The Ray Dalio All-Weather ETF Portfolio

The case for an all-weather portfolio

Ray Dalio, founder of the Bridgewater Associates hedge fund, designed his firm's portfolio based on these principles. Dalio observed that different asset classes performed better in various economic scenarios, or "climates." He posited that there were generally four cycles:

1. Higher-than-expected inflation
2. Higher-than-expected growth 
3. Lower-than-expected inflation 
4. Lower-than-expected growth

The point of the all-weather portfolio is to create a fund that chugs along in all market conditions, without the need for timing or predictions. This portfolio is not meant to maximize returns – the goal here is to limit volatility and drawdowns. 

Dalio suggested four types of assets that corresponded to his understanding of economic "seasons": stocks, Treasury bonds, commodities, and gold. 

The role of stocks

Stocks will drive most of the portfolio's returns during bull markets. Dalio suggested using the total U.S. stock market, but in my opinion, the total world market is preferable as to avoid a repeat of the 2002-2009 "lost decade" for U.S. stocks. Remember, we're trying to maximize diversification here and avoid easily mitigatable risks, like investing in a single country.

The following low-cost index ETFs could work based on your thesis for the U.S. vs worldwide stocks:

1. Vanguard Total Stock Market ETF (VTI)
2. Vanguard Total World Stock ETF (VT)

The role of bonds

Bonds (Treasurys) provide deflationary crash protection. When a market crash occurs, central banks often drop interest rates to stimulate the economy, which sends bond prices (and especially long-term Treasurys) soaring. This is called the "flight to safety." Bonds also generally lower volatility (in a non-rising rate environment). Dalio suggests a combination of long-term (20+ year) and intermediate term (7-10 year) duration Treasurys to balance interest rate risk and crash protection.

The following low-cost index ETFs could work:

1. Vanguard Intermediate-Term Treasury Index ETF (VGIT)
2. Vanguard Long-Term Treasury Index ETF (VGLT)

The role of commodities/gold

Commodities provide inflation protection, but in all other market conditions tends to be a poor investment. Commodity funds use futures contracts, which suffer from contango, high costs, and volatility decay. Gold, on the other hand, actually has poor short-term inflation protection thanks to its high volatility but does act as a safe haven for political/socio-economic turmoil. Both have a low to negative correlation with both stocks and bonds, making them decent diversifiers.

The following low-cost index ETFs could work:

1. Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)
2. SPDR Gold MiniShares Trust (GLDM)

Constructing the portfolio

Dalio suggested the following allocations: 

• 30% stocks
• 15% intermediate bonds
• 40% long-term bonds
• 7.5% commodities
• 7.5% gold

These allocations are not mean-variance optimized or accurate for a true risk parity weighting. Dalio's weights were intended to be a useful rule of thumb for investors that could be easy to implement. I would also be cautious of using backtests to find the "correct" allocations as that is highly subject to over-fitting of data. 

That being said, here's how it has performed compared to the S&P 500 since 2007 with annual rebalancing:

We see far better risk-adjusted returns (Sharpe ratio), with significantly lower volatility and drawdowns. Overall, the sequence of returns was much more predictable, which can be desirable for low-risk investors.

Personally, I would prefer a lower allocation to long-term Treasurys in favour of a higher (40%) stock allocation and the addition of some short-term Treasury Inflation Protected Securities (TIPS). Then again, who am I to argue against Ray Dalio?