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:
[1]
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 [2] 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 [3].
Gold is sometimes placed in the right-hand quadrants because it has a reputation as an inflation hedge [4]. This is a myth. See our post on whether gold is a good investment [5].
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 [6] 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 [7] 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 [8] then you have a problem.
Meanwhile, the overwhelming bulk of such a portfolio’s risk exposure (as measured by volatility [9]) 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 [10]. 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:
[11]
Data from Summerhaven [12]1 [13], BCOM TR [14], JST Macrohistory [15]2 [16], British Government Securities Database [17], The London Bullion Market Association [18], Measuring Worth [19] and FTSE Russell [20]. 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 [21], 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 [22] (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:
[23]
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 [24] (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 [25].
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 [26].
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 [27] 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 [28] (UC15) |
| Gold | Invesco Physical Gold A (SGLP) |
| Money market | Lyxor Smart Overnight Return ETF (CSH2) |
*Use a global tracker fund [29] 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 [30] 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 [31] and therefore less volatile than their UK counterparts. A money market [32], 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 [33].
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. [↩ [38]]
- 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. [↩ [39]]
- i.e. annualised standard deviation [↩ [40]]