Our guests are Alex Shahidi, and Damien Bisserier, both Managing Partners and Co-Chief Investment Officers at Evoke Advisors. Evoke is a $20 billion Registered Investment Advisor based in L.A. They are also well-known as the portfolio managers of the Risk Parity ETF (RPAR:NYSE).
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In our conversation, Shahidi and Bisserier outline how they construct their portfolios, what are the basic components of their portfolios, and why. They explain the way each asset type behaves and interplays with the other three in the context of four main asset categories, and how they perform through extreme market events.
This is ordinarily a fairly complicated topic to discuss, however, Alex and Damien have clearly found a very layperson-friendly way to explain how to construct robust and resilient 'all-weather' portfolios that can profit from as well as preserve capital in all economic and market climates.
What you can expect to take away from this, assuming you make the time to listen to the whole conversation, is how you can construct a portfolio that can keep you and your clients invested, and can keep you from potentially losing your heads, behaviourally, during events like the March 2020 Pandemic drawdown.
If the key to long term investment success is to get investment selection and risk budgeting correct, so you, as an investor, and your clients, as investors can stay fully invested through market crashes, economic events, and 'black swans', then "Balanced Asset Allocation" by definition, is seriously worth your consideration. By a country-mile, the 2020 drawdown in the value of almost all risk assets, served as an inflection point which will define how successful investors will be from that moment in time forward.
Please feel free to share your thoughts about this. Please comment below, AND if you enjoyed this episode and others we have recently shared with you, please subscribe, and by all means leave us a review on Youtube, Apple Podcasts or iTunes, or wherever you listen to your favourite podcasts.
SUMMARY KEYWORDS
Equities, portfolios, inflation, risk, growth, parity, clients, assets, investors, return, asset classes, treasuries, commodities,Bridgewater, market, gold, environment, approach
Full Transcript:
Pierre Daillie, Alex Shahidi, Rodrigo Gordillo, Damien Bisserier, Adam Butler
Pierre Daillie [00:00] Welcome, everyone. I'm Pierre Daillie, managing editor of AdvisorAnalyst.com. From ReSolve Asset Management, SEZC. Our very special guests are Alex Shahidi, Managing Partner and Co-Chief Investment Officer at Evoke Advisors and Damien Bisserier, also a Managing Partner and Co-Chief Investment Officer at Evoke. Evoke is a $20 billion registered investment advisor based in LA.
Pierre Daillie [00:28] Alex, Damien, welcome to raise your average.
Alex Shahidi [00:32] Thank you.
Pierre Daillie [00:33] Excited to talk to you today. It's, as Adam was saying before, it's very timely conversation. I think I think to kick things off, it would make sense for you to introduce yourself, talk about your path, how you've ended up working together, how you to how the two of you met, where you where your beginnings were, how you got started in the industry? Sure.
Alex Shahidi [00:54] Well, we're happy to be here. I my career started at Merrill Lynch in the late 90s, at the peak of the internet bubble. So that was a fun time to start, you know, the first three years of my career, the market fell 50%.
Alex Shahidi [01:08] And so that teaches you some things about downside protection right off the bat, which was which actually is really good perspective to have starting your career. So I was I was at Merrill for 15 years. And and while I was there, I managed portfolios, I think a little bit differently for most people.
Alex Shahidi [01:26] I viewed myself as a independent advisor, they just happened to be working at a brokerage firm. So I tried to give advice in the most objective way that I thought made sense. So I didn't really use Merrill Lynch products that in user research, I didn't even user custody, for the most part, because I found, you know, better solutions for clients outside of the firm.
Alex Shahidi [01:49] And the firm is very open with, you know, working in that regard. So that so I did that for 15 years. While I was there, we discovered Bridgewater associates, the largest hedge fund in the world. And and I got to learn about the risk parity framework. So I spent a couple years researching it, wrote a book about it. With with Bridgewater's help they helped provide the data, provided feedback, you know, great partnership there. And that's also where I met Damien. And, and he and I've been talking about working together for a long time, I'll let him share his perspective. But in 2014, it was time to leave Merrill, and start our start my own firm along with Damien.
Alex Shahidi [02:31] And the idea there was, we needed more tools in our toolkit to help clients achieve, you know, reasonable returns with with controlled risk and what we viewed as a challenging market environment for the next decade or two. And, and so left, Merrill Lynch, was able to transition a lot of clients and we launched our firm in 2014. And then fast forward to last year, we merged with another firm, evoke, Evoke advisors, and we're kind of taking on their name. And, and the reason for that is, it's again, it's a group of people I've known for, for about 15 years, they work with me at Merrill, we've been talking about working together for for a decade and a half. And finally, the stars aligned and it made sense to, to partner.
Alex Shahidi [03:14] So I'll stop there and let Damien jump in.
Damien Bisserier [03:18] Thanks. So I spent most of my career at Bridgewater first in the research group, and then I ended up working with clients. One thing that was unique about Bridgewater is we took investment professionals, and we put them in the seats of managing client relationships.
Damien Bisserier [03:37] And the reason why Bridgewater did that it was really a philosophical orientation towards billet building client relationships. We want it to be more than a return stream to clients, and really help them across the broad spectrum of strategic challenges they faced. So things like portfolio construction, you know, what do I do about my liabilities? How do I build a hedge fund portfolio?
Damien Bisserier [04:00] All all nature of strategic questions were things that I was, I was essentially tasked with working with endowments and pension plans, CIOs on these types of questions. And I really enjoyed that consultative aspect of my job. So much so that I've dedicated my career to that challenge, which is really thinking about how do you combine return streams to produce the best outcomes for for a variety of different investors.
Damien Bisserier [04:25] And one of those investors that I worked with one of those clients that I worked with was Alex. So Alex had built a really successful business, probably the largest institutional consulting practice at Merrill Lynch. And most importantly, Alex was one of our most sophisticated clients, you know, he, he wrote a book on asset allocation. I think he just he has a very good informed perspective on investing based on his own independent view of how things should work, ultimately, a function of the research that he's done and that that I think, is the right way to approach the advisory business.
Damien Bisserier [05:02] Frankly, one of the reasons why Bridgewater was so involved with providing advice to our clients was that most advisors are more salespeople than they are actual investment professionals. And so Alex just stood out to me as as doing it the right way. And so when I, for personal reasons, decided to move back to California, I grew up in Los Angeles, I talked to Alex, I said, Hey, you know, making the move, and he said, great, you know, let's, let's, let's start a business together. We've been talking about it for a number of years. And so we made that a reality in 2014.
Adam Butler [05:33] Thanks, that's great. And we get a chance to correspond quite a bit, Alex and I over the years, and I think we sort of paths are a little bit parallel in terms of sort of how to think about diversity and balance and forming this risk parity concept. And all of obviously, all of us kind of informed by the original writing from from Bridgewater, which was really neat. And it's, it's one of these things where there are a whole all weather risk parity concept, where once you internalize that it's really hard to, to look at any other core investment approach as being even mildly coherent. Right. So I just, I wonder if maybe you can describe a little bit because there's a lot of different sort of ways to execute or implement risk parity. I mean, obviously, all-weather is one way – you guys do it your way, and we've got our interpretations or other big funds out there that do this, maybe let's start with maybe a discussion about what all of these risk parity or all weather type funds have in common, what is what are the core fundamental beliefs that underlie the this approach?
Damien Bisserier [06:47] So I think there, there's one fundamental aspect that is in common across all of these strategies, which is that all assets provide a risk premium relative to cash. So when you take risks, the fundamental underpinnings of a capitalist system, dictate that you need to be compensated to take risks to take your money out of the safety of your bank account. And whether that's treasury bonds, as as as maligned as an asset classes, that is, you know, there is a premium there relative to cash, we look at longer data treasuries, their interest rates that are in excess of cash, equities, various types of credit.
Damien Bisserier [07:33] There, there are, there is a very understandable compensation you get from investing in in different asset classes. And risk parity is the idea that the traditional approach is primarily concentrated in one asset, which is equities. And so you're not getting much diversification from those other types of risk premia. Specifically, you know, bonds are the most commonly held asset outside of equities.
Damien Bisserier [07:59] You look at the traditional 6040 approach, that 40% is in low duration, low risk bonds, which don't move much. And so the volatility of the portfolio is overwhelmingly driven by one asset and and over overwhelmingly dependent on favorable environments for that one asset.
Damien Bisserier [08:18] Risk parity is the understanding that you can actually derive an attractive return from a variety of different assets, it does require you to adjust some of those assets. So for instance, treasury bonds come prepackaged in lower risk forms, that's how most people think of them.
Damien Bisserier [08:35] But you can actually hold treasury bonds with longer duration or add some leverage, and you can make them look from a return to risk perspective, much more similar to equities. And when you do that, you unlock the potential for much greater diversification because now you can be agnostic in terms of return because you can basically hold assets at a similar level of return and risk.
Damien Bisserier [08:59] And then you can really focus on diversifying, finding risk premia that have very different exposure biases to different economic outcomes. And that's really powerful you can you can basically create something that is, you know, 50 to 75% more efficient than an equity dominated 60/40 portfolio from the perspective of how much return relative to risk you can earn.
Adam Butler [09:21] One of the one of the ways that we like to articulate the all weather framework is in the context of what drives asset price returns. And Alex, I really think your book, it's called balanced risk, if I recall, balance, balance allocation, how to profit in any economic climate. But the great title, yeah, agreed, does a great job of highlighting how sustained asset price moves are generally driven by changes in expectations along the dimensions of growth and inflation, right and So maybe dig into that concept a little bit and maybe describe how some of the different asset class types that are typically held and risk parity portfolios are fundamentally designed to react in different ways to these to these fundamental economic drivers.
