We use the 10 year TIPS real yield as a proxy for the long-term risk-free real rate.

December 2020 Year-End Investor Report for Elm Partners Portfolio LLC

Dynamic Index Investing

Helping you and your families comfortably and efficiently maintain a significant equity allocation over the long term

2020

The economic and market volatility induced by the global pandemic provided a demanding test for the Fund’s dynamic

asset allocation model, which it passed commendably. US stock market volatility in March was the highest on record,

providing as much volatility in one month as we experienced over the four years to the start of 2020. Reducing exposure

in light of such extreme volatility made sense and was the course of action of many seasoned market professionals. By

design, our momentum overlay did its job of smoothing portfolio risk by reducing the allocation to equities starting in late

February. By late April, US and Emerging Market equities had positive momentum again, and the Fund was significantly

overweight equities for the rest of year, due to the combination of positive momentum and attractive valuations.

The Fund’s return for 2020 came in at 11.97%, about 2% higher than our static Baseline portfolio. Valuation and

Momentum complemented each other throughout the year, performing well at different times, as we generally expect

them to. Below we show the cumulative benefit of the Valuation and Momentum adjustments across all of the Fund’s

asset buckets:

One of the most common questions we were asked this year is whether our framework takes account of the current, very

low level of real rates. And indeed it does, through Elm’s Valuation metric. We forecast long-term real equity returns using

the Cyclically Adjusted Earnings Yield (1 / CAPE), and we view the attractiveness of equities through their excess return

over the long-term risk-free real rate.

_{So all other things equal, lower real rates will cause us to see equities as more}

attractive. As we wrote in our March note Taking Stock, we saw global equity risk premia as very attractive, in no small

part due to the historically low levels of real yields, and this increased our comfort in holding significant equity positions

throughout the tumult of February and March. We’re not alone in this perspective: the past few months saw Robert Shiller,

the father of the CAPE metric, introduce “Excess CAPE Yield” as a superior metric to CAPE on its own.

Looking Ahead

One obvious concern is that, if risk assets are being supported by extremely low real rates, what will happen if or when

real rates head higher? We’ve given this a good deal of thought, and if it does happen, we believe our current Valuation +

Momentum framework will handle it appropriately. Higher real rates will make equities look less attractive through our

Valuation metric, reducing our positions, and falling equity prices will cause us to further reduce positions through the

Momentum metric. A process of upward real-rate adjustment and feeback into equities is also like to play out over a

relatively long timeframe appropriate to the timescale of the Valuation and Momentum metrics we use.

1 _{Elm Partners Portfolio LLC is open only to qualified purchasers. This monthly note and related materials are not intended to solicit future}

investment, but rather to elicit discussion and exploration of better ways to invest. Please see www.elmfunds.com for supporting research. This is a preliminary “flash” return estimate, net of fees; the official monthly return is as reported by the Fund’s administrator, Circle Partners. Returns represent performance since the inception of the Fund on January 1st_{, 2012. Past performance is not necessarily}

indicative of future results.

We also note that, while a significant real-rate adjustment certainly can happen, it’s not the market’s expectation:

bond-markets and equities seem in agreement on expecting negative real rates for the foreseeable future. The drop in real rates

over the past 30 years has been driven by powerful forces. These include the response of central banks to the

disinflationary inpulses of globalization, and technical factors such as the demand for long-term bonds from defined

benefit pension funds.

Despite the ample expected excess return currently offered by global equities, we are concerned by warning signs of

intemperate enthusiasm such as extreme valuations of dozens of high-growth US stocks, the rapid proliferation of SPACs,

the explosive growth in stock option trading by individual investors, and the exponential upward trajectory of digital

currencies. Our worries are lessened by noting that these signals are largely limited to US risk assets, which account for

just a bit over a third of the Fund’s investments.

The current Cyclically-adjusted Earnings Yield for global equities is about 4.7%, and the excess over the 10y TIPS real yield

is about 5.7%. This level of risk premium is more attractive than global equities have been for about 75% of the time since

1970.

Annual Review of Investment Approach

We perform an annual review of our investment framework, and we are not making any changes. Our dynamic asset

allocation methodology acted as expected even in this quite remarkable year, and we continue to believe our systematic,

rules-based approach is the best way to help our investors sensibly and comfortably maintain exposure to equity markets

over the long run.

Is There Such a Thing As Too Much Diversification?

Your Fund effectively owns a slice of over 8,000 different publicly traded companies across the globe. Not long ago, most

investors owned just two or three individual stocks in their brokerage accounts. In Burton Malkiel’s book, A Random Walk

Down Wall Street, he proposed that owning 30 well-chosen stocks would give an investor almost all the benefits of

diversification she could want or need. In 2020, we just witnessed one portfolio of 250 large cap stocks underperform

another portfolio of 250 large cap stocks by about 40% in just one year! Those two index funds are Vanguard’s Value ETF

(VTV) and Growth ETF (VUG) holding about $240 billion of assets in total. This experience reinforces our belief that sound

investment portfolios should be built on a foundation of broad, market-capitalization weighted index funds and ETFs.

We will continue to seek the highest level of diversification possible, subject to cost, liquidity and the robustness of the

underlying indexes. The delayed inclusion of Tesla in the S&P500 last month strengthened our preference for broader

indexes, such as the total-market indices underlying the ETFs VTI and ITOT, which are quicker and less subjective in how

they include new publicly traded companies in their indexes.

And finally…

We are modifying how we report returns of the Fund’s model portfolio. We have been using total return indexes mostly

published by MSCI, but their use has introduced spurious tracking error into the monthly return series arising from

asynchronous closing prices of the MSCI indexes versus the ETFs and index funds in which we invest. Also, in several cases,

low-cost, liquid vehicles don’t exist based on the particular MSCI indexes we have been using. For 2020 and going forward,

we will construct model returns using the total returns of liquid and low-cost investible instruments, which should give

you a more accurate picture each month of how your Fund is performing versus its model target.

In case you missed it, you might enjoy this NY Times article: A Columnist Makes Sense of Wall Street Like None Other (See

Footnote), celebrating one of our favorite financial journalists, Matt Levine.

As always, please don’t think twice about getting in touch with us for any questions or suggestions you may have, or just

to say hello.

With best wishes for a healthy, happy and prosperous new year,

Victor and James