Conventional equity / bond portfolio splits did not acquit themselves well during the cost-of-living crisis. When the enemies at the gate were fast-rising interest rates and inflation, standard portfolios looked like a suit of armour missing its faceplate – nominally effective but with a glaring weak spot.
If only someone would invent the faceplate.
Well as it happens, somebody already has.
The All-Weather portfolio integrates a fuller spectrum of defences – including assets with a better record against the withering winds of inflation. (Hmm, smooth metaphor mixology – Ed).
We’ll examine the long-term track record of the All-Weather portfolio in a minute. But first we need to ask…
What is the All-Weather portfolio?
The All-Weather portfolio was popularised by Ray Dalio, the founder of the Bridgewater hedge fund behemoth.
The portfolio is configured to contain downside risk by including a variety of asset classes such that the portfolio as a whole is capable of performing regardless of the macroeconomic conditions.
Bridgewater identified the weather conditions that investors should prepare for as:
- Economic growth
- Economic slowdown
- Inflation
- Deflation
Those scenarios and their asset class countermeasures combine to present an investment model:
The model’s four quadrants represent the main economic environments that we’re likely to pass through during our investing journey.
Pack a raincoat and a sunhat
Each quadrant is staffed with the asset class(es) most likely to positively respond to its conditions:
Left-hand upper quadrant: Rising demand and low inflation is the economic equivalent of glorious sunshine. Fast-growing equities is the ready-to-wear investment outfit for this type of weather.
Left-hand lower quadrant: Falling demand and low inflation (or even deflation) means we’re in for a market storm. Shelter beneath a sturdy umbrella fashioned from bonds and cash.
Right-hand upper quadrant: We’re sweltering as rising demand and high inflation overheats the economy. Commodities are well-adapted to these conditions, even though they can feel ridiculous at other times – like wearing a giant sombrero to a board meeting.
Right-hand lower quadrant: Stagflationary intervals of falling demand and high inflation call for a coat of inflation-linked bonds. The UK’s own index-linked gilts were issued from 1981 partly to restore confidence in governmental fiscal responsibility after the stagflationary 1970s.
Imagine you find yourself invested during one of these four seasons at any given time. The model reveals which asset class is suited to each circumstance.
However even Bridgewater concedes it can’t consistently forecast shifts in economic weather fronts. Hence the All-Weather portfolio hedges uncertainty, by taking a position in each useful asset class.
Granted, this is a very simple model and asset classes aren’t guaranteed to respond according to type. Yet the empirical data shows that the strategy is relatively weather-proof over the long-term.
We’ll dig into the specific asset allocation recommended by Dalio’s portfolio in a moment, but first we need to acknowledge some caveats.
Caveat acknowledgements
Inflation-linked bonds are only certain to hedge against inflation in the short-term if you hold them to maturity. You can’t do that with linker funds, but you can with individual index-linked gilts. See our post on building an index-linked gilt ladder.
Gold is sometimes placed in the right-hand quadrants because it has a reputation as an inflation hedge. This is a myth. See our post on whether gold is a good investment.
As it happens, gold still earns its place in the All-Weather portfolio due to its lack of correlation with equities and bonds. In asset allocation terms, gold is like that Swiss Army knife tool whose original purpose is a mystery, but which often comes in handy all the same.
The Ray Dalio All-Weather portfolio: asset allocation
A passive investing version of the All-Weather portfolio could be structured like this:
- 30% equities
- 40% long-term government bonds
- 15% medium-term bonds
- 7.5% commodities
- 7.5% gold
You may be shocked by the idea of holding 55% in bonds. The Ray Dalio portfolio is designed like this because it’s informed by the principle of risk parity, which aims to better balance risk exposure across its different building blocks.
For example, a stock-heavy portfolio loadout – an 80/20 split or even the 60/40 portfolio – is making a big bet on the performance of equities. That’s obviously fine so long as equities perform. But if you live through a multi-decade stock market depression then you have a problem.
Meanwhile, the overwhelming bulk of such a portfolio’s risk exposure (as measured by volatility) is stored in its large equity allocation. When stocks plunge the portfolio does too, because it doesn’t pack enough bonds to offset the equity downdraught.
The risk-parity approach tries to solve this issue by attempting to equalise the amount of risk associated with each asset allocation.
We’ll see clearly in a moment that this strategy works – but there is a price to pay.
Why no inflation-linked bonds?
If inflation-linked bonds are so great at combating inflation why don’t they feature in the All-Weather portfolio?
The short answer is that the portfolio was conceived in the US before TIPs existed. (TIPs – Treasury Inflation Protected Securities – are the American equivalent of the UK’s index-linked gilts).
Bridgewater acknowledges that inflation-linked bonds are an important part of the All-Weather strategy. However the investment community hasn’t updated on that fact.
It’s a strange instance of cultural inertia – a bit like the Japanese devotion to fax machines. We’ll look at a version of the All-Weather portfolio that does include index-linked gilts in the second part of this mini-series.
All-Weather portfolio drawdowns
Alright, let’s check that the All-Weather portfolio works as advertised. Is it less volatile than conventional portfolios when the market blows a gale?
This drawdown chart shows us how the All-Weather portfolio performs vs 100% equities and the 60/40 portfolio during every market setback from World War 2 onwards:
Data from Summerhaven1, BCOM TR, JST Macrohistory2, British Government Securities Database, The London Bullion Market Association, Measuring Worth and FTSE Russell. July 2024.
