jebmo's posthaven

The rate of return on everything

There is a new NBER paper on that topic byÒscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor, here is the abstract:

This paper answers fundamental questions that have preoccupied modern economic thought since the 18th century. What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run?Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles.

Here is what I learned from the paper itself:

1. Risky assets such as equities and residential real estate average about 7% gains per year in real terms. Housing outperformed equity before WWII, vice versa after WWII. In any case it is a puzzle that housing returns are less volatile but about at the same level as equity returns over a broader time span.

2. Equity and housing gains have a relatively low covariance. Buy both!

3. Equity returns across countries have become increasingly correlated, housing returns not.

4. The return on real safe assets is much more volatile than you might think.

5. The equity premium is volatile too.

6. The authors find support for Piketty’s r > g, except near periods of war. Furthermore, the gap between r and g does not seem to be correlated with the growth rate of the economy.

I found this to be one of the best and most interesting papers of the year.

The post The rate of return on everything appeared first on Marginal REVOLUTION.

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Ray Ferraro: How to Build Up Young Hockey Players

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He’s back!

Ray Ferraro is a local legend here in Vancouver, though I’m not sure it’s because of his ridiculous junior hockey prowess or 400+ goals scored for six National Hockey League teams. Those items are part of it, sure, but I think one of the reasons Ray has endeared himself to the locasl market is because he tells it like it is. He’s passionate and opinionated, and in a sport where boring stock answers are the norm, Ray Ferraro is a breath of fresh air.

Plus, it seems like every sentence he says is quote-worthy, so he’s really making our jobs easier.

“Your goal is always to make your kids or your players as good as they can be.”

For Ray Ferraro, the true benefit of hockey is not the rewards on the ice, but off the ice. A coach’s primary function is not to make better hockey players, it’s much bigger than that, “bigger than the game,” as Ray says.

It’s something that’s easy to lose sight of. And sure, you might think it’s easy for Ferraro to say since he did have so much success in hockey, but in the snippet below it’s easy to see how important the path to building a young person through hockey really is.

And the game has changed. Nobody wants to be yelled at. When Ray played, that was the norm because we didn’t know any better.

Nowadays? “The coach has to treat a player like he would want to be treated.”

But don’t take my word for it.

If you enjoy these video excerpts, remember you can sign up for a free 30 day trial on our TCS | MEMBERS site. This gets you access to our entire library of videos from our annual TeamSnap Hockey Coaches Conference. You can cancel any time, although after joining a community of coaches from all over the world using the videos on a daily basis to pick up new tips and stay relevant, we doubt you will.

Why Sweden is Not the Social Utopia We Think It Is

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Why Sweden is Not the Social Utopia We Think It Is | Zero Hedge

People often think that the grass is greener on the other side especially when things aren’t exactly going well on their side of the fence. Some end up wishing they were born in a “better” country. Sweden is typically considered a nice place to live as the country appears to offer better lives for its citizens than most. Even the United States Senator Bernie Sanders quipped that the US should be more like Sweden. But is Sweden really the utopia everyone thinks it is?

It does seem cozy in the Nordics. The Swedish people enjoy high standards of living. Along with its Scandinavian neighbors, Sweden consistently tops the list of the happiest countries in the world. Citizens have access to quality social services. Education (even college) is free and health care is decentralized as well as government-funded.

Sweden is also the world’s closest thing to a modern cashless society. Only less than 1 percent of the value of all payments made in 2016 used cash or coins. Payments are done efficiently through digital means. According to the 2017 State of Online Banking report by Swedish payments service Trustly, Swedes are highly satisfied with their banks’ services. They also have the Swish mobile app for peer-to-peer payments and they only need their nationally approved BankIDs to authenticate transactions.

This forward-thinking attitude towards finance and clear understanding of market preferences have made Sweden a leader in financial technology (fintech). For instance, bank accounts are central to Swedish finances. Knowing this, Trustly found success enabling merchants to accept bank transfers for payments. Since other markets share the same preference of payment methods, Trustly was able to bring its business to other European markets. The company has recently surpassed €10 billion in total payments this year.

Other fintech ventures Klarna and iZettle have already joined the likes of Spotify, King, and Skype as Sweden’s unicorns. Sweden is also home to other global brands like Volvo, H&M, and IKEA – all of which contribute to the country’s thriving business sector. However, like with most things, imperfections often reveal themselves to those who stare close enough. Sweden isn’t without its own issues and the perception of Sweden as a utopia may not exactly be accurate.

High cost of living

According to Numbeo, Sweden ranks 15th in the Cost of Living Index as of mid-year 2017. In contrast, the US and the UK rank 24th and 25th respectively. While social services are provided for by the government, personal income tax can be as high as 60 percent. People have to commit themselves to work in order to produce enough disposable income.

Higher education may be free but students in Sweden often have to take out loans to cover living expenses including rent and food while studying. 85 percent of students in Sweden graduate with debt and these fresh graduates also suffer from a high debt-to-income ratio once they land jobs. Sustaining oneself while trying to establish a career can be tough. Rent in centers like Stockholm can be both expensive and hard to come by for most young professionals.

Immigration and refugee issues

Sweden also has the highest rate of refugees accepted per capita in all Western nations. The country has taken some flak for its position on refugees and immigration particularly in light of the attack on Stockholm earlier this year. Despite the criticism, Sweden maintains that its acceptance of refugees hasn’t caused a spike in crime and terrorist activities.

However, immigrants themselves face challenges in the country. Only half of the refugees who arrived in 2003 were able to get jobs by 2013. Swedish businesses still prefer hiring people who can speak the native tongue. Since most immigrants flock towards jobs and businesses that could accommodate English, they have to fiercely compete for limited jobs. Claims of discrimination also exist.

