Defensive ETFs And Risk Parity ETF (RPAR)

Aug. 16, 2020 10:26 PM ETDFND, DRSK, FIXD, PHDG, RPAR, SWAN, TMSRX28 Comments
Charles Bolin profile picture
Charles Bolin
2.5K Followers

Summary

  • In this article, I highlight six ETFs with low drawdowns and year-to-date returns of 9-15%.
  • I use Portfolio Visualizer to select funds from a universe of funds to maximize the Sharpe Ratio and a second portfolio to weight the funds using Risk Parity.
  • The Tidal ETF Trust - RPAR Risk Parity ETF is profiled.
  • Lipper Categories with high positive fund flows in July are listed.

Each month, I extract about a thousand funds from the Mutual Fund Observer Screens and rate them based on Risk-Adjusted Return, Risk, Momentum, Valuation, and Quality. In this article I highlight six ETFs with low draw downs and year to date returns of 9% to 15%. I use Portfolio Visualizer to select funds from a universe of funds to Maximize the Sharpe Ratio and a second portfolio to weight the funds using Risk Parity. Tidal ETF Trust - Risk Parity ETF (RPAR) is profiled.

Six Defensive ETFs and one Alternative Multi-Strategy Mutual Fund

I chose a top performing fund from seven different Lipper Categories that had low draw down in 2020 and high returns. I excluded traditional bond funds because interest rates are so low. The data is from Mutual Fund Observer year to date. Ulcer Index measures the length and duration of draw down. Martin Ratio is the Risk Adjusted Return. MFO Risk refers to the safest funds (1, green shade) and the riskiest funds (5). MFO classifies RPAR with a MFO Risk of 3 which is higher than the others in the table.

Table #1: YTD Performance of Defensive Funds

Symbol Name Lipper Category YTD MAX DD Ulcer Index Martin Ratio MFO Risk MFO Rating Age yr ER% Yield% AUM$M
FIXD First Trust Oppor Fxd Inc Multi-Sector Income 8.6 -1.1 0.4 36.7 1 5 3.4 0.6 2.1 3,188
TMSRX T Rowe Price Multi-Strtgy Ttl Rtrn Alternative Multi-Strategy 7.0 -4.7 1.8 6.6 2 5 2.4 1.2 2.4 80
DFND Reality Shares DIVCON Div Dfndr Alternative Long/Short Equity 12.2 -3.4 1.4 14.8 2 5 4.5 1.4 0.3 27
SWAN Amplify BlackSwan Grwth&Treas Large-Cap Core 11.4 -2.6 1.1 18.4 2 5 1.7 0.5 0.8 510
DRSK Aptus Defined Risk Flexible Income 12.3 -2.7 1.0 21.0 2 5 1.9 0.8 1.4 378
PHDG Invesco S&P500 Dwnsd Hdgd Absolute Return 14.7 -1.0 0.4 70.6 2 5 7.6 0.4 1.4 85
RPAR Toroso Risk Parity Flexible Portfolio 12.1 -7.1 2.7 7.8 3 5 0.6 0.5 - 629

Source: Created by Author using Mutual Fund Observer

The YTD performance of these funds is shown below compared to the Vanguard Balanced Index Fund. Notice that RPAR (dark green) had a higher draw down but recovered quickly. Also note that in August, all of the funds have started to trend downward.

Chart #1: Defensive Fund Performance YTD

ChartData by YCharts

Risk Parity

I used the funds in the previous table plus traditional top performing funds from different Lipper Categories as shown in Table #2 year to date. Later in this article, I use more traditional risk parity assets of equity, long dated treasuries, and commodities.

Table #2: Low Draw Down, High Performing Funds

Source: Created by Author using Mutual Fund Observer

The twelve funds in the previous table, excluding RPAR because of its short life, were used in Portfolio Visualizer to create two portfolios to maximize the Sharpe Ratio (red line) and to weight the funds using risk parity (blue line). I personally like the steady increase in these portfolios with low draw downs. The link to Portfolio Visualizer Optimization which contains the funds and allocations is here. According to Portfolio Visualizer, Risk Parity:

This portfolio optimization strategy finds the portfolio that equalizes the risk contribution of portfolio assets.

