Porter Stansberry: The secret of ‘risk parity’ investing…

From Porter Stansberry in Stansberry Digest:

Well, that was quick…

The May mini-panic reversed, almost immediately, with new all-time highs set in tech stocks and the broad market index (S&P 500). There’s no doubt – It’s a bull market.

Today, rather than talk about big macro themes… I (Porter) would like to give you something far more valuable.

Over the years, I’ve introduced individual investors to several more advanced strategies that can be incredibly lucrative and that definitely make successful investing much easier and safer.

I’m talking about strategies like investing in distressed corporate debt. As I’ve often explained, I firmly believe that most individual investors would be far better off if they never bought stocks and only invested in bonds. It’s awfully hard to convince folks that’s true… until they try it.

Just look at our track record in Stansberry’s Credit Opportunities. Of the 16 positions we’ve opened since launching the service in November 2015… only one has closed for a loss. The average gain on our closed positions has been 25%.

I’m also talking about our Alpha strategy.

In our Stansberry Alpha trading service, we sell puts on stocks we want to own, at a price that’s far superior to the one currently being offered in the market. Pairing this safe income strategy with buying call options produces a “synthetic” long position that offers almost all the upside of buying a stock, but with much less downside. And it generates great rates of income on the margin employed. Admittedly, this is a strategy for investors with larger accounts and access to margin loans, but it’s a great way to earn 20%-plus returns on margin, very safely.

But… there’s another, even easier way, to get the greatest returns from your investments with the least amount of risk.

I’ve written about “risk parity” investing before, but I doubt most subscribers believe me when I tell them what an incredibly powerful strategy this can be.

And what I’d bet almost no one believes is that this strategy can take losing portfolios and turn them into big winners without changing anything else about your investments.

In other words, by only changing the relative sizes of your investments, you can radically increase your likelihood of producing profitable results.

Hard to believe, isn’t it?

Well, the world’s biggest and most advanced quant hedge funds (firms like Bridgewater and AQR, that emphasize numerical models for identifying investments rather than human reasoning) have used these techniques since the late 1990s to dramatically increase the performance of their portfolios, while decreasing volatility.

So… please… let me show you exactly how you can radically improve your results as an investor without changing anything about what stocks you buy or when you buy them.

Here’s the secret:

You decide how many shares to buy and how much capital to allocate to each position in your portfolio by measuring the volatility of each stock. You use volatility as a proxy for risk. And you make sure that each position has the same amount of capital at risk.

Huh? The same amount of capital at risk?

Yes. Let me walk you through it.

Let’s say you have a $100,000 portfolio.

If you’re smart, you’re holding at least a dozen positions. If you put the same amount of capital in each position, that’s $8,333 in each investment. And let’s pretend that each position has the same amount of risk. That means the average daily change in value of these stocks is probably around 1%. So on average, you’re risking $83 each day, on each position. A bad day sees your portfolio fall by $1,000.

But, of course, most portfolios don’t contain positions of equal risk.

If one of your investments is a conservative blue chip, like chocolate maker Hershey (HSY), its volatility might be only half of the average. To have the same amount of capital at risk in this position, you’d have to double the allocation, to $16,666.

Or on the flipside, you might have a biotech stock that’s twice as volatile as average. To have the same amount of capital at risk, you’d have to reduce your position size by 50%.

In our studies of actual newsletter subscribers’ portfolios, we’ve found that there’s no better or more powerful way to increase results than by simply using risk to define position sizes.

The world’s top quant hedge funds have found similar results in their studies.

Virtually every portfolio we’ve ever studied (out of hundreds) was improved by this technique – usually substantially. It even turned losing portfolios into winners. So if you’ve never had great results with your overall portfolio, this is the strategy I believe will help you the most. This will improve your results more than any other technique we’ve ever studied.

I know… it seems too simple to work.

It’s hard to believe that you can radically improve your investment results by simply changing the amount of capital you put into each stock. But I know it really does work. In fact, it works better than any other technique we’ve ever studied.

It works because it allows you to buy far more divergent types of investments (like biotechs and gold stocks) without overwhelming your portfolio with volatility. And it forces you to concentrate your investments in the best businesses, which typically have low volatility.

Let me show you how to do it…

We’ll use The Capital Portfolio from our Portfolio Solutions product as an example.

We’ve allocated this portfolio (which has 19 positions) using our own insights. And as a result, the overall portfolio has a volatility quotient (“VQ”) of 12. Don’t let the fancy math confuse you. All this means is that our portfolio’s average daily value changes a bit more than the S&P 500 does on most days. The S&P 500 has a VQ of 10. (The higher the VQ, the more volatile the investment.)

That’s to be expected. The S&P 500 has a lot more stocks than our portfolio, and this greater diversification produces less overall volatility.

But our Capital Portfolio has low overall volatility because it’s well diversified too. It only has one position – the PowerShares High Yield Equity Dividend Achievers Fund (PEY) – with a VQ of less than 11. The positions, individually, have an average VQ of over 20. But, combined into a portfolio, they’re much, much less volatile – that’s the primary benefit of diversification.

You can tell that we’ve done a pretty good job with our position sizing by how much lower the portfolio’s VQ is than the average VQ of the individual stocks in the portfolio. But what if, instead of deciding our allocations by our “gut,” we used math to measure the exact risk of each position and then allocated so that each position, no matter how stable or volatile, would give us the exactly same amount of risk?