Not reliving your personal worst nightmare in the stock market when you scan the graph above? We’re using annual returns, which can blunt the extreme edges of bear markets compared to monthly peak-to-trough measurements. (Sadly, monthly data isn’t publicly available for gilts pre-1998.)
You easily notice though that the deepest declines still look like jagged ravines – and that conventional portfolios fall much further than the All-Weather.
Navigating stock market hurricanes
100% equity portfolios in particular aren’t for widows, orphans, or those with a dicky ticker.
For example, during the UK G.O.A.T. crash of 1972-1974, the All-Weather portfolio ‘only’ dropped -28% compared to -60% for the 60/40 and a mind-bending -72% for 100% equities.
Investing returns sidebar – All returns quoted are inflation-adjusted, GBP total returns (including dividends and interest). Fees are not included. The timeframe is the longest period that we have investable commodities data for. Equities are UK, because world data is not publicly accessible before 1970. The long-term historical gilt index is dominated by long-dated maturities. Separate data is not available for intermediates. Thus the All-Weather fixed income allocation here is 40% long bonds and 15% money market/cash. Portfolios are rebalanced annually.
Most extraordinary were the Dotcom bust and the Global Financial Crisis (GFC). While conventional portfolios heaped misery on their investors, All-Weather owners were asking “bovvered?” with a shrug.
Here’s the steepest loss each portfolio bore during those market tempests:
| Portfolio | Dotcom Bust | GFC |
| All-Weather | -5.8% | -3.4% |
| 100% equities | -38.6% | -32.1% |
| 60/40 | -17.8% | -14.5% |
Those were two almighty crashes. The largest of the 21st Century so far! Yet the dip registered by the All-Weather portfolio would barely give you butterflies, never mind sleepless nights.
Casting our eyes back to the drawdown chart cum investing slasher flick above, we can also see that the All-Weather portfolio merely performed much the same as the 60/40 on some other occasions.
Typically this happened when bonds were crunched harder than equities and the performance of the All-Weather’s minor asset classes didn’t compensate.
The most significant of these incidents was in the late 1950s and during the 2022 bond crash.
Overall though, the All-Weather delivers on its promise of relatively smooth sailing.
See these 1934-2023 volatility figures:
| Portfolio | Volatility |
| All-Weather | 9% |
| 100% equities | 20.6% |
| 60/40 | 14.8% |
Nice – but remember this stability has been bought by loading up on bonds and cash. And that must have cost a fair wedge of return, right?
Right…
All-Weather portfolio historical performance
Here’s the total return growth chart:
Inevitably, the All-Weather’s two-stroke equity engine leaves it underpowered versus normie portfolios.
A table of cumulative and annualised returns tells the story:
| Portfolio | £1 grows to… | Annualised return |
| All-Weather | £15 | 3.1% |
| 100% equities | £119 | 5.5% |
| 60/40 | £34 | 4% |
And there’s the rub. Tricking the portfolio out with gold and commodities doesn’t circumvent the usual risk/reward trade-off (though other figures do show it’s far superior to a 30/70 equity/bond split). The dampening of drama on the downside means a lack of fireworks on the upside.
That said, if you like your returns risk-adjusted then the All-Weather delivers:
| Portfolio | Sharpe ratio |
| All-Weather | 0.34 |
| 100% equities | 0.26 |
| 60/40 | 0.27 |
The Sharpe ratio is a measure of risk vs reward. The higher your Sharpe ratio, the better your risk-adjusted returns. In other words, the more return you get per unit of risk, as measured by volatility3.
By that measure the All-Weather portfolio offers more growth in exchange for the pain it causes. In contrast there’s scarcely any difference between the 60/40 portfolio versus 100% equities.
Which essentially means that UK government bonds have not been a great risk-reducer historically – much less so than in the US experience – as we pointed out when we wrote: Why a diversified portfolio needs more than bonds.
Should you choose an All-Weather portfolio?
If you hate market turmoil or your focus is on holding on to what wealth you have, then Dalio’s brainchild looks like an excellent choice.
I’ve often wondered how I’d cope if I had to face a rout on the scale of 1972-74. The All-Weather portfolio would reduce my odds of ever being blasted like that.
But if you need more growth than the All-Weather offers then you’ll have to overclock your equities and accept the consequences. It’s that, extend your time horizon, or increase your contributions.
The undeniable downside of the All-Weather approach is this lack of equity oomph. That means it’s not ideal for young investors hoping for lift-off or for accumulators still far from their investing destination.
If that’s you then choose a more conventional portfolio, so long as you’re prepared to accept the risks.
How to build an All-Weather portfolio
| Asset class | ETF |
| Developed world* | Amundi Prime Global (PRWU) |
| Long bonds | SPDR Bloomberg Barclays 15+ Year Gilt (GLTL) |
| Short inflation-linked bonds** | Amundi Core Global Inflation-Linked 1-10Y Bond (GISG) |
| Broad commodities*** | UBS CMCI Composite SF (UC15) |
| Gold | Invesco Physical Gold A (SGLP) |
| Money market | Lyxor Smart Overnight Return ETF (CSH2) |
*Use a global tracker fund to include emerging markets diversification.
**See comments above about using individual linkers to hedge inflation. If that’s too time-consuming then opt for a short-duration global inflation-linked bond fund hedged to GBP.
