The Tobin Two-Fund Portfolio

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The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

The Two-Fund Portfolio is widely accepted by Bogleheads. It consists of holding an all-world stock fund and a bond fund (my preference is intermediate treasuries) and is generally represented by the blue efficient frontier curve shown in the graphic below.

As many here know, the efficient frontier was introduced as part of Harry Markowitz's Modern Portfolio Theory and it represents the blend of risky assets that provides the most amount of return per unit of risk.

A few years after Markowitz presented Modern Portfolio Theory, James Tobin presented a paper that introduced what is now referred to as Separation Theorem. Separation Theorem builds upon Modern Portfolio Theory by introducing the Risk-Free Rate into the analysis. It generally states that there exists a single portfolio of risky assets that provides the highest return per risk (Tangency Portfolio) and that any investor's portfolio should be a trade-off between the risk-free rate and the Tangency Portfolio (move up/down the Capital Market Line). If your risk tolerance is equal to the expected risk of the Tangency Portfolio, you just own the Tangency Portfolio. If your risk is lower, you exchange some of the Tangency Portfolio for the risk-free rate. If your risk tolerance is higher, you borrow at the risk-free rate to invest more in the Tangency Portfolio.

The Separation Theorem is the basis for what is now commonly referred to as a risk parity style of investing. Until recently, the implementation of risk parity concepts have been difficult, especially for the retail investor that has a higher risk tolerance than the Tangency Portfolio. But today, more and more products are coming to market that implement these concepts and allow an investor to maintain the base asset allocation of the Tangency Portfolio while also achieving their desired level of risk. This has now lead to the introduction of UPAR, a risk parity index fund that targets similar risk as a 100% stock portfolio. UPAR includes other assets beyond stocks and bonds such as commodities, commodity producers, and TIPS, but for the purpose of this post, let's assume that the performance of UPAR can be represented by the extension of the Capital Market Line (grey line) to a point equal in risk to 100% stock.

Now that a high volatility risk parity index fund is available, I think it is an appropriate time to present an idea that I have been thinking of for a while and have posted about before in slightly different context. Now that UPAR is available, it is possible for an investor of any risk appetite (similar to 100% stock or less) to implement a two-fund risk parity portfolio. In honor of James Tobin's Separation Theorem, I think it is appropriate to call this portfolio the Tobin Two-Fund Portfolio.

The Tobin Two-Fund Portfolio, which is depicted by the Red Line in the graphic, consists of a risky asset and a risk-free asset. The risky asset is the high volatility risk parity portfolio. This can now be implemented through just holding UPAR or can be implemented in a more custom manner using derivative products (e.g. futures, options). The risk-free asset is a fixed-income instrument that you have access to that provides the most amount of return with zero risk (generally speaking). For instance, if you have a stable value fund or have access to the TSP G-Fund, you could use that. They are currently paying around 1.6%. If your assets are outside a 401k, you could create a ladder of Multi-Year Guaranteed Annuities (MYGA). These can be considered risk-free from a default perspective as long as you stay below state guarantee fund limits. However, there is some term-risk associated with them. If you have a ladder of 4-5 year MYGAs, your total volatility experienced is similar to that of a short term treasury bond fund like SHY but the yield of a MYGA ladder like this would currently be in the range of 2-2.5%.

The primary benefits of this Tobin Two-Fund Portfolio are twofold:
1. The risk parity style of investing makes use of a more diversified portfolio and should theoretically earn more efficient returns than a stock-heavy portfolio over time.
2. By using fixed income products as the "risk-free" investment, the investor is effectively able to arbitrage the difference between the risk-free rate and the higher yield of the fixed income product.

Image
Note: This graphic is purely for the purpose of introducing the concept. It is not a prediction of future returns of any assets. The efficient frontier curve was generated using Portfolio Visualizer's Forecasted Efficient Frontier tool.

