Episode #145: Cloning The Largest Hedge Fund In The World: Bridgewater’s All Weather
Guest: Episode #145 has no guest, It’s a Mebisode.
Date Recorded: 2/27/19 | Run-Time: 11:32
Summary: Episode 145 is a Meb Short. In this episode, you’ll hear Meb follow-up on his 2014 article, Cloning the Largest Hedge Fund in the World: Bridgewater’s All Weather. Meb covers how Bridgewater’s All Weather portfolio compared to the global asset allocation portfolio, and an extension, the global asset allocation portfolio with leverage. He winds down by giving an update on how the strategies have performed since writing the piece in 2014.
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Links from the Episode:
- 0:50 – Welcome
- 1:25 – Cloning the Largest Hedge Fund in the World: Bridgewater’s All Weather (Faber)
- 1:52 – Principles: Life and Work (Dalio)
- 1:54 – Big Debt Crisis (Dalio)
- 2:06 – Bridgewater Research Library
- 2:12 – Bridgewater Media Archive
- 2:17 – Building an All-Weather Portfolio (Faber)
- 4:11 – Risk Parity is About Balance (Bridgewater)
- 4:13 – Engineering Targeted Returns & Risks (Bridgewater)
- 5:05 – Invest with the House (Faber)
- 5:14 – Cloning the Largest Hedge Fund in the World – Twitter Update
Transcript of Episode 145:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hello, podcast listeners. Today, we have a short episode. We’ve done this in the past, we could call it a Meb episode or just a short piece where I’m gonna read a recent article I’ve pinned or follow-up on our older article. I think these are a lot of fun, it allows me to riff on some ideas in longer form. This will probably the first of about a half dozen. We may start publishes on Mondays, every Monday or do a Q&A on Monday. It gets to be too much, too little, you hate it, you love it, give it some feedback at the mebfabershow.com. We’d love to hear what you think.
So, the first one is a follow-up to an article I pinned in 2014 called “Cloning the Largest Hedge Fund in the World.” And for many who aren’t familiar with the hedge fund space, the current largest hedge fund, and they go like horses or cars around a track in and out of 1st, 2nd, 10th place, go out of business, start new business, but Bridgewater, everyone’s favorite, has become quite a bit more publicity-friendly over the past few years, founded by Ray Dalio in the 1990s. He’s been doing a lot of publishing lately, he’s had a couple of good books, principles, and the debt crisis book. I’ll post some show note links. But last I checked they were over something like $160 billion. They employ over 1,000 people. In fact, you can find a lot of their writings online and if you wanna know more about how the economy works and other ideas, they have some fun videos that talk about that as well.
They have two main portfolios. One is called All Weather, which if you go back to the very origins of the blog was one of their ideas and concepts we posted to the blog because they were talking about risk parity and how if you’re building a portfolio you don’t necessarily have to accept asset classes pre-packaged. And what I mean by that, and what they meant by that, is so say you have equities, equities are inherently leveraged, they have debt, the real estate investments, real estate trusts. So, there’s no reason necessarily to take equities at it for the notional value, you could, say, invest half in equities and half in cash. And same thing with bonds. You don’t have to accept bonds, government bonds, at a certain volatility level. You can leverage them up or leverage them down.
This theory has been around for a long time, well over 60 years going back to the days of Markowitz and Sharpe, but anyway, it’s a lot of people have repurposed it into how to build the ideal portfolio and Bridgewater, among others, call it risk parity. But really the concept, certainly, we found an old book that had published a portfolio that was pretty darn similar called All Weather even before the Bridgewater All Weather portfolio came out. So, it’s funny how everything old is new again. But Dalio also often mentions in a lot of his pieces this is how he would invest his money for his trust and for his family and future generations if he passed away and needed a simple allocation for his children, etc. It’s meant to be a buy and hold and rebalance portfolio versus their second portfolio, which is called Pure Alpha, which is meant to be the multi-strategy, go anywhere alpha portfolio.
So, he’s separated this concept of beta and alpha and thinks that you should separate them as well and beta is something that you should pay very little for. We’ve often been on the record saying you should pay nothing for at this point, it’s basically zero is where you can get a portfolio ETFs. We launched I think the world’s first ETF, the permanent 0% management fee under this same theory. But you can find more information on their website, they got some fun articles. Risk parity is about balance, engineering targeted returns and risk, which is one of my favorite names for a paper, etc.
So, here’s a quote from the risk parity is all about balance the article says, “Since 1996,” And this is Bridgewater course, “our All Weather approach has been stress tested through significant bull and bear markets and equities, two recessions, a real estate bubble, two periods of Fed tightening and easing, a global financial crisis, and fears of common between. Through these varied environments, All Weather asset allocation mix has achieved a Sharpe ratio in line with the expectation that we establish the outside strategy and also in line with performance over 85 years of backtesting.” And that’s always good to see. You have a portfolio that does well in real time, always makes you feel warm and fuzzy versus just the backtests.
So, what we did is we did a thought experiment. We said, “Why don’t we look at the All Weather portfolio, to an extension Pure Alpha, and see if we could tease out any information about what they’re doing?” And hey, as everyone knows I wrote a book called “Invest with the House,” which is free to download on cambriainvestments.com. The clones hedge fund manager, but I said, “Can we do it on this allocation concept too?” And so we published a chart, which will be in this post and it’s also on my Twitter feed, but it shows the real-time returns of All Weather all the way back to its inception in 1996. And then we said, “Hey, I wonder how this compares to this simple global market portfolio.” Meaning, we talked a lot about this, but the gold market portfolio is roughly if you invest half in stocks and half in bonds, if you bought all the public assets around the world, it’s roughly half stocks, half bonds, half U.S., and half global ex-U.S.
