Stable Returns. Stable Ride. All-Weather Investing.
This seems like it’s a game changer. If you can get the returns to go higher and the drawdowns to get smaller and the risk to get smaller, isn’t that the whole point of the industry?
- Eric Crittenden, Standpoint, CIO
An All-Weather strategy is a tool for long term growth and capital preservation, built to navigate changing market conditions while maintaining stability and balance. It means being prepared for all kinds of economic conditions, such as inflation, deflation, bear markets, bull markets, and potentially everything in between.
Some investors may be attempting to double their money in six months with a cryptocurrency bet, others might be day traders glued to CNBC placing market orders on S&P 500 options with their fingers crossed. But if you can approach investing from a more humble perspective and with a long term mindset, steady returns and capital preservation are realistic objectives. Building a solid retirement portfolio or creating a plan for generational wealth is a noble pursuit and in recent years all-weather strategies have become more available to the public in the form of mutual funds.
This strategy, All-Weather investing, was made popular by Bridgewater’s Ray Dalio (https://www.bridgewater.com/research-and-insights/the-all-weather-story). All-Weather strategies have proven themselves resilient through inflationary periods like the 1970s, through the market crises of 2001 and 2008, and have managed to keep pace during the bull markets of the 1990s and 2010s. All-Weather investing is not a new phenomenon, it has been used by hedge funds, pension funds, and endowment funds for years.
So, why aren’t more people investing like this? Well, the answer to that may be – they haven’t had to.
In recent decades, constructing a portfolio has been relatively simple. A passive approach using exchange traded funds has rewarded investors with a long enough time horizon. Others that have subscribed to Jack Bogle’s method by complementing their allocation to stocks with bonds, have enjoyed high bond yields for decades. Even those venturing out into emerging markets or other fixed income options such as corporate bonds, have faced little adversity. But we are now facing a new reality, and it looks very different than the last 40 years.
What we haven’t seen in the last 40 years is rising interest rates or any meaningful increase in inflation. As these both become a future reality, the advantage an All-Weather Portfolio has over a 60/40 portfolio will become more apparent.
Most investors understand that stocks carry the risk of severe, and sometimes prolonged, declines. This has become almost acceptable because investors have either had the time to recover their losses or the bonds in their portfolios have acted as a buoy. But what happens if bonds, the only diversifying feature of most portfolios, can’t be relied on going forward to offset losses in stocks? What happens in a scenario where bonds lose money at the same time as the stock market?
It's important to ask these questions now, at a time when interest rates are extremely low. Interest rates have declined from the high teens in the early 1980s to low single digits today. When interest rates are low, bonds are less likely to produce meaningful returns. Therefore, bond investors are faced with two likely scenarios: interest rates remain low and bonds continue to produce low returns, or interest rates increase and their bond holdings lose money.
Whether you have accepted the reality of the “bond problem” or you have always believed in the benefits of diversification, alternative strategies, in theory, offer an appealing sales pitch. But like a bait and switch at a car dealership, alternatives always seem to be more costly than advertised. Historically, many alternative strategies have proven to be ineffective and have fallen short on their promises to either enhance returns or mitigate risk.
The very definition of diversification implies independent movement relative to the rest of the portfolio. Despite understanding the logic of needing a diversified portfolio, watching in real time as an ‘alternative’ goes down while the rest of the portfolio goes up, rarely makes investors happy. This is sometimes referred to as diworsification. However, a smart asset allocation strategy alongside proper risk management controls, can find the balance between a traditional portfolio and diworsification. An All-Weather approach is that balance.
By combining multiple asset classes and strategies into one investment, investors can experience the benefits of diversification without the pain of diversification.
An All-Weather portfolio can be constructed in many different ways but the overall philosophy of being prepared for any economic environment remains the same.
Standpoint’s version of All-Weather includes exposure to equity markets in over 25 different countries, U.S. and foreign government bonds, metals, energy markets, currency cross rates, agricultural markets, and other various commodities. Standpoint also believes that exposure to these asset classes should not be constant, nor should it be long only. Using futures contracts as a vehicle to access the largest and most liquid markets in the world allows investors to benefit from both up and down moves in these markets.
