Ray Dalio is the founder of money manager Bridgewater Associates, the largest hedge fund advisor on the planet. One of Bridgewater’s claims to fame is the “all-weather portfolio” that is designed to perform reasonably well in any market environment. The big idea is that there are four possible fundamental economic scenarios based on inflation and real growth turning out to be above or below consensus forecasts. That is, the four possible economic scenarios are: the rate of inflation above consensus and real growth above consensus; second, inflation above consensus and real growth below; third, inflation below consensus and real growth above; and finally, inflation below consensus and real growth also below consensus. In theory, it is possible that the economic scenario should turn exactly like consensus, but that case has low probability and is ignored.
The all-weather portfolio is an asset allocation across major asset classes such that something you own will do well in each of the four economic scenarios. For example, stocks tend to do well when growth is stronger than expected, and long-term bonds tend to do well when inflation is lower than expected, and really well when both inflation is lower and real growth is lower than market expectations. Inflation-adjusted bonds (TIPS, for Treasury Inflation Protected Securities) will do well when growth is low and inflation is high. Thus, a portfolio evenly divided between stocks, long-term bonds and TIPS would be a simple all-weather portfolio.
Naturally, Bridgewater would not be managing $160 billion of assets if this simple idea was the only one they had. They believe that they can add substantial additional returns to their portfolios beyond base asset class returns by various strategies within broad asset classes. These strategies include security selection, timing and the use of leverage.
What I find interesting is that the retail investor (mom and pop) can easily implement an all-weather strategy. Dalio lays out a specific recommendation in his interview with Tony Robbins in Robbins’ book “Winning the Money Game.” Here is Ray’s recommended portfolio:
Long-term Treasury Bonds 25%
Inflation-Indexed Treasury Bonds 25%
Real Estate 10%
Corporate Bonds 10%
If you have no clue about the likelihood of the four scenarios, the best thing to do is to follow something close to the recommendation above. But if you do have access to a quality forecast, or your own prognostication gene, then you can add value by over-weighting allocations to the scenario you perceive to be most likely. Of course, that strategy will create underperformance if your predicted scenario does not unfold.
CLU is blessed with having an economic forecasting group on campus (the Center of Economic Research and Forecasting, or CERF) that has earned an enviable reputation for accuracy in recent years. One way to utilize the forecast group is as follows. Start with the all-weather portfolio. If the CERF forecast for economic growth is greater (lesser) than the consensus forecast as reported every quarter in the Wall Street Journal, then expand/contract the equity allocation and contract/expand the Long Treasury allocation. And if the CERF forecast for inflation is greater/lesser than the WSJ consensus forecast, then expand/contract the allocation to Real Estate or Inflation-Indexed bonds. The amount by which you should expand or contract allocations based on the forecast is dependent on how confident you are in your forecast. I would suggest keeping these amounts fairly small, like 5% or so of the overall portfolio. After all, the future is unknowable.
Also, within each asset class there are numerous ways to invest. For example, an investor can gain overall stock market exposure through the use of low-cost passively managed index funds, higher-cost actively managed mutual funds, or individual stock selection. Bridgewater naturally assumes (with a good track record to support the assumption) that they add value within asset classes by manager or stock selection. For most of the rest of us, relying on low-cost passively managed index funds (either in mutual fund form or exchange-traded fund form) is probably a better way to go.