The Derivative - Setting the Risk Parity Record Straight (it’s NOT just stocks/bonds) with Resolve’s Rodrigo Gordillo and Mike Philbrick

Episode Date: May 12, 2022

We’re talking with the purveyors of one of the best performing mutual funds thus far in 2022, the dynamically shifting asset allocator, RDMIX (past performance is not necessarily indicative of future results). It hasn’t all been rainbows and lollipops, however, for the ReSolve Asset Management Global team of Rodrigo Gordillo and Mike Philbrick, and they explain why and when a core of Risk Parity should work, and exactly what is and isn’t a Risk Parity approach (hint: it’s not just levered stocks and bonds). In this episode, we're tackling topics like; does anyone actually use 60/40, The RDMIX 50/50 portfolio (50% Risk Parity/50% Alpha Strategies), ensembles of alpha sources, diversification of betas, and asset allocation in general, commodity trend following, return stacking and dispersion, and more. Plus, we're getting personal with Rodrigo and Mike (we even include Adam), and it's up to our host Jeff to decipher what is true and what is not. Chapters: 00:00-02:03 = Intro 02:04-20:19 = Does anyone actually use 60 /40?,  "TIPS", and inflation 20:20-30:25 = No, bonds aren’t the end of Risk Parity, Risk Parity isn’t just Stocks/Bonds 30:26-46:01 = RDMIX’s 50/50 portfolio = 50% in Risk Parity/50% in Alpha Strategies 46:02-01:00:53 = Ensembles, Diversification & Asset Allocation in RDMIX 01:00:54-01:16:13 = Commodity Trend Following, Return Stacking & Dispersion 01:16:14-01:24:54 = Three Truthful/not true, well... Manager "stories" from ReSolve From the Episode: Return Stacking Whitepaper  |   Lunch & Learn webinar with ReSolve Asset Management  |  ReSolve's Riffs Podcast Previous Podcasts: Researching the Risks of Return Stacking  |  Talking Asset Allocation, AI, and the Alpha process with Resolve  Follow along with Rodrigo Gordillo @RodGordilloP & Mike Philbrick @MikePhilbrick99 on Twitter and visit investresolve.com for more info Don't forget to subscribe to The Derivative, and follow us on Twitter @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Happy bear market, everyone. Well, not really. S&P is only down 16%, not 20% yet. But it's starting to feel real, isn't it? Amazon down 40% or so. A bunch of stuff like Peloton, Shopify, Zoom, and more down more than 80%.

Some CryptoLuna, UST, stablecoin stuff breaking. Interesting times indeed. Which called for interesting guests. See what I did there? Which we have coming up in spades this month. We got part two of the Noel Smith of Convex AM next week. Talking volatility trading. Good timing on that. Then Anthony Zhang from VinoVest for National Wine Day. Then Charlie Magera, chief strategist at blockchain.com, by way of some rather interesting

former places like Goldman Sachs, on talking crypto and trend following. And be sure to go listen to Jeff Eisenberg over on the Hedged Edge pod talking with Dick Stiltz. Great name. On to this pod where we have Rodrigo Gordillo and Mike Felberk on, which you may know from their entertaining Resolve Riffs Friday live show slash pod. But these guys have real jobs too, running Resolve Asset Management Global with Adam Butler and sub-advising on a risk parity based mutual fund. We talked through how leveraged stocks and bonds hijack the risk parity name, how Resolve layers alpha strategies on top of their carry-tilted risk parity approach,

also get into what exactly carry-tilted means, and play the best version yet we've had on the pod of Two Truths and a Lie. Send it. This episode is brought to you by RCM's Outsourced Trading Desk, which guys like Resolve use 24-6 as their outsourced trading operation. Check it out under the services slash trading firm slash 24-hour desk on the main navigation at rcmalt.com. Now back to the show. Okay, we're here with Rodrigo Gordillo and Mike Felbrick, dialing in from the Cayman Islands. Welcome, guys.

Thanks for having us. Yeah. Yes, great to be here. How are you doing? I'm good. How's things down there? Nice and warm? It is very warm. Rainy. I think I'm just starting to catch up on the heat a little bit. It's 35 here in Chicago today, so I'm a little jealous.

Last week, we had like a 79-degree day, and it was like God stepped on a human ant pile. Just people everywhere, every street. Pouring into the streets. Oh, my God. So much to my chagrin, we're going to talk about a mutual fund you guys sub-advised, which comes with a disclaimer. Yes. So let's have some fun with the disclaimer. The dramatic reading of the investment disclaimer. We are the portfolio managers for the Rational Resolve Adaptive Asset Allocation Fund.

And as we discuss the fund today, do not treat our opinions as a specific inducement to make an investment in this mutual fund or any fund that Resolve Global manages. It is also not a recommendation to follow any specific investment strategy. Our opinions are based on information we consider reliable, but we are not making any warranties of its completeness or accuracy. Past performance is not indicative of future results, and we do not guarantee any specific outcome or profit. Listeners should be aware of the real risk of loss in making investments or following any investment strategy.

This discussion does not take into account any individual listener's specific investment objectives, circumstances, or needs, and is not intended as any type of recommendation. Listeners should make their own independent decisions regarding any investments discussed here today, considering whether it is suitable for their objectives, circumstances, and needs. You might also consider seeking advice from your financial professional or an investment advisor. And with that, I conclude the dramatic reading of the investment disclaimer. Very serious stuff. Thanks.

Class all around. You ever considered doing a side hustle for Cialis ads or something? Did you recognize my voice from that? I did. That's good. All right. We'll never get those two minutes of our life back. So let's get on to the show. I want to start with the old 60-40 portfolio, Rodrigo. It's been getting wrecked, which is about as polite as I can put it. So does this sort of point out the flaws in that thinking, Rob? Well, yeah, no, the flaws have always been there, right? But, you know, the truth about investing is, or anything in life is that you, it doesn't matter how much you talk about it. Wisdom only

comes via experience. And I think in the last 10 years, just looking at the numbers prior to 2020, when 60-40 is looking at a sharp ratio nearly of two, just to put that into context. Historically, the sharp ratio of equities is 0.25 to 0.3. Sharp ratio of sovereign bonds is 0.25 to 0.3, together in 60-40, maybe 0.45. We've seen a sharp ratio of nearly two for a decade. And so when you see that as your lived experience, it doesn't matter how many times you hear what the actual legitimate and fundamental blind spots of 60-40 are, you're not going to pay attention to it. And certainly it costs too much to act on those blind spots. So what are they? They should be fairly intuitive. One is inflation. As inflation rises, then you're going to have

whatever rates are in the market and bonds be underwhelming compared to what real cost of living is. So bonds are going to go down in price, they're going to be less favorable. And then prolonged and persistent multi-year bear markets are also going to hurt equities, right? And so those are the two blind spots at 60-40, prolonged inflationary regimes and prolonged bear markets, which we haven't seen. Inflation we haven't seen in 40 years, real inflation really. And a prolonged multi-year bear market we haven't seen since 2008. So I think we're being hit in the head with it in the last couple of quarters and people are starting to perk up to what they need to do to fill in those blind spots. And even beyond the last decade, the last 40 years, right, it's been very rare for bonds and equities to go down at the same time. Together, right.

The stagflation environment, right, where you're seeing low growth and prolonged inflation. But we did see inflationary growth in the 2000s with two major bear markets in the tech crisis and the 08 crisis. That didn't fare well for 60-40, but certainly the bonds acted as a good offset during those two regimes. And what do you say to, I've started to see more of this as bonds have been getting hammered of, who cares? Just it's duration. You get your principal back at the end, right? If you're doing a 60-40, you should be rebalancing. So that kind of negates the duration. Like, what are your thoughts on how that dynamic works?

