Lead-Lag Live
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Lead-Lag Live
Money & Markets: Navigating Stagflation
The specter of stagflation—sluggish economic growth combined with persistent inflation—looms large in today's uncertain economic landscape. While Federal Reserve Chair Powell once claimed to see "no stag and no flation," current indicators suggest otherwise. Economic growth appears to be slowing after an extended expansion, while inflation remains stubbornly above target levels. Adding to these concerns, potential tariffs could exacerbate stagflationary pressures by simultaneously hampering growth and increasing prices.
Amid this challenging environment, conventional investment wisdom falls short. The standard 60/40 portfolio, commonly touted as "balanced," actually maintains a 90% correlation to an all-stock portfolio—hardly providing true diversification when markets face stagflationary headwinds. This reality underscores the value of risk parity strategies, which distribute risk evenly across assets that perform differently under varying economic conditions.
Gold emerges as a particularly compelling asset in this context. Contrary to popular perception, gold has outperformed stocks over the past 25 years and has nearly matched global equities' returns since 1971, trailing by merely half a percent annually. During the stagflationary 1970s, gold appreciated by approximately 30% annually, highlighting its effectiveness as a portfolio stabilizer during precisely the economic conditions many fear today.
The risk parity approach offers a systematic framework for achieving genuine diversification—not by simply holding numerous securities, but by balancing risk exposure across uncorrelated assets. This means owning more of less volatile assets and less of more volatile ones, ensuring no single economic factor dominates portfolio performance. When implemented within an ETF structure like RPAR, this approach gains additional tax efficiencies while automating the psychologically challenging process of regular rebalancing.
Ready to protect your portfolio against stagflation while maintaining long-term growth potential? Explore how risk parity strategies might complement your existing investments and provide smoother returns through uncertain economic conditions.
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Let's talk about stagflation if there's a risk that we're entering that, and what that means on various investments Sure.
Speaker 2:I think there is certainly a risk. Obviously, we don't know what's going to happen, but the risk of growth being weak is significant. Tariffs, depending on how it goes, is a tax.
Speaker 1:The economy seems to be slowing and we've had an expansion for a long period of time, so the longer term trend for gold, is it fair to say that stagflation is sort of the ideal kind of environment for it?
Speaker 2:Gold has outperformed stocks the last 25 years and its return since we came off the gold standard in 1971, which is when it basically became free floating is almost the same as global equities. I think it's about half a percent a year behind global equities since 1971. I view this as a world of great uncertainty, wide range of potential outcomes, probably a heightened risk of extreme outcomes because of all the not just the uncertainty with geopolitics and US politics and policy, but also-.
Speaker 1:My name is Michael Guyatt, publisher of the Lead Lag Report. Joining me here is Alex Chihuly of Evoke Advisors, the man behind the ARPAR risk parity ETF. This is a sponsored conversation by Evoke and I know we've done this a few times. Alex, I'll put your background, but I want to get right into the more pressing thing which I think is increasing on people's minds, which is the risk of stagflation. There was a juncture sometime last year where Powell said I see no stag and I see no flation. I don't even know what that means, but Powell said it, so it sounded smart. Let's talk about stagflation. If there's a risk that we're entering that, and what that means on various investments, sure.
Speaker 2:I think there is certainly a risk. Obviously, we don't know what's going to happen, but the risk of growth being weak is significant. Right, Tariffs depending on how it goes, is a tax. The economy seems to be slowing and we've had an expansion for a long period of time. So, as we all know, the business cycle, it's a cycle. So on the growth side, there's certainly risk that growth could slow.
Speaker 2:On the inflation side, inflation is sticky. It's higher than the target. It's been higher than the target for some time. Tariffs could. It's interesting. Tariffs are stagflationary, right. They hurt growth and they increase inflation. So, depending on how that plays out, that could have an impact. But there's also a lot of secular shifts that could potentially be more inflationary and on the other side you have AI and the potential productivity gains from that. So maybe that pushes inflation down. I'd say, on net, there is risk that inflation is higher than expected and if we look at what's discounted, it's not very high in terms of looking at the difference between nominal yields and real yields, so what the market is discounting. So it's not that high. So I think there's certainly a risk of stagflation and I don't know if it's like the 1970s stagflation, but I'd say there's definitely a risk of that and what's interesting is, most investors don't have a lot of assets in their portfolio that is designed to do well in that type of environment.
