All Weather Portfolio

[Stefan]

Ray Dalio, of the Bridgewater Associates hedge fund ($175 billions), is running a strategy called the All Weather Portfolio.

The interview I linked to below gets into the details.
But, what was striking for us here, and the reason I linked to it, is the similarity of its fundamental basis with Harry Browne's rationale for PP. The universal brilliance of HB's portfolio design.
RD chose a more extensive set of asset classes. But, here is what I found a strong validation of HBPP basis:

"Strategic diversification through the economic cycle is achieved through a balance between asset classes whose fundamentals are best suited to different parts of that cycle, defined as rising growth (good for equities, credit, commodities and emerging market debt); falling growth (good for nominal and inflation-linked bonds); rising inflation (inflation-linked bonds, commodities, EM debt); and falling inflation (nominal bonds and equities)."

Here is the article http://www.ipe.com/news/editors-choice- ... _37195.php

I am interested to know your opinion on how this could add/improve on PP or whatever comments you may have.

[craigr]

Inflation linked bonds and emerging market debt would be completely worthless for inflation in all likelihood. Why would an investment advisor think a country like Brazil or Argentina in the EM bond index would know anything about protecting people from inflation based on their history? Egads.

[Stefan]

Inflation linked bonds and emerging market debt would be completely worthless for inflation in all likelihood. Why would an investment advisor think a country like Brazil or Argentina in the EM bond index would know anything about protecting people from inflation based on their history? Egads.

Here are my thoughts:

Inflation refers to US inflation. I.e US government printing dollars and basically debasing the world currency reserve. This increases the price of commodities, which are traded in US dollars. Brazil & Russia are the major natural resource commodity producing countries.
Others, like China and India are in a major growth cycle, independent of the US & European debt ridden slowing economies. China for instance, is, actually, overflowing with US dollars and has a problem of how to invest them, outside the $1 Trillion US treasury they already have.

Now, the major emerging markets are these 4 BRIC countries - with Korea, Taiwan and other exporters w/o debt following in tow. Bonds of big commodity producers or of debt free industrial exporters a) have little credit risk, as they are flush with $$$$ and b) their currency goes up when the dollar goes down, because the local currency is backed by the commodities/assets they own. And because their bonds are isued in their local currency, their yield in dollars goes up when the US dollar goes down aginst this currency => that is why they protect you when the dollar is debased.

I don't understand the comment about Treasury TIPs. They do protect you in inflation, as their principal increases with the inflation rate, don't they?

[MediumTex]

Ray Dalio is a smart guy, but I find him to be a little intellectually arrogant.  People like that make me uneasy. 

He clearly is in the HB PP neighborhood with his conceptual framework, but as craig notes his asset mix doesn't really make much sense other than the way I assume it backtests.

If you aren't familiar with Ray Dalio, he is kind of an interesting guy.  Below is a good profile with a link on the second page of the article to his "manifesto", which is a 110 page book of his ideas and beliefs, which are actually kind of Harry Browne-ish in some ways.

http://nymag.com/news/business/wallstre ... io-2011-4/

[MediumTex]

I don't understand the comment about Treasury TIPs. They do protect you in inflation, as their principal increases with the inflation rate, don't they?

I think that the point is more conceptual.  How can the entity that creates the inflation be trusted to compensate you for the inflation they created?

In other words, if inflation is in some ways a failure of the government to maintain the value of its currency, what would make one think that the government will be any more successful in its effort to provide a financial instrument that will always compensate bondholders for the government's failure to maintain the value of its currency?

In addition to the problem above, sooner or later every government defaults on its debt.  It's just what governments do--they make promises that they would like to keep but for whatever reason can't.  In order to have a truly safe portfolio, you need to be prepared for this scenario, however unlikely it may seem at a given point in time.

With all that said, TIPS can probably serve some role in different portfolio configurations, so long as it is not critical that TIPS provide real inflation protection in all cases.  IMHO, no paper instrument can do that.

If you like your bond analysis in the form of a riff on classic literature, consider "Tipsymandias":

I met a traveller from an antique land
Who said: I have seen a curious bond
This bond made a promise rare among men and kings,
Backed by full faith and credit
The bond made it clear to all who bought, purchasing power is safe
Those who look upon the bond are counseled to take comfort
That which is will always be, a promise made is a promise kept,
And other assorted platitudes and assurances.
On the back of the bond these words appear:
"Inflation is tamed for all time!
Gold is barbarous and obsolete, inflation look upon this mighty bond and despair!"
No record of the issuer of the bond remains. Round the decay
Of this curious promise, boundless and bare
The lone and level sands of change stretch far away.

