I have studied Ray Dalio’s career in hopes of learning from the hedge fund master. Dalio is the founder of Bridgewater Associates LP, which currently manages $122 billion in assets. In a recent speech, Dalio shared the following insights:
“If you have 15 or more good, uncorrelated return streams, the math of that is such that if you go from one to two uncorrelated streams, you would reduce your risk by 80 percent.
I will attempt to mimic this insight by buying income-producing asset classes available to the retail investor. In this article, I will try to replicate a few of Dalio’s concepts to build a hedged income investing strategy with a net-positive result.
My Macro Investing Assumptions:
1. The U.S. and European markets are in a multi-year deflationary environment. This is based upon a continual decline in home valuations, lack of job creation, and a forced return to austerity. Sovereign nations must cut spending in order to maintain some public image of fiscal discipline. These markets will experience deleveraging on all levels of government spending. Austerity is here to stay.
2. Growing markets will increase their leverage due to their favorable sovereign nation balance sheets and favorable business environments. This will benefit China, India, Latin America, and other emerging markets.
3. I believe the U.S. dollar will retain its strength as a currency. Bernanke has stated the Fed Funds rate will remain low for at least 2 years. This provides continual investor demand for U.S. dollars to establish carry-trade positions.
4. Bernanke will arrive on the scene to establish a Quantitative Easing 3 as the U.S. economy continues to weaken.
Investing Income Positions:
1. I will possess a long position in American Capital Agency Corp (AGNC). On September 26th, American Capital Agency confirmed a nationwide refinance plan was unlikely. The key prepayment risk, due to Operation Risk, is expected to be organic and not widespread. Although Operation Twist has flattened the net yield curve, American Capital Agency remains profitable and with a strong book value per share.
2. A deflationary macro environment will decrease commodity prices. This impact is somewhat muted for oil, as the demand vs. supply balance is very tight. I will put on a pair trade to take advantage of a potential oil spike and hedge with an inverse fund. The pair trade will include long MV Oil Trust (MVO) and long ProShares Short Oil & Gas (DDG). MV Oil is unhedged and is currently yielding 10.7%. The ProShares Short Oil & Gas position will mitigate a continued deflationary environment for oil prices.
3. I will possess a long position in CVR Partners (UAN), which is yielding 6.8% as a master limited partnership (MLP). I believe fertilizer equities will continue to outperform as the world’s populations expands. I will own a short position in SPDR Gold Shares (GLD) to reflect deflationary pressures. In addition, the strength of the U.S. dollar and a resolution of the euro crisis are likely to put a cap on SPDR Gold Shares' 2- to 3-year price appreciation.
4. I want to short the countries that are deleveraging and returning to austerity. I want to be long the regions that are leveraging and growing. This results in long positions in the following 4 regional exchange-traded funds: ProShares Short MSCI EAFE (EFZ), ProShares Short S&P500 (SH), iShares MSCI Emerging Markets Index (EEM), and iShares S&P Latin America 40 Index (ILF).
5. I want to own 3 recession-resistant, dividend-paying equities: Philip Morris International, Inc. (PM), Altria Group Inc. (MO), and iShares S&P Global Utilities (JXI). Philip Morris provides international growth exposure in the cigarette market; Altria provides exposure to the U.S. cigarette market; the iShares S&P Global Utilites provides global exposure to the constant and increasing utility bills.
6. A long position in the Market Vectors Chinese Renminbi/USD ETN (CNY) will provide some upside, I anticipate, as the Chinese currency inflates slightly to the U.S. dollar.
Each of these 11 positions will be equally weighted to determine portfolio success. The goal is to achieve income and capital appreciation, and to reduce downward pressure through inverse funds. If my assumptions are correct, as Ray has noted, then I hope I can provide an outperforming portfolio.
Disclosure: I am long AGNC, PM, MO, UAN, MVO, DDG, GLD, SH. I will buy positions, after 7 days, in all securities mentioned that I do not presently own.