Additional thoughts:
- The purpose of this post is to present the concept of a Tobin Two-Fund Portfolio. It is not a recommendation to use UPAR. UPAR just started trading on 1/3/22, so it doesn't have much of a track record and has a low AUM. UPAR just happens to be the product that is now available to implement these concepts. I'm hopeful that other products will continue coming to market that allow these concepts to be easily implemented by the retail investor.
- UPAR has a 0.65% expense ratio. I'm hopeful this will come down over time as it grows and other products come to market. For now, I think it's a fair price as it could have been much higher given the lack of competition they have in the risk parity space.
- UPAR is offered by Evoke-ARIS, the same company behind RPAR. UPAR follows the same index as RPAR (Advanced Research Risk Parity Index), but aims for 1.4x the volatility of RPAR. RPAR started trading on 12/12/19 and has ~$1.6 Billion AUM.
- The implementation of the Tobin Two-Fund is contingent on having access to a high volatility risk parity asset and a fixed income asset. If the majority of assets are in an employer-sponsored retirement plan, you may not have access to one or both.
- Depending on where assets are and what type of assets are being used to implement the Tobin Two-Fund, rebalancing could be tricky. You may run into liquidity issues if using a MYGA ladder or you may run into an inability to transfer assets in/out of a workplace plan if using it for your stable value fund but implementing the risk parity part of the portfolio outside the plan.

edit/add:
- Since the original post I took a closer look at how the RPAR, Evoke's moderate volatility risk parity ETF, has performed since inception in Dec 2019. It seeks to track performance of the Advanced Research Risk Parity Index. For the 2 year period from Jan 2020 - Dec 2021, RPAR underperformed its index by about 2% per year. About 50 basis points of that can be explained by the expense ratio. The other 150 basis points would be attributable to tracking error. If you are looking to use these funds, it would be prudent to keep an eye on how well they are tracking their indexes.
Last edited by EfficientInvestor on Wed Feb 09, 2022 7:47 am, edited 1 time in total.
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

The UPAR ETF follows the Advanced Research Ultra Risk Parity Index (UPARTR). I was able to get daily data since inception of the index (May 1998) and uploaded it to PortfolioVisualizer. I also uploaded data for the TSP G fund to use as a Stable Value fund. Below is a comparison of a 50/50 split of these two funds (a Tobin Two-Fund Portfolio) against the S&P 500 since May 1998. Similar return as the S&P 500 over the time period with less than half the volatility.

Image
Last edited by EfficientInvestor on Thu Jan 20, 2022 6:05 pm, edited 1 time in total.
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Re: The Tobin Two-Fund Portfolio

Post by 000 »

Interesting. How does DCA look over that time period?

I think there have been times when SV and MYGA like products yielded less than Total Bond. Does this require leverage cost to be less than yield on available fixed income?
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

000 wrote: Thu Jan 20, 2022 6:02 pm Interesting. How does DCA look over that time period?

I think there have been times when SV and MYGA like products yielded less than Total Bond. Does this require leverage cost to be less than yield on available fixed income?
The S&P wins out on dollar cost averaging since the best years for the S&P were in the second half of the time period when the account balances were higher. But there is definitely sequence of return risk going on there. If years were reversed, S&P would have been worse using DCA.

Regarding SV and MYGA vs Total Bond...I suspect that depends on the shape of the yield curve but I've never really thought about it. But I think it isn't fair to compare the two since SV and MYGA are generally risk-free whereas total bond is not.
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Re: The Tobin Two-Fund Portfolio

Post by 000 »

No I was thinking of the internal leverage cost of something like UPAR. If it costs more to lever risk parity than what you get on SV/MYGA does it still make sense?

