Rather than getting into complex futures-based approaches involving risk parity theories, etc, let's examine a simple, dumb, do-it-yourself approach using ETFs.
Here are the rules:
II. Rebalance annually to maintain the equal dollar weightings between the positions.
The logic is that SPY gives cheap stock market exposure. GLD gives monetary inflation exposure. TLT provides potential deflation exposure through long duration bonds, while handily moving inversely to stocks (on average, but not always).
In a stagflation in which both stocks and long duration government bonds drop, gold has a good chance of rising.
Here are the latest updated results in a log scale:
As we previously observed, the approach has higher returns and lower drawdowns across an entire bull and bear market cycle than the S&P 500, along with a better Sharpe. The strategy's worst year is 2013, at -3.1%, which is probably enough to get most portfolio managers fired when the stock market has a 30%+ year (even though such an investor would have looked like a hero in 2008). However, a portfolio manager who employed this decidedly humble, simple approach, would actually have been doing well for clients as a fiduciary.
The recent market volatility has served as an interesting walk-forward test. YTD, the outperformance of this dumb strategy has been excellent on a drawdown basis:
I appreciate this dumb strategy's low 0.20 correlation to the broad equity markets, conservative drawdown, and excellent Sharpe.
The recent equity market volatility has been another validation of the strategy's robustness:
I am sure that most investors would have appreciated a less than 1% drawdown compared to what they probably experienced.
This dumb strategy index is perfect for institutions which want to create an ETFs which has potentially market-beating performance across an entire cycle with far reduced risk than just passively holding stocks.
Indeed, a strategy ETF which replicated this strategy would give simple stock market exposure combined with exposure to instruments which could help offset inflation or deflation scenarios. Not bad.
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