One of the best ETF portfolio strategies on Wall Street today is called “risk parity.” See the leading examples online at InvestableBenchmarks.com.
Risk Parity
Risk parity simply implies using a well-diversified and balanced mix of asset class index funds, and possibly leverage, to reduce risk while increasing return.
Here are some recent developments:
- The world’s largest hedge fund is bringing risk parity to China.
- ETF PM launched risk parity portfolios in 2016, and 2017 was extraordinary.
- Yale and Buffett underperformed risk parity as another benchmark emerged.
- Another robo-advisor and hedge fund manager plan a risk parity mutual fund.
- Some believe risk parity can drive the market or sink it.
Free Nest Eggs
In 2016, ETF PM shifted to focus on risk parity portfolios, or “Income & Growth (IG),” when we upgraded the investable benchmarks to allow for the moderate use of leverage. These passive index portfolios have proven that just as strategic diversification can be a free lunch, leveraged diversification can be a free retirement nest egg.
Below, see the performance of the Buffett & Swensen ETF portfolios versus the S&P 500, Long-term Treasury bonds, and the investable benchmarks:
Buffett & Swensen
Over the past 10.3 years, the Buffett & Swensen ETF portfolios delivered 8% and 6% annualized, or 114% and 77% in total return. These unleveraged growth portfolios significantly underperformed the investable benchmarks in total return and risk.
S&P 500 and Long-Term Treasuries
Over the same period, both the S&P 500 (SPY) and Long-term Treasuries (TLT) delivered annualized returns of 8% and 6% as well. However, neither Buffett nor Swensen recommend an allocation to TLT even though the asset class has historically delivered critical portfolio protection.
For example, during the stock market crash from 2000 to 2002, TLT delivered a 47% gain while the S&P 500 fell 38%. TLT also delivered shocking relative outperformance in 2008, 2011, and 2014 with gains of 34%, 34%, and 27% respectively.
For the full-year 2017, SPY gained 22%, and TLT was up 9%.
InvestableBenchmarks.com
Over the past 10.3 years, the Income & Growth (IG) investable benchmark returned 7% annualized, or 96% in total return. We estimate that the Income and Growth 2x/3x portfolios delivered annualized returns of 13% and 20%, respectively, or 242% and 551% in total return.
Given the strong growth in technology and automation, we launched Income and Tech 3x (IT 3x) for aggressive growth investors, and we predicted a mega stock market bubble ahead. Over the past 10.3 years, we estimate that IT 3x returned 29% annualized or 1,324% in total return.
However, IT 3x and the other investable benchmarks may be extremely volatile at times. Therefore, these portfolios are available through a range of passive and active asset allocations. We strongly encourage investors to engage leverage slowly and to employ ETF PM’s overriding risk controls.
Bottom Line
Over the past decade, risk parity and moderate leverage have enabled the investable benchmarks to significantly outperform the ETF portfolios recommended by Buffett and Swensen. Just as strategic diversification can be a free lunch, leveraged diversification, such as risk parity, can be a free retirement nest egg.
Still, past performance can never guarantee future results, and leveraged ETFs often do not deliver the exact multiple of the underlying index return they target. Investors should be careful to engage leverage slowly and cautiously.
As per Greek philosopher Heraclitus, “Life is Flux” meaning “all things change.” Given this truth, and the wide range of economic environments, the best ETF portfolio is certain to change over time.
See our prior versions of this article: 1/18, 12/17, 6/17, 10/16, 6/16, 3/16, 9/14, 6/14, 3/14, 12/13, 9/13, 9/12, 5/12, 4/10, 4/09.
Contact ETF PM to learn more.