Speaker 1:Well, you could argue, maybe to some extent. Nor should they, because it's a very rare combination of macro factors.
Speaker 2:Well, it depends on how you define it. So the way I think about it is that the two big factors that drive asset classes is growth and inflation. You know the thing that Feds try to manage and you really have to look at it relative to what's discounted. So, in my analysis, about half the time growth surprises to my analysis, about half the time growth surprises to the upside and about half the time surprises to the downside, you have to look at it relative to what's discounted in the price and the same thing with inflation. So you could argue, if you're thinking of stagflation as growth surprises to the downside, inflation surprises to the upside. It happens a lot more than I think people realize.
Speaker 2:If we just study it history, you think about the 1970s as a very clear example, and that was a decade or so of stagflation. But there's going to be shorter periods in history where you had a stagflationary type of environment and it doesn't have to be high inflation and very weak growth, it just has to be less growth than discounted and higher inflation than discounted at the same time. So I don't think it's as rare as the history books would suggest.
Speaker 1:I think it's fair to say that that's probably largely what gold has been sensing sort of this concern around stagflation. There's the constant argument of why is gold performing well? Gold short term tends to have these bursts when there's geopolitical risks you know, threat of war, you see that time and time again. But the longer-term trend for gold is it fair to say that stagflation is sort of the ideal kind of environment for it?
Speaker 2:Yeah, in the 1970s gold was up 30% a year. So I guess that's a resounding yes in terms of stagflation. But there's other factors you know. So, for example, if you just look at countries outside of the us, if you were to interview them and say, of all your reserves, do you have more? You know, us dollars in your reserves that you ultimately would like to have, I would guess most would say probably. Then do you have less gold than you would ultimately want to have given the geopolitical backdrop? And my guess is most would say yeah, we prefer to have more gold. Now you can't make that swap quickly, but I think that trend has something to do with gold's strong performance near term. But I think what is? I think a lot of people miss it because we've seen how well it's done the last few years. But gold has outperformed stocks the last 25 years and its return since we came off the gold standard in 1971, which is when it basically became free floating is almost the same as global equities. I think it's about half a percent a year behind global equities since 1971. Half a percent a year behind global equities since 1971.
Speaker 2:And if you kind of zoom out a little bit and you look at when in the last 54 years did it do well? When did it do poorly? In the 1970s it did really well. In the 2000s it was up double digits. So far this decade, in the 2020s, it's up double digits. The other decades it was terrible. In the 80s and 90s it was negative. In the 2010s, I think, it was about 3% a year. So it's like boom or bust. And what's interesting is those boom and bust periods are the opposite of equities. So equities did poorly when gold did its best and gold did its worst when equities did its best. And over 54 years it's about zero correlation. At its best and over 54 years it's about zero correlation. So I think, regardless of what you view what the future is going to look like and whether you think stagflation will transpire or not, it's a very good diversifier to equities.
Speaker 1:Well, it's funny to me that it's true that you always have a cult in an asset class, the cult of equities, cult of gold, the gold bugs but the audiences are a lot lower, meaning there's a lot less number of members of gold bugs than there are equity bugs, you can argue. And yet gold has performed very similarly, although with a very different sequence of returns. Why is it that gold isn't sort of more mainstream?
Speaker 2:Yeah, it's a really good question. I think part of it is we. I think we're a byproduct of our current environment. So the last 15 years stocks have done great. The prior 10 years stocks were negative in the 2000s. My guess is is if you ask somebody who was a significant investor in the 1970s, there were probably more gold bugs then than there are now, because during that decade stocks underperformed cash for a decade and gold was up 30% a year. So you probably had more people that were on the gold bandwagon than on the stock bandwagon. And I remember in the early 80s there was a famous article that came out I think it was Newsweek or one of those big magazines, and it called for the death of equities. And of course it was at the very bottom of the cycle. That was right before the greatest bull market in the history of stocks, uh. But but I think part of uh, what you just described is is a byproduct of the current environment that we live in, and my guess is it changes over time.
Speaker 1:Of course, stocks have always been more popular than gold on net, but that gap is probably uh, it probably changes over time it probably also has to do a little bit with how much you can make a narrative around it With the narrative so many times, you know, with variations around gold. But there's a lot more diversity of things you can talk about when it comes to individual stocks, the stock market, macro, all this stuff. So I'm wondering if it's just a byproduct of just the storytelling.