Pierre Daillie [10:18] I love the title of your book, because, you know, balanced asset allocation is, is a term that's commonly used in the industry. But what you define is balanced asset allocation. And what most advisors define as balanced asset allocation are two very different things. And so So, and the idea, of course, I think everybody's interested in the idea of how to profit in any economic climate.
Pierre Daillie [10:49] But how do you so how do you approach balance? How do you do that? And, and how do you view it? I mean, how does it work in your in your view?
Alex Shahidi [10:58] Well, let me start with a quick story. So this was probably seven, eight years ago, I was having lunch with a retired portfolio manager who his portfolio was called, it's called balance.
Alex Shahidi [11:09] It was the name of the firm will go unnamed, balanced fund. And we were having lunch, he managed it for 30 years. And and I said, Well, let me ask you a simple question. I said, Why do you call it a balanced fund if it's not balanced? And he said, What do you mean that 6040 it is balanced? Everybody knows that? I said, Well, if it's if it's balanced, and why is it, you know, high 90% correlated to equities?
Alex Shahidi [11:33] He said, No, that's not possible. I said, Oh, it is, you know, 60/40 is like 98% correlated equities over, you could look it over any long timeframe. He said, That's not possible. If that's the case, it's not balanced. I said, Well, let me explain why. And I walked him through just two minutes of why it's highly correlated. And he said, I don't believe you. I said, Go home, pull up your Excel spreadsheet, and call me tomorrow, and tell me what you find.
Alex Shahidi [11:58] And he called the next day, he said, I'm so embarrassed. He said, I managed a balanced portfolio for 30 years, I didn't realize that it was highly correlated to equities, the name is is misplaced.
Alex Shahidi [12:10] And this is unbelievable that nobody has figured this out. I said, Well, some people have figured it out. But most have not. And so that was an eye opener. And it was a successful Manager for 30 years managing, you know, a balanced fund.
Alex Shahidi [12:21] So that goes to your point here that, that this is really unknown by the majority of people, even professionals in the industry, because I think most people are they they start with, they don't start from point A where they would they are redesigning or re re creating the foundations.
Alex Shahidi [12:42] They start by at point D or E, which is the point that everybody else starts, which is the assumptions that are pre existing in the markets. And I think to be a very thoughtful, independent investor, which I think is critical. You can't just assume what everybody else believes to be true to be true without testing yourself. So in some ways, you're recreating the wheel, even though you're taught from an early age don't do that, I think in investing that's it's mandatory.
Alex Shahidi [13:08] So that is, I think, some background as to why this is, it's so different to think this way, then then I think most people, you know, the path that most people follow.
Alex Shahidi [13:19] And I think this discovery early on, led us down a very different path. So we don't just take what we hear and assume it's gospel, we we challenge all these assumptions. And we go back to point a, and figure it out and start over over and over again, until we think, you know, we think we have what the right answer is. And then we challenge that again, and again and again and again, which is how I think you'd make improvements over time.
Alex Shahidi [13:43] Okay, so going back to Adams question about what true diversification is the our our understanding is that, as the class returns are, by and large, driven by the economic environment, and to be more specific, it's how the environment transpires versus what was discounted, which is really important.
Alex Shahidi [14:03] Because if you think about if you go and buy stocks, it is the price that you pay for the market is discounting what it thinks the future economic environments going to look like, both in terms of growth and inflation, which are the two big drivers. So if you think about q1 of 2020, before that quarter, you know, the market wasn't discounting a global pandemic, it wasn't discounting, you know, unemployment quadrupling in a couple months.
Alex Shahidi [14:26] And so when that actually happened, and that that reality was starting to become realized, the market fell 33% in five weeks, like how can how can the market be that off, you know, to fall a third of its value in five weeks, because something happened that it was totally unexpected. Right?
Alex Shahidi [14:43] And you and so the same thing happened in 2008. You know, most most people thought 2008 was gonna look like 2007 and it looks completely different. So and then if you go back to the 1970s, you know, equities and bonds underperformed cash for a decade.
Alex Shahidi [14:58] That's because you had this spike in in and that was totally not discounted. So so by studying market history, and and understanding what is the fundamental driver of these asset classes, purely from a mechanical standpoint, it's really how the economic environment transpires relative to what was expected.
Alex Shahidi [15:16] And in terms of growth and inflation, there are other factors, but that's the majority, especially over longer timeframes. So when you're thinking about how to build a diverse portfolio, we think it makes sense to start there, which is kick asset classes that you know, are reliably diverse in respect to growth and inflation.
Alex Shahidi [15:34] So 2000, you know, Q1 of 2020, equities took a huge hit, and treasuries were in a bull market at the same time. And that's not a surprise, you know, the treasuries didn't know that the there's gonna be a global pandemic, it just, it's just biased to do well, because you get a downside growth, surprise, interest rates fall in response as their treasuries rally tips, and gold did well, as well. And that's not a surprise. And then since then, it's been the opposite.
Alex Shahidi [15:58] Treasuries have been one of the worst things to own, but equities and commodities have done well. So all of that is very predictable, not not when it's going to happen. But when the environment transpires, and depending on how it plays out, you know, certain assets or buys to do well or poorly in that environment.
Alex Shahidi [16:14] So when you pick asset classes, pick the ones that are that, you know, are going to be diverse. So one of the things that we don't own is credit, for the most part, because it acts like equities. That's the same bias as equities. And so we own equities, but we don't own credit in our in our risk parity fund.
Alex Shahidi [16:30] And it's because you're, you know, equities are more tax efficient than than credit. And it's more capital efficient, it's more volatile. And in this case, volatility is actually your friend, because that's how you build balance.
Alex Shahidi [16:43] So we pick asset classes that we know are reliably diverse to different assets, to different economic environments. And then the second step, which Damien referenced earlier, which is really the risk parity part is you you equalize the return and risk of all of them.
Alex Shahidi [16:58] And when you do that you have you know, so we have equities, commodities, treasuries and tips, and all four are very diverse, you could just look at him through all of time. And then if you structure each to have similar return to risk, now, that portfolio is going to be more diverse than just an equity centric portfolio, and it's gonna have a relatively high expected return. And then you just rebalance, and you're off to the races.
Adam Butler [17:22] So you, yeah, he did a great job of sort of describing how asset prices will respond to unexpected changes in the dynamics of growth and inflation and diverse assets are fundamentally designed to react in different ways to shifts in these expectations. And then, as he said, sort of, you know, repeated through Damien, it's important if you've got diverse assets in the portfolio, but they have fundamentally different ambient risk characters, in order for them all to be able to express their unique personality, you've got to hold them in appropriate balance, right.
Adam Butler [17:52] And just to reinforce, if you hold diverse assets, that appropriate balance in the portfolio, it expresses the view that all of these different markets have approximately the same expected risk adjusted performance over time, once you sort of roll through all of the major global economic environments that investors should expect to encounter over their investment horizon.
Damien Bisserier [18:17] I get that that's, that's true. But it's not necessary for this to make sense.
Adam Butler [18:22] So So this, so dig into that, for me, yeah,
Damien Bisserier [18:24] This is a common criticism of the approach, which is, how on earth could you tell me that treasury bonds no matter? How long duration or or how levered, have the same return US equities, and you don't have to assume that they do. I mean, empirically, historically, they have, but you don't have to believe that. You have to believe that they're additive to the portfolio, which is not just a function of their return, but also a function of their diversification.
Damien Bisserier [18:55] And historically, treasury bonds have had a very clear and reliable benefit. When, when when sitting alongside a portfolio of equities, so specifically, you get into an environment like Q1 of 2020, or Q4 of 2008. And it's one of the only assets that is bias to do well in those environments. We often describe it to clients as a hedge that has a positive expected return, And that's really powerful. So it doesn't necessarily mean that you need to generate the same return as equities, as long as you're in the ballpark. It's not none of this is very precise.
Damien Bisserier [19:35] But as long as there's a positive expected return, and, and that diversification benefit works as we expect, it can be very additive at the portfolio level. And you also get incremental benefit just by smoothing out the ups and downs. So this is something that also I think is not well understood but you have a portfolio of assets.
Damien Bisserier [20:00] That's where the individual line items are both volatile, and reliably different meaning lowly correlated to one another, you actually get a portfolio level return that is higher than the average of the underlying components, because of the rebalancing benefit that accrues, when you're constantly buying something that has been out of favor and selling things that have been in favor, that over time that buying low and selling high practice of just rebalancing in a disciplined way actually generates a higher portfolio level return.
Damien Bisserier [20:29] So diversification is not just about lowering risk, it actually is incrementally additive to return. And so that's why I said, it doesn't depend on this notion that they all give you exactly the same return relative to risk, as long as they're roughly similar. Maybe equities do have a higher Sharpe ratio, even though this has not been the case empirically.
Damien Bisserier [20:50] But let's say for whatever reason, going forward, you don't believe treasuries have the same return relative to risk that stocks do, you don't need them to. As long as they're not significantly sort of persistently negative from a return perspective, you're still probably better off when you do the math, of having them in your portfolio because they are a hedge to the worst equity environments. And they actually pay you something along the way.
Adam Butler [21:16] Interesting.