***Broad commodity ETFs diversify across commodities futures and are the right choice to replicate the asset class.
The ETFs I’ve listed in the table are just suggestions to get you started. They’re good but not intrinsically better than other choices you could make.
In truth, index trackers are like tins of soup: much of a muchness. For more options see our low-cost index funds article.
I wouldn’t use an intermediate gilt fund to replicated the original All-Weather’s 15% fixed income allocation. US intermediates are typically much shorter in duration and therefore less volatile than their UK counterparts. A money market, or short linker, or short nominal gilt fund can fill this slot.
Indeed the various options – plus material differences between the US and UK markets – might imply there’s some cunning asset allocation tweak that can squeeze a bit more juice out of the All-Weather portfolio for British investors.
We’ll investigate that in part two.
Take it steady,
The Accumulator
- Bhardwaj, Geetesh and Janardanan, Rajkumar and Rouwenhorst, K. Geert, The First Commodity Futures Index of 1933, Journal of Commodity Markets, 2020. [↩]
- Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. The Rate of Return on Everything, 1870–2015. Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
- i.e. annualised standard deviation [↩]
Your comments on commodities are interesting – I share the same nervousness despite having 6% of my portfolio allocated to Broad Basket Commodities (in the equity part).
(I use the Lyxor funds CRBL (and CRNL) which I believe have tracked their index with an error of about 3% over the last five years. They are swap based and a reasonable TER of 0.35%.)
They are certainly not showing any correlation with global equities at the moment!
I try to console myself that the significant drag on returns over the last few years will be compensated for by less pain when equities turn down and that I am also buying myself some extra inflation insurance along with my linkers.
I did my research on contango and the risk of front running etc and decided to hold the asset class anyway. When it is getting beaten down it is natural to think it was a mistake, but I am staying the course and have been rebalancing into commodities recently (though not with a whole lot of enthusiasm!).
Would be interested hear other views from those who have researched the asset class.
Having finally decided not to go 100 % equities, I’m having trouble with what to do with fixed income. I would jump into bonds no problem , I like whats been said here, the linkers and the hedged international bonds but I fear this much talked about bond bubble thats predicted to burst soon. I’ve even considered EM bonds. Maybe too risky though. So I’m sitting in cash at 2% interest which is ok while inflation is so low though. Reading on A Wealth of Common Sense he states “nobody knows what to do about bonds”!
Another great article. The key takeaway here is passive investment for an all weather portfolio, not chasing returns by switching to this n that, that is active management and a whole other topic. Take all the assets in the picture and equal weight them using the most “appropriate” vehicle. Whether that is a BTL flat or a REIT ETF, or a forest in Scotland, or a synthetic Wood ETF baked by Swaps and Derivatives, it’s up to you to decide. Remember though, diversification amongst implementation is just as importance as diversification amongst assets, i.e. keep a bit of property, keep a few ETFs backed by real shares and bonds, keep a few synthetic ETFs, keep a bit of cash and you’ll do much better than those that don’t.
Depending on your risk appetite, peer to peer lending for some (not all) of your cash, Dawn? You’ll be getting between 5%-10% instead of 2%
@weenie is your peer to peer approach based on never taking the capital out, or have you factored in the illiquidity and still think the juice is worth the squeeze?
i.e. do you consider your peer to peer investments to be liquid like cash, or illiquid, say like a property?
the problem i have is that if you want to get out of peer to peer you either have to plan 3 to 5 years ahead, or take a hit in terms of losing a few percent in fees. If you’re making say 5% but you get hit with 2-3% on way out then its not clear if its worth the extra risk
The key here is to invest in a broad spectrum of assets, using various implementations, this ensures minimum correlations between returns.
Piling into an asset classes that has done well is too late. I was buying equities in 2008/09 when others were selling. I’m starting to sell equities now and buying commodities. It is called rebalancing and its not rocket science. It just requires conviction and discipline to stay the course, unfortunately most people just can’t do it because they chase returns and listen to popular media.
Re : Commodities,
Have for some years overweighted and underweighted Blackrock Blackrock Commodities Income Investment Trust (BRCI) in it’s roller coaster ride, dependent on running yield. Certainly not correlated with stocks in recent years, so a useful diversifier. BRCI does have a healthy yield, useful in retirement, but be aware payouts could be cut in the present environment.
Must point out that the ongoing charges are high, and not what most investors here would think acceptable.
TA
Forgot to say thanks for another insightful article.
Thank You
@ Helford Pirate – I researched and had a small amount invested in commodities 5 or 6 years ago. I got very concerned about contango and the lack of roll return that went with this. Without the roll return a commodity ETF just becomes a bet on future commodity prices with a very large head wind. Someone somewhere said that if you don’t understand an investment then you should be invested and i eventually felt this applied to me. For what its worth I am about 50% in equities (10 years from retirement but quite risk adverse) with the rest in shortish duration bond funds / linkers funds / cash and buy to let.
Sorry that was ‘should NOT be invested’ . This is from the ETF website on the problem with contango:
The roll yield, in turn, depends on whether the futures market is in contango or backwardation. The magnitude of the impact of these market traits on ETC returns should not be underestimated. For instance, in 2009, although the spot price of crude oil increased over 50%, contango negated almost all the gains.