Speaker 2:Yeah, yeah, and storytelling has a lot to do with it, because we live in a world where we tell stories. Stories are told every day on TV, in newspapers, on the internet, and I think we all kind of want to be part of a story, so I'm sure that has something to do with it.
Speaker 1:Speaking about stories, there is this story of the only free lunch is diversification. It proved to be a bit fictional in this current cycle, or maybe last cycle, but the point is it's still a cycle-driven type of dynamic. Let's get into what the real story around diversification should be.
Speaker 2:Well, I think you're right. The one free lunch in investing is diversification, and what that means is you can get a higher return for the same level of risk, or you can get the same return with less risk than if you had a less diversified portfolio. So that in theory, shouldn't exist, but diversification allows it to exist, and there's a very simple math behind that. And you're right. We had what I call the bear market and diversification for a while. The less diversified you were, particularly in US stocks, the better you did for 10, 15 years, and the more diversified you were, the worse you did.
Speaker 2:This year is almost the opposite. So it's interesting, and when you look at across asset classes, almost everything is not only up but doing relatively well, except for US stocks, which are still negative year to date. And so this year is a good example of diversification quote unquote working where everything is doing well, and so when you ask somebody how's the market doing, they automatically think about the US stock market. And when somebody asks me how the market's doing, I respond in terms of a balanced mix of markets, because I always think in terms of diversification, because you're right that one free lunch you should always take advantage of, even when you go through periods where you would be better off being more concentrated, over the long run the math shows that you're better off being diversified, because you just get a higher return to risk ratio.
Speaker 1:The thing I think most people fall prey to is the idea that the more positions you have in your portfolio, the more diversified you are, as opposed to looking at it from correlation perspectives. I think that what you're describing there is basically kind of the genesis of a of a risk, parity or permanent portfolio type of construct, but the challenge there is everyone always hears that, but they don't think it's the next level, which is how do you think about weighting what the diverse fire? So let's explore that, because I always go back to this idea that oftentimes what you own matters a lot less than how much you own of it.
Speaker 2:Yeah, because you could say two extremes. You could have a hundred securities in your portfolio, a hundred line items, and if they all go up and down together, that's like having one line item. So the number of securities has nothing to do with being diversified. And then, on the other end, you could have two securities and be way more diversified than something that has a hundred securities. So, for example, if you just own a stock index and you owned a tips index, that's a pretty diversified portfolio, way more diversified than something with 100 securities that are equity-like. So, yes, the exposure matters. So you want things that do well in different environments. And then the question that you asked is the weighting. It doesn't do much good to say I've got five securities that do well in different environments, but I've got 99% of my assets in one and hardly anything in the other four. And the way I think about waiting is what you're trying to wait is the exposure to those different environments. So you want assets that do well in different environments and you want equal risk exposure to all those assets, so that one asset doesn't drive your total returns. And the simple way to think about that is assets that are more volatile you should own less of and the assets that are less volatile you should own more of. And the way to think about that is you have an environment that's good for asset A. If asset A is very volatile, it goes up a lot. If it's a bad environment for asset A, it goes down a lot. Asset B, which is less volatile a good environment it goes up a little. A bad environment it goes down a little. So if you overweight the more volatile asset, like most people do they overweight stocks versus bonds then your total return is dominated by that one asset.
Speaker 2:It's not a diversified portfolio 60-40 is 90% correlated to 100% stock portfolio. It's basically violating the first rule of investing Don't put all your eggs in one basket. Many investors violate that simple rule. So the way to think about it is own assets that do well in different environments and then weight them where the less volatile assets you own more of, the more volatile assets you own less of. And that is what the risk parity concept is is pairing the risk so that you get equal risk contribution, equal contribution from all these assets, and then if you pick the assets that do well in different environments, that's how you diversify. You know, from my perspective.
Speaker 1:The challenge there is, you know, is that obviously risk regimes for different asset classes also change, right. So you know, as we saw, the risk in treasuries, for example, it was a lot higher the last several years than it had been in years prior. So how do you think about if you're going to normalize to volatility or to risk across the different asset classes? What happens when you're in a small sample where the risk for that particular class may be in an anomalous period?
Speaker 2:Yeah, it's a good question. So I think there's two approaches there. One is you can take a passive approach and say you know the average volatility for asset class A is, you know, 15%. Asset class B is 10%. So I should own more of B than A to get the equal risk contribution. So you can just look at average volatility over time. So that's one approach which I think makes sense because and I'll get into why so the second option is you can try to be dynamic, and when volatility is higher, maybe you own less, when volatility is lower, maybe you own more.