Chart #2: Risk Parity and Max Sharpe Ratio Portfolio Optimization

Source: Created by Author using Portfolio Visualizer

The two portfolios are back tested year to date and compared to the new Risk Parity (RPAR) fund and the Vanguard Balanced Index Fund (VBIAX). The results are shown in Table #3 and the link is provided here. RPAR had higher returns and lower draw down than the Vanguard Balanced Index Fund.

Table #3: Short Term Portfolio Performance of Risk Parity, Max Sharpe, RPAR

Portfolio Return Stdev Max Draw down Sharpe Ratio Sortino Ratio
Custom Risk Parity 8.4% 5.6% -1.8% 2.3 5.4
Max Sharpe Ratio 10.8% 5.4% -1.2% 3.1 9.7
Risk Parity (RPAR) 12.4% 14.2% -6.5% 1.4 2.6
Vanguard Balanced Index (VBIAX) 5.0% 19.5% -12.3% 0.5 0.8

Source: Created by the Author using Portfolio Visualizer.

For More Information on Risk Parity

For more information on risk parity, please see the following articles:

Article Source
Market Structure Challenged: TLT And SPY Both Down As Risk Parity Suffers A Blow Seeking Alpha
60/40 Is Dead: Risk Parity Isn't That Much Better Anymore Either Seeking Alpha
Building A Risk-Parity Portfolio: An Example Seeking Alpha
Risk Parity ETF: Pay Very Close Attention Seeking Alpha
Can Bridgewater, AQR Risk Parity Funds Hang in There? Institutional Investor
Is There a Risk in Risk Parity Funds? Wealth Management
Invesco Balanced-Risk Allocation Morningstar

Rolling Optimization with Risk Parity

Portfolio Visualizer Rolling Portfolio Optimizer was used to adjust weights based on changing risk. It does have a slightly higher return, lower volatility, and draw down without the use of leverage than the Vanguard Balanced Index Fund. The link to Rolling Portfolio Optimization is provided here. For this example, I used mostly Vanguard funds, including long term treasuries, total stock market, emerging markets, developed markets, gold (IAU), and high yield corporate bonds.

Chart #3: Risk Parity and Max Sharpe Ratio Rolling Optimization

Source: Created by Author using Portfolio Visualizer

A Review of Risk Parity Fund Performance

Below is a comparison of a portfolio of mostly Vanguard Funds that I set allocations using Portfolio Visualizer Risk Parity, the AQR Risk Parity Fund (QRMIX), and Columbia Adaptive Risk Allocation (CRAAX) compared to the Vanguard Balanced Index Fund (VBINX). The link is provided here. Michael Yu makes the prediction that risk-parity funds will average 5% annually over the next decade, based in part on high valuations. The funds and portfolio below have averaged under 5% for the past seven years. Notice the losses in 2013 and 2016. Risk parity funds fail to perform when two or more asset classes under-perform such as when interest rates rise.

Chart #4: Comparison of Risk Managed Funds and Portfolios

Source: Created by Author using Portfolio Visualizer

With the exception of during bear markets, risk parity funds appear to be almost as volatile as a traditional 60% stock/40% bond fund. That is because risk-parity funds use leverage to make up for low risk components have low returns. Leverage increases the risk of the risk parity funds in the hopes of increasing returns.

As Michael Mendelson explained at Morningstar:

Risk-parity strategies are liquid, only modestly leveraged, and invest mostly in futures, so managing that risk isn't nearly as difficult as managing the concentration risk of the traditional portfolio.

Table #4: Risk Parity and Risk Managed Funds Long Term Performance

Source: Created by Author using Morningstar

The funds are shown in Chart #5.

Chart #5: Long Term Performance of Risk Parity Funds

ChartData by YCharts

I included the Permanent Portfolio (PRPFX) which was conceived by Harry Browne in the 1980s to be an all weather portfolio. It was split equally among growth stocks, precious metals, government bonds and treasury bills. Risk parity was made popular by Ray Dalio in the 1990s as an "all weather" alternative to a traditional 60% stock/40% bond portfolio. Permanent Portfolio differs from risk parity which may more funds, weights the funds according to risk, and may use leverage.

