In this episode of Lead-Lag Live, I sit down with Alex Shahidi, Co-Chief Investment Officer at Evoke Advisors, to unpack the structural forces reshaping markets — from persistent inflation to weakening growth, rising deficits, and the return of macro volatility.
From the limitations of the traditional 60-40 portfolio to the misunderstood mechanics behind risk parity, Shahidi explains how investors can build portfolios that survive multiple economic regimes without relying on forecasts or market timing.
In this episode:
– Why inflation volatility poses the biggest risk to portfolios today
– How the past decade created dangerous concentration in equities
– Why most investors misunderstand what true diversification means
– How risk parity protects against extreme macro outcomes
– How RPAR expresses a balanced, multi-regime investment framework
Lead-Lag Live brings you inside conversations with the financial thinkers who shape markets. Subscribe for interviews that go deeper than the noise.
#RiskParity #Diversification #Inflation #RPAR #Markets #EvokeAdvisors #PortfolioConstruction #MacroInvesting
Start your adventure with TableTalk Friday: A D&D Podcast at the link below or wherever you get your podcasts!
Youtube: https://youtube.com/playlist?list=PLgB6B-mAeWlPM9KzGJ2O4cU0-m5lO0lkr&si=W_-jLsiREjyAIgEs
Spotify: https://open.spotify.com/show/75YJ921WGQqUtwxRT71UQB?si=4R6kaAYOTtO2V
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
SPEAKER_01 (01:12):
Then the risk parity part of it is recognize that to
build actual balance, you needroughly equal risk contribution
from all these assets.
So that one asset does notoverly influence the total
returns of your portfolio.
So I mentioned 6040 is not thatwell diversified because the 60
is a lot more volatile than the40, and it's overweighted.
So to risk balance them, youneed to own more of the less
(01:34):
volatile assets, own less of themore volatile assets so that you
have roughly equal riskcontribution from all the
assets, which allows you to havea more diversified allocation.
SPEAKER_00 (01:59):
Markets are working through a complicated
environment right now.
Inflation is sticky in wayspolicymakers did not expect.
Rates continue to sit higher forlonger, and the growth outlook
is getting cloudier.
At the same time, geopoliticaltension and shifting global
policy are adding to cross-assetvolatility.
It's exactly the type of setupwhere disciplined portfolio
(02:20):
construction matters more thanever.
My guest today is Alex Shahidi,co-chief investment officer at
Evoke Advisors and one of themost respected voices in
risk-balanced investing.
Alex, it's great to have youhere.
Glad to be here.
Thank you.
So for anyone who's new to yourwork, can you start by sharing
(02:41):
your background and how you uhbecame focused on risk parity
and diversification?
SPEAKER_01 (02:46):
Uh sure.
Uh I've been a financial advisorfor 26 years, started right
before the uh dot-com bubble andbust and the lost decade in the
stock market, which helps uhform your early uh opinions of
the markets and how to invest.
Uh so I've been investing for 26years for clients.
I manage about$15 billion inassets, um, co-CIO of a firm
(03:09):
that manages about$20 billionbased in Los Angeles.
I host a podcast called TheInsightful Investor, where I
interview a lot of really smartpeople and uh glean some
insights from them.
I love writing and speaking.
And uh so all of that uh helpsme form some opinions about what
the future may hold.
And recognizing that even thesmartest people are wrong a lot,
(03:32):
uh, it uh informs my views onhow to build a resilient
portfolio, particularly in theunique environment in which we
currently live.
SPEAKER_00 (03:41):
I'm looking forward to hearing some of your
thoughts.
So when you look across today'smacro landscape then, what what
are the major risks that standout to you and what should
investors be paying closerattention to right now?
SPEAKER_01 (03:52):
Uh I think you mentioned some of them earlier,
but uh inflation staying higherfor longer is is an issue.
If we if we just look at wherewe are the last four years
relative to the Fed's target of2%, we've been above that for
four years running.
Uh, the last time something likethat happened was in the 1970s,
when inflation surprised theupside for a decade.
(04:13):
And during that time, the stockmarket and the bond market
underperformed cash for adecade.
So we had a lost decade for thestock market and the bond market
the last time inflation was aproblem, which is what you would
expect in periods like that.
So that's certainly on theradar.
Uh we don't really know howinflation is going to play out,
but we we've seen what'shappened the last several years,
(04:33):
and the market isn't discountinghigh inflation long term, and
there is a risk that it uhinflation comes in higher than
expected.
Um that's I think something toreally consider because for uh
almost four decades, inflationwasn't a question.
There was there wasn't muchinflation volatility.
What moved around was economicgrowth.
We had booms and busts, and aportfolio that just owned stocks
(04:56):
and bonds worked because whenyou have when inflation isn't
moving around and growth ismoving around, then stocks and
bonds are diversifying.
But in the 70s, they bothunderperformed cash.
They were highly correlatedbecause inflation was volatile.
