ReSolve Riffs: Risk Parity with RPAR ETF creators Alex Shahidi and Damien Bisserier

and i'm like are you guys uh sorry alex i missed it were you were you from there originally um yeah i grew up in orange county and i've been up and down the coast my whole life and uh kind of still up and down the coast try to stay just in case you know very cool i get that i was born uh on an island and and have always craved living close to the water though not the north atlantic so much but but certainly warm oceans and beaches um so okay we're live uh welcome everyone and welcome uh alex and damian uh so today we are speaking with alex shahidi and damian is it besserer the series yeah that's right the syria all right got it yep um i think as canadians were maybe a little bit better equipped to to to pronounce those names the french derived names but um so yeah the progenitors of the rpar etf of course that's not the entire story and we want to get a much more comprehensive view of both of your stories today i guess before we get going maybe our chief comedian and compliance officer uh can say a few words about what everyone should expect from this episode can i just have a sip of my alcohol yeah i'm drinking my red today did you guys uh did you guys get the memo that this was a drinking interview maybe uh at the very at the very last minute so i i don't actually have anything besides my coffee which is not as exciting you know you could have just lied and said there's whatever rum or whiskey i guess i could have said the west coast i guess there might be other things available other party favors you can't talk about um so all right mike take it away well just uh just a warning for everybody that we are going to discuss lots of topics they're very wide-ranging uh some of them may include investing topics and that you should take any advice that you receive from this particular uh venue and not use it in any way shape or form there is no advice as it were and that you should consult a professional in executing anything that you might find interesting from this conversation and uh with that let's roll well said so i mean obviously uh alex damian we have a shared interest in asset allocation particular risk parity so we're going to certainly talk about your new etf our par but i think we'd all like to know a little bit more about your respective careers and how they culminated in a partnership on this project uh sure damon you want to kick it off yours is a lot more interesting than mine um so i grew up in in la and uh then moved back east uh to go to college and worked in financial services spent most of my career actually at bridgewater it's a large hedge fund in connecticut and uh when i was at bridgewater i met alex he was actually one of our uh largest clients and and uh he was overseeing institutional consulting practice at merrill lynch uh probably the largest uh at the firm so he had some multi-billion dollar clients pension plans uh that were investors with bridgewater so um actually a funny story he uh he was in the office uh meeting with my boss ray dalio back in i think it was maybe 2009 and they had a good conversation and afterwards ray grabbed me in the hallway and he said that guy i was talking to he's got good common sense we should hire him which is not you know a little atypical after meeting someone for the first time for ray that was pretty high compliment and so i called up alex and i basically offered him the opportunity to move cross country because he was in los angeles and uh and so he basically said i you know can i move my you know can i do this from los angeles i was like i've been trying to convince ray of that for years it's not happening and uh and so he said well while we're on the topic would you ever consider working with me so that was when we when when we when we first started talking about you have some common sense that's yeah right there yeah so uh so yeah we talked about it for a number of years and then uh my wife and i decided to move back to uh la to start a family and that was back in 2014 so i left bridgewater and and alex and i started the business and what were you focused on in bridgewater i mean there's many roles that one takes there uh was it the risk parity side for you um well so um at bridgewater it's a lot of generalists so i mean there's obviously different departments so i started in research um i was in their investment associates program and then you have the opportunity to choose different paths and i and i really enjoyed working with clients so one of the unique aspects of bridgewater is that they put investment professionals in the seats of client relationship managers and the goal was to deepen the relationship beyond just uh the return stream we wanted to be a partner to our clients to help them think through their their strategic challenges like asset allocation and so all weather was kind of core or risk parity was kind of core to how we approached the a whole range of strategic issues related to asset allocation that was our philosophy around how you should allocate assets and so i was in that role of basically providing that advice and that um that strategic help to you know endowment cios and pension plan cios and those types of investors and alex is one of those so actually um he'll talk about his background but one of the first things that he did um after we introduced that philosophy to him was and this is an indication of the kind of person that alex is he his response was ah that's interesting let me let me do my own work on that and so he went back and did a bunch of research on the topic he ended up writing a book that was published by wiley the first book that i know of that really elaborates on that philosophy in any detail because he thought this was such a a wonderful thing that every investor should have access to that knowledge base and you know and actually was only available to a few institutional investors who would embrace the concept so um that's the thing i remember reviewing it before it came out it was uh read it a couple times just to round things off i mean we'd written a book that touched it but nothing as detailed as uh balanced risk is that what it's called balanced acid allocation allocation so how many electrodes did the average employee get hooked up to in bridgewater on a daily basis like what was it what was the routine there how many buttons were you pressing and telling you the well the button the buttons in the electrodes increased over time so when i joined it was 200 people ray hired me so there were no there were no electrodes there was just there was just ray in his watchtower you know and uh and uh and then over time you know you can't scale ray and so he he decided that you know the same way that he approached investing which was to systemize his investment thinking he wanted to systemize his management process and so that he could essentially build a management infrastructure that implemented the same type of management style that he was implementing on his own and so then then the electrodes came and all the other things came along with that interesting all right so alex why don't you give us your background uh sure i you know i grew up in california up and down the coast uh went to college in santa barbara and then went i went to law school in san francisco and while i was at law school the first thing i realized is i didn't want to be a lawyer and and so i i still went through i finished finished i graduated took the bar exam and a week later i started a merrill lynch as a financial advisor and and what's fun about that experience is you arrive and they say welcome here's a computer and here's a phone go get clients and it's a it's really interesting to do that when you're at the top of the market which is in the late 90s so my first three years in the business the market fell 50 um so it's not it's not the you know it's not the headwind you're hoping for when you're launching your career but what it did what it taught me is the value of protecting uh principle and and trying to achieve a steady return and so all those uh that that was kind of instilled in me early in my career um you know obviously i wasn't managing very much but it gives you the you realize how important it is to protect and then also the behavioral biases of people and you know this whole you know selling low and buying high and and so all of that was instilled early in my life and uh in my career so as i was a merrill lynch for 15 years um in 2014 i felt it was time to move to the next chapter uh damian and i have been talking for felt like almost 10 years you know we moved slow in our business and uh and you know all the stars aligned and it was time to leave and uh you know launch our own firm which we did in 2014 and uh i think within a month is when the book got published so i was working on that at the same time and since then we've been embracing this risk parity concept implementing it in client portfolios and always looking for ways to incrementally make improvements and the launch of the etf is kind of a continuation of that process and i think we'll probably talk about that but you know our mission is is keep improving the investment process and so all the resources that we that we bring in all the people we talk to we're always looking for the you know people who are smarter than us that's why i thought it was good for demon to join me he's you know he doubles our iq average and and so so if you keep doing that and you look forward 10 to 20 years your portfolios will be better than they are today so that's that you know that's the lifelong uh objective that we'll never get to uh you know the ultimate but we're always gonna get better that's that's you know that's who i am so currently today you manage um a private practice it's mostly high net worth is it also institutional is it a combination what does the practice look like it's a combination uh so we advise uh about 18 billion in assets um and it's for institutions and high net worth it's like 50 50 in terms of assets um and uh you know the portfolios are you know our goal is slow and steady wins the race and and you know that's that's the way we manage it so we've been talking first for several years mostly i think on the topic of risk parity so my understanding is that you have been employing a risk parity concept whether it was an allocation to all weather or your own internal risk parity formulation for a while how do you articulate it i mean are the people that listen to this to this podcast and and all of our other content i think are sick of hearing how we articulate it so i'm always curious to hear how other people think about it and describe it and make it understandable and approachable sure damon do you want to you want to start sure um so i'm going to take it a step back actually and talk about in our view how to build a great portfolio which i think is um you know this is very much an implementation of of how to do that um it but it's a limited implementation in the sense that it's just focused on things that are easily accessible so public markets and so so our view on a great portfolio is lots of individually attractive return streams let's say return streams that offer you equity like or better returns but that are reliably different from one another and that second part is the part that is probably the most underappreciated aspect of investment management the vast majority of portfolios are full of lots of line items that are very closely related to one another they're equity oriented line items and so they tend to go up and down together there isn't a lot of diversification reliable diversification in most client portfolios or most investor portfolios generally and so risk parity is our our attempt to look at what's available in the public markets and try to build something that is as consistent as possible by taking advantage of of those diversification benefits so that that's how i'd say and then we can get into the mechanics of risk parity but i think it's important to start there because it's just not how people think about investing when it actually in our view is very common sense so what are the fundamental assumptions for that inform a risk parity portfolio that are different from how many investors think about forming portfolios yeah i mean the i and a lot of the sounds uh intuitive but the way most people