Finding A Home For Risk Parity?

For this post I wanted to follow up on some portfolios we constructed last summer as well as tie in a new idea to those year old portfolios. As I was looking through last summer's content I saw that I really wrote a lot of articles crapping on risk parity funds like RPAR, UPAR and WFRPX but we'll circle back to those in just a bit. 

A major focus of all these related posts about return stacking, using alternatives and yes, crapping on risk parity has been that there are plenty of ways to construct a portfolio that builds in offsets to equity market volatility without taking on the elevated risks that I now believe exist in many parts of the bond market and what I think is extreme and unreliable volatility that is now embedded in many parts of the bond market. 

We've got three portfolios from over a year ago to circle back to as well as a new idea and we'll compare them all to Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

The first one is from July 31, 2022.

And the second is from August 10, 2022.

Both are of course very simple in terms of how few funds are used but there is a little sophistication to them. The one from July 31 uses some return stacking but BTAL and RYMFX help with leveraging down. The one from Aug 10 doesn't truly use return stacking but it does allow for leveraging down. We can have more in equities than VBAIX but do so with a lower standard deviation than VBAIX which is 60% equities, thanks to what I believe is superior diversification from BTAL and RYMFX. That was the case a year ago and still the case a year later.

This is how they compare longer term to VBAIX.

 

The back test is kind of short because NTSX is fairly new but the four and half years we can look at have been jam packed with market events. The conversation about avoiding duration has been going on here since the aftermath financial crisis. The way we've been looking at portfolios over the last year and change is simply the latest evolution of that discussion as the investing market place has grown increasingly sophisticated with many more choices to do this kind of work. I pretty much had this conversation with a client today. Something that I used to say in the early days of the ETF era was that it was clear that there would be more funds offering more sophisticated strategies. It was an obvious conclusion and we've seen that play out at an accelerated pace in recent years. 

The third portfolio I was to circle back to is from a post on September 3, 2022 where I made a joke about starting a global macro fund. I said I was going to use this traffic light as the logo.

And this was going to be the allocation.

 

Here's how it has done versus VBAIX.

 

The Sept 10 portfolio gets a big bump from GBTC that might not be repeatable but the standard deviation number are probably truer and in the eight years studied, including 2023, the Sept 10 portfolio outperformed in four of them which is very unremarkable but I think demonstrates it can be a sustainable portfolio. That it might be similar to 60/40 is not necessarily a bad thing in my opinion but I do want to avoid interest rate risk and long bond volatility. If there is no consequence for interest rate risk and no volatility I think that would be a win for a lot of people. 

And now a new idea related to risk parity. Although I have crapped on it many times, I say similar things each time which to say it is intellectually appealing and I want it to work it just doesn't seem like it can, noting the three symbols at the top of this post. 

But I've been thinking about Tuesday's post where we looked at the Simplified Game Plan Portfolio from Bob Elliott that calls for 50% into risk parity with Bob citing RPAR as an example along and the mention the other day of the AQR Multi-Asset Fund (AQRIX/AQRNX) from Rod Gordillo who said the AQR fund is a truer representation of risk parity. It certainly has done better than the others. It is actively managed and it appears to be underweight bonds currently. It was not on my radar as risk parity because it isn't in the name of the fund. It changed names from AQR Risk Parity in 2019. 

I had the following idea using AQRIX.

 

Compared to VBAIX.

 

Portfolio 1 avoided the bond market calamity of the last two years but if that is due to an active decision under the hood of AQRIX, which it appears to be, the risk becomes that they later get this wrong. They've been right on this but there is no guarantee of staying right. Still though, I am intrigued. 

Fun post!

Disclosures. BTAL, ASFYX, MENYX and BLNDX are client and personal holdings.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.