Bridgewater's All Weather Portfolio With Risk Parity

by: MyPlanIQ

In our previous article, we proposed an all weather portfolio that was based on actual asset allocation instead of the real risk parity consideration. The allocations of the proposed Bridgewater All Weather Portfolio are as follows:

Growth + Growth - Inflation + Inflation - Total Fund
Equities 6.25% 12.50% 18.75% VTSMX
EM Debt Spreads 6.25% 8.33% 14.58% PEBIX
Commodities 6.25% 8.33% 14.58% GLD
Corporate Spreads 6.25% 6.25% VWEHX
Nominal Bonds 12.50% 12.50% 25.00% VBMFX
TIPS 12.50% 8.33% 20.83% VIPSX

The percentages were derived based on equal spreads on the four corners of economic cycles. However, in Bridgewater's original presentation, the all weather portfolio should allocation 25% risk to each corner, instead of just simply the actual portfolio allocation.

To derive a more accurate portfolio, we extend the above work by treating the derived percentages as risk allocations instead of actual asset allocations. We then use 10 year standard deviation of a fund as its risk and solve a linear equation based on each fund's target risk allocation:

Tgt Risk Allocation Fund Std Dev (Risk) Actual Allocation %
Equities 18.75% VTSMX (VTI, SPY) 0.21 6.23%
EM Debt Spreads 14.58% PEBIX (PCY, EMB) 0.07 14.80%
Commodities 14.58% GLD (IAU,SLV,DBC) 0.21 4.84%
Corporate Spreads 6.25% VWEHX (HYG,JNK) 0.05 9.06%
Nominal Bonds 25.00% VBMFX (AGG,BND,IEF) 0.04 42.30%
TIPS 20.83% VIPSX (TIP,LTPZ) 0.07 22.77%
Total Risk 14.07 100.00%

Comparing the portfolio Bridgewater All Weather Portfolio With Risk Parity with the previous one, Bridgewater All Weather Portfolio, we notice:

  • Total risk asset allocation (equities + commodities + high yield bond + emerging market debts) is reduced from 54.16% to 34.9%
  • This makes the new portfolio fall into the conservative allocation category.

The following shows the performance comparison:

Portfolio Performance Comparison (as of 2/22/2013)

Ticker/Portfolio Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
Bridgewater All Weather Portfolio -0.7% -0.2% 2.8% 71.1% 9.2% 185.7% 7.0% 105.2% 8.7% 134.6%
Bridgewater All Weather Portfolio Risk Parity -0.3% -0.6% 5.0% 217.6% 8.3% 257.6% 6.9% 154.7% 7.3% 152.3%
VBINX -0.2% 3.9% 9.5% 146.2% 10.5% 100.4% 5.8% 32.6% 7.7% 52.8%
VFINX -0.3% 6.6% 13.7% 98.4% 13.2% 69.6% 4.7% 16.3% 8.1% 32.5%

*: NOT annualized

**YTD: Year to Date

VFINX: Vanguard 500 index fund (similar to SPY or VOO)

VBINX: Vanguard 60% stock 40% bonds index fund

You can find more detailed year-by-year performance comparison here.

The risk parity portfolio has higher Sharpe ratio (1.52 vs. 1.34) and smaller maximum drawdown (15% vs. 20%). It is thus a better portfolio using risk adjusted return (Sharpe ratio) metric.

One should note that this portfolio can be further improved to allow long-term Treasury bonds (such as TLT), long-term inflation protected bonds (such as PIMCO's LTPZ), long-term corporate bonds (NYSEARCA:LQD) and other instruments such as international stocks (EFA or VEA), emerging market stocks (EEM or VWO). Furthermore, in the inflation and equity category, REITs (IYR or VNQ) can be added to increase diversification.

The takeaway is that ordinary investors can now mimic the well known institutional all weather portfolios using increasingly available ETFs to achieve a fairly reasonable return (10 year 7.3%).

Disclosure: I am long GLD, SPY, EEM, IYR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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