So how the dynamic of... Just that argument of like, who cares if bonds are down? Like, you'll get your principal back at the end. Yeah, well, it depends on whether you want principal that purchases the same amount of goods as it purchases today, right? Like we're talking about nominal return of capital rather than real return of capital. So it's certainly important to understand that dynamic that just because you're getting

a coupon that is fixed for a 10-year period with a value that existed today, if inflation doubles, then you're going to get half the purchasing power and half the coupon you expected in real terms. That's the only thing that really matters. So the importance here from the perspective of balance and diversification is that you need to have something to offset the risk of an inflationary regime and bonds just simply don't do it on their own. Mike, does anyone actually do the 60-40 portfolio anymore? Are you talking to investors who actually have that? Yeah. Well, I think we're in an interesting set of circumstances where we've had declining rates for 40 years. And so even the recency bias that people are experiencing, which then feeds the overconfidence bias, which then feeds the performance chasing, all leads to 60-40 as being the predominant benchmark. And although we don't see a lot of

60-40 particularly, i.e. 60% stocks, 40% government bonds, what you do see is a lot of proxies for that 60-40, a lot of chasing income for the 60-40. So the 40% that's in bonds, it's not in sovereigns, it's not in US dollar type bonds, it's often in some junk or chasing a little bit extra yield. And so all of a sudden that introduces a further equity component to the bond portfolio, rather than having true bond risk there. And you also have this weird imbalance where 60% in stocks, that volatility dominates the portfolio. And that's kind of a 90% stock portfolio from a risk perspective. And if you think about the last 40 years, what has been predominant? Well, interest rates have been falling. So you've had benign inflation, you have had global growth, and you've had abundant

liquidity. And this has caused this cycle of a recency bias over confidence bias leading to performance chasing in what is the 60-40, we'll call it as the benchmark. And I think that's pretty close. The correlation that most portfolios would be feeling is very close to that. Is it that specifically? No, it's not, but it's not iterating very far. The alts that they're including are like private equity, which is equity. It's in the name or it's credit and credit functions a lot more like equity than it does bonds. So I think at root, yes, most folks have a pretty significant correlation to a stock bond portfolio. Is it specifically that? Maybe around the edges, it's not, but it's probably 95% correlated to that.

That's interesting. Popped into my head of like, that's probably on the conservative side, right? People have probably said, oh, with the 60, let's do a little more NASDAQ. Let's put some in ARK. Let's do some higher growth stuff. And like you said, on the 40 side, hey, yields are zero. We got to get some yield out of this 40% side. Let's do private credit or peer-to-peer lending or whatever, crypto yield farming. Yeah. And so you're right. The equity side is probably a beta of 1.1 or 1.2 to the S&P. It's not the S&P, for example. And most people have abandoned those diversifiers, the emerging markets, the small cap value. The bonds even to some extent have been abandoned previously because it's hard to underperform such an easy benchmark for a long period of time.

And that's what diversity in a portfolio does. Now, how you achieve the diversity and how you want to think through that problem and account for changes of inflation, the expectations around inflation and changes around the growth expectations. That's a very, very large and wide open discussion of how you're going to want to approach that. And we've certainly taken a view on that in the Rational Resolve Adaptive Asset Allocation Fund. And that has paid off in spades over the last six to eight months. I will tell you it's had its trying moments, though, over the last three to four years. It hasn't been all rainbows and unicorns. But now is the time where this is starting to shine. And why is that? Well, think about that global growth, benign inflation, abundant liquidity.

We're going to have a CPI print that's double digits. So benign inflation is done. We have quantitative easing ending, i.e. quantitative tightening. Preston Pysh, I like quantitative teasing that you have, the Freudian slip there. Greg Foss, Yes. So we're pulling that out of the system. And at the same time with the supply chain issues and the surge in this commodity and inflation impulse, you have global growth starting to shiver a little bit, starting to quiver a little bit here. So the three pillars

that have driven returns to the 60-40 paradigm are shifting. The sand is shifting. And now folks who've been trapped over there have to think, is it too late? What do I do? If I allocate away, what am I allocating to? How much? What strategies? They're sort of caught flat-footed here. And a lot of them are saying, right, the Fed will save me. Like, bring the pillars back. Right.

Yeah, yeah. Where's the Fed put? Yeah. So what are your thoughts there? Like, they can't? They can't control some of these things? Well, I mean, you look across. So the Fed put is an interesting

one. They probably can for the next year, just buy bonds all day or teeter this thing on the brink. Japan certainly cannot. So Japan is going to have to buy a lot of those JGB bonds as we go through the year. They're not going to be able to tolerate a 1% interest rate, I don't think. And there are 25 basis points now. So it's interesting because it could be that the central banks are engineering a slowdown on purpose in order to facilitate the development of the supply chains, in order to slow the economic growth, kind of put the brakes on it a little bit and allow the system to kind of catch up, allow inventories to build in the commodity areas, allow the supply chain issues to fix themselves. I mean, if you're thinking as a central banker, that's not a bad plan. You can't have runaway growth right here, or you're really going to have some issues in the commodities for

whether they're food commodities, whether they're base metal commodities, there's not a lot of extra inventory around. So it almost makes sense to me if I'm the central banker globally to kind of say, I don't mind over-tightening here a little bit. But that comes back to like, okay, maybe those pillars can still exist. But I think you guys talked about in the pandemic, like no harm was a big thing there. So it's like, who knows what the Fed's going to do? Who knows what the central bank's going to do? Just position yourself well so you do no harm. You don't take a big bet one way or the other. Well, and that's the basic premise of one of the parts of the Rational Resolve Adaptive Asset Allocation Fund is it's based on a risk parity framework,

which takes into account the two dynamics of inflation and growth and those four quadrants that stem out of that and builds a portfolio that has assets in it that are structurally robust each area. So the areas of stagflation and deflation have assets. In stagflation's case, it's commodities, it's gold, it's those inflationary type assets. Those are the things that can carry the day. In a deflationary bust, it's more long-term government bonds and gold that carry the day. And if you want to start from the position of let's be prepared rather than trying to make too much in predictions, you start with a risk parity framework at the base. And then you layer on what you believe can be excess returns and alpha added to the portfolio.

Trey Lockerbie a few things to unpack there. One, as we're talking about protection, a lot of people were worried about inflation that's going to come someday and bought tips. They thought they were protecting themselves. Rod, what are your thoughts on why that went so poorly for them? Well, you know, tips are a complicated asset class and often misunderstood. Also, inflation is a complicated scenario and often misunderstood. Right. So what inflation are we talking about? I think people think inflation is this blanket term of the CPI.

But inflation, as we know, can be commodity inflation. I mean, certainly commodities have really struck a winning chord here in the last few quarters that may or may not be feeding into the CPI. Inflation can be monetary inflation. It can be supply pull or demand. So supply push or demand pull inflation. So all these things will affect different areas of the economy and different asset classes in different ways. So tips are only a solution for a type of inflation. And the commodities, certain commodity sectors are going to be affected in different ways. So we are short a bunch of commodities and long a bunch of other commodities. Obviously, energies and grains are going to be more long right now. And we're short certain things like copper and the like. So you're going to have deferring impacts of the, I would say, term structure of inflation that is going to get you back to what we're talking about, which is massive diversification.