Pierre Daillie [21:16] Yeah. I'm just I'm curious, because, sorry, I was just gonna bring up that that, you know, you mentioned the 70s before, that it was a losing decade for equities and bonds. And people weren't investing in, you know, by the time 1980, I just recall, the article in Newsweek, or the front cover of Newsweek magazine, equities are dead.
Pierre Daillie [21:40] And I'm just curious, you know, like, during the 70s, people adapted to the conditions in the 70s. By the time 1981, rolled around, they were fully on board with the 70s. But it was that that's that's really where things turned, because almost immediately after the Newsweek article, equities turned interest rates topped out. And then I'm just curious, like it took How long did it take for investors? Do you have any data on how long it took investors to adjust away from the 70s mindset into what eventually became a 60/40? mindset? From the 80s? onward? And and aren't we sort of facing the same kind of problem right now? How long will it take for investors to to adapt away from 60/40? And to what we're talking about today, which is really balancing for a variety of tail risks and, and unforeseen events? Like, like, you know, you were just talking about Damien about, nobody saw COVID coming, if you had, you know, if you were long, long bonds. Wonderful, right? But for those who weren't, it wasn't such a, it wasn't a pretty picture for five weeks. So how long do you have any data? Any thoughts on how long it'll take for investors to break away from the 60/40 – 80s Through 20s – 2000s mindset?
Alex Shahidi [23:09] We don't have I mean, I don't know if there's hard data, because, you know, yeah, there's dude, there. I don't know if there's a composite for that. But the but one thing is for sure, is that investors, and I think humans in general, are backward looking creatures, meaning they look, because you don't know what the future returns are, you know, what the past returns are. And those numbers are crystallized and advertised, even though you have the warning of, you know, past performance is not indicative of future results. I think that morning is by by, by and large is ignored.
Alex Shahidi [23:42] Most people react to what they've seen in the past both long term and short term. And so so I feel that investors are constantly behind the curve. Because, you know, they're doing what worked best in the past. And, and not really thinking about the future. And so but what happens is, it's self reinforcing. So if you just follow the past, you may look good for a while. But But the key is, is the major inflection point is where you, you get wiped out.
Alex Shahidi [24:09] And that happens all the time. If you just look at if you just look at asset class returns by decade, you know, so the 1970s, we talked about treasuries and equities, underperformed cash, but gold averaged 30% a year for a decade.
Alex Shahidi [24:23] Right, commodities were up a lot. And then what happened the 1980s and 90s, for 20 years, equities are the best, and gold was negative for for 20 years. Right? And then you have the 2000s.
Alex Shahidi [24:34] So I remember in the late 90s, it was all about equities. And you know what, yes, I know the valuations are high, but equity is that's where you want your money to be after what you mentioned that, you know, the early 80s it was about the death of equities equities are gonna be the worst thing though. That was the beginning of the bull market. That in the in the beginning of 2000s, equities looked fantastic. And they were negative for a decade, one of the worst decades on record. And few people saw that decade coming had just witnessed, you know, the greatest bull market in history.
Alex Shahidi [25:03] And then the 2010s was the opposite. Equities were the best and commodities are the worst even though commodities were the best in the 2000s. And so you get this flip flop. And if you think about the next decade, so the 2020s, who knows what's going to be best? Right? You could, you could have equities be the best, you know, commodities, which are the worst, the last 10 years could be the best the next 10 years, especially with all the printing of money, gold could be the best tips, if you get a stagflation environment could be the best, especially longer duration, even treasuries, even with, you know, the yields where they are today.
Alex Shahidi [25:34] If you go into a Japan style deflationary downturn, treasuries might be the thing you want to own even with low yields. So so it's just really hard to predict, especially now, if you just think about all the things that are happening, right, the money printing and the zero rates, the, you know, the political and political uncertainty, this this rise of populism, the the wealth, wealth inequality, and the income gap, all those things, these are major forces, and how it nets out is just really hard to know. So we think that being violence is probably more important today than ever. The on the question of here my screen?
Pierre Daillie [26:12] Sure, yes, you are. Yeah.
Rodrigo Gordillo [26:16] This just kind of I had one point, I want to make sure my
Rodrigo Gordillo [26:22] Go ahead while I bring up the chart now.
Damien Bisserier [26:24] Yeah. Just to add to what Alex said. And very specifically, to answer your question here, I think investors have already moved on from 6040.
Damien Bisserier [26:37] I have yet to see a 60/40 portfolio where the 40% is in the Barclays aggregate bond index, that 40% is in various fixed income, yo, yo, hi, yield type of securities could be high yield, it could be preferred equities, could be mlps, could be Reed's all those things now get bucketed as fixed income.
Damien Bisserier [26:58] And they're actually a lot more like equities than like fixed income. And then you might have alternatives in those categories, things like private equity, which obviously is like equity, private credit, which is like equity, even hedge funds, most of them run very long biased.
Damien Bisserier [27:14] And so what's happened, I think, is that 60/40 isn't 60/40 anymore. 60/40 is like 80/20. And some investors have actually gotten more levered and more risky over the last decade, because that's what's worked. So you know, I actually think 6040 is dead. It's still called 60/40. But actually, it's more like 80/20 or 90/10. And that's a lot of risk that I don't think many investors really appreciate.
Pierre Daillie [27:44] Yeah, absolutely. I mean,
Alex Shahidi [27:48] yeah, the other thing is, I think the behaviors change based on pain points. And so q1 of last year, was it was too short lived, right? You got this, you got the rebound. Even Oh, wait was too short live. So a lot of the lessons were lost. So I feel like you have to go through an extended period of pain before the behavior changes. Sorry Rodrigo.
Rodrigo Gordillo [28:12] But again, I think the key here is understanding that benefit of diversification and that rebalancing premium because that, you know, the the biggest objection happens to be that the expected returns to bonds are gonna be low. The reality is that the expected returns to everything are going to be low if we believe in that discounted cash flow approach. And if everything is going to remain low, then how do you get that extra yield?
Rodrigo Gordillo [28:36] Well, guess what diversification offers you that yield, and in a traditional risk parity setting, you're looking at an extra 1% return? If you're rebalancing at a decent frequency, right?
Rodrigo Gordillo [28:47] So you just kind of have to stick with asset classes that may be doing poorly in your portfolio. In hindsight, right, things that I've recently done poorly, we tend to think extrapolate and say, Well, I got to do less of that, and do more of something else. And when you do that, it just turns out that you are looking at the past and not prepared for the future,
Alex Shahidi [29:10] Then you actually have to do the right things out of them. Perfect, right? You have to buy the things that do poorly, not sell them.
Pierre Daillie [29:18] Yeah, that's the hardest part with
Damien Bisserier [29:19] This was this was the reason why we created the portfolio. Right and realized we tried to do this on a bespoke basis in client portfolios. And you can't get very diversified. Because it all it's all great when you go through a period like the first half of last year when the treasuries and the gold were helping a lot. But try holding on to a meaningful position in treasuries and gold when you go through what we just experienced over the last six months. It's impossible.
Pierre Daillie [29:50] And so yeah, you're getting you're getting sorry, I'm sorry to interrupt you, Damien. You're getting all that all that sort of pressure from FOMO. Right. I mean, people are looking at Bitcoin they're looking at that, you know, the the GameStop stories are looking at all the stuff Robin Hood's doing with Tesla, and, you know, Ark, and you know, all the stuff that's going on in various markets where we're, you know, if you feel like you've being left behind, or your neighbor talks to you and says, You know, I got some of that, you know, I've owned some of that Ark, that that Ark Innovation Fund, and you know, it's up like, it's up 100% this year, and what do you qwn? Right, and you get so you get a lot of resistance?
Damien Bisserier [30:31] Yeah, yeah, that's right.
Alex Shahidi [30:32] Yeah, I mean, it goes back to the, to the basics, right. So if you if we were sitting here 200 years ago, you'd have, you know, the best investment philosophy ever is buy low, sell high. Right, and that that's hard to do in practice, people want to buy high and sell low. So so it's the only industry where, where you should, you know, everybody knows what you're supposed to do, but they can't do it. And then the other thing is this whole, you know, fear and greed, right?
Alex Shahidi [31:00] When something is doing well, you see, what is the last opportunity and you know, others, you know, celebrating how well they've done, and you want to be on that on that ride. And, and when, you know, times are tough, and you're losing money you want to fix you want to fix it, you want to do something about it. So those emotions drive investor behavior.
Alex Shahidi [31:19] By and large, even sophisticated investors, it's just really hard, you know, sophisticated investors do the same thing but they justify it better. You know, so it's just, it's just really hard to do it. And so I don't think I don't think it makes sense to say it's irrational and say, don't do that. I think it's important to create solutions that, that almost protect people from themselves. And that's, you know, I think what we found is hiding the line items is the best protector of bad decision making.
Pierre Daillie [31:50] Yeah, hence, the portfolio. Yeah.
Alex Shahidi [31:53] Yeah, I mean, you can explain what's in there. So you're not actually hiding it. But it's that line item risk, because, because investors are trained to to look at their portfolio and their eyes immediately go to the things in red, right, because they're always trying to improve their portfolio. So to them, you know, losses are bad, we need to fix it, we have to do something about it. And then and then even if they resist the temptation to sell the things that are down, when it goes down further, they look back and say I knew I should have sold, and I didn't. But now I'm going to take action. Right? That's just a it's just a natural human reaction. And and so you just you can't ignore it, you have to learn to work with it.
