A Realistic Way To Replicate College Endowments

Man Institute did a deep dive on capital market assumptions with a favorable bias toward risk parity. Risk parity weights different asset classes by their risk in such a way that each asset class contributes the same amount of risk to the portfolio so the strategy would own more in bonds typically, often with leverage, to equal the risk exposure of equities. 

Similar to the crazy high yielder ETFs we looked at on Sunday, I am not a huge fan of risk parity but the strategy is still fascinating and I think there is something to learn by studying risk weighting. 

A lot to unpack here. Portfolio 2 is not something that can replicated in a brokerage account but the leverage used creates useful context for what risk parity might look like with funds that we regularly use for blogging purposes. BSJR is a client holding. 

Portfolio 3 offers one way to build a leveraged portfolio thanks to NTSX' capital efficiency. NTSX leverages up such that a 67% weighting to it equals 100% into VBAIX so a 64% weighting to that fund gives Portfolio 3 a 57.3% weighting to equities and 74% in fixed income/fixed income substitutes. AQRIX used to be the AQR Risk Parity Fund and while the fund changed its name a while back it still incorporates much of the risk parity strategy. Portfolio 5 is a lot of risk parity with ROM to add a little more equity exposure in a capital efficient manner.

AQRIX as an exception here, but there hasn't been much in the way of crisis alpha with this idea. Portfolio 5 did go down less in 2022 but just a little less. I tried to equal out the volatility which is a little different than the risk. 

The way we've constructed risk parity, I'm not sure there's much value in trying to replicate it. There's nothing catastrophic here but not very additive either. 90% or 100% in any alt fund is really a bad idea. Ruling something out can be just as useful as ruling something in.

With the slightly longer timeframe of this one, the AQRIX/ROM combo is a little more compelling but still no element of crisis alpha. 

The Wall Street Journal took another look at college endowment portfolios including this chart.

You can hover over it to get exact numbers and yes, not all of them add up to 100. The averages are 57.7% to equity (public and private combined), 21.1% in hedge funds, 11.2% in real assets, 5.6% in bonds and 3.3% in cash. The averages add up to just shy of 100% for obvious reasons. Combining private and public equity makes this something a little easier to replicate and for the most part, the combined equity allocations are pretty close to a "normal" allocation that an individual might have. There are plenty of mutual funds that are hedge fund-ish with quite a few different strategies that offer differentiated return streams versus equities and bonds. 

There is an infinite number of ways to go with this. Where it could be useful and/or realistic is that most of these are heaviest in plain vanilla equities, I constructed them to not take interest rate risk, I split the hedge fund proxies into to two disparate strategies and EIPCX is new to the blog, it is a commodity fund that utilizes a futures curve strategy to minimize the detrimental effect of contango where possible and benefit from backwardation where possible. This means it should do better than something like DBC. The first few years that EIPCX traded, that wasn't really the outcome but lately it has had more success in this regard.  

Domestic equities have done much better than foreign for quite a while until this year, unless this year turns out to be an anomaly in a longer trend. Obviously if domestic does better going forward then Portfolio 1 would outperform the other two and if foreign outperforms, Portfolio 1 would lag. 

Portfolios 1, 2 and 3 offered real crisis alpha in 2022 but fared worse in both the 2020 Pandemic Crash and this year's Liberation Day Panic. I threw in 90% AQRIX/10% ROM from above for a little more context.

I think I'd describe 1, 2 and 3 as being valid, I think they could get the job done but not unusually robust along the lines of some other ideas we've played around with. 

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.