And so back to tips, you know, tips have been outperforming, like they outperformed in 2021, compared to the aggregate bond index, because remember how tips are priced is based on the expectations of inflation. So at that time, you saw if you were a tips owner, you actually held it really, really well. What's happened in 2022 is that the Fed has come in and said, we are going to be hiking rates to fight inflation. And so the outperformance in the past two years is now underperformance based on the Fed actually making a go at trying to reduce the amount of inflation that might exist, right? So tips were good for inflation, monetary inflation, when it first started occurring after the COVID crisis. And now in the later stages, we're seeing other types of commodities fill in the other areas of

inflation. The other thing about tips that's tough is that Alex Shahidi wrote a book that kind of cleared it up really nicely, where you should think about tips as being half treasuries, half traditional treasuries and half inflation protection. So if treasuries are going to get hurt, tips are also likely to get hurt in similar ways, but to a lesser extent, right? So again, it's a much more complicated asset class. And certainly inflation is much more nuanced than people think. And that cuts both ways, right? Your protection is based on one singular reading of inflation, which is also, we didn't touch on highly messed with for lack of a professional term, right? Like adjusted.

Yeah. Better to have something that's kind of more natural. Yeah. And look, even gold, right, is another aspect. I was like, why didn't gold perform the way it should have? Well, it did, because gold is highly correlated to real rates of return, right, and monetary inflation. In 2021, gold did a phenomenal job. It was able to capture that monetary money printing and inflation that went into the economy. But then real rates went negative and stayed

negative for a long time and gold flatlined. So people were really worried, if it's inflation, why isn't gold? Gold is supposed to be my savior. It's just not gold is not enough. Tips is not enough. A single energy stock is not enough. You have to be diverse to fight against this inflation decade. Going back, talking about those four pillars and the base and the core risk parity core. I know you guys have gone back and forth between embracing risk parity, kind of pivoting from risk parity. It kind of gets a bad name here and there. Like talk to me about why is risk parity good or compare and contrast a simplistic risk parity approach with what you're doing in the RDMIX. Right. We need, we need a nickname for the fun. Can we come up with a nickname here on the spot? Uh, for RD mix? Yeah. RD mix. RD mix. All weather, baby. I like the all weather. It's all weather as

well, for sure. So with respect to thinking about risk parity and sort of thinking through the good, the bad, and the ugly. So quick, quick refresher on risk parity. Risk parity is sort of a risk-based approach to allocating assets, which makes it less sensitive to assumptions around the return, which makes it a little bit more robust. And you're going to want to have many diverse asset classes that are driving different structural return vectors to the portfolio. And then this allows you to target volatility. And so you've got some really nice, robust, sort of simple rules around this. And I will say that, you know, sort of carrying the risk parity albatross up the hill for the last several years and, you know, hearing about how bonds are going to be the end of risk parity has been something that we've soldiered on through, but now we're faced with this idea that, wait a second, look at these risk parity portfolios. And even the basic ones with bonds are often,

they're certainly outperforming the 60, 40, because they have a structural allocation to assets that do well when, when we have inflationary impulses and that's offsetting those losses. And that's this, you know, that's the old, you always have something in your portfolio that's killing it, and you always have something that's killing you. And those are those underperforming, diversifying assets. In this case, it's been commodities. And so I think there's been actually a very positive shift lately. Everyone's rediscovering risk parity because they're seeing the robust diversity in the portfolio. And that changes across different implementations. We have to keep in mind that the implementation, there's a lot of details in how you might implement it, what kind of structure it's going into. Is it a mutual fund?

Is it an ETF? Is it a private fund? And those three different domains have very explicit limitations that can drive some of the investment returns in one direction or another. And so those are considerations as well. But I think that most folks, as we've talked about, the 60-40 have been overexposed to that growth, low inflation, abundant liquidity dynamic. That has shifted. We've had a shift in the regime and risk parity has a portion of the portfolio that's structurally targeted at the shift. And so some things in the risk parity portfolio are killing it, but nobody else owns those. But risk parity does. And those who are in a risk parity framework already know what they're going to do. They know what the allocation

was. They know what the allocation will be. and they know the steps to take in monitoring their portfolio. Contrast to that person who's got the 60-40, maybe with a NASDAQ tilt and a little bit of arc. And now they're like, oh shit, what do I do? How much do I sell? Maybe it'll come back. Then it comes back and they say, I don't need to sell. I don't need to rebalance. I'll just stick with it. And then it hits them in the face again and they go, oh shit. And so we have crisis, necessity, change. Those folks are going through a crisis. There will come a point when they feel a necessity and they'll make a change. Others, those who have been in more risk balanced or all weather portfolios aren't faced with that right now. And then you've got, you know, what do we do on top of that? So we can talk about the alpha that comes, you know, with how you might think about

that, but let's pause there and I'll flip it over to Rob. Let me just add a couple of interesting things. You asked, you know, what, you know, we thought about talking about risk parity, not talking about risk parity. I think the first issue with the name, the label risk parity is that it's been hijacked by people who just lever up bonds and equities. It's like a lever at 60-40. And somehow that got the label of risk parity. And it's not. I mean, risk parity is an equal contribution from inflation assets like commodities, equal contribution from growth assets like equities, and equal contribution from protection assets like sovereign bonds, right? And that third component, that third leg of the stool, the inflation portion is missing

when people talk about risk parity. When they say that risk parity is going to blow up when correlations between equities and bonds go to one, like they have in the last two months, they're right. I agree with them. That type of risk parity is going to blow up. But a balanced risk parity,

I think if you look at just a plain risk parity, Invesco has one, AQR has one, they're flat to down a couple of points throughout the year. They haven't gotten hurt because of that inflation protection, right? Now, what we do for the fund is a bit more robust because we are, we made, again, different implementations. We have a carry tilted risk parity portfolio that allows us to kind of overemphasize asset classes with a positive yield. One of the biggest detractors of risk parity has been that, you know, why are you adding to asset classes and have no return expectations? Well, if you do a little bit of tilting on the carry side, that base portfolio is doing well. The other thing I would say that people tried to go against risk parity on is, well, how

well did it do in periods of liquidity events? Like, you know, there is a portion there in November, October of 2008, when you see a gap down. I thought it was an all weather strategy. Similarly, the last week of the crash and COVID, there was, you know, it was holding well, holding well, and then it had this a little bit of a drawdown. Well, that was when everything correlated to one. Yes, gold and commodities and equities and bonds for a short period of time went down together. So I think a blind spot for risk parity

that is a valid argument is the liquidity shocks. The way we've handled that in the fund is we've added a long volatility strategy that has the ability to fill that gap, to be able to offset the losses when things do correlate momentarily to one. And so when you put those two together, you actually get a pretty good, robust risk parity framework. Balance across asset classes, updating your weights consistently, doing a carry tilt toward it, and then filling that liquidity risk with a long volatility strategy. And then we'll get to the final overlay, the stacking on top, I'm sure we'll get to soon, which is the alpha side. So talk to me a little. So it seems like we're saying risk parity is not necessarily because of the risk parity piece of it, but the choice of the assets. The choice of what you're allocating to is way more important to keep that stability than the risk weighting per se.

You need the structural differentiated sources of return. So sovereign bond risk is very different than the risk you derive from owning stocks. And that's very different from the risk that you derive from owning commodities. And then the various different types of commodities within the commodity complex are also quite diverse in offering different opportunities and areas of excess return to the portfolio that are different. And what Bridgewater's, everyone's example, right? So has Bridgewater always had that commodity piece? Do we know? I don't know. As far as I know. Commodities and tips. They've leaned on tips because they're so large, right? Yeah. As you know, there's a CFTC limit as to how much exposure you can have per organization on commodities. And so as they bumped up against that, they're massive, right?

