us to zoom in. You know, you're hearing the news every day. There's there's outlooks, there's good news, there's bad news, there's market returns that happen, you know, every second, and so the world pulls us in and the idea here is to recognize that it's important to try to pull yourself out and zoom out and look at the big picture.

Speaker 1: 35:22

So if you zoom in, then you go through a period like this where the green line is flat or down and the blue line is up a lot, and you look at the difference between the two and you say, you know, I don't think this is working.

Speaker 1: 35:35

The blue line looks a lot more attractive. And then you sell the green line and you go buy the blue line. Looks a lot more attractive. And then you sell the green line and you go buy the blue line. And then what happens is you go through a period where the blue line starts going down, the green line is flat or up, and then you jump to the green line and if you keep doing that, that discipline will lead to a point that's worse than either one of those lines. So that's really the risk is changing the strategy, and I feel like the way to avoid that is to conceptually understand what does it mean to be more diversified, recognize that you can go through five or 10 year periods where being more diversified doesn't feel as good as being less diversified, and then vice versa, but over the very long run you end up in about the same place with less risk. So that's why I think that's probably the biggest risk is this risk of zooming in.

Speaker 2: 36:22

A question from an attendee. Say something about asset management experience around the last several years. Yeah, I think investor experience is always an interesting concept and it's a function of, obviously, when the investor decides to allocate. But, alex, from your perspective, your experience, what's been the reception to those who have invested over the last several years?

Speaker 1: 36:43

Let me show you returns, because oftentimes what happens is the returns. You can basically tell how people reacted by the returns because most people just look. They look at the returns and their response is is how did those returns compare to if I just bought the stock market? That's the typical reference point and it goes back to what I just showed, which is the risk of zooming in. So when we launched in 2020, this was right before the global pandemic our power was up 19.4% in 2020. It was down about 4% in Q1 of 2020 when the stock market was down 21. So in that period it fell significantly less than the stock market exactly what you expect. And then it bounced a lot and finished the year ahead of equities. So equities were up about 16,. Opera was up 19. So for the year, protected on the downside, outperformed over the full cycle, even though three quarters of the year you're in a bull market. One quarter of the year, protected on the downside, outperformed over the full cycle, even though three quarters of the year you're in a bull market, one quarter of the year a massive bear market. So outperformed for the full period and outperformed on the downside.

Speaker 1: 37:51

So everybody loved it. They said, oh, this is exactly what I expected. It did exactly what I thought Great strategy. And, by the way, this is an index fund. There's no active management. You could take this portfolio and go back 50 years and see how it would have done in all different types of periods.

Speaker 1: 38:08

Then, in 21, equities are up 22% and this is up seven and a half. Then it's like, oh you know, and maybe it's not as good as I thought, right, but it's because that was a period where stocks did great and other assets classes didn't do as well. It's a more muted return, perfectly normal, nothing unusual. It's an index fund. Then, 22, a lot of eyebrows were raised Wow, this is down 23%. So it was bad for stocks down 18, but this is down more than stocks, so it's supposed to do better than stocks. On the downside, what happened? There's got to be something wrong and it goes back to. It was a period where cash is king. This is more levered than equities and so it makes sense at underperforming and downside. Same thing would happen in the early eighties. No surprises, that's exactly what you would expect. So it's gone from like a love hate type of relate, love to hate type of relationship. Again this year, a lot more people are are favoring it because it's outperforming equities. But this is all accidental, right? It's the more diversified portfolio.

Speaker 1: 39:12

The other way to look at it is since since we started so this is a little over five years it's average 1% a year and it's because you had this big negative in 22, which happens, I don't know, once every 30, 40, 50 years, something like that. So that has hurt returns. So people look at it and say, okay, you've had good periods, bad periods. The average is slightly up. That doesn't seem to be working. I could have just bought stocks and did better. So if you look through, these are the underlying asset class returns Equities over that time period plus nine, that's fine.

Speaker 1: 39:45

Commodities did a little bit better than equities. Nine and a half. Gold was the best place to be almost 12% a year. Treasuries and tips were negative for annualized for five years. So that's the culprit. So the reason it's under reform is because treasuries and tips did poorly.