There is also some deep risk having all fixed income in (1) insurance products and (2) a levered fund compared to a direct holding in Treasuries.
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

000 wrote: Thu Jan 20, 2022 6:02 pm Does this require leverage cost to be less than yield on available fixed income?
To directly answer the question, I would say yes. But if you can obtain leverage at the risk-free rate (which is effectively what UPAR is able to do using futures contracts), the yield of a stable value fund or MYGA should always float at some point above the risk-free rate. I would say this "float" is primarily due to the liquidity premium.
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Re: The Tobin Two-Fund Portfolio

Post by vineviz »

EfficientInvestor wrote: Wed Jan 19, 2022 1:46 pm The risk-free asset is a fixed-income instrument that you have access to that provides the most amount of return with zero risk (generally speaking). For instance, if you have a stable value fund or have access to the TSP G-Fund, you could use that. They are currently paying around 1.6%. If your assets are outside a 401k, you could create a ladder of Multi-Year Guaranteed Annuities (MYGA). These can be considered risk-free from a default perspective as long as you stay below state guarantee fund limits. However, there is some term-risk associated with them. If you have a ladder of 4-5 year MYGAs, your total volatility experienced is similar to that of a short term treasury bond fund like SHY but the yield of a MYGA ladder like this would currently be in the range of 2-2.5%.
None of these represent the actual nature of the risk-free asset, unless the investment horizon is infinitesimally short (i.e. one month). The risk-free asset would be zero-coupon default-free bond whose maturity matches your investment time horizon. For most investors the closest approximation would be either long-term Treasury STRIPS or TIPS.

The scale of the mean-variance graph should also match the investment horizon. In other words, the variance should be plotted not as the standard deviation of 1-year returns but instead as the standard deviation of rolling 30-year returns (or whatever).

Most textbooks make these mistakes as well.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

vineviz wrote: Thu Jan 20, 2022 6:20 pm
EfficientInvestor wrote: Wed Jan 19, 2022 1:46 pm The risk-free asset is a fixed-income instrument that you have access to that provides the most amount of return with zero risk (generally speaking). For instance, if you have a stable value fund or have access to the TSP G-Fund, you could use that. They are currently paying around 1.6%. If your assets are outside a 401k, you could create a ladder of Multi-Year Guaranteed Annuities (MYGA). These can be considered risk-free from a default perspective as long as you stay below state guarantee fund limits. However, there is some term-risk associated with them. If you have a ladder of 4-5 year MYGAs, your total volatility experienced is similar to that of a short term treasury bond fund like SHY but the yield of a MYGA ladder like this would currently be in the range of 2-2.5%.
None of these represent the actual nature of the risk-free asset, unless the investment horizon is infinitesimally short (i.e. one month). The risk-free asset would be zero-coupon default-free bond whose maturity matches your investment time horizon. For most investors the closest approximation would be either long-term Treasury STRIPS or TIPS.

The scale of the mean-variance graph should also match the investment horizon. In other words, the variance should be plotted not as the standard deviation of 1-year returns but instead as the standard deviation of rolling 30-year returns (or whatever).

Most textbooks make these mistakes as well.
I don’t disagree with you about the risk-free asset. Even the G fund has a std dev of about 0.5% due to its variability. So I should revise my image to move it a little off the y axis and should specify that the risk-free asset in this approach is any asset that has fully protected principal and the ability to rebalance out of it in annual intervals. A stable value fund checks these boxes. MYGAs are trickier due to additional illiquidity but can still serve the purpose.

As for the scale of the graph…I see what you’re saying. But for the purpose of this conversation, I think it’s helpful to look at it on an annual basis since it is what we are all used to looking at and we can all standardize on a 1-year time frame. Everyone has different time horizons so we can’t have 1 graph that works for everyone unless we just standardize on the 1-year.
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Re: The Tobin Two-Fund Portfolio

Post by 000 »

EfficientInvestor wrote: Thu Jan 20, 2022 6:16 pm
000 wrote: Thu Jan 20, 2022 6:02 pm Does this require leverage cost to be less than yield on available fixed income?
To directly answer the question, I would say yes. But if you can obtain leverage at the risk-free rate (which is effectively what UPAR is able to do using futures contracts), the yield of a stable value fund or MYGA should always float at some point above the risk-free rate. I would say this "float" is primarily due to the liquidity premium.
You also have the ER on the UPAR.

There are two things going on here, SV/MYGA arbitrage and holding a diversified portfolio different from S&P 500.