So all of a sudden, that isn't aconcern.
So I think that's something thatshould definitely be on people's
radar.
Uh, growth is starting to weakena little bit.
(05:18):
Uh, it's been resilient for avery long time.
I remember after the massivetightening in 2022, almost
everybody said, oh, 23, we'regonna have a recession.
Every time there's an invertyield curve, anytime the Fed
tightens that quickly, we have arecession.
And what happened?
No recession.
And here we are three yearslater, um, and no recession in
sight.
(05:38):
Um, so but you know, recessionsare always a surprise.
Uh, I I don't remember the lasttime everybody predicted a
recession and it happened.
Usually something occurs and itcomes out of the blue.
So we should always be mindfulof that.
Uh, we have these massivedeficits, um, and we've had them
for a long time, for decades.
Uh, and it's one of those thingsthat doesn't matter until it's
(06:00):
the most important thing.
Um, and uh I don't know whenthat point is going to come, but
at some point you can't just rundeficits forever and the debt
burden becomes bigger and uheventually it uh becomes a pol
uh becomes a concern.
So that's something to keep inmind.
Uh immigration policy and itsimpact on the labor market.
We're seeing labor marketslowing.
(06:20):
Uh you talked aboutdeglobalization.
You know, we had uh multipledecades of globalization, and
that's shifted into reverse.
And what are the implications ofthat?
And then all of those potentialheadwinds, you have to weigh
against the potential tailwindof AI and its productivity and
the timeline of thatproductivity, hitting earnings
(06:41):
and uh supporting growth.
Um, and so I think of it as youhave these major forces of play,
massive, uh, in terms ofmagnitude.
And they're kind of going headto head, and how it nets out is
really anybody's guess.
It's really hard to predict howthese things will net out.
But but my sense is that givenall that, there's a wide range
(07:01):
of potential outcomes, and therisk of extreme outcomes is
probably greater than it's beenfor a long time because these
forces are so significant.
So all of that feeds into, youknow, this is a really unusual
environment in that regard, andit's really hard to predict how
it's going to play out.
unknown (07:16):
Yeah.
SPEAKER_00 (07:16):
So with all of that in mind, most investors try to
deal with risk through hedges ortactical moves.
How should people think aboutbuilding a portfolio that can
weather the multiple economicregimes without relying on
forecasts?
SPEAKER_01 (07:29):
Yeah, and that's probably the most important
question because what what Idescribed earlier is that it's
hard to predict how things aregoing to play out.
And my sense, in my experience,is many investors have some
prediction of what the futureholds and they invest based on
that prediction uh actuallytranspiring.
And it's really risky to playthat game now because you could
(07:50):
predict scenario A, and scenarioB could be almost the opposite
of scenario A.
And the odds of A, B, C, D, andso on are pretty diverse,
meaning there isn't high odds ofany outcome.
Um, so so it is really risky toassume one outcome and invest
for that.
So basically, what that means isbe diversified.
(08:11):
It goes back to one of the firstprinciples of investing.
Don't put all your eggs in onebasket.
This is a period where I thinkthat is very true, is be
diversified.
And what's interesting is myguess is most people would agree
that who knows what the futureholds, wide range of outcomes,
be diversified makes sense.
Yet when you look at mostportfolios, they're probably
less diversified today than theywere a decade ago.
(08:33):
There's more concentration inequities because they've done
well.
There's more concentration inU.S.
equities, because U.S.
equities until this year havesignificantly outperformed the
rest of the world.
And there's more concentrationwithin the U.S.
equities.
And the concentration withinU.S.
equities are a lot of these bigtech companies that are
competing with each other.
So there's far moreconcentration today in
(08:54):
portfolios.
And we live in a world where youprobably want more
diversification than you have ina long time.
So there's a there's a prettybig disconnect there.
Uh, and oftentimes investors,their portfolios reflect what's
worked in the past.
And it seems like theenvironment is shifting.
And the next 10 years isprobably gonna look very
different from the last 10years.
(09:14):
I don't know when thatinflection point is or if we've
already passed it.
Oftentimes you don't know untilyears have passed and you look
back and it was obvious, right?
And we everybody knew this wasgonna happen.
Uh, when you're living throughit day by day, it's not as
obvious.
So, so all of that feeds into bediversified.
And and my sense is most peopleare not that well diversified.
SPEAKER_00 (09:32):
Yeah.
And talking specifically aboutdiversification, you, Alex, have
a much more specific definitionof diversification than most
investors probably use.
How do you define truediversification?
And why do you think so manyportfolios fail to achieve it?
SPEAKER_01 (09:48):
Um I think you have to have a uh you you in many
ways you have to be a markethistorian.
You have to study markets for100 plus years.
You have to look at differentenvironments, what what has
done, what did well in the 70s,what did poorly in the 70s.
Uh, you have to think about the80s and 90s, the 2000s, the loss
ticket in stocks.