Speaker 1: 40:01

It's part of a balanced portfolio. Those now yield the highest they've yielded in 15 to 20 years. Is that the time you want to sell those? Or should you be more bullish on those asset classes? And so that's to me. That's the analysis, but most people just look at the headline and determine and compare it to the stock market and compare how it did relative to the stock market and then, based on that, decide if it's been good or bad. But really you should just think of it as it's a balanced portfolio. It owns all these assets and it just so happened during this period you had a big move in interest rates. That didn't have to happen and stocks did well, commodities did well, but treasuries and tips took a huge hit. I don't know what the next five years looks like. It could be the opposite. As we've seen, these markets are very cyclical through time A number of good questions showing up here.

Speaker 2: 40:53

Are you benchmarking? If so, to what? That's always an interesting question, you know, because something like this really can't be benchmarked to anything.

Speaker 1: 41:00

Well, in some ways it is the benchmark Right. So it's a very good question. It's a very thoughtful question and one way to look at it is okay. What are you trying to do with this portfolio? And the idea is it's a balanced portfolio. So the technical benchmark is the Advanced Research Risk Parity Index and it's tracking that index.

Speaker 1: 41:25

It's an index fund. It's an index fund of a balanced portfolio and I think what happens in reality is most people benchmark to the stock market or 60-40. And so there's a natural tendency to benchmark this to the stock market or 60-40. And in reality, to me this is the benchmark, because this is just a super balanced portfolio and all other portfolios should be compared to this. So in the last five years, being balanced wasn't a great idea. You would have been better off just owning the S&P and not being balanced. And so if you compare it to anything that is overweighted to the S&P or stocks, a balanced portfolio doesn't look as good Over time. We know it works, and this is part of that whole zooming in problem and diversification works over time. It hasn't worked in the last five years and at some point it will work. You know, I don't know when that is, but it's a very reliable thing that it works through time.

Speaker 2: 42:46

Another good question how do you invest Meaning? You know investors think about this from the standpoint of dollar cost averaging If they're looking to reallocate their portfolio. What do you typically see in terms of the sequencing there?

Speaker 1: 43:00

Yeah, that's another good question. So the way I think about it is this is a very diversified portfolio, but it's not a conventional portfolio, and and, and I think that's important. So I view it in the form of a spectrum. On one end, you have a more conventional, less diversified. On the other end, which is our part, you par, you have more diversified, less conventional, and, and the way I think about it is investors should individually decide how much diversification can they handle.

Speaker 1: 43:33

Uh, and it's not that the math says be more diversified, but the reality says be more conventional, and so there's a tension between the two. And the reason there's a tension is because of of the other questions that we're getting is how do you compare performance? So you know, for five years it earned 1% a year. So if the stock market was negative 10% during that period, I got almost equal odds of it earning 1% a year when stocks are minus 10 versus when they're plus 10, because that's how diversified it is. So if the stock market was minus 10, people look at that one and say, oh, that's fantastic, you're positive when the stock market was negative 10. And if it's stock market's up 10, and this is one you say something's not right. And so the reality is there's a natural tendency to compare to the stock market and stock concentrated portfolios. So, in reality, we should be very mindful of what is our reference point, what is our time horizon. The longer the time horizon, the less the reference point is the stock market and stock oriented portfolios.

Speaker 1: 44:35

The more diversified you can be on that spectrum, and the more oriented you are towards the stock market, the less diversified you can be practically. And so you can think of our part andAR as tools to build a more diversified portfolio. They're just efficient ways to get there. And so if you have a portfolio let's say that's 60-40, and you want to take one step towards being more diversified, less conventional, you could take a little bit of the 60, a little bit of the 40, and put it into RPAR or UPAR. If you want to amp it up, go to UPAR. And now you've taken one step towards this side of the spectrum by being more diversified and also more tax efficient because of the wrapper, and that's the way I would think about implementing. And then you do that a little bit and you see how it goes, and if it makes sense, you can take another step by allocating a little bit more to that, and I think of it as just a tool to help you efficiently navigate how diversified and how conventional you want your portfolio to be.