Pierre Daillie [32:30] Well, we've had many conversations, right, Adam and Mike and I, about getting comfortable with being uncomfortable. So very interesting. It's, it's the toughest thing to do with with, especially with retail investors, it's the hardest thing to do is to, to get them on board with owning things that they don't like, or they don't want to like,
Alex Shahidi [32:56] yeah, yeah, the The other aspect that's really different from this field versus others is, is a short period of time might be five or 10 years, everywhere else five to 10 years is an eternity. Right. So that so you combine those emotional impulses, which are which are counterproductive, on top of the definition of what long and short term is, it makes, you know, a very, it makes this, you know, very, very challenging, you know, it kind of industry to navigate.
Adam Butler [33:29] So, Alex, how do those conversations go with clients as you begin to sort of help them to understand the this idea that sort of prediction is hard. And yet, you want to start with the right level of balance and diversity and and then only really nudge your way into making active decisions, when it with great humility, and only where you feel like you've got somebody who genuinely has a meaningful and diverse edge. Right, so an edge that is that is orthogonal to the other bets in the portfolio? How do you? How do those conversations go? Do you find and what are some of the stuff stories or allegories? Or or metaphors that you find? Maybe helpful and in, in those conversations to bring them along?
Alex Shahidi [34:23] Yeah, I mean, it's, it's a lifelong process. Because I think a lot of it is, is storytelling, and I'll share some and also there's a there's, I think, a mathematical answer to it. And then there's real life experience.
Alex Shahidi [34:39] And and so so for example, one of the stories we always share is, you know, some of the smartest, you know, most experience, best resource managers out there might be right 55 or 60% of the time, and if they're right 55 60% of the time, and somebody who knows nothing is going to be right 50 percent of the time, that shows you the range of kind of the best to the worst.
Alex Shahidi [35:04] And that is just not high odds. And if you just think about the investors who've been around the longest, there's not that many actually, which is remarkable. You know, so many funds come and go. But the ones that have been around 3040 years are the ones who just avoided catastrophic losses.
Alex Shahidi [35:21] And they did that because they're really well diversified. And, and so, so we share stories like that. We remind clients of, you know, how many people predicted q1 of 2020, how many people predicted 2008? If you just look at the the market, Sears and the prognosticators and you just actually honestly review the record of what they said, what's going to happen versus what actually happened, you find very few of any that are consistently right.
Alex Shahidi [35:51] So what does that tell you? Right, we share stories about, you know, the economist, surveys of what they you know, what they predicted, the economy is going to look like, just 12 months ahead, and how off that it was from what actually happened. So it's just and then and then the best, the best way to make progress in that regard, is, is when something completely unexpected happens.
Alex Shahidi [36:12] Right after that, while it's still fresh, you remind them look, look what just happened, who predicted that, right? And look at the impact it has. And really, you know, you you the most important part about investing is just avoiding those big losses. And those big losses always happen when something, you know, like a black swan hits and nobody's expecting.
Alex Shahidi [36:32] And so so if you're trying to operate, you know, by a philosophy of what we call a crystal ball investing, which is, this is what I think the future holds there from an invest in things that will do well in that feature environment, if you're wrong about that. And by the way, you're gonna be wrong a lot, you're gonna take huge hits.
Alex Shahidi [36:50] And and so that basically takes us back to our perspective of long term successful investing is the motto of slow and steady wins the race, right, you just want to be steady and slow over time, rather than riding the roller coaster ride of the markets. That's how you achieve wealth over time. And also, that's how you prevent yourself from making bad decisions that will will compound to reduce your overall returns.
Alex Shahidi [37:15] So so it's kind of telling that story over and over and over again, and then relating real life examples to help, you know, crystallize it in their minds. But even then, we recognize that, that clients don't have the patience to do something that is totally different from what everybody else does. Because their reference point is the market. Right? So when somebody says,
Alex Shahidi [37:39] How did the market do today, they're not talking about the bond market or the real estate market, they're talking about the stock market. And so so we recognize that, that, you know, for most people, they can hold on to slow and steady wins the race over the long run, because of FOMO.
Alex Shahidi [37:53] Because when the markets doing well, they feel like they're a five but the markets up 10, you're not gonna just bought the s&p, you get those arguments. So we have to so part of our job is is economist, part of it is market strategist, an investment expert, but it's also psychologists, we have to get into the minds of our clients and see what can they actually hold.
Alex Shahidi [38:13] And we want to try to get as close to what we think is a optimal diversified portfolio as we think they can handle. Because Because ultimately, it's their money, it's not ours, and and they have the power to, to cut out whenever they want. So we have to figure out how far along that direction we can go, that is going to be acceptable to them.
Adam Butler [38:34] So I think there's a anyone who's followed along thus far, I think is is probably we get this a lot where we present the ideas that underlie this idea of all-weather risk parity, and people people are sweating nodding along, and it just, it just makes eminent sense.
Adam Butler [38:52] And then, when it sort of gets to the end, and we're asking them, how would you like to proceed? And there, you know, it's a press pause, because it's just so uncomfortable and different, but I do think it's worthwhile. Because we've been, we've been sort of talking about the moving parts, but we haven't really landed on what a risk port parity portfolio might look like, like what is what do they look like in practice?
Adam Butler [39:14] And, and what are some of the different ways that some of the really big practitioners like Bridgewater or an AQR, or, you know, what you guys are doing? How do those portfolios look? And what are some of the similarities and differences and what do those similarities and differences mean to what investors should expect from those products?
Damien Bisserier [39:37] So, to the similarities, they will all incorporate some mix of equities, sovereign bonds, and inflation hedges, as inflation hedges could be commodity related exposures could be tips.
Damien Bisserier [39:53] That's the most typical, you know, configuration is is those three buckets and then each practitioner will have their own process for arriving at the appropriate weights. Sometimes that's a more dynamic process. So one of the things that actually caused a lot of dispersion last year across risk parity strategies more than normal, is that you had this big drop in February and March and in, in most assets, actually, every asset for a period of time in March was going down at the same time. And in that environment, volatility spikes.
Damien Bisserier [40:30] And a lot of these strategies, not all, but a lot of these strategies are very dynamic. So they target a short term level of volatility. And when you get a big spike in observed volatility, they cut their positions.
Damien Bisserier [40:44] So they reduce the leverage, in some cases, as much as half of the portfolio position sizes were cut. And that happened in the middle of March, in retrospect, at the worst possible time, because subsequent to that, you had a big rally across all of these asset classes.
Damien Bisserier [41:02] And the the managers that had the most, you know, sort of the shortest time horizon in terms of their volatility targeting, cut the most, and ended up missing out on the rebound. And so you saw some managers who were flat or even down on the year, and some managers, like our ETF, you were up almost 20% on the year, and says it was a very big spread.
Damien Bisserier [41:28] And and the reason why we did on a relative basis better last year is because we approach this more from the perspective that volatility is very hard to time. And that we just want to hold a balanced portfolio. And we'll size the positions on the basis of very long term measures of volatility, that that are not very influenced by short term changes.
Damien Bisserier [41:50] And so we were more or less static through that period, in terms of the position sizes, and that benefited our strategy relative to some others that were more dynamic in terms of cutting risk, you know, we didn't really cut our position sizes, or they weren't cutting risk, they were cutting their, their position sizes in order to target a constant risk.
Damien Bisserier [42:08] So that's one big difference is is the, the whether or not the target the volatility targeting, or the sizing of the positions is more dynamic versus more static or longer term in nature.
Damien Bisserier [42:20] Another big difference would be how they choose the configuration of the portfolio. So which specific asset classes do they choose and in what proportion to one another. So we have a a perspective that growth and inflation are the dominant drivers of relative asset class performance.
Damien Bisserier [42:40] So we've picked very explicitly for asset classes that have different exposures to different growth and inflation outcomes. So we think about it more from an environmental perspective. Some other managers might think about it more from a line item perspective.
Damien Bisserier [42:54] So for instance, they might have equal risk to equities and to credit, things like high yield spreads and corporate spreads, that those two exposures in our view to Alex's earlier point, are not that diversifying, they actually are quite similar, in that they do best when you have a strong growth environment, and they do worst in a weak growth environment.
Damien Bisserier [43:15] And so you also saw some dispersion in performance, because some some portfolios were more oriented to equities in credit than others. And we happen to be a little bit less oriented to equities and credit from that perspective, because again, we were focused on the environmental sensitivity of the assets, as opposed to just the trying to equal risk weight, a number of different asset classes.
Damien Bisserier [43:42] And then, and then I'd say the third, differentiating aspects is it's more of an implementation question. But you can hold these assets in different ways. You can do it through derivatives, you can do it through physical securities, you can do it in ETF, you can do it in a mutual fund, you can do it a hedge fund, you can do it a separate account.
Damien Bisserier [44:04] And we found that the advantages of doing it in ETF at a low cost are significant. And so we've been able to gain incremental benefits from a tax deficiency and a cost perspective and an ETF structure that we think is advantageous for our clients versus some of these other approaches, which are heavier on the usage of derivatives which generate more income, that that's less tax efficient.
Damien Bisserier [44:30] They're also oftentimes a lot more expensive in terms of the headline fees. So that's the other aspect that I think is a differentiator.
Pierre Daillie [44:39] Yeah, plus it It also, as you said earlier, it removes that line item, behavioral risk, right where your your clients are looking at their portfolio, and all they see is the red items. And instead of the one line which is which is the ETF or the portfolio and and they don't get hung up on it.
Alex Shahidi [44:59] That's Right.