Worrying to say the least
@Rhino
My own peer to peer approach is to consider it illiquid – it’s not cash that I’m looking to call upon in the near future. At some point, I may stop reinvesting the repayments and the interest I’m getting monthly but for now, I’m just happy letting it all compound.
Much like the money I’ve put in funds, trackers or shares – I’m not intending to cash those in any time soon.
Thanks for the informative read.
Is it just me or does the chart look a bit flipped? Seems that the upper left and the lower right quadrants should be flipped. Not trying to be picky, it was just a little bit confusing given the indexes and what I took to be increasing (up/right) and decreasing (down/left).
@ravic — A bit off-topic, but I’d beware ETFs as a way to get exposure to forestry/timberland, especially if you mean the Blackrock vehicle which last time I looked was effectively an S&P tracker (it holds lots of sawmills and so forth that are geared into the economic cycle).
Timberland/forestry is a very hard asset class to buy easily and cheaply. There were a couple of specialist investment trusts launched a few years ago, and they’ve both been awful investments.
I used to hold Plum Creek (a US Reit) but it has some of the problems I mentioned with the ETF. It does also hold a lot of forestry though.
The trouble with being linked to production/consumption (sawmills, processing etc) is one of the benefits of forestry traditionally is that you can cut when it’s profitable to do so and leave it grow (and get more valuable) when not. That doesn’t work when you’ve mills to turn and people to pay etc.
There were a few specialist (unlisted) funds that used to periodically open and close a few years ago that got a fair bit of press. I wonder what happened to them, if anyone knows?
Does seem a bit of a gap in the market. The UK has plenty of managed forestry, and plenty of investors who like it (albeit partly for tax breaks that I doubt would apply to a fund).
Thanks for an extremely helpful article. I’ve taken the graphic to mean that you need something from each quarter to prove most effective against differing economic conditions, so it’s shown me where I should be focusing my investments and WHY. I understand that no asset classes are equivalent but it’s useful to know that I would have some kind of ‘insurance’.
I’ve not really considered property as an asset class much previously but this article made me look into REITs. The amusingly named Reita website at http://www.bpf.org.uk/en/reita/index.php has been most useful in learning what is available in the UK.
How does commercial property compare to residential as a part of a portfolio? I consider UK houses to be well overpriced at the moment so couldn’t convince myself to put much that way, but would consider commercial property if the market is different.
It’s also bolstered my urge to put a chunk into inflation-linked gilts at the moment as they are probably cheap due to inflation being so low. Of course I may be way off target!
Nice article.
If you do become a landlord, how will you rebalance your portfolio? Will you include the mortgage on the btl as an offset on the asset? Leverage on the entire portfolio? A negative allocation to bonds?
I’ve been struggling with this myself – wonder what the pure passive answer is. In the end, I took the asset net of mortgage and put outside of my rebalance. It’s too big and too illiquid to practically manage, even though I know rebalancing’s critical to a well-allocated portfolio.
I went for gold as my commodity allocation
@passive investor
Re contango. My conclusion was that in a broad diversified commodities holding (not just oil or gold say) I would have a mix of contango and backwardation and that this was just part of the random walk of commodity pricing – oil has recently been in backwardation for example.
That said other CCF indexes claim to have better roll strategies than CRY to avoid losses..
Your comment on don’t invest in what you don’t understand is fair. I think I have done a bunch of work on it – but I’m still not 100% clear…
@helford pirate – you may well be right about the mix of contango and backwardation over the medium term. I got concerned about a lot of commentary at the time saying that passive commodity funds (and the vast amounts of new money in the commodity markets) had changed the market in favour of contango. Also that passive instruments (unable to control length or timing of futures contracts) were a sitting duck (compared with direct investors with flexibility and who were on the other side of the contract). In the end it was the feeling that I didn’t fully understand the source of the return (in abroad diversified commodity fund), the thought that investment should be simple and the worry that I was buying into the latest gimmick that made be stick with bonds / equities / buy to let. Who knows whether that was the right decision for the long term (it was a lucky call five years ago for sure). ?
Another great article. I’m interested in how this transfers to the real world. What are the likelihoods of each of these scenarios occurring?
If they are equally likely, then maybe we should invest equally in each. If not, then I guess we have to weight them.
You suggest that the most common scenario is the bottom right quadrant of growth without excessive inflation, so that fits with the general preference for equities over other assets.
The suggestion that 50% of the fixed income allocation should go to bonds seems to imply that stagflation is as likely as low growth + low inflation. Is there any evidence for or against this view? (Not sure if I’m being over-literal here!)
I can imagine that the top right quadrant (high growth + high inflation) is actually fairly common, but it seems that the assets in this quadrant are not easy to invest in. I don’t consider my own home to be a part of my portfolio, as I need to live in it. I also think that there is a lot of self-deception around buy-to-let, including a tendency to ignore the project management work it often involves, overestimate income and underestimate expenses (returns calculated on the basis of best-case scenarios) and, perhaps worst of all, ignore the fact that it involves concentrating a lot of risk in a single asset.
Judging from the comments, a lot of people respond to this problem by investing in something that looks like this asset class but really isn’t (‘commodities’ ETFs, for example). I wonder if it would be better just to accept that most of us can’t access this asset class, and leave it at that.
Again an interesting article.
Easy to understand but I think difficult to implement. What is high growth? Whose deflation? In the world, US ( as the largest investible market), home market? Some evidence that high growth does not lead to high returns.