invest is they look for things that they think are going to go up over time and they look for things that they think are attractive returns and they just allocate to those and then if if those things are too risky then they'll own bonds or other things to control the risk and and so when you when you approach it from that framework you basically end up with a portfolio that has a lot of stocks and maybe high-yield bonds or corporate bonds because the the assumption is the expected return of those is higher than it is for you know you know higher quality bonds and so if you're a longer-term investor if you're more comfortable taking risk you should own more of those things and and if you're less comfortable or have other other concerns or needs you you own less and you scale up and down based on your risk profile so that's the way you know that's the return return expectations based yeah et cetera yeah exactly right that's that's a simple way to say it thank you okay so that's the way most people think the the challenge though is that is that if you follow that path you could end up with a portfolio that is not very balanced and and balance to us means i mean something that is not highly dependent on any single economic environment so so portfolio that is equity-centric or credit-centric will do well when the economy is doing well and it'll do poorly when the economy is doing poorly and it also is not the great inflation hedge so like in the 1970s it would have done really poorly and and what's really interesting is because most portfolios are positioned that way when bad times come and you lose money you look around and everybody you know has lost money too so it feels like that's the way it is and and we're all in this together we're down together everybody just hold on it's going to come back so that's the that's the philosophy but there is a better way and and it's and it's reliably better over the long run and and so but you have to you have to dismiss the traditional way of thinking the conventional wisdom um so so the way we think about it which is which is i think a different approach is is rooted in what demon described which is look for return streams that are attractive that are different from one another as opposed to what you just said which is focusing on just the returns and and what is really surprising is you can take these traditionally lower risk asset classes and you can scale them up to give you comparable return and risk so so i'll give you a couple data points which i think might surprise a lot of people so if you look at the last 50 years global stocks have earned eight to nine percent a year for 50 years long-term treasuries you know the the thing that nobody likes today has had about the same return for the last 50 years and and you think about uh philosophically conceptually how can that be how can a government guaranteed security have the same return as stocks which are really risky and it's because you're basically you can extend the duration and you can increase the risk so so stocks are have a higher return because the risk is higher and bonds have a lower return because the risk is lower but you can you can equalize them and you can do the same thing with things like gold or inflation linked bonds or commodities and and if you if your menu of choices isn't just you know high risk stocks and low-risk bonds if your menu is is a bunch of things that have similar returns and risk then your framework for building a portfolio is a lot more advanced and you can end up with a portfolio of asset classes that go up and down in different environments fairly reliably that have all have high expected returns and you end up with a lot less risk so that's that's the the way i think about it and the framework that that i hope makes sense the interesting thing about this conversation is that rodrigo and i get to play a role on the on the other side um asking i got 50 questions yeah that's right that that we hear all the time is challenges one of them of course a timely challenge is the fact that government bond rates are a fraction of what they were 30 or 40 years ago and so why should investors think that the next that the returns to bonds or the risk-adjusted returns to bonds rather over the next 10 20 30 50 years are likely to be similar to the risk adjuster returns on stocks how do you respond to that so so that's a question i've been getting for about 10 years right so so rates have been low for i mean rates have been falling for 40 years right you go to the early 80s and and you know 10 years ago they were too low they can't possibly go any lower nine months ago they were too low there's no way they can go any lower and look at where we are now right so so if you just look at u.s rates relative to the rest of the developed world they're actually high right so so they can certainly go lower uh so so that's point number one number two is rates falling has it has benefited bonds it's also benefited stocks it's benefited all asset classes and looking forward the expected return of all of them is lower right because when cash is you know i remember when i started in the late 90s cash was yielding six percent right so you could you could just buy cash and earn six percent and and you know in stocks you would expect a much higher return than that otherwise who would take the risk of stocks to to get something less but today cash is zero right and and over you know the last hundred years stocks about perform cash by four or five percent a year that's where you get those you know nine to 10 returns when cash is zero the expected return of stocks is low so so um you know the it's it's a challenging environment because cash is at such a low rate right so so then you know so the third point and i'll let damon jump in is that the real question you have to ask isn't whether rates are going to go up or down you have to ask what would cause that to happen right so so let's say you know we're looking at the next we're looking in the next 12 months if i told you that the economy was going to suffer a you know a devastating hit more so than what's already uh it's already happened there's a good chance rates are going to fall further and if you don't own that bond right you're going to you don't have the you don't have the balance in your portfolio and likewise if the economy does really well rates will probably rise and that bond will get hurt but your other assets will do well and and so you so rather than trying to guess because it's really hard to do that i think 2020 is a perfect example of the difficulty in predicting you know the markets and and even the economy um it's in our view it's better to be balanced and especially you know in today's environment yeah i think i use the example of what did german advisors say to their clients in 2015 when yields were 0.75 for the german bund right why what's the point of owning these they're only yielding 75 basis points who would own these who would own such things fast forward three years and if you held a portfolio of german buttons the 10-year you would have annualized that just under six percent right so these are this is the challenge is everybody i remember oh nine there's nowhere else to go but up in terms of yields and uh here we are today so right certainly it's easier i do think yeah but do you think you need to you need to make some adjustments though because if you know if you're holding just very short-term bonds there isn't much more room to fall and so one thing that we're conscious of is we want to make sure that in a downside growth scenario you're actually getting meaningful diversification from the bond portfolio that's the role of the of the treasury exposure is to provide a hedge to that downside growth scenario when equities are likely struggling and so one thing we have done is we've moved further out on the curve where there's a lot more room to fall so 30-year bonds in the u.s are 1.4 which doesn't sound like a whole lot but if we go the way of japan and europe which you know is a not an unreasonable assumption those rates could be much closer to zero and so that type of a rally with long-duration bonds would have a meaningful uh return impact on the portfolio and so that's one thing we've done is we've moved further out on the curve um and then the other thing that i think is relevant in this environment is we've also increased our exposure to gold right and so if you think about monetary policy traditionally it was to lower interest rates to stimulate the economy that is a tool that has minimal maybe no effectiveness at this point and so now the way that central banks manage their economies the way they stimulate is to print money and initially it was to print money and buy assets and now it's to print money and and uh and then turn around and have the government uh fiscally stimulate so it's a print and spend policy and so that environment i think gold in many ways has become a barometer for stimulus that's likely to come in a weaker growth environment and i think it it can function in that way as as a complement to the treasury exposure where you don't have any sort of upside cap on how high gold can go um and in this environment i think it's hard to envision a scenario over the next decade or two where you don't get a lot more printing from global central banks can i just go back to your first point on going up the um the maturity so in your implementation respiratory in lieu of levering up the bond portfolio you're going up the maturity curve so you're not you're not choosing to lever up the the short term cash rate yeah um is is there an advantage what is the advantage or disadvantage of of uh choosing to go up the maturity curve versus leveraging is there have you guys put any thought into that we have um i mean if you look historically the uh shorter term bonds have a higher sharpe ratio than the long-term bonds so so i guess on if you were to look at that narrowly and you say that the future is going to be like the past you'd say i'd rather lever up the shorter term bonds the challenge is of course that shorter-term bonds are offering you virtually no yield and um and i think there are also challenges with managing a higher degree of leverage in the strategy which you know also in a fortiac context that that also gets challenging so um so i think um as i think about the future because we're trying to manage this portfolio for the environment that we're in today um again we come back to this notion of why are the bonds in the portfolio they're they're in the portfolio obviously to deliver a return but also to provide outperformance in certain environments that are challenging for equities and namely a downside growth scenario and so in our view that 30-year bond offers you much more potential return because there's just physically you know for the same amount of duration at the 30-year point versus the 10-year or the 5-year point there's just so much more room for that rate to fall um that it's it's possible that you know you get better returns on a prospective basis from those bonds than you do from the shorter duration bonds which you know may not be able to get more you feel like you get more convexity from the 30 year than you would from the uh levering up the short end that's right okay so it almost becomes because that's another thing that i wanted to ask you guys about is the um the idea of disparities that you have balance across these different regimes right high growth low growth low inflation and yet empirically we see that when there is a big uh growth shock respiratory doesn't do so well so um one of the ways that you guys are looking into reducing that is by high convexity options on that bond side and and i guess increase the gold side as well that would that would definitely i mean the the question you really have to ask is if you get a downside growth surprise what's probably going to do well and that's the question you should always be asking so so let's say hypothetically the 10-year treasury is at zero um and you ask that question what's going to do well when when you know the economy experiences a downturn the 10-year is probably not going to move very much because it's maybe goes negative but it has limited room the 30-year has a lot more room and then you also you know in an environment where the fed can't lower rates anymore maybe they go negative but they're near