They're multi-billion dollars. They had to find a solution to protecting against inflation. And their solution was to go to the government and actually lobby. And they created, they were a big part of why tips exist today back in the late 90s is is lobbying the government to be able to to create something like this in order to be able to create a risk parity strategy in that manages billions and billions of dollars saying the fund was at capacity wasn't an option they yeah they're like nope rarely is on. We can go to 150 billion. Let's get it done. The other interesting thing, as I understand it, and speaking out of what we

might know about Bridgewater, is that it's a counter-cyclical approach to risk parity. So when the market's coming at them, that's when they'll buy bonds. Let's say bonds are going down, they're actually buying that topping up the bond portfolio. So rather than trying to chase an asset class because they're so large, they're a little bit more counter cyclical. So as asset classes come down, they're selling the ones that are going up and buying the ones that are on the drawdown because the volume is there for such a large portfolio, a smaller advisor manager like us is able to be pro-cyclical. So we can emphasize the portfolio with things like a little bit of carry or a little bit of trend rather in those types of things and not have the slippage eat into the profits too much. Get more active, yeah.

Is that why they underperformed during most of that stock run-up? Because they're waiting for it to come back into them a little bit instead of reallocating into it. Well, they would be selling the stock part and buying the bond part. So, Rod, you mentioned carry tilt. Can we define that and talk about what that is exactly? Well, it carries like the equivalent of yield, right? The definition of carry is what return you make assuming the price of something does not move. So, for example, the carry of an equity

is its dividend. If the equity, if the stock starts at 50 in the beginning of the year, ends at 50 and you receive the 5% dividend, that's your carry, right? In the futures world, you deal with periods of, with asset classes that, contracts that may be in contango or backwardation. And so you're either going to be in contango or backwardation. And so you're either going to be in a position to have a positive carry, where if you hold that futures contract that's below spot, it's going to gravitate towards spot by the end of its maturity. And by holding it long, you're going to have a positive yield. If the opposite is true, if it's going to cost you to carry,

if the contract costs you more than spot, then it's going to gravitate lower. And so while the asset class might go up or down, the carry, if it doesn't go up and down, the carry will provide a negative yield. And so you want to tilt towards asset classes and futures contracts that have a positive carry and tilt away from those that have a negative carry. So another way to think about it is you want high yield versus low yield. And so when you say the portfolio has a carry tilt inside each selection of each stock index, each bond inside each sleeve has that carry tilt? That's right. And so would that look like you're always choosing the higher

yielding bond? What's the practical limitations of that, right? You're not going to go into urgent debt. It's again, it's overweight versus underweight. You're not going to go 100% with the highest yielding asset class. We're still want to keep the essence of the risk parity concept and in recognition, again, this is why risk parity implementation across different providers is so important. You know, for us, we think that having a carry tilt, we know intuitively it makes sense. And so you want to, for us, it made sense to have that extra layer tilt on the risk parity without sacrificing everything that risk parity is, the right at the limit uh you would just choose the one security that has the highest yield that's not what we're doing we're and keeping the risk parity framework and tilting slightly and carry always right oh wait people are

getting carry traders are getting taken out in body bags as correlations went to one and yeah all that currency traders were keep right okay carry currency traders were carry isn't necessarily counter cyclical um and across commodities across equities and the like um certainly speak to that with officially yeah and uh statements yeah you're seeing it year to date i think carry is doing a phenomenal job like a pure long short carry strategy is actually holding up really nicely and making some returns And statements. Yeah, you're seeing it year to date. I think carry is doing a phenomenal job, like a pure long short carry strategy is actually holding up really nicely and make some returns. So it's not it's not people perceive carry to be that currency carry, right, where you're long the Mexican peso, and short the U dollar. And if something goes wrong, and in a recessionary environment, then the U dollar goes up and everything else gets taken to the cleaners.

That's not the case if you're using a carry strategy across the board. So that's the number one thing that's important to understand there. And also if there is components of the asset universe that will get taken to the cleaners, that's another reason why we have that long volatility overlay. And there's also the alpha. So, I mean, coming back to first principles on it, risk parity allocation is an allocation based on the volatility of the underlying asset and assumes all the returns are basically the same. And you can enhance that by having some insights on what the actual carry yield is going to be and use that as your return estimate.

Turns out it's not a bad estimate and you can construct a pretty robust portfolio with that. Right. It just comes back to the rest is all basically noise, right? There's something structural there you can more count on than the rest of the noise. And we might have buried the lead here. Let's just go back for a second and talk about the, why we're saying that the naive risk parity is just stocks, bonds, the more advanced is stocks, bonds, commodities. So just give us the whole- I wouldn't even call it naive risk parity. Call that a levered bond equity portfolio. Yeah, precisely. So there's levered stocks and bonds. That is not risk parity. That is a portfolio that is imbalanced and it does not cover all the potential economic regimes that can manifest. In order to do that, you need to include

assets that thrive in inflation. And so if you haven't included those, you don't really have risk parity. You've violated the first paradigm, which is maximum diversification so let's say we move to the the risk parity which is only risk-based we're going to just take the the return assumption out and whatever the vol of the asset is we're going to allocate on a risk weighted basis and we're going to make sure that we have equal risk allocations to the four regimes that can occur. And that's a pretty robust four by four. It doesn't matter what the weather is, you're going to get to work. If it's the wintertime, your four by four is going to get you to work. If it's summertime, your four by four is going to get you to work.

Other cars might be a little bit more seasonally sensitive. If it's sunny out, you can drive your sports car, which maybe is your 60-40, levered 60-40. But when it starts to get snowy, that's going to be a bit of a wreck. And then you go through, okay, so what can we layer on top? And we've discussed this a little bit. I think the construction matters, but we could spend hours on that. I would say, basically, risk parity should cover these four regimes that can manifest from these two dynamics of inflation and growth. We definitely do that. We have some insights on that that I think are better return assumptions than just using the volatility as a return indicator

for the portfolio. And then we add on the active overlay. So we've actually been probably from the beginning of the year, net short bonds in a risk parity portfolio because the alpha side was saying, yeah, these bonds are no good. Reduce, reduce your allocation. Yeah, still no good. Keep reducing the allocation until the allocation is actually marginally negative. And that has been a significant source of profits in the portfolio since the beginning of the year, which is what happens when you get an inflationary shock. That's what happens to bonds. Bonds are discounted cash flows. We are changing that little R in the discounted cash flow calculation. When you change that little R, it changes the end result and has pretty dramatic outcomes on the final price, which is what we've seen bond prices go down as yields go up. And the sources of alpha or our alpha stack or our ensemble of features identified that and sort of kept us out of the way of bonds. That's been

attenuated and is much more neutral now. It's much closer to sort of flat bonds, just slightly short in some portfolios, slightly long in other. And that has to do with the different constraints and assets available in different portfolios. But for RD Mix as an example, a marginal short in bonds generally in rates at the moment. And by the way, I just want to warn everybody when we talk about positioning today, it changes every day. So please don't take that as any kind of indication as to that's what it'll be tomorrow. Not investment advice. Yeah. Yeah. Yeah. So I'm just trying to provide color and flavor. And in an inflationary impulse, actually being short bonds does provide some pretty significant value.

And just in practical matter, is the trend following is taking you short bonds? Or is there also, you're saying kind of a risk overlay that's on taking the weighting down on the kind of core side? Let's take a step back and really, I want to flesh out that alpha overlay. You know, we've written a piece called Return Stacking last year that's gone pretty viral. And I think the term is intuitive, right? What we're trying to do is allow ourselves to identify unique sources of return and then stack,

you know, we like risk parity. I like that. You like long volatility, stack that on top of risk parity. And then, and then if you have any expertise in trying to predict the future, you know, our, our hedge fund is trying to predict the next five days movement of any asset class and has an equal chance of going long or short any asset at any time. All right. So now we're really, our hedge fund is hubris. What we did is we grabbed that concept, that hedge fund alpha and stack that on top of risk parity and long volatility. And so the correlation between something like pure alpha and that best beta is zero. And that's what we were doing with RDMIX. Right now you've asked,

what is the alpha? Like, what was it trend? Is it all pure trend? Is that what's making us short bonds? Trend is a trend is in this bottom piece as well. Right. And, and a risk parity. No. Okay. Okay. Risk parity is not trying to risk Risk parity is the do no harm portfolio. It's the one that says, I have no real prediction of what's going to happen in the future. I just want to be balanced.

