Creating an All-Weather Portfolio - The Comfy Armchair

Markets are volatile. Not that they ‘can be’ volatile, they are volatile. Sometimes, like we saw with the crisis of COVID19 and the resulting financial markets’ response to massive injections of income supports and business bailouts from world governments, they can be terrifying for the average long-term investor.

Prior to COVID19, economies and markets were already teetering on the edge of recession. The only questions seemed to be ‘when’ and ‘how bad’. Frankly, although most analysts and commentators are saying a recession (and maybe a….ummm….depression) is now essentially inevitable, nobody has the proverbial ‘crystal ball’ to know for sure what the outcome of all this will be.

Your post-COVID19 portfolio may already be down anywhere between 15 and 30% depending on its asset allocations, current events, or the time-of-day. Painful to say the least. Most advisors will tell their clients to stay the course, and historically, that has always been good advice. Losses are only realized when assets that have dropped in price are actually sold. While it would be great to ‘sell high’, that ship has currently sailed. Conversely, looking at the other side of the coin, the opportunity to ‘buy low’ can also be tricky. No one can consistently call a market high or low with any degree of accuracy, until (of course) after the fact….when everything suddenly becomes clear again!

All-Weather Portfolios

Wouldn’t it be nice to have a portfolio that not only does well in good times, when the bull is stampeding, and also in bad times when the bear is on a tear? And for the latter, think of ‘performing well’ as meaning losing less, and preferably a lot less, than the underlying markets and indexes.

A number of people have tried to do just that over the years, creating relatively simple portfolios utilizing mixes of asset categories that, working together, ensure you’re going to do fine under virtually any economic conditions. Let’s look at a couple.

Ray Dalio’s All-Weather Portfolio

American hedge-fund manager and writer Ray Dalio designed his version of an all-weather portfolio in the 1970’s, in response to political and economic uncertainties relating to the Nixon presidency.

It’s relatively simple, consisting of 30% US equities, 7.5% commodities, 7.5% gold, 40% US long-term treasuries (bonds), and 15% US medium-term treasuries.

Dalio recommends that the portfolio be rebalanced at the beginning of each year, in January.

The Golden Butterfly

‘Tyler’, a writer and contributor at portfoliocharts.com, looked at Dalio’s and other versions of permanent (all-weather) portfolios, made some modifications, adjusted the asset allocations of came up with what he called the Golden Butterfly.

The Golden Butterfly consists of 5 asset classes, each weighed equally at 20%. They are : gold, US short term treasuries, US long term treasuries, US large cap equity, and US small cap equity.

Like Dalio’s portfolio, Tyler’s Golden Butterfly should be rebalanced on a periodic basis to ensure it maintains its intended asset allocation percentages over time.

The Comfy Armchair

Having a fair amount of time on my hands given the COVID19 lockdown conditions currently in place in Canada, I decided to take a stab at this myself. I took a look at Dalio and Tyler’s portfolios, played with the allocations, tried including some other asset classes (like REITs), and adjusted the weightings to try to maximize the upside, minimize the downside, and mitigate fluctuations due to volatility (resulting from market conditions and/or investor behaviour).

I found that adding more asset classes and complexity wasn’t the answer. Simple actually works best. Through trial and error validation and back-testing, I ended up sticking with four asset classes, and fine-tuned the allocations (the percentage weightings) to optimize the results as best I could.

The end result is a portfolio which rivals the All-Weather or Golden Butterfly, with the potential to do even better in terms of overall performance in good times and recession-proofing in bad. The main challenge of course was to come up with a catchy name for it. I decided on the Comfy Amrchair.

So here it is. The Comfy Armchair permanent portfolio is comprised as follows: 35% US equities, 10% gold, 40% US long term treasuries, and 15% US medium term treasuries.

Like the other portfolios, periodic rebalancing is a must. Once a year, in January, would be fine. But hey, doesn’t your portfolio deserve two good looks a year? So why not take stock (so to speak) a second time and rebalance again in early June? January and June are usually pretty stable times in the markets, so those would seem to be ideal moments to reflect and make any necessary adjustments.

