Why Volatility Trend Tracking Matters And How To Optimize Your Portfolio Based On Inverse Volatility

As an investor who has adopted a risk parity mindset, and perhaps have implemented a portfolio following risk parity principles, such as the All Seasons Portfolio, I am sure you at least have a fundamental understanding of the importance of volatility.

In several articles, I have discussed why it is vital for retail investors in particular to decrease portfolio volatility, and using another term, to decrease portfolio risk. Otherwise, we risk not achieving our financial goals, if we would encounter bigger drawdowns than we can afford, or that we allocate too much capital to a single asset class such as stocks when such assets face a period of lagging returns.

So, if the question is "How can I reduce portfolio volatility", the answer is Risk Parity. Using these types of strategies and investing in several asset classes and allocating capital based on the asset classes' relative risk, you can significantly decrease the overall volatility of your portfolio, while still earning the risk premiums of each asset.

To facilitate management of risk of the different assets in a portfolio, and to implement a bottom-up risk parity approach for my stock exposure through an Inverse Volatility strategy, I have developed a Volatility Analyzer tool that also includes an Inverse Volatility Portfolio Optimizer. I first and foremost developed this for my own needs, which I will describe further below, but have found that it may be a useful resource also for you.

In this article, we expand on why tracking volatility is important and how it is easier to forecast than returns, as well as explain how my developed tool works.

Continue Reading Why Volatility Trend Tracking Matters And How To Optimize Your Portfolio Based On Inverse Volatility

Portfolio Update – July 2021 – The Two Most Important Risks For Retail Investors And How To Avoid Them

With the recent strong positive trend in stocks and risk assets since April 2020, I have been thinking quite a bit about a couple risks that face retail investors and which have become more and more relevant now that I get a bit of vertigo from the S&P 500.

These risks are 1) the risk of us not reaching our financial goals by not managing our investment risk properly and 2) abandoning a safer strategy when we see others making more money with high-risk strategies.

I will discuss these risks more in details below and why they matter, and in particular why it is more urgent for retail investors to have understood these risks.

Namely, apart from institutions with more or less infinite investment horizons, we as retail investors are only active on the financial markets for a quite brief moment when you zoom out and consider all the history of investing.

And as we only get one shot at it (no do-overs), it is important that we get it right from the start. It is crucial to avoid making a mess of our investing careers that we cannot repair later.

I hope you find this text useful, and please share your thoughts in the comments or directly by email to nicholas@allseasonsportfolio.eu.

And as usual, the regular update of my All Seasons Portfolio(s) follows right after the month's special topic. July was a quite good month for me, and I have made a slight alteration of my portfolio, switching the TIPS ETF from a global one to one with longer-term US inflation-linked bonds.

But more of that to come. Now, let's have a look at a different way of defining "risk".

Continue Reading Portfolio Update – July 2021 – The Two Most Important Risks For Retail Investors And How To Avoid Them

Portfolio Update – June 2021 – A study of risk parity portfolios against S&P 500 since 1927

Earlier this week, I received a very good comment to the monthly portfolio update article which I published last month. In that article, I discussed how the stock market seems greatly overvalued based on several widely different indicators, measuring both listed stock’s earnings and assets, as well as market cap in relation to GDP.

Based on the indicators CAPE (Shiller's PE), Q Ratio, and the Buffett Indicator (market cap to GDP), future potential returns of the stock market over the next decade appear limited.

In the light of this, the question arises whether the All Seasons Portfolio would be a better choice, and how it has performed under similar conditions in the past when compared with the S&P 500. The comment reads as quoted here below and this is what I have set out to answer in this month's article.

We can anticipate that future returns of the stock market will be below what we have become used to in recent years based on these metrics, and the fact that returns 1) usually are clustered in a way that good years are followed by further good years and bad years are followed by further bad years, and 2) always regress to the mean (between 7-10% annually) and that the last decade has seen annual returns far above this level.

When acknowledging the current worrying state of the equity markets, it becomes relevant to further understand how the All Seasons Portfolio has performed versus the stock market under similar market conditions.

Instead, it is relevant to compare against 1) long-term performance over several decades, and 2) periods with similar conditions as where we are currently. To me, these are two extremely central questions to clarify, and that I wanted to have answers to as well.

Continue Reading Portfolio Update – June 2021 – A study of risk parity portfolios against S&P 500 since 1927

3 must-read books for better understanding Risk Parity Investing and the All Seasons Portfolio Strategy

  • Recommendations for the 3 best books to start with for better understanding risk parity investing
    • The Permanent Portfolio by Craig Rowland and J.M. Lawson
    • Balanced Asset Allocation by Alex Shahidi
    • Risk Parity Fundamentals by Edward Qian
  • Reviews of each book below and suggested reading order
  • Which to pick if you are only going to read one

The isolation and restrictions of movement during the Covid-19 pandemic and the lockdowns and curfews have been challenging to say the least. How can you spend your time, in an effort trying to stay sane, when you no longer can travel, barely go to the office, and perhaps not even physically meet friends and family.