Not a socialist utopia

Sen. Sanders claimed that lessons on democratic socialism can be learned from the Nordics. However, Scandinavians were among those quick to correct Sen. Sanders saying that they aren’t socialist. They are technically market economies. Perhaps there’s this notion that a utopia is where citizens are provided everything and that everyone enjoys freedom and equality.

For the most part, this seems to apply to Sweden since the government covers essential services and the people have an egalitarian outlook hence the reason they’re mistaken to be democratic socialists. Still, the reality is that people have to work hard, pay taxes, and deal with competition common in a market economy if they want to thrive in Sweden.

Not a perfect model but still a good one

These said it’s only fair to accept that no country is ever going to fit everyone’s nuanced definition of “perfect”. Even the concept of utopia can be highly subjective. Sweden may have its own set of issues and isn’t exactly perfect but countries would do well learning from what Sweden has done right. Much could be learned from how the country effectively managed its economic crisis in the 1990s. Business could also benefit studying how the Swedish model can be applied to good board selection to ensure responsible stewardship of organizations.

Sweden has also been open to embracing disruptive technologies. While most countries have approached the emergence of blockchain with caution and skepticism, Sweden is already actively exploring the technology’s use for government purposes. The country is already testing its blockchain-powered land registry system that’s aimed to save taxpayers $100 million.Context and perspective play huge roles in how people perceive their respective situations. Sweden may appear to be ahead but countries may also just have to appreciate the positives from their own experiences.

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Fox-Disney: NewFox Is Extremely Cheap

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On the deal announcement, Fox (NASDAQ:FOX) (NASDAQ:FOXA) shares sold off considerably on the headline deal number of $52 billion perceived to be low and the sizeable $8.5 billion estimated tax liability which would be funded by issuing $9 billion of debt at NewFox as well as the antitrust risk (particularly related to the RSNs). With FOX shares at $33-34, we think that there is a compelling opportunity to buy FOX shares and create the NewFox stub extremely cheaply as well as participate in potential upside if the tax liability ends up being less than estimated.

Fox is selling selected assets to Disney (NYSE:DIS) for $68 billion in enterprise value ($54 billion in equity value) including the assumption of $13.7 billion of net debt by Disney and the tax liability at the parent which will be paid for by a dividend from NewFox. As consideration FOX shareholders will receive 0.2745 shares of DIS plus one share of NewFox. At DIS’s current share price of $107.61, this works out to $29.50 per share plus the value of NewFox.

Source: Own calcs and transaction presentation (here)

The Bottom Line is NewFox is Very Cheap

Based on the current share price, FOX is currently valued at $75 billion and the transaction creates NewFox at $15 billion or 5.3x estimated OIBDA of $2.8 billion including standalone company costs. Basically, investors in FOX have the opportunity to buy NewFox at $4 per share when it generates $1.10 per share in FCF. The valuation of NewFox is extremely compelling and we think that the NewFox should conservatively trade at 9-12x EBITDA or a 8-10% FCF yield which would imply a deal value of $29.50 plus $9.55-$14.09 or $39-44 per share. Applying a 10% discount to reflect a wider arb spread, we think FOX should trade at least at $37-40.

NewFox is a Cash Machine and Will Delever Quickly

NewFox will have $7.5 billion in net debt and generate around $2 billion in free cash flow annually enabling it to delever quickly with this value accreting to shareholders. If NewFox is able to pay down $7.5 billion in debt this would create around $4 per share in value to NewFox shareholders. Additionally with the FCC recently relaxing regulations on local media ownership, NewFox can deploy excess cash flow into M&A to acquire television stations and news assets.

Potential Upside from Lower Tax Liability

The headline tax liability number is misleading because the transaction is smartly structured to be tax neutral as it will result in a step up of NewFox’s tax basis resulting in $1.5 billion of annual tax savings for 15 years at the spinco. The huge tax benefit to NewFox means that shareholders are not taxable on either side of the transaction.

There is also a provision baked into the deal whereby NewFox shareholders would benefit substantially if the tax bill ends up lower than $8.5 billion. The first $2 billion of savings will flow directly NewFox through a lower dividend payable to the parent per section 2.01(F) of the Merger Agreement (available here). Anything over $2 billion results in an upward adjustment of the exchange ratio, further benefitting FOX shareholders.

The upside from a lower tax liability would provide a small but nice bump to the value of NewFox.

Conclusion

FOX shares look extremely compelling even without considering the potential upside in pro forma Disney shares largely due to the hidden value in NewFox. We are comfortable owning FOX without the hedge as we are bullish on the pro forma DIS and NewFox and see them benefiting from lower corporate tax rates. The buying opportunity exists because of the convoluted arb structure and regulatory dimension to the deal/long time frame to closing. We think that the deal closing risk is partly mitigated by the $2.5 billion regulatory break-up fee payable to FOX ($1.35 per share), FOX’s reasonable valuation at 10x OIBDA and the presence of other potential interested parties in FOX’s assets (e.g. Comcast (NASDAQ:CMCSA)). When taking into account the breakup fee and where the break price would be if the deal fails ($28-$29), we like the risk reward at current levels.

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Disclosure: I am/we are long FOXA FOX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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PowerPlayer: Feedback is Fuel for Young Hockey Players

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Good coaching exists in that intersection where time, passion and effort meet. And these days, a fourth element—communication and feedback—has been added to the mix. Any coach will tell you that it can be tough for everything to align. Most are volunteers with a desire to give back to the sport, while juggling the endeavour with their own personal lives.

Enter PowerPlayer. The feedback platform attempts to close the gap between what players and parents want, and what coaches can give. “It was designed to help bring some transparency into the coach, player, parent triangle,” says founder Dave Mason.

“We know from personal experience that most hockey coaches are so busy actually coaching that the communication aspects of their jobs — the all-important feedback that tells athletes and parents what’s going on — can be incredibly challenging. PowerPlayer is designed to make coaching and communicating a one-step process.”

