RPAR - RPAR Risk Parity ETF: Playing The Waiting Game

Summary

• Despite having been burned in the past by bullish calls that proved premature at best, I remain optimistic about the Risk Parity ETF.
• In this article, I run through the math that tells me how RPAR could produce 6% to 7% in annual returns for many years to come.
• I see RPAR producing risk-adjusted returns that look better than what most investors might be able to find elsewhere.

The Risk Parity ETF ( RPAR ) has had a decent 2023 so far, up around 4% as I type this sentence after climbing as much as 8% higher YTD earlier this month. However, the fund is far from fully recovering from the painful losses of late 2021 and 2022, when the balanced portfolio sank as much as 33% from the peak of October 2021 to the recent all-time low (see chart below).

Despite having been burned in the past by bullish calls that proved premature at best, I remain optimistic about the multi-asset class strategy — provided that investors who buy shares today stay focused on the long term. Below, I show the math behind why I think this fund could return 6% or 7% per year for the next decade-plus, hopefully without the same losses witnessed in the past 18 months.

What is RPAR?

To get the discussion started, it helps to quickly revisit RPAR's investment strategy . The fund is inspired by the risk-parity approach of allocating capital across a diversified pool of assets in a risk-balanced fashion.

The name "risk parity" and the investment process described above may sound more complicated than they actually are. In a nutshell, the objective is to seek exposure to a broad basket of investment vehicles that include stocks, bonds and commodities. These assets tend to react differently to different macroeconomic environments, so positive returns can be created consistently over time even when the stock market is not performing at its best.

Below are the targeted asset and risk allocations. The chart on the left adds up to more than 100% because, through modest exposure to certain futures contracts, RPAR is effectively leveraged at a ratio of 1.2 times.

Playing the waiting game

As implied earlier, I believe that the best way to "play" this ETF is to have a long-term investment horizon — think many years or even decades, not just a few months. "Where will the markets be in six months?" is not quite the best question to ask when assessing this fund, in my opinion.

For what it's worth, I think that RPAR will have a good year of returns in 2023 considering (1) the buy-the-dip opportunity, following a dismal twelve months of performance in 2022, and (2) the highly bearish developments involving white-hot inflation and interest rates that increased at a historically fast pace to levels not seen since before the Great Financial Crisis of 2008, all of which I believe to be mostly in the rearview mirror.

But to get the most out of RPAR, I think that investors must be patient and think at the highest level possible. From the pie chart on the left above, I can estimate how much RPAR might be able to produce in annual returns going forward. Keep in mind that these forecasts are high-level approximations:

• 35% Treasuries : As I explained a few times before, the expected return of a bond and bond fund should be roughly their yield to maturity. Government bonds that mature in five to 30 years currently yield just south of 4%. Since 35% of RPAR's capital is allocated to this asset class, I derive around 0.35 times 4% equals 1.4% in annual returns coming from this slice of the pie alone.
• 35% TIPS : The same rationale above applies to this bucket as well. Of course, the returns in inflation-linked bonds can vary based on the direction of consumer prices, which makes the math here a bit more speculative. But considering 10-year inflation expectations of 2.3% and real rates of 1.3% , I derive 0.35 times 3.6% equals 1.3% in annual returns coming from the TIPS piece of the portfolio.
• 25% stocks : while RPAR invests in global stocks, I think that looking at the S&P 500's ( SPY ) equity risk premium of about 5.5% helps to estimate the return potential here. The premium plus today's risk-free rate of 4.7% implies return potential of 10.2% in equities. RPAR's 25% allocation to this bucket suggests 2.6% of gains from this slice of the pie.
• 25% gold and other commodities : Lastly, future returns in commodities may be the hardest to estimate. Gold, for example, has gained an average of 6.5% per year since 1928 . I may feel uncomfortable assuming that commodities will continue to offer gains this high going forward, but at the same time think that 5% is not too bad a benchmark. Apply 25% allocation to the commodities bucket, and we might be looking at 1.2% annual returns from this corner of RPAR's portfolio.

Add all the bolded percentages above, and we are looking at 6% to 7% in annual return potential for RPAR investors. This is not necessarily a very high return target, to be fair, but it is one that I find enticing, considering how the diversified nature of the fund should make it less volatile and less exposed to sizable losses than stock-only approaches to investing — again, this was not the case in 2022, but I expect last year to have been a fairly rare outlier.

The trick, once again, is that none of my projections above matter in the short term. Given a time horizon of months or even a year or two, anything can happen to diversified multi-asset investing. But wait long enough, and I see RPAR producing risk-adjusted returns that look better than what most investors might be able to find elsewhere.

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