You could assume high growth occurs more often (does it?) and weight the high and low growth chunks accordingly.
Would you see inflation and growth rates changing anyway and adjust asset holdings.
W Buffett suggests that good asset back equities will see you through most situations in the long term.
Thanks. Something to think about.
@Tim G
“I also think that there is a lot of self-deception around buy-to-let, including a tendency to ignore the project management work it often involves, overestimate income and underestimate expenses (returns calculated on the basis of best-case scenarios) and, perhaps worst of all, ignore the fact that it involves concentrating a lot of risk in a single asset.”
Yes self-deception is a trap many investors probably fall into with BTL, as we have witnessed in earlier discussions here with some fanciful over-optimistic calculations, esp involving gearing.
We may see as the media suggests, another rush of monies into BTL with the impending changes to ‘free up’ pensions, and perhaps some sad stories.
But don’t write off BTL completely. As investors we should always keep an open mind.
A number of smaller properties (to spread risk) without gearing, offers a just about acceptable yield of 4%+ real in the currrent market less whatever ‘hassle factor’ the investor determines. Difficult to match that at present with other asset classes, and much much more importantly a terrific diversifier, as stock and real estate valuations seldom seem to move in lock-step.
Watching rental yields is the key to this asset class, and current real yields are as noted are a little better than most of the competing asset classes, but in a curious hot market of too many investors/monies chasing too few assets (stocks, bonds,RE). RE yields are nowhere near the comfortable levels on offer mid to late 90s, then 10%+ which gave a substantial safety margin for error.
Biggest snags? Illiquidity and bad tenants.
Are we buying more RE at present valuations? : NO.
Postage stamp corner: how about buying shares in Statoil? (How do you do that by the way? Is it on the London SE or do you have to buy in Norway?)
dearieme March 19, 2015 at 1:04 am
Postage stamp corner: how about buying shares in Statoil? (How do you do that by the way? Is it on the London SE or do you have to buy in Norway?)
One simple option buy Staoil ADR (American Depository Receipt?) on the US market. Get form from broker to avoid double taxation.
TD Direct can help. Not sure if can be put in an ISA.
@ Dawn – anyone who’s not 100% equities should go bonds / cash. Worried about poor returns? That’s not the point of fixed income. They’re job is to provide you with stability which they will do. Stick with short-term bonds if you’re worried about losses.
http://monevator.com/sell-government-bond-funds/
@ DW – property in this sense is commercial not residential. Many UK investors already have a fair chunk of their wealth tied up in residential i.e. the mortgage!
@ Tim G – you mean 50% of the fixed income allocation to index-linked bonds. The piece quotes evidence for the likelihood of stagflation but bear in mind there are two high inflation scenarios and inflation is more likely than deflation. Also, high inflation can devastate your wealth in short-order. Remember too that linkers are the only convenient, easily accessible and understood inflation-resistant option available – given the problems identified with the other assets that are meant to work in this scenario.
@ Oldie – are you thinking of no evidence linking GDP to high growth? Bear in mind the old adage, in the short-term the stock market is a voting machine, in the long-term it’s a weighing machine.
The best answer to deflation exposure is long-term bonds. Doesn’t matter where it comes from if you’re exposed to it, and the solution is the same. But you may consider it a relatively unlikely scenario. William Bernstein argue’s that inflation is the bigger risk in his book Deep Risk. The all-weather portfolio aims to defend against all scenarios though. We only need to think about the last 7 years to consider the futility of forecasting the future though. The bond apocalypse hasn’t happened, hyper-inflation hasn’t happened, now the spectre of deflation looms large – will it take hold? Nobody knows but deflation proof assets are only cheap when it’s not expected.
@DW “I’ve taken the graphic to mean that you need something from each quarter to prove most effective against differing economic conditions, so it’s shown me where I should be focusing my investments and WHY.”
This is what slightly concerns me about displaying these conditions as a quadrant. It can make an active decision (which risks and opportunities do I need to incorporate into my portfolio, and to what extent) feel like a passive one (4 broad scenarios = 4 broad asset classes).
If we’re not careful, it can be taken to imply that: i) each of the conditions is equally likely; ii) each has the same scale of impact; iii) but (fortunately) there are investible assets to cover each.
In reality, it’s just as likely that one of the situations is much more likely or unlikely, that there will be disproportionate impacts, or that the only assets available to cover a given scenario do so at an unacceptably high cost. In other words, the quadrant should be used as a starting point for considering these scenarios and the potential responses to them, not a blueprint for creating a diversified portfolio.
The arrows in the graphic are labelled wrongly. Or am I going crazy?
@Don – no not crazy, I came here to say the same thing ! The axis labels are swapped I think. Curiously I found an entirely unrelated pages that talks about the same four-way split, and their chart is flipped too (although in this one you have to flip the X axis to make sense of it : https://seekingalpha.com/article/4055785-framework-for-thinking-rising-inflation-think-function-not-form). Clearly some sort of conspiracy by big chart-makers to pull the wool over our eyes 😉
@ Chris – I think the ‘Inflation’ label should be where ‘Economic Growth’ is.
But ‘Economic Growth’ needs to move one position clockwise to sit at 3 ‘o’ clock on the diagram.
Then both labels would sit at the ‘high’ end of the scale.
Make sense?
Agree that the Military-Charting complex is up to no good 🙂
After nearly ten years in the trenches, we’ve totally overhauled our take on the All-Weather Portfolio. Comments above this one might refer to the original article so do check the date if confused.