Maybe the S&P 500 should not be the benchmark for SV/MYGA + UPAR?
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Re: The Tobin Two-Fund Portfolio

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EfficientInvestor wrote: Thu Jan 20, 2022 6:46 pm

I don’t disagree with you about the risk-free asset. Even the G fund has a std dev of about 0.5% due to its variability. So I should revise my image to move it a little off the y axis and should specify that the risk-free asset in this approach is any asset that has fully protected principal and the ability to rebalance out of it in annual intervals. A stable value fund checks these boxes. MYGAs are trickier due to additional illiquidity but can still serve the purpose.
A risk-free asset should have zero price volatility ONLY over the investor’s investment horizon, and it should have no yield volatility over that period either.

The problem with using the G Fund as a proxy for the risk free asset isn’t that the annual volatility is too high, but that the annual volatility is too low.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

000 wrote: Thu Jan 20, 2022 6:54 pm
EfficientInvestor wrote: Thu Jan 20, 2022 6:16 pm
000 wrote: Thu Jan 20, 2022 6:02 pm Does this require leverage cost to be less than yield on available fixed income?
To directly answer the question, I would say yes. But if you can obtain leverage at the risk-free rate (which is effectively what UPAR is able to do using futures contracts), the yield of a stable value fund or MYGA should always float at some point above the risk-free rate. I would say this "float" is primarily due to the liquidity premium.
You also have the ER on the UPAR.

There are two things going on here, SV/MYGA arbitrage and holding a diversified portfolio different from S&P 500.

Maybe the S&P 500 should not be the benchmark for SV/MYGA + UPAR?
Yes, the ER of UPAR is 0.65%. So on my 50/50 portfolio you could subtract 0.325%/yr. Even with that, it’s still attractive against the S&P. I agree the S&P is not an appropriate apples to apples benchmark. I’m just trying to show that the approach would have earned stock-like returns over the time period with less than half the risk.
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Re: The Tobin Two-Fund Portfolio

Post by a_s_h »

EfficientInvestor wrote: Thu Jan 20, 2022 5:54 pm The UPAR ETF follows the Advanced Research Ultra Risk Parity Index (UPARTR). I was able to get daily data since inception of the index (May 1998) and uploaded it to PortfolioVisualizer. I also uploaded data for the TSP G fund to use as a Stable Value fund. Below is a comparison of a 50/50 split of these two funds (a Tobin Two-Fund Portfolio) against the S&P 500 since May 1998. Similar return as the S&P 500 over the time period with less than half the volatility.

Image
Thanks EfficientInvestor for the excellent post. I also find UPAR very interesting and own a little.

One challenge with this backtest is that, today, starting bond yields are so much lower and for a sufficiently long-term investor (2y-1; y=years to maturity), the starting yield is an excellent predictor of future returns. Since UPAR holds so many treasuries and TIPS, we would expect much lower returns for the next 20 years than for the past 20 years. Tough to be fair, current S&P500 valuations also suggest lower returns over the next decade from US stocks.
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

a_s_h wrote: Sat Jan 22, 2022 1:41 pm
EfficientInvestor wrote: Thu Jan 20, 2022 5:54 pm The UPAR ETF follows the Advanced Research Ultra Risk Parity Index (UPARTR). I was able to get daily data since inception of the index (May 1998) and uploaded it to PortfolioVisualizer. I also uploaded data for the TSP G fund to use as a Stable Value fund. Below is a comparison of a 50/50 split of these two funds (a Tobin Two-Fund Portfolio) against the S&P 500 since May 1998. Similar return as the S&P 500 over the time period with less than half the volatility.

Image
Thanks EfficientInvestor for the excellent post. I also find UPAR very interesting and own a little.

