Lead-Lag Live

The Truth About Risk Parity: Alex Shahidi on Building a Real Balanced Portfolio

• Michael A. Gayed, CFA

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Markets sit near record highs even as economic signals send mixed messages, and many portfolios are more concentrated today than ever. In this Lead-Lag Deep Dive, Melanie Schaeffer sits down with Alex Shahidi, CO-CIO at Evoke Advisors, to break down what risk parity really is and why traditional frameworks like 60 40 may leave investors exposed.

Shahidi explains how growth and inflation cycles historically drive long term returns, why diversification is often misunderstood, and how a true balanced allocation uses equities, commodities, gold, treasuries, and inflation linked bonds to weather very different market regimes. He also discusses the philosophy behind the RPAR Risk Parity ETF and why more advisors are reconsidering how they approach portfolio construction.

In this episode:

  • Why most portfolios are less diversified than investors think
  • How growth and inflation surprises drive major market cycles
  • The role of commodities, gold, and inflation linked bonds in a balanced allocation
  • Why equal risk contribution matters more than traditional 60 40 mixes
  • How advisors can use risk parity to build more resilient portfolios

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SPEAKER_00:

Owning inflation edge assets like commodities, gold, tips, uh, which are inflation link bonds, are really important. And it's easy to underestimate the importance. So if you go back to the 1970s, uh, as an example of a period where we had inflation problems for a long time, uh, not just a year or two, uh, but for a decade or longer. In that time, the stock market and the bond market underperform cash. So if all you're picking from is traditional stocks and bonds, and you go through a period like that, you may do very poorly for a long uh for an extended period.

SPEAKER_01:

All right, well, it's the holidays, and I'm officially going to be spoiling one of you. I'm giving away this duffel bag packed with a bunch of our signature Few Crew branded merch that has all the inside jokey slang that you only get if you actually get it. So what's inside? Well, a men's What Up Bitches hoodie, an exquisite hoodie for her, and a few other things to take you from, I think I get it, to Few Crew certified. Now, if you want in, here's the deal. You have to follow at lead leg report on X, follow me, Mela underscore Schaefer on X, subscribe to Lead Leg Media on YouTube, and like and share this video. You do that and boom, you're entered. No gimmicks, no funnels, and no nonsense. One winner gets the whole package. The rest of you stay f until next year. Happy holidays from the Few Crew. I'm your host, Melanie Schaefer. Welcome to Lead Lag Live. U.S. indices are trading a close to record highs, even as economic signals send mixed messages. Weak private payroll data push treasury yields down and stoked rate cut hopes. Yet beneath the surface, there is still dispersion between megacap leadership and the rest of the market. My guest today is Alex Shahidi, co-chief investment officer at Evoke Advisors and one of the architects behind RPAR Risk Parity ETF. Alex, it's great to have you back. Thanks for having me. I appreciate it. So let's start really simple. What is risk parity and how does it differ from traditional uh portfolio construction?

SPEAKER_00:

Uh I think of risk parity as just a balanced portfolio. Um I frankly I don't love the name, but that's just you can't call it a balanced portfolio because uh most people don't uh in my experience think of a balanced portfolio differently than the way we think about it. Um and so I guess that leads to what does it really mean to be balanced? So the traditional portfolio, from my perspective, is not very well balanced. And the way to think about that is uh a conventional framework is 6040, meaning you have an allocation to high return, high-risk stocks, an allocation to low risk, low return bonds, and you mix between the two depending on how much return and risk you're seeking. And the challenge with that framework is if you just think about a 60-40 moderate risk portfolio, that 60-40 portfolio is about 98% correlated to 100% stock portfolio. Meaning it's basically putting all the eggs in the stock market basket. If stocks do well, 6040 does well, stocks do poorly, 6040 does poorly. And that is not diversified by definition. If, you know, if your portfolio is 98% correlated to a single volatile asset that can't be diversified. So to me, 6040, even though it's commonly termed balance, I mean there are balanced funds that are 6040, that's not really balanced. And so I think of risk parity as just another framework for building a balanced portfolio. And so basically, and then we can get into this, but there's a couple steps that you follow to get to what is a more balanced allocation. And that portfolio is not going to be highly correlated to any any single asset class.

SPEAKER_01:

So can you walk us through that then, Alex? What does a a real balance in your opinion portfolio look like?