And so think about the way Bridgewater and Ray Dalio thinks about it, right? They don't offer a full single solution. They segregate their best beta, their all weather strategy, their risk parity, and they have a separate fund called Pure Alpha. And they allow the investor to choose how much they want between the two. What we put forth with the Rational Resolve Adaptive Asset Allocation Fund is we made the decision for the retail investor. Half of the risk comes from risk parity and the other half comes from our version of Pure Alpha.

And that version of Pure Alpha has trend as one of the styles. It also has mean reversion as another style. It has seasonality as another one. Carry is another one. Relative value is another one, right? So these are unique drivers of future returns with an expectation that it's going to continue to exist for structural reasons.

And we don't know whether trend is going to be the best performing thing for the next 10 years or the worst. We don't know whether it's seasonality that's going to outperform everything or not. And again, now we're grabbing our alpha sleeves and applying a risk parity understanding that if you don't know the future of your alphas, you might as well use them all. Right, right. So trend has contributed to the short of bonds, but so have other of these mean reversions and whatnot, right? I love it. So that's the part I was trying to get at. We're making progress. So that core base, just give it to us one more time so listeners understand inside just the risk parity piece is

stocks, bonds, commodities. That's it? Anything else? Rates, currencies. Equally weighted. But essentially, you think of it across each market or as buckets of the stock bucket, the bond bucket, the commodity bucket? Yeah. You'll think about it from the perspective of, and when you x-ray the portfolio, you're going to see 60 plus futures contracts. We are creating and identifying their correlations and volatilities and making sure that each one of them contributes an equal amount of risk to the portfolio with a slight carry tilt. That's the way to think about that. For every dollar that you give this fund, you're going to get a dollar exposure of that

kind of all weather long only risk parity portfolio, right? A little bit of humility, something that can get us there, that four by four truck that's going to get you there long term. And then, you know, we overlay on top of that a layer of long volatility, just for the rainy, real rainy, thundery days that even the four by four might get stuck in, right? And then finally, we have the special forces coming in and stacking that return for another dollar's worth of exposure on pure alpha. So again, the bridge water view, right? Your best beta, your best alpha.

The only difference is we're not giving people a choice. They're getting 50-50 in this case. And the 50-50, how often is that rebounds? Daily? Monthly? It's all integrated rebounds? Daily? Monthly? It's all integrated into a single trade order, right? The signals come in internally, we net it out, which is a huge benefit, right? We could have launched all those sleeves that I talked about, trend, mean reversion as separate ETFs or mutual funds, but then the trading costs are so large that the only way to really implement a multi-strat like that, including risk parity and that long volatility is to isolate all the signals,

net them out. And that netting effect means that we are trading on the daily, but we're trading around the edges most of the time. Although sometimes it can be very, very quick and abrupt changes, but the netting out across these things is what allows us to be able to implement this at a low cost. Right. So simplistic example of that, if trend wants to go short, 10-year notes, mean reversion wants to go long, 10-year notes, the same size, do nothing. Be flat.

Yeah, exactly. The other thing that's interesting on the tail hedge protection, the vol strategy Rod talks about is it's a bit of a flashing red light. It means something bad is going to happen when you start. It doesn't always happen, but it means that there's a critical state developing in markets where if something does go off the rails, it could go off the rails in a big way. And what was interesting is during the initial stages of the Russian invasion into Ukraine, we had almost a maximum position in long vol in V stocks in Europe.

And nothing happened in that attenuated. It wasn't a huge cost of the portfolio at all. You know, it was kind of a flat trade, um, but it was there and it always makes me a little nervous. It makes me nervous and excited because I know there's an opportunity for diversified, diversifying or differentiated outcomes, um, and that we're prepared. Um, but at the same time, you know, you, you, same time, you're seeing the conflict in Europe and thinking about what the actual ramifications can be, can be a bit scary. I will also note that we've started to see that red flashing light appear again in our dashboards. I was just going to ask if it was flashing yesterday.

It's flashed yesterday. We have positions on in that realm. And so, yeah, there's a high level of uncertainty in markets. And we'll see which way that goes. Does it attenuate? Does it break? We don't know, but we're prepared. We mentioned ensembles you guys have been banging the drum on ensembles for a long time talk to me about the difference between an ensemble diversification and asset allocation

sure i mean once it's it's a it's a layered topic right because? Because ensembles are, again, a recognition of our ignorance. And so I did say that the alpha sleeve, for example, human nature is going to be human nature, and people will pile on to things going up and run for the exits when things are going down. And so we understand this level, this base level of human nature, and we want to be able to capture it in prices. A longstanding way of doing this has been, advisors use this, the 200-day moving average, right? That is a way of capturing trend. Go long when it's above the 100-day and the 200-day, go short when something's below the 200-day. Diversify your assets and you're done, right? Okay, that's the signal. That's the human nature. That's kind of like what we decided to do. But what's so special about that perfectly well-coiffed 2-0-0, right? What about the 201-day moving average? Why don't we do that one,

right? It's a human heuristic. It doesn't make much sense. And so when you start exploring what trend might also be, it might be the 20 day, maybe the 300 day, it might be the two month crossing over the 18 month. Can you tell me for any real fundamental reason why the three and nine month moving average is not just as good long-term as the 200 right you can do a back test and find that the 200 beats the other one but for no reason but pure noise right i could come up with some bs but yeah yeah like it could tie to quarterly results it could tie to like months ends and people have to do stuff to finish a month but

yeah we've all been humbled enough in the markets to know that trying to be specific about something leads you to be specifically wrong. And what ensembles are about is about understanding that we'd rather be broadly correct. What do you and I see eye to eye on? We see eye to eye on the fact that people heard, right? We don't see eye to eye on maybe on the, you believe in the 200 day, and I believe in the six and nine months moving. Well, that's silly because none of us can prove whether the future is going to be one or the other, but we can all get behind the fact that they're probably all both okay. And so if you kind of play that out and you create as many thoughtful ways of extracting hurting behavior, and you put all those together,

then what tends to happen is we wrote a paper called Global Equity Momentum, a Craftsman's Perspective. And we're talking about a simple, I think, 10 or 12 month strategy where you go with the S&P 500, you go long or flat. It's based on Gary Antonacci's global equity momentum. And we were saying how that works over time because it's turning behavior, but it may not be as robust. And then we went and tested all the different imagination that we could put in towards trend and momentum

and found that using an ensemble and netting out creates a much higher Sharpe ratio, a much lower drawdown, a much, a much stabler equity line long term than being specifically wrong about a single thing. Right. And so you can imagine how this can be applied within trend, it can be applied within multiple factors and using them all in all in and mixing them together and netting things out and so this is kind of our dna our dna is diversity and diversification and balance and that includes diversification across alpha buckets and across alphas that's the idea of ensembles a little sense of humility um right and i think jason buck coins as like the, he's trying to get the beta signal

out of the alpha, right? The more you ensemble it, you can get like one signal out of there instead of one short, one's long, one's flat. And so how does that differ from your views on asset allocation? So then why wouldn't you do what you sort of do do, but right. Infinite number of assets, Bolivian real estate, and right. Just like go across the board and we need more and more and more assets in the asset allocation. Mike, do you want me to answer that? Yeah, please. So, so the, I thought you were on a roll. Yeah, sure. Like it's all constrained as to what you can, what you can allocate to you. So the first thing is, what is liquid that I can allocate to so that I can maintain the balance by being able to trade that market on a daily basis? And so first, where do you get all this?