Long exposure to different asset classes has obvious benefits. When the stock market is going up, investors expect their portfolios to be making money; getting left behind in a runaway bull market can potentially negate the benefits of diversification. Periods of inflation offer another clear benefit of long exposure. By including commodities and currencies in the portfolio, an All-Weather approach can take advantage of inflationary pressures.
On the other side, short exposure can be extremely valuable in particular market environments. For example, at the beginning of the Covid pandemic, an All-Weather strategy was able to generate returns from short positions in oil markets as prices approached zero and eventually turned negative. The ability to short currencies during economic downturns can also benefit a portfolio. An All-Weather strategy has the ability to take advantage of periods in which a traditional portfolio of stocks and bonds is underperforming such as supply/demand imbalances, geopolitical crises, and other unforeseen situations.
However, access to and inclusion of global markets is not the entire solution, a professional approach to portfolio management is vital to a strategy’s success. This means minimizing taxes and trading costs, monitoring liquidity and counterparty risk, and ensuring the execution of the strategy regardless of external factors. Alongside the skill of a portfolio management team, a systematic, rules-based approach to investing allows us to take the emotion out of investing by creating disciplined, repeatable processes. An All-Weather approach, just like market cap weighted equity indexes and laddered bond portfolios, should be systematized. In our view, minimizing human intervention and the biases that come along with that, is just as important as minimizing tax consequences.
The idea of an All-Weather approach to investing is not a new, radical innovation. It’s simply a natural progression of modern portfolio theory: invest in multiple, independent return streams in order to increase returns and reduce risk. For decades, investors have allocated to the components of an All-Weather portfolio, but usually as separate holdings in a sporadic or undisciplined manner. Standpoint blends these valuable components into a single strategy so that you, the investor, can experience the benefits of professionally managed diversification without the burden of managing this risk on your own.
IMPORTANT RISK INFORMATION
All information contained herein is for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation, or recommendation to purchase any security. The information contained herein has been prepared from sources believed reliable but is not guaranteed by Standpoint Asset Management, LLC ("Standpoint"). The views presented represent the opinions of Standpoint as of the date of this presentation and are subject to change.
Standpoint is an investment adviser registered with the US Securities and Exchange Commission (SEC). For more information regarding the firm, please see its Form ADV on file with the SEC. Registration with the SEC does not imply a particular level of skill or training. Past performance does not guarantee future results. Diversification does not guarantee a profit or protect against a loss.
All statements, other than historical facts, are forward-looking statements. The statements contained herein may contain certain forward-looking statements relating to Standpoint that are based on the beliefs of the management as well as assumptions made by and information currently available to management. These forward-looking statements are, by their nature, subject to significant risks and uncertainties. These forward-looking statements include, without limitation, statements relating to future developments, trends and conditions in the industry and geographical markets in which Standpoint operates. Important factors that could cause actual results to differ materially from such plans, estimates or expectations include, among others, (1) evolving legal, regulatory and tax regimes; (2) changes in general economic and/or industry specific conditions; and (3) other risk factors.
Investing involves risk, including loss of principal. Equity markets include risk factors such as domestic and economic growth and market conditions, interest rate levels and political events that may affect securities markets. The value of an equity security may decrease in response to the activities and financial prospects of an individual security in the portfolio. The primary risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates rise. By buying a bond, the bondholder has committed to receiving a fixed rate of return for a fixed period. Should the market interest rate rise from the date of the bond’s purchase, the bond’s price will fall accordingly. The principal risks of investing in managed futures includes risk involving commodities, currencies, interest rates, equity securities, futures and forward contracts. Investments in alternatives should be viewed as a long-term investment and may not be suitable for all investors and may only be suitable for investors who can bear the risks associated with investments in derivatives that may give rise to leverage risk.