RPAR Risk Parity ETF: Fed Day Could Trigger Long-Awaited Rally

My track record on the RPAR Risk Parity ETF (NYSEARCA:RPAR) has been spotty. While the fund has managed to produce very modest gains since my original bullish article of July 2020 (which also marked the all-time high in treasury prices), RPAR has performed very poorly so far in 2022: down 12%.

However, the fund’s recent price movements have not shaken my confidence that this multi-asset class ETF will eventually move towards its peak level of November 2021 — and then past it. The harder question to answer, in my opinion, is when.

Maybe the Federal Reserve’s fairly dovish approach to the most recent interest rate hike could be the catalyst that sends RPAR higher from its second worst drawdown ever. The current drop from the peak has been nearly as bad as the pandemic-driven, very short-lived March 2020 correction (see below), and an imminent recovery would not come as a surprise to me.

A quick word on interest rates

The financial news media has covered the events of May 4 extensively, but it does not hurt to revisit the highlights. On Wednesday, Fed chair Jerome Powell announced a widely expected 50-bp increase in the Fed funds rate, alongside details about the projected unwind of the central bank’s very large balance sheet.

The markets (plural: from stocks to bonds to commodities and crypto) rallied in the afternoon, although probably not because of the interest rate increase itself. Instead, Jerome Powell seemed to suggest that the pace of future hikes may lag the market’s current expectations, as very early signs of inflation moderation and economic growth slowdown begin to surface.

Take a step back

The May 4 developments helped RPAR to post its largest daily gain since February: +1.6%. Whether this is the beginning of a longer-lasting rally is hard to tell for sure. But it is certainly plausible that the Fed announcement could have marked “peak fear” of rampant inflation and sky-high interest rates, maybe as the market anticipates what could be a more balanced macroeconomic environment six months or so down the road.

That said, my bullish stance towards RPAR goes well beyond any opinion that I may have about where the bottom might be. Rather, I encourage readers to take a step back and realize that the risk parity ETF is arguably one of the most likely strategies to find its way north once again due to its deeply diversified nature.

As a recap, RPAR invests largely in stocks (including those of commodity-producing companies), bonds (nominal and inflation-adjusted) and gold, as depicted below. The ETF does not have much of a bias on future economic cycles: it tries to perform well regardless of what may happen to economic growth or inflation. The current year has been unusually brutal for risk parity, but extended periods of drawdowns are not at all common.

Investment strategies similar to that followed by RPAR have been about as consistent as they get at creating wealth over the long term. Take the famous permanent portfolio of equal parts US stocks, treasuries, gold and cash, for example.

This hypothetical, equity-light portfolio would have produced average annual gains of nearly 9% since 1972 — that’s right, high single digits for the past 50 years, through all kinds of macroeconomic environments. Even more impressively, the worst annual return would have been a very manageable loss of 4% in 1981. Against this benchmark, RPAR’s year-to-date losses of 12% stick out like a sore thumb (granted, the ETF is effectively leveraged at a factor of 1.25 times and does not park money in cash, which makes it riskier).

Some may argue that the recent selloff in diversified portfolios is simply a correction following the “peak everything” period of 2020 and early 2021. But the data does not support the idea. In fact, as the histogram below illustrates, the annualized, rolling ten-year return of the permanent portfolio is currently at its lowest since the early 1980s, at least: 4.5% vs. average 8.5%. If anything, multi-asset class diversification may be overdue for a rebound towards the mean, not for further decline from here.

Last few words

If the five-decade-long history repeats over the next few months, I find it highly likely that RPAR will reach all-time highs in the not-too-distant future. Such move would effectively represent a climb of nearly 20%. The most recent Fed Day could have been the greenlight for the start of the rally, although I cannot say for certain that this will be the case.

I think that investing is not about accurately and consistently predicting the future. Rather, it is an exercise in figuring out how the upside opportunity compares against the downside risk, then allocating capital accordingly. I believe that the risk-reward dynamic for RPAR is highly favorable at current levels, which is why I upgrade this ETF to a “strong buy” today.