As an aside, what a great comment thread this was! Hoping for more of the same today 🙂
Hi. That was good, thanks. Curious about outright deflation as IL bonds track it down I understand.
If you can be bothered, I didn’t grasp
‘Which essentially means that UK government bonds have not been a great risk-reducer historically – much less so than in the US experience – as we pointed out when we wrote: Why a diversified portfolio needs more than bonds.’
This is underneath the Sharpe chart but I didn’t understand the logic.
Cheers.
Hi! Yes, UK linkers wouldn’t cope well with outright deflation but long bonds would be amazing in this scenario. Other country’s linkers e.g. US are protected by a floor against deflation. Equities and commodities would have a tough time during deflationary recessions too.
Re: UK govies – the benefits of diversification should hopefully show up in better risk-adjusted returns. As in the low correlation but positive returns of equities and bonds mean that the reduction in volatility from adding bonds is proportionally greater than the reduction in overall portfolio return. This is the essence of “diversification is the only free lunch in investing.” You’ll see the effect show up in efficient frontier illustrations and in analyses of the US historical track record.
But it doesn’t necessarily hold for the UK. It’s hard to be certain because the UK historical index is composed of longer maturity bonds than the US, but the implication is that UK investors have good reason to diversify beyond equity/bond portfolios.
Hi. I’d be interested to know if there’s anything out there from a fund of funds perspective (along the Lifestrategy lines) that covers this sort of thing? Does this currently necessitate a DIY portfolio approach?
Cheers!
“that Swiss Army knife tool whose original purpose is a mystery”
In my boyhood pocket knives had a tool for “taking stones out of horses’s hooves”.
UK CPI protection with a floor to protect it from deflation is available: the ns&i Index-linked Savings Certificate. You can’t buy them any longer but you can (I understand) inherit them. So if your APs hold some do recommend that they don’t cash them in.
Always been a fan of the all-weather idea. I prefer to consider additional regimes and use more asset classes, but the basic idea is the same.
For me, the issue with the equity-bond (60/40 type) portfolios is they only cover 50% of the scenarios (those on the left hand side of diagram). It’s true that, in my lifetime, those two have been more commonly observed regimes than those on the right hand side. The left hand scenarios are also far easier to hedge. The result is that most seem to ignore the right hand scenarios.
The problem with that, is that while the two right hand side scenarios have been less frequently observed in recent decades, they can still be particularly damaging in terms of sequence of returns risk. So I just cannot ignore them. What’s also noticeable in my portfolio is that the left hand regimes are almost completely hedged with index trackers. Conversely, the right hand regimes are hedged with active funds or my own active trading/hedging.
What I haven’t worked out yet though is how the hell I hedge existential risks of the “Trump-Vance” regime. That one definately wasn’t on the horizon when I started. Short of a wormhole to take me to an alternate reality, I think I’m screwed.
@ZX. I am concerned with the existential risk from the Starmer regime, not the ‘“Trump-Vance” regime’ at all. Funny how people perceive risks differently…
UPAR ETF is the closest that I’ve seen to date to a solution to the 3.1% real return issue for the All Weather (i.e. doubling every 23 years is probably not fast enough in the accumulation decades of investing). It’s 168% risk parity. Of course, it would only be available to US investors wouldn’t it 😉
https://www.rparetf.com/upar
https://pictureperfectportfolios.com/upar-ultra-risk-parity-etf-all-weather-portfolio-that-outperforms-stocks/
Another way to try and make money with risk parity is to call yourself Ray Dalio, found a hedge fund based around risk parity, write some econ/philosophical books to raise your profile, and then sit back and watch the AUM pile up. $19 bn wealth and counting according to Forbes. Nice gig if you can get it 🙂
@dearieme – that’s very interesting about being able to inherit ILSC’s….i had no idea. Thanks for that.
@ZX Buy tech if you think Trump/Vance will win. The tech bros generally (not exclusively) support Trump. And they do that for a reason.
Thank you for the article. I have been invested in a world tracker via my company DC pension scheme for 30+ years which although has seen ups and downs has overall done very well. Next year I will take a sabbatical / early retirement meaning much reduced or no more contributions and will perhaps in 5 years start drawing down. I do understand the point of total returns, protecting your pot and mitigating sequence of risk. However, I can’t quite work out given ups and downs are part of equity investing if overall based on historical data you would still have been better to maintain a 100% investment in world equities vs a total return concept over say a period of 20 or 30 years? I do understand you need a strong stomach to resist meddling when a down turn happens and you need to maintain a believe that there will always be an up side so it’s more about putting the emotions to one side and understanding what the data will say as you draw down.
Do the long term bonds historically have a better return than simple savings account interest? I am talking about the long term bonds bucket in the portfolio.
GLTL LN shows a -0.02 return since inception in 2012.
My googling failed to come up with a typical return of UK cash savings accounts for same period but for sure its a lot better than that.
Appreciate that recent period has been uniquely dire for Gilts, nonetheless are we sure that over the long-term gilts are better return than a savings account? I appreciate that cash outside an ISA/SIPP has capital gains so lets assume I am talking about Cash in an ISA or setting in your SIPP to keep it simple.
Intereactive Investor SIPP pays 3% interest on cash balance. Struggling to see why I would swap this for something like GLT LTN
@33 ZXSpectrum48k – I’d be fascinated to see what a more sophisticated version of an All-Weather Portfolio looks like.
