Lead-Lag Live
Welcome to the Lead-Lag Live podcast, where we bring you live unscripted conversations with thought leaders in the world of finance, economics, and investing. Hosted by Melanie Schaffer each episode dives deep into the minds of industry experts to discuss current market trends, investment strategies, and the global economic landscape.
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Lead-Lag Live
Beyond 60/40: Alex Shahidi on Diversification, Inflation, and Risk Parity Investing
In this episode of Lead-Lag Live, I sit down with Alex Shahidi, Managing Partner and Co-Chief Investment Officer at Evoke Advisors, to explore why traditional portfolio construction is failing investors.
From lost decades in the S&P 500 to the dangers of overconcentration, Alex lays out why diversification is more than a buzzword—and how risk parity creates a framework that can withstand both growth and inflation shocks.
In this episode:
– Why owning the S&P 500 alone exposes investors to hidden
– The lessons from the 1970s inflation era and what they mean
– How risk parity differs from traditional 60/40
– The biggest misconceptions investors have about risk
– Practical first steps investors can take to diversify
Lead-Lag Live brings you inside conversations with the financial thinkers who shape markets. Subscribe for interviews that go deeper than the noise.
#LeadLagLive #Diversification #RiskParity #Investing #Inflation #StockMarket
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All we have to do is go back to the 1970s. That that's probably the closest analog to what we've already experienced so far in the last few years. The Fed was raising rates, but they were behind inflation. So nominal rates went up a lot. During that decade, you know, the stock market underperformed cash for 10 years. Um, and it wasn't a straight line.
SPEAKER_00:I'm your host, Melanie Schaefer. Welcome to Lead Lag Live. Now, the the U.S. government is officially in shutdown mode after Congress failed to pass new funding legislation, which has many investors treading cautiously. My guest today is Alex Shahidi, managing partner and co-chief investment officer at Evoke Advisors. Alex is the co-architect behind the RPAR risk parity approach, and he brings deep insight into how we manage risk, growth, and portfolio construction, especially in volatile markets. Alex, thank you so much for being here. Thanks for having me. So let's begin with diversification. There's been a lot of talk this year about how well diversification works. How do you personally approach the concept of uh diversification in your portfolio management framework?
SPEAKER_01:Uh the the way I think about it is uh from a high level, the future is always uncertain. Uh we, we it's, you know, there's periods where it's more uncertain. And I think now is one of those periods. You know, you we really have no idea where inflation is going to go. We don't really know where growth is going to go. Everybody has an opinion, but in reality, nobody really knows. Um, and and so I think of in an environment like that, it makes sense to be well diversified. Um, and the way I think about diversification, to answer your question more directly, is uh if you take a look at asset classes and what really drives our returns through time, the the two big forces are growth and inflation. And more specifically, it's how growth and inflation transpire versus what was expected. And in other words, it's the surprises that matter. And that is a hard thing to figure out which way growth and inflation are going to go relative to what's discounted. Uh, because you you not only have to guess correctly, but your guess has to be different from the consensus, which is what's already reflected in the price. And and we all know the old adage, diversification is the one free lunch and investing, and don't put all your eggs in one basket. Yet when you look across portfolios, given you know the great uncertainty that I described, and you look at how most people invested, they're very concentrated. Uh, most portfolios own a lot of stocks. They own a lot of U.S. stocks, and even the US stocks are highly concentrated within just a few names, all of which about compete with one another. So uh, so there's a like a big disconnect between how investors should think about being diversified and what their portfolios actually look like. And and again, it goes to just be diversify across growth and inflation. And there's no long-term cost of doing that. You can just own assets that do well in different growth and inflation environments pretty reliably, and you uh balance the portfolio across those assets and then you rebalance, buy low, sell high programmatically. It's actually relatively simple. And and I think that is one of the biggest uh oversights of investors today.
SPEAKER_00:So just to follow up on this uh a little bit more, you often point out that just owning the S P 500 isn't enough for many long-term investors. Why should long-term investors consider options beyond simply holding uh the S P 500?