Alex Shahidi [45:00] Yeah, yeah. And there's one more point there, which is that, I think it's really important to keep it as simple as possible. Because there is this tendency to try to over optimize and try to create precision out of out of inputs that are emphasized, I think you just want to be generally in the ballpark of balance allocation. Keep it very simple, just own index exposures across the board, and then make it very transparent as to what you own and why you own it, and why the performance is what it is, because there's just a balanced mix of assets, you can just look at the asset class returns, and basically figure out how your portfolio is doing.
Alex Shahidi [45:36] And repeating that process over and over again, I think sticks in the minds of investors, and when they understand what they own, and why they own it, and what the long term rationale is, for a balanced mix, they're much less likely to sell, when it's underperforming, and actually more likely to buy when it's underperforming.
Alex Shahidi [45:54] And ultimately, that's what you need to do to achieve, you know, attractive returns for clients is that prevent them from hurting themselves, even when you hide the line items, the package itself is a lot more palatable than the line items, that's for sure, because it's gonna have a, you know, less volatility.
Alex Shahidi [46:11] But still you I think it's really critical for people to know what they own. And so we spend a lot of time and focus in, in clarifying our message, trying to keep it simple, creating, you know, videos and presentations, and repeatedly sharing the same story, because that is I think that's really under appreciated, that there's so many funds out there that people just don't really understand what's in there.
Alex Shahidi [46:35] And and I think that's critical, because when you don't understand something, and it's doing poorly, your reaction is gonna be to sell it. And that's just not in the best interest of investors, which goes back to buy low sell high, you know, even at a portfolio level.
Adam Butler [46:52] Yeah, you know, there's what we've we've obviously done a lot of tire kicking on the concept, one thing that we noticed was that the outlets call it sort of a strategic risk parity, where you're holding the weights relatively constant over time, right, versus a dynamic risk parity, which is adjusting the weights over time in response to changes in estimated volatility and, and correlations.
Adam Butler [47:25] And what I think it just is important to recognize that there's kind of no universal optimum, right? The strategic approach does better than the dynamic approach in certain environments, for example, V bottoms, obviously benefit, strategic methods and penalise more dynamic methods, whereas sustained bear markets, like what you sort of experienced in say, 2008, and another period through like 2000, 2003, that sort of thing. They they tend to favor the dynamic method.
Adam Butler [47:59] But what we also observed was that the, the real juice comes from from owning a bit of both, right, so having some allocation to a strategic risk parity, and some to a dynamic risk parity, they actually work nicely together to offset some of the path dependencies of the risk parity experience. So I think that's a neat thing to take away.
Rodrigo Gordillo [48:26] And I'm, you know, one of the things that's Top of Mind and everybody's head right now, is that inflation, right, everybody now thinks, because inflation has recently spiked, that it now is the thing to, to get ready for. So let's, let's indulge them a little bit and talk about the many types of inflation that can materialize.
Rodrigo Gordillo [48:47] Damien, You were discussing how risk parity portfolio has a microsystem bonds and an inflation hedge, one of the many inflation hedges that could be part of a well balanced portfolio, and how do you see them differ from each other in different inflation scenarios.
Damien Bisserier [49:03] There are two core types that we hold. One is commodity exposure. And we hold that through commodity producer equities. So companies that are pulling commodities out of the ground, as well as physical gold bullion. And then there are also inflation index bonds.
Damien Bisserier [49:26] So these are Treasury inflation protected securities, we hold the US inflation index bonds, but there are actually global options as well to hold and I know a lot of the strategies hold the mix. And so when you think about it, maybe maybe I should say three categories, because you have the industrial commodities, whether you get that through futures, or we do it through the producer equities, the goals and the tips.
Damien Bisserier [49:50] And I think each of them actually have a very different sensitivity to other drivers beyond just inflation. So commodity, industrial commodities. are going to be more of a pro growth asset class, you think about what industrial commodities are think copper, or oil, or other types of commodities that the global economic engine runs on, those are going to be in higher demand, and therefore experienced upward price pressure in a strong economic environment and vice versa.
Damien Bisserier [50:23] Whereas gold tends to be more of a weaker growth, inflation hedge. So gold tends to do best when you have weaker growth, which is encouraging more monetary inflation or money printing in order to stimulate growth.
Damien Bisserier [50:38] If you think about gold, it really is a currency more than it is something we use. It's a store hold of wealth. And so in that lie, you can compare it to the US dollar or the euro. And so it tends to be a great diversifier against fiat currency devaluation. And it tends to do best in environments where fiat currency is paying us zero or negative yields because there's no opportunity cost of holding gold.
Damien Bisserier [51:04] I've joked I made this joke the last few years with clients that gold is one of the highest yielding currencies today, which is mind blowing, if you think about it, because it is euro. And so so it tends to do best though, in a weaker growth environment. So you've had inflation recently, or at least fears of inflation, and some people are scratching their heads, wondering why it is that gold isn't doing better.
Damien Bisserier [51:25] Partially, it's because you've had tightening liquidity conditions, you've had rising interest rates. So even stronger dollar you on the on the margin, gold as a currency is less attractive than than the dollar and and so you're seeing some headwinds for gold as an asset class as the economic growth improves, I still think longer term that there is a role for gold as a hedge against that monetary inflation that that devaluation of fiat currencies that seems likely to come.
Damien Bisserier [51:55] And then TIPs are a little different in the sense that they're the only asset that pays you CPI inflation, they're actually the interest rate is indexed, or the principal is indexed to CPI inflation. And that's valuable as well, because, you know, that's commonly the the nature of the inflation that people are most concerned about, which is the cost of consuming things.
Damien Bisserier [52:18] And so that's the one most direct hedge there, it also has a tendency to do best and weaker growth environments, because you have falling real yields, which is, you know, something that drives the pricing of tips.
Damien Bisserier [52:30] And so when you put that all together, if you have a mix of tips and gold for the weaker growth environments, but again, they're both inflation hedges. And you have the industrial commodities, as a pro growth, inflation hedge, you put those together, and you get something that's very balanced to different growth outcomes, very balanced to different types of inflation outcomes. You can get a commodity price spike, which is one type of inflation outcome, you could get monetary inflation because of all this money printing, so currency devaluation, that's a very different type of, of inflation outcome.
Damien Bisserier [53:02] And so we think by holding all three of those inflation hedges, you get a very nice diversified exposure to different types of inflation in different types of growth environments.
Alex Shahidi [53:12] And Rod,...
Rodrigo Gordillo [53:13] Plus, you get that boost from the rebalancing premium, right, yeah,
Alex Shahidi [53:16] I was just going to add one quick thing to what Damian said before damage, Thompson is that there's all this talk about inflation concerns, but nobody owns inflation hedges. You know, they're they're missing in portfolios, right?
Alex Shahidi [53:28] The allocation to TIPs or gold or commodities is tiny, if any, in portfolios. So there there is a disconnect between the fears that are emerging and what's actually in portfolios, and that's because we haven't had high inflation since the 70s. Right, and maybe we don't get it.
Alex Shahidi [53:44] There's a lot of deflationary pressures. But, but it's interesting how you're not actually seeing in portfolios, which also goes back to Pierre's earlier point as window investors. You know, they just they move very slowly, right, these shifts occur, you know, at a snail's pace.
Rodrigo Gordillo [53:59] Yeah, that's what I was interested to see that everybody's go to inflation, magic gold, and hasn't been working out for them. So, you know, they're raising their hands and they're shaking their heads and raising their hands thinking like I thought, you know, I was covered for inflation.
Rodrigo Gordillo [54:12] This is why it's so important to understand, like, there's many different types of inflation. The continent commodity complex will respond differently, including gold and silver and the like. So it's it is it is much more complicated than people I think have expected. Yeah. And you're right.
Rodrigo Gordillo [54:27] There is their go to with gold. It's still small. And I think there's just this hang up that come up that people feel like commodities may not have any is any risk premia. And that's why they don't have them in their portfolios.
Damien Bisserier [54:40] That's a reason why we hold the the equities because, you know, if you look at the equity, the producer equities over a long period of time, there's a very clear risk premium there. I'd also say that this is not something we're holding currently, but it's something we're thinking about.
Damien Bisserier [54:53] I do think there's the potential for another store hold of wealth, which is crypto, you can't have a conversation these days without Talking about crypto. So specifically Bitcoin, right?
Damien Bisserier [55:03] Because there has been a tremendous amount of institutional adoption, infrastructure built around that. The challenge, of course, is that it's a technology. And it's a relatively new technology, it's been around for a little over 10 years. And just as it has gained popularity, because it has attributes that make it an attractive form, essentially of digital gold, it could easily be displaced by a new technology in the future that might be better, a better form of digital gold.
Damien Bisserier [55:33] So So I think, you know, the, you've got the bull case of going to like the market cap of gold, right, and, and the bear case of going to zero. And so but I do think that there's, there's a role for other store holds of wealth, Bitcoin and others can be considered in that. And I think investors could consider a small slice of that as well.
Damien Bisserier [55:53] I don't think that bitcoin's been running up recently, because of some fears of inflation, per se, I think it's more of a supply demand aspect where, you know, it's getting caught up in this speculation, which is driving a lot of the market outcomes in the in the near term, and it does have, unlike some other stores of wealth, it does have much more of a speculative aspect to it, that actually makes it hold up less well in periods of time, like march of 2020, you know, because you get a lot more outflows in that than you do in something like gold.
