The All Weather Portfolio: Built for Any Forecast

Markets are unpredictable, but an All Weather portfolio approach, pioneered by Bridgewater Associates, is built to prepare for a wide range of economic environments. Explore how this approach can help you build a more resilient portfolio for the long term.

Have you ever dressed for hot and sunny weather, only to step outside and realize it had begun to rain? In many ways, markets and economies behave like the weather: there are patterns, but they can be wildly unpredictable at times.

Investors certainly spend a lot of time trying to predict what the market will do next. They invest today based on what they think will happen tomorrow. But the biggest risks to markets are often the ones you don’t see coming. How could you have known it would rain when the weatherperson said it was going to be a beautiful day?

Investors shouldn’t have to be “market meteorologists.” Instead of trying to predict the future, now you can prepare for it with an All Weather portfolio approach — designed to deliver resilient returns over the long term.

What Is An All Weather Portfolio Approach?

Created by Bridgewater Associates, All Weather is an asset allocation approach designed to deliver consistent returns across economic environments and market cycles. The approach seeks to allocate to assets based on how those assets respond to changes in growth and inflation — the most important drivers of market returns. By allocating risk across different asset classes and regions, it seeks to create a balanced portfolio that generates high and consistent returns over the long term, while mitigating downside risk along the way.

The All Weather portfolio approach invests beyond just stocks and bonds. Globally diversified, it provides exposure to:

• Global equities.
• Global bonds, both inflation-linked and nominal, with varying durations.
• Gold.
• Broad commodities.

By balancing risk across assets that do well in different economic environments, an All Weather approach seeks to grow wealth with equity-like but more stable returns over time — without trying to predict the future.

What Are Economic Environments, Anyway?

Understanding economic environments and how they drive the returns of asset classes is vital to understanding how All Weather investing works. Assets respond differently to two main drivers: growth and inflation. Growth and inflation matter because they drive the cashflows of different assets, and how valuable those cashflows are. Therefore, you can think about four key economic ‘environments’ that impact asset prices:

1. Rising growth environments: when economic growth is stronger than markets expected
2. Falling growth environments: when economic growth is weaker than markets expected
3. Rising inflation environments: when inflation is higher than markets expected
4. Falling inflation environments: when inflation is lower than markets expected

Different asset classes have different biases, meaning they behave differently in different environments. The All Weather approach is designed to take advantage of these differences to neutralize the impact of changing economic environments on the total portfolio (Figure 1).

History of the All Weather Approach

Bridgewater’s All Weather approach dates back to the 1970s, a decade that helped reshape the field of portfolio construction and risk management.

All Weather Approach: Key Features

The All Weather approach has several unique features that differ from traditional asset allocation approaches: it allocates to assets based on risk rather than based on capital, it diversifies based on cause-and-effect relationships rather than unstable correlations, and it uses capital-efficient portfolio engineering. Capital-efficient portfolio engineering refers to the use of futures, swaps, or other derivatives to achieve greater exposure to assets than the initial cash outlay. This allows you to diversify into lower-risk assets without sacrificing potential returns.

Allocate Risk, Not Capital

Because asset classes perform differently depending on the economic environment, an All Weather approach aims to maintain balance across environments by allocating risk, not capital, across assets that tend to do well at different times. This is different from many traditional stock-bond portfolios, where risks can become concentrated and imbalanced. Approaching asset allocation this way may lead to more consistent, long-term portfolio outcomes.

Risk Allocation vs. Capital Allocation: What’s the Difference?

Capital allocation is a common strategy for constructing portfolios, where an investor allocates dollar amounts to certain assets without considering the portfolio risk exposure. A portfolio with equal capital allocation to stocks and bonds is balanced from a capital perspective. But because stocks are more volatile than bonds, the portfolio performance will be primarily driven by stocks, resulting in imbalanced risk allocation.

Here’s how risk allocation works. Imagine you have $100 to invest, and you’re only allocating that $100 to stocks and bonds. Here’s how you might allocate your investment using each approach:

• Traditional Capital Allocation: Using a traditional capital allocation approach, you’d assign a dollar amount to each asset class. For example, in a 60/40 portfolio, you’d allocate $60 to stocks and $40 to bonds.
• Risk Allocation: Using a risk allocation approach, you’d assign how much risk you want to come from each asset class, then evaluate the risk profiles of those assets and allocate a dollar amount to those assets to achieve the target risk exposure. Imagine, for example, that you want a portfolio where the risk comes equally from stocks and bonds and stocks have a 10% volatility level and bonds have 5% volatility.
  
  In a risk allocation approach, you’d invest around $33 in stocks, and around $67 in bonds. In other words, you’d put twice as much in bonds as stocks because stocks are twice as risky. In this approach the risk is more balanced. However, the challenge is that you could be sacrificing returns by holding more bonds (which generally have lower risks and lower returns). This is why it’s important to pair a risk allocation approach with capital-efficient portfolio engineering, as discussed below.

This example only looks at stocks and bonds, but the All Weather approach is designed to balance risk to different economic environments using a variety of asset classes across major developed and emerging geographies.