SPEAKER_01:Yeah, it's an easier conversation after a bear market than it is during the uh the bull market. And and I think to see the picture more clearly, you have to zoom out. And if we just take the SP 500 as you as you referenced, uh, you know, you go back about 100 years and you've basically had about three really strong long-term bull markets and about three long-term bear markets. And think of it as it goes up significantly for 15 to 20 years, and then it's about flat for 15 to 20 years. Um, and so here we are 16 years in a really strong bull market. It's averaged about 16% a year for 16 years since the GFC lows. But people forget the prior decade, the SP was negative. It was actually one of the worst markets in the world and negative, you know, underperforming cash. And the same thing happened in the uh mid-60s to early 80s. Uh the SP underperformed cash as inflation became a problem. And back in the 30s and 40s, uh, the SP earned zero for 20 years. Um, so so the big risk if you put all your eggs in one basket, and and the popular basket today is the SP because you're on the tail end of a really strong bull market that seems it'll never end. Um, uh, and it will at some point. We just don't know when. But when you see, when you see those numbers, it's easy to forget the long-term uh uh trajectory and and uh cycles of of this market. Um and and so that is it becomes more challenging to talk about diversification in a in a period like that. There's a recency bias that that we all face. Um and so it that can be a part of your portfolio. But if it's if you're putting all your eggs in that basket, that could be a really risky basket, especially when you're you know at valuations where we are and you've had this long-term trend that uh we all know is going to reverse at some point.
SPEAKER_00:Yeah, and you mentioned inflation, which has stayed above target for more than four years. With that persistence, how do you think investors should navigate the continuing uncertainty around inflation and its impact on portfolios?
SPEAKER_01:Yeah, I think this is an area that is probably underappreciated. Uh, and all we have to do is go back to the 1970s. That's probably the closest analog to what we've already experienced so far in the last few years. Uh, during the decade of the 1970s, uh inflation continually surprised to the upside. You know, the Fed was raising rates, but they were behind inflation. So nominal rates went up a lot. Real rates actually fell during the decade to give you a sense of uh the Fed being behind inflation until Volker came in and uh significantly hiked rates to kill inflation uh uh ultimately. Uh but during that decade, you know, the stock market underperformed cash for 10 years. Um and it wasn't a straight line. And so oftentimes you could be in a bear market and not realize it until the the period is over. Uh and bonds underperform cash. So if you have a portfolio that is uh heavily invested in stocks and you can also throw uh nominal bonds in that category, and we do have inflation uh that continues to surprise us to the upside, uh then you do risk underperforming cash for an extended period of time. And the simple uh resolution to that is just own inflation edge assets, own assets that do well during uh inflationary environments. In the 70s, gold was up over 30% a year. Uh commodities did really well. Uh tips didn't exist, but they would have done well as real rates fell, as I as I mentioned earlier. So owning these assets as part of your diversified portfolio makes a lot of sense, particularly given the uncertainty that we face in terms of inflation.
SPEAKER_00:Yeah, and just uh, Alex, I want to go back to sort of the intro where I mentioned that you use risk parity, risk parity framework in your work. Can you explain how risk parity differs from traditional investment approaches and why it matters, especially in times like these?
SPEAKER_01:Um yeah, it's it's an important question. So let's start with the traditional investment approach and just the investment framework. So I think the way most people think about it is uh you have high-risk, high return stocks, low risk, low return bonds, and investors allocate between stocks and bonds depending on how much return and risk they're trying to achieve. And the longer your time frame, the more stocks you own, and the more concerned you are about risk, the more bonds you own. And there's a trade-off between return and uh risk. And so that's a typical framework, which makes a lot of sense. But the challenge is that's not a very well-diversified portfolio. So the simple math is a moderate risk portfolio using that framework is 60-40, um, 60% stocks, 40% bonds. That portfolio is 98% correlated to the stock market. And and the reason that is is because you have 60% in something that's very volatile, 40% in something that doesn't move around very much. And so the total return is dominated by the overweighted asset that's also significantly more volatile than the underweighted asset. So that's 98% correlated. By definition, that can't be diversified. You can't have a portfolio that's 98% correlated to the stock market and consider that consider that to be balanced or diversified. So that's the traditional framework, which I believe is highly flawed. And the reason it matters is because when you're 98% correlated to the stock market, you're effectively putting all your eggs in that basket directionally. And if you go through a lost decade, like we've had multiple times, as I referenced earlier, then you're probably going to have a bad outcome. And that's a big deal. You know, if you're 50, you want to retire at 60 or 65, and you put all your eggs in the stock market basket, it may seem like it's not a huge risk today because you're looking backwards. But if you do end up with a lost decade, then it's a huge risk looking forwards. So uh that's a traditional framework, which I feel is flawed. Uh, the risk parity framework uh is just a more balanced allocation. Um, rather than just putting all your eggs in the stock market basket, you spread it across equities, commodities, uh inflation link bonds, nominal bonds. And that is, to me, a more robust allocation, more resilient through time. Uh, it should generate more consistent returns through time. Uh, it'll go through bad stretches, just like the less balanced portfolio. But those bad stretches aren't going to be because of growth or inflation. Uh, it'll be because you get a massive tightening like we saw in 2022. That's that's your main risk. But 2008 isn't a huge risk. Uh the the uh uh the global financial crisis. Um, you can go back to the 70s, that's not really a big risk. Uh, even COVID, uh our ETF RPA was down 4% in the first quarter when the stock market was down over 20. So you're not risking growth and inflation surprises. You can diversify that, but your main risk is uh massive monetary tightening, which doesn't happen as often as those other things. So to me, that's a more uh robust framework. And that's uh especially in in times like this.