I think you have to have abroader perspective.
(10:08):
Um, and so I think what I foundis people who've been investing
for 40, 50, 60 years, who'velived through all these
different environments, theytend to have a broader
perspective of what does itreally mean to be diversified?
Um, and then if you studyhistory going back hundreds of
years, you're you're you becomeeven a broader thinker and you
think of it globally.
So um uh I think my sense ismost people use what I call a
(10:32):
conventional framework forbuilding what they view to be a
diversified portfolio.
They think of you basically havetwo assets, high risk, high
return stocks, low risk, lowreturn bonds, and you allocate
between the two to give you uhthe return and risk targets that
you're trying to achieve.
And the assumption there is thatstocks and bonds are
diversifying to one another.
And that's been true for a fewdecades.
(10:53):
But when inflation was aproblem, they were not uh
diversifying to one anotherbecause they both do poorly in
the same inflation environments.
Um and so I think you have tothink of diversification as
including more assets withinthat portfolio.
So you need inflation hedgeassets within that mix.
And then secondarily, the thechallenge with that conventional
(11:14):
framework is it's notdiversified.
So 6040, and the simple math is6040 is about 98% correlated to
100% stock portfolio.
So by definition, it can't bediversified.
You can't have a portfolio thatyou call balanced that is 98%
correlated to the stock market.
And the reason it's so highlycorrelated is think of it, you
have two assets.
(11:35):
One is stocks that it's veryvolatile, goes up and down a
lot.
You have bonds that tend to beshorter intermediate term that
goes up and down a little bit.
And so your total portfolio isdominated by the overweighted
asset class that's significantlymore volatile than the
underweighted asset class.
So directionally, what mattersis how the stock market does.
So stocks do well, your 6040does well, stocks do poorly,
(11:58):
6040 does poorly.
It's just a matter of magnitudeby reducing the risk with bonds.
So that can't be diversified.
So include inflation hedgeassets, include other assets
that might do well in differentenvironments.
And I think of that as a as a inmany ways a different framework
for building a diversifiedportfolio that my guess is is 10
years from now, people look backand say, yes, that that makes
(12:20):
sense.
Um, but but today it may be lessobvious.
SPEAKER_00 (12:22):
Right.
So I mean, risk parity has astrong long-term record as uh as
opposed to what you've justspoken about with the 6040
portfolio.
But there are critics who arguethat certain environments can
break the strategy as well.
In your view, what is the realrisk that risk parity does not
work?
And what do people misunderstandabout it?
SPEAKER_01 (12:40):
Yeah, no, it's it's a it's an important question and
it comes up uh quite frequently.
So I think of risk parity asjust a balanced portfolio.
Um, and and the way I thinkabout constructing that balanced
portfolio is own assets that dowell in different environments.
So own equities, you can own umbonds or treasuries, but include
inflation hedge assets like uhcommodities, including gold uh
(13:03):
and inflation link bonds.
Uh so many portfolios own verylittle in commodities or gold or
inflation link bonds.
So include that as part of yourbalance mix.
Then the risk parity part of itis recognize that to build
actual balance, you need roughlyequal risk contribution from all
these assets so that one assetdoes not overly influence the
(13:25):
total returns of your portfolio.
So I mentioned 6040 is not thatwell diversified because the 60
is a lot more volatile than the40, and it's overweighted.
So to risk balance them, youneed to own more of the less
volatile assets, own less of themore volatile assets so that you
have roughly equal riskcontribution from all the
assets, which allows you to havea more diversified allocation.
(13:46):
So that's effectively what therisk parity concept uh implies.
You don't have to have anyleverage.
So this is a misnomer.
You don't have to have anyleverage in risk parity.
You can just own a balanced mixof assets, overweight low-ball
assets, underweights, high volassets, and you have a balanced
mix.
You could take that portfolio,you can lever the whole
portfolio to raise your expectedreturn, raises your expected
(14:08):
risk.
The sharp ratio stays about thesame because it's the same
portfolio, it's just levered up,and you can lever it up to
different degrees.
And that's a very efficient wayto manage a portfolio,
particularly when you're tryingto be diversified.
So, so I think of that as a riskparity framework, which to me is
a little bit more efficient thana 60-40 framework that's less
diversified.
(14:28):
So, so your question of, well,when does it not work?
Um, so the assumption inbuilding that portfolio is that
a balanced mix of assets beatscash over time.
That that tends to be true overlong periods of time.
Otherwise, capitalism wouldn'twork.
Um, but it could be not trueover shorter periods of time.
And I think of those as periodswhere cash is king.
And and 2022 was a was a recentexample of that.
(14:52):
When cash went from zero to fivepercent very quickly, cash was
king.
It's hard to compete with cash,the risk-free rate going from
zero to five very quickly.
All assets tend to do poorly atthe same time.
They face that headwind at thesame time because they're all
competing with the risk-freerate.
Think of equities that you know,equities have outperformed cash
by five or six percent a yearover 100 years.
