i am a finance person so when i talk about optimising returns it means returns on a risk adjusted basis. if not i would highly recommend some junk stocks or s-chips which can give higher returns without mentioning the risks involved.
IMO, there is no such thing as interest parity, balance or all equal, simply because
1) Gold, Equity, Bond and Cash dont have similar risk profile
2) Inflation, Properity, Deflation and Recession events dont happen in equal periods
3) Inflation, Properity, Deflation and Recession events dont happen with equal likelihood
So putting a 25% allocation to each asset is considered a blind and lazy approach. Of course it does work and the PP leads to reasonable returns which i agree for a layman investor. But does it make the porfolio an optimised one? I certainly dont think so because of the 3 reasons above. Laziness and blindness dont always yield the best results. Thats why there is a trade-off in this world. Someone who does consider the future likelihood of those events happening may try to tweak around with the % allocations to give a more optimised portfolio. Of course on the flipside, the portfolio can turn into a worse portfolio than what a PP can give. Thats a trade-off too.
Sorry for wall of text here. Just trying to be clear.
A 50/40/10% stock/long bond/gold portfolio has sharpe ratio of 0.67, which is worse that the 0.72 sharpe ratio of standard 25% PP. On risk adjusted basis, standard PP still has the higher "rewards per unit of risk" (sharpe ratio) and lower std deviations, unless you can show otherwise. Data from Simba's spreadsheet.
I don't agree that just because the allocation happen to be 25%, PP is designed blindly and lazily. In fact PP is well designed because:
1) Gold, stock and long bond do have similar risk profile, in terms of having volatility around the 18% to 20% region. That is why they hold equal weighting in portfolio to "balance risk". Cash has zero volatility so it does not throw off this "risk balance".
The term is "risk parity" not "interest parity". Risk Parity initially looks strange because it is a relatively newer portfolio theory than Modern Portfolio Theory. Ray Dalio pioneered and uses his "All Weather" Risk Parity portfolio as foundation for his world largest hedge fund firm, so I believe there is some real merits in risk parity portfolio. You may wish to familiarise yourself more about "risk parity" theory first, if you havent yet.
(here).
2,3) It is true Inflation, Growth, Deflation and Recession do not happen in equal period or likelyhood. There is a more important factor you have not consider, which is the size of the returns. For example, there can be 5 good years of Growth with 9% annualised returns, followed by 1 year of 'rare' recession with -50% loss to portfolio. So total returns in 6 years becomes just about 0.5% annualised. So i disagree that portfolio should be weighed according to probability of event of occurrence, without considering the size or consequence of the event.
Someone who does consider the future likelihood of those events happening may try to tweak around with the % allocations to give a more optimised portfolio.
I am not from finance side. Speaking from viewpoint of an average investor, the average investor should not try to optimise allocation to beat the market returns because: they cannot forsee the future accurately and do not have discipline to manage risk and losses. A working passive static allocation is better for average investor. Asking average investor to tweak portfolio allocation based on crystallballing the future
eventually ends up in irrecoverable disaster.
To put things into perspective and as an example, let us consider a PP for an investor in India and Singapore. For a country with a weak government and inflationary environment like India, i think it warrants to put a heavy 25% gold allocation for a PP in India. For Singapore on the other hand, I dont agree with a 25% gold allocation. The likelihood of a hyper-inflationary environment to happen in India is much much higher than Singapore. So why 25% gold allocation in a Singapore PP too?
3 things: Most people cannot crystalball accurately 1~10 years into the future and say severe inflation has very low chance of happening in Singapore, or that Singapore's good government will not make a fiscal policy mistake (in the magnitude of two-child policy, COE, housing shortage), or that MAS will not depreciate SGD severely.
With regards to PP, Inflation is defined as currency depreciation. In Singapore's case, interest rate is near zero now so if there is recession in next couple of years, MAS cannot lower interest rate anymore to stimulate economy, so they will devalue SGD (a.k.a. print money) to make Singapore exports more competitive to stimulate economy. Just look at how Japan is trying to 'print money' to devalue Yen to "stimualte economy" to get out of their recession and deflation - a japanese gold owner will be making much money from 25% gold, or more accurately, preserving his/her purchasing power (wealth) singnificantly by owning 25% gold.
What i dont like most about adjusting PP asset allocation is that it messes up the "risk balance" and subject the portfolio to certain rare "fat tail" events that have severe consequences. We are still in middle of world economic turmoil and 15 years global develeraging, I cant predict what problems are going to happen next, so there's no way i want my portfolio to half-die from a combination of unforseen fat-tail events in future.
To optimise portfolio returns, as retail investor i would prefer to tinker with the separate Variable Portfolio to overweight certain assets now and then, without affecting core PP portfolio. That is, if i am capable of crystalballing the future, which I am not.
If i were a professional investor, i would optimise PP returns by introducing moderate amount of leveraging (around 30%) which will increase returns while still totally preserving the risk balancing and protection from severe fat tail events, without raising the risk much.