Speaker 2:The challenge with that is you only know what the volatility of the past is. You don't know what the volatility of the future is, and you go through periods where high volatility precedes low volatility and vice versa. So the challenge with trying to change your weighting based on your expectation of future volatility is you're going to be wrong a lot, and we saw this in 2008. We saw it in Q1 2020, where you had a period of low volatility, and so maybe you're overweighting something, and then volatility spikes and now you have too much exposure, so you cut your exposure and then markets recover. So now you're overweighted on the downside and then you're underweight on the upside so you can get whipsawed.
Speaker 2:So in my experience 26 years tracking investments and managing client portfolios is that predicting volatility is really hard. And you'll be right sometimes. You'll be wrong sometimes and sometimes you'll be really wrong. And so trying to balance the weight based on your expectation of where volatility is going to be and that's usually informed by past volatility it's just too hard to do, and that's usually informed by past volatility. It's just too hard to do. So I prefer to just take average volatility, weight it and just that exercise. It's so valuable over time because you're so far ahead of most people who are not well diversified. So to me, the big step is become diversified. You can even take average weightings. It doesn't really matter as long as you're moving in that direction. You're so far ahead of most people that if you get the timing off by a little bit, it doesn't really matter that much. It's more about thinking long-term and having the philosophy of how to build that diversified portfolio.
Speaker 1:How did that philosophy come about? I mean, where did the whole concept of risk parity kind of originate from? What's the history of it?
Speaker 2:Where do the whole concept of risk parity kind of originate from? What's the history of it? So the term risk parity is probably a couple of decades old. I think of it as a balanced portfolio and I don't call it a balanced portfolio because that term balanced is. It's kind of ubiquitous in our industry and I feel like it's misused. Most quote unquote balanced portfolios are not balanced. People think of it as 60, 40 is balanced. It's 98% correlated stocks that by definition, can't be balanced. So so if you kind of go back to even before the concept of the term risk parity came out, this idea of pick asset classes that are diverse to different economic environments and then weight them where you own less of the more volatile assets, more of the less volatile assets. I believe Bridgewater came up with that idea probably three and a half, four decades ago and they've been managing money that way ever since. Let's talk about your risk parity ETF RPAR.
Speaker 1:Talk about the history of that launch, how it's performed and maybe make the case for why now might be a good time for thinking about that.
Speaker 2:As the first part, with my clients, we're also an RA, manage about 26 billion for wealthy families and institutions, and this philosophy of risk parity and balanced portfolios I've been using with my clients for 20 plus years. I've written a couple of books on it and it's just something that, to me, makes a lot of sense, and so about six years ago, we figured out it'd be a lot more efficient if we created a vehicle and take the strategy, put it inside of it and get all the efficiencies that come along with an ETF structure, taxes being one implementation efficiency, passive vehicle to get exposure to this balanced portfolio, which includes global equities, commodities, gold tips and treasuries, and it's risk balance across those asset classes and rebalances once a quarter and it's effectively passive. We have target weights very simple to follow. It's a very simple strategy that I think can be very effective over time. It's a very simple strategy that I think can be very effective over time, and I intentionally kept it very simple because I feel the concepts are really powerful and so you don't want to get lost in the details. You want it to be easy to follow, easy to understand, easy for people to appreciate what they own, why they own it and what that exposure is. So we launched it in December 2019.
Speaker 2:And its first year it did really well. It was down 4% when COVID hit in Q1 of 2020. Stocks are down 21. It was down four and it finished the year up 19 and change, and so that was like a very good stress test, because you had an economic collapse and it doesn't matter what caused that collapse In this case it was COVID but economy collapsed, assets performed exactly as you would expect. Commodities and equities got crushed. You know those are rising growth assets. Gold tips and treasuries were in a bull market. Those are falling growth assets and so they reacted exactly as you would expect. Those are falling growth assets and so they reacted exactly as you would expect and they roughly netted out equal down net 4% in a very volatile period and then you had the recovery. So good start.
Speaker 2:2022 was a terrible year. That was an environment where cash went from zero to five very quickly. That's an environment you can't really diversify against because it has nothing to do with growth and inflation. The cash rate went up a lot and all these assets compete with cash and if you told me today, cash would go from five to 10 in six months. I tell you you don't want to be in a diversified portfolio because it's probably going to do poorly, and so 22 was a terrible year. So far this year, it's been a pretty good year.
