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What explains the recent performance of Risk Parity?

Since the Fund’s launch in January 29, 2018, all but one of the asset classes represented in the Risk Parity portfolio (reported in the quarterly Form NQ filing) are down. Emerging markets stocks and bonds, which contribute a significant portion of the portfolio, have been particularly impacted due to various political and financial reasons, including the imposition of trade barriers. By comparison, losses in US bonds since the beginning year have been modest.

 

Jan. 29 - Oct. 31, 2018

Tickers

Asset Class Return

US Stocks

SPY

-4.3%

Foreign Developed Stocks

EFA / VEA

-15.3% / -15.8%

Emerging Markets Stocks

VWO

-24.3%

Real Estate

VNQ

1.6%

US Bonds

AGG

-1.5%

Emerging Markets  Bonds

EMB

-6.7%

 

Portfolios constructed from these asset classes have similarly experienced declines, regardless of the asset allocation methodology used to construct them (e.g risk parity or mean-variance optimization). For example, the table below displays a performance decomposition for a  hypothetical buy-and-hold portfolio, whose initial allocation on July 31, 2018, was set equal to that of the Wealthfront Risk Parity Fund (reported in the quarterly Form NQ filing). This risk parity portfolio assigns higher weights to relatively less risky asset classes, such as bonds, and smaller weights to riskier asset classes, such as stocks, and then applies leverage to achieve the desired level of overall portfolio risk. The presence of leverage is reflected by the fact that the portfolio weights sum to an amount greater than 100%.

 

Aug. 1 - Oct. 31, 2018

Tickers

Asset Class Return (A)

Weight (B)

Contribution

 (A * B)

US Stocks

SPY

-3.4%

18.3%

-0.6%

Foreign Developed Stocks

EFA / VEA

-9.4%

20.5%

-1.9%

Emerging Markets Stocks

VWO

-12.7%

13.3%

-1.7%

Real Estate

VNQ

-3.1%

22.0%

-0.7%

US Bonds

AGG

-0.7%

169.5%

-1.2%

Emerging Markets Bonds

EMB

-2.8%

43.1%

-1.2%

Portfolio

 

 

286.7%

-7.3%

 

Over the period from August 1, 2018 to October 31, 2018, this hypothetical portfolio would have declined -7.3% (before accounting for the financing costs of the positions). The principal contributors to performance were Foreign Developed Stocks (-1.9%), Emerging Markets Stocks (-1.7%), Emerging Market Bonds (-1.2%), and US Bonds (-1.2%). Although Emerging Markets Stocks had the smallest allocation (13.3%), they experienced the sharpest decline over the last quarter (-12.7%). Foreign Developed Stocks accounted for a slightly larger share of the allocation (20.5%), and also experienced a sizeable decline (-9.4%). Finally, though US Bonds experienced the smallest decline of all the asset classes over the last quarter (-0.7%) they accounted for the vast majority of the allocation (169.5%).

US Bonds have historically acted as a strong diversifier relative to Emerging and Developed Market Stocks, as well as, Emerging Markets Bonds, as evidenced by their negative long-run return correlations. Recently, however, trade tensions with foreign economies (particularly China), coupled with the continued economic expansion in the US have broken this link. As these trade tensions are resolved, we expect these relationships to revert to their historical norms.

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The Wealthfront Risk Parity Fund (the “Fund”) is managed by Wealthfront Strategies LLC (formerly known as WFAS LLC), a registered investment adviser and an affiliate of Wealthfront Advisers LLC (“Wealthfront Advisers,” the successor investment adviser to Wealthfront Inc.)  Wealthfront Strategies LLC receives an annual management fee equal to 0.25% of the Fund’s average daily net assets. Northern Lights Distributors, LLC, a member of FINRA and SIPC, serves as the principal distributor for the Fund.  Both Wealthfront Advisers and Wealthfront Strategies LLC are not affiliated with Northern Lights Distributors, LLC. FINRA and SIPC, serves as the principal distributor for the Fund. Both Wealthfront Advisers and Wealthfront Strategies LLC are not affiliated with Northern Lights Distributors, LLC.

Before investing in the Wealthfront Risk Parity Fund, you should carefully consider the Fund's investment objectives, risks, fees and expenses. This and other information can be found in the Fund’s prospectus. Please read the Fund's prospectus or summary prospectus carefully before investing. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses.

Investments in the Wealthfront Risk Parity Fund (the “Fund”) involve risk including possible loss of principal. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. The Adviser's assessment regarding the risk and correlation of the various asset classes and the Fund's exposure to leverage through the use of derivatives may prove to be incorrect and may not produce the desired results.  Financial leverage will magnify, sometimes significantly, the Fund’s exposure to any increase or decrease in prices associated with a particular reference asset resulting in increased volatility in the value of the Fund’s portfolio.  While such financial leverage has the potential to produce greater gains, it also may result in greater losses, which in some cases may cause the Fund to liquidate other portfolio investments at a loss to comply with limits on leverage and asset segregation requirements imposed by regulations or to meet redemption requests. The net asset value of the Fund while employing leverage will be more volatile and sensitive to market movements. The Fund’s investments in total return swap agreements also involves the risk that the party with whom the Fund has entered into the total return swap agreements will default on its obligation to pay the Fund.  The Fund’s use of derivatives may cause the Fund to realize higher amounts of short-term capital gains than if the Fund had not used such instruments. Overall equity market risk, including volatility, may affect the value of individual instruments in which the Fund invests. In addition, the Adviser relies heavily on models and information and data supplied by third parties (“Models and Data”).  Models and Data are used to construct sets of transactions and investments and to provide risk management insights. The Fund may be exposed to additional risks when Models and Data prove to be incorrect or incomplete. The Adviser is also newly established and has not previously managed a mutual fund.  The Fund is a new fund and as such has limited performance history. The Fund is not suitable for all investors. The Fund should be utilized only by investors who (a) understand the risks associated with the use of derivatives, (b) are willing to assume a high degree of risk, and (c) intend to actively monitor and manage their investments in the Fund. Investors who do not meet these criteria should not buy the Fund. An investment in the fund is not a complete investment program.

9043-NLD-11/12/2018