Speaker 2: 45:31

I'm going to modify one of the questions that I see here, which I think is a good one and it's fair. I don't think it's something anybody can argue about for any ETF, but yeah, given that it seems like a fairly straightforward mix of allocations, why go with RPAR as opposed to just kind of an investor doing it themselves? A?

Speaker 1: 45:49

couple of reasons, and I say this from experience because I did it myself for over a decade, and so there's two challenges with doing it yourself. And you're right, you can go buy these underlying index funds yourself. There's a couple of challenges. One is it's actually hard to do. You can buy the ETFs but it's hard to hold on to them Because you'll go through periods where one of the asset classes will do very poorly. Like, think about it. Could you have held on to treasuries at minus 7% a year and some bad years? You know, minus 6, minus 23, minus 2 last year, minus nine and 24. You could have a year where it's plus 30. Are you going to own them at the right time? Are you going to sell them at the wrong time? It's hard to do in practice because there's a tendency towards selling things that are down selling low and buying things that are up buying high and so when you put it inside of an ETF like this, it automatically does it for you. So that's, and I wouldn't underestimate that. So that's number one.

Speaker 1: 46:54

Number two is the leverage part is hard to do outside of the ETF structure. The way we get the leverage is we invest in treasury futures because the cost of financing is very low. It's cash effectively. So that's a efficient way to get the leverage, and so the implementation is challenging if you try to do it on your own. The other advantage is when you put all these assets inside of an ETF wrapper.

Speaker 1: 47:19

You get the tax efficiencies that come along with it with an ETF wrapper. And the big one is when you rebalance, which is selling high, you sell the outperformer, you buy the underperformer. Normally you sell the outperformer for a gain and you have to pay capital gains on that. Inside of an ETF wrapper you can effectively defer the capital gains until you sell the entire portfolio so that tax advantage over time can accrue and it can compound over time can accrue and it can compound. And so that is, I think, a very efficient way to get that exposure from an implementation standpoint plus from a tax standpoint, and that also goes to. I saw a question also about why is the expense ratio 0.5 rather than maybe 0.1 or 0.2, like maybe a lot of the underlying indexes? Part of it is the management of this. It takes a little bit more to do it than just going by, and yes, it'd be 500 index fund, but that extra fee could easily be made up with just the implementation efficiencies and the tax efficiencies.

Speaker 2: 48:24

I know your thing is obviously nobody can predict the future. I make that point myself. Um yeah, no amount of a lot. A lot of people try. Yeah Well, I mean, listen, we all have to make predictions, right? I always make the joke that every time you set your alarm clock, you're making two predictions. You're making a prediction that you're going to be off five, uh, otherwise, when you set your alarm clock and that you're gonna have a job. So you need a reason up early. So you know, we're always in the business of predicting. But having said that, I do think there's something to the idea that the older a bull market is in a particular asset class, the more likely you are at the end of that bull market. So is it fair to say that, given the nature of our power and you power, that those that are maybe a little more negative or bearish on US equities would gravitate more towards it because they're looking to diversify away from that risk?

Speaker 1: 49:13

I think that's fair, you know.

Speaker 1: 49:15

So another way to say that is let me go back to this chart where we started Is is it a better time to be more diversified near the end of the bull market than during the beginning of the bull market?

Speaker 1: 49:29

Probably, um, you know, because if you're, if you're, betting it all and one thing, which is you know effectively what 60, 40 does, you better get that thing right and the odds of getting it right are lower when you've had, you know, high valuations and a long bull market. That's just the math of it. It doesn't mean that the odds are zero, it just goes down. So let's say the stock market goes up another 30% this year, then the odds are probably even lower. From that point forward, if it goes down a lot, maybe the odds go up a little bit, but it's kind of incremental. So I think, generally speaking, uh, it does make sense to be diversified all the time. But if you're trying to time it um, I probably do it, you know closer to the end of the bull market or after a long bull market, um, than I would after a long bear market.