[stone]

I wonder whether for them gold isn't liquid enough? We have no problem rebalancing in and out of gold but since they have $95bn to manage; perhaps selling $10bn of gold at a rebalance would create problems? I agree with Stephan that emerging market government debt (so long as it is in the emerging market currency and that currency is properly free floating) and very long dated TIPs are "similar" to gold in some respects. I don't think it would be totally stupid to diversify into those.

[craigr]

Inflation linked bonds and emerging market debt would be completely worthless for inflation in all likelihood. Why would an investment advisor think a country like Brazil or Argentina in the EM bond index would know anything about protecting people from inflation based on their history? Egads.

Here are my thoughts:

Inflation refers to US inflation. I.e US government printing dollars and basically debasing the world currency reserve. This increases the price of commodities, which are traded in US dollars. Brazil & Russia are the major natural resource commodity producing countries.
Others, like China and India are in a major growth cycle, independent of the US & European debt ridden slowing economies. China for instance, is, actually, overflowing with US dollars and has a problem of how to invest them, outside the $1 Trillion US treasury they already have.

Now, the major emerging markets are these 4 BRIC countries - with Korea, Taiwan and other exporters w/o debt following in tow. Bonds of big commodity producers or of debt free industrial exporters a) have little credit risk, as they are flush with $$$$ and b) their currency goes up when the dollar goes down, because the local currency is backed by the commodities/assets they own. And because their bonds are isued in their local currency, their yield in dollars goes up when the US dollar goes down aginst this currency => that is why they protect you when the dollar is debased.

Your points are all understood. But my experience is it just doesn't work out that way. Currently places like Brazil are slapping on taxes for people looking to buy their bonds because the Real is under a lot of pressure due to US monetary policy. Places like Switzerland threatened to peg their currency to the Euro because it had been run up so much due to similar problems. Other countries are also in a race to the bottom to devalue to insure their own exports aren't hurt. So the idea that inflation protection is achieved by owning a basket of currencies is on pretty shaky ground for me. The only asset, the only one, that is not affected by these kinds of policies is gold. That's because gold does not have to answer to any central authority on what its value should be. The entire world market determines it and no single entity can control it.

Lastly I am biased against emerging markets because I've been to over 20 countries in my life, including some of these supposed up and coming powerhouses the media is always talking about. My opinion is that I would put as little money as possible into emerging economies. They may be fine places to visit. However many of them are fundamentally flawed because the the business and government culture is very corrupt. They also tend to adopt destructive economic polices (e.g. various leftist dogma) that has shown to always fail eventually. Finally, when problems happen in these economies, the politicians often find it easier to skin the foreign investors first because they have virtually no power to do anything about it.

So for me, emerging market debt is probably one of the worst investments you can own. It has a very bad risk/return outlook in my mind.

I don't understand the comment about Treasury TIPs. They do protect you in inflation, as their principal increases with the inflation rate, don't they?

Tex's answer has my opinion in it. At best, they will tread water under high inflation in my opinion. At worst they are going to be gamed to put investors at a disadvantage. You simply cannot ignore the conflict of interest that exists between the group issuing the inflation protection being the same group that is causing it.

[Stefan]

I understand your point. I was also trying to understand Ray Dalio's allocation rationale -as he was not as generous with his explanations as HB.
But, because Ray Dalio has super powerful research resources to draw on in designing this asset allocation strategy and has a great record with this portfolio, it is worth understanding or at least rationalizing his choice of asset classes. He runs half of Bridgewater money with this program. And the program is apparently in great demand with conservative wealthy individuals and institutions.

I believe his opening of the kimono, so to speak, on the All Weather Portfolio choice of asset classes is part of his marketing this program, which he ran from the early 90's, first for his family trust and now later, due to increasing demand, for his clients.

So, in this context, I was curious what his choice of asset classes is and how could one rationalize it. My explanation above was an attempt at intellectual speculation about RD's choice of emerging market debt for his portfolio. But, also based on the point you made, I think that RD is opportunistic here, and chooses, for instance, emerging market debt because this asset class happens to perform well and is less correlated with the other asset classes at this time. So, performance and diversification is what he is after. And "at this time" is the operational word here.
But RD (me speculating again) will probably drop it from the portfolio in the future if economic & financial conditions make it unsuitable for the portfolio criteria (either it becomes non-performant or it shows increased correlation).

Whereas HB provided an universally enduring set of asset classes in the PP design - an invariant - independent of rising and falling opportunities in the world.

I was curious though and backtested All Weather against PP, from about 1992 to today. There are a few emerging market debt and TIP mut funds which can be used to test RD's portfolio performance for this time interval. Unsurprinsingly, both HBPP and RD's All Weather delivered very close performance and with PP showing a bit more volatility and maxDD.