Tidal ETF Trust - RPAR Risk Parity ETF (RPAR)

Fund Profile

Tidal ETF Trust - RPAR Risk Parity ETF is an exchange traded fund launched and managed by Toroso Investments, LLC. The fund is co-managed by CSat Investment Advisory, L.P. It invests in public equity, fixed income and commodity markets across the globe. The fund invests directly and through derivatives including futures contracts to create its portfolio... The investment seeks generate positive returns during periods of economic growth, preserve capital during periods of economic contraction, and preserve real rates of return during periods of heightened inflation.

According to Advanced Research Investment Solutions,

Absolute underperformance can occur during periods when cash outperforms all asset classes. Since RPAR provides exposure to a balanced mix of risky asset classes, the strategy tends to perform poorly when cash outperforms all risky assets. This typically happens when the broad appetite for taking risk fades and investors seek the safety of cash.

According to the Fact Sheet, the current allocation at the end of July is:

Table #5: Portfolio Composition of RPAR

So how did RPAR do so well this year and the other risk parity funds not so well? According to Lewis Braham in Barron's,

On Dec. 31, 2019, AQR Risk Parity II MV had 69.7% in equity, 177.1% in bonds, and 42.0% in commodities. By March 31, those weightings were 8.4% equity, 91.1% bonds and 7% commodities. Yet the leverage is misleading, says co-manager John Huss...

That is a lot of turnover, especially for a new fund!

D. M. Martins provided a good description of RPAR, and a positive outlook on July 23rd. With the benefit of 20/20 hindsight since then, I am less convinced. The only fund of the seven defensive funds at the beginning of this article that is not trending down significantly is the T. Rowe Price Multi-Strategy Total Return Fund TMSRX.

Chart #6: Risk Parity (RPAR) ETF

ChartData by YCharts

Source: Created by Author using Portfolio Visualizer

If Not Defensive Funds Where?

I continue to believe that the market is risky given the unknowns of COVID and the related recession. I have less than 15% of my portfolio in a gold ETF and a basket of alternative funds.

In my opinion, Risk Parity Funds are most suited for risky markets or as a small part of a portfolio for moderately safe funds. Over longer periods, I don't see that they will replace a traditional 40% to 60% stock allocation portfolio. My preferred method is to maximize returns for a target volatility which I showed in Chart #2.

The table below shows which Lipper Categories are attracting inflows for the thousand or so funds that I rank. I provide an example fund for each Category. I have made a very small allocation to DBA, and continue to like TMSRX as a longer term investment. In addition, I have been shifting to shorter duration bonds of high quality. The International Multi-Cap Value Category is of interest and should benefit if the dollar continues to fall.

Table #6: Lipper Categories with High Fund Flows

Fund Flows Example Rank Flow% Ulcer MaxDD Martin RTN 3Mos
1. Commodities Agriculture DBA 2 15 10.3 (19.2) (1.1) 3.9
4. Alt Multi-Strategy TMSRX 70 8 1.7 (5.8) 4.9 6.4
7. Absolute Return PHDG 41 6 2.7 (5.9) 5.6 6.8
8. Intrntnl Mult-Cap Valu ANTYX 31 6 10.0 (24.4) (0.3) 11.0
9. Ultra-Short Oblgtns VUSFX 65 6 0.3 (1.3) 10.0 1.2

Source: Created by Author using Mutual Fund Observer

The above funds are shown in Chart #7. The following funds don't exhibit as pronounced downward trend in August as the defensive funds in Chart #1.

Chart #7: Funds From Categories with High Fund Flows

ChartData by YCharts

Best wishes, and stay safe.

This article was written by

Charles Bolin profile picture
2.5K Followers
I use Mutual Fund Observer MultiSearch as the primary tool to analyze and rank funds based on risk, momentum, quality, income, and consistency factors. I classify nearly 300 funds each month by investment buckets for risk and trends. I began contributing to the MFO monthly newsletter in 2019.I retired in June 2022.  I am an individual investor and retired engineer with an MBA.

Disclosure: I am/we are long DRSK, SWAN, TMSRX, DBA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional. In September 2019, I began contributing to the Mutual Fund Observer monthly newsletter.

Recommended For You

Comments (28)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.