the near the bottom they're probably going to print money and that's good for gold so so those are the i think if you ask yourself those questions without having to guess what's going to happen you know it's like an if then type of series of questions of downside growth upside growth downside inflation upside inflation what's probably going to do well and you just own those assets and you risk balance them that's how you get you know a solid portfolio can i push back just on that point i want to i want to i haven't thought it through really um is you said something that there isn't a lot of room with the forward guidance from the fed you know really make taking that zero bound out of the equation and allowing things to go negative can we truly say that there is less room um is it more of a politically it's untenable and therefore there's less room or is this a kind of a mathematical reality of some sort well i mean there's less room than it was 15 years ago right or 10 years ago or even one year ago so so yes you can go negative but there's limits you know at some point when you're when you're too negative people just hold the cash right then it's you just run out of room literally um and you're seeing some limits you know globally i think i think the lowest negative i've seen was negative 70 bits or 75 bips um so there is some lower bound we don't know exactly where it is you know maybe it's zero maybe it's slightly right now they're telling you we're never going to go zero but that may change in a crisis right so um so i think but but you are you're getting there uh we don't know exactly where the line is but we know we're a lot closer to it than we've ever been got it so one thing that i've always struggled a question i've always struggled to answer which comes up a lot especially in conversations with institutions so i'm actually really curious how you approach this problem but it's the question of capital market expectations for a risk parity portfolio um because it seems to me the intuition around the efficiency of the portfolio is relatively tight you're making very few assumptions yeah you've got a general efficiency or equilibrium model um to form the portfolio but then how do you approach the question of how much return you should expect to get per unit of risk right what is the slope of the capital market line after you form this portfolio damien you want to take that one sure um so it's interesting so you can go asset class by asset class so um you know with with regards to the the treasuries and the tips um you know there's there's both the yield but there's also rolling down the curve which is a which is an aspect of investing in bonds that people don't appreciate um but but you actually do get a an increase in valuation which is a portion of your return as rates come down as you essentially roll down the curve um and so even with negative real yields that's right that's right so so you know you could have yeah or negative nominal yields in the in you know in in europe you know you can get you can still get positive returns like if you you know so so anyway so that's a that's a little bit of a distinction and actually the way we allocate to treasuries here is we we use futures and so futures actually they're not the total return of bonds they're actually just the excess return of bonds so it really is just a function of how bonds do relative to cash um you know and that that ultimately determines your your return profile there um and so so so that's how i think about the bonds so we we think you can get close to equity like returns if you're holding them longer duration you use some leverage meaning it may not be literally levered so in the tips context we just hold more than we do in commodities and equities um and then the way we solve for that on the commodity side is that commodity futures i think there's an argument there around what is the return of commodity futures is there an excess return or risk premium and so we actually approach that differently we actually hold commodity producer equities where we're much more convicted in the risk premium you know historically there's been a very persistent risk premium in fact commodity equities over the last 50 years have outperformed traditional you know broadly diversified equities and so um so that's that's how we're generating a lot of the return there reliable return equity like return on the on the commodity side and the gold you can argue you know there's probably not a risk premium there but it's interesting if you look at the 50-year return of gold it's actually almost spot on the 50 return of equities so that's maybe an indication of how you know um you know what what it's like to have a fiat currency regime because it's basically since the end of of the of bretton woods and and and when we came off the gold standard but i think you can certainly imagine a scenario over the next 10 or 20 years where gold has a similarly attractive return profile because central banks are just printing and printing and printing so so we don't necessarily think there's a risk premium there but we do think there's a um an attractive return profile just by virtue of the supply of fiat currency increasing that could be quite competitive with equities and so when you when you get down to it we still think you're getting similar return contributions from the different components and then there's another piece here which i think is really underappreciated which is the rebalancing benefit so when you have a portfolio of low correlation line items and you're constantly buying the thing that underperformed and selling the thing that outperformed so you're you're buying low and selling high you do that over and over again the average return of the portfolio is actually higher than the average of the underlying components on a standalone basis and in a portfolio like this we've looked at this over long time frames it's about one percent of incremental return you get at the portfolio level relative to the average of the underlying returns and that's like what are you guys rebalancing in this implementation quarterly quarterly and then this is this this gets to another really interesting feature of etfs which is that you can do the rebalancing in etf without triggering any tax consequences and so so it's really powerful from a portfolio management perspective because you know i can tell you as a financial advisor we run into this all the time that you want to rebalance but you don't because things are appreciated and clients don't want a tax bill and so inevitably that people have a hard time selling high and buying low yeah yeah because you're telling them to buy the thing that just did terribly so yeah and so so in the context of etf we can do that programmatically but then importantly we can do that in a tax efficient way and so it's it adds incremental return to the portfolio and so that's why you know we think we have a good shot at being competitive with equities right sorry go ahead mike good i was just going to ask on that note so you've got sort of precious metals energy and non-energy commodities so you've you've decided that commodity exposure through the through the the sort of equity assets but as you say you don't necessarily have to anticipate a positive risk premium to benefit from an enhancement in the geometric mean of the portfolio if there's a rebalancing opportunity so did you ever think of was the limitation for commodities other than gold those that you are doing through the equity piece was was that ever a consideration was it a structural limitation of the etf that sort of steered you away from the the the sort of non-uh direct gold yeah the direct commodity exposure rather than the equity-based equity exposure um so the the equities have a couple of attractive features so i talked about one which is a higher expected return but obviously there's a negative that comes with that too which is that it's more equity-like um and so the way that we solve for that uh well actually i would say the other big positive that you have to factor in is there's a tax advantage to it so if you're gonna hold commodity futures you would have to do that in a way that utilizes derivatives you know most likely you'd have to hold that through a cayman subsidiary right you've got a blocker so there's and that's going to generate income that's going to generate income and there's nothing you can do to shield that income it's going to so if it goes up it's going to generate income for your portfolio and so that's that's far inferior to managing it in the context that i just described which is to basically defer all your capital gains so so that was a big piece of it as well um and then what we did was on the on the commodity side to solve for the negative that i mentioned which is that it's more related to the equity markets is we created our own basket which was as close to the underlying commodity price as we could get so so we redefined the commodity universe to just identify companies that were pulling it out of the ground essentially so we don't include refiners or even like steel makers because that is that is more you're taking iron ore as an input um and so in the mining and energy space it's very directly um related to those pulling it out of the ground and then agriculture is a trickier one because there's not as direct of a link so we we chose companies that were you know logically connected to the price of of crops and so you know it would be you know fertilizer companies or um or uh or a deer you know machinery agricultural machinery companies and but that's a smaller allocation than the other two and then we did include things like clean energy and water as well and clean energy i imagine might grow as a as a piece of this as fossil fuels become less utilized um but that's how we that's why we did it right right so securities rather than than energy sector etfs and correct yeah we actually created our own index um which also has a cost advantage so if we're using an etf we have to pay another layer of fees we hold it in the fund just on a direct basis it's less expensive and that's why when you look at the holdings you might be confused like why do they hold a bunch of resource stocks and then a bunch of etfs it's because for broad market exposure the vanguard etfs are very efficient and low cost but for tailored exposure it made more sense for us to build it ourselves right and so the basis risk that you experience but through the basis rescue experience through the through the proxy of the equity uh is overwhelmed by the fact you get these tax advantages um and all of these other sort of structural advantages in the etfs that that flow back to the investors which is a very thoughtful construction there's two more things actually so one is you can you can basically dissect a commodity equity into equity and commodities exposure right so so you can bake that into how you build your equity allocation so you don't get over allocated there so that's one component just just think of it as two and actually it's there's some leverage there too so that's efficient um so so it's not like a commodity equity exposure is 50 50 stocks and commodities it's more like 60 60 or 70 70. um and so you can bake that into how you build a portfolio and then the other piece is that we have a larger allocation to gold than you know then um then is probably typical in a lot of these risk parity strategies and part of it is related to gold helps hedge some of that equity risk that's embedded in the commodity producer equities it really does that that's actually a i think an uh maybe an unknown point that the the correspondence with gold and inflation is not as the correlation rather is not as great as the correlation between gold returns and volatility which seems to be a nice offset in that in that sense so now do you do so do you do the gold exposure via stocks or is that via both or the commodity how do you you may have covered that only the commodity yeah so only the commodity we just hold uh we we hold one of the grand tour trust uh etfs that give you exposure to the physical bullion okay yeah the other thing about gold is that is that you know we're always looking backwards and seeing what worked in the past and trying to formulate a portfolio looking forward but gold has a very interesting place today when you you know we have