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Cloning Ray Dalio’s All Weather portfolio

It's a great time to be an investor. As we look at the broader industry, we see downward pressure on fees, greater transparency in various products, greater access to new investment markets and technological advancements that give retail investors professional-level portfolios with one-click convenience.

And the benefits of investing in this day and age don’t have to stop there. With a little forward-thinking, we can mimic the most respected portfolios offered by some of the world’s most successful fund managers – without paying exorbitant management fees or meet hefty investment minimums.

For example, let’s take Ray Dalio and his All Weather portfolio. For anyone unaware, Dalio is one of the leaders in fund management, with over 1,000 staff and billions of dollars under management at his firm, Bridgewater Associates.

“With a little forward-thinking, we can mimic the most respected portfolios offered by some of the world’s most successful fund managers”

Pure Alpha is Bridgewater’s flagship strategy, engineered to be a multi-strategy, go-anywhere portfolio. Its goal is outperformance, and the complement to it is Bridgewater’s All Weather portfolio – intended to capture “beta”, or average market returns. Of course, “average market returns” often outperform actively managed efforts.

The theory that underpins the All Weather approach goes back over 60 years, to the days of Markowitz and Sharpe. It is essentially a buy-and-hold and rebalance portfolio – one that Dalio says he would choose was he to need a simple allocation for his children. All Weather focuses on risk parity. In other words, it focuses on a portfolio’s allocation of risk (usually defined by volatility) rather than its allocation of capital (for example, investing the same dollar amount over various asset classes).

Risk parity was a novel idea: it showed investors that they didn’t necessarily have to accept asset classes and their associated volatility levels at face value. For example, equities – which are an inherently leveraged asset – have debt, which increases volatility, so there’s no reason to incorporate them into a holistic portfolio at their notional value, without this debt in mind.

To adjust for it, an investor could allocate half of his capital to equities and the other half to cash, which would reduce the overall risk (volatility) of this equity allocation. We can make similar tweaks for bonds or any other asset class.

Bridgewater says that its All Weather portfolio “has been stress-tested through significant bull and bear markets in equities, two recessions, a real-estate bubble, two periods of Fed tightening and Fed easing, a global financial crisis and periods of calm in between”.

“The All Weather portfolio has been stress-tested through bull and bear markets in equities, two recessions, a real-estate bubble, two periods of Fed tightening and Fed easing, and a global financial crisis”

With that in mind, several years ago, we set out to see if we could mimic All Weather returns with our own simple allocation. We started with a global market portfolio of half stocks and half bonds. Of the stock component, half were allocated globally, the other half US-based. The allocation, which we termed Global Asset Allocation (GAA), is broken down as: 20% in S&P500; 15% EAFE; 5% EEM; 22% corporate bonds; 16% 10-year foreign sovereign bonds; 15% 30-year US bonds; 2% Treasury inflation-protected securities; and 5% real estate investment trusts.

 

So, what was the outcome?

 

We back-tested GAA from 1996 through 2014, and found that its returns were neck-and-neck with All Weather. While the Bridgewater fund did perform a little better than GAA, it did so with more volatility. And as we know, the risk parity strategy actually uses some leverage. To account for this, we ran a separate back-test with GAA that incorporated leverage.

We walked the results forward since 2014. We found that, from 1996 through to 2018, the All Weather portfolio returned about 7.5% per year. GAA posted 7% returns, and GAA leveraged came in at 8.2%. Volatility of All Weather was around 11%, GAA was lower, around 8%, and GAA leveraged mimicked All Weather at 11%.

8.2%

GAA leveraged's return

I tip my hat to Dalio and his company for doing this in the 1990s in real time with real money. But it’s good to see that you can replicate virtually all of the All Weather strategy through a simple allocation that rebalances once a year. And keep in mind, while Dalio believes investors should pay very little for beta, we’ve gone on record as saying investors should pay nothing for it – and we’ve just shown you how. It truly is a great time to be an investor.

 

By Meb Faber Co-founder and chief investment officer of Cambria Investment Management and author of books Invest With The House: Hacking The Top Hedge Funds and Global Asset Allocation: A Survey of the World’s Top Investment Strategies. He also created and hosts ‘The Meb Faber Show’ podcast.

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