Where do you get access? The most liquid markets in the world that have diversity in them happen to be in the future space, right? Because if you, we did a study on this where we showed, you know, 2,500 stocks in the US and still no diversification, right? If you put those line items, you feel like you're diversified highly, but when you put on your risk parity goggles on, when you actually examine the amount of unique bets embedded in that market, you end up with 1.2 unique bets, as in it's basically a bet. Then if you extract that to, let's say, a permanent portfolio where you have gold equities and bonds, you end up having what you expect around three unique bets. When you expand that to the

futures universe of 80 plus futures contracts, in reality, sadly, we get down to around 13 unique bets long term. Now, this will vary depending on correlations and whatnot. It can be as high as 25 and as low as five. But on average, you see around 13 unique bets, right? so we don't so much see the world from the sense of line items and asset classes we see it from a sense of liquidity and within that liquidity universe using you know a maximum diversification algorithm there's a wide wide variety of ways to measure the amount of unique bets in the market and in a universe, we get the maximum that we can get, which is sadly not much. We got to get Elon tomorrow so that we can have a new economy that's truly non-correlated to what we have here. So it's really difficult at volume and high

liquidity to find truly orthogonal bets, but certainly we can do better than the two we have right now, bonds and equities, which have turned into one. And so part of this is, hey, Mr. Investor, you're doing this mutual fund. You're putting your 50K in there. I need to be able to let you out tomorrow. So I can't be in some locked up real estate thing or some- You can't be in Venezuela in oil. Yeah. And so if you were unlimited right you could be in cat bonds and things that are orthogonal and have no correlation to anything um cool yeah if you're a private trader and your net worth is a million dollars you can do a lot more than what we can do at you know 500 million and result and certainly we can do more than AQR can and so on and so forth.

Because of their size. Yeah. Yeah. That's interesting. So, I mean, put a finer point on that, right? There's, out of those 80 markets, 12 are grains and 10 are energies and seven are currency. So they're going to tend to group together and move together and be highly correlated it's essentially what we're saying but you're saying without without you'll basically do the math and bucket them without really you could do it blindly without knowing their names that's right just look at the time series you can get all the information you need right versus others might say hey we're going to do these five energy markets. We're going to do these five currency markets. And you end up with an allocation that's

intuitive. We look at data, the data spits out. And when we look at the labels, they make sense. Right. The other thing is that you kind of look at them as schools of fish. It is funny that from time to time, a fish will swim in different schools. So gold is a bit funny that way. It acts like a certain set of commodities and then it acts in a different regime, like another set of commodities. And so that is all calculated when we do the sort of systematic calculations daily. Is this fish swimming with this school or is it swimming with that school? That's why the word dynamic is right there in the name. You got it. There you go.

And talk to me a little bit about the systematic ability, right? Or pause on that. I want to talk a little bit about, we're talking about these futures markets, these 80 markets, right? You'd probably trade like cotton or something, right? For an individual investor to put in the man hours to understand the cotton market, to see what's going to drive it higher or lower, to get a futures account, to open it, to participate in that, it's just not worth it on

any imaginary scale to be able to access that market. Correct. And to do the calculations daily as to what is the optimal level of exposure given all the other exposures you have in the portfolio. So today markets are trading. There's changes in price that are occurring. There's changes in their volatility characteristics of those assets and the correlations. So at the end of the day, we run the machine again and it says, actually, this is the new allocation. And there's just no way, there's none of us that could do it personally and sit down with a pad and paper and do it. This is done by a computational intensity because it's an edge and the netting is factored into that. And the diversity is factored into that. And the signal strength coming from the alpha features is calculated into that.

And so that is a large set of calculations that are done daily and spit out a portfolio. And operationally, as you know, Jeff, that futures are much more different than trading stock, right? You have future expirations. When you're looking at your data and how you're testing on that data, you have to stitch together the different futures contracts going back in time. So if you want to do testing, you want to make sure you're getting robust data. When are you going to roll it? What's most ideal? You need to have expertise and trading expertise in different markets across that space. Do you have those? We have a team that is able to execute all those things, both internally and externally, that allows us to be able to provide whatever is on paper that seems to be alpha. There's a big difference between what's on paper and what goes in your

pocket. And that's the gap that oftentimes novice investors in the futures markets tend to miss. Right. The other thing is granularity. You know, a single contract can represent a large portion of your net worth if you're an individual. And so you'll start allocating more or less to a contract because you don't have the granularity required. And so in a way, there is a sweet spot there where you need X amount of AUM to be able to trade the system that you actually want. So there's a wide variety of operational reasons why trading futures is that much more complex and why it tends to warrant a higher fee generally. If it were easier, I'm sure the fees would be lower. I was coming at it from

obviously all that, you need all that expertise, but I'm coming at it from the investor who's like, cool, copper's moving. I need exposure to that. Cotton's doing this. I need exposure to that. Like to actually go get that exposure, not from the technical expertise, but just like, what ETF do I use? Where do I get that? Or like you guys have carbon credits in the portfolio, right? Like, hey, carbon's interesting to me. I want to get some exposure to that. All these things, it's easy to get exposure inside of this portfolio is what I'm getting at. Yeah. And it's monitored and managed. The other thing is, hey, I'm going to go get commodity exposure and toddle out and buy

the Deutsche Bank liquid commodities ETF index, right? The problem with that is you're going to be faced in that scenario. Let's say you took that approach back in the 2000s. In 2007, you were faced with a 60% drawdown in that commodity exposure because maybe you weren't managing it. Maybe you allocated on a capital basis and said, I'll plug my nose. Well, that's going to leave a pretty significant dent in the portfolio. Whereas if you're managing that commodity exposure vis-a-vis a risk parity framework, it doesn't have too much exposure in

the first place. Next, you're layering on top those alpha indicators that will attenuate exposures when it's not doing as well as it should. And then lastly, you've got a tail hedge protection in there to contribute some returns in those highly correlated timeframes where everything in the portfolio might be struggling. So again, it's thinking through this layer by layer and constructing a portfolio that is fulsome, that covers the areas that you're not going to do as an advisor. You're not going to short bonds and you're not, let's be honest, you're not going to own cocoa and cotton and platinum and palladium. You're not going to short bonds. Let's be honest, you're not going to own cocoa and cotton and platinum and palladium. You're just not going to do those things.

And so from the perspective of, will this add value to the rest of my portfolio or does this add value to a 60-40 portfolio, ergo the return stacking mindset? Yeah, it has a very low correlation to the 60-40 portfolio. That adds massive value. And it's something that in my mind needs consideration, especially when we've eviscerated global growth. We don't have benign inflation. We have raging inflation and we have contracting liquidity. You got to make a move. Yeah. But to me, the, and if you're wrong on all that, if those three pillars shoot back out of the ground and reestablish themselves, super strong. Cool. We've got the core. We've got the, we've got the base. That's going to be long. Those things you'll be okay. Commodity trend. We got to talk about it. CTAs, you guys have been banging the drum for about as

long as I've been. It was a brutal 10-year period in there where trend was doing nothing. I feel most everyone who's still in the game is back at equity highs. Just talk about, and you can even expand on that whole alpha bucket. How do you keep the conviction, right, of year after year of underperformance or losses to keep that in the model, to keep allocating assets to it? That's right. Systematic, thank God, because if it was like, you had to wake up every morning and hit a button to choose to keep doing it, you'd probably stop hitting it. Yeah, I think the understanding of history and historical dynamics is an important thing, right?