we've never had interest rates this low in the us and and we haven't had monetary policy like we have today where you've got a you know you had a trillion dollar deficit before covid and now you've got a multi-trillion dollar deficit after and you know with promises to keep it going as long as possible and so as part you know part of the idea is balance and you have to you can't just look at the past you have to consider that we're in very unique times and gold is one of those assets that you know it's been around thousands of years right it's a storehold of wealth and ultimately you're trying to achieve a return for clients that protects them in a terrible environment and gives them some upside and gold could do participate in both of those and you've seen that this year right it was up you know in the beginning when the market collapsed and it's up you know 20 plus percent year-to-date um so so that part of this is forward thinking as well i think adam you you want to say something no i mean i just wanted to i i know for sure that a good a good friend of ours uh dave cantor i wonder if he's listening is going to want me to press the point on how how you come up with capital market expectations and i know you started going down that path but i'd love to be able to close that loop because all right so so so okay so so what we do is we assume a similar sharpe ratio across assets so um we actually don't believe in cap m cap m doesn't actually reflect reality in any shape or form so so as a great example inflation index bonds have a negative beta the stock market but they do not have a negative excess return and so cap m depends on all of these assumptions that just don't hold in practice they it assumes that every investor has the same objective function it assumes everyone can leverage um you know you have it's just it's just not reality and so so this is i think the the reason why risk parity works is that people don't price for diversification benefits so theoretically at cap m the reason why the market portfolio is the efficient portfolio to hold in theory is that assets that offer you diversification benefits should have their price bid up to the point where they don't have any excess return or negative excess return but that's not the reality you know bonds of outperform stocks over the last 30 years you know so it doesn't so in in the in practice what we find is that assets actually give you a much more similar return relative to risk um uh and then would be implied by cap m and so maybe it's not perfect you know and nobody knows what it's actually going to be but in empirically that's what's been the case is that they all give you an excess return above cash and so we go into this assuming that we can get similar returns relative to risk for each asset class understanding that maybe in practice on a prospective basis bonds don't do quite as well that's okay because they have really powerful diversification properties and we're also picking up some return in the pre-balancing um and you know maybe gold you know you don't have a same argument for a risk premium but i think there are other logical arguments there for why there should be a positive expected return and that definitely doesn't fit cap m right um and so so that's that's how i'd answer that question directly okay as i look at as i look across the different asset classes i mean i in an effort to answer this recently i mean one thing that we can calculate a fairly high degree of certainty is the expected sharpe ratio on bonds because you've got to generally even a decent estimate of the roll yield you know the starting yield you know that there are really good simple formulas for forecasting expected bond returns over a horizon equal to twice the duration of the bond for a continuous contract um you sort of start there for a 30-year bond maybe you're looking at you know let's say the bond has a 15 ball it's expected return is 1.5 percent sorry yeah about 1.5 a year so you're looking at a sharp ratio of about 0.1 maybe less than that on it because if you want to sort of um build in excess returns so if yeah i mean it's probably a little higher than that like if you look at investing in long-term bonds in japan over the time like if you just look at if you started buying long-term bonds in japan after they fell below two percent it was literally the best sharp ratio on the planet of any asset you know because it's a steep curve that was controlled by the central bank you just roll down the curve every year and volatility actually was nowhere near what you're describing because they're intervening in their markets and so so that's the challenge of trying to to to use some sort of precision with this assessment we don't really know i think there's a you can make an argument that it's a terrible investment a lot of people say like this is the worst investment on the planet but then you have to think about okay in what scenarios are they are they thinking about and how would the other assets in the portfolio do in those scenarios and ultimately we're trying to construct something that's like a finely tuned engine right where there are components that would do well in any scenario you can envision and um and in treasuries like them or not is one of it has a very specific role and i don't think that you know even with low rates that role changes meaningfully i do i do give i would give on the point that i do think the expected return the sharp ratio is certainly lower than what we've experienced you know because you just don't have that tailwind of falling rates but it doesn't mean it's not attractive um and if you're in this sort of context you know deflationary type of environment that we're in today you know it could still be a great performing asset class we don't know keep in mind we i agree with you i think that we are big believers in the respiratory portfolio it's just getting a lot of the pushback we get is how do you what are the expected returns on this portfolio right so if we're expecting all of you the same uh diversification adjusted sharpe ratio right in the portfolio then you know if we know what that sharp ratio is then we've got the slope of that line and we can tell them give some sort of forecast about the expected return that they can get per unit of volatility so it's just what the slope of that line is at the moment i think is pertinent to institutions i mean it's it's funny because we talk to institutions and large investors and we talk to the principals at aqr for example we understand that you know this is a core their their risk parity strategy is a core holding for many of the principles that's very difficult to sell outside the firm institutions don't generally buy into it yeah major challenges is it's really hard to come up with capital market expectations and if you do come up with capital market expectations that are fundamentally aligned with the principles of the strategy then you end up having fairly low expectations at this time right so i just think it's it's it's very i do i agree i agree on the bond part you you probably have lower expectations than you did historically but you do have the same problem on the equity part i mean equities are historically high valuations so it's not like it's in isolation that the expensive problem exists it exists everywhere in every public market asset and every private market access to right that's that's the thing that's very difficult to get across or any investor right is that you're coming in with this as you said fine-tuned machine that it's trying what we say here is that it this is about preparation and it's not about prediction right and every everybody else in our industry is designed to think about prediction before preparation and that's a big problem especially in a period right now where you said look you got expensive bonds you got expensive equities and you know there's no point in investing in something that's going to consistently invest in those two things and equal risk like why on earth would i do that what if it goes to well it didn't it hasn't and but let's put put that push that aside why when is a period where both bonds and equities go down together it's a period of rising or unexpected inflationary shocks right was the last time we saw that in the 70s well what happened to that gold component in the 70s or a commodity component that tips component that had existed well it turns out that the returns for that asset class were way outside of expectations you know huge right tail event that tended to offset the losses of the other two so that your expected sharp ratio is within normal expectations of a well to the fine-tuned machine like respiratory so there is the hope here or if we think about this problem appropriately is that one of the components one or two of the components is going to have ridiculous positive returns when the other ones suffer but the problem that we all fall into is every time we think we know what the returns are going to be and what our worries are going to be next year we're always wrong right that's the whole point yeah so say listen you got to be okay with with losing money in two components and sticking to it because we have this other thing and not then have your committee say well why don't we just own a bunch of gold right now because maybe tomorrow it goes to like it's just it's a difficult conversation go back let's just rewind 12 months so if we were sitting here 12 months ago one one we wouldn't be on on on video right in person but two who would have predicted where we are just 12 months later not a single person on earth right that you know unemployment rate would quadruple in a couple months that you know the whole world would be on shut down i mean who would have possibly expected that right and then who would have expected that the market would go up during that time i mean good luck trying to figure these things out right and and so so you know i remember nine months ago very few people wanted to own you know long bonds or long tips i mean that was like that's what that you know it's a crazy thing to buy gold there were some people there were some gold bugs saying yeah gold is a good thing but you know hardly anybody expected to go up that much that fast so so it you know i think a lot of people and you look at you know what's on tv and the news it's all about predicting what's going to happen next everybody has a crystal ball if you actually you know honestly tested the accuracy of those they're very poor right not much better than satisfying i think i think and also collective memory and you know right and so and and obviously you know most people think they're good at it because they forget the things that they completely miss and you know only remember the things that they were right about um and and so it's what's what's shocking to me is after the experience we just went through that there's that you know people have aren't really understanding that these things are really hard to predict i think i think the the one thing that damien you said that that i wanted to come back to is this idea that we don't know the future sharp ratios right so so in 1980 to 2000 there was a pretty significant stagflationary set of assets in a risk parity portfolio that were a tremendous drag all the way until the bottom of oil at nine dollars a barrel in 1999 and gold at 200 there was a massive drag you're always going to have something in the portfolio killing it and you're always going to have something killing you right the point is that you want to keep those bets in balance harvest all that risk premium and you just don't know that future sharp ratio that's right and so we the sharp ratio of gold for the next 20 years could be two and a half we don't know right we don't know so this is what i always say to people right this is and you know i have this back and forth with all the consultants all the time well what capital market expectations should i should i declare for my pension client for this portfolio that you're recommending that their actuaries need to stamp right so this is why i keep pressing this point because i keep saying i have no idea i could tell you i i i think that this is the most efficient portfolio but i cannot tell you with any reliability what the expected sharp ratio on this portfolio is and this is somehow unsatisfying so this is why i keep pressing the point