Read of the Day: Analyzing Ray Dalio’s All Weather Portfolio

Here’s a good post on an attempt to analyze and rebuild Ray Dalio’s All Weather portfolio strategy.  It’s a similar idea to the Permanent Portfolio, an idea I think makes a lot of sense in terms of portfolio construction for the passive investor.  Via CSS Analytics:

The All-Weather Portfolio was introduced by Ray Dalio- the founder of Bridgewater -which is arguably the largest and most successful hedge fund in the world. His landmark concept was to create a portfolio that would have roughly equal risk in four different economic regimes: 1) rising growth 2) falling growth 3) rising inflation  and 4) falling inflation. His other major concept was to leverage up each asset to have the same risk so that returns could come from multiple different sources, and not rely on an equity-centric environment. Of course, it is more accurate to think of each of these as sub-regimes since the change in growth is often accompanied by some change in inflation. Thus, in this adaptation the four major regimes are exactly the same as in the Permanent Portfolio , the only difference is the type of assets included in each regime. By structuring a portfolio to be balanced across economic regimes, the performance and volatility is more stable over time. The inspiration for this post, and a good explanation of the All-Weather Portfolio can be found here.

Read more here.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Treasury Bonds
    Corporate Bonds
    Emerging Mkt Bonds
    Inflation-linked Bonds

    There are WAY too many bonds in that so-called All Weather Portfolio for my taste.

    • Geoff, you need to get acknowledged with the concept of risk parity. There bond investments are levered up (via futures) to have the same volatility as equities. The Sharpe Ratio is the same or higher in case of bonds. And correlation to equities is low as we know. So you get a very powerful portfolio.

    • Treasury Bonds – TLH – 12 month total return = 9.9%
      Corporate Bonds – LQD – 12 month total return = 10.7%
      Emerging Mkt Bonds – EMB – 12 Mo. tot. return = 13.1%
      Inflation-linked Bonds – TIP – 12 mo. tot. return = 7.2%

      @Geoff, you said: “There are WAY too many bonds .. for my taste”.
      What is it that you don’t like about strong positive returns with relatively low volatility? Of course, no guarantee going forward, but the majority of investors and fund managers hated bonds during the last 3 years, and still hate them today. For me, that is a good reason to continue holding them.

      • I’m not arguing about the relative merits of bonds. I like bonds. My point is about diversification, which is what an All Weather Portfolio is supposed to be all about. Holding a 67% weight in bonds does not sound diversified to me.

        • Geoff, again check what Risk Parity means. In a 50%equity, 50 bonds portfolio, the risk is 85% equity, 15% bonds.

          • +1 – Very good point, InvestorX ! It is the risks that we are balancing, not the asset classes.

  2. Harry Browne, who devised the Permanent Portfolio in the 1980s, intended it to be for wealth preservation of the “money you can’t afford to lose”. He also recommended that for those who want more risk, they set up a “Variable Portfolio” (for speculative investing) in conjunction with their Permanent Portfolio — with money they can afford to lose. The Variable Portfolio can be anything. This allows everyone to custom tailor their own risk while simultaneously preserving their wealth.

  3. Believe for “average” investor these theories are sound, but much too complex. My hunch is stocks, bonds and perceived inflation protection issues are only required items. Also guess that these basic items are correlated in today’s globalized universe.

    • Hard to believe that the Permanent Portfolio, which consists of only four investments, is too “complex” for average investors. Though, I agree that the All Weather Portfolio, has more moving parts.

      Not sure why the All Weather Portfolio would be more desirable to an average investor. The Permanent Portfolio is far more stable and has provided a nice steady return.

  4. Cullen, how does something like this compare with what Orcam designs for people? I don’t fully understand the philosophy there based on the website.

    • I don’t believe (entirely) in holy grail one-stop shop portfolios like this. My approach has always been multi-strategy. At Orcam I offer a few different perspectives which round out the overall view. The portfolio reviews are generally for the more passive investor. I essentially offer a core piece for the investor who is not looking for active management or doesn’t want to outsource their portfolio to an advisor. It’s control without the hassle. I set it up, you maintain it.

      The research is my active component and is used mostly by portfolio managers and active investors. This is essentially a satellite component and where the real risk management occurs. Combining the two is my overall approach and what I perceive as an ideal overlapping of passive and active investing.

  5. I like Ray Dalio a lot. I think that risk parity makes a ton of sense, I just wish he gave Harry Browne credit for planting the seeds. I watched an interview where he explicitly said that a mixture of stocks, long duration bonds, gold, and cash was the best portfolio for a retail investor. He didn’t even mention Harry Browne at all.

    If anyone is interested in risk parity, they should take a hard look at the Permanent Portfolio. It is the easiest risk parity portfolio to implement for retail investors because it doesn’t rely on lines of credit, margin, or futures for leverage. Rather, it uses the implicit leverage embedded in long duration bonds, which anyone can get.

  6. The catch 22 with Dalio’s AWP is that he uses “risk parity”, a fancy word for leverage, so that he can “elevate” bond returns to that of equities in assembling the portfolio and that way reduce volatility, achieving a lower higher Sharpe ratio. The problem of course, is that little guys cannot borrow at the risk free rate (3 mo. T bill) but MUCH higher which makes risk parity for the little guy useless. Dalio, of course, can borrow at an almost zero rate by shorting 3 mo. T bills.

    • There are ways around this. If you buy a 30 year zero coupon bond and perpetually roll it over, you have the financial equivalent of leveraging a 15 year zero coupon bond at very close to the risk free rate. There is leverage embedded in the market that retail investors can grab, especially in the bond market.

    • He uses futures. Now the little guy cannot buy futures, but he can buy a fund.

  7. It was mentioned on the Seeking Alpha comments but I didn’t notice it here. That sample portfolio that the SA contributor calls the “Bridgewater All Weather” portfolio is _value_ weighted. The actual Bridgewater portfolio is labeled as _risk_ weighted.

    I think that’s a potentially significant differentiator.