(15:14):
If cash is zero, that's adifferent expected return for
stocks than if cash is 10,right?
Like it was in the in the early80s.
So when cash all of a suddengoes from zero to five, massive
headwind, you should expect thebalance mixes of assets to
underperform cash, which isexactly what happened in 2022.
But the the risk that you'rereally diversifying, which is
the really important risk, isgrowth and inflation surprises.
(15:37):
So what happens if growth isreally weak for an extended
period of time, like whathappened in the 2000s, what
happened in the 1930s?
What happens if inflationsurprises to the upside for an
extended period of time, likethe 1970s?
If you build that diversifiedportfolio that I described using
that risk parity framework, youdon't experience a lost decade
during those periods becauseyou're diversifying the growth
(15:59):
and risk uh uh sides of theequation.
What you're not diversifying iscash is king.
Recognize that hard to predictwhen it starts, when it ends,
just hold through those periodsand diversify the things that
are diversifiable that you'renot compensated for.
And that's generally how I thinkabout that risk parity
framework.
SPEAKER_00 (16:17):
So Alex, staying on the topic of risk parity.
Um, for the audience who may notknow it very well, can you walk
us through uh RPAR, the riskparity ETF that you manage, and
talk a little bit about whatproblem is what problems it's
built to solve and how does itexpress the principles behind
your approach?
SPEAKER_01 (16:34):
Yeah, so this is something that I've been using
with my clients for 20 years,this framework.
And and basically owning, youknow, things like gold and
commodities and inflation linkbonds on top of equities and
high quality nominal bonds.
So that's something I've beendoing for 20 plus years.
I learned it from Bridgewater acouple decades ago.
That's the framework that theyuse.
I think it makes a lot of sensein building a diversified
(16:56):
allocation for clients.
Um, so about six years ago, uh,we figured out, you know, it'd
be a lot more efficient if wetook that strategy and wrapped
it inside of an ETF vehicle.
Um and and and it basicallyallows you to implement the
strategy a lot more efficientlyand effectively.
And and the areas where I thinkit's really helpful is uh, you
(17:17):
know, number one, is it's noteasy to be diversified.
It's not easy to be balanced.
So for example, you know, gold,everybody loves gold today
because it's gone up so much,but there was periods where it
did terrible.
And those are the periods youhave to own it so that you can
enjoy the benefits of the runthat we're seeing uh currently.
It's too late to buy it afterit's up, you know, 50, 60%.
(17:38):
Um, so so it's hard to do it insize.
Um, same thing with withtreasuries, uh, inflation-linked
bonds.
Uh, both of those have beennegative the last five years,
long-dated treasuries and tips.
Um, but those are greatdiversifiers in a portfolio.
Commodities have gone throughlong stretches with them done
great, long stretches with themdone poorly.
So, to get more balance, it'shelpful to wrap it inside a
(18:01):
single vehicle where you can putall those allocations in place.
Uh, rebalancing uh canpotentially be a huge benefit to
clients, you know, buying low,selling high.
Uh in theory, it it makes sense.
The math proves it out.
In practice, I can tell you it'sreally hard because it's hard to
tell people sell your winners,buy your losers.
Because the assumption is thewinners will continue to be the
(18:21):
winners and the losers willcontinue to be the losers.
Why would I why would I makethat trade?
Um, but we know that works overtime.
Uh it's also difficult when youhave to sell the winners and pay
taxes.
You have cap gains when you sellthe winners typically.
So you put all that inside of anETF wrapper and you gain the
efficiencies of overcoming thatthat emotional burden of buying
low, selling high.
(18:42):
Uh the ETF automatically doesit.
Uh, and then the cap gains getdeferred inside of the ETF uh
because of the tax efficiency uhstructure of the ETF.
Um so I think that's a veryimportant aspect of that.
Uh you know, the the our par uhhas a little bit of leverage at
the portfolio level.
It's achieved very cheaply.
Basically, the financing cost iscash.
(19:02):
It's hard to do that outside ofthe ETF vehicle by using
futures.
Um, so there's all theseefficiencies that come along by
wrapping that framework insideof a single vehicle.
Um, and then the vehicle itselfis very tax efficient because
it's an ETF.
And so the way I think about itis I think of it as a tool.
If you're trying to build a morediversified allocation, you can
(19:23):
own some RPAR and you canbasically take whatever your
current allocation is, add RPARto it, and you take a step
towards being more diversified.
And the and the further you wantto go along that spectrum, the
more you own.
If you don't want to be thatdiversified, you can own less or
own none.
Um, and I just think of it as atool in the toolkit to help you
get there in a very efficientway.
SPEAKER_00 (19:43):
Wow.
So you did a great job of uhexplaining the psychological
psychology behind uh buying andselling.
Uh, just lastly, Alex, foranyone watching who wants to
follow your work or learn moreabout what you're doing at Evoke
Advisors and about uh RPAR,where's the best place for them
to go?
