Top 10 Risk Parity Resources: #2... Bridgewater (2012)

"All Weather Story"

Narrative history from Bridgewater Associates, the hedge fund started by Ray Dalio, which covers the evolution of thinking that led to the first Risk Parity portfolio back in the mid-1990s. Great to read early on as you investigate RP.

Read the Original:

The All Weather Story
January 2012

Important Points for the RP Investor:

Page 2: Starts off with an anecdote about the US’s move off of the gold standards in 1971 and Dalio’s surprised reaction to how markets moved afterwards. From there, Dalio began thinking about what the shift in conditions did for the values of various asset classes. This prompted a fundamental question: “What kind of investment portfolio would you hold that would perform well across all environments, be it a devaluation of something completely different?” This led to development of an investment strategy “structured to be indifferent to shifts in discounted economic conditions.”

Page 3: A short paragraph on the advent of Chicken McNuggets (really!). Long story short: McDonald’s developed the Chicken McNugget, wanted to sell, but was worried that it couldn’t depend on the future price of chicken. They hired Dalio, and the breakthrough was that, while there were no such things as chicken futures, McDonald’s could go long on corn and soybean futures (or “hedge” their bets on chicken), since those were the possible risks for the future price of chicken. This way of breaking risks down into component parts is one of the key insights that helped produce the All Weather.

Pages 4-5: The next key step was Dalio’s work with the CIO of a large manufacturing firm. The company pension was heavy on risk from the stock portion, and the CIO wanted a way to balance out that risk. The idea there was to increase the allocation to long duration treasuries, thereby giving the plan a different source of return in case economic conditions changed.

In the 1980s, Dalio and his associates were aware that the world of just stocks and bonds was too simplistic, and also that in certain times (like the 1970s which they had just been in), stocks and bonds could both underperform together. For conditions of inflation, the key might be to hold commodities.

Page 6: Shows a four-box grid that Dalio began to use to describe the range of economic environments an investor can face, along two factors: growth and inflation.

The Four Economic "Seasons"

These are the “seasons” to prepare for, and the key to the portfolio would be to have assets suited to each with equal amounts of risk exposure in each box..

Page 7: The All Weather portfolio then launched in 1996, originally just as the portfolio to manage Dalio’s personal trust. The portfolio depended on futures contracts and swaps to increase exposure to certain assets. While the exact mixture and method is proprietary of course, the All Weather portfolio used the following assets to invest in the four boxes described above:

Bridgewater's List of Assets for the Four Economic "Seasons"

Page 8: The All Weather Portfolio came of age and grew in popularity in the 2000s. Part of this was due to the economic conditions of the decade; with the popping of the bubble in 2001, an investment approach that allocated more to alternatives was certain to find more success.

Page 9: Nice summation for the All Weather strategy:

“It is as simple as holding four different portfolios, each with the same risk, each of which does well in a particular environment: when (1) inflation rises, (2) inflation falls, (3) growth rises, and (4) growth falls relative to expectations.”

Notes: The All Weather Portfolio is difficult to construct, verbatim, for individual investors. The exact allocations are proprietary, change over time, and also likely involve the use of advanced trading methods (swaps, futures contracts, etc.) that are beyond the scope of the DIY investor. However, there is a simplified version of the All Weather which we track on this website, called the All Seasons, and then a leveraged version of that called the Levered Seasons. You can also see the links below for more information on the All Seasons portfolios.

All Seasons Portfolio – Portfolio Charts
Asset allocation. investing theory, and historical data for the All Seasons Portfolio by Ray Dalio, via Tony Robbins