A BALANCED PORTFOLIO ACHIEVES THE SAME RETURNS AS EQUITIES WITH 1/3 THE RISK...
Cumulative Total Returns (ln)
Global Equities Unhedged All Weather Asset Mix at Same Return
All Weather Asset
Mix at Same Return
Sharpe Ratio 0.21 0.72
...AND WITH LESS FREQUENT, SMALLER & SHORTER LOSING PERIODS
Global Equities Unhedged All Weather Asset Mix at Same Return
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Simulated return stream for the All Weather asset mix consists of Bridgewater’s simulation of the returns that would have been generated by applying the described All Weather asset allocation to historical market
returns. The returns used are actual market returns where available and Bridgewater Associates’ estimates otherwise. Markets may or may not be currently traded in actual All Weather portfolios and are subject
to change without notice. Neither of these return streams consider the impact of investment advisory fees. Bridgewater started managing All Weather portfolios for managed accounts in 1996. Past results are not
necessarily indicative of future results. WHERE SHOWN, HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHEREN T LIMITATIONS. UNLIKE AN AC TUAL PERFORMANCE RECORD, SIMULATED
RESULTS DO NOT REPRESEN T AC TUAL TRADING OR THE COSTS OF MANAGING THE PORTFOLIO. ALSO, SINCE THE TRADES HAVE NOT AC TUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER OR OVER
COMPENSATED FOR THE IMPAC T, IF AN Y, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJEC T TO THE FAC T THAT THEY ARE DESIGNED
WI TH THE BENEFI T OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT AN Y ACCOUN T WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.
Balancing a portfolio between stocks and bonds is better than not balancing a portfolio. But stocks and bonds are both
vulnerable to rising inflation. Therefore, in order to have a fully balanced portfolio you also need to include assets that do well
when inflation rises, like commodities and inflation-linked bonds.
A balanced portfolio need not be a low returning portfolio. This is because a portfolio’s return will equal the average of the
returns of its component assets. And the return of each asset can be adjusted to any reasonable level by borrowing or lending
at the risk free rate. For this reason, a balanced portfolio can match the expected return of a portfolio that is 100% invested in
equities, but can do so at a much lower level of risk. The following chart shows the cumulative return of a fully balanced portfolio
and the cumulative return of a portfolio that is 100% invested in global equities. The balanced portfolio achieved the same return
with around one-third of the risk. The same returns were achieved with much smaller losing periods, and these losing periods
passed relatively quickly rather than lasting for many years.
Since 1996, we have applied this Risk Parity/All Weather approach 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. Through these varied environments the All Weather asset allocation mix has achieved a Sharpe Ratio in-line with the
0.6 Sharpe Ratio expectation that we established at the outset of the strategy and that was shown in our simulated back tests of
the strategy back through the Great Depression and across a variety of other countries. At the normal 10% targeted risk it has
outperformed stocks, bonds and the conventional asset allocation portfolio, with much less risk.
We think it is great that Risk Parity is catching on because we really do believe that it is the right way to do asset allocation.
However, it is not safe to blindly assume that all Risk Parity approaches are the same or will perform reliably through all
environments. We have seen some Risk Parity approaches that we think are overly engineered. Some are based on estimated
future volatilities and correlations using recent data. Since these things change in unexpected ways, we judge this to be a
problem. It is more reliable to estimate the risks and correlations of assets with a hand-held calculator and a basic understanding
of asset pricing structure than by trailing quantitative measures. Bad, though less worrisome, other strategies include alpha bets
without tailoring the amounts of alpha and beta for the quality of each return stream, which can also be problematic. To be clear,
we do not believe that our All Weather approach is the only good approach to Risk Parity. But we believe it is the best approach
and its long-term track record speaks to its quality.
Most institutional portfolios are badly out of balance. The returns of most institutional portfolios are 90+% driven by the return
of equities, exposing them to a single adverse event, a declining equity market. Given the current choices available, not balancing
the portfolio is not only unnecessary, it is imprudent.
Bob Prince is Co-Chief Investment Officer of Bridgewater Associates, based in Westport, CT.
Bridge water Associates, LP advises certain private investment funds and institutional investors, and is not available to provide investment advisory or similar services to any other clients. This article does not contain the
information that an investor should consider or evaluate to make a potential investment. Offering materials relating to investments in entities managed by Bridgewater are not available to the general public.
The research in this presentation is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. It does not constitute a
personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Investors should consider whether any advice or recommendation in this research
is suitable for their particular circumstances and, where appropriate, seek professional advice, including tax advice. Investment decisions should not be based solely on simulated, hypothetical or illustrative information.
The price and value of the investments referred to in this research and the income therefrom may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original
capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Fluctuations in exchange rates could have adverse
effects on the value or price of, or income derived from, certain investments.
The All Weather asset mix performance is simulated based on All Weather asset mix weights applied historically to market returns. The All Weather asset mix weights are determined based on proprietary calculations
and include the use of historical returns and data available at the time the weights were constructed and may vary over time. The historical market returns are based on a combination of index returns and representative
market returns and do not reflect reinvestments of dividends, the deduction of fees, commissions or any other expenses that an investor would pay as it is not possible to invest directly in an index. No claim is being made
of the All Weather asset mix’s ability to perform in absolute terms or relative to any market return in the future, during market events not represented or during market events occurring in the future. Market conditions
and events vary considerably, are unpredictable and can have unforeseen impacts resulting in materially adverse performance results.