SPEAKER_01 (19:59):
Uh sure.
So the RPAR website is rpar.com.
Uh we do quarterly webcaststhere that are uh the replays
are uh posted.
Uh there's a lot of informationabout the ETF, so you can go
there and learn about that.
Uh and then evokeadvisors.com uhis our website.
Uh we we share insights there, alot of other tools.
(20:20):
And then also my podcast isinsightfulinvestor.org uh if
you're interested in tuning inthere.
SPEAKER_00 (20:25):
Oh, Alex, thank you for that.
And I always appreciate yourinsight and thanks to everyone
for watching.
Be sure to like, uh share, andsubscribe for more episodes of
Lead Light Live.
Then the risk parity part of it is recognize that to
build actual balance, you needroughly equal risk contribution
from all these assets.
So that one asset does notoverly influence the total
returns of your portfolio.
So I mentioned 6040 is not thatwell diversified because the 60
is a lot more volatile than the40, and it's overweighted.
So to risk balance them, youneed to own more of the less
(01:34):
volatile assets, own less of themore volatile assets so that you
have roughly equal riskcontribution from all the
assets, which allows you to havea more diversified allocation.
SPEAKER_00 (01:59):
Markets are working through a complicated
environment right now.
Inflation is sticky in wayspolicymakers did not expect.
Rates continue to sit higher forlonger, and the growth outlook
is getting cloudier.
At the same time, geopoliticaltension and shifting global
policy are adding to cross-assetvolatility.
It's exactly the type of setupwhere disciplined portfolio
(02:20):
construction matters more thanever.
My guest today is Alex Shahidi,co-chief investment officer at
Evoke Advisors and one of themost respected voices in
risk-balanced investing.
Alex, it's great to have youhere.
Glad to be here.
Thank you.
So for anyone who's new to yourwork, can you start by sharing
(02:41):
your background and how you uhbecame focused on risk parity
and diversification?
SPEAKER_01 (02:46):
Uh sure.
Uh I've been a financial advisorfor 26 years, started right
before the uh dot-com bubble andbust and the lost decade in the
stock market, which helps uhform your early uh opinions of
the markets and how to invest.
Uh so I've been investing for 26years for clients.
I manage about$15 billion inassets, um, co-CIO of a firm
(03:09):
that manages about$20 billionbased in Los Angeles.
I host a podcast called TheInsightful Investor, where I
interview a lot of really smartpeople and uh glean some
insights from them.
I love writing and speaking.
And uh so all of that uh helpsme form some opinions about what
the future may hold.
And recognizing that even thesmartest people are wrong a lot,
(03:32):
uh, it uh informs my views onhow to build a resilient
portfolio, particularly in theunique environment in which we
currently live.
SPEAKER_00 (03:41):
I'm looking forward to hearing some of your
thoughts.
So when you look across today'smacro landscape then, what what
are the major risks that standout to you and what should
investors be paying closerattention to right now?
SPEAKER_01 (03:52):
Uh I think you mentioned some of them earlier,
but uh inflation staying higherfor longer is is an issue.
If we if we just look at wherewe are the last four years
relative to the Fed's target of2%, we've been above that for
four years running.
Uh, the last time something likethat happened was in the 1970s,
when inflation surprised theupside for a decade.
(04:13):
And during that time, the stockmarket and the bond market
underperformed cash for adecade.
So we had a lost decade for thestock market and the bond market
the last time inflation was aproblem, which is what you would
expect in periods like that.
So that's certainly on theradar.
Uh we don't really know howinflation is going to play out,
but we we've seen what'shappened the last several years,
(04:33):
and the market isn't discountinghigh inflation long term, and
there is a risk that it uhinflation comes in higher than
expected.
Um that's I think something toreally consider because for uh
almost four decades, inflationwasn't a question.
There was there wasn't muchinflation volatility.
What moved around was economicgrowth.
We had booms and busts, and aportfolio that just owned stocks
(04:56):
and bonds worked because whenyou have when inflation isn't
moving around and growth ismoving around, then stocks and
bonds are diversifying.
But in the 70s, they bothunderperformed cash.
They were highly correlatedbecause inflation was volatile.
So all of a sudden, that isn't aconcern.
So I think that's something thatshould definitely be on people's
radar.
Uh, growth is starting to weakena little bit.
(05:18):
Uh, it's been resilient for avery long time.
I remember after the massivetightening in 2022, almost
everybody said, oh, 23, we'regonna have a recession.
Every time there's an invertyield curve, anytime the Fed
tightens that quickly, we have arecession.
And what happened?
No recession.
And here we are three yearslater, um, and no recession in
sight.
(05:38):
Um, so but you know, recessionsare always a surprise.
Uh, I I don't remember the lasttime everybody predicted a
recession and it happened.
Usually something occurs and itcomes out of the blue.
So we should always be mindfulof that.