yeah yeah well i think you can take a pretty simplified approach um which is just to say the return you expect from assets is the return of cash plus an excess return and so cash is easy right we know what that is and uh and then the excess return is going to be a function of the sharp ratio and again we don't know what it's going to be but it's probably positive you know for capitalism to work you need to assume you can get a better return by taking risk otherwise you're just going to leave your money in the bank and so central banks are very clear about their mission to to avoid that scenario it might happen for short periods of time which is by the way one of the scenarios where where this underperforms um because that's when all assets fall is when people want cash discount right the discounts changes that's right um and so but but over time you know they're they have to engineer a situation where you get positive excess returns and we don't know what those excess returns are going to be it's not that important you're not all that dependent on how you know because one's probably going to shoot the lights out and one's going to do terribly and you don't know which is which and if you're if you have your if you basically spread your bets you don't worry about it right and then and then you also as i said earlier i would not discount this rebalancing benefit it makes a big difference and then i'm much more convicted that that's beneficial to you i know that that works relative to you know the sharpe ratio um because again i it comes down to the structural diversification here these assets are different not because of a correlation we measured but because the way they're constructed they have very reliable outcomes in different economic environments you know when they're structurally yeah they're structurally connected to the economy in ways that causes them to act in these ways right that's right you keep going yeah and so one of the really interesting thing is when when you concentrate on one asset class you subject yourself to these very prolonged periods of underperformance that are devastating we should just end it there and on that point no so just for those listeners um we've had we got a freeze frame here i bet alex can uh can pick up where yeah so rather than rather than taking the risk of going through a lost decade you can you know diversify across things that you you know are very unlikely to all do poorly at the same time but from a rebalance seventies in perspective right the 70s stagflationary perspective if you're in a balanced portfolio you experienced basically a 20-year period where you just didn't have any positive returns now now add-on decumulation as baby boomers are de-accumulating their savings this is amplified dramatically uh in taking a bet on any one specific economic regime uh manifesting through stocks and bonds yeah yeah i want to go back to the rebalancing premium i think you wanted to finish up is that this idea that you you don't get that premium when you're focused on a single asset class right and i think a lot of the reasons as to why people don't don't even talk about it is because when they're thinking about rebalancing premium they're thinking about rebalancing across 500 equities right is there any rebalancing benefit across 500 well no a little bit and correlated right it's it's proportion it's proportional to the correlation so the lower the correlation and the more volatile the assets the higher the benefit exactly so if you have created i mean adam is is about to publish something on this but if you've created out of all the portfolios you can create with public markets right the one that provides the highest level of rebalancing premium is the one that that structurally creates the biggest distance between those assets that you create so if you can find if if elon musk goes to mars and creates a colony that's completely non-correlated to the i want to have that part of my portfolio because it will allow me to have even a higher rebalancing premium that's that's exactly right people ask one of the things that people ask all the times like why would i invest in risk parity because it's going to have no returns you got bonds not you got well let's assume that that's true and that gold isn't going to do anything the rebalancing premium alone will hedge a lot of that risk yeah yeah and it's it's something that needs to be discussed here that you guys came to the one because i get one percent as well on um the portfolio in general that you guys constructed um what is interesting is if you add more granularity within some of the asset classes that you can get to more bets and the rebalancing premium per unit of volatility is a function of the number of bets that you are able to extract from the portfolio there's a bit of a trade-off because you've got to get have a little bit more commodity exposure in there in order to get some of those other bets so you maybe are ejecting assets with a slightly lower expected premium but on the flip side you're able to extract a higher rebalancing bonus so for example if i look at a permanent portfolio that's just you know basically uh stocks uh bonds gold and cash then at about a ten percent ball i get maybe a one or one and a quarter percent rebalancing premium but if i if i create the most diversified portfolio of 65 or 70 different um futures markets across a bunch of different equity indices bond indices and a wide variety of commodities i get up into i can almost double the number of bets and i get up into the sort of two and a half to three percent a year in this rebalancing bonus at the same level of volatility yeah but again there's trade-offs there as well but it i do think that this volatility premium is is profoundly underappreciated and what's so great about it is just it's a mathematical um it's not a certainty there's an error term there but the mean of that is is actually a lot higher than anybody expects and if you if you do it properly that even if the underlying assets deliver a near zero real return over the next five or ten years the rebalancing premium if you do it properly may take that excess return up to the two or three percent range yeah can i and i know we only have damien for five more minutes or so and there's two questions that i really want to have hit one is what role do currencies play as a as a as another asset class in a risk parity framework and two is and i know corey hofstein is going to want to ask this who's paying this rebalancing dividend or bonus is it is it that we're transporting liquidity across these um these asset buckets and as we transport liquidity we take it from where we have liquidity and the market doesn't so we get some equity premium or some risk premium for that um who's absorbing it who's paying it like what what are your thoughts on on those so two things before damien has to go that's the second question is a really good one i actually don't know if i have an answer but i'll try to think through it make one up just make one up you're credible you can answer that when i have a second question after you answer the first one sorry what was the first question maybe i think that was just what role currencies oh yeah so currency um so you can think of currency it doesn't generally have an expected return you know it's a it's a relative price between two economic um regimes uh in the form of an exchange rate and so because it doesn't have an expected return it's incremental risk for the portfolio even though it's uncorrelated so in general you know you probably don't want too much currency because it introduces an uncompensated risk at the same time you have to think about the objective of wealth preservation and ensuring that you have exposure to assets that can preserve wealth in a dollar collapse because again we want to generate as consistent of a return as possible and we don't want to be overly influenced by the the problems in one economy and so we do have exposure to non-us assets in pretty large size in this portfolio gold is a 17 and a half percent allocation that's a that essentially is a another currency it's non-us non-us dollar currency um we also have of the 25 in equities half of that is globe is is non-u.s so it's em and developed non-us and then we also have a component of the commodity producer equities that are international as well so when you when you add all that up you probably have you know 40 of the portfolio and non-us equities and then if you broadly define commodities as another you know way of preserving you know real returns then you know maybe that bumps up to 45 so it's it's a pretty meaningful portion of the portfolio so so here's a question i want to i want to ask wait wait wait so i want to hear the rebalance premium expected so i don't know where the bonus comes from i want to hear the speculation sorry sorry rod yeah um so i mean look it exists because there's mean reversion in assets um who who pays for that i'm not exactly sure i mean i think probably you have um some element of just overreaction to things um and so maybe you know investors through just behavioral biases you know essentially pay that um but i'm not exactly sure you know why this exists like what's amazing is that it actually exists in a weiner process so you don't even need you know uh specifically mean reverting pressure that's true that's true it's it's more of a mechanical thing which is why i've never thought of it as a premium right really i mean we always talk in risk period about the two axes right the growth and the inflation shocks but we rarely talk about liquidity shocks and it seems to me that risk period does really significantly better when there's positive liquidity and there's a lot of money going into everything and then during acute growth shocks there is a point like it like you saw it this year respiratory held in there held and they're held in there it was cold and treasures were going up and then all of a sudden in three days everybody just said i want cash and the liquidity dried up you saw this cap laid down and so we've had a bunch of speakers on on our circuit here that are they say there's only one asset class in its volatility and yet in risk parity we only talk about volatility as an asset class um is there room for some sort of volatility uh allocation some sort of tail protection or if not how do you guys think about this issue yeah i mean the challenge is you don't have an expected return right you start throwing things in there that don't have an expected return and over time or a negative expected return actually because you're paying a premium yeah it's insurance as a cost so so so the way we think about it is if you can if so set that aside if you can build a portfolio that is has assets that are biased to do on different environments such that there it's hard imagine environment where you have sustained losses and you know significant drawdown it might be for a short period where there's a liquidity squeeze and that's hard to protect against as you mentioned because cash out performs all assets so as long as you can protect against a material downturn then you don't need to pay the insurance right so so you know you you're basically self-insuring without paying that extra extra premium and you know maybe that including that will help on the downside but you're going to give up over the long run so that's that's the trade-off right that's the that's the that's how you get the premium you need to pay right that's right access return yeah so that's that's a really that's a really that's a really important point which is for anyone who's thinking about embracing this concept it's not riskless there's risk here what we what we do is we try to mitigate the risks to the things that we can mitigate which is big shifts in economic environments we can mitigate that risk by designing the portfolio in a better way what we cannot protect against is these type of tight liquidity environments which can be either caused by the central bank tightening faster than expected that's like a 94 example a 79 example a 2018 example uh 2000 um yeah 2018 examples there's a few of them the 2013 was a big one because of the temper tantra taper tantrum that uh bernanke uh kicked off and and so those are environments where a balanced collection of assets will underperform because there's this headwind of tightening liquidity