@Laurence. An extended set of parameters for defining the economy would be growth, inflation, fiscal deficit/surplus and the balance of payments. Broadly the “All-weather” idea assumes a simple closed system where a local investor invests in local assets to hedge local liabilities, with no credit risk. Adding in the balance of payments vs. rest of world adds in currency risks. Adding in the fiscal position (of both public and private sector) adds in more explicit consideration of credit risks.
You could continuing adding further economic (or even political) dimensions or dividing up one component into sub-components (such as separating inflation into inflation and the monetary policy reaction). You can go as complicated as you like.
The issue is that none of these dimensions are actually orthogonal. Growth impacts inflation. A fiscal expansion normally adds to growth and inflation. A balance of payments deterioration may add to inflation but add/subtract from growth depending on whether it’s export or import driven.
So it’s really a question of how complex you want it and whether you can identify the correct hedges for each regime. That’s not easy. Against that though the basic equity-bond portfolio is essentially a one-dimensional “all-weather” portfolio i.e. growth up= equities, growth down = bonds. Dead simple but blunt in that every other economic dimension is essentially subsumed. It’s worked in recent decades because it’s been a low inflation world, without balance of payments crises or fiscal catastrophe. At least in developed markets.
@TenaciousJ – returns to money market / treasury bills are typically used as a proxy for cash. Cash beats bonds since 2012 as the 2022 bond crash looms large as you mention.
Longer-term, bonds beat cash.
Annualised real total return 1900-2023
Cash = 0.42%
Gilts = 0.91
See this post for other timespan comparisons:
https://monevator.com/uk-historical-asset-class-returns/
Aside from bonds return advantage over most periods, cash doesn’t spike during a crash, so it doesn’t do much to offset equity losses.
I throw caution to the wind at all times – go out in my little shorts & vest in bright sunshine and then swiftly get washed down the river in a monsoon – not looking good really………. but the All Weather’s not created for the likes of little old me
@TA (#30)
“But it doesn’t necessarily hold for the UK. It’s hard to be certain because the UK historical index is composed of longer maturity bonds than the US, but the implication is that UK investors have good reason to diversify beyond equity/bond portfolios.”
You might be interested in the indices I calculated going back to 1870 for a variety of gilt maturity ranges (see https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4742450) based on price and coupon data of individual gilts (which were drawn from the dataset presented by Ellison and Scott, “Managing the UK National Debt 1694-2018”). Essentially this extended the total return data at the BGS (https://www.escoe.ac.uk/research/historical-data/fiscal-data/) to before 1998. The data are downloadable (link in my paper linked above).
@The Accumulator fantastic answer. Thx
@TenaciousJ (#39)
If you want to put some returns for cash accounts together, you can find the best easy access and 1 year savings rate by delving into the archive of weekly emails at moneysavingexpert.com (they go back at least 10-15 years, but sometimes the info is a bit sparse in the early versions).
There is also information going back to 1999 at the Building Societies Association website.
The returns for cash tend to be better than bonds (particularly long bonds) in periods with increasing yields/interest rates.
The returns for long bonds tends to be best where yields stay the same or fluctuate or tend to decrease (i.e. pretty well from 1980 to early 2022).
An illustration of the power of modesly leveraged All Weather/Risk Parity.: bit of a nasty day in the markets. So far today the SPXS ETF (UCITS S&P 500 tracker) is down 0.75%, the XS2D LETF (UCITS 2x S&P 500) is down 1.84%, and the 3LUS LETF (UCITS 3x S&P 500) is down 3.06%. But RPAR LETF (at 1.25x risk parity) is down just 0.25% and UPAR LETF (1.68 x risk parity) is showing no change. Steady eddy, but with a long term return boost from modest leverage. If and when the FCA recognise US ETFs under the Overseas Fund Regime then one potential solution to improve upon the All Weather will be to hand.
@ZXSpectrum48k – thanks, that makes a lot of sense and could be a great article 🙂
I hadn’t considered balance of payments or the fiscal positions of the state or private sector. I guess it comes down to a combination of assets denominated in foreign currencies and ways of trading credit risk – either via corporate bonds or credit swaps.
I’ve never agreed with the prevailing wisdom of having bonds either in domestic currency or hedged to it, because I think it’s an asymmetric risk. If sterling gradually improves against a basket of currencies over the long term, that will benefit my earnings and life in many other ways. If, on the other hand, it collapses in a Zimbabwe-style crisis, I’ll be very glad to have unhedged dollar, euro and yen bonds. So I hope I’m slightly ahead in terms of hedging balance of payments risks.
I think another downside of the standard equity/bond split, and even all-weather and risk-parity variations is that they’re heavily skewed towards assets that do well from falling interest rates. This is compounded by the relationship between house prices and interest rates. Not an easy thing to hedge, but I think trend following may offer some degree of hedging. Or for people with a lot of leverage, taking longer term fixes and/or using interest rate swaps. For decumulators then a large cash position may make sense.
My current thinking is something like:
Disinflationary growth:
– Equities with a factor tilt
Disinflationary recession:
– Long term bonds, diversified across major economies
Inflationary growth:
– Commodities
– Commercial property with inflation-linked rents
– Infrastructure with inflation-linked revenues
Inflationary recession:
– Short-dated inflation-linked bonds, diversified internationally
– Gold
Rising interest rate insurance / wildcard:
– Trend following
Lots of imperfect hedges I know, particularly for inflationary growth.