Uh, we have these massivedeficits, um, and we've had them
for a long time, for decades.
Uh, and it's one of those thingsthat doesn't matter until it's
(06:00):
the most important thing.
Um, and uh I don't know whenthat point is going to come, but
at some point you can't just rundeficits forever and the debt
burden becomes bigger and uheventually it uh becomes a pol
uh becomes a concern.
So that's something to keep inmind.
Uh immigration policy and itsimpact on the labor market.
We're seeing labor marketslowing.
(06:20):
Uh you talked aboutdeglobalization.
You know, we had uh multipledecades of globalization, and
that's shifted into reverse.
And what are the implications ofthat?
And then all of those potentialheadwinds, you have to weigh
against the potential tailwindof AI and its productivity and
the timeline of thatproductivity, hitting earnings
(06:41):
and uh supporting growth.
Um, and so I think of it as youhave these major forces of play,
massive, uh, in terms ofmagnitude.
And they're kind of going headto head, and how it nets out is
really anybody's guess.
It's really hard to predict howthese things will net out.
But but my sense is that givenall that, there's a wide range
(07:01):
of potential outcomes, and therisk of extreme outcomes is
probably greater than it's beenfor a long time because these
forces are so significant.
So all of that feeds into, youknow, this is a really unusual
environment in that regard, andit's really hard to predict how
it's going to play out.
unknown (07:16):
Yeah.
SPEAKER_00 (07:16):
So with all of that in mind, most investors try to
deal with risk through hedges ortactical moves.
How should people think aboutbuilding a portfolio that can
weather the multiple economicregimes without relying on
forecasts?
SPEAKER_01 (07:29):
Yeah, and that's probably the most important
question because what what Idescribed earlier is that it's
hard to predict how things aregoing to play out.
And my sense, in my experience,is many investors have some
prediction of what the futureholds and they invest based on
that prediction uh actuallytranspiring.
And it's really risky to playthat game now because you could
(07:50):
predict scenario A, and scenarioB could be almost the opposite
of scenario A.
And the odds of A, B, C, D, andso on are pretty diverse,
meaning there isn't high odds ofany outcome.
Um, so so it is really risky toassume one outcome and invest
for that.
So basically, what that means isbe diversified.
(08:11):
It goes back to one of the firstprinciples of investing.
Don't put all your eggs in onebasket.
This is a period where I thinkthat is very true, is be
diversified.
And what's interesting is myguess is most people would agree
that who knows what the futureholds, wide range of outcomes,
be diversified makes sense.
Yet when you look at mostportfolios, they're probably
less diversified today than theywere a decade ago.
(08:33):
There's more concentration inequities because they've done
well.
There's more concentration inU.S.
equities, because U.S.
equities until this year havesignificantly outperformed the
rest of the world.
And there's more concentrationwithin the U.S.
equities.
And the concentration withinU.S.
equities are a lot of these bigtech companies that are
competing with each other.
So there's far moreconcentration today in
(08:54):
portfolios.
And we live in a world where youprobably want more
diversification than you have ina long time.
So there's a there's a prettybig disconnect there.
Uh, and oftentimes investors,their portfolios reflect what's
worked in the past.
And it seems like theenvironment is shifting.
And the next 10 years isprobably gonna look very
different from the last 10years.
(09:14):
I don't know when thatinflection point is or if we've
already passed it.
Oftentimes you don't know untilyears have passed and you look
back and it was obvious, right?
And we everybody knew this wasgonna happen.
Uh, when you're living throughit day by day, it's not as
obvious.
So, so all of that feeds into bediversified.
And and my sense is most peopleare not that well diversified.
SPEAKER_00 (09:32):
Yeah.
And talking specifically aboutdiversification, you, Alex, have
a much more specific definitionof diversification than most
investors probably use.
How do you define truediversification?
And why do you think so manyportfolios fail to achieve it?
SPEAKER_01 (09:48):
Um I think you have to have a uh you you in many
ways you have to be a markethistorian.
You have to study markets for100 plus years.
You have to look at differentenvironments, what what has
done, what did well in the 70s,what did poorly in the 70s.
Uh, you have to think about the80s and 90s, the 2000s, the loss
ticket in stocks.
I think you have to have abroader perspective.
(10:08):
Um, and so I think what I foundis people who've been investing
for 40, 50, 60 years, who'velived through all these
different environments, theytend to have a broader
perspective of what does itreally mean to be diversified?
Um, and then if you studyhistory going back hundreds of
years, you're you're you becomeeven a broader thinker and you
think of it globally.
So um uh I think my sense ismost people use what I call a
(10:32):
conventional framework forbuilding what they view to be a
diversified portfolio.
They think of you basically havetwo assets, high risk, high
return stocks, low risk, lowreturn bonds, and you allocate
between the two to give you uhthe return and risk targets that
you're trying to achieve.
And the assumption there is thatstocks and bonds are
diversifying to one another.