One challenge with this backtest is that, today, starting bond yields are so much lower and for a sufficiently long-term investor (2y-1; y=years to maturity), the starting yield is an excellent predictor of future returns. Since UPAR holds so many treasuries and TIPS, we would expect much lower returns for the next 20 years than for the past 20 years. Tough to be fair, current S&P500 valuations also suggest lower returns over the next decade from US stocks.
Thanks. I would say that the challenge with every backtest and every asset is that you need to view it in excess or real terms and not in nominal terms. Since 1998, stocks have had a ~6.5% excess return above cash and intermediate treasury bonds have had a ~3% excess return. That’s not too far off from what I would expect going forward for excess returns (6% stocks and ~2% bonds). You just have to know that the cash rate is 0% right now and that brings down the expected nominal return of all assets since expected nominal return is just cash rate plus expected excess return.
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Re: The Tobin Two-Fund Portfolio

Post by WHYCLIFFES »

EfficientInvestor wrote: Thu Jan 20, 2022 5:54 pm The UPAR ETF follows the Advanced Research Ultra Risk Parity Index (UPARTR). I was able to get daily data since inception of the index (May 1998) and uploaded it to PortfolioVisualizer. I also uploaded data for the TSP G fund to use as a Stable Value fund. Below is a comparison of a 50/50 split of these two funds (a Tobin Two-Fund Portfolio) against the S&P 500 since May 1998. Similar return as the S&P 500 over the time period with less than half the volatility.

Image
This is a great post. I'm trying to grasp UPAR. Do you have a similar chart but without the 50/50 split? The UPAR-index may appear to be doing quite well.

Image
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Re: The Tobin Two-Fund Portfolio

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WHYCLIFFES, Welcome! Your image can not be processed by the forum software. Right-click on the image, then open the image in a new tab to obtain the correct link (Chrome browser). Here is your image:

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Re: The Tobin Two-Fund Portfolio

Post by rkhusky »

EfficientInvestor wrote: Wed Jan 19, 2022 1:46 pm - Depending on where assets are and what type of assets are being used to implement the Tobin Two-Fund, rebalancing could be tricky. You may run into liquidity issues if using a MYGA ladder or you may run into an inability to transfer assets in/out of a workplace plan if using it for your stable value fund but implementing the risk parity part of the portfolio outside the plan.
+1
What rebalancing method did you use for your analysis?
Did you consider taxation or are all assets assumed to be held within tax-advantaged?
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

WHYCLIFFES wrote: Wed Feb 09, 2022 3:12 am This is a great post. I'm trying to grasp UPAR. Do you have a similar chart but without the 50/50 split? The UPAR-index may appear to be doing quite well.
Here is the chart of the Ultra Risk Parity Index vs the S&P 500 from May 1998 - Dec 2021. Note that this is the index and not actual performance of UPAR. Also note that RPAR, the less aggressive version of UPAR, has underperformed the RPAR index by about 2% per year since inception ~2 years ago. ~50 basis points of that underperformance can be explained by the expense ratio, but the other ~150 bps would be tracking error. I will be keeping my eye on the ability of these funds to closely track their indices.

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Last edited by EfficientInvestor on Wed Feb 09, 2022 7:38 am, edited 1 time in total.
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

rkhusky wrote: Wed Feb 09, 2022 6:30 am
EfficientInvestor wrote: Wed Jan 19, 2022 1:46 pm - Depending on where assets are and what type of assets are being used to implement the Tobin Two-Fund, rebalancing could be tricky. You may run into liquidity issues if using a MYGA ladder or you may run into an inability to transfer assets in/out of a workplace plan if using it for your stable value fund but implementing the risk parity part of the portfolio outside the plan.
+1
What rebalancing method did you use for your analysis?
Did you consider taxation or are all assets assumed to be held within tax-advantaged?
Just annual rebalance. I didn't take tax consequence into account. I find that it's easier to have these theoretical discussions without accounting for taxes since everyone's tax situation is different. I will say though that this whole concept can now be implemented in a much more tax efficient way due to UPAR being available. Instead of holding all assets of a risk parity portfolio separately and holding tax-inefficient derivates like futures or options separately, they are now all packaged within a more tax-efficient ETF. So the only taxes to worry about now would be on any distributions from the ETF, any long term gains from the ETF during the annual rebalance, and ordinary income tax on accumulated value of the MYGAs when they mature. But I will note, as I did on my last post, that I will be keeping my eye on the tracking error of the ETF to see how well it tracks the index.
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Re: The Tobin Two-Fund Portfolio

Post by rkhusky »

EfficientInvestor wrote: Wed Feb 09, 2022 7:37 am Just annual rebalance. I didn't take tax consequence into account.
I was mainly wondering about tax drag due to rebalancing. And adding that to the ER drag.