I mean, from trend alone, you can go back, there's been enough, trend is an easy thing to study across centuries even, where you can see that over time, trend tends to have this kind of, it tends to have most of its returns during convex environments when chaos ensues. But over that, there's one that goes back 600 years, you will see decades long periods where you're being chopped up and providing single digits. It's not like trend has done negatively for every single year for 10 years, it has underperformed what it did in the previous decade when everybody bought into it, right? you if you actually examine what the trend factor is it's like anything else it works over time uh over time but not all the time um and this is why you own it you own it when there's when there's chaos when there is prolonged trends. And so I've been talking a lot, in fact, in the webinar that I did with you guys, that lunch event that I did with you guys last week,

you might want to put the link up there because I go through the history of inflation volatility and when multi-asset long short strategies, such as trend, but also including things like value and carry when do they do really really well when there's dispersion when do we see dispersion right after growth stocks peak why did growth stocks peak because inflation was benign for a decade and persistent growth existed and when that happens liquid assets, every part of the liquid market concentrates into a handful of stocks. It happened in the roaring 20s. It happened in the 50s.

It happened in the late 90s and it happened in the last decade. But once that breaks and it generally breaks with a bit of inflation, you start seeing the trickle down effects of inflation. It stops being US currency and everything else. It stops being NASDAQ stocks and everything else. And you start creating ripples across the world. Currencies start to act differently across different pairs. You start seeing certain

emerging markets crushing it, that own copper, own gold, own silver. And then you start seeing emerging markets that are getting crushed, that have to import their grains in order to survive. You start seeing multiple opportunity sets. And that opens up alpha across trend, across seasonality, mean reversion, value, and carry. And so if you look at the, for example, the Goldman Sachs macro factor index in the 2000s and kind of scale it to 10%, it was an amazing decade from 2000 to the peak of the commodity boom, which was February, 2011. And then from 2011, when benign inflation came in, then you see nothing but NASDAQ and US Treasuries really dominating. And it's not,

it was just an underperformance. It wasn't a terrible thing. So you examine history, you identify moments of strength. I think multi-asset funds like ours are likely to outperform in periods of inflation for obvious reasons, right? What we're investing in, and we can go long and short these things. And we're likely to outperform during periods of prolonged, good old-fashioned sector rotation bear markets, where you can short the S&P like we have this year. You can short the NASDAQ like we have this year. You can short bonds and you can go long commodities. This is an ideal period for multi-asset long and short funds. And trend is a benefactor of that. And then when there's benign inflation, there's just less opportunity. So this is a great time

to be investing in these asset classes in my view. Well, you sort of answered the question, right? Because a simplistic view would be, oh, trend's doing well because energies have gone up. It caught it, right? Caught these single trends. But to me, like pivoting from that environment where it was struggling for those years, now into this environment, it's more than just these few trends and commodity prices are going up. Like you're saying, there's divergence. The yen seems to be doing its own thing. Some metals are going up, some are going down. So there's all this divergence and that's really what's fueling it. And to me, that's what can remain, right? That's what you need. If someone's like, is it too late for trend? Is it

too late for commodities? Maybe some of those trends, but if you can count on more and more divergence or the same amount of- Dispersion. Dispersion is the real key, right? If we have 10 investments and they all have the same, the exact same trading vector, they all have the same return. What's the opportunity for diversity in the portfolio? It's none. You need the fan of the vectors of returns in order to be able to structure a portfolio, to reduce the volatility by combining those lines to lever up or down that exposure in order to maximize exposure when volatility is stable and low, adjust when it increases. You need dispersion. If you don't have dispersion, it's tough to differentiate.

Yeah. Jeff, you remember how I was talking about the number of unique bets? On average, it's 13, but sometimes you're 25, sometimes you're five. If you examine the rolling unique bets that existed in the two thousands, we are hitting like peaks throughout the mid two thousands. And then we're, we have been at all time lows in terms of unique bets in the last decade, all of a sudden though, it's spiked back up. Right. So there's a correlation understanding why we put that chart out there. Let's, let's get that chart out on a blog post. It is it is in the works.

But the idea here is, why, again, going back to portfolio construction, and why do this is because most advisors have a bunch of bonds and a bunch of equities, and nothing else, or maybe now their bonds are bond like an equity like bond like bondlike stuff like private credit, right? Or private equity, God forbid. And so now I mostly see just an equity portfolio. What we need is that third piston that has the ability to fill in those blind spots, which is high inflation and prolonged bear markets. Understanding that if we go back to the last 10 years to benign inflation and persistent growth and everybody kumbayas and the world goes back to normal and we don't have supply chain disruptions and all that fun stuff, if we go back to that world,

then you as a portfolio constructor need to know that this piece is likely to underperform the year 60, 40. And that's okay. We need big winners and big losers. Here we are. That's why you stick to it and now it's winning. And to be fair, that was the reason that return stacking was postulated as a solution because people have not been able to get off their 60-40. So the idea there was let's give you your 60-40 plus 30 to 40% of alts that are truly non-correlated and have those different return drivers because you're so addicted to that group thing. You need to be there because you have to kind of be like your friends, but not too much like your friends,

right? When it goes down, I don't want to be like my friends, but I can't be behind my friends. And that's where return stacking came in. And I think we were going to talk about at one point, like return stacking versus RDMIX. And I think that is a preference around, do you really feel you have the tracking error sensitivity to the 60-40 portfolio. If you do, return stacking is probably a better solution because it's going to attenuate your behavioral bias. If you can think a little bit more broadly and you can understand or come to grips with the idea of a risk parity portfolio being, I'm going to own everything and I'm going to have it properly balanced and I'll let everybody else fight over what they want to buy and sell every day. I'm just going to keep this nice

conservative sort of balance thing trucking along. I think that you would prefer that. I certainly prefer that. Yeah. Plus the alpha. I prefer- Yeah. You're substituting 60-40 with risk parity, right? And so the contrast is very clear. I was just looking up. So if you go to returnstacking.live, you'll see what it's done year to date. So return stacking is 60-40. The return is 60-40 has lost 11% year to date, roughly, and the return stacking has only lost 4%. And the differential is that 60% alpha stacked, right? In contrast, RDMIX is up 10-to-date. Why? Because risk parity didn't lose like 60-40. And the pure alpha is our pure alpha.

You can stack on top of that. So that's the contrast right there. But our correlation to 60-40 is very low. Return stacking is designed to be highly correlated to 60-40 while attenuating some of the pain, right? So giving just enough medicine so that people don't have sugar to get the medicine down. Yeah. And in my mind, the choice is, Hey, if you're fine trailing your peers for two to three years in exchange for outperforming

them for two to three years, right? RDMIX is a choice for you. If you want to be pretty close to your peers with the opportunity to outperform them, go with the return stack. Fair enough. Awesome. I had one kind of technical question, maybe we'll do it real quick. So I was going to tell an example of the trend first. I got in a Twitter fight, right? And we did a blog post of like, updated, here's the past 20 years, 20 plus years of trend with the indices, right? And I think it was compound 4.5% or something. And some guy came out of the woodwork of like, 4.5%, that's stupid. That's crazy.

