How's The (All) Weather (Portfolio)?

Revisiting a favorite portfolio.

In the last couple of years the phrase All Weather Portfolio has come to be popularly associated with Ray Dalio and Bridgewater Associates. The Bridgewater portfolio is a risk parity strategy which means it tries to balance out the risk taken across multiple asset classes which means it often ends up needing to use leverage to own enough fixed income to equal the risk taken from a modest exposure to equities.

All Weather also implies a portfolio that can endure any market environment with reduced volatility thanks to broad diversification that I kind of equate to the Permanent Portfolio which was devised by Harry Browne in the 1970's, it had equal 25% allocations to equities, long bonds, cash and gold. The big idea was that no matter what was going on, at least one of those would be going up. The track record for it is pretty good, except maybe for the last couple of years, because of how well equities and bonds did for the vast majority of the last 40 years.

I stumbled across a couple of different versions of the all weather portfolio this week. Neither has anything to do with Bridgewater, they appear to be built more along the lines of my comparison to the Permanent Portfolio's diversification.

The first one is the Toroso All Weather Plus which we have looked at before. YTD through September 30th it is down 1.76% versus a decline of 30 basis points for its benchmark, the Solactive Neutral Index, and a gain of 10.56% for the S&P 500. For five years annualized it is up 3.60% versus 3.23% for its benchmark and 13.95% for the S&P 500. The portfolio is not an equity proxy but the numbers versus the SPX gives a little utility in showing it may not look like equities. Toroso doesn't chart it against the S&P 500 in its report so it doesn't provide a great understanding of what it looks like against equities. They would probably provide more info to any advisor who wanted to learn more.

I won't name names of what they own but you should be able to find this out. At a high level it has an neutral allocation of 25% each to "prosperity" (equities), "inflation" (commodities), "deflation" (bonds) and "recession" cash. For equities it owns three broad based ETFs and two thematic ETFs. It uses to short term T-bill ETFs for cash, for deflation it owns three bond ETFs that appear to take some interest risk and for inflation it owns several different gold ETFs, a thematic ETF in the materials sector and Texas Pacific Land Trust (TPL).

The other portfolio is posted at ETFshark.com but apparently it was devised by Tony Robbins. It owns SPDR S&P 500 ETF (SPY) 30%, PowerShares DB Commodity Tracking ETF (DBC) 7.5%, iShares Barclays 7-10 Year Treasury Bond ETF (IEF) 15%, iShares Barclays 20+ Year Treasury Bond ETF (TLT) 40%, SPDR Gold Shares ETF (GLD) 7.5%. Again, it appears to be reminiscent of the Permanent Portfolio and it appears to take interest rate risk. Return info is provided but with a little less detail than at the Toroso site, it shows an annualized return since its inception in November 2014 of 8.56%. Unlike Toroso All Weather Plus, the portfolio from Robbins is static other than rebalancing. The Toroso portfolio is actively managed.

If either of these peak your interest, I would tell you that 40% in TLT is a nightmare waiting to happen. From August 24 to October 8th, TLT dropped from 121 to 112 on a 35 basis point move in the ten year treasury. Maybe interest rates will never normalize but if they do, TLT will fall precipitously.

I don't think you can build something like this on your own with the expectation of setting and forgetting. Equities are the asset class that does the best most of the time. Any investor relying on equity market appreciation for their financial plan to work probably needs more than 25% or 30% allocated to equities. Also, there are times where someone actively engaged might want to reduce equity exposure which obviously is the exact opposite of set and forget.

In choosing an equity fund for some sort of all weather portfolio I would say that sticking with broad funds makes more sense. While a homemade all weather portfolio probably won't be set and forget, if you build it with a bunch of thematic funds for your equity exposure you are essentially guaranteeing you will have work to do. Whether you want that or not depends on the amount of time you want to spend. Additionally, delving into thematic funds runs the risk of being wrong. There is nothing that says some theme can't go down while the broad market is going up. Again, that risk doesn't have to be a negative but it is important to understand.

