- Seeking alpha? I would much rather seek beta, which is why the Risk Parity ETF is one of my favorite funds to own.
- If history serves as a guide, the recent dip in RPAR's price suggests that the ETF could recover in the next few months and deliver solid returns.
- Not only will RPAR probably perform decently in a 2022 marked by uncertainty, but I think that the current price is very attractive.
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Although I am publishing this article on Seeking Alpha, I have always been a much bigger fan of seeking beta — i.e., capturing the gains inherent in holding risk assets vs. trying to "beat the market." This is why the Risk Parity ETF (NYSEARCA:RPAR) is one of my favorite funds to own. The case for buying shares becomes even more appealing when the ETF is in a noticeable drawdown from a prior peak, which has been the case lately (see chart below).
Today, I briefly revisit the concept of risk parity, and explain why this could be a good time to accumulate shares of RPAR on the dip.
Source: Data from Yahoo Finance
A quick recap of risk parity
The term risk parity, made popular by my former employer Bridgewater Associates, sounds more complex than the strategy actually is. In simple terms, risk parity is the investment philosophy of (1) buying into a wide variety of asset classes (think stocks, government and corporate bonds, gold and industrial commodities) in search of broad diversification; and (2) balancing the portfolio according to each asset's risk profile — lower allocation to riskier assets, higher allocation to less risky ones.
The chart and table below show that risk parity, approximated here through Ray Dalio's All Seasons, has performed much better than the S&P 500 (SPY) and the standard 60/40 portfolio, in risk-adjusted terms. This is represented by the much higher Sharpe and Sortino ratios highlighted below, and it is a testament to the strategy's ability to serve "free lunches": that is, higher returns without higher risks.
Source: Portfolio Visualizer
RPAR targets the following allocation: 25% global equities, spread across US and international; 70% treasuries, both nominal and inflation-linked instruments; and 25% commodities, with most of the exposure achieved through an investment in stocks of commodity-producing companies. Since most of the AUM is allocated to low-risk bonds, the target risk allocation ends up being evenly split across stocks, nominal bonds, TIPS and commodities.
One last detail worth noting: RPAR partially compensates for the lower expected return of investing so heavily in bonds by leveraging its overall exposure to risk assets at a ratio of 1.2 times — which is why the individual pieces of the pie below on the left add up to 120%, not 100%. This leverage effect is currently achieved through long positions in futures contracts on intermediate and long-term treasuries.
Source: Fact sheet
Buy the dip: A good strategy
Notice that, by being broadly diversified, RPAR does not try to produce superior returns during certain macroeconomic or market environments. Instead, because the fund seeks balanced exposure to multiple asset classes, it is more likely for this ETF to climb steadily over time, without deviating too much from its path towards the targeted long-term returns.
But of course, the markets are much messier than this. Even a well-balanced fund like RPAR will rush ahead or fall behind its normal long-term trajectory. The COVID-19 bear of 2020 has been the most noticeable example of atypical underperformance relative to the fund's own average.
The better news is that RPAR tends to revert to a mean. That is, each spike in price tends to be followed by a slowdown in the fund's rate of market value growth; and each sharper drawdown from a peak tends to precede a rally. Now, refer back to the first graph above.
Since RPAR's 2019 inception, I have calculated that the fund's average drawdown on any given trading day is 2.1%. Let's consider this number an ordinary dip from the all-time high. I then calculated the fund's performance over the following six months whenever shares were bought at a drawdown deeper than these normal levels. Here is what I observed:
- RPAR's median six-month annualized return has been 16.5%. This figure compares to a base-case 13.6% (i.e., when shares were bought on any given day, regardless of previous price action), which is nearly 3 percentage points lower than the performance of the timed strategy.
- The higher returns above did not come at the expense of more risk. When bought in a steeper-than-normal drawdown, RPAR returned a minimum six-month annualized return of 3.8%. This figure is better than the base-case minimum of -1.1%.
All the above can be interpreted simply as follows: because RPAR chases beta across multiple asset classes, it is not unreasonable to expect (1) returns to be positive over time and (2) fund prices to fluctuate relatively little. When the ETF is in a noticeable drawdown, as it is today at around 4%, buying the dip and waiting for prices to return to their normal trajectory has worked well in the past. I have no reason to believe that this will be different going forward.
This is why I believe that now is a good time to own RPAR at nearly $25 per share: not only will the ETF probably perform decently in a 2022 marked by uncertainty, but I think that the current price will also prove to be an enticing one, in hindsight.
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This article was written by
Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.
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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.
He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.
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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.
DM Martins Research also manages a small team of writers and editors who publish content on several TheStreet.com channels, including Apple Maven (thestreet.com/apple) and Wall Street Memes (thestreet.com/memestocks).
Analyst’s Disclosure: I/we have a beneficial long position in the shares of RPAR, SPY either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.