The All Weather Story

How Bridgewater Associates created the all weather investment strategy, the foundation of the ‘risk parity’ movement. 

Risk Parity is about balance

Over twenty years ago Bridgewater Associates pioneered portfolio balancing concepts that came to fruition with the creation of the All Weather asset allocation strategy in 1996. Recently, several managers have begun to offer strategies based on some of these concepts, under the banner of “Risk Parity.” Adoption of these more balanced asset allocation strategies has surged in the institutional investment community, as investors increasingly realize that concentrated portfolios are dangerous and unnecessary for meeting their return requirements. In the following article, Bob Prince, Co‐Chief Investment Officer of Bridgewater, explains the concept of balance that lies behind the Risk Parity approach, and All Weather’s unique way of achieving reliable balance. 

ENGINEERING TARGETED RETURNS & RISKS: 

Ray Dalio, founder of Bridgewater Associates, explains how to structure a portfolio to target a 10% return with 10-12% risk. 

In 1996, Bridgewater Associates established the All Weather principles for asset allocation, which have now been more broadly adopted under the banner “Risk Parity.”
In 2004, Mr. Dalio wrote an article in which he explained these principles. That article is reprinted here, with relevant updates. 

Understanding Risk Parity:

So, You Think You’re Diversified...  

The outperformance of Risk Parity strategies during the recent credit crisis has provided evidence of the benefits of a truly diversified portfolio. Traditional diversification focuses on dollar allocation; but because equities have disproportionate risk, a traditional portfolio’s overall risk is often dominated by its equity portion. Risk Parity diversification focuses on risk allocation. We find that by making significant investments in non-equity asset classes, investors can achieve true diversification – and expect more consistent performance across the spectrum of potential economic environments. 

Leverage Aversion and Risk Parity 

We show that leverage aversion changes the predictions of modern portfolio theory: It causes safer assets to offer higher risk-adjusted returns than riskier assets. Consuming the high risk- adjusted returns offered by safer assets requires leverage, creating an opportunity for investors with the ability and willingness to borrow. A Risk Parity (RP) portfolio exploits this in a simple way, namely by equalizing the risk allocation across asset classes, thus overweighting safer assets relative to their weight in the market portfolio. Consistent with our theory of leverage aversion, we find empirically that RP has outperformed the market over the last century by a statistically and economically significant amount, and provide further evidence across and within countries and asset classes. 

All photography by Jared Chambers