Damien Bisserier [56:26] But, but I think it's interesting, and it's definitely worth exploring your longer term. Because, again, I think it's it's pretty clear that central banks are going to continue to play this game, they're going to produce more and more fiat currency to deal with their problems until there's some sort of negative repercussion.
Damien Bisserier [56:42] And so are earning things that are, you know, store holds of wealth, whether it's real assets that get utilized or alternative store holds a wealth like gold or Bitcoin, I think that there's an attractive case to be made there.
Rodrigo Gordillo [56:56] And in the case of risk parity, the volatility of a Bitcoin is probably the most volatile component of your portfolio, and therefore the allocation will be commensurate to that risk. You're not, you're asking people to put in 20%, like, like my mom wanted me to do for her portfolio,
Alex Shahidi [57:14] She would have done well.
Rodrigo Gordillo [57:17] No, I'm definitely I'm definitely the loser in that scenario. Well, I haven't answered her call in weeks.
Damien Bisserier [57:22] So far, you know, so I mean, look, I don't think gold is going to go to zero. Because it's had this role for 1000s of years. But But I think there's a real chance that Bitcoin could go to zero, you know, it could also be, you know, 10x what it is today. So, I guess the sizing is the key question.
Damien Bisserier [57:41] They're just sizing it appropriately relative to what else you're doing, I think, is important
Adam Butler [57:47] that we've started,
Pierre Daillie [57:49] go ahead Adam, go ahead.
Adam Butler [57:52] One of the things we've noticed as we sort of prepared proposals for institutional risk parity mandates is when you sort of X ray through the risk exposures through time for many of the big risk parity products.
Adam Butler [58:05] There's it seems like there's a an overweight to disinflationary growth assets, like there's, there's typically call it somewhere in the neighborhood of, you know, 60 or 70% of the risk is or, you know, 80% the risk, so sort of 40% of the risk budget is equity. 40% of the risk budget is his rates, and then only 20% of the risk budget goes to that inflation basket.
Adam Butler [58:33] And I can't help but presume that that's because sort of, to go back and examine the probability through time of experiencing an inflationary versus a disinflationary regime or a growth versus a negative growth shock type regime, then the odds have historically favored disinflationary growth assets, right bonds and stocks.
Adam Butler [58:58] And I think we would take the position that, while that may be true in the historical distribution, that we shouldn't expect that in the, you know, going forward, right, they sort of all are equally probable.
Adam Butler [59:12] How do you guys think about AI? First of all, that you observe the same and I would be curious, actually, Damien, given your experience at Bridgewater because when I sort of, do examine the risk budget, allocation of all weather over time, it does seem like they D prioritize the inflation basket over the equity and, and rates allocations.
Adam Butler [59:33] So I'm just wondering, you know, have you seen that as well? And how do you guys think about that, for for your ETF.
Damien Bisserier [59:42] I actually have not seen that at Bridgewater because they have a similar framework to ours, which is having more or less equal risk to rising growth assets versus falling growth assets and rising inflation versus falling inflation assets. So in that configuration, I wouldn't perceive a bias there. Out of inflation, hedge assets. But But you're correct that some other risk parity providers are very explicit about that type of a, of a risk allocation for the reasons you mentioned.
Damien Bisserier [ 1:[00] 2] And so we take more of a Bridgewater approach is, is from the perspective of, you know, at any point in time, there's a certain future discounted and asset prices, and we think the markets equally likely to get it, you know, wrong on either side. And so we want to be balanced to growth and inflation.
Damien Bisserier [ 1:[00] 9] And as you very astutely observed, maybe inflation is a greater issue in the future, maybe it's more of a driver of relative asset class performance and growth has been, you know, I think, then, in that light, it's always useful to take a step back and think in decade increments, as opposed to in in in our recent years, for the past few years, because it's very easy to extrapolate what we've been living through where inflation hasn't been a concern.
Damien Bisserier [ 1:[00] 3] But if you take a step back, and you look in the 70s, and even in the 80s, and 70s, because you had a big run up in inflation, the 80s, because you had a big drop in inflation, the dominant driver of asset class returns was inflation volatility. And so in that period, people forget this, but actually, stocks and bonds had a very positive correlation.
Damien Bisserier [ 1:[01] 1] And so, and then, since, you know, in the 2000s, you had the slowest rate of growth since the Great Depression, after having phenomenally optimistic expectations coming into the 2000s, which Alex alluded to. And so that big adjustment and in, you know, very optimistic growth expectations to very pessimistic growth expectations was really good for bonds in the 2000s, and terrible for stocks.
Damien Bisserier [ 1:[01] 4] And then you've kind of in some ways, had the reverse happen more recently, where and so in other words, if you if you look at a decade increments you've had of the for last, you know, the four past decades, you based or five past decades, you basically had, you know, inflation dominating early period, and then growth dominating in the second half, who's to say what's going to happen next?
Damien Bisserier [ 1:[01] 4] And I'd say you have to also, I think, define inflation differently than maybe we have historically, because you have this tremendous potential for monetary inflation in a way that, you know, we probably have never experienced in this country. But there have been some historical examples of this in emerging markets and such.
Damien Bisserier [ 1:[02] 0] And so not to say that that's going to happen, but it's, it's a possibility that you have to budget for. And so we don't think it makes sense to take a you know, to overweight, one versus the other, we think they're both equally important.
Damien Bisserier [ 1:[02] 3] And, and I think when you think about those drivers, you just want to make sure you're balanced to both not necessarily take view on them.
Adam Butler [ 1:[02] 2] I think we would be remiss if we didn't address the what's going on currently in the fixed income markets has certainly been interesting. Time to be an owner of duration? How are you guys finding this period? And and how are you communicating this experience? Or about this experience with with clients?
Alex Shahidi [ 1:[02] 7] I mean, I'd say what's happening is, is not a surprise, given the economic environment, right? It goes back to that economic environment again, so if you go back a year, right, interest rates collapsed, right, they almost went to zero. And, and that's, and that made sense, because you had the economy shutting down.
Alex Shahidi [ 1:[03] 6] And then since then, rates are up, you know, about a percent. Right. And so and that makes sense, because the economy isn't going to zero, right, it's starting to come back. And now, with the rollout of the vaccine, you know, we have all this stimulus that's being pumped in, the economy is recovering, the growth is surprising a little bit to the upside relative to where we were a year ago.
Alex Shahidi [ 1:[03] 7] And so it makes sense that rates have risen. And the reaction of various asset classes sit out for those two environments, you know, the bear market and the bull market also makes sense.
Alex Shahidi [ 1:[03] 7] So the thing that's done the best, most recently are commodities, because you're in a rising growth, rising inflation type of regime, and which can obviously quickly change, but commodities and unwell and that's the worst environment for treasuries, which has been the worst thing.
Alex Shahidi [ 1:[04] 2] So, so none of that is a surprise. And, you know, people talk about, oh, gold isn't working, you know, gold was up in q1, when commodities collapse, and stocks fell, and, and it hasn't done as well, since and that's, that's understandable. So, so I don't think any of this is really surprised.
Alex Shahidi [ 1:[04] 9] And the way I think about it, just from a from, you know, 30,000 foot level is, you have a, you have a balanced portfolio, that includes, you know, pro growth assets and falling goes down with inflation and so on.
Alex Shahidi [ 1:[04] 2] And, and in some of those hedges, you can think of them that way, or treasuries and tips, when the yield is higher, expected return of them is higher, and the diversification potential diversification benefit is better. So so you can think of it as you have this portfolio of assets.
Alex Shahidi [ 1:[04] 9] You know, what happens and you're down 4% because the hedges paid off. Now, it's the opposite, right? So you've actually you've done relatively well since the lows, but you're resetting your head. Right, you're kind of reloading the interest rates. And if you get another downturn, those hedges probably pay off again.
Alex Shahidi [ 1:[05] 8] And so I think this is just part of the normal cycle. And there's really no, I'd say there's really no surprise in the way things have played out.
Rodrigo Gordillo [ 1:[05] 8] And when you're looking at one other thing I would add is that as these hedges or asset classes that recently paid off, do poorly, it just so happens that the other side of the ledger is having returns that are out side of their normal range, offsetting many of those losses from your hedges.
Rodrigo Gordillo [ 1:[05] 8] So it's not, again, it's there's always something that's killing. And there's always going to be something that's killing you. But generally speaking, you expect these asset classes to have a upward sloping Equity Line over time, adjust over time means to be something very different two very different people, right?
Rodrigo Gordillo [ 1:[05] 6] It could be it could be a decade or two. you tighten every drug. So you'd have left less left tail events, right? You have that left tail phenomenon happens when you decide to go 100% into a single asset class. 100% of the commodities are 100% in equities.
Rodrigo Gordillo [ 1:[06] 5] So this idea of trying to add alpha by shifting 100% into any one of these because because you think you know what's going to happen over the next six months, all you're doing is exposing yourself to negative three standard deviation events, admittedly, also positive three standard deviation events if you get it right. But as Alex alluded to earlier, is it 50? Or 51%?
Rodrigo Gordillo [ 1:[06] 6] What's your edge right? Now? often do you want to make 100% bet on that? 51%. So I think, you know, I think the framework that you guys have laid out on the best beta best balanced beta, where you're not taking any bets makes total sense.
Rodrigo Gordillo [ 1:[06] 1] But I know that you guys are also big proponents of the Bridgewater model, which is, once you have your do no harm portfolio set, as your core, there is an ability to possibly add some excess returns through to alpha. Right, so maybe you guys can dig into that concept a little bit. And I'd be curious to see that to learn about how you how you find that alpha with confidence.
