We’re always trying to build a better mousetrap around here by adding non-correlated asset classes to our portfolio.
While there is no “free lunch” in economics, true diversification is about as close as you’re ever going to get. And by “true diversification,” I mean adding assets to the portfolio that really do zig when the others zag. A portfolio of 100 stocks doesn’t offer much diversification benefit when the entire market rolls over.
At any rate, Dr. Phillip Guerra and I have cooked up a suite of alternative portfolios based on the principles of risk parity. We’ve been running our Active Risk Parity Portfolio With 7% Annual Volatility Target live since September, and we’ve backtested it to 1996.
aren’t too shabby, if I do say so myself. Average annual returns of 11.5% with a maximum drawdown of just 9.8% and a correlation to the stock market of just 0.24.
Rather than target returns — which are impossible to know with any accuracy in advance — we target volatility. While volatility will also fluctuate over time, we find it to be more accurate to target and also that it gives us a better handle on risk. The key to making money over time is first to avoid losing it.
I don’t consider this a replacement for a traditional long stock portfolio. In fact, most of the money I manage is long-only and dividend focused. But I certainly do consider this a nice addition to a traditional stock portfolio. With bonds not likely to offer much in the way of return any time soon, you need viable alternatives for the “40” in the old 60/40 portfolio of stocks and bonds. A risk parity model can certainly fill that role.
For more information on alternative portfolios in general, click here.
Charles Lewis Sizemore,
CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long AAPL and MSFT. To read more of his work, CLICK HERE NOW.
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