ETF Friday

The FT dug into the coming Bridgewater Risk Parity ETF. There was a little bit of humor and they raised good questions. It seemed like they believe there is a way to make it work while admitting that the strategy has struggled in recent years. The plainest vanilla explanation is that bonds are leveraged up so that the leveraged bond position has the same "risk," although volatility might be a better word, as the equity exposure. A more real world implementation is there are several asset classes involved and where the relationships between the assets are dynamic, so too should the allocations to the assets be dynamic. 

We've looked many times at the Risk Parity ETF (RPAR). It doesn't do well and maybe part of the story there is that the fund is indexed. As I read the FT article, I had a thought about how to try to make the fund work as part of diversified portfolio, not the entire portfolio. 

The idea here is to look to see if any value can be added. The way Portfolios 1 and 2 are weighted, the math works for being a 60/40 portfolio and then from there we add portable alpha/capital efficiency/return stacking. Portfolio 1 looks at whether putting the leftover 20% in T-Bills adds anything. Portfolio looks at adding managed futures and client/personal holding BTAL. Portfolio 2 adds some basis points of CAGR versus VBAIX but that comes with a larger increase in volatility. Portfolio 2 has pretty much the same Calmar Ratio as VBAIX but has a bit better Kurtosis. So, could this be a way to use RPAR? You can decide for yourself but as for me,

One of the Bloomberg premarket emails on Friday pondered "Is There Any Reason To Diversify?" The context was whether to just leave it all, meaning all, in domestic equities. Ok, well that's not the sort of thing you read when markets are fearful. When anyone talks about staying the course, they usually mean when markets are declining and people are fearful. The question of just going 100% US equities is the exact same thing, considering deviating from the course as a function of emotion, greed now, is a terrible idea. 

I've mentioned my involvement with a local foundation that awards grants to non-profits. I'm a research volunteer. In late 2021, when things were going well in markets, they brought up whether they should start to give out a higher percentage every year. My input was something like "no, no, oh my God, no." It's the same behavior. It takes discipline to stick to whatever strategy you chose for yourself as being best when emotion wasn't playing a factor. If anything, the good feeling of equities doing very well could be a time to derisk a little. Not sell down a lot of equities, just derisk a little. 

An interesting, new (to me) ETF popped up on my radar. The Horizon Kinetics Inflation Beneficiaries ETF (INFL) started trading in early 2021 and already has $1 billion in AUM. You can read the boilerplate here but basically it tries to isolate companies that can raise prices in an inflationary environment but not be forced to do so because their costs went up. 

The holdings include land companies, commodity streamers and four different publicly traded exchange stocks that total a little over 11% of the fund. I've owned at least one exchange for clients going back more than 10 years, I'm a pretty big believer in that space. Obviously the fund is heaviest in energy and materials combining for 57% but there doesn't appear to be any megacaps from either of those sectors.

With a fund like this, it would make sense to assess how buying the fund would impact the sector weightings of the entire portfolio. For example, if someone put 30% into this fund (it's just an example), that would add a little 15% of natural to the portfolio. That's a big weighting compared to the S&P 500 which may not be bad but not knowing there is such a big overweight would be bad.

So does it work?

Well yeah, maybe it does. It certainly had a relatively good 2022 when CPI jumped 8%. I threw RAAX in there since we mentioned it earlier this week. It is also doing very well in 2024, it is 1100 basis points ahead of the S&P 500. INFL equaled the S&P 500 in 2021 and lagged it badly in 2023. It has a 0.78 correlation to the S&P 500 compared to 0.70 for RAAX. INFL's beta is 0.82, the Calmar Ratio is a little higher (better) than the S&P 500 and the Kurtosis is a little lower (better) than the S&P 500.

It's interesting and has some differentiation. I think it's probably worth following.

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