This article is a continuation of an article written about Chris Cole's Dragon Portfolio. If you'd like to start from the first article, then please click here.
What Is A 60/40 Risk Parity Portfolio?
A 60/40 risk parity portfolio is basically a 60-40 stock-bond split strategy that allocates money across assets based on how risky they are. It typically takes a heavy debt position.
They have been the darlings of investment for the past 40 years and a lot of corporate employees have them. Anybody who knows anything about building an investment portfolio these days will tell you that 60/40 is dead in the water. Here's why.
Financial advisors are suffering from recency bias
It comes down to recency bias. The recency bias goes back to every single financial advisor you have ever heard telling you to buy the dip.
They really do believe the next 40 years will behave like the last 40 years and they have no problem betting your retirement on the idea.
Is Buying The Dip An Effective Long-term Strategy?
Buying the dip exists for a reason. Retail investors do it. Let's take a look at how it would have panned out over the last 90 years.
From Chris Cole…
Starting From 1929
Check out the chart above. If we started off buying dips with the dollar back in 1929 we'd have blown up our account buy 1946.
Same thing between '47 to '63 and '63 to '84.
It has only been recently, and just in the United States, I might add, where this buy the dip risk parity portfolio approach has worked well. I would like to remind you that markets -and the world for that matter- operate in cycles. What goes up, comes down. What goes down, goes back up.
Just because something happened in the recent past doesn't mean that it's going to happen indefinitely into the future.
I'd also like to point out that if you look at the timeframe between the late 1990s and today, it represents almost 100% of the gains in the housing market, going back to 1900 when you adjust for inflation.
You also need to remember the graphic above doesn't include what has happened recently with Covid-19.
So how is this 60-40 risk parity portfolio, and buy the dip approach going to work out in the next cycle?
Well, to get some insights on that, I included a short transcript from my full-length interview with the legendary hedge fund manager, Hugh Hendry.
Every expert like me, or every pro looks like a dumb ass when you consider the investment strategy of the permanent portfolio.
‘m sure at some point it's going to be on your whiteboard. You're going to explain the concept of disparity.
You're the biggest hedge fund in the world. You do it…adjusting for risk, but you sit there with 25% of your portfolio of precious metals, gold, and maybe a bit of silver.
You sit there with 25% in the S&P, or maybe you have a bit of NASDAQ or whatever.
You sit there with 25% in government bonds. You might have a little bit at the short end, you might have a little bit long end. You might even have a bit of commercial.
Then you sit there with some cash, looking for opportunities,
That strategy for the last 40 years has just wiped everyone. It's the leader. It's the Olympics. It's the Usain Bolt or whatever.
I don't know the American sporting analogies to make but it has hit the ball out of the park time after time after time. It's finished. This is the time to preserve the account.
So as Jim Rogers always likes to say:
This risk parity portfolio, buy the dip strategy is going to be a fast way right to the poor house.
It makes sense when you go back and look at Chris's chart. From 1929 to '46, this approach would have gone bust. '47 to '63, bust. '64, '83, bust again.
The main point is people who advise taking this approach are suffering from the recency bias I always talk about in my articles. Chris Cole outlines this beautifully in his paper.
How did we have this huge boom between '84 and '07?
Demographics, falling rates, rising assets, globalization, and a massive expansion in debt. However, in the next cycle, that most likely won't continue.
We're going into a period of bad demographics, rising interest rates, falling asset prices, de-globalization, #Covid19, face masks, pharmaceuticals, and debt contraction.
This takes us straight over to the doom vortex, the largest percentage of the US population, the baby boomers are going from the peak down to the weak.
I don’t mean they just walk around with canes or in wheelchairs. I'm not implying that if you're a baby boomer. I'm just saying they're going from peak spending down to very weak spending.
If we combine the Baby Boomer doom vortex, and the reversal of the cycle we had from '84 to '07, this leads to less spending and less income, which means lower GDP.
The worst the economy gets, the quicker we go right back to the baby boomer generation, which have a lower propensity to spend and consume. This takes us straight into a depression, which Jeff Snyder calls GFC 2.0.
The big question is whether the depression is going to be deflationary or inflationary.
To give you some food for thought I wanted to throw in another bonus from Chris Cole's paper. It is a quote from Bill Gross, the bond king himself.
There isn't a bond king or a stock king or an InvestorSovereign alive that can claim title to a throne.
All of us, even though old guys like Buffett, Soros, Fuss, yeah, and even me, have cut our teeth during perhaps the most advantageous time an investor could experience.
An investor that took a marginal risk, levered it wisely, and was conveniently sheltered from periodic bouts of de-leveraging or asset withdrawals could, and in some cases, was rewarded with the crown of greatness.
Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch.
In other words…
- Were the greats, really that great? Or were they just at the right place at the right time?
I'll let you be the judge.