While the idea for a platform that is both user-friendly and useful had been brewing for some time, a moment of clarity came when Mason’s own son was being approached by scouts. “My son was about 15 and was getting recruited by junior coaches. And these coaches would see him play a couple times and would ask to have a meeting,” Mason said.

He realized the process was flawed. The scouts were asking the wrong questions to the wrong person, Mason said. “They’re asking him, ‘what are your strengths? What are your weaknesses?’” A young athlete can’t answer those questions correctly, nor should they have to. But there was nowhere else that information existed.

“Imagine if that was school and I got no feedback from their teachers, no test results, no grades. You wouldn’t accept that as a parent. So, why should we accept that in youth sports?”

That question inspired Mason to begin working on designing and building the platform that would eventually become PowerPlayer. Timing helps, too. A platform like this couldn’t have existed ten years ago, both in terms of technology and in the approach coaches take. But today, young coaches, and young players, are used to a digitized world. And everyone expects unlimited information at their fingertips.

But it’s not just information for the sake of it. PowerPlayer does offer coaches a chance to record tangible data like time and shot accuracy. They can also track “soft and squishy” data like a player’s coachability or work ethic. And this can have a huge impact on players’ lives beyond the rink.

“By scoring and visualizing intangibles, PowerPlayer elevates them to a place of importance in the mind of the athlete… And over time, their maturity as people and players becomes an asset that will help them get where they are hoping to go, in hockey and in life.”

There are some questions that arise: how much is too much information? Is it too much to expect of coaches? PowerPlayer has thought of the hurdles, and has worked the solutions into the design. Coaches can make the system age- and level-appropriate; can provide one on one communication with players and parents; and can use it as much or as little as they choose.

The success of something like PowerPlayer is a result of changing times, especially at the rink. “Younger coaches are eager to get their hands on this kind of thing. It’s not a must do, it’s a want to do,” Mason said. And judging by the numbers that are signing up for the platform, there is a clear trend that this is exactly the kind of tool coaches want.

Jeremy Kavanaugh is the Head Defence Instructor with St. John’s-based Xtreme Hockey, and has integrated PowerPlayer into his program. “I like to give a detailed analysis of how each player is doing, and I really focus on providing positive comments. We love that the system allows us to really be age and skill level appropriate in our instruction, we want the kids to know that it’s ok to learn, and that everyone can get better at something,” he said.

Hockey, and youth sports in general, has become so much more than just a physical skill set. “It’s an interesting revelation for parents, and for the kids themselves, that it takes a lot of things to be a good hockey player,” Mason said. “Some of the kids in the system are not the strongest skaters in the world, but they’re rated very highly in other areas by their coaches.”

The world is going the way of information. It wasn’t long ago when, even at the top levels of sport, data was collected on spreadsheets (at best) and all too often ended up in boxes collecting dust. Now young athletes expect instant and accessible information. And coaches today are expected to keep pace.

Access to our entire library of videos from our annual TeamSnap Hockey Coaches Conference. You can cancel any time, although after joining a community of coaches from all over the world using the videos on a daily basis to pick up new tips and stay relevant, we doubt you will.

Cues of men's upper-body strength account for most variance in attractiveness

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Strength Accounts for Attractiveness | Proceedings of the Royal Society of London B: Biological Sciences

Research article:

Cues of upper body strength account for most of the variance in men's bodily attractiveness

Aaron Sell, Aaron W. Lukazsweski, Michael Townsley

Proc. R. Soc. B 2017 284 20171819; DOI: 10.1098/rspb.2017.1819. Published 13 December 2017

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How Does the Flu Actually Kill People?

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How Does the Flu Actually Kill People? - Scientific American

One Sunday in November 20-year-old Alani Murrieta of Phoenix began to feel sick and left work early. She had no preexisting medical conditions but her health declined at a frighteningly rapid pace, as detailed by her family and friends in local media and on BuzzFeed News. The next day she went to an urgent care clinic, where she was diagnosed with the flu and prescribed the antiviral medication Tamiflu. But by Tuesday morning she was having trouble breathing and was spitting up blood. Her family took her to the hospital, where x-rays revealed pneumonia: inflammation in the lungs that can be caused by a viral or bacterial infection, or both. Doctors gave Murrieta intravenous antibiotics and were transferring her to the intensive care unit when her heart stopped; they resuscitated her but her heart stopped again. At 3:25 P.M. on Tuesday, November 28—one day after being diagnosed with the flu—Murrieta was declared dead.

Worldwide, the flu results in three million to five million cases of severe illness and 291,000 to 646,000 deaths annually, according to the World Health Organization and the U.S. Centers for Disease Control and Prevention; the totals vary greatly from one year to the next. The CDC estimates that between 1976 and 2005 the annual number of flu-related deaths in the U.S. ranged from a low of 3,000 to a high of 49,000. Between 2010 and 2016 yearly flu-related deaths in the U.S. ranged from 12,000 to 56,000.

But what exactly is a “flu-related death”? How does the flu kill? The short and morbid answer is that in most cases the body kills itself by trying to heal itself. “Dying from the flu is not like dying from a bullet or a black widow spider bite,” says Amesh Adalja, an infectious disease physician at the Johns Hopkins University Center for Health Security. “The presence of the virus itself isn't going to be what kills you. An infectious disease always has a complex interaction with its host.”

After entering someone's body—usually via the eyes, nose or mouth—the influenza virus begins hijacking human cells in the nose and throat to make copies of itself. The overwhelming viral hoard triggers a strong response from the immune system, which sends battalions of white blood cells, antibodies and inflammatory molecules to eliminate the threat. T cells attack and destroy tissue harboring the virus, particularly in the respiratory tract and lungs where the virus tends to take hold. In most healthy adults this process works, and they recover within days or weeks. But sometimes the immune system's reaction is too strong, destroying so much tissue in the lungs that they can no longer deliver enough oxygen to the blood, resulting in hypoxia and death.