For broad based equity funds, there are many to choose from that are cheap and depending on your brokerage firm, might be commission free. One fund that I am intrigued with in this context is the Horizons NASDAQ 100 Covered Call ETF (QYLD). As the name implies it sells call options and the fund has a very high payout which shows on ETF.com currently at 11.2%. When something has that high of a yield I usually talk about how risky the fund is, that kind of doesn't apply because in no way shape or form is QYLD anything but an equity proxy. The last few weeks give a good microcosm of what to expect during downdrafts.

For some context, the Invesco QQQ Trust (QQQ) was down 9.6% in the period charted. Being spared 50 basis points is certainly better than the alternative but it's not really a place to hide out from a fast or slow decline, it is an equity proxy with a high yield.

Also charted is the iShares Core S&P Total Market ETF (ITOT) which is a fine proxy for broad, domestic equity market exposure, and the AGFiQ U.S. Market Neutral Anti-Beta ETF (BTAL) which of course is a client holding. An at home all weather portfolio's equity allocation should IMO anchor around something like ITOT, straight, plain vanilla equity exposure. Exposures to other things like in the case of this post, QYLD and BTAL should be pretty small. If you do a little spreadsheet work, you'll a small allocation to QYLD along with a lot of something like ITOT would increase the overall yield considerably. QYLD will of course lag at times but adding basis points in the form of yield can add meaningfully to long term returns.

As a substitute or possible as a pairing with something like ITOT, a fund that takes defensive action could also be considered. I own Pacer Trend Pilot Large Cap ETF (PTLC) for clients and there others, WisdomTree has one or two funds that take defensive action. PTLC is likely to miss the lift off of any bear market bottom as a function of its methodology, at least that is my expectation as a holder of the fund. If it were my only equity position I might want to be prepared to switch to ITOT or the like when the market is in a state of panic, easier said than done of course. Working PTLC or something similar in to a portfolio provides an extra bit of defense beyond BTAL (discussed below) but with a better opportunity for upcapture over the course of the entire cycle.

BTAL has a role in this type of portfolio in terms of weathering adverse market conditions. Unlike an inverse fund, BTAL has shown it can go up as the market is going up. For most of its existence it has gone down in value and I would expect that coming off the bottom of the next bear market (regardless of whether it has started or not) and into a new bull it will decline for a long time. It doesn't have to decline (repeated for emphasis) like an inverse fund but I would expect it to which speaks to why an all weather concept can't be set and forget.

I would want to include more alternatives in such a portfolio. Some consider gold to be an alternative, and I own it for clients, and maybe it is but I would want something that could offer bond market returns without taking interest rate risk. Anyone reading my posts for a while knows I like merger arbitrage in this context. The IQ Merger Arbitrage ETF (MNA) and the ProShares Merger ETF (MRGR) are the only two ETPs in the space. I've owned the Merger Investor Fund (MERFX) for clients for many years and it seems like that fund outperforms the ETPs far more often than not. This has been a relatively good year for the fund having gained 4.51% YTD per Yahoo Finance.

I have also owned floating rate products for clients for a while and not surprisingly they are doing well because interest rates are going up and their rates float higher, they essentially do not take any interest rate risk which is a good place to be when rates are rising.

With the recent lack of volatility in Bitcoin, I wonder if it has turned a maturity corner of some sort? Could it do well against slightly higher inflation or interest rates. To be clear, I don't know and I have no plans to buy for clients but I don't know why someone actively engaged in markets would not continue to try to learn more about it. It costs nothing to learn, you risk nothing by learning and why couldn't it evolve into some sort of alternative with either no correlation or a low/negative correlation to other asset classes but maybe now without moving 20% per day.

I wrote posts like this long before BTAL and QYLD existed. I imagine that if we revisit the idea in five years, there will be good things to say about funds that today do not exist which is yet another reason why this should not be a static endeavor, it requires active engagement.

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