there's also so those are the ones that are sort of central bank engineered and then there are the panics selling environments that you reference so march was a perfect example 2008 was a good example now the the reason why we're okay with that risk i mean one we have to be because that's just the risk of investing in markets in a lot of those scenarios that i described particularly the panic selling scenarios you're going to be better off in a balanced portfolio because at least there are some things that are going to hold in there like treasuries then you would be in a more conventional equity-oriented portfolio but then more importantly these environments tend to be short-lived because central banks cannot allow them to exist you know they will respond and they will do that by any means necessary to avoid that scenario because it's devastating it will destroy the social fabric of the country if you allow that to persist and so um it's because capitalism doesn't work in that environment and so um so we're comfortable with that risk because we know it's going to be short-lived it will it will be painful for some period of time but it'll be short-lived and the thing you get with risk parity that i think is the is the biggest takeaway that i want people to think about is that you don't get well i think it's very unlikely you will see bad decades and the reason for that is that um you can have any single asset class dislocate for a decade you had that the the equities were negative for for the the duration of the 2000s for over a decade and it's because you came into the 2000s with these wildly optimistic assumptions of what the future was going to be coming out of the tech bubble and then what you actually got was the slowest rate of growth since the great depression so that disconnect of what was priced in to start and then what actually happened was devastating for equities to the point that they were negative for a decade and and yet if you look at a balanced portfolio like this you wouldn't notice any difference between the 2000s or the 2010s or the two or the 1990s and it's because you had assets in there that were in bull markets bonds were in bull markets commodities were in bull markets and so so that's the benefit and when you think about having liabilities or trying to save for retirement or whatever your objectives are you can afford a bad year you cannot afford a bad decade precisely and and even though everybody likes to talk on tv about what's going to happen nobody really knows we've established that and so that's why we're so convicted in this strategy which which we believe should be the core of every investor's portfolio this is how you should hold assets because you can avoid in most scenarios a bad decade and that and that and that makes sure that you can achieve your long-term objectives start start here this is the do no harm portfolio if you want to have tilts and bets then you would bet against this portfolio because you feel you have some edge or advantage to predict the future but you start here you don't start with well i'm not going to own any bonds because i think this if you're going to do that if you're going to try to make alphabets then be honest about your ability to successfully achieve that handicap don't mask it behind beta and thoughts yeah yeah i'm here um i was curious i mean we talked about how we all agree that risk parity is a logical core for a long-term portfolio and i'm just wondering what are some of this i know that that's you you practice what you preach there but but what are some of the satellites that you consider and how do you think about allocating to the sort of alpha sleeves um well there's also other beta sleeves so you can own real estate um you know there are other asset classes that are that are diversifying to what's in a core risk parity portfolio but basically you're looking for other return streams that are that are different so so you know one thing we look for are market neutral hedge funds um because you know you we call them hedge funds at hedge you know most of them don't they basically go up and down with stocks and and if you can find some that are that are truly uncorrelated you know whether in market neutral or they're market neutral over time that can be additive because it's low correlated attractive returns and you put them together that obviously gives you similar return you get a rebalancing benefit there too um with less risk and and and also private assets i think they're if you start navigating towards less efficient markets there's more alpha potential there obviously you have to think of it neta fees and if you're you know a taxable investor net of taxes which is a high hurdle but but those are areas where you can try to uh what do you what do you think what do you think alex about about so we we've established hey we've got risk parity is our this is our this is our do no harm portfolio we have these events that occur from shocks what about a tail protection strategy as an adjunct this is going to be non-correlated it's going to have a different series of returns what do you think about that as a as an adjunct to the the risk parity type solution yeah the the challenge with that is as we mentioned before it has a negative expected return okay so so you're so basically where you're trading off is uh risk for reduced return so you're basically scaling down a little bit um if you're what i think is a better approach is to start with risk parity add less correlated returns and if you do it well you can actually achieve a total portfolio that has relatively low risk if you execute on that where you don't need to add those tail hedges so so basically you can self-insure without experiencing a negative return you know addition to the portfolio apologies on the call who are going to be grinding their teeth at this well i mean there's there's an assumption the the assumption first is there's a drag uh the other thing is in those moments where you could rebalance to assets you get a shock the risperity shock happens you have a tail event that allows you to rebalance back to that it really is a function of the drag yeah the lack of the lack of diversification the opportunity to get more assets into long-term growth assets and a risk parity framework so there's there's a couple of assumptions that you have to make they're all valid you know a lot a lot of the folks that we talk to do a lot of work in order to you know sort of minimize the drag um in order to have that optimality and that moment of failure when everyone's going to be calling you right you have your your your hey everyone's going to call me so i might think of that as a way to hedge some of those calls you've got something in your portfolio doing well everybody calm down and relax anyway yeah i mean you also have any whatever your strategy is you have to factor in the behavioral biases that we know correct right and and you know when we you could just take any fund uh that's been around a long time and you look at its time rate of return versus its dollar weighted return and in most cases the dollar way to return is a few percentage points below the time rate of return meaning people you know buy buy high and sell low over and over and over again so one of the issues that i've seen with tail risk hedging strategies is they're very popular after a bad event and they they you know their their the optimism towards those fades as the bad times fall further in the reverie mirror so so that's i think we can't as humans we can't ignore that we have this natural bias and and so you have to factor that in on top of just the the math equations yeah you're speaking of tail sorry adam you've also got the positive tail right so you've got risk parity and if you have a period like we've had with u.s equities or nasdaq if someone has that proclivity from a behavioral aspect right you might say just hey just buy that buy that thing so that we can hedge your behavioral bias with a particular asset that satiates that yeah the the the vast majority is going to be a risk parity construction and oh you know here's some other things around the around the edges private equity and whatnot anyway sorry go ahead well no i mean i was just going to you mentioned private equity real estate market neutral hedge funds i'm sure there's other alpha sleeves um am i right in assuming that you think about allocations to those in the context of risk parity as well um so they're just other sleeves that you're you want to add to a broader conceptualization of the risk parity portfolio and then somebody asked um which i think is a a good question uh how do you how do you think about risk in the context of you know building a risk parity portfolio but when you're also allocating to private assets that don't have the same sort of pricing frequency for example yeah the way i would describe it is the framework is you want a bunch of returns that are attractive and low correlated to one another and you can really break it up into three three categories there's public markets right which we think of risk parity there's private markets right and and those are they come as a package of alpha and beta right so so those are typically together um and and so you want to think about what your your equity exposure is within those you know beyond what the numbers show right you just need to understand fundamentally how where the returns come from so you have public assets private assets and then you have what we call hedge funds at hedge and which which should be uncorrelated because if you have a fund if you have a hedge fund that is highly quarterly equities you're paying a lot of fees and it's tax inefficient and you have bad terms for something you already get right so so if you look across those things and you're really thinking about your exposures from a from a kind of a high level of what is my exposure you know and what environment will this hedge fund do poorly and environment will do well if it's truly uncorrelated it's that's totally different from equities right it could be down when equities are down it could be up when they're down you don't really know but that's diversifying and then the private assets the less correlated they are the better right and so so i think the framework is just thinking about it from a risk parity framework from the top down which is things that are uncorrelated to one another are low correlated to one another and just don't over expose yourself so just to put a pin in that for example real estate you would look at the real estate or reits or read portfolio or a private real estate portfolio and you'd say well the um the loan to equity ratio is whatever uh 30 or 40 and therefore you've got a short bond uh portion of that real estate portfolio and the beta of the real estate to equities is whatever 0.4.5 and you would you would seek to sort of neutralize or account for those relative betas in the broader context of the portfolio to preserve that risk parity spirit even though you know that you don't have precision but you want to approximate that in general yeah and and the way i would describe it is one step further so zoom out a little bit more which is in what environment is that real estate going to do well and in what environment is it going to do poorly even even setting aside the beta exposure even the short bond exposure it's it's that asset that you own what is its bias to the economic environment and so you put that into that bucket and then you add up all the buckets for all the assets and then alpha is separate from that and then you just see what your exposure is yeah not like that is there any um speaking of just leverage and how high you might target the volatility of risk parity strategies where's the where's the limit where does that where does it kind of move from you know sort of signal to noise or just fall apart where does that the fraying around the sort of working closer you know there's at this point where the arithmetic means can converge the geometric and then they and then they any any insight into that also the more the more vol you have the the bigger the difference between the time rate of return and the dollar weight of return right because volatility is the more volatile something is the harder it is to hold on so so i think you're trying to optimize because ultimately investors earn their dollar weighted return