In other cases it is not the flu virus itself that triggers an overwhelming and potentially fatal immune response but rather a secondary infection that takes advantage of a taxed immune system. Typically, bacteria—often a species of Streptococcus or Staphylococcus—infect the lungs. A bacterial infection in the respiratory tract can potentially spread to other parts of the body and the blood, even leading to septic shock: a life-threatening, body-wide, aggressive inflammatory response that damages multiple organs. Based on autopsy studies, Kathleen Sullivan, chief of the Division of Allergy and Immunology at The Children's Hospital of Philadelphia, estimates about one third of people who die from flu-related causes expire because the virus overwhelms the immune system; another third die from the immune response to secondary bacterial infections, usually in the lungs; and the remaining third perish due to the failure of one or more other organs.

Apart from a bacterial pneumonia, the secondary complications of the flu are numerous and range from the relatively mild, such as sinus and ear infections, to the much more severe, such as inflammation of the heart (myocarditis), brain (encephalitis) or muscles (myositis and rhabdomyolysis). They can also include Reye’s syndrome, a mysterious brain illness that usually begins after a viral infection, and Guillain–Barré syndrome, another virus-triggered ailment in which the immune system attacks the peripheral nervous system. Sometimes Guillain–Barré leads to a period of partial or near-total paralysis, which in turn requires mechanical ventilation to keep a sufferer breathing. These complications are less common, but can be fatal.

The number of people who die from an immune response to the initial viral infection versus a secondary bacterial infection depends, in part, on the viral strain and the cleanliness of the spaces in which the sick are housed. Some studies suggest that during the infamous 1918 global flu pandemic, most people died from subsequent bacterial infections. But more virulent strains such as those that cause avian flu are more likely to overwhelm the immune system on their own. “The hypothesis is that virulent strains trigger a stronger inflammatory response,” Adalja says. “It also depends on the age group getting attacked. During the H1N1 2009 pandemic, the age group mostly affected was young adults, and we saw a lot of primary viral pneumonia.”

In a typical season most flu-related deaths occur among children and the elderly, both of whom are uniquely vulnerable. The immune system is an adaptive network of organs that learns how best to recognize and respond to threats over time. Because the immune systems of children are relatively naive, they may not respond optimally. In contrast the immune systems of the elderly are often weakened by a combination of age and underlying illness. Both the very young and very old may also be less able to tolerate and recover from the immune system's self-attack. Apart from children between six and 59 months and individuals older than 65 years, those at the greatest risk of developing potentially fatal complications are pregnant women, health care workers and people with certain chronic medical conditions, such as HIV/AIDS, asthma, and heart or lung diseases, according to the World Health Organization.

So far this flu season more than 6,000 people in the U.S. have tested positive for influenza and 856 have been hospitalized for laboratory-confirmed flu-associated reasons, according to the CDC. The most effective way to prevent the flu and its many potentially lethal complications is to get vaccinated.

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Team Canada Prepares for Team USA at Selection Camp

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Now that Team Canada’s selection camp is done, there’s a full 22-man roster getting ready to face the world’s top junior teams. Beginning on Tuesday, December 26, 2017, are the preliminary games for the 2018 IIHF World Junior Championships in Buffalo, NY and from now until then, the Canadians have a lot of preparation to do. […]

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How To Beat The Market (Pt. 2): Two-Fund Portfolio Beats Market By 37% And Weathers Downturns Better

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Summary & Thesis

In this article, I compare the use of a risk-parity-weighted leveraged portfolio to a pure SPY portfolio. These portfolios use a leveraged index fund (SSO, ULPIX, FLGE, QLD, TQQQ, UPRO, SPXL) to gain leveraged exposure to equities. The risk from this leverage is offset using a bond fund (AGG, BND, IEF, TLT), and in one portfolio, also using a gold fund (GLD, IAU).

I compare the results between each portfolio from the Great Recession with today. The goal is to see how to use leverage while also being able to weather significant downswings.

Portfolio	Total Return (6/30/06 to 12/15/17)	CAGR	Maximum Draw-down	Sharpe Ratio
Portfolio 1 (Bond ETF and leveraged equity ETF)	272%	12.1%	23.4% (Mar-09)	0.96
Portfolio 2 (Same, but also with a gold ETF)	213%	10.5%	19.5% (Nov-08)	0.88
100% SPY Portfolio	164%	8.8%	55.2% (Mar-09)	0.40

The leveraged portfolios showed excellent returns. Each portfolio outperformed the S&P 500 by a large margin, had much less significant draw-downs, and had a higher Sharpe ratio.

I am not yet leaping to invest in these portfolios, but risk parity-based weights show promise of achieving significantly better returns than other leveraged portfolios with reduced risk.

Background

As a note, I do not necessarily recommend the portfolios discussed herein to anyone. My interest here is for my own portfolio, and determining efficient allocations for the parts of my portfolio that I am not actively managing. The relevant portion of my portfolio I am considering investing in this manner is in a retirement account, so transaction fees apply but taxes are not a concern. Your investment goals are likely to vary from mine, of course.

This article is a continuation from what I wrote on Dec 14, 2017, "Using Leverage To Beat The Market." In that article, I discussed two leveraged portfolios and compared the performance of those portfolios with that of an un-leveraged portfolio consisting of only the S&P 500 (SPY, VOO).

In response to my prior article, I received several very insightful comments from those much more knowledgeable than I. I am thankful for all the comments and encourage people to opine below and help guide me on my path to better portfolio management.

Of specific interest was a comment from Varan, who noted:

Adding a leveraged equity ETF to an equity ETF is not the solution as it increases the drawdown.

A simple approach is to have a periodically rebalanced portfolio of the equity ETFs and some asset that is negatively correlated with the equities.