[craigr]

Well the problem with Emerging Markets of any kind (whether stocks or bonds) is they have a relatively high expense load involved. Market transaction fees are often much higher than a developed nation and there are problems in liquidity as well and this widens bid/ask spreads. So even if someone is comparing an EM index back that far, chances are they are not deducting the actual real-world expenses it took to get exposure to that asset class. I don't know if this gentleman did that or not. But if he is simply quoting an EM index data sheet and not deducting expenses (which could easily be in excess of 1% a year) then the results are not going to be realistic.

This also would include the management fees Bridgewater charges as well if they are not deducting them from their returns data.

The benefit of the Permanent Portfolio is that it isn't using anything exotic. The assets are all very cheap to own and everything you save on expenses is money you get to add to the bottom line.

Consider:

Vanguard Total Stock Index fund: Expense Ratio over this time period was probably around 0.20% and falling.

Gold has purchasing premiums and it would be fair to say that expense ratios in funds are around 0.50-1% over this time. However if you buy and hold it in a safe deposit box then the annual expense drops to basically zero.

Treasury bonds can be bought and held directly for no annual expense.

T-Bill cash funds are very cheap on average at iShares, Vanguard and Fidelity. Under 0.20%. Or you can build your own Treasury Bill ladder and cut out even more expenses.

So for an average annual expense of well under 0.20% you can run the Permanent Portfolio. All the assets will have very little additional overhead. This means the numbers you see quoted in terms of performance are pretty darn close to what an investor will actually receive after expenses are taken out. Maybe lagging by 0.20% once you roll them in. Today the expenses are much less because fees on many index funds are now even lower. I bet you can run a typical Permanent Portfolio now for about 0.10% a year.

[craigr]

BTW. I'm not trying to be critical about this portfolio. This is the area for Variable Portfolio speculation so if it seems like a good gamble for speculative money, then go for it.

Re: Iceland

The more important detail is that a Permanent Portfolio investor in that country likely would have been rebalancing out of very expensive bank stocks and into assets like gold. When the market collapsed, a lot of the risk was eliminated because the profits would likely have been largely diversified away.

Plus admittedly, if I was in a small economy like Iceland I would advise diversifying my stocks outside to the Eurozone in general because of the close connection of those economies. Sometimes home country bias in very small focused economies needs to be diversified. Iceland in this respect is much different than the US, European, Australian, Canadian or Japanese investor for instance.

[Gumby]

CSS Analytics has an analysis of the All-Weather Portfolio (mentioning that it's basically a copy of the Permanent Portfolio)...

https://cssanalytics.wordpress.com/2012 ... erivation/

...and they also have an analysis of the Permanent Portfolio as well.

http://cssanalytics.wordpress.com/2012/ ... rformance/

(Nice graphics)

Via PragCap. Nice to see Cullen mentioning the Permanent Portfolio too.

[MachineGhost]

Looks like the All Weather bungles it with Inflation-Linked Bonds.  It is riskier than the PP as a result.

The big weakness is stagflation (growth falling+inflation rising).

[melveyr]

The All Weather has the same underlying principles as the PP.

It uses risk parity and leverage to make sure the portfolio has equal exposure to rising/falling growth as well as rising/falling inflation. That is exactly what the PP does (although the PP gets all of its leverage implicitly, through duration in the bond markets). Ray Dalio gets all of the credit, but I wonder if he just read Harry Browne and then ran with it.

In my mind the real benefit of the all weather portfolio is that it has international diversification that we cannot achieve. I do not know how I can buy a 30 year JGB or a UK Gilt. If I could have an international PP perhaps with some forex hedging I would do so in a heartbeat. Additionally, Ray Dalio can cast a wider net when looking at asset classes because even if the expected return is low for that asset class he can lever it up. For example, I wouldn't buy junk bonds to fill out my prosperity section of the PP because I would want them to be more volatile. Mr. Dalio never has to worry about this because he can cheaply lever things up to get the volatility that he wants.

I think studying Bridgewater's strategy is very illuminating. It will help you see portfolio management in a new way, and it has changed the way I view the PP.

[melveyr]

There's something that's been bothering me.  The EM Debt Spread.  It shows up in the Penn State's Public School Pension report on the fund.  That's very different than just buying emerging market bonds.  Same with the corporate credit spreads.

It's not just a matter of leverage or ability to buy foreign bonds.  This is a very different beast that requires sophisticated over the counter derivatives to pull off efficiently.

Just saying, be careful with the oversimplification of some blogs.

Kind off topic but it jumped out at me.

0.37% expense ratio for the All Weather if I am reading that document correctly. Pretty cheap.

[Ad Orientem]

I am not a fan of international bonds outside of the VP. There are just way too many variables you can't predict or cover. If you want to add a bit more currency diversification beyond gold I'd consider maybe putting a little bit of your stock allocation in an international stock market index fund.