SPEAKER_00:

Yeah, I think it starts with the core understanding of what drives the returns of asset classes. So if we just look at stocks, uh in the and we can just look at the stock market over the last hundred years. It's gone through really good periods, it's gone through terrible periods. So for about 20 years from 1929 and 1949, the SP averaged 0% a year for 20 years and it fell 85%. And it took you know a couple of decades to break even. So the reason that happened is because you're coming off the roaring 20s and the market was discounting that economic growth would look like the 20s, and instead you had got the Great Depression. And that the difference between what was expected and what actually transpired was so bad and so significant that you ended up with a zero return for 20 years. So growth significantly disappointed on the downside. Um, from 1966 to 1982, the stock market underperformed cash for 16 years. Um, and and what happened there? That wasn't really a growth story, it was more of an inflation story. An inflation surprised to the upside by a lot and over a long period of time. So, so stocks clearly have a bias to growth and inflation. Uh, in the 2000s, we saw another loss decade for the stock market. Stocks were slightly negative. And again, what happened there was you're coming off the 1990s and the 1980s, and the market was discounting growth in the 2000s, what looked like the 80s and 90s. Instead, it was the slowest rate of growth since the Great Depression. So stocks were negative for a decade, underperformed cash again. And so growth and inflation are big drivers of asset class returns, particularly over longer time frames. So to diversify that risk, which is a big risk, uh you can own assets that do well in different growth and inflation environments. So very simplistically, other assets to include in the portfolio besides stocks are core, you know, sovereign, high-quality bonds, inflation-link bonds that act differently from traditional bonds, uh, and then commodities, uh, and including gold. And those four asset classes uh act differently in different growth and inflation environments. And that I think is a very sound starting point for building a more diversified allocation. But but the weighting matters a lot. And so part of the reason 6040 is not well diversified is because you put 60% in something that's very volatile, 40% in something that's not very volatile. So the volatile asset that's overweighted drives a total return. So basically, the lesson from that experience is the, you know, the four asset classes I described, the ones that are more volatile, you have to own less of, and the ones that are less volatile, you have to own more of. So you get to equal risk contribution so that no single asset class uh overly influences the total portfolio's return. And so if you do that, to me, that's what a risk parity portfolio is. And it's just a more diversified allocation.

SPEAKER_01:

So Alex, yeah. And you you took us through a bit of the history of the stock market. What are the biggest risks investors face today in the future over the next decade or so? And how does risk parity help to mitigate that?

SPEAKER_00:

Um, yeah. So if you look today, uh there's significant risks uh looking ahead. Uh, I think one of those is inflation. You know, inflation until recently hasn't been a problem since the early 1980s. So it's in many ways been forgotten. But infl owning inflation-edge assets like commodities, gold, tips, um, uh, which are inflation-link bonds, uh, are really important. Um, and it's easy to underestimate the importance. So if you go back to the 1970s as uh as an example of a period where we had inflation problems for a long time, uh not just a year or two, uh, but for a decade or longer. In that time, the stock market and the bond market underperform cash. So if all you're picking from is traditional stocks and bonds, and you go through a period like that, you may do very poorly for a long uh for an extended period. So during that time, gold was up over 30% a year. Uh commodities did really well. Tips didn't exist, but they probably would have done well because you get paid the inflation rate and real rates fell, even though nominal rates went up significantly. So owning those assets, I think, is really important today because inflation is a concern. Inflation's been above target for four years now. Uh, who's to say that it's going to go back to target anytime soon? Um, the impact of tariffs haven't even flown uh been uh built into those inflation numbers yet. That takes some time for it to flow through. So inflation is a problem, and most portfolios don't have much in inflation protection. Um, I think another risk is growth. Uh so growth has been resilient, surprisingly resilient for years. Uh I remember after 2022, most people thought 23 we'd have recession, no recession in 23, and no recession in 24. Here we are near the end of 25, still no recession in sight. But the thing about recessions and economic downturns, it at least in my experience, is they're almost always a surprise. Something happens, some shock occurs that's out of left field, and all of a sudden the economy turns down. And when the market's not expecting a recession, it's not discounting it, and you do get one, that's when you get the big market moves. So all of that speaks to uh an environment where it makes sense to be well diversified. And when you look at where most portfolios are today, they're less diversified than they were a decade ago. They have more stocks than they used to, they have more U.S. stocks, and even the U.S. stocks are more concentrated in just a handful of companies. So it just seems like an environment where investors should opt for more diversification rather than less diversification. And in reality, we're actually seeing the opposite.