Here are some examples. (I have used ULPIX instead of SSO, but both are 2X SP500). The rebalanced portfolios, even though they contain a leveraged ETF have drawdowns which are lower that the drawdowns of the best of balanced funds."
- Varan, December 14, 2017

In his comment, Varan including a link to the following chart:

^{SOURCE: VARAN ON SEEKING ALPHA}

These portfolios are attractive to me for at least two reasons.

First, Varan's risk parity portfolios have dramatically less draw-down than his two non-risk-parity portfolios. Draw-down is vitally important when considering leverage portfolios, since the primary risk from leverage is the risk of increased losses during poor economic times. Therefore, the remarkably good results during the 2007-09 crisis is promising.

Second, Varan's risk parity portfolios also significantly outperform the simpler portfolios of 100% SPY, and 75% SPY/25% ULPIX. I was intrigued, so I decided to dig in a little.

What is Risk Parity?

If you're already familiar with risk parity, feel free to skip this section. Alternatively, please read it and correct me in the comments where I make a mistake. I do not claim to be an expert on risk parity.

In short, risk parity seeks to find a portfolio in which each of the components of the portfolio contributes an equal amount to the risk of the portfolio. In theory, this reduces the risk of the portfolio while allowing for better performance.

For example, take a simple three-fund portfolio. Risk parity will seek to ensure that each of the three funds contributes 33% to the overall risk of the portfolio, by adjusting the weightings of the portfolio. Thus, safer funds will be owned in higher quantities than riskier funds.

Risk in this sense refers to the price variations of a given fund (daily, weekly, or monthly), as measured using a standard deviation. Risk parity also compensates for the correlation between the different funds.

For example, if a three-fund portfolio included both the S&P 500 and the NASDAQ, as well as a gold fund, the first two funds would be highly correlated. That is, they would tend to rise and fall similarly each day, whereas daily performance of the bond fund would differ substantially. Accordingly, a risk parity portfolio would adjust for this correlation by reducing the weights of the first two funds.

Thus, a risk-parity portfolio adjusts for the risk of the funds within it, and the correlation of those risks, to allow each security in the portfolio to contribute an equal amount of risk.

If you would like a more mathematically rigorous definition and formula for risk parity, here are some Efficient Algorithms for Computing Risk Parity Portfolio Weights. As a warning, it involves somewhat heavy levels of statistics and linear algebra.

Risk parity is only useful if it results in better portfolio performance. Therefore, I wanted to back-test risk parity portfolios against other portfolios.

Constructing Leveraged Portfolios

The main point of this article is to look at leveraged risk-parity portfolios and to compare their risk profiles with those of other leveraged portfolios. To do this, I will construct a few portfolios, and compare how they have fared since at least before the beginning of the 2007-09 crisis.

My focus here is on leveraged portfolios. Therefore, it is vitally important to see how those portfolios fare during draw-downs. Nearly any leveraged portfolio will outperform an un-leveraged portfolio during a bull market, but those gains may come at the cost of taking on an undue amount of risk during bear markets. Making twice as much money when the market rises 40% is great, but not if it means you'll go broke if the market drops 40%.

Chart ^SPX data by YCharts

Therefore, I have chosen funds which were created prior to the beginning of 2007. This excludes 3x leveraged funds, since the earliest of those was the Direxion Daily S&P 500 Bull 3X Shares (SPXL), but it was not introduced until November 5, 2008.

Portfolio 1 ("P1"): Portfolio 1 is a combination of two ETFs. These holdings will be weighted and re-balanced every six months using risk-parity-based weights.

iShares 20+ Year Treasury Bond ETF (TLT): Government bonds are used to hedge risk from a leveraged stock ETF. I chose TLT because it is the largest long-term government bond fund. Other choices here could include intermediate-term treasuries (IEF, IEI).

The expense ratio of TLT is 0.15%. While this is not high, Vanguard's government bond funds (VGLT, VGIT) have lower expense ratios at 0.07%. If I were to invest in this portfolio, I would invest in the lower-fee Vanguard funds rather than the iShares fund. However, the Vanguard funds have inception dates in 2009, which is insufficient for my back-testing.
ProShares Ultra S&P 500 (SSO): My leveraged fund of choice here is SSO, with an inception date in 2006 and an expense ratio of 0.90%. This ETF is 2x leveraged. In an actual portfolio, I would consider using 3x leveraged ETFs as well, but they have inception dates too late to observe their responses during the 2007-09 crisis.

Portfolio 2 ("P2"): Portfolio includes the same two funds as Portfolio 1, but adds another fund to further reduce risk. I have chosen to use gold because its performance is uncorrelated with either stocks and bonds, which is desirable in this setting.

iShares Gold Trust (IAU): Gold has long been known as a hedge against risk, so it seemed an appropriate choice to hedge against the risks involved in a leveraged portfolio. This fund was founded in 2005.

IAU also offers a lower expense ratio than the larger GLD (0.25% versus 0.40%), and so it is the fund I would use in my own portfolio.

Portfolio 3 ("SPY"): The third portfolio is just 100% SPY. Adding leverage to this portfolio will only worsen the performance during the 2007-09 crisis. Details on the performance of those portfolios can be found in my previous article. Note that in an actual portfolio, I would use VOO over SPY, due to lower expense ratio. The difference would be very minimal, however.

All portfolios were tested back to June 30, 2006. Performance of the relevant funds is shown below.

Chart SPY Total Return Price data by YCharts

I have also included maximum draw-downs, to show the effect of the 2007-09 crisis on these various investments. Note that the chart shows the bottom of the S&P 500 specifically, but is not the lowest point for IAU or TLT. As shown, SSO dropped nearly 85% from its peak, while SPY dropped over 55%.

Chart SPY Total Return Price data by YChartsMethodology

The following methodology is used for each relevant portfolio within the sample.