Do they work? The Back-testing Results

I’ve looked at all three – the Dalio All-Weather, the Golden Butterfly, and the Comfy Armchair – and back-tested them from the end of 2019 all the way back to 2006, to ensure they at least ‘experienced’ the last major financial crisis of 2008/2009. How did they fare? In a nutshell, good. Very good.

How did I back-test them? I’m glad you asked. The internet being the amazing thing it is, I found a great free back-testing tool called the Portfolio Visualizer. It allows you to look at several portfolios at once, adjust the assets and the weightings, and immediately view the results based on the time period you’ve selected. How cool is that?? (Note for readers: that is a rhetorical Finance and Investment Nerd question….actual answer not required or expected)

A hypothetical $10,000 was invested in each, and have been compared to an all-equity ‘Vanguard 500’ Index Investor. As you can see, all 3 of these portfolios performed admirably in relation to the index.

The Comfy Armchair comes closest in overall final balance and compound annual growth rate (CAGR) to a long-term, all-equity approach. But it does so with a highly reduced level of volatility, as can be seen in the figures relating to standard deviation, worst-year and maximum draw-down. The Comfy Armchair has a worst year of 2.65%, versus 37.02% for the index. The max draw-down is 12.58% versus 50.97% (ouch).

The compound annual growth rate is 7.76% for the Comfy Armchair versus 8.68% for the index. Very comparable. But oh, what a far less stomach-churning ride.

What kind of investor would this appeal to? It could appeal to many, but I’m thinking especially to those who have a substantial nest egg and are approaching retirement, who want to protect themselves from the sequence of returns risk inherent with an early retirement hit on assets. You don’t want to deal with the possibility of a 40 to 50% hammering of your assets immediately before giving the Boss your retirement notice!

Where’s the Canadian Content?

Some will wonder why these portfolios neglect to include Canadian equities and bonds. Good question.

From a practical standpoint, both the Dalio All-Weather and the Golden Butterfly were designed from the American investor standpoint. And I wanted to design something to compare and compete with those.

Remember, however, that the Canadian market comprises only 3 or 4% percent of global markets, and it is highly concentrated in sectors like financials, energy, and communications. The US market (the total market and/or S&P 500) offers wide global coverage, given the number of companies that operate as multi-national corporations around the world. In terms of equities, legendary investors like Warren Buffet have opined that the broad US markets provide the necessary level of diversification most investors need.

But hey, if you’re a patriotic Canuck and you want to make sure you include the Canadian market, you could allocate a portion of the 35% equities to that. The exact portion of course is ultimately your decision, but I wouldn’t go over 15%, lest you want to experience ‘home country bias’. And that would be 15% of the 35%….so essentially, maybe, 5.25% of the total Comfy Armchair.

Similarly, on the bond side, it would be easy enough to swap out the US government bonds for Canadian, in whatever proportion or mix you want or feel most comfortable with.

Sample Porfolio

OK, before you ask, I know you want me to actually show you how this can be done, using low-cost ETFs of course. So here you go:

US equities: Horizons HXS Total Return S&P 500 in a non-registered (taxable) account, or Vanguard VUN Total Market in an RRSP or TFSA

Gold: MNT Royal Canadian Mint exchange traded receipts, or iShares CGL Gold. I like MNT, but CGL is more liquid and therefore easier to buy and sell.

US Long Term Treasuries: Bank of Montreal ZTL (Canadian dollars) or ZTL.U (US dollars)

US Medium Term Treasuries: Bank of Montreal ZTM (Canadian dollars) or ZTM.U (US dollars)

So are these ‘Pandemic Portfolios’?

If your portfolio has already been clobbered due to the market conditions relating to COVID19, it’s probably not the time to make major changes. It’s too late, the damage is done. If you already have a globally diversified balanced portfolio that is aligned with your risk comfort level, the best thing you can probably do at this point is ride things out.

That being said, it’s never a bad time to review your current asset allocations and risk tolerance. If anything’s out of whack with your target weightings, go ahead and make the necessary adjustments to bring things back into alignment.

Final Disclaimer

This is not to be considered as investment advice. As always, before making any new investments decisions or changes to your existing portfolio, please do your own full and due diligence, and consult with a professional and properly accredited financial advisor.

Hope that you enjoyed reading this post. Please leave a comment and let me know.

Armchair