Bridgewater Associates' iconic risk-parity strategy, All Weather, recently has been tweaked with the addition of new interest rate hedges aimed at reducing the variation of returns from the expected rate of return of the portfolio over longer time periods.
Bridgewater co-CIOs Raymond T. Dalio, Greg Jensen and Robert Prince spent the last six months researching the interactions of real yields, asset class returns, risk premiums, monetary policy and economic conditions.
Their conclusion was that “real yields are part of the discount rate by which all assets are valued. Changes in real yields impact all assets, not just bonds,” Mr. Prince told investors in the $70 billion All-Weather strategy who participated in a conference call on Monday. Pensions & Investments heard a replay of the call and received supporting documents.
The implication for the risk-parity strategy was it has “more real yield exposure than we need” within non-bond assets in the passive portfolio, Mr. Prince said.
Applying interest rate hedges to the “real yield exposure embedded in non-bond assets … we end up with about the same Sharpe ratio but with a cumulative return that is closer to the straight-line return that we're trying to achieve,” Mr. Prince told investors on the call.
The addition of the interest rate hedges will allow the strategy to “achieve less variation” in returns over shorter time periods but not change the long-term expected return, Mr. Dalio told investors.
“It's not really that big of a deal,” Mr. Prince said on the call. The return will be a “little bit better … you get closer to tracking that straight line … which is basically the accrual of the risk premium.”
The annualized return expectation is 6.5 percentage points over cash over with a 0.65 Sharpe ratio and with 10% of market volatility.
Returns of the All Weather strategy for periods ended May 31 were one-year, 5.6%; three years, 13.5%; five years, 5.8%; and 10 years, 8.2%. Multiyear returns are annualized.