Each portfolio begins with $1,000 on June 30, 2006.
All portfolios with multiple holdings are re-balanced every six months, on July 1 and January 1 of every year.
Dividends are always reinvested into the same equity. This is equivalent to using a dividend reinvestment plan, and is what I would use in my real portfolio, primarily to minimize trading fees. But for trading fees, it would be better to put dividends into whichever holding was short of its target percentage, but I expect the impact would be extremely minimal.
All risk parity weightings are based solely on data from prior to the date of that weighting, and use the past five years of data. All weightings are based on daily price data (rather than weekly or monthly).

That is, these are weightings that I could have calculated on the day of that weighting, rather than weightings based on future data. The latter would not accurately reflect possible real-world portfolios.
I do not account for partial shares. Using only $1,000 would often result in a relatively significant amount of money being un-invested due to the inability to purchase partial shares during re-balancing. I do not account for this, and the model assumed all that money has been invested. This is more realistic in a large portfolio than a small portfolio.
I do not account for any trading fees or taxes. This is unrealistic, but given re-balancing only every six months, there will be a small number of trades (six/year for a three-fund portfolio). I anticipate investing in a non-taxable account, such that taxes are not relevant.
Sharpe ratios herein are calculated annually. These ratios are based on the values of the 10-Year Treasury Constant Maturity Rate.

I use internally consistent methodology for my Sharpe ratios, but my methodology is unlikely to match that used elsewhere. Therefore, they are best used in comparison with each other, but not to externally sourced Sharpe ratios. I do not personally put much faith in Sharpe ratios. They are provided only for the convenience of readers who would like to see them.

Results & Analysis

^{SOURCE: AUTHOR BASED ON DATA FROM ALPHA VANTAGE}

As shown, the risk parity portfolios significantly outperformed the pure SPY portfolio. Both risk parity portfolios offered much better performance than SPY during the 2007-09 crisis especially. Both risk-parity portfolios stayed above $1,000 during the entire crisis.

Here are a few statistics from these portfolios:

Portfolio	Total Return (6/30/06 to 12/15/17)	CAGR	Maximum Draw-down	Sharpe Ratio
1: TLT and SSO	272%	12.1%	23.4% (March 2009)	0.96
2: TLT, SSO, and IAU	213%	10.5%	19.5% (November 2008)	0.88
3: SPY	164%	8.8%	55.2% (March 2009)	0.40

It is easy to spot which portfolio offers the worst performance. The 100% SPY portfolio gained the least of the three portfolios, in total return and CAGR. It also suffered the highest draw-down during the crisis. Further, its Sharpe ratio was also the lowest.

The choice between Portfolios 1 and 2 may come down, in part, to taste.

Chart Gold Price in US Dollars data by YCharts

Returns: Portfolio 1 offers the highest returns over the sample. However, its returns were lower than P2 from 2007 to 2013. P1 only passed P2 when the price of gold dropped in 2013. Gold prices have no recovered since then. As a result, P1 has been able to outperform P2, since P1 does not have gold in its portfolio.

It is unclear which portfolio will offer better returns in the future. I suspect that P1 will offer better performance in bull markets, while P2 offers better returns in bear markets. This is because P2 has less exposure to the stock market, and more exposure to gold.

Maximum Draw-downs: Both P1 and P2 dramatically outperformed SPY during the downturn. P2 offered better performance, however.

P2 recovered its maximum draw-down in mid-November 2008, at 19.5% off its peak. However, be the end of December 2008, P2 had regained all its previous losses. During the rest of the downturn, P2 was usually less than 10% off its peak levels.

P1 fared slightly worse during the 2007-09 crisis. For a majority of 2009 (from January until August), P1 was down double-digits from its peak, recorded its worst draw-down in March 2009. Although it performed a bit worse by this metric than P2, the two-fund P1 still performed very well during the crisis.

Sharpe Ratios: The general idea of a Sharpe ratio is that a portfolio should be compensated for the risk it contains. For example, if your portfolio takes on a great deal of risk, it should be compensated for that risk through higher returns. A Sharpe ratio represents how much a portfolio gained (compared with the risk-free rate) for each unit of risk.

A higher ratio is better, since it indicates that risks are being rewarded with higher gains. By this metric, P1 and P2 were similar at 0.96 and 0.88, with P1 having a slight edge. Both portfolios had much higher Sharpe ratios than SPY.

Note: These Sharpe ratios are not comparable with those found elsewhere. Calculating a Sharpe ratio requires many choices, including the risk-free rate used, the frequency of sampling (daily, weekly, monthly, annually, etc.), and the duration of the sample (here, from June 30, 2006 to present). Thus, don't compare these values with values found elsewhere, as it will not be an apples-to-apples comparison.

Current Portfolios And Future Work

Here are the current portfolio weights, if these portfolios were to be weighted today. This is not the weight used in the portfolios modeled above, since they last re-balanced on July 1, 2017. As a result, weights were slightly different.

Weightings As Of Dec. 16	TLT	SSO	IAU	SPY
1: TLT and SSO	65.4%	34.6%
2: TLT, SSO, and IAU	44.3%	23.4%	32.2%
3: SPY				100%

I do not necessarily recommend (or not recommend) that anyone invest in any of these portfolios. Future results may not look at all like past results.

In the future, I would like to look at a few different things, before I'd consider using a portfolio like this for the passive portion of my portfolio. These include:

The addition of more investments into the portfolio. I expect that my passive portfolio will include at least two equities ETFs (one Canadian and one American or global). I may also wish to include other asset classes, such as REITs, or sector ETFs such as Vanguard Consumer Staples (VDC). I am interested to see how the addition of more asset classes might reduce risk, although at the cost of having to make more trades when re-balancing.
Reviewing how a risk-parity portfolio performs with and without leveraged ETFs. I am not sold on the use of leveraged ETFs, due to beta-slippage and to higher fees than non-leveraged ETFs. In a retirement account, those long-term effects may be detrimental to returns compared with non-leveraged ETFs, especially if the market move sideways or declines over a longer timeline.
Investigating longer timelines. This may not be possible using actual ETFs, since data is limited by when those funds were founded. However, similar work may also be possible using the underlying indices. It may be instructive to see how model portfolios would have performed in the more distant past.