As you mentioned, rebalancing when the two funds are in different accounts may be more complicated.
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Re: The Tobin Two-Fund Portfolio

Post by WHYCLIFFES »

EfficientInvestor wrote: Wed Feb 09, 2022 7:26 am
WHYCLIFFES wrote: Wed Feb 09, 2022 3:12 am This is a great post. I'm trying to grasp UPAR. Do you have a similar chart but without the 50/50 split? The UPAR-index may appear to be doing quite well.
Here is the chart of the Ultra Risk Parity Index vs the S&P 500 from May 1998 - Dec 2021. Note that this is the index and not actual performance of UPAR. Also note that RPAR, the less aggressive version of UPAR, has underperformed the RPAR index by about 2% per year since inception ~2 years ago. ~50 basis points of that underperformance can be explained by the expense ratio, but the other ~150 bps would be tracking error. I will be keeping my eye on the ability of these funds to closely track their indices.

Image
Thank you for the pictures. The maximum drawdown (34 percent) surprised me, but it appears to be a fascinating ETF to track.

Where can I get daily or monthly data for indices like this?

I've been worried about such strategies in light of growing inflation, interest rate rises, and diminishing equity earnings. But then I saw this: https://seekingalpha.com/article/396981 ... rest-rates

I'm not sure I agree with everything, but it was a fascinating read.
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

WHYCLIFFES wrote: Wed Feb 09, 2022 11:55 am Thank you for the pictures. The maximum drawdown (34 percent) surprised me, but it appears to be a fascinating ETF to track.

Where can I get daily or monthly data for indices like this?

I've been worried about such strategies in light of growing inflation, interest rate rises, and diminishing equity earnings. But then I saw this: https://seekingalpha.com/article/396981 ... rest-rates

I'm not sure I agree with everything, but it was a fascinating read.
I was able to get a table of the data from Evoke. When they sent it, they said it was also available on Bloomberg, but I assume that requires an expensive subscription. A chart of the data for this index can be found here: https://www.solactive.com/indices/?index=DE000SL0EPR8

Regarding growing inflation...RPAR and UPAR seem to be well positioned to protect against inflation due to inclusion of TIPS, gold, and commodity producers. I recommend you pick up a copy of Risk Parity, which was just published a few months ago. The author is Alex Shahidi, the co-Chief Investment Officer of Evoke. It goes into detail about how they think about risk parity and how they structure their portfolios to potentially do well regardless of whether the economy is growing faster or slower than expected or inflation is rising faster or slower than expected. Their approach is very much in line with Bridgewater's approach to risk parity.

Here is an article written by Shahidi from 2012. This article is essentially a short summary of his book.
https://www.advisorperspectives.com/new ... sified.pdf

Here are articles/papers by Bridgewater about their risk parity approach:
https://www.bridgewater.com/research-an ... -investing

edit/add: I looked into Hedgewise, the author of the article you linked. It doesn't surprise me that he worked at Bridgewater. It seems like most of the funds/advisors offering risk parity strategies have some sort of tie with Bridgewater, which makes sense given their role in promoting the use of the strategy.
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Re: The Tobin Two-Fund Portfolio

Post by WHYCLIFFES »

Any thoughts on this: given that TIPS and bonds make up a substantial portion of the ETF's composition, how would this Risk Parity approach perform in a climate of rising interest rates, and poor equity performance?


I read this: https://papers.ssrn.com/sol3/papers.cfm ... id=2445380 , and the conclusion:

"The risk-parity strategy's attractive risk / return profile is therefore primarily attributable to the fact that stocks and especially commodities were able to offset the bond-loss phases. This serves as a clear reminder that risk-parity strategies exhibit more-than-negligible sensitivity to bonds. This can become problematic "


Do you think UPAR suffer big if we have a period of low stock returns and rising interest rates?
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

WHYCLIFFES wrote: Sat Feb 12, 2022 11:08 pm Any thoughts on this: given that TIPS and bonds make up a substantial portion of the ETF's composition, how would this Risk Parity approach perform in a climate of rising interest rates, and poor equity performance?