that that's the actual dollar and so if you have too much volatility theoretically it might make sense especially when you can borrow at near zero uh it might theoretically make sense but investors can't hold on so so to us the way we think about it is how much can people hold on you know at what ball level can people hold on so the way we've structured it is it has something like 60 40 expected volatility um and you know equity plus type returns which which i think is something that most people can hold on to now we're you know thinking about well maybe we can come up with another version as a little bit higher volatility we have some limitations um and especially when you can borrow you know what's interesting we talk about all these asset classes being expensive the one asset class that is actually really cheap is cash right yeah if you can borrow near zero and lever up you know this is what the fed wants they want they're telling you cash is going to be zero for a long time we're going to keep it there we might make a negative i mean we want you to take we don't we want you to take the cash and borrow or or spend or you know buy things don't hold cash so so if you don't want to fight the fed one thing you can do is borrow but you don't want to overdo it right so so if you can do it in a responsible way and responsible has to factor in what investors are likely to do yeah and what what do you think the um there was an earlier question what do you think about it in the number of non uncorrelated bets that you can create in a portfolio or is it sort of you've got structural sort of the viewpoint so there's four there's five or there's three like obviously if we could all get 20 uncorrelated bets streams would be great what do you think there actually are are there new ones coming is bitcoin won when would you when would you think an asset class might cross the um cross the chasm to you know frontier um to being included in any thoughts that was a lot of questions i'm sorry just answer the first five the yeah the last big one was tips and i was you know these things moved slow and that was you know 20 plus years ago um you know the i saw a question earlier which is how many uncorrelated bets are there right asset classes you're limited they're not really even uncorrelated they might be uncorrelated over time but they may be correlated for a decade at a time right so so finding these uncorrelated assets is a lot harder to do than than to you know might seem um you know so i i would think of it as you know if environment a transpires what's likely to do well and and so when we do that go through that process we get to you know four or five if you think of gold as a separate asset class versus commodities maybe real estate could fit in there um you know and then you're starting to move into alternative asset classes that are not as maybe not as liquid not as well understood not have hasn't been around long enough but we're always looking right but you need a you need a positive risk premium right you want some liquidity you want some history um and you want the a clear economic bias and that just takes a long time to collect all that data for sure well it takes a long time for the structural sort of implications of that of an asset class like you think about tips right so you have to government has to manufacture them they have to start trading there's all the infrastructure that's involved with trading and right and so there's a lot there's a lot to that um from that perspective so yeah but if you can jump in early you can actually benefit so tips for example since their inception their sharp ratio blows everything else away i mean they they've actually outperformed stocks since they came out by a few percentages a year i think that is why what's unique about tips that make them that has made them um work as well as they have i think part of it is they're widely misunderstood you know it's it's really interesting when you see how they behave oftentimes it's not what you expect initially and then they behave exactly as you expect um there's obviously there's less liquidity there than in treasuries and that liquidity has been been increasing and i would suspect there'd be more issuance there you know obviously limited history so investors take a long time before they they buy so maybe the first 10 years it did exceptionally well obviously you had falling real yields during you know its inception uh so that's helped but but what's remarkable is you've had such great returns and tips without inflation right inflation actually has been falling um which gives which gives you a sense of how well it could actually do especially if we live in a world of negative real yields for an extended period well in your book you mentioned you exact tips into into you know them being a hybrid between inflation protection and growth shocks right so it's kind of like a little bit of a 10-year treasury and a little bit of a gold but it's actually more directly correlated well it's directly correlated to the cpi yeah and so it's ideal place when there is a growth negative growth shock and pot and positive inflation shock right that's when they kind of will do better than either of them yeah which is the exact opposite of equities so if you if you told me hey you you only have two assets to build a diversified portfolio you can just buy equities and tips yeah because because their their bias is the exact opposite um and in like a perfect example is in 1970s right that we didn't have tips at the time but that probably would have rivaled gold gold earned 30 a year for 10 years right up there i actually think that's the reason why why risk parity gets such a bad name i think that people may have heard somebody say look a good respiratory portfolio some tips and some equities and then they they just hear bonds and equities and then they say well seventies are correlated to each other right um you know it's just it's amazing how pervasive that view that that's just those two asset classes is yeah in in your in your rounds of talking about respiratory uh how often do you have to deal with that objection and disabuse people of that um quite often the the other part of that that is um pretty interesting is there's a i think an over focus on correlation so people will say oh the correlation of you know x and y were high recently and you're assuming that they're going to be low and so that that you have a failed assumption there and it's not about correlation because you know you can take any two asset classes and they could all go through periods of high correlation or even negative correlation it's about the economic bias you know so so you just look at stocks and bonds right in the 80s and 90s they were highly correlated right because because you had falling inflation and they're both biased to do well in that environment and in the 70s they were highly correlated because you had rising inflation but in periods where where it's growth that's really moving like the 2000s you know that's that was the real driver inflation didn't really move very much but growth was all over the place the correlation was negative right so so correlation is just the manifestation of the environment right and so i think there's an over focus on such a good point on the specific numbers you have to think about the the economic bias and that and most people don't think in that framework it's kind of the relationships that manifest over much longer time periods than this sort of oh there was correlation for 10 years no no and you don't even have to know the correlation in the short like just know that they're sort of generally not correlated in the longer term right all the error terms that are happening in the short term they're going to kind of offset and they're going to do some funky stuff yeah but you like that's one of the things you're right people will be very precise about oh well they're correlated or not over a decade or five years and i just like can't hit you know hand to forehead i'm like right with all this computer power there's there's an a sense of obligation of trying to fine-tune the machine right like the market is so peculiar because when you try to fine-tune it it'll it'll literally work against you because because that's how it prices right it discounts what the inputs are right discounts what people what the consensus view is um and and so it's it's you're much better off zooming out and forgetting the details and forgetting the noise and just looking at the fundamental relationships that you know are true even without being you know even without studying the data you just know that you know if the economy weakens rates will fall and it's because of what the fed's going to do there's these these natural relationships that are far more reliable than trying to guess what the sharpe ratio is or what the expected return is or the expected risk or the correlation you know all the inputs into an optimizer right there there's you're trying to create precision out of something that's not precise right very interesting one other question that often comes up is when the people you know the concept of respiratory equal wrist balance everything we discussed would kind of all make sense but there are definitely two major ways of implementing risk parity that have been created the the pro cyclical and the counter cyclical right the pro cyclical one being that you're you're creating a risk parity portfolio and you're constantly measuring the volatility of that portfolio and either increasing or decreasing your exposure in order to hit a target and kind of the bridgewater approach which is listen we expect these relationships um these these are structural relationships across these asset classes and we're going to create weightings based on those structural relationships um how do you think about that problem what is the way that you guys uh prefer to implement yeah we're we we don't assume we can be precise about these things right so so part of and and i think this goes back to what i just said which is this um this objective of trying to be more precise so a lot of funds what they do is they try to target a certain volatility right and there's maybe too much science in this where there and basically the way it ends up is when market volatility is low they have more leverage and when market volatility is high they have less leverage because they're trying to target a certain volatility because that's the their perspective is that's what risk parity is supposed to do and the challenge there is you can get whipsawed and it happens all the time because often times periods of low volatility are followed by periods of high volatility and vice versa and and if you're trying to fine-tune that way that we saw this this year a lot of these funds lost a lot on the downturn cut their leverage at the near the lows and then didn't rebound as much and you know our our little etf that isn't very active and it just holds you know 20 leverage all the time it was down four percent in q1 and is up 10 now and there's nothing fancy about it there's no trying to fine-tune and and target volatility we just know what these relationships are over time and we just hold it it's actually very simple when when i when i look through the um because you guys you guys published the index right it's the advanced research institute risk parity index um which is great because it provides some um ability for analysis and a good sort of uh illustration of what one might expect in general in terms of the character of risk parity strategy um but one thing that did stand out as i as i just did a quick uh poke around it at the index was that it does seem to have a rather high strategic beta to treasury risk higher than what we observe in some of the other indices and i'm just wondering is that strategic and i mean like going all the way back right so you can look at a rolling basis or you can look at it on an average basis but certainly it does have a very and i obviously that that was very very helpful in the more recent episode where having a larger allocation of fixed income obviously was was very useful um so what are the risks and and benefits in your mind to having that larger strategic beta together so i think it's a little misleading so the exposure there is very similar to the etf and then the reason there's a difference in in market value is