That time of the year….Wish everyone a very happy new year.
For 2020 – We are up by 57.5% in the Risk Parity Platinum Portfolio.
So what does that mean? Did we perform well or bad? How does one measure the performance of a portfolio?
When I started out with algorithmic trading, my benchmark was initially about beating the stock indices. Then as I learnt more, the benchmark reference changed to the 60:40 stocks : bonds portfolio. As I learnt even more, the benchmark reference changed to the All Weather Portfolio.
Here is our performance by month against these benchmarks and also against bonds and gold. The graph below shows the growth of $10K invested on Jan 1st 2020.
Why am I comparing performance against the Balanced portfolio and the All Weather Portfolio? Read our blog on this topic for more details on this. But in summary, each of these models are models that you can do on your own without any dependency on financial advisors, experts etc. An hour every year is all it takes.
So how did we do against these benchmarks?
The Nasdaq 100 went up by 41.5% this year. The Balanced 60:40 portfolio did 32.7%. The All Weather Portfolio did 25.7%.
We did 57.5%. Good, right??
Not really. B minus. Why?
While the absolute performance was good, the relative performance was average.
Consider the average annual performance of each of these models. A Nasdaq 100 allocation provided an average return of 14.4%; with a risk (measured using drawdown) of 50%.
The Balanced portfolio provides a performance of 12.8%, with a risk of around 23%. The All Weather portfolio provides a performance of 10.8% with a drawdown risk of only 11%.
The Risk Parity on an average is expected to beat the return performance metrics by around 30 percentage points as you can see in the table above. Our 2020 performance beat was only 16 against the Nasdaq, 25 against Balanced and 32 against the All Weather portfolio. Hence B minus.
Take a look at the monthly performance again.
Looking back, we did very well the first 3 months of the year, We did ok from April to July. From August to October, the model under performed, primarily because all the assets including stocks, bonds and gold went down. We recovered in November and December, but not completely. We are still still below the peak that the portfolio hit in July.
Why did the model not put money in stocks in April? Because we are built like Adam Sandler, not Keanu Reaves. It has served us well these past few years and I still don’t see a reason to change that.
Why did all assets including stocks, bonds and gold go down from August to October? This tends to happen periodically and usually happens before the stock market starts trending significantly in one direction or the other. I have interpreted it as a sign of uncertainty; traders are not sure which way the wind is going to blow. It is a day-traders market and most swing trading algorithms don’t do too well during this period.
Neighbors Envy. Suffering is relative. It was interesting to see some of the human psychology play out in conversations throughout the year. When the stock market goes down and your portfolio goes down, most people find a way to explain that away. Everyone else is suffering, so my suffering is not that painful. However if the stock market is going up and your portfolio goes down, I guess that pinches more!! Many of the questions I got on portfolio allocation were from clients whose neighbor had bought Tesla or Amazon and made lots of money when our portfolio was going down.
Some of you who joined these past 2 months will go through the emotional up and down at some point. You will have moments where you will feel “Neighbors Envy”. Take a deep breath. This too shall pass.
Please remember that the Risk Parity – Platinum is designed to have a 20-25% risk for which it gives a 40% plus return based on past results. If you want a 100% return per year, all you need to be ready to do is to take a 50-60% risk….which is about the same risk that exists in the Nasdaq 100.
Next Year and Looking Forward. I think the higher volatility is here to stay for the next few months. The Nasdaq going up by 41% in a year has not happened too many times before. If you guys remember my horse analogy from the video, would you bet on a horse that has done well this past year, but has run at nearly 4 times the pace it is used to run at? The way the model reacts to these situations is to increase cash exposure. In the process, we may leave some money on the table, but our target is to manage risk. Remember that the high returns are a by-product and not the objective. The objective in the Risk Parity – Platinum version is to maximize returns for a target 20-25% risk.
Wish you all the very best for the coming year. Hopefully we are able to take some of you closer to “retirement”. Take care.