@ Alan S – I’m very much interested. Thank you for sharing your work. I look forward to reading your paper and messing around with the data. How wonderful that you’ve found the time to do this.
Thanks for this article – very informative as usual.
I’m a big fan of the all weather/ permanent portfolio approach in general – ie the idea of adding different asset classes/ return streams to a portfolio. It can be pursued in a more watered down form. For example, a portfolio could be principally individual equities, equity funds, etfs and trusts but well – diversified by geography(EM, developed, Europe etc) and factor(size, value, quality, dividend yield, industry group, low volatility, momentum etc) and then theoretically uncorrelated asset classes(eq commodities, bonds, cash, hedge funds, precious metals, crypto(just a little bit!) can be added up to a percentage that the individual is comfortable with.
However, my impression now is that we are on the verge of a multi-year rally for stock markets taking us to 100,000 on the Dow, 10,000 on the S & P 500 and 50,000 on the Nasdaq. So not sure it is the best time to implement the all weather approach. Of course, there will be drawdowns along the way and having some diversification can help buffer the drawdowns.
None of the above is a recommendation by the way – just my opinion!
@Indyinv 3.0: FWIW tend to agree with your prediction.
I know absolutely nothing for sure about the future, especially where markets are concerned. That said, I’m feeling that, in general, the indices want to go higher, and are slowly melting up.
But….volatility is worryingly low, market leadership is too concentrated and 2009 is now a loooong way back in the rear view mirror; all of which tempers my hopes.
I’m still fairly nearly a 100% in global equities, with just crossing into a 7 fig portfolio now, and nearing 50 years old much quicker than I’d like. So I’ve gotten optimism bias for sure, notwithstanding the drawdowns make me feel quite sick sometimes.
Although I’d like to diversify, I also don’t want to risk getting off the fastest horse.
What I’d like these days is access to some sort of tail hedge product like the Alpha Architect Tail Risk ETF, ticker CAOS 😉 , to take the worst edges off of the risks of a >25% fall.
A 5-10% allocation here; rather than pulling out of overwhelmingly equities, and then going All Weather.
Inevitably, it’s unfortunately presently a US only availability ETF.
@TA (#49)
Good to know. Bear in mind the paper has not been peer reviewed (although it was informally looked at by a few other people who work in this area). If you find any errors let me know (e.g., I note that for pre-1915 returns, there are a number of assumptions made for the intermediate maturity indices – in reality only undated gilts and bills existed in any great quantities at that time).
I’m a retired scientist and now have the luxury of calculating things that interest me rather than having to follow research that brought in money (which to be fair was always interesting too!). It has the useful additional benefit of keeping the mind active…
Just my tuppence worth but obviously not an investing guru and never worked in financial services. This allocation would not suit me well I don’t feel. Tend to agree with Delta Hedge #51 that you could be jumping off the fastest horse (onto a seaside donkey maybe) with a poor return overall and only limited downside protection.
When I have held some bonds (or mixed asset funds) in the past I have found it has taken very much away from my overall returns. I now mainly hold equities and, apart from 2022, when everything generally went t*ts up, have done very well although appreciate may not continue to do so well (but sure damn hope it does!) I do mainly hold low cost global/dev world tracker funds & ETFs but not exclusively and wouldn’t say I’m passive – don’t have bonds now and no gold/commodities.
I couldn’t see I would ever hold 55% in bonds and only 30% in equities – just not enough for growth although do concede if your pot is very large and don’t need the growth then might as well play safe and hunker down in preservation mode but that’s not the case for me. It must drag down any potential upside even though it could protect downside/volatility maybe …………….providing it actually works (which it doesn’t always do anyway?)
I try not to listen to too many experts like the ones saying for at least the last 10 years that US growth/tech is overvalued and set for a surefire fall ……..just about anytime now. If I had listened I would be streets poorer than I am currently. We all know it will be true one day but nobody knows which one so would rather stick with profits I have had over the past so many years rather than slim pickings otherwise. Go with gut and what I feel suits me best. But I accept that this does not suit everyone who maybe want more certainty/less volatility (but with likely poorer long term return).
Don’t feel I am a cautious, nervous type and that would be too distraught with any general volatility that would be enough to cause me to sell – providing any great bears don’t last too many years, which they normally don’t, often fairly rare. And if your equities are diversified pretty much globally/dev world then this should give more protection than just investing in smaller geographic region(s). The market has a lot more up days than down, so we are told and lets hope it stays that way.
I’ve also read some of those articles which now advocate holding much more in equities in retirement in general than was reccomended previously, well maybe apart from when approaching retirement and for a period just after because of SOR risk.
I’m not working so SORR is a worry but I’ve never had mortgage as saved and bought my house for cash and have smallish amount other income and also keep a fair amount in cash savings accounts as a back up especially whilst rates are this good. I don’t mind rate tarting for best rates – it’s not that much of a chore to me to open a new account – usually no more than 5- 10 minutes. Currently have easy access pays 5.1% / fixed account paying more – both well above inflation at moment although aware that this will likely change in medium term as if inflation stays at target then they will fall and I may have to change tack as I don’t like losing really. Hope this would tide me over through pretty much most of the drawdowns along with cutting back on spending as well.