because in the index we're just buying 10-year treasuries whereas in the etf it's 10s and 30s so so that's limitations with the index and having a long track record because it's back tested to 98. so that's why it's there but the duration exposure is very similar in the etf so so so it is risk balanced it's not it just looks that way because of the allocation it's just lower um it's a little bit shorter duration than the etf right sure okay yep makes sense all right good well look we're we're in an hour and a half almost uh that's what we've only got five more questions this is fun you do this every friday this is yeah yeah we'll have you back on too yeah it's a lot of fun and we'll definitely have you back on because i i want to i want to know what mike's five questions are great thing i i say i actually have them i'm just want to save them i asked them you had them i did well that was the first set of five that's a five five six of five it's the the conversations are usually more contentious too i mean we we we've been racking our brain about how to like poke and prod on a subject that we're all in violent agreement on um but uh if everybody was not for the rest of it do you guys have another half hour that's right oh it's been it's been helpful though to to understand how um how you and your group cross the rubicon help people understand uh we are always struggling with that you know the discussion we've had so many times with you know the idea of treasuries and you know risk parodies lever bonds and uh you know it's sort of like saying hey risk parodies is lever gold in in 1980 it's just it's it's it's not it's an eye view and uh but it's really hard to get people over it and and i think i you know i'd love to and the next time we we get together i want to want to hear more about how you get how do you well i wouldn't mind knowing now actually because we have two minutes before an hour yeah but how do you get the how do you get that you know so adam was poking and prodding on this earlier but how do you get the institutional client over the hurdle on this or is it that they've come over the hurdle already and so they're looking for expertise and they they're ready to buy or do you ever convert them are they kind of like you know real estate investors trying to convert them to public markets this is never going to happen yeah i mean it's easier to convert people their thinking when it's doing well than when it's doing poorly right so let's start there okay so people are more open things that are doing well yeah that has launched something like this at the right time that i've ever met congrats yeah i mean normally when you launch an etf before a global pandemic that's not a good time right it's like starting business before like you open a restaurant january it's probably not the best you're gold right but in this case you know you have this philosophy of how things are supposed to work and then you've got this the real life stress test in both scenarios not just the downside scenario but in the upside scenario right and then and then the turn which timing that turn is nearly impossible right so and let alone predicting it um so you got it you actually got the test on both sides so so that that helps obviously so when you tell the story with that backdrop you know you get a lot of nodding of heads so so i think you have to think of it a in an environment where that's not happening and and how do you convince people um so i think the the first thing is is the way people are trained to think about investments is i think environment a is going to transpire therefore i want to own acid a right as opposed to i don't really know what the environment is going to be and and i need to recognize that if it's environment a acid a is the thing to own if it's environment b then acid b is the one to own if it's c then and recognizing that you don't know what the environment is going to be and part of that that that bridge is understanding that if if your view of what the future looks like is a consensus view that's not insightful because that's already in the price so not only you have to guess what's going to happen you have to guess relative to what's already discounted so so those are the steps so that's like you go from a to b to c and if you can make that connection that logical connection then they recognize wow i really don't know what's going to happen relative to the price and if i don't know and and i know that if if a happens it's good for a if b happens it's good for b then you start you basically get them to tell you how they should invest without you telling them the way to do it okay but that's let's let's talk about that a little bit right because i think i am genuinely curious as to whether it's people coming to you that have already been converted or if you've ever actually been able to convert anybody because if you're dealing with institutions yep cio's job is to pick winners and drop losers whether that is from a security selection perspective or from a strategy selection objective or from future assumptions of returns in asset allocation their job is that and you're coming in there and saying let's go to the point a then point b and then point c do you see how you've been useless everything you've done up to this point has been wrong are you with me so far just disparity so i just i i've never been able to convince anybody that hasn't completely lost faith in their abilities i mean and you need to get got people from like the depths of hell when they've they're done they've never been able to get it right they had finally admitted they're responding they get fired yeah um so so the short answer is yes been able to convert people a lot of it is from the book that's actually one of the reasons i wrote the book because i spent so much time explaining the concepts that i said you know what i should just write this down and somebody who's really interested read the book and then let's talk okay and and so that helps when you when you invest the time to go through it and see the data and all that you're much more likely to to you know for the light to turn on than a short conversation and then and then the other thing is is the big key is recognizing the relationships of environment a and acid a environment b and acid b because those those relationships happen even over shorter periods of time right you get a small downturn and you know qf q4 and 18 and you can see what the assets do and so that that logic gets embedded in your brain you view the markets and now you're thinking from that framework and you see it happening and that builds confidence over time even if you haven't invested yourself but you start to see the relationships it's kind of like it's like the matrix right you you're you're kind of in that zone and you can see these things that kind of move in slow motion and then it reinforces the the belief and then that leads you down that path the the other interesting because oh no you have another point about it is you don't have to go from i know the future to i have no idea right there's a middle ground which is i think i do but i'm not going to always be right so maybe my hit rate is 60 or 70 if you're over confident and and so in that environment or in that in that framework maybe risk parity is your core and maybe your neutral portfolio right and then you tilt around it and the more confidence you have your ability to tilt either yourself or by hiring active managers then you then you have less risk parity and more of the other things and the less confident you are you have more risk parity but to not have it at all is making a huge assumption that there's no way you can you can uh plausibly make yeah i like that we use 3g it's the humility hubris uh right violent agreement [Laughter] 75 well that percentage is a good heuristic that's right that's right it is interesting though because we are our experience because we we i think communicate in in the same way and position in the same way um and our experience is often that the cio will invest his personal account with us and the the endowment will not have anything to do with it right and so so that's an interesting that happens career risk is real right you can't ignore it because and that goes into the dollar weight of return as well because you know if you if if career risk is at play and it always is um then you may not be able to hold on for the ride and if that's the case then you shouldn't do it or you should minimize your exposure so so it's really those who have the complete buy-in where they're basically setting aside the risk of looking like an idiot for an extended period of time and potentially getting fired or shunned right those are the ones who embrace it more and then the ones that that maybe really embrace it personally but at that institutional level can't implement it for those challenges maybe they just do less so so i think of it as like a sliding scale and and you know as an advisor i think of it there's a spectrum on one end it's a really well balanced diversified portfolio the other end is what everybody else does and our job as advisors is to play psychologists in some ways and find the right point along that spectrum for each client where they can go as far towards the diversified balance side as they can handle and and so we test them so a lot of times i sit down with a client and and i say look this is what everybody else does this is what we think is ideal we're not going to put you in the ideal portfolio because you can't handle it right and you take away you can't handle the truth right so so we're going to test you and we're going to start a little bit over in that direction and then there's going to be a challenging environment that's going to come in the future i don't know when or how it's going to transpire but it's going to come and then we'll sit down we talk about it again and see how you feel and then we'll do that again and every time you pass the test we'll go further and further and if you fail we'll take a step back and we'll work our way in this direction so that's and you tell people i like the language the pass fail you can't handle it these are good takeaways really good ways to position it for for uh this is what you can't have that yeah yeah yeah right brilliant right really empty will happen did you just say i can't have something what yeah you know who i am and usually we're dealing with people who are very confident and successful so no i'll prove you wrong i can do it fantastic well that was that was one of i'm going to keep all my other questions for later that i wanted to get that one awesome all right well alex it's been uh many years that we've been uh interacting i'm glad we finally got you on the podcast and got to chat about our joint passions we'll definitely have you and raymond in it here again to appreciate it or maybe we'll bring some other guys that have contentious views on that that's even better i kind of feel like chandler um jason buck and uh shahidi damian thing would be just let's just drop them in the the podcast and walk away thunderbill do you want to thunder dome them yeah no we need someone who just wants 100 us equities too like we need rick ferry on this fairy will get us in here henry are you hungry let's put him in there right mad man well thank you for being so generous with me alex you've been amazing looking forward if you're in the caymans drop by if we're in la we're definitely going to knock on your door so sounds good um cheers and thank you very much and everybody remember that just smile and nod like the penguins in madagascar while annie takes this off of this office a little bit everyone stay here and smile or not purpose though go ahead and take us that's a wrap on it

Channel: ReSolve Asset Management

Views: 1,447

Rating: 4.9166665 out of 5

Keywords: adaptive asset allocation, alpha, asset allocation, asset management, diversification, equity momentum, evidence based investing, factor investing, financial plans, global equity, hedge fund, investments, liquid alternative, machine learning, managed futures, momentum, mutual funds, portfolio management, portfolio optimization, quant, quant investing, risk parity, security selection, systematic investing, tactical asset allocation, trend following, wealth management, RPAR ETF

Id: vCiPDIB6TWg

Length: 98min 10sec (5890 seconds)

Published: Sat Sep 26 2020