Is There A Way To Invest In Risk Parity?

Risk parity's utility in a brokerage account accessible fund is lost on me. We've had quite a few posts lately trying to figure out how it can work. The idea is appealing, I say that in every post, but the funds don't seem to work, I say that too but would like to find a product where it does work. I remember when the Risk Parity ETF (RPAR) launched, I was intrigued. I'm always going to be intrigued. It now is getting close to three years of track record and the time it has been trading has been very eventful and the fund has been successful bringing in AUM, it looks like it now stands at $1.3 billion. 

What about performance? What attributes does it bring? How does it help an investor do something...like maybe manage volatility or diversify away from 60/40? Here is RPAR pretty much since inception versus VBAIX which is a proxy for a 60/40 portfolio.

 

This really surprised me. 

RPAR takes some leverage to build its asset allocation but not a ton. This is from the literature.

In the context of recent posts, is RPAR leveraging up or leveraging down? Yes. Sorry for the snark but there's no reason why all of the exposures can't go down at the same time. Judging by the 2022 performance that has sort of happened. 

We know what equities and long bonds have done, the 35% in treasuries shows as notes and bonds, so longer maturities that were hit hard. The TIPS listed are also long term so using TIP, client/personal holding GLD and GUNR as proxies for the rest of the portfolio, here's the YTD.

At a low point in July, they were all down YTD. In that unfortunate circumstance for RPAR holders, it was an instance of leveraging up. GUNR, a commodity producer ETF, worked great for a while this year but it wasn't enough to help RPAR avoid looking exactly like VBAIX.

We know diversification into bonds didn't work this year. Gold often works but is not infallible and commodity producers do benefit from inflation but they are also pro-cyclical. If instead of everything going in the same direction, enough of RPAR zigged when stocks zagged then I'd be saying the fund leveraged down. Really though, I think with this allocation, whether the result is it leverages up or down is a matter of luck bordering on 50/50. 

I would contrast that with holdings that more reliably zig when equities zag. I'll stick with the same examples I've been writing about all summer with managed futures, certain types of long short and tail risk. We've used the example many times of 70% equities, 20% client/personal holding BTAL and 10% RYMFX to make this point, comparing that to 60/40 VBAIX. 70% equities versus 60% in VBAIX but more reliable protection from BTAL and RYMFX. More reliable but not infallible but an example to me of leveraging down as 70/20/10 had a better CAGR than VBAIX but lower standard deviation. I think RPAR is less reliable in terms of the way it protects. 

VBAIX has two asset classes, so holders just need to worry about those two plus how those two interact with each other. RPAR, depending on how you count has 5 exposures to worry about plus how they all work together. So more things to worry about but the same result as 60/40. I'd rather build/manage the broader diversification myself and layer on some sort of tail risk or VIX protection without the leverage as RPAR uses it. 

Of course what I would much rather is avoid the interest rate risk RPAR takes as much as possible. Obviously I don't have a three fund, 70/20/10 portfolio but client accounts certainly resemble that in terms of equity exposure, little to no interest rate risk by using income sectors that mostly avoid that risk and exposure to diversifiers that are more reliably, negatively correlated to equities. 

I get that 2022 could be anomalous but nonetheless, it's been a great test for many strategies and concepts and the risk parity funds don't seem to have passed the test.  

For risk parity narrowly speaking, this is probably the end of the conversation for now. Bigger picture, this is essentially the same conversation we've been having for years and I think continuing to avoid interest rate risk will be the right decision for a while still as bonds have become what I've been describing as unreliably volatile.