And that's been true for a fewdecades.
(10:53):
But when inflation was aproblem, they were not uh
diversifying to one anotherbecause they both do poorly in
the same inflation environments.
Um and so I think you have tothink of diversification as
including more assets withinthat portfolio.
So you need inflation hedgeassets within that mix.
And then secondarily, the thechallenge with that conventional
(11:14):
framework is it's notdiversified.
So 6040, and the simple math is6040 is about 98% correlated to
100% stock portfolio.
So by definition, it can't bediversified.
You can't have a portfolio thatyou call balanced that is 98%
correlated to the stock market.
And the reason it's so highlycorrelated is think of it, you
have two assets.
(11:35):
One is stocks that it's veryvolatile, goes up and down a
lot.
You have bonds that tend to beshorter intermediate term that
goes up and down a little bit.
And so your total portfolio isdominated by the overweighted
asset class that's significantlymore volatile than the
underweighted asset class.
So directionally, what mattersis how the stock market does.
So stocks do well, your 6040does well, stocks do poorly,
(11:58):
6040 does poorly.
It's just a matter of magnitudeby reducing the risk with bonds.
So that can't be diversified.
So include inflation hedgeassets, include other assets
that might do well in differentenvironments.
And I think of that as a as a inmany ways a different framework
for building a diversifiedportfolio that my guess is is 10
years from now, people look backand say, yes, that that makes
(12:20):
sense.
Um, but but today it may be lessobvious.
SPEAKER_00 (12:22):
Right.
So I mean, risk parity has astrong long-term record as uh as
opposed to what you've justspoken about with the 6040
portfolio.
But there are critics who arguethat certain environments can
break the strategy as well.
In your view, what is the realrisk that risk parity does not
work?
And what do people misunderstandabout it?
SPEAKER_01 (12:40):
Yeah, no, it's it's a it's an important question and
it comes up uh quite frequently.
So I think of risk parity asjust a balanced portfolio.
Um, and and the way I thinkabout constructing that balanced
portfolio is own assets that dowell in different environments.
So own equities, you can own umbonds or treasuries, but include
inflation hedge assets like uhcommodities, including gold uh
(13:03):
and inflation link bonds.
Uh so many portfolios own verylittle in commodities or gold or
inflation link bonds.
So include that as part of yourbalance mix.
Then the risk parity part of itis recognize that to build
actual balance, you need roughlyequal risk contribution from all
these assets so that one assetdoes not overly influence the
(13:25):
total returns of your portfolio.
So I mentioned 6040 is not thatwell diversified because the 60
is a lot more volatile than the40, and it's overweighted.
So to risk balance them, youneed to own more of the less
volatile assets, own less of themore volatile assets so that you
have roughly equal riskcontribution from all the
assets, which allows you to havea more diversified allocation.
(13:46):
So that's effectively what therisk parity concept uh implies.
You don't have to have anyleverage.
So this is a misnomer.
You don't have to have anyleverage in risk parity.
You can just own a balanced mixof assets, overweight low-ball
assets, underweights, high volassets, and you have a balanced
mix.
You could take that portfolio,you can lever the whole
portfolio to raise your expectedreturn, raises your expected
(14:08):
risk.
The sharp ratio stays about thesame because it's the same
portfolio, it's just levered up,and you can lever it up to
different degrees.
And that's a very efficient wayto manage a portfolio,
particularly when you're tryingto be diversified.
So, so I think of that as a riskparity framework, which to me is
a little bit more efficient thana 60-40 framework that's less
diversified.
(14:28):
So, so your question of, well,when does it not work?
Um, so the assumption inbuilding that portfolio is that
a balanced mix of assets beatscash over time.
That that tends to be true overlong periods of time.
Otherwise, capitalism wouldn'twork.
Um, but it could be not trueover shorter periods of time.
And I think of those as periodswhere cash is king.
And and 2022 was a was a recentexample of that.
(14:52):
When cash went from zero to fivepercent very quickly, cash was
king.
It's hard to compete with cash,the risk-free rate going from
zero to five very quickly.
All assets tend to do poorly atthe same time.
They face that headwind at thesame time because they're all
competing with the risk-freerate.
Think of equities that you know,equities have outperformed cash
by five or six percent a yearover 100 years.
(15:14):
If cash is zero, that's adifferent expected return for
stocks than if cash is 10,right?
Like it was in the in the early80s.
So when cash all of a suddengoes from zero to five, massive
headwind, you should expect thebalance mixes of assets to
underperform cash, which isexactly what happened in 2022.
But the the risk that you'rereally diversifying, which is
the really important risk, isgrowth and inflation surprises.
(15:37):
So what happens if growth isreally weak for an extended
period of time, like whathappened in the 2000s, what
happened in the 1930s?
What happens if inflationsurprises to the upside for an
extended period of time, likethe 1970s?