SPEAKER_00:Along those lines, Alex, what are some common misconceptions about risk parity that investors should be aware of? And what are the things that often trip people up?
SPEAKER_01:Yeah, I think the the main one is there's just this view that risk parity is about leveraging bonds. And and uh, you know, why would you want to leverage bonds, especially after they've been negative for the last five years? Um, so I don't think of it that way. I think of it as it's just a balanced portfolio. Um, and and so I think of it there's there's two steps. There's pick diverse asset classes. So we think of it as equities, commodities, uh tips, and treasuries. That's a very simple uh starting point. And you don't have to introduce any leverage to have a risk parity portfolio. All you're doing is matching the risk. And so think of it as equities and commodities, including gold, have more volatility. Treasuries and tips have less volatility. So to balance, you own more of the less risky assets and you own less of the more risky assets. And that effectively balances your risk to growth and inflation outcomes. Um, and and so you could have an unlevered risk parity portfolio. You're just pairing the risk and you're owning more of the less volatile assets. And that is a balanced starting point. Then from there, you can say, well, I have a balanced portfolio of assets. I expect these assets to beat cash over time. They won't beat it every year, but they they should beat it over time. That's why capitalism works. And so you could effectively lever that entire portfolio. And if you do it through the use of futures, which is what we do, your cost of financing is effectively cash. So think of it as an unlevered risk parity portfolio. You can lever that a little bit to have a levered risk parity portfolio where you're effectively levering the whole portfolio. And that should beat an unlevered risk parity portfolio over time, assuming balanced mix of assets beats cash. And then you can lever that at different degrees. Um and the more leverage you introduce, the more volatility, same sharp ratio. It's the same uh uh exposure, just more leverage. And as long as a balanced mix of assets beats cash, then that portfolio outperforms over time. Um, and and that is just a more diverse allocation than the 6040 or uh an equities uh centered portfolio. So I think that's uh that's probably the biggest misconception, just really understanding it's all it is is just a balanced allocation.
SPEAKER_00:So, Alex, for investors who have been following on and who are motivated to improve diversification, what are some practical first steps that they could take to strengthen their portfolios in the beginning without overcomplicating their strategies?
SPEAKER_01:Yeah, the the main thing is just own, start adding diverse assets. So you can add things like gold or commodities or uh uh tips, treasuries. Tips and treasuries have been negative the last five years. That's the highest yield they've had in about 15 years today. Um, and those tend to do well when you get an economic downturn. And, you know, nobody is expecting an economic downturn today. That's usually the case. Usually those downturns are surprise. Uh, and typically what happens is you get a fall in rates and those assets tend to do well. Uh so start adding more of those assets and have less equity concentration. Uh, a very simple way to do all of that is uh through our ETFs, RPAR and UPAR, um, that are uh risk parity ETFs. Uh RPAR has a little bit of leverage, 20% of leverage. UPAR is 1.4 X RPAR, so it's a little bit more leverage, same exposure. And so if you imagine you have a 60-40 portfolio, you want to take one step towards being more diversified. You could own a little bit of RPAR or UPAR, depending on your risk appetite, and take away from stocks and moms or wherever else you own, and you take an uh one more step towards a more diverse allocation. And the and the more you do, the more diversified you are. So I think those are easy steps that investors could consider.
SPEAKER_00:Alex, just but uh uh before we wrap up, where can investors go to find more about your research and to connect with you uh directly?
SPEAKER_01:Uh sure. Uh so our website for the ETFs is RP uh it's uh rparetf.com, rparetf.com. Um, there's a lot of information about both those ETFs, RPAR and UPAR. Uh and then our advisory site is evokeadvisors.com. Um I write white papers, uh uh I have a weekly podcast that we post there as well. Uh so those are some places uh uh investors and advisors can go to.
SPEAKER_00:Fantastic. Well, Alex, thank you so much for joining me. And thanks to everyone for watching. Be sure to like, share, and subscribe for more episodes of Lead Lag Live.
