RISK PARITY PORTFOLIO STRATEGY

Using risk parity to build and/or balance our portfolio achieves a robust outcome: to perform above average under varying market and economic fluctuations.

Our portfolio management parameters include:  weighted average daily returns, standard deviation of the portfolio’s daily returns, Return on Equity, Earnings Per Share, Probability of Bankruptcy, Volatility (Value at Risk) and three Greeks: Alpha, Beta and Sigma.

Additionally, we take it one step further; running the portfolio through a proprietary statistical probability model based on a volatility formulary between the options and underlying asset.

Moreover, we want more diversity in the motif that fits the “risk averse” hedge strategy, rather than a “risk lovers” speculation strategy.  Our reasoning is based on the fact that Motif Investing’s conceptual niche of building thematic portfolios falls into a speculative category of heightened risk exposure, as defined by attaching relevancy to a particular industry and/or sector.  

Through our use of pair trading, we’ve hypothesized that asset allocation ought to be replaced by risk parity  before we execute a “blast all” motif trade.

For example, among the number of calculations uses, such as the Business Adjustment Factor (To understand the adjustment factor read: Investments: Portfolio theory and asset pricing, Edwin J. Elton, Martin Jay Gruber); the Motif Risk Model is meant to quantify aggregate risk exposure of the weighted Motif Universe.

The proprietary Motif Optimization Engine is “…designed to determine maximum diversification while tracking the risk-return characteristics of the weighted Motif Universe as closely as possible.”

 

The caveat here is  – “maximum diversification” a calculated performance result rational that has a bias toward and leniency when leaning heavily on endogenous inputs, rather then including exogenous factors.  We will look at the “maximum diversification” of Chinese Solar.

Last year, we put some money down on Motif Investing’s Chinese Solar (Zacks: Inside the Incredible Surge in Solar ETFs), after beta testing some of their more popular motifs to establish confidence of their credibility with posted yearly returns.  Moreover, back in October 2013, Clean Energy ETFs showed Japan at 20.86%, China at 17.55% and the US at 13.73% in holdings.  Reportage from the Energy Information Administration (EIA) pointed toward solar generation as the primary contributor to renewable capacity growth, wind power taking second place.

Our returns were sparse going into autumn and then we took a bloodbath as Chinese Solar went south.  Even though the S&P 500 was actually making new highs, Chinese Solar’s returns were skewed in comparison.

Lesson learned.  Portfolio construction in the Motif Universe is tricky.  It must be scrutinized, even though Motif Investing’s advertisement tells you to invest in “ideas” their analytical inputs don’t equate into minimizing risk versus return.  

The process of breaking it all down is a means to an end; understanding what you need to know when you invest in a Motif Investing’s portfolio and how to measure and manage it to keep your profits.

Let’s cut to the chase:

(To follow along open the Macroaxis Chinese Solar portfolio on the Chrome browser to see its present value.  Then open the Motif Investing Chinese Solar portfolio for comparison.  We  use Macroaxis to perform our analytics.

If we had invested in Chinese Solar on January 16th, to date, our gain/loss would be -21.69%.

 

Motif Investing’s Chinese Solar shows drawdowns on the “Overview Table” performance for the past month, for each individual asset in the basket.  But you don’t get an overall monthly return, instead the “Key Stats” post 1 Year; +97.3%, since the assets in this basket are closely correlated to the S&P 500. (On Valentine’s Day the S&P 500 moved +0.48%; Chinese Solar moved +0.28%.

However, based on our capital investment of $2226; resembling as closely as possible Chinese Solar’s customized weighted asset allocation formulary, we have a drawdown of -$492.00; our current balance is $1774.

The “bear trap” lies with the 1 Year Return posted at the top of each portfolio’s page, next to the Motif Index, which is currently 1532 (-2.16%) for Chinese Solar.  

There are three generic Motif models (Non-Modeled Motifs, Model Based Motifs and Fixed Income Motifs).  In part  “…linear regression to compute each company’s past exposure to risk factors…” is incorporated along with “pure-play”, “market capitalization” “excluding illiquid firms” and finally weight the “…constituents of the Motif Universe based on the appropriate weighting parameters to construct the Weighted Motif Universe.”  

Chinese Solar is not optimized so it falls within the “Model Based Motifs” category – based on the criteria they have listed, where Non-modeled Motifs are optimized.  The construction incorporates price momentum, price-to-earnings ratio, price-book ratio and dividend yields.

Based on our replicated Chinese Solar motif in Macroaxis (using professional financial portfolio management indicators – our default assumptions are a 30 day horizon, and moderate risk taker), Chinese Solar’s Alpha (Return over Market) is 0.01; Beta (Market Sensitivity) is 1.47; Sharpe Ratio (portfolio efficiency) is -0.01 and Expected Return (Sigma) is 0.00.

Correlation match ups are extremely high. The strongest diversified assets are CSUN, ASYS and DQ.  This means, you’d be better off just trading these three to minimize negation of profits. Maximum drawdowns outweigh Potential Upside profits on every asset. Value at Risk is 6.83.

Consequently, the interdisciplinary inputs for calculating a viable and robust portfolio based on a weighted indexes that qualifies Chinese Solar’s lucrative one year return (solely based on past performance) is more of a halo effect in the Motif Universe of renewable energy investments.

We’re doing out due diligence on this one.  The concept is great, but at a high risk.  Chinese Solar, in reality, will not bring you the one year return it claims.

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We beta test all portfolio assumptions through Macroaxis, a professional financial portfolio management service that provides the full spectrum tools one can use to make informed investment decisions.

To troll for sector based motifs, we incorporate FINVIZ and most recently Rizm (Equametrics) to start building algorithms  based on our strategic parameters and validations for specific fundamentals.  

Our preferred brokerage account is with TD Ameritrade and Dough, so we access the “thinkorswim” platform to paper trade our strategic models before executing real trades. To further our bench strength, we plug into the tastytrade team bootstrapping traders of invention.

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