Now in March, it becomes one full year of the exceptional circumstances and measures to limit spreading of the virus. It has been a difficult year for all, but even worse for some directly affected by the worst thinkable consequences of the pandemic.

Risk parity investing is an established discipline among institutional investors and family offices. Of these, the most famous are Bridgewater Associates' All Weather fund was a pioneer of the field, and is only accessible to pension funds and high net worth individuals.

But the benefits of risk parity investing reach also retail investors - people who do not get access to Bridgewater's products - as most investors are easily swayed by the most recent developments on the stock markets not to be sufficiently protected against the effects of what changes in expectations of economic growth and inflation can do to a portfolio.

Reading is a pastime of successful investors, not only in quarantine, and if you are keen on setting up your own risk parity portfolio (it is very easy to do with widely available ETFs), you should begin by seeking information on this investment discipline in the form of literature.

To make the getting started phase a bit easier for you, in this article, I highlight three great books about setting up a balanced portfolio. They all describe asset classes included (mainly stocks, bonds, gold, and commodities), and, more importantly, the reason behind why each asset class is needed in a portfolio to protect against the changing seasons of the economy.

Continue Reading 3 must-read books for better understanding Risk Parity Investing and the All Seasons Portfolio Strategy

2020 Year in Review – Never Let A Good Crisis Go To Waste

  • List of 3 best lessons from 2020 and the Covid-19 stock market crisis
  • Summary of the most popular articles in 2020 from the All Seasons Portfolio blog
  • Some predictions for 2021
  • My portfolio development and stats

This past year has been nothing like we imagined a year ago. Luckily for me, in my summary post of 2019, I was not bold enough to make any public predictions. But while I may have saved face, this past year has in many ways been a complete train wreck.

There are many negative memories that we will take with us from 2020, whereof most can be traced back Covid-19 and its impact on families, the elderly, employees, and businesses. Let us remember that the year has not only brought distress to financial markets and investors, but too many have experienced hardships in the form of personal losses like loss of a family member, loss of income, or have been severely ill in the virus.

Maintaining an investor perspective, as this is a blog about personal finance and risk parity investing, a famous quote by Winston Churchill comes to mind that I think should shape our mindsets and outlooks for 2021. After World War II, in connection to the forming of what would become United Nations, Churchill proclaimed, “Never let a good crisis go to waste”.

While our reality has been dire looking the past 12 months, and at times many things have seemed hopeless, there are still many lessons to be learned from the Covid-19 pandemic. Here, I will focus on such lessons from a personal finance and investing perspective.

Hence, before I review my portfolio, let me summarize three key lessons that I have identified from 2020 that are important to take away to the future. This way, we will be much more prepared for the next crises.

I remain a strong believer in that modern financial markets and macro settings are too complex for anyone to have a complete edge and make accurate predictions. Therefore, it is always much more important to admit to oneself that we cannot predict what will happen, but we can prepare.

Continue Reading 2020 Year in Review – Never Let A Good Crisis Go To Waste

Insight – How to Improve Portfolio Performance and Risk-Adjusted Return with VIX ETFs

This post was originally published on the Patreon page on November 5th, 2020. https://www.patreon.com/posts/43569940  If you like the content I publish on this blog, I appreciate your support to cover hosting costs etc. Even small contributions are greatly appreciated.

Contents:

  • How all common asset classes had weak performance at the same time in March 2020 due to the Coronavirus crisis.
  • That the only asset class actually performing well in that time was VIX ETFs
  • What the VIX is and how you can use it as an insurance policy in your portfolio to protect against volatility, uncertainty and black swans,
  • How including only 3% of a VIX ETF in a risk balanced portfolio increased return, lowered volatility and increased the Sharpe ratio of an example All Seasons Portfolio. This is shown with an extensive case study through first half of 2020 and the 30 month period leading up to 30 June 2020.
  • All raw data on which the analysis, graphs and tables in this article is based on, are exclusively found in the Patreon version of this post. Support the blog to get access.

All assets under-performed in late March.

Do you still remember how different asset classes performed amidst the most urgent phases of the coronavirus crisis? Or have you intentionally suppressed those bad memories and only chosen to remember the recovery in assets such as stocks?

As a reminder, there was period from about March 10th to March 20th when every major asset class declined in valuer, regardless if they were biased to perform well in increasing or decreasing economic growth environments. Stocks and commodities had already fallen by then, but by March 10th, also gold, treasury bonds and inflation-linked bonds fell as well. Nothing managed to offset the declines in growth assets, and any balanced portfolio suffered.

While a risk parity strategy, such as the All Seasons Portfolio strategy, performed much better than the stock market or a 60/40 portfolio, the Covid-19 crisis caused a dent also in the All Seasons Portfolio. The All Seasons Portfolio even turned into negative territory on a YTD basis, even though it recovered rather quickly from that temporary dip.

[3,500 more words]

Continue Reading Insight – How to Improve Portfolio Performance and Risk-Adjusted Return with VIX ETFs