On the other hand, the further back data goes, the less relevant it will be to today's market and to future markets. For example, the risk and return of bonds in the next ten years is more likely to parallel the last ten or twenty years than the distant past.
The effects of longer and shorter look-back windows when determining standard deviation and correlation of securities in a portfolio. This is used for weights in the portfolio. The portfolios above use five years.

The idea here is that the correlation and risk in different asset classes will change over time as the economy changes. Thus, using windows that do not include potentially outdated data can be beneficial. However, using a window that is too short may exclude relevant data. This is a trade-off, like those made when choosing shorter-term or longer-term betas (although I tend to use a bottom-up beta).

Conclusion

In this back-test, risk parity portfolios performed extremely well against the S&P 500 (SPY). The risk parity portfolios offered both higher returns and lower risk (as measured by maximum draw-downs) than a pure SPY portfolio. The risk parity performance during 2007-09 was especially impressive to me.

If I was to invest in one of these portfolios today, I would choose Portfolio 1. While it suffered worse draw-downs, it also offered better performance over the life of the sample.

This choice is also because I do not hold especially positive views about gold as an investment. I personally do not expect gold to match the performance of bonds or the stock market in the future. Others will hold contrary views, of course.

However, I do not plan to invest in any of these portfolios today. My timeline for re-allocating parts of my portfolio is at least a month away. During that time, I anticipate looking at other investments for a portfolio and at other ways to balance portfolios to achieve desirable returns with reduced risk.

Please leave a comment below if you have questions, criticism, or any other feedback or suggestions. Please also follow me if you're like to receive updates on my portfolio and my strategies for obtaining good results while reducing downside risk.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Techies Still Think They're the Good Guys. They're Not

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In September, I met with a prominent entrepreneur looking for positive press on his new project. Meetings like these are a common, usually formulaic, part of my job—except in this one, the conversation drifted to the tech industry’s year of bad headlines. As we discussed the latest sexual harassment scandal, he posed a question: Will anyone ever write another positive story about a tech startup?

I said probably not.

We’ve been burned, I explained. The many hype-building stories about deceptive companies haven’t aged well. I once wrote a largely positive story about Zenefits CEO Parker Conrad, lightening his outsize personality by calling him “the enfant terrible of the back office.” Not long after, he was ousted after the company admitted its employees cheated on mandatory compliance training.

The issue is bigger than any single scandal, I told him. As headlines have exposed the troubling inner workings of company after company, startup culture no longer feels like fodder for gentle parodies about ping pong and hoodies. It feels ugly and rotten. Facebook, the greatest startup success story of this era, isn’t a merry band of hackers building cutesy tools that allow you to digitally Poke your friends. It’s a powerful and potentially sinister collector of personal data, a propaganda partner to government censors, and an enabler of discriminatory advertising.

The world is no longer interested in that kind of story, I told him. Anything that doesn’t address the thorny questions facing the tech industry feels beside the point.

The entrepreneur was disappointed by my cynicism. The industry’s problems, he believed, could be solved with more technology. As a matter of fact, his startup was working on just the thing: a tool that would tackle a problem caused by tech. If he was successful, the world (and his bank account, and his investors’ bank accounts) would be better off for it, he argued.

So if I could just do him—and by extension, everyone—a favor and explain that in an article, it would really help us all out.

Talking to tech founders every day, it’s clear how little their lives have changed in the last year, even as the world around them has shifted. Even top bosses who’ve noticed the change in public opinion aren’t willing to adjust. On his blog, Y Combinator president Sam Altman argued that political correctness was damaging the tech industry. “This is uncomfortable, but it’s possible we have to allow people to say disparaging things about gay people if we want them to be able to say novel things about physics,” he wrote. On the ground, the startup kings haven’t changed their behavior. They’re still pitching me their companies with the same all-out exuberance. They’re continuing their quest to move fast and break things—regardless of what broken objects are left in their wake.

Outside the bubble, things are different. We’re not egging on startups that willingly flaunt regulations. We’re wary of artificial intelligence and its potential to eliminate jobs. We’re dubious of tech leaders’ promises to make their products safe for their kids to use. We are all sick of the jokes that no longer feel funny: lines about the lack of women in tech, about obscenely rich 20-somethings, about awkward coders with bad people skills, about “hustling” and growth at any cost. It all feels inappropriate.

But this backlash against tech is difficult to see from inside the Silicon Valley bubble. And it’s not hard to understand how we got here. In the late 2000s, just after the financial crisis, the world was eager to hear positive stories about tech. The fast rise of services like Twitter and Facebook was thrilling—a spot of optimism in the gloomy aughts—and their geek genius founders made better heroes than the greedy Wall Street jerks that had just tanked the economy. Facebook was making the world more open and connected. Twitter was aiding revolutions in the Middle East. Sure, those fresh-faced founders became billionaires, but their mission-driven companies felt about as noble as capitalism gets.

The business world celebrated this swashbuckling freedom, adopting startup culture’s management philosophies, office designs, and ethos of innovation. It seemed impossible that a company like Uber, the most valuable privately held startup in history, could ever face a moral reckoning. But that was before 2017, when journalists revealed that Uber’s swaggering “bad boy” reputation had enabled a host of abhorrent and potentially illegal business practices. Uber’s meltdown was part of a steady drumbeat of revelations that have turned the headlines out of startup-land negative.