Speaker 2:Uh, as I mentioned, diversification is working Um and in, and I think, if you look forward, uh, I I view this as a world of great uncertainty, wide range of potential outcomes, probably a heightened risk of extreme outcomes. Um, because of all the, not just the uncertainty with geopolitics and US politics and policy, but also uncertainty as it relates to how is growth going to transpire, how's inflation going to transpire, it seems like it's a really important environment to be diversified, and so I feel like you should know what it means to be diversified, which is what we've talked about today, and then how to implement that diversification, and I hope that RPAR can serve as a tool to do that.
Speaker 1:Yeah, I think the point of the uncertainty is key, right? It's like if there's conviction around a particular future path, then you want more concentration, obviously. Well, if the crowd is convinced of that, then yeah, it's all versus discounting. Right, but when you think about ARPOR and when you talk to advisors that are looking at it, are they looking at it from the standpoint of it being a core position, a satellite position, because it's ultra-diversified from that standpoint, it can be any of those.
Speaker 2:I think if you look at it from a pure standpoint, it could theoretically be the total portfolio because it's got 13,000 securities. It it could theoretically be the total portfolio because it's got 13,000 securities. It has equities, commodities, gold tips and treasuries. So it's pretty diversified, probably more diversified than most total portfolios, even though it's one security. So in theory it could serve as a total portfolio.
Speaker 2:Now, in practice that's not practical, and so so I view it more as a tool to get more diversified. So I think you know I always think of it as there's a spectrum. On one end of the spectrum is the conventional portfolio, what most people do. On the other end of the spectrum there's a more diversified portfolio. So think of conventional. Is not that diversified? I mentioned 60, 40 is 90% correlated stocks.
Speaker 2:On the other end of the spectrum you can think of RPAR on that end, where it's super diversified. Now, most people can't get all the way there because it's just so different from what's convention, and so the way I think about it is RPAR is a tool to get closer to being more diversified and for those that are more comfortable moving away from convention towards diversification, they understand what it means to be diversified. They appreciate the benefits of it. This year it's easier because it's done better, but for a long time it did worse than being more conventional and over the long run I think it should do better than being more conventional because it's more efficient. But for those that feel that they can handle being more diversified, less conventional, they can own more of it and move in that direction.
Speaker 2:And for those who feel they want to be more conventional, they can own less of it or not own it at all and move towards that conventional side. So I don't really think of it as a core or satellite. I think of it as just a tool to become more diversified. And if you're all in and you 100% get it and you're not going to sell it when it underperforms the conventional portfolio, then you can be more in that camp. And if that's a more difficult thing or it might take time to get there, then you can be more conventional and just maybe own a little piece of it.
Speaker 1:We should talk about time frame on this you mentioned. You're much more longer term in your thinking. I look at the RPAR volume as we're speaking. Yeah, it's around 10,000 shares being traded, which some people would get nervous about because they think it's not liquid from that standpoint. So let's do a little bit of myth, busting around volume, liquidity and how to think about the timeframe with which you should look at RPAR and hold on to something like that yeah.
Speaker 2:So liquidity is? It's an interesting topic because you're talking about an ETF, and so the liquidity of the ETF is really represented by the liquidity of the assets the ETF buys. And it's because if you, let's say, there's 10,000 shares traded and you put in an order to buy 10 million shares, you would think, oh, now the price is going to move. But what happens is shares are created. When you put in a 10 million share order, either a buy or sell, they're either redeemed or they're created, and so what matters is the liquidity of all the underlying assets that you're buying. So RPAR includes ETFs that are very liquid. Inside of it includes tips, bonds, treasury, futures, commodity equities and gold ETF, so it's very liquid. So you could put it in an order for 10 million and it shouldn't move the price very much, and so that's a little counterintuitive and that applies across all the ETF landscape.
Speaker 2:It's not unique to RPAR. So you have to look at the assets that the ETF is buying and the liquidity of those assets, and that will determine how liquid the ETF is, not necessarily the volume. So that's the response on the volume. So to me it's not a concern at all. I'm sorry, what was the other question I got?