If you build that diversifiedportfolio that I described using
that risk parity framework, youdon't experience a lost decade
during those periods becauseyou're diversifying the growth
(15:59):
and risk uh uh sides of theequation.
What you're not diversifying iscash is king.
Recognize that hard to predictwhen it starts, when it ends,
just hold through those periodsand diversify the things that
are diversifiable that you'renot compensated for.
And that's generally how I thinkabout that risk parity
framework.
SPEAKER_00 (16:17):
So Alex, staying on the topic of risk parity.
Um, for the audience who may notknow it very well, can you walk
us through uh RPAR, the riskparity ETF that you manage, and
talk a little bit about whatproblem is what problems it's
built to solve and how does itexpress the principles behind
your approach?
SPEAKER_01 (16:34):
Yeah, so this is something that I've been using
with my clients for 20 years,this framework.
And and basically owning, youknow, things like gold and
commodities and inflation linkbonds on top of equities and
high quality nominal bonds.
So that's something I've beendoing for 20 plus years.
I learned it from Bridgewater acouple decades ago.
That's the framework that theyuse.
I think it makes a lot of sensein building a diversified
(16:56):
allocation for clients.
Um, so about six years ago, uh,we figured out, you know, it'd
be a lot more efficient if wetook that strategy and wrapped
it inside of an ETF vehicle.
Um and and and it basicallyallows you to implement the
strategy a lot more efficientlyand effectively.
And and the areas where I thinkit's really helpful is uh, you
(17:17):
know, number one, is it's noteasy to be diversified.
It's not easy to be balanced.
So for example, you know, gold,everybody loves gold today
because it's gone up so much,but there was periods where it
did terrible.
And those are the periods youhave to own it so that you can
enjoy the benefits of the runthat we're seeing uh currently.
It's too late to buy it afterit's up, you know, 50, 60%.
(17:38):
Um, so so it's hard to do it insize.
Um, same thing with withtreasuries, uh, inflation-linked
bonds.
Uh, both of those have beennegative the last five years,
long-dated treasuries and tips.
Um, but those are greatdiversifiers in a portfolio.
Commodities have gone throughlong stretches with them done
great, long stretches with themdone poorly.
So, to get more balance, it'shelpful to wrap it inside a
(18:01):
single vehicle where you can putall those allocations in place.
Uh, rebalancing uh canpotentially be a huge benefit to
clients, you know, buying low,selling high.
Uh in theory, it it makes sense.
The math proves it out.
In practice, I can tell you it'sreally hard because it's hard to
tell people sell your winners,buy your losers.
Because the assumption is thewinners will continue to be the
(18:21):
winners and the losers willcontinue to be the losers.
Why would I why would I makethat trade?
Um, but we know that works overtime.
Uh it's also difficult when youhave to sell the winners and pay
taxes.
You have cap gains when you sellthe winners typically.
So you put all that inside of anETF wrapper and you gain the
efficiencies of overcoming thatthat emotional burden of buying
low, selling high.
(18:42):
Uh the ETF automatically doesit.
Uh, and then the cap gains getdeferred inside of the ETF uh
because of the tax efficiency uhstructure of the ETF.
Um so I think that's a veryimportant aspect of that.
Uh you know, the the our par uhhas a little bit of leverage at
the portfolio level.
It's achieved very cheaply.
Basically, the financing cost iscash.
(19:02):
It's hard to do that outside ofthe ETF vehicle by using
futures.
Um, so there's all theseefficiencies that come along by
wrapping that framework insideof a single vehicle.
Um, and then the vehicle itselfis very tax efficient because
it's an ETF.
And so the way I think about itis I think of it as a tool.
If you're trying to build a morediversified allocation, you can
(19:23):
own some RPAR and you canbasically take whatever your
current allocation is, add RPARto it, and you take a step
towards being more diversified.
And the and the further you wantto go along that spectrum, the
more you own.
If you don't want to be thatdiversified, you can own less or
own none.
Um, and I just think of it as atool in the toolkit to help you
get there in a very efficientway.
SPEAKER_00 (19:43):
Wow.
So you did a great job of uhexplaining the psychological
psychology behind uh buying andselling.
Uh, just lastly, Alex, foranyone watching who wants to
follow your work or learn moreabout what you're doing at Evoke
Advisors and about uh RPAR,where's the best place for them
to go?
SPEAKER_01 (19:59):
Uh sure.
So the RPAR website is rpar.com.
Uh we do quarterly webcaststhere that are uh the replays
are uh posted.
Uh there's a lot of informationabout the ETF, so you can go
there and learn about that.
Uh and then evokeadvisors.com uhis our website.
Uh we we share insights there, alot of other tools.
(20:20):
And then also my podcast isinsightfulinvestor.org uh if
you're interested in tuning inthere.
SPEAKER_00 (20:25):
Oh, Alex, thank you for that.
And I always appreciate yourinsight and thanks to everyone
for watching.
Be sure to like, uh share, andsubscribe for more episodes of
Lead Light Live.
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