When Bodega, a startup making “smart” vending machines, announced its launch in September, it encountered an angry mob on Twitter. Bodega’s co-opted name, along with its founders’ stated plan to make corner stores obsolete, fit perfectly with the stereotype—arrogant, elite tech bros trying getting rich by disrupting a lovable local icon. “Let’s see your shitty glass box make me a bacon, egg and cheese with jalepenos on a roll you sick, capitalist scum,” the rapper El-P tweeted. The company’s founder issued an apology, which was subsequently mocked.

“Bro-dega,” as it’s since been named, was just one catalyst of the anti-tech sentiment rippling beneath our collective surface. After Skedaddle, an “Uber for Buses” startup, was featured on Business Insider, a screenshot of the four young male cofounders, smiling atop an article describing an unsavory-sounding mission, ricocheted across Twitter. “What a nightmare,” the writer Lisa McIntire tweeted, adding, “Silicon Valley is run by complete sociopaths.”

A trend story about startups riding the trend of “co-living” emerged; Twitter screamed, “YOU INVENTED ROOMMATES!” When Bloomberg revealed that fruit packs made by Juicero, a well-funded startup selling expensive juicing appliances, could be squeezed with bare hands, commentators howled with schadenfreude. Juicero wasn’t just a preposterous company: It was “a symbol of the Silicon Valley class designing for its own, insular problems,” and “an absurd avatar of Silicon Valley hubris.” When a study showed that a “brain-hacking” supplement created by a venture-backed startup called HVMN was no more effective than a cup of coffee, mockery ensued.

This week, when Netflix tweeted a joke about some of its customers’ viewing choices—a marketing ploy that, just a few years ago, would have felt like a clever insight gleaned from the wonders of big data—the press and tweeting masses immediately attacked it as creepy and a violation of privacy. These rifts have solidified the feeling that techies and their moneymen are painfully out of touch.

The Valley’s investors are at least aware of the problem. Two years ago, a bad reference or a small public scandal wouldn’t have blown up a fundraising process for a hot deal. But venture investors are increasingly passing on deals—including hot ones they’d normally fight to get a piece of—because of negative character references. Post-Uber, post-harassment scandals, post-tech backlash, investors are hesitant to touch companies that are adjacent to any kind of scandal. “People are hypersensitive to working with anyone with any type of issues,” one investor told me. They’re scared of the reputational blow they face if they’re associated with a “tainted” startup.

In 2008, it was Wall Street bankers. In 2017, tech workers are the world’s villain. “It’s the exact same story of too many people with too much money. That breeds arrogance, bad behavior, and jealousy, and society just loves to take it down,” the investor said. As a result, investors are avoiding anything that feels risky. Hunter Walk, a partner with venture capital firm Homebrew, which invested in Bodega, attributes the backlash to a broader response to power. Tech is now a powerful institution, he says. “We no longer get the benefit of the doubt 100 percent of the time, and that’s okay.”

The privilege that techies have enjoyed for years is starting to erode. It’s taking them some time to see what other people are seeing, but if VCs, media critics, and people adjacent to the industry are starting to get it, then it’s time to make a change. Right?

Startup founders with any potential for success are used to being treated with the reverence of a war hero. This status earns them business clout, like extra voting power and control over their boards (a practice that’s caused problems for startups like Uber and Theranos). But more importantly, this heady mind-meld convinces them they’re invincible. The culture of founder worship is bred into tech’s legacy, from Steve Jobs to the latest batch of Y Combinator wannabes. The royal treatment seems surreal at first, but most founders quickly acclimate to the free helicopter rides, the free concerts, the free gadgets, and the invites to rub elbows with one another at plush resorts on Montauk or Necker Island or Hawaii. They work hard, the justification goes. They’re changing the world. They deserve it.

Which is why many of them were delighted when the city of Lisbon came to a standstill in November. I was attending the Web Summit conference, on a bus headed to a private dinner where the prime minister of Portugal was slated to make an appearance. Police motorcycles, their sirens blaring, surged through gridlocked traffic as caravans of entrepreneurs and investors tried to keep up. Our busses zipped down winding cobblestone hills, darted against traffic on narrow one-ways, and careened around stopped vehicles in the middle of intersections. The rest of the city waited for us to pass.

“I feel like an asshole,” I said to the men seated around me. It seemed wrong to create a massive traffic jam so we could zoom through the fast line. “Move aside, losers!” the sirens screamed in my head. “These techies have a special, fancy palace dinner to get to!”

“This is awesome!” one of the techies exclaimed. A police escort—what an Insta-brag! (#VIP #BallerStatus.) He and the others leaned toward the windows, phones extended.

Over the years I’ve spent chronicling the ups and downs (but mostly ups) of the startup world, I’ve witnessed plenty of over-the-top parties, publicity stunts, and gift-lavishing. “This is why they hate us,” I used to joke. But in Lisbon, I realized the joke was true.

Evidence is mounting that that the world is no longer fascinated with Silicon Valley: It’s disturbed by its callous behavior. But it will take a massive shift to introduce self-awareness to an industry that has always assumed it was changing the world for the better. Cynics would argue it doesn’t matter. The big tech companies are too big to fail, too complicated to be parsed or regulated, and too integral to business, the economy, and day-to-day life. We’re not going to abandon our cell phones or social networks. This is how we live now.

But even if things stay the same inside the Silicon Valley bubble, change is coming from the outside. Critics from the government, the media, and watchdog groups are calling for regulation, be it antitrust, compliance, or transparency around advertising. Some execs are beginning to acknowledge their personal roles in the shift. But for a lot of them, it’s business as usual. They are still preparing their apocalypse bunkers. They’re still privately wondering if the sexual harassment accusations are turning into a witch hunt. They’re still hiring models to fill their holiday parties. They’re still one-upping one another at Burning Man. They’re still asking if it’s possible do something, and not whether they should.

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