Speaker 1:On the timeframes, because a lot of people, obviously with ETFs, have to be much shorter term. Um, uh, I'm sorry. What was the other question I got on the yeah, no on the timeframe. So it's because a lot of people have a much short term, shorter term.
Speaker 2:Yeah, the way I think about that is I think it's a little counterintuitive. So I think of that as you're trying to go from point A to point B, so you know lower left of the chart on on a upper right on on B, and I think there's. You can simplify it to two paths. From A to B. You could be on the volatile path and let's call that equity. So you invest 100% equities. It goes up over time but it's a very volatile path. It goes through good periods, bad periods and this is long-term. You can be on a smoother path. So I think of RPAR as having an equity-like expect a return with less risk. So similar point A and point B over time, but a smoother path to get there because it's more diversified and again, that's that free lunch and investing. So if you're investing for a hundred years, do you want to be on the smoother path or the more volatile path? If they end up in the same place, I'd prefer to be on the smoother path or the more volatile path. If they end up in the same place, I'd prefer to be on the smoother path. If you're investing for five years, do you want to be on the smoother path or the more volatile path, I'd still choose the smoother path. Assuming they get to the same place on average, I take the smoother path. Now the challenge is if you're judging success or failure not on whether you're on the smoother path or the more volatile path, but if you're judging it based on. How did I do relative to the volatile path. If I choose a smooth path and my other option was the volatile path, about half the time you'd be better off in the volatile path because it's more volatile. So over five years it could be up a lot more. It could also be down a lot more, but on average you end up in about the same place and the smoother path will get there more consistently. So if you did five years, five years, five years, five years you'd win more with the smoother path. But in any one five-year period you'd probably be disappointed about half the time. So that goes back to.
Speaker 2:It's not necessarily a timeframe question.
Speaker 2:It's more about what is your reference point. Is your reference point steady returns or is your reference point? Is your reference point steady returns or is your reference point? I could have been in the more volatile stock market and done better, and so the more oriented you are to judging success or failure based on what could have been meaning the more volatile path, then. And that matters, by the way, because if you feel like you made the wrong decision five years ago by being on a smooth path, then and that matters, by the way, because if you feel like you made the wrong decision five years ago by being on a smooth path, then you're more likely to change your mind for the next five years. And if you keep changing your mind, you'll probably be up in a worse place than if you just held one or the other the whole time. So I think that's where the psychology comes in. So it's not necessarily a timeframe, it's more about what is what is your patience and what is your reference point. So that's the way I would respond to that question.
Speaker 1:I always like using the analogy of I'd rather get to my destination If I'm flying slower and smoother than faster, with more turbulence, all right. Like yeah, you're going to get there faster, but it's not going to be comfortable, right yeah, like yeah, you're going to get there faster, but it's not going to be comfortable, right, yeah.
Speaker 2:And long term, you don't win that way, you know. But long term is a long time.
Speaker 1:Well, and, as you know, the unfortunate thing is that long term for most people now is three months. Yeah, I know, Long term is getting shorter. That's the money line for the podcast on this. Long term is getting shorter. We haven't talked about the commodity side of risk parity and how our power wars. Talk about gold, right, but let's talk about how that diversifies as well. And how do you.
Speaker 2:Yeah, I think of commodities as a basket there's, there's gold and then there's all the other commodities. And the reason I draw the line between those two is because gold acts more like a storeholder wealth and it tends to do better when growth is weak, and all the other commodities have industrial use and are demand-based, and they tend to do better when growth is strong. So, for example, in first quarter 2020, covid hit, economy collapsed, gold was up and all the other commodities got crushed. Same thing happened in 2008. Gold was up. The other commodities went down significantly. So I think it's good to separate those two.
Speaker 2:So the way I think about constructing a commodity portfolio is, rather than just owning the commodity prices, which tends to have a low return over time and is pretty volatile. So, like through futures, we own commodity producer equities the companies pulling the commodities out of the ground. So their price of those stocks is heavily influenced by the commodity price. So, for example, in 2022, we saw commodity prices go up. That index of commodity producer stocks was up double digits when global equities were down almost 20%. And in the 1970s, those stocks did really well as commodity prices rose through that decade when global equities underperformed cash.