In other words, we’d end up owning a little bit less of some of our more volatile stocks and little bit more of our safer ones.

If we did these calculations and allocated exactly by the “math,” we’d end up with a portfolio with a VQ of 10 – matching the S&P 500. That just shows you… No matter how good a job you think you’ve done of managing your risks, until you know the actual math, there’s a chance you could be doing better.

So how can you find out exactly how volatile your portfolio is?

How can you measure the VQ of every position you hold? How can you know exactly how many shares of each stock in your portfolio to buy so that you’ve got exactly the same amount of risk in every position? You could get a good math textbook and learn how to do it yourself using an Excel spreadsheet and a lot of data. Or… you could subscribe to a service like Bloomberg ($25,000 a year) and run a series of advanced portfolio analytics.

Or you could try a risk-free, 60-day trial to TradeStops – the only resource in the world that was built specifically to give individual investors access to the same advanced analytics that Wall Street’s top hedge funds use. Best of all, this suite of tools includes full tutorials and full-time customer service help to guide you through how to use everything.

It also allows you to instantly import your own portfolio data from a dozen different brokerage firms. It will even allow you to instantly import the portfolios from dozens of different newsletters. You can build your own portfolio and then allocate properly with just a click. (To learn more about signing up, click here.)

There’s nothing like it anywhere else.

That’s why I invested in the company. And why I recommend it, above anything else, for individual investors.

That’s not all…

TradeStops also has a host of proprietary indicators and screens to help you figure out which stocks are currently trending higher (or lower). If you sign up at the Lifetime level, you can even download entire portfolios from the world’s top investors, like Warren Buffett, David Einhorn, or George Soros. You can also pick several of your favorite newsletter publishers (yours truly?), immediately import all of their current holdings that are trending higher, and build a custom portfolio that’s perfectly allocated.

There’s no need to buy an exchange-traded fund, a mutual fund… or even read a newsletter. Your perfect portfolio – a portfolio that you’ve built from the world’s best investors and that’s perfectly allocated according to risk parity – is literally just a few clicks away.

Horse, meet water. TradeStops will turn you into a professional, successful investor, instantly. All of you’ve got to do is use it. And follow your stops. It really is that easy.

And again… you can try all of this out, at no risk. If this tool isn’t everything I’m promising, you can have 100% of your money back. How can we make an offer like that? Because for individual investors, this is the single most indispensable tool that’s ever been built. Once you use it, you’ll never go back.

Oh… One more thing…

While I know stocks are hitting new highs, I continue to see big warning signs that the fundamental driver of liquidity over the past seven years (consumer debt) is reversing.

If you study big bull markets, like in the ’20s and in the ’90s and 2000s, you’ll always find matching credit inflation – that is, a period where credit was increased far in excess of savings. Eventually rising defaults and losses results in the credit spigot being turned off. And then it’s just a matter of time until the bull market in stocks runs out of steam.

The main driver of liquidity over this past cycle was, incredibly, student loans.

That spigot is being slowly turned off as both losses soar and the political environment changes.

For example… last Thursday James Runcie resigned from the Department of Education. He ran the office of Federal Student Aid, which administers a large portion of the federal student loan program. Under Runcie, the portfolio of student loans administered by the Department of Education grew tenfold, to $1 trillion. (Yes, $1 trillion.)

The federal takeover of student lending was accompanied by a correspondingly large increase in… fraud. (Shocker.)

It’s hard to believe that the Obama administration turned a blind eye to the fact that billions and billions of dollars were being distributed via fraudulent Pell grants to poor families around the country. Poor families who just happened to be Democrats. Of course, I’m sure that had nothing to do it…

The Office of Management and Budget found that under Runcie’s watch, more than a billion dollars in fraudulent grants (aka, “improper payments”) were made in 2014 alone, about 4% of all the distributions made. Rather than admit this, the Obama Administration decided to retroactively change the audit methodology. (I’m not making this up…)

It reported an “improper payment” rate of only 1.5%. And a subsequent investigation by the government’s Inspector General found that the Department of Education lied when it published these loss statistics. (Shocker.)

Called to testify to Congress about these and other abuses of the public Treasury, Runcie resigned… and blamed the whole mess on the new, incoming head of the Department of Education, Betsy DeVos. (Again, I’m not making that up.)

And the best part? Look at the media’s reporting on Runcie’s resignation. The media all blames DeVos too. The Politico headline, for example: “Top Education Dept. Official Resigns After Clash with DeVos.”

Nothing about the billions and billions he distributed illegally to Obama’s backers. Nothing about lying about it for years. Nothing about the hundreds of billions in losses that the loans he approved will cost taxpayers. And nothing about facing Congress this week if he didn’t resign.

Nope… Just blame it all on Betsy DeVos. Obviously, it’s her fault.

One final note…

I’m excited to unveil my new podcast – the Stansberry Investor Hour – which I’m co-hosting with America Now‘s Buck Sexton. On the weekly show, Buck and I will dive into everything from business, investing, and politics to entertainment and social issues. As you know, I never shy away from telling you exactly what’s on my mind. This podcast will be no different. To sign up for free show updates, click here.

Regards,

Porter Stansberry

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