Articles on investing and capital management, with a quantitative focus.

#prp - Permanent Risk Parity (how I invest)

Not a Great Year So Far


Many asset classes have been declining this year. Like most investors, I have a negative return year-to-date (YTD). We are now entering the fourth quarter, and I'm bracing myself for more potential losses.

I have not changed my investment plan. I'm still primarily invested in the PRP portfolio with a few non-index positions such as #xiutop, #growth, and #bullsignals to add some trend-following to my stock allocation. For simplicity, I will refer to the performance of my PRP model portfolio, which is similar (but not identical) to my actual investments.

YTD, at the end of the third quarter, I'm down -10.6%

Note that I have a CAD currency basis. The exact same allocation would be down -18.0% in USD terms.

Is this normal?

In my annual performance posts, I have noted that a 5% to 10% single year decline would be normal. My modelling has suggested that these occur somewhat frequently.

A historical back-test shows the occasional drawdown to about -13%. However, this is based on monthly (not daily) data and under-states the magnitude of those declines. I think you could comfortably add another 10% on top of that, estimating the historical drawdowns at more like -23%.

That historical back-test also uses similar (but not identical) asset classes. In any case, my current -10.6% decline seems within normal. It has happened before, and will probably happen again.

Estimating year-end performance

I'm now going to make a pessimistic estimate for the end of the year. This exercise might help to prepare me for further losses. Obviously, I hope to see a result that's better than this. Here is a "bad scenario":

XIU (TSX 60 stock index). This is down -11.2% YTD. Extrapolating to the end of the year, I'm estimating -14.9% for the year.

ZSP (S&P 500 stock index). This is down -17.0% YTD. Extrapolating, I'm estimating -22.7% for the year.

CGL.C (gold bullion). This is down -1.2% YTD, almost flat. Let's add a bit more pessimism here and estimate -10.0% for the year.

XBB (broad Canadian bond index). This is down -12.1% YTD. For this projection, I'll calculate the drop in bond prices assuming another 1.0% increase in interest rates. If the 10 year bond yield increases by that much, the approximate drop in XBB = 7.5 duration x 1% = 7.5%. This gives me an estimate of -19.6% for the year.

Using these projections, my "bad scenario" estimate is -17% for the year.

For a "good scenario", I will assume that stocks and bonds return to their 200 day moving averages, which is quite plausible. I will assume that gold ends the year flat.

This results in a "good scenario" estimate of -6% for the year.

There's no way to accurately predict markets. These are just rough guesses based on some very simplistic projections, and should not be taken seriously. I am holding onto all of my positions and not selling anything. Note that my "good scenario" represents a gain from the current level.

Jem Berkes