I read this: https://papers.ssrn.com/sol3/papers.cfm ... id=2445380 , and the conclusion:

"The risk-parity strategy's attractive risk / return profile is therefore primarily attributable to the fact that stocks and especially commodities were able to offset the bond-loss phases. This serves as a clear reminder that risk-parity strategies exhibit more-than-negligible sensitivity to bonds. This can become problematic "


Do you think UPAR suffer big if we have a period of low stock returns and rising interest rates?
I don't necessarily think it will "suffer big" in that scenario. If interest rates rise sharply enough to cause bonds to have large losses, then it will likely be because the fed is raising rates faster than expected to prevent further inflation. If that is the case, then other assets in the portfolio like TIPS, gold, and commodity producers would likely be doing well or at least be neutral because they do well when inflation is higher than expected. But the real answer is, "you never know" and that unknown is why I think it is a benefit to have adequate exposure to all of these asset classes. The FAQs from the "Investment Case" document on the RPAR/UPAR website might also be helpful in answering your question: https://www.rparetf.com/upar/investment-case
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Re: The Tobin Two-Fund Portfolio

Post by imak »

Thank you EfficientInvestor for the insightful post on UPAR and its relevance to Tobin's separation theorem.

This is a fascinating discussion, UPAR is highly interesting product especially in terms of access to leverage and internal rebalancing (without the daily rebalancing volatility drag of 3x ETFs as seen in HFEA).

I have been following Alex Shahidi's Quarterly Reviews of RPAR ETF performance and their strategy seems to be highly robust in different growth/inflation regimes.

Commodity producers and Gold allocation are the primary aspects which I don't fully understand, especially in terms of expected returns. Looking forward to reading Alex Shahidi's Risk Parity book.
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EfficientInvestor
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Re: The Tobin Two-Fund Portfolio

Post by EfficientInvestor »

imak wrote: Sun Apr 24, 2022 2:00 pm Thank you EfficientInvestor for the insightful post on UPAR and its relevance to Tobin's separation theorem.

This is a fascinating discussion, UPAR is highly interesting product especially in terms of access to leverage and internal rebalancing (without the daily rebalancing volatility drag of 3x ETFs as seen in HFEA).

I have been following Alex Shahidi's Quarterly Reviews of RPAR ETF performance and their strategy seems to be highly robust in different growth/inflation regimes.

Commodity producers and Gold allocation are the primary aspects which I don't fully understand, especially in terms of expected returns. Looking forward to reading Alex Shahidi's Risk Parity book.
Thanks for the post. Based on what you’ve said here, I think you will really enjoy the book. It provides a good basis for the use of commodity producers and gold.

My thought process, which mostly aligns with the book, is that a portion of your portfolio should be in assets that generally do well during inflation. This would generally include TIPS and commodities. Owning TIPS is pretty straightforward…just buy them.

Commodities are trickier. For many commodities, the long term expected return is negative because the cost of storing the commodity wipes away any price appreciation. Therefore, it isn’t advisable to just hold something like DBC straight up. An alternative is to own commodity producers that are highly correlated to the commodity price but still have a positive expected return because the businesses will continually position themselves to attempt to generate profit.

My theory on gold is that it can be held directly because its storage cost is negligible due to the price of gold being so high relative to its weight and volume. Therefore, the storage cost doesn’t present a drag on the performance of an ETF the same way it does for other commodities. Gold also is a different kind of commodity in that it is seen as a historic store of wealth and transfer of value as opposed to a consumable product like other commodities. Therefore, it should have a larger position in the portfolio than other commodities due to it being a hedge against devaluation of currency.

That is just my two cents on the topic. You will have to let me know your thoughts once you read the book.
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