SPEAKER_01:

I I just want to change pace for a minute and ask you uh what inspired the creation of the RPAR risk parity ETF? And uh you've answered it a little bit, but just to be very specific, what problems does it solve for investors?

SPEAKER_00:

Yeah, I mean, it's basically it's just a way to get more diversified. And while that sounds intuitive and straightforward, in practice it's actually hard to do. Because to be well diversified, you have to own assets that many may not have in their portfolio. So it's things like gold or commodities, inflation-link bonds, even high-quality uh treasuries are diversifying assets. And you can see that through time. They do well in different environments, so conceptually it makes sense. But in practice, it's just hard to own. Um, and you know, like for example, gold today, people are like asking about gold. It's like, oh, gold's up 60%. You know, should we have gold in a portfolio and it's hitting headlines? But to get that return, you would have had to buy it when it wasn't doing well. Um, so so diversification is really important. People understand it, they appreciate it, but it's really hard to do in practice. So, one of the reasons we created our par is to help investors become more diversified by incorporating all those diversifying assets inside of a single vehicle. And our sense is the vehicle is easier to hold than maybe some of those individual line items. And and and one of the one of the, I think, misnomers about diversification, I just want to mention this, is that there's, and just from talking to investment professionals, financial advisors, uh clients, and investors, is there's this general sense that that diversification costs you returns over time. And what I mean by that is if you want high returns, you invest as much as you can handle in stocks. And then all the other asset classes will reduce your risk, but they also reduce your long-term expected return. So diversification comes with a cost. You reduce risk, but you give up returns. And I don't know if that has to be true. I think you can build a well-diversified portfolio and not necessarily give up returns over time. Um, and that is what that risk parity framework uh uh suggests. And it's own those diverse asset classes, risk balance them so that you overweight the less volatile assets, underweight the more volatile assets. And if you want, you can lever that portfolio. So you can lever a less risky portfolio, lever the entire balance portfolio, and that's our part has 20% of leverage. And that portfolio could uh compete with equities over the long run with less risk. So you don't necessarily have to give up returns to be more diversified.

SPEAKER_01:

Yeah, and you you've mentioned the asset classes and you've mentioned cold uh quite a few times. Can you walk us through the each of the asset classes uh in our part and why they were chosen uh in particular?

SPEAKER_00:

Sure. Yeah. So you start with equities, it's a it's a good starting point. That tends to do well when growth surprises the upside, inflation surprises the downside. Uh so that's a starting point. Then you want other asset classes that are diverse to that. So so uh for commodities, we own commodity producer stocks, the companies pulling the commodities out of the ground. Um, those tend to, the price of those uh investments, those companies, tends to be heavily influenced by the commodity price. So we saw that in 2022, for example, global equities were down quite a bit, the commodity producer stock index was up quite a bit uh at the same time as commodity prices soared. Uh, that was part of the issue, was inflation. Um, so that's a good diversifier. It's had attractive returns over the long run. And then you complement that with gold, uh, which uh uh we we know recently it's done really well, but even over the long term, it's done phenomenally well. 25 years, I believe gold has outperformed the stock market. Even 50 years uh since we came off the gold standard in 1971, so 54 years now, uh it's it's uh its returns are competitive with equities, and the average correlation has been zero. Um so so those I think are really good diversifying assets to include in in that uh balanced mix of assets. Uh and then we also include TIPS and treasuries uh that do well when growth is weak, um, as you get a fall in interest rates typically. And then treasuries and tips are also diversifying versus one another because they have different biases to inflation. So I mentioned the 1970s, tips didn't exist. I think they would have done well as real rates fell. Uh, but treasuries underperformed cash for a decade. Um, and uh, and again, we haven't had inflation problems until recently. So tips, I think, is an important part of a balanced allocation. So we include all of those assets uh within our park.

SPEAKER_01:

Uh and as well, I mean, you've mentioned that you talk to clients and investors and advisors. I want to ask specifically about advisors, what advice would you give to those of them who are are hesitant to adopt risk parity strategies?

