Could There Be Any Hope For Risk Parity?

Part of my post market routine everyday is to run through to see where the dust settled on the overall portfolio plus the myriad of other things I keep tabs on including several risk parity funds and I continue to be astounded by how badly it is doing.

I've been intrigued by the strategy since I first heard about it but leveraging up on treasuries just never make any sense to me with rates being low. The RPAR Risk Parity ETF (RPAR) which I believe is the first ETF to track the strategy launched in 2019. I was curious of course, looked and never bought. Back then I knew the AQR fund was having its struggles but I will always take a close look. 

Here's the YTD. I threw in TQQQ because without it, the amount of RPAR's decline is obscured. 

 

It is down more than 10-20 year treasuries, TLH, and SPY because it uses leverage to add to its treasury exposure. Here's something from the fund website.

Seeks to generate positive returns during periods of economic growth, preserve capital during periods of economic contraction, and preserve real rates of return during periods of heightened inflation.

I'm sorry, preserve what? 

Here's how ETF.com describes the fund's allocation;

Per the prospectus, the fund rebalances quarterly to fixed allocation of 35% TIPS, 25% equities. 25% commodities and 15% Treasurys. However, the Treasury allocation includes T-bill collateral for a hefty allocation 10-yr Treasury futures, stated at 60% notional. Thus, the all-in nominal asset allocation is unclear as it sums to more than 100% but a) appears to be skewed to T-Notes and TIPS, consistent with its thesis, and b) implies leverage. 

I was curious though, what a couple of unleveraged versions of the strategy would look like. Portfolio 1 takes interest rates risk and the Portfolio 2 does not, maybe a little, and I compared them to 100% in Vanguard Balanced Index Fund (VBAIX).

 

Here are the results.

 

And

 

Would you be ok with CAGR of 4.xx%? That might be insufficient for someone needing stock market growth but for someone in game over mode it might work. They were ahead of inflation until this year. 

Since 2012, both unleveraged versions had two years or double digit gains with a standard deviation that is about half that of stocks and two points less than 60/40. Obviously both would have been far worse off if commodity proxy DBC was down YTD. Having at least one thing going up is kind of a permanent portfolio concept.  The unleveraged risk parities have large, even if not equal, allocations to just four asset classes which is also similar to permanent portfolio. The Permanent Portfolio allocates 25% each to stocks, long bonds, gold and cash.  

For a little context, Portfoliovisualizer has the Permanent Portfolio down 10.66% this year with a slightly lower CAGR and standard deviation than the two unleveraged risk parity portfolios.

Devising and implementing a game over portfolio is the right thing for some people and figuring out and then refining what that looks like is a useful endeavor for understanding risk for a more standard allocation relying on "normal" stock market growth. I've been referring to longer maturity bonds, even intermediate, as having become a source unreliable volatility. A portfolio that overweights or even relies heavily on that part of the market the way that risk parity and the Permanent Portfolio both do is an obvious thing to avoid. A huge, long only allocation to commodities is not where I want to be either. Mark Yusko likes to say risk happens fast and that has been true all year with longer bonds and has been the case for DBC since early June, that fund is down 20% since then.