And so it turns out if you take this portfolio and compare it to when we wrote this in 2014, it showed that All Weather did better than this global market portfolio but it did so with a little more volatility. And as we know, this risk parity strategy actually uses some leverage and so we try to dial in about the right level of leverage, in which case the GAA portfolio when you apply it about 40% leverage, so meaning 140% notional, you got to about a near identical equity curve is the risk parity All Weather allocation. And again, it’s roughly the global market portfolio, and we did this all-market cap weighted, so no value or anything else but a pretty simple apples-to-apples comparison.
In the results, when we actually walked this forward since 2014 is the…and we call it GAA for global asset allocation not referencing our fund, but referencing the portfolio we published in our book many years ago, as well as this article, GAA and GAA were 140% which is the leverage version. So, All Weather since ’96 through 2018 did returns of about 7.5% per year. The non-leveraged version of GAA did almost 7% and the leveraged version did 8.2%. So, obviously, one last, one more, but the volatility is roughly in line. Volatility of All Weather was around 11%, the non-leverage GAA was around 8%, and then the leveraged version also around 11%. Sharpe ratio also very similar, All Weather was around 0.48 and then the GAA and GAA leveraged around 0.5, 0.6.
Drawdown for All Weather was pretty high. A lot of people for buy and hold portfolios, 33% drawdown seems high, but we’ve written a lot on this and you basically can’t find a buy and hold allocation that doesn’t decline by about that much at some point. And a lot of people aren’t aware of that fact but really you can’t find much that…you’re really hard pressed to find something even hypothetically that doesn’t decline by at least a quarter at some point for sure and on after-inflation bases, it’s even higher. So, the drawdown for the GAA in leverage version same ballpark, 27% to 36%.
So, the cool part, again, when we wrote in 2014, they were neck and neck and then real time the global marker portfolios outperformed by quite a bit. That probably has something to do with All Weather having much higher allocation to bonds, but it’s good to see that it’s worked in real time. Now, to be fair, a lot of people would say, “That’s pretty cool, Meb, but Dalio and company built this in the ’90s. So, part of their…you’ve got to give them credit that they did it in real time with real money,” and I absolutely hat tip to that. But also it’s good to see that it’s such a simple allocation you could replicate for almost free.
Now, to be fair, they would probably also say that Pure Alpha is their flagship strategy. That one is one that has, again, similar returns over the period, but the beauty of that one so that All Weather has about a 70% plus correlation to the buy and hold whereas the pure Alpha, which is the go anywhere multi-strategy fund that charges a lot more, I think it’s 2 in 20 or there was a recent article where they said you could also just choose a management fee, something like 3.7% per year. But hey, they did it net after fees and so they end up in the same place. So, volatility is not a story better but the drawdown was low, I think it was 15%. And even more importantly, there was almost no correlation to a traditional portfolio.
So, a lot of the things that Dalio has arrived at with this concept of you have a buy and hold anchor, and then this pure Alpha, what they call the go anywhere Alpha portfolio, is actually pretty similar in concept to our Trinity portfolios. And while all together different in how they construct it, it has this concept, and Bridgewater’s rolled out what they call optimal portfolios, which is probably, and I don’t know the exact number, but about half in buy and hold and half in pure Alpha. And something similar that we’ve done with the Trinity, which was half in buy and hold allocations and half in trend falling type of allocations with part of the reason being risk and return statistics. But the other part of the reason being behavioral where a lot of people feel comfortable with the buy and hold portfolio, but a lot of people also want to try to add some value, but the challenge with value-added strategy is you often look different and weird.
In 2017 and ’18 was a great example where…excuse me, ’18 and ’19 where buy and hold looked really smart for a good part of 2018 and then really foolish in Q4. And then trend falling looked much better and then flips again in 2019 where buy and hold looks brilliant again and trend falling not so much. But that’s the nice part of that strategy is it offers somewhat of a yin-yang when they’re not correlated. So, the good news to wind down this post is you don’t have to pay Bridgewater half a million dollars, which I think is their fund minimum, you don’t have to have a $5 billion fund, which I think is their minimum AUM. You can actually replicate a lot of what they do on their All Weather strategy just by buying the global market portfolio for a near-zero cost and rebalancing it once a year. If you feel particularly aggressive, you could do so with leverage whether actual leverage or simply allocating more to your strategy than you would to your cash balances.
Listener, beware. One of the worst practices a lot of the brokerages is they charge the extremely high margin rates. So, if you don’t know what margin rates you’re paying and using leverage you’re probably way too much and these are the big brokerages too. So, Schwab, Fidelity, etc. are often guilty of charging 9%, 10% margin rates. So, be very thoughtful about that if you are going to lever, be cautious about what you’re actually paying. But there’s plenty that don’t charge much either. But, in general, we tell people leverage probably isn’t that necessary, you can build wealth without doing it.
So, we’re gonna wind it down. Hope you enjoyed cloning the largest hedge fund in the world. As always, you can find more at mebfaber.com/podcast. Shoot us an email, let us know what you think about these shorts, email@example.com. And if you get any ideas for articles, updates, suggestions, let us know. We love to read them. Thanks for listening, friends, and good investing.