SPEAKER_00:

Yeah, I think the first thing is it I think it's important to educate yourself on the various options and then make an informed decision of how you want to invest and recommend your clients invest their assets. Um, so I think of risk parity as just a different framework. And and to me, it goes back to what does it really mean to be balanced and diversified? Um, and and again, that's the typical framework of 60-40, you know, own more stocks if you want to take more risk and you want higher return. That's not a very diversified portfolio. And in some ways, it violates one of the first rules of investing is don't put all your eggs in one basket. And effectively, that's what that allocation uh philosophy does, is it puts all the eggs in the stock market basket. There's also a trade-off between diversification and return. So if you want to take less risk, you own more bonds, less stocks. If you want to take more risk and have higher return, you own more stocks, less bonds. And the more stocks you own, the less diversified the portfolio becomes. So there's a trade-off. If you want higher return, your diversification goes down because you're increasing the stock allocation. So that's a challenging framework because we know the the one free lunch investing is diversification. You get more return per unit of risk by being more diversified. And if you have to give that up to achieve higher returns, that risk is significant. And you know, the risk is it's hard to appreciate during bull markets and it and it's and it jumps to the surface during bear markets. And we've had a bull market for a long time. It won't continue forever, and nobody knows when it's going to turn, but uh, you don't want to be in that position once it does. So I think of risk parity as a framework where you can basically lever up a portfolio to different degrees of return target, but you're not giving up diversification. You know, an unlevered risk parity portfolio um has an attractive return for the risk you're taking, but it has the same sharp ratio, you know, return-to-risk ratio as something that's more levered. So you can scale up and down the return spectrum without uh sacrificing diversification.

SPEAKER_01:

And Alex, um, just a couple of last questions. But I know you've been very comprehensive and provided tons of information.

SPEAKER_00:

What's one thing about risk parity that most people don't know but should? I think one of the misunderstandings that I think is pretty broad-based is that there is a perception that for risk parity, you have to lever bonds to do that. And people look at bonds and say, this is a terrible asset class. It's been negative the last five years. Why would I want to lever that? And I don't think of it that way. I think of it as risk parity is about building a balanced allocation. You can have an unlevered risk parity portfolio. You can just have you, you know, those four asset classes I mentioned, equities, commodities, tips, and treasuries. You can build a balanced portfolio of those assets with zero leverage. Uh, you just overweight the less volatile assets, you you underweight the more volatile assets, and you have equal risk contribution across a diverse mix of assets and it's un and no leverage at all. So that's a balanced portfolio. Now you can take that entire portfolio and you can lever it a little bit. And that's basically what RPAR is 20% of leverage. You're balance, you're levering the entire portfolio, and the cost of financing that is cash. So if a balanced mix of assets beats cash over time, then RPAR beats an unlevered RPAR, an unlevered risk parity portfolio. And you can lever that even more if you wanted to. And so I think that is it's just a different way of thinking of building a balanced allocation. Rather than saying to scale up and down the return spectrum, I own more or less stocks. You could build a balanced allocation and scale up and down with leverage. And again, you're not levering a single asset class, you're levering a total balanced portfolio, which is a safer form of levering than a single investment that might be more volatile. So, so again, it's all about the balance and mainly maintaining diversification. And I think the way investors can think about using this tool is as part of their whatever their current allocation is, if they want to take a step towards being more diversified, they can use it as a tool to get there. And that's effectively to answer your earlier question, that's the reason we created it. That's what inspired the creation of the ETF is to create a tool that didn't previously exist that helps us more practically implement uh a diversification in our client portfolios.

SPEAKER_01:

And Alex, uh, just for listeners who want to follow up on your research, learn more about RPAR and Evoke Advisors, where's the best place for them to go?

SPEAKER_00:

Uh sure. For for RPAR, it's uh rparetf.com, uh, the website we have uh we do a quarterly uh review and we go through the strategy there. Um there's uh other material as well. Um and then uh uh for the evoke advisors, it's evokeadvisors.com. Uh we have a website that has a lot of information there. I also host a weekly podcast called the Insightful Investor. Uh, insightfulinvestor.org is the website for that podcast. So uh you can uh go there and learn more about some of the discussions we have. It's not it's not just about risk parity. Uh actually, risk parity isn't covered much uh in those podcasts. It's it's pretty uh wide range.

SPEAKER_01:

Great. Well, Alex, it's I always appreciate your insight. It's great to have you here. And uh thanks to everyone for watching. Be sure to like, share, and subscribe for more episodes of League Light Live.

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Michael A. Gayed, CFA

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