CapitalTime

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#prp - Permanent Risk Parity (how I invest)

Volatility and Risk-Adjusted Return

2023-02-09


One of the main goals of my PRP portfolio is to have lower volatility, and (by extension) a better risk-adjusted return. I prefer stability over highly erratic portfolio movements.

You might ask: why do I prefer less volatility? It's more comfortable for me, and is also more compatible with occasional withdrawals out of the portfolio. These things might not be important to other investors; that's why I suggest that other people don't use my portfolio.

It might be helpful to study the PRP through a stress-test period, to see how it behaves. Well, lucky us! The last 3 years (from 2020-02-09 to 2023-02-09) are an interesting period:

A lot has happened in this 3 year period, so I think it's a useful stress-test case study. I will compare my PRP to a standard 60/40 balanced fund, using XBAL as the most comparable portfolio. Both portfolios are bond-heavy.

Canadian PRP vs XBAL

The XBAL fund from iShares is a generic, low-fee balanced fund which has many of the same holdings as PRP.

First, let's examine the "drawdowns" — the % decline from a peak to a trough. Amazingly, there were two severe drawdowns in this 3 year period.

PRP had slightly better (less negative) drawdowns.

Portfolio 2020 Drawdown 2022 Drawdown
PRP -13.5% -12.6%
XBAL -20.9% -16.5%

Next, let's look at the annualized return (compound annual growth rate) as well as a volatility measure, the standard deviation. Higher standard deviation = more volatility.

We would like to see a favourable tradeoff between risk (volatility) and return. The Sortino ratio is my preferred measure of risk-adjusted return; it places emphasis on downside volatility, just as humans do. A higher Sortino ratio = better risk-adjusted return.

PRP had less volatility and better risk-adjusted return.

Portfolio Annual return Std dev Sortino
PRP 3.9% 8.1% 0.52
XBAL 3.6% 11.5% 0.35

American version of PRP

I only have high granularity (daily) data for the Canadian PRP, which is what I actually invest in. For an American version of the PRP, I'll have to use data from the Portfolio Visualizer.

The comparison fund is Vanguard Balanced Index, which again is a low-fee balanced fund. To do a fair comparison, I changed the composition of PRP-US to use American ETFs. Here's a link to the comparison.

I'm not posting the drawdown comparison, because the coarse granularity data at Portfolio Visualizer (monthly prices) under-states the actual drawdown. PRP-US had milder drawdowns, but it's hard to say by how much.

PRP-US had less volatility, but almost identical risk-adjusted return.

Portfolio Annual return Std dev Sortino
PRP-US 2.4% 9.5% 0.32
Vanguard Balanced 3.3% 14.3% 0.34

Note that the PRP-US has different underlying holdings than the Canadian PRP. Additionally, the Canadian comparison used 3 years of data to today, whereas the American comparison used 3 years ending 2022-12-31.

Conclusions

Over the last 3 years (starting just before the pandemic), my Canadian PRP portfolio had lower volatility and a better risk-adjusted return than a standard 60/40 "balanced" portfolio.

The American PRP also had lower volatility than a standard 60/40 portfolio, but virtually the same risk-adjusted return.

In both cases, the PRP also had milder drawdowns. I think it's successfully doing its job as a conservative portfolio with lower volatility than 60/40.

Jem Berkes