Why would anyone invest in this? I'm like, that's a positive 4% carry per year for something that has the smile we're talking about that performs in crises. That's the exact thing you should be seeking out, right? So thanks for coming into my defense on that. You guys must have missed that one. Yeah, you got to tap us, man. You got to at us. I would have been on it. And the thing is that this is a beautiful thing about stacking, and one of the benefits of futures, right, that you can have your 100% full exposure to whatever portfolio you love, and then you're going to have the ability using a little bit of margin to stack

a full trend or systematic global macro alpha on top, that even if it only does 1% a year after fees and transaction costs and taxes, even if it does 1%, that's an extra 1%, assuming no benefit from diversification. Add the benefit of that smile that you talked about, the ability to make lots and lots of money in periods of extremes, then you have the added diversification benefits. That means that your overall portfolio, even at 1% excess return, assuming that that's all you got, is going to reduce the portfolio volatility and stack 1% on top. In a decade like we saw in the 2000s, the type of stacking that you will see is two, three, four times that. So so it's um on average four percent maybe yeah and by the way during the 2000s the return to u.s equities whether they be nasdaq or s p was zero for 12 years yeah yeah why would

anyone invest in that yeah with two fifty percent drawdowns why would you invest in that it's just amazing personal because on average from two to now, it's annualized at 10%. And it's underperformed gold, but whatever. Recency bias over confidence and performance chasing. People have a bias. That's their bias. And if they have that bias, then we accept it. Do return stacking.

I mean, we're not hating on anybody. We're just trying to help out right oh and then my technical question was okay do i have for that alpha sleeve or whatever we keep using our hands here sorry for anyone who's listening instead of watching um for the alpha piece do all those components have to have a net positive expected return or could you have something in there that has a negative carry, but on a portfolio level, it's going to be added to? Look, the paper that we wrote was not trying to be too prescriptive, right? We ended up the paper with what we

perceived to be the most accretive. And the most accretive to us is trying to provide an overlay or a stack on top of your beta. Well, I wasn't talking return stay. I'm talking you're the in RDMIX and the alpha sleeve, but sorry. In the alpha sleeve. Yeah. Yeah. No, I mean, in the alpha sleeve exclusively where, you know, the, the long volatility strategy has a potential. We're trying to make it a negative carry, but it has a potential to have a slight negative carry most years, but with the benefit of providing significant outsized returns to fill in those gaps when nothing else does.

Liquidity, really. It provides liquidity to a portfolio when liquidity is heavily rewarded. And that is what's lovely about that, why you suffer maybe a small negative carry, because at some point, a large chunk of liquidity will be injected into your portfolio, and it's when the market will be demanding liquidity, and you will be handsomely rewarded for having that liquidity. And the good news is that nobody sees that negative carry, right? That's the benefit of having a name to wrap or believe. I think we've talked about this before, Jeff, in one of our podcasts with you, but I used to have that as a separate line item on clients' portfolios.

And it's just too painful to see it bleed. And so by embedding it into a single fund that has a positive carry because of risk parity, positive carry because of the alpha sleeves and a slight negative carry at times because of the tail protection, nobody knows or cares, but it's going to be there when you need it. So yeah, I'm a fan. Our last bit here, I'm going to change up our two truths and a lie bit today a bit i'm gonna change up a bit a bit um and i was trying to do something clever with your resolved riffs and say it was going to be three riffs and a buy but i don't know what a buy means so uh we'll just go on to can you guys give me three personal stories? One about Adam,

who's not on the pod here, Adam Butler, one about Rod, one about Mike, anonymous, and I'm going to assess out which story is for which person. And if you wanted to make one of them slightly untrue, then I could try and see if I could identify that untrue one as well. Who wants to jump on that grenade first? Three stories. Sure. I think what you're asking us for is one story for each person. Yes. And we'll tell a story and one of us will tell a couple of stories. Okay. Something that is entertaining. Yeah. Entertaining. And so, and may or may not be true. So one of, one of the,

I'll, I'll tell a story and you guys can decide it's true. If you've ever met Adam Butler, he's not the most athletic guy in the world. But if you put a table tennis racket in his hand he actually turns into spider-man and he like or forrest gump right yeah he literally will turn into forrest gump i think i that up though right because i guess you're supposed to guess who it is yes but one of us i guess it's one of us if you place so i get the gig now if you place a table tennis racket into one of the hands of the people here that person turns into spider-man who is it that would have been the better thing right that's the setup that's the setup all right okay so now i gotta think of another now okay you okay. You think, all right, Rod, you're up. All right.

These are PG. You can go R-rated. All right. So one of us has been engaged a couple of times. And the first engagement was broken up while in a short bus, a school bus trip that went from Ontario, Canada, all the way down to the tip of South America. And while in Mexico, while being invited at 4 a.m. to La Cucaracha, the future spouse did not want that to happen. And therefore, the individual broke up with that person and were looking for flights out the next day. And sadly, there were no flights out for three weeks.

So the disengaged had to stay on the bus for three of those weeks. Disengaged. I've never heard it called quite that. That should technically be what it's called, disengaged. That's a tough one. It's harder than I thought. Right. Oh, well, this is interesting. One of our wives has appeared naked in a magazine.

Okay. Right. You couldn't go, one of us played professional Canadian football, because I know who that is. One of us won a Grey Cup. Right. One of us is on a Walk of Fame. One of us is on a walk of fame. None of those are going to be for them.

For the listeners, Mike played in the Canadian football. He won the great cup. What was your team again? The Hamilton Tiger Cats. Hamilton Tiger Cats. And you played. We did this way longer. Who was one of the famous guys you played with

played against Doug Flutie a lot as per his brother Darren was on my team played with Dexter Manley played with there's a few NFL guys that trip back through the CFL and

whatnot so a bit of fun alright Brad you guys one of us in undergrad trip back through the CFL and whatnot. So a bit of fun. Yeah. All right, Brad, you guys, one of us, one of us in undergrad, one of us in a, in a moment of possible intoxication went and stole a crepe, crepes cart, you know, crepe, crepes, and brought it to the

quad to cook crepes for the crowd of 20 from 2 a.m. to 4 a.m. in the morning while waking up the next morning and getting arrested by the police for stealing said credit card these are tough all right yeah i guess i guess the other thing is that if i were to say one of us has been arrested that would be a lie as well i will say that one of us has been to Disney more than 30 times. Ooh. One of us. I've been to Disney more than 30. There you go.

Well, I don't know if you've seen us there. One of us plays D&D, and his character is an elven barbarian. Okay. All right. Let me search these out. I'm going with D&D. It's got to be Adam. Correct?

Yep. Nice. I'm going undergrad, crepe cart as Mike, but also untrue because none of you have been arrested. That is incorrect. Incorrect.

An untrue story. But it would have been Mike. I don't know. That's a good question. It is a story that did happen, but not to any one of us in this group. The bus to South America, I'm going to say, was you, Rod? You had an amazing amount of detail on that. Well, we all know each other.

I don't know. Was it me? I guess it was me. Brutal. And wife appeared naked in a magazine. Mike? I mean, the pro athlete makes the most sense there right i love doing this to my wife it's actually untrue she wasn't quite naked but there was there was a woman in a um uh i don't know if it was playboy or penthouse and it looked, it was a doppelganger for my wife and she worked at a car dealership and they brought it in. They're like, is this you

Sharon? Is this you? And she's like, no, that's me. I'm like, give me that book. I'm keeping that. All right. Um, thanks guys. This is my idea. I want to just do a pod with guys like this, and we don't talk one thing about investments. We just talk about life. It would be a lot more fun. This is fun. We'll put in the show notes, everything.

Make sure you guys check out their Resolve Riffs every Friday. You're still doing it mostly every Friday? Yep. Friday at 4 o'clock Eastern. Yeah. Those are fun. And the return stacking. We'll put all these links. We're going to have a lot of links in the show notes, yep 4 o'clock eastern yeah those are fun and the return stacking

we'll put all these links we're going to have a lot of links in the show notes but we'll put them all in there and great talking to you guys always a pleasure Jeff

great seeing you you too go Trent you've been listening to The Derivative links from this episode will be in the episode

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