Speaker 2: 50:22

I think of our part much more as core than he else, but I'm sure some would think of it more like a satellite. From the types of advisors you talk to, Alex, is there sort of a typical range that people allocate to?

Speaker 1: 50:34

you know it's all over the place. And, and I'd say the range this sounds like I'm not answering your question the range is zero to a hundred, okay, and, and so I'll, and I'll describe the range. So you have the. You have people who are more focused on. You know, I could just buy stocks and, yes, I see this chart, but I I have a lot of faith in stocks and even if it go through a bad period, I'll hold on and I'll enjoy the good period. And so those people might own zero because they just they're comfortable putting it in that basket, because they're confident in the basket when that stock can work a basket. So that's kind of one extreme. The other extreme are people who 100% get this and I'll put myself in that category who 100% get this, who appreciate that diversification works. They're not going to sell it when it underperforms. If anything, they'll buy more and they're just going to hold it forever and not even think about it. And you have to check off investing in public markets. And those people might put 100% of their public markets into our part. And the ones who are huge believers will just buy you part and not look at it. And the vast majority of people are somewhere in the middle and they're going to be closer to zero than 100, obviously.

Speaker 1: 51:47

But conceptually you could understand why having a large allocation makes sense conceptually because it's a super diversified portfolio. If you look inside there's over 13,000 individual securities. It's about as diversified as you can get in public markets. There's obviously alternatives and all these other things you can buy that diversify even further. But in public markets it's a very efficient way to get that exposure. It's very tax efficient, it's very diversified and it has an equity-like return or more, depending on whether you're an RPAR or UPAR. So on paper it makes sense. But what you have to weigh against that is the practicality of holding on through those periods where your reference point did a lot better. So I think most people end somewhere between the, you know, zero to 10 percent allocation range and the ones that are bigger believers may have a little bit more than that.

Speaker 1: 52:40

And there's also a question about dollar cost averaging, which you ask and I and I fail to answer. You know it is. It's not low volatility, right? The volatility of our part might be 10 or 15%, you know, kind of like market, like stock, a little bit less than the stock market. So it's not low volatility.

Speaker 1: 52:59

So dollar cost averaging, I think, generally makes sense when you're going into things that are that exhibit some volatility, because you're reducing your risk of going in at the wrong time. And so by splitting the difference of okay, rather than putting all my dollars in on day one, I'll put some in on day one, some in a quarter or some in six months, or however way you want to spread it out you're effectively reducing your risk of a bad entry point. Now, if it goes up, you wish you put everything in, but you already have some invested. If it goes up, you wish you put everything in, but you already have some invested. And if it goes down, you're sad that you lost money, but now you're buying at a lower price. So it's a way to just mitigate that risk. So I think that's fine to do that.

Speaker 2: 53:38

Alex, for those who want to learn more about RPAR or UPAR beyond this presentation, where would you point?

Speaker 1: 53:43

that to To our website, which we have at the bottom of this, to our website, which we have at the bottom of this, rparetfcom, and there's a lot of information on the website. We do a quarterly market review, a quarterly webcast that is recorded and presented on there so you can go back many quarters and watch that and this presentation is also on that website.

Speaker 2: 54:07

Again, folks, for those that want the CE credit, I will be emailing everybody that's attended after this webinar. So once I get your CFP number and information I'll make sure that's submitted. Appreciate those that have attended some of these webinars repeatedly. Apologies for having to reschedule it from last week. Alex was obviously unable to speak on our part because he was dealing with a little bit of illness. He's fine now, as you can tell. Send feedback to me, to Alex. Want to get these on a regular basis. Any kind of feedback would be much appreciated. Alex. Any parting words here?

Speaker 1: 54:40

I mean other than you know. If you look forward, is this a world you want to be more diversified in or less diversified? I think that's like the key question that investors should ask themselves. The past is the past. You look from this point forward to the next five or 10 years. Is it a world where you feel like there's a lot of uncertainty and therefore more diversification is desired? I think this is an interesting way to take a step in that direction.

Speaker 2: 55:06

Thank you, Alex.

Speaker 1: 55:07

Thanks everyone.

Speaker 2: 55:08

Cheers everybody.