Alex Shahidi [ 1:[07] 7] Yeah, before Damien jumps in. And just a quick overview of that, if you think about it, when you're trying to build a diversified portfolio, you want a bunch of return screens that are reliably different from one another.
Alex Shahidi [ 1:[07] 8] So if you're looking at it within public markets, we think risk parity is this an optimal framework, because you can take these public markets structure them to have similar returns and risk, you know, at least in the same ballpark, and are reliably diverse.
Alex Shahidi [ 1:[07] 2] So so that we think is a very good starting point, if you can think of that as the core. And then you can move outside of public markets into other market segments, that that might have a different return stream.
Alex Shahidi [ 1:[07] 3] But the key is, is it can't act like what you already own. So if you're going to go and buy other equities that are going to act like the equities you already own and risk parity, there better be a lot of alpha there for it to be differentiating. Otherwise, you're just overlapping. And you're not producing, you know, that reliable diversification. So I'll let Damon jump in a little bit deeper in that starting point.
Damien Bisserier [ 1:[08] 8] Yeah, I would, I would, though, say on that point, that it's most common for us to hold risk parity alongside equity allocations for clients. Because going all the way to risk parity is just not something that I think most investors are going to be comfortable with for the reasons we discussed earlier.
Damien Bisserier [ 1:[08] 4] So it's about finding, you know, where where is appropriate on the spectrum for each client, that they're likely to hold through whatever we experienced, like, this year is a great case in point, you know, risk parity has lagged at the same time that you've had, equities do quite well.
Damien Bisserier [ 1:[08] 2] And so, you know, I think it's important that you have things in the portfolio where the clients can point to that and say, I am participating in what my neighbor's doing, you can't ignore those types of things. And, and there's also, you know, frankly, you have to admit that there's a chance we're wrong, you know, and so there's, it's, there are other approaches out there that have a lot of thoughtfulness behind them, too.
Damien Bisserier [ 1:[09] 2] And so, I think diversification should apply to that approach as well. You can't be overly rigid with any one approach. And, and so I would say that typically, that's where we have a collection of, you know, typically equity and risk parity. And so a little bit of fixed income on the traditional side on the public market side.
Damien Bisserier [ 1:[09] 3] And then we, ...
Rodrigo Gordillo [ 1:[09] 4] Would you have a FOMO allocation for your clients
Damien Bisserier [ 1:[09] 6] that there's an aspect of that. Yeah, absolutely. That's exactly right. And I define our goal as ensuring the best outcome for the client.
Damien Bisserier [ 1:[09] 6] If you're a broader in your definition of that the best outcome is one that they can actually achieve. If you put them into something that they're not as comfortable with, they're likely to sell at the absolute worst time and then go to the thing that just did.
Damien Bisserier [ 1:[10] 0] Well, so they're going to get the worst of both of the approaches, as opposed to being in something that they understand and feel comfortable with and can stay the course with, that's the most important thing. Whether it's 60/40, or or, or something more akin to risk parity.
Damien Bisserier [ 1:[10] 5] You need to stay the course, you know that that's the biggest destroyer of value in client portfolios. Investor portfolios is changing your mind at the worst time. Right. So, so that's, that's just one thing that I think is important to realize.
Damien Bisserier [ 1:[10] 8] And I think I think in that light, our risk parity, actually, is a valuable way to incorporate those diversifiers into client portfolios in a way that they're more likely to hold on to, as we talked about earlier, as opposed to having the you'd say, optimally, you would just hold the things that are, you know, it would be risk parity, x equities. But again, that's a really hard thing for most people to hold on to. But then beyond math, or what's up?
Rodrigo Gordillo [ 1:[10] 6] That's when math and art meet.
Damien Bisserier [ 1:[10] 8] Yeah, that's right. Yeah. So beyond that, you're absolutely right, that, that you can incorporate high quality returns that come from manager skill. You refer to it as true alpha. And that could be in the public markets, or it could be in the private markets. And there are a lot of ways to generate compelling returns through manager skill. It could be through, you know, we recently made an allocation to early stage, you know, venture and growth equity managers. So if you believe that the managers you're hiring have an edge, and in identifying innovation, that is likely to change the way we consume, or do business or interact with one another, there's potentially return from that.
Damien Bisserier [ 1:[11] 1] And so, you know, we're trying to generate alpha, and that way, we're trying to generate alpha by hiring very experienced real estate operators. Guys that know how to manage an apartment building, which sounds boring, but I'm telling you, it's real alpha, that's actually quite a bit easier to underwrite than a stock picker.
Damien Bisserier [ 1:[11] 8] You can see when a property's managed well, you know, the way that they, you know, are collecting fees and, and not running with too much staff and thinking about the leasing efforts. And all these things go into operational alpha, which which we can underwrite in the private markets.
Damien Bisserier [ 1:[12] 7] So we actually, what we do is we think about it in terms of two categories. So there's one is largely in the hedge fund category, where we think the most skilled active managers tend to participate, because they frankly, the rewards are better if you're successful within hedge funds. And they have the opportunity to structure portfolios that are less directional with regards to the market, so they will be more hedged.
Damien Bisserier [ 1:[12] 3] And in fact, we tend to favor managers that tend to be more hedged and less directional, because then we can more easily determine whether it's alpha, versus just market tailwinds or being in the Right Sector.
Damien Bisserier [ 1:[12] 5] And so it could be literally market neutral, meaning they have equal Long's and shorts or it could it be that they overtime are market neutral, like a Bridgewater, where they don't have any bias to be long or short any one given market, but that at points in time, they'll have a directional view on where interest rates are going or where the stock market is going.
Damien Bisserier [ 1:[13] 1] And so we've spent a lot of time trying to identify the handful of managers we believe can consistently outperform whether it's through some sort of quantitative edge, or whether it's through just, you know, experience and understanding of the global linkages between economies and markets.
Damien Bisserier [ 1:[13] 7] Or it could be just something much more nitty gritty like being able to work through distressed situations and advocate on behalf of your shareholders or go into activists situations, there's, there are countless ways to make money out there. And what we're trying to do is fold in as many different paths to generating a skill based return as we can, when we become confident in that manager skill set. And so that's an ongoing effort.
Damien Bisserier [ 1:[13] 2] You know, we have a handful of managers we allocate today that we allocate to today. And we continue to look for that. It's like uncovering gems out there. But it is challenging, and you never get the past returns, you only get the future returns. So I'd say there are filters we use from a quantitative perspective to say whether or not they've generated alpha historically, but that's just the ticket to get into the to the park, then you've got to, then you got to figure out who is likely to do it going forward.
Damien Bisserier [ 1:[14] 8] And that's much more of a qualitative exercise. And we often takes years to get to know managers and assess whether or not they really have an edge. You know, are they thinking about risk in a holistic way?
Damien Bisserier [ 1:[14] 9] Do they have the right values in terms of closing their strategies being their own largest investors, there's a number of things that go into that assessment.
Damien Bisserier [ 1:[14] 6] And then I say on that private market side, that's a continual effort of ours to source really high quality privates. And that spans the spectrum from things that are really off the run, like healthcare royalties or life settlements, all the way to things that are more familiar, like private equity.
Damien Bisserier [ 1:[14] 2] I mentioned growth equity, that's a popular area. But I do think that there is a premium for those managers that can identify and access that innovation. And private real estate is a big, big area of focus for us as well. So it spans the spectrum, there's there, that's a longer conversation. But I do think all of those things are very complimentary to getting the right asset allocation on the public market side.
Alex Shahidi [ 1:[15] 4] And then one quick comment on from a high level is, our stance is that markets are becoming more and more efficient. So if you go back 50 years relative we are where we are today, there are just more and more participants in that space, your information is widely available.
Alex Shahidi [ 1:[15] 9] So it's more and more efficient, which makes alpha opportunities more and more challenging, which is one of the reasons why efficiency is so important. So tax efficiency, cost efficiency, capital efficiency, being really well balanced, getting getting the rebalancing benefit.
Alex Shahidi [ 1:[15] 6] So that is what why we created the ETF, because we think that's a very efficient way to get that exposure. And then you spend most of your time trying to identify alpha in less efficient space with like private markets, some of the things that the hedge funds do, where they can buy things that are more esoteric, and that I think, is a very good way to to get balanced, you know, market exposure plus alpha, and you put all that together, and you can build an extremely diversified portfolio that can actually do well in a period of, you know, low cash rates. But that's that's kind of the big picture.
Adam Butler [ 1:[16] 7] Do you guys typically like to put those more idiosyncratic, you know, the private, direct real estate investments, life settlement type investments, the type to deal to wrap those in, in a fund together, or do you typically have those on client statements as as individual line items, any preferences, there are trends?
Damien Bisserier [ 1:[16] 9] It depends on the opportunity. So sometimes we'll do feeders, they could be single manager feeders or multi manager feeders. For instance, within growth equity, where we're doing a multi manager feeder.
Damien Bisserier [ 1:[17] 1] Last year, when there was the big dislocation associated COVID, we did a multi manager feeder with different distress credit managers, because we wanted diversification in those segments. And then other times, we might get great access to a multifamily manager.
Damien Bisserier [ 1:[17] 5] And we might want to just have a dedicated single manager feeder there. So it really depends on the opportunity. Also, there's a sizing constraint. So we don't want to do a feeder, unless it's a meaningful size. Otherwise, they're incremental costs that come from that. So sometimes we'll just do direct investments with the managers as well, and just have, you know, those individual line items being held in client portfolios.