Speaker 2:So it's a good diversifier, particularly over those environments where inflation really surprises the upside, and global or commodity producer equities have actually had a pretty good return over a long period of time. Our analysis shows that it's actually outperformed global equities by a couple percent a year over 50 plus years. So you can get diversified without giving up returns as you go into a segment of the global stock market that is pretty different from the other segments, is pretty different from the other segments. So the way I think about building a pretty efficient commodity exposure is commodity producer equities plus gold and just the gold price and that basket, I believe, has an equity-like expected return over time but is a much better inflation hedge than global equities. So it's a good way to be diversified without giving up much in terms of return long-term.
Speaker 1:As you know, one of the things with ETFs, of course, is transparency, and anybody can look at an ETF and see the holdings and weightings. If somebody is on board with all this thinking, why would they invest in our car as opposed to just, you know, look at the holdings daily and do it themselves?
Speaker 2:Well, I think I can answer that pretty easily because that's what I did for 15 years For my clients. I bought the underlying exposures through ETFs or managed funds or however way you want to get that exposure, and six years ago we figured out it's more efficient to do it inside of an ETF wrapper, so one. You get the tax efficiencies that come along with wrapping all those assets inside of a single ETF vehicle and I feel like that technology of tax efficiency within that ETF wrapper is heavily underutilized in the industry. The big advantage is, in assuming you manage it well, you can effectively defer capital gains until the ETF is sold. And so if you have asset classes within that ETF structure and you do regular rebalancing, which is a repeated process of buying low and selling high, you sell a little bit of the winner, you buy a little bit of the loser. That can potentially add returns through time because you're buying low, selling high repeatedly.
Speaker 2:In practice it's hard to do that outside of the ETF wrapper because you have to pay cap gains on the winners that you sell. Inside of the ETF wrapper. You have the opportunity to defer all those gains until the total ETF is sold. So I think doing it inside of RPAR or ETF wrapper is potentially more tax efficient. It also takes away you don't have to actually manage it, it's managed for you, it's automatic away you don't have to actually manage it, it's managed for you, it's automatic. The rebalancing just from personal experience, it's hard to do because you not only have to sell the winners and pay the taxes, you have to buy the losers. And buying the losers is not easy to do in practice because there's a lot of emotional pushbacks against buying the losers. There's always a narrative as to why it has been a loser and why it'll continue to be a loser, and the same thing with the winners. So inside of the ETF wrapper it's automatic, you don't have to look at it, you don't have to think about it.
Speaker 2:And then there's also other efficiencies. Like you know, rather than owning treasury bonds that are pretty tax inefficient because the income is ordinary income, we own treasury futures that are more tax efficient than treasury bonds because there is no income and all the return is cap gains and you can potentially generate cap losses to offset the cap gains. Also, RPR has 20% of leverage inside of it and that leverage is achieved very cheaply because we use futures to get that and the implied financing cost of futures is cash. So think of it as you can get 20% of leverage, your cost of financing is cash. It's harder to get cheaper financing than that. So you get a little bit of leverage inside the ETF and that can potentially add returns through time. So I think there's a lot of efficiencies that come along with using the ETF, which is exactly why we created it and why we use it, alex, for those who want to learn more about RPAR and, in general, just kind of educate themselves on the entire concept.
Speaker 1:where would you point them to and what resources would you have them look at?
Speaker 2:Sure, a lot of resources, because I've spent a lot of time you know 20 years thinking about this, writing about it. So the RPAR website is rparetfcom A lot of resources there about the ETF. We do quarterly webcasts. The replays are on the sites where we kind of walk through the strategy. I've written a couple of books on this. Risk Parity is the most recent one. Evokeadvisorscom is our advisory site, so there's a lot of information there. I also do a weekly podcast Insightful Investor is the name where I interview guests. It's not about risk parity, it's more about markets and investing and I try to focus on things that are counterintuitive or widely misunderstood. That, I think, are the best insight. So there's a lot of resources there for people to tap into.
Speaker 1:And one thing we haven't touched on, which we should, briefly before we wrap up here, is you have more than just RPAR.
Speaker 2:Yes, there's RPAR, and then there's RPAR on steroids, which is UPAR, and so that's ultra risk parity and it's the same exposure as RPAR, except it's levered 40% more. So it's 40% more risk, 40% more excess return, none of that financing cost, and I think of RPAR as equity-like expected return with less risk, and UPAR as equity-like risk with an expected return that I would expect to be above equities long-term. So there's two versions of that risk-paired ETF.
Speaker 1:Learn more about RPAR. Again, this is a sponsored conversation and I'll see you all on the next episode. Thank you, alex, appreciate it. Thank you.