Emphasis on Risk Diversification

All Weather portfolios are globally diversified across many different kinds of asset classes. Diversifying across assets may mitigate risks that come from growth and inflation surprises, while global diversification may mitigate volatility driven by economic cycles in any single region.

No one region and no one asset outperform all the time, so diversifying across asset classes and regions may deliver more consistent long-term returns. Here’s why:

Asset Class Concentration Can Be Risky

Because asset prices are impacted by changes in economic environments, any single asset class can experience boom and bust cycles — and, as history shows, periods of underperformance can last a long time (Figure 3).

Asset Correlations Can Be Unreliable

Different assets are not diversifying to each other all the time and relying on unstable correlations can lead to unintended portfolio concentration. This is because correlations are not timeless characteristics of assets, but rather are dependent on the unfolding economic environment.

Diversify Based on Cause-and-effect Relationships, Not Correlation

Due to their environmental biases, asset classes outperform in some macroeconomic environments and underperform in others. Instead of relying on correlations, which can be inconsistent, the All Weather approach relies on the time-tested sensitivities asset classes have to different economic environments. By diversifying across assets with different environmental biases, an All Weather approach seeks to balance risk across economic environments, creating a more resilient return stream.

The Role of Portfolio Engineering

It’s important to ensure that All Weather’s diversification doesn’t come at the expense of potential returns. All Weather portfolios use capital-efficient portfolio engineering to aim to achieve an overall portfolio with equity-like returns but with lower risk.

Diversification Without Sacrificing Potential Returns

An All Weather portfolio approach may use futures, swaps, or other derivatives to gain greater exposure to certain asset classes than the initial cash outlay. It does this to increase exposure to lower-risk assets so they can be put on a “level playing field” alongside higher-risk assets — without sacrificing potential returns.

For instance, bonds tend to be less risky than equities, but as a consequence their returns also tend to be lower. Without a capital-efficient approach, bonds would need to make up a much larger part of the portfolio at the expense of the equity exposure, and investors would sacrifice some potential return as a result.

The use of capital-efficient portfolio engineering may help investors to achieve increased exposure to diversifying assets without sacrificing potential returns.

All Weather Wisdom: Philosophy Behind the All Weather Approach

Building a globally diversified portfolio on your own can be a daunting task. But investors can embrace core principals of the All Weather approach — based on three time-tested investment realities — to guide their investing process.

1) Stay Invested: Assets Go Up Over Time

Over the long-term, assets have outperformed cash. But the path is rarely smooth. An All Weather approach looks to keep investors in the market accruing returns, while preparing for the unexpected.

2) Diversify: No One Asset Class Stays on Top Forever

Portfolios that are concentrated in any asset class can experience prolonged periods of wealth destruction. Market leadership rotates. What led in the last few years, or even decades, may not lead again for a long time.

3) Prepare: The Future Is Uncertain

Investors tend to extrapolate the present (or recent past) into the future, but rarely do things stay the same. Unexpected events, from financial crises to geopolitical shocks, can disrupt even the most well-reasoned financial forecast. That’s why it’s vital to position for a wide range of environments.

Why Consider All Weather Now?

US equities recently experienced their best 15-year period relative to cash since 1970.⁹ But it is far from guaranteed that this exceptional run will continue.

The beginning of that 15-year period of outperformance saw favorable conditions for US equities — low valuations following the Global Financial Crisis, low inflation, and easy monetary policy in the form of low interest rates. But times are changing, and the next economic season could look very different from the last:

• Starting equity valuations are much higher, creating a higher bar to clear for outperformance.¹⁰
• Geopolitical risks are elevated, and shifts in the direction of deglobalization or the implementation of tariffs create novel risks.¹¹
• Inflation has become a relevant concern for investors and policymakers, after decades where it hovered right around 2%.¹²
• Monetary policy, in response, remains tighter than last decade, as central banks worldwide continue to fight inflation.

As the winds shift, to prepare their portfolios for a wide range of possible outcomes, investors may want to consider adding the kind of diversified, multi-asset global exposure an All Weather portfolio is built to provide.

Considerations Before Investing in an All Weather Approach

Although the All Weather approach is designed to provide consistent returns in the long run, like any investment strategy, it carries its own risks and potential downsides.

• Added Complexity: An All Weather approach to investing can be complex because it is globally diversified across multiple regions and asset classes, including commodities. Moreover, it also uses derivatives like futures and swaps. For many, trying to create and manage and All Weather portfolio on their own may be an impossible burden.
• Underperformance in Equity Bull Markets: Because of its diversified allocation, an All Weather approach may underperform traditional equity-dominant portfolios in environments that are particularly favorable for equities.
• Losses in Risk-Averse Markets: An All Weather approach, like any strategic asset allocation, may underperform cash when cash is the most attractive asset amid sharp increases in interest rates or risk-averse investor sentiment.
• Leverage Risk: The use of leverage has the potential to amplify losses.

Resilient Long-term Returns: Is All Weather the Answer?

Uncertainty might be the only certainty in life and in the world of investing. As the world evolves, so do the conditions investors face — often in outrageously unexpected ways.

The good news is you don’t have to struggle to predict the future. Prepare for the future instead with an All Weather portfolio approach designed to deliver resilient returns over the long term, no matter which way markets move or how the economic environment changes.