Alex Shahidi [ 1:[17] 5] I mean, ultimately, we're trying to get the return screen for the clients. And the second decision is, what's the most efficient way to get that? Sometimes when you do a feeder, you get good cost efficiencies, because you go in with $100 million check as opposed to a bunch of smaller investments.
Damien Bisserier [ 1:[17] 0] Yeah, we can usually get, you can usually get preferential terms, you know, whether that's lower fees, or better governance, better access, you know, co investments, those types of things.
Pierre Daillie [ 1:[18] 4] So, one of the things I wanted to point out was that, in terms of most investing, most investors are constructing their portfolios, according to expected returns. But when it when it comes to constructing a portfolio, using risk parity guideline, you're actually constructing the portfolio according to expected risk. That's right.
Alex Shahidi [ 1:[18] 8] Yesterday, you kind of have an expected risk that also is associated to an expected return. Because there, there's a rough estimate of what returns to get for every unit of risk that you take.
Pierre Daillie [ 1:[18] 0] Okay, Thanks for clarifying that. So what are some, if we have time? What are what are some of the biggest risks that you're thinking about right now?
Alex Shahidi [ 1:[18] 3] That's, that's what we spend most of our time thinking about it, because it's such an unusual environment. You have to think about, you almost have to think about the things that nobody's thinking about.
Alex Shahidi [ 1:[19] 4] So you know, a year ago, we weren't thinking about a global pandemic, but it happened.
Alex Shahidi [ 1:[19] 8] But I think you have to consider things like, you know, what happens if the US loses its world reserve currency status?
Alex Shahidi [ 1:[19] 5] What happens if inflation really takes off and it can't be controlled?
Alex Shahidi [ 1:[19] 0] What happens if we, you know, the Fed is trying to create inflation with all the tools in the toolkit, but what if it's not successful? Japan's been trying to do it for a couple decades, Europe's been trying for a decade without success? Maybe the deflationary pressures or the secular forces are so significant, that printing trillions of dollars isn't enough. And so what happens in that environment? And you know, if you just think about these forces, they're so significant that not just in terms of the headlines, but in terms of the magnitude, printing trillions and trillions interest rates near zero for a decade.
Alex Shahidi [ 1:[19] 4] The deflationary forces. You could end with significant deflation and you Things that do well in that environment, which is very different from the things that do well in a, in a strong inflationary period. And so we think about all those tail risks, and we're constantly thinking of new ones, unfortunately.
Alex Shahidi [ 1:[20] 4] And you just want to own things that protect you, because you just like ...
Alex Shahidi [ 1:[20] 7] The key to all of this is just don't get wiped out. And I think that's it, that's a risk, most people underestimate until it happens. And then it's too late. And then I mean, as fiduciaries, you know, that's, that's where we are, our main job is to protect clients in the secondary, grow your capital, but the way you grow it over the long run is just don't take a huge hit. And I think that has to be the primary focus.
Damien Bisserier [ 1:[20] 1] Since our job is to help our clients manage their wealth, I worry about the inevitable wealth confiscation, that's going to happen.
Damien Bisserier [ 1:[20] 1] There is it's unsustainable for a society to exist with these types of wealth extremes, which have only been exacerbated by COVID, and by the monetary policy of the last decade.
Damien Bisserier [ 1:[21] 1] So the owners of assets, the owners of businesses of real estate, are getting wealthier and wealthier. And the average person, I don't think, feels that their circumstances are improving in the same way. And so that will lead to more and more extreme political outcomes. And it's your, you know, your guess is as good as mine as to what that looks like in practice. But I think that that is going to be a very challenging environment, generally, to help us take care of our client wealth, which is why we think about some of these extreme outcomes. But certainly, I would think about things like higher taxes, potentially higher rates of inflation, which is another form of wealth redistribution. And, you know, all the way to things like a real problem with the currency.
Damien Bisserier [ 1:[21] 5] And so it speaks, again, to a framework like risk parity, which I think is much more robust through a range of those types of outcomes, versus something that's more conventionally allocated, which, by the way, that on the 60/40, if you look at most of those portfolios, they're predominantly US equities, because they've done the best recently. And I think, you know, I think those are, you know, that's just susceptible to the change in the environment.
Pierre Daillie [ 1:[22] 0] Thanks, Damien, that that's, that's very enlightening. Actually, it's the first time anyone's put it quite that way. There's been a lot of talk of inequality, this last year, but I don't think it's that's the first time at least I'm speaking for myself. That's the first time I've heard about it put that way in terms of wealth confiscation. So
Damien Bisserier [ 1:[22] 9] Yeah, I mean, it's happened for 1000s of years, right? There's the day of Jubilee in the Bible. You know, it's like you forgive the deaths. And there's just a, you know, a redistribution of wealth. And I think there are different ways it can happen. There are orderly ways, there are disorderly ways. But I think it's unquestionable that there's going to be some sort of redistribution of wealth.
Pierre Daillie [ 1:[22] 5] Yeah, you know, my speaking of which my godson was in his economics class online the other day, and the teacher put a question forward, which was, do you agree with the sort of the question was a sort of exist to existential question, do you agree that, that there should be billionaires?
Pierre Daillie [ 1:[23] 7] Just 25 out of 27 of his classmates, except him, said no.
Damien Bisserier [ 1:[23] 8] Yeah,
Pierre Daillie [ 1:[23] 8] You know, so, so. But I just thought, I just thought that was such a reflection on, you know, on the the mindset that's happening that's occurring, you know, in these times that, that, there's, there's the feeling that, that there shouldn't be that kind of concentration of wealth in such a small number of people. And and I thought, you know, this is the future, these are 17 year olds, who are thinking this way, well, what are they going to do with that thought, when they you know, when they get into their 20s and 30s? Are they are they going to be activists? Are they going to be? Are they gonna hang on to that, that mindset and take that forward with them and do something with it? And and that that actually ties into what you just said? Which was why sort of lit up when you said it? Thank you.
Alex Shahidi [ 1:[24] 0] Question. 30 years ago, you probably got the opposite answer.
Pierre Daillie [ 1:[24] 4] Exactly.
Alex Shahidi [ 1:[24] 5] It shows you which way the trends go.
Pierre Daillie [ 1:[24] 9] So gentlemen, we've we've come it's been a really, thank you very much. It's been a really, really great discussion we've come to towards the end. It's time for one more question.
Pierre Daillie [ 1:[24] 2] Would you rather? And the question is, would you rather spend a week in the past or a week in the future?
Alex Shahidi [ 1:[24] 2] And then you come back to the present?
Pierre Daillie [ 1:[24] 5] Yeah. Call it a vacation in somewhere in time. Either. You have a choice of spending a week in the future or a week in the past?
Adam Butler [ 1:[24] 5] I'm reminded of Back to the Future, part two, right. It goes ahead and he gets that Sports Almanac and then they come back. And
Adam Butler [ 1:[25] 4] yeah, so i think i think that's there's an easy... if you're able to go to the future and then come back to this. There's some there's some opportunities there that your direction and your answer. Yeah.
Adam Butler [ 1:[25] 0] I don't know. I mean, I
Alex Shahidi [ 1:[25] 1] think if you get a glimpse of what the future holds, even if it's just the second, I think it, it at least get you on, closer to the right path than the wrong one. I mean, the past you can read about, I guess, if you go back a couple thousand years, you can read in detail, the past you can read about you can really read about,
Damien Bisserier [ 1:[25] 0] Oh, no, I don't know that I would survive in 2000 years ago, I don't have that. I tend to be an optimist. So I I look forward to what's to come. You know, and it is exciting. I mean, obviously, there are things to be worried about, you know, that's our job, we worried about things, but I also think that humanity is progressing. And, and we have this incredible ability to course correct, you know, when you get extremes and either way in either side. You know, the fact that young people care about the environment. You know, like they care about these things. It really extraordinary, right. And so that's the only way you're going to make changes is is for people to collectively decide that these things are important, and you're going to value them and and I think, you know, normally you think of it being very difficult to make decisions. You know, normally people decide on what's best for them in the near term, like right in front of them, you know, and now you're seeing people decide on what's best for their kids and their grandchildren. And that's encouraging to me, you know, so I would love to spend a week in the future.
Pierre Daillie [ 1:[26] 1] All right. That's great. Well, Damien, Alex, thank you so much. It's as I said before, it's been a terrific conversation. I think you've shared a lot of food for thought. We hope to do this again with you very soon.
Damien Bisserier [ 1:[27] 8] That'd be great. We'd love that. Thanks.
Adam Butler [ 1:[27] 1] Thanks, guys.
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Alex Shahidi, Co-CIO, Managing Director, Evoke Advisors - https://www.linkedin.com/in/alex-shahidi-071706b3/
Damien Bisserier, Co-CIO, Managing Director, Evoke Advisors - https://www.linkedin.com/in/damien-bisserier-3b64132/
Evoke Advisors - https://www.evokeadvisors.com/
Risk Parity ETF (RPAR:NYSE) - https://rparetf.com/
Mike Philbrick, CEO, ReSolve Asset Management SEZC - https://www.linkedin.com/in/michaelph...
Rodrigo Gordillo, President, ReSolve Asset Management SEZC - https://www.linkedin.com/in/rodrigogo...
ReSolve Asset Management – https://investresolve.com/
ReSolve Asset Management Blog - https://investresolve.com/blog/
Pierre Daillie, AdvisorAnalyst.com – https://www.linkedin.com/in/pierre-da...
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