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The PowerShares S&P 500 Low Volatility Portfolio ETF: Taming The Shrew?

An S&P tracking fund that ‘filters out’ volatile S&P issuers and tempers overall volatility. The fund has proven itself with consistent dividends and share appreciation. Incepted in May 2011, the fund has yet to be proven in a bear market. In the dialogue of ” The Taming of the Shrew” , Gremio famously asks , ” But will you woo this wild-cat? ” Gremio must have surely understood investing! You see, trying to tame portfolio volatility is like wooing a wildcat. However, as many an investor has discovered, there’s no attaining above average returns without taking higher volatility risks. According to Investopedia, “Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared and Sharpe ratio” and that Alpha is, ” the excess return of the fund relative to the return of the benchmark index. ” Every passionate investor seeks Alpha through ” a course of learning and ingenious studies,… though time seem so adverse and means unfit .” Another technical risk ratio, ” Beta “, is the measure of volatility relative to the market. In brief, it’s a statistical relationship measuring the volatility of an asset relative to the market as a whole; i.e., to a benchmark. The benchmark is assigned a beta of 1. A beta of less than 1 means that the asset is less volatile than the market and a beta greater than 1 means that the asset is more volatile than the market. Beta is best thought of as the expected percentile change of an asset’s value relative to a benchmark change. After a little thought a prudent investor is certain to ask whether it’s possible, through careful selection of low volatility stocks, to produce above average results. In other words, can low beta produce high alpha? A passionate retail investor might even attempt to construct such a portfolio but generally speaking it would be quite a task. So it begs the question, whether there are ETF products available to satisfy this requirement. There are at least 20 volatility focused ETFs. These include those focused on the Russell 2000 and Russell 1000, S&P 500 enhanced volatility, rate-sensitive low volatility, Japanese, European, International Developed Market, Emerging Market and Global volatility focused funds. There’s one plain vanilla ETF that seems to focus simply S&P 500 low volatility. That is the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ). According to Invesco: The PowerShares S&P 500 ® Low Volatility Portfolio is based on the S&P 500 ® Low Volatility Index… …The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the S&P 500 ® Index with the lowest realized volatility over the past 12 months… The fund remains at least 90% invested at all times. Since the fund’s objective is to track low volatility, it’s a good idea to see how volatility is distributed throughout the fund. It’s said that a picture is worth a thousand words so the following table tells quite a story. The question becomes just how to describe the volatility by sector. To this end, a simplified version of beta is constructed by determining a simple average beta of the fund and it’s sectors and then comparing it with the entire S&P 500. This may be accomplished through the use of the corresponding individual Select Sector SPDR S&P ETFs. Average Beta Per Sector Sector Average Beta Consumer Discretionary 0.990 Sonsumer Staples 0.878 Financials 0.864 Health Care 0.858 Industrials 0.761 Technology* 0.670 Materials 0.893 Utilities 0.220 Energy 0.000 Average 0.682 According to Select Sector SPDR; … Each Select Sector Index is calculated using a modified “market capitalization” methodology. This formula ensures that each of the component stocks within a Select Sector Index is represented in a proportion consistent with its percentage of the total market cap of that particular index. However, all nine Select Sector SPDRs are diversified mutual funds with respect to the Internal Revenue Code. As a result, each Sector Index will be modified so that an individual security does not comprise more than 25% of the index… According to the Select Sector prospectus these are actively managed funds and are focused on tracking the entire sector regardless of volatility . It’s then becomes a simple matter to table and compare each sector’s beta. The S&P 500 is divided into 9 sectors. The fund is also divided into nine sectors but in a different way. The companies in the fund’s IT and Telecom sectors are included under the single heading of the S&P ‘technology sector’. Also, SPLV omits the energy sector completely. Hence, in order to create a 1-1 correspondence, the IT and Telecom sectors are combined and an entry of 0.00 is assigned to the energy sector. Beta Comparison Table Sector SPLV Weight SPLV Beta SPDR Beta Consumer Discretionary 6.504% 0.990 1.050 Consumer Staples 21.028% 0.878 0.610 Financials 35.413% 0.864 1.270 Health Care 11.195% 0.858 0.690 Industrials 14.083% 0.761 1.200 Technology* 6.355% 0.670 1.000 Materials 2.832% 0.893 1.290 Utilities 2.596% 0.220 0.250 Energy 0.000% 0.000 1.340 Average SPLV Beta 0.682 It is plain to see from the table that in some cases, the SPDR Sector Fund actually has a lower beta than does the SPLV sector. It is important to observe also, the Select Sector SPDR funds have far more holdings in each portfolio. For example, the SPLV financial sector includes 35 holdings and a beta of 0.864. On the other hand, the Select Sector SPDR Financial Sector fund, XLF has 88 holdings, essentially the entire S&P financial sector, with a beta of 1.27. What about SPLV’s performance when compared to the entire S&P 500? This is accomplished through the use of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) which tracks the performance of the S&P 500. ETF Shares 1 Month YTD 1 Year 3 Year From 5-5-2011 SPY -2.17% 0.87% 5.09% 53.20% 54.86% SPLV -0.72% -2.19% 4.86% 34.53% 46.69% In the volatile month of June, SPLV did prove its mettle, losing a mere -0.72% versus a -2.17% loss for the unrestricted S&P tracking SPY. Year to date SPY was virtually unchanged with a 0.87% gain whereas the more defensive SPLV was down; -2.19%. This is more than should have been expected. Having an average 68% of the volatility of the S&P, SPLV should have returned at least a positive 0.59%. Over one year, it was nearly even with the unrestricted S&P tracking ETF. Over three years, the SPLV low volatility shares returned 34.53%, which works out to about 64.90% of the 53.20% return of the market tracking SPY shares. Hence, in the expectation ballpark. Lastly, from the inception date of May 11, 2011, SPLV outperformed its expectations with a 46.69 return vs. the unrestricted SPY’s 54.86%. Having an average of 68% of the S&P volatility, a 37.30% returned would have been expected. These are market price comparisons which do not include the $3.5381 total dividends distributed since the May 5, 2011 inception date. (click to enlarge) The question then becomes whether holding a low volatility S&P fund is worth the sacrifice of some of the upside gains vs. the unrestricted S&P 500? This is difficult to answer since SPLV came to market, as mentioned, in May of 2011 and has yet to prove itself in a real bear market. However, if the correlation of the fund to date is any indication, SPLV may well serve as an excellent ‘ defensive tool ‘ for an investor already in the market. There are many important questions the investor must consider. For example, is it worth the commission cost of reallocating? How much of the investor’s portfolio is really at risk? What will be the short or long term capital gains tax risk? Is there enough free capital at hand to ‘average down’ portfolio holdings in the event of a bear market? There are numerous good reasons to invest in the fund. For example, an investor might be too close to retirement to risk the full volatility of the equities market, but still has several years before the funds are needed, may consider it. Another is too use the fund to protect profits accumulated over the past several years and still participate in the market. It’s also important to note that the fund is marginable and that there are listed options for SPLV. Hence an experienced option investor may use SPLV as an underlying asset in combination with various options strategies. According to the summary prospectus the fund carries 100 holdings, matching the number of holdings in the S&P Low Volatility index and has 127.4 million shares outstanding adding up to a $4.742 billion market cap. However, it should be noted that the fund’s most recent P/E at 19.37% is higher than the unrestricted SPY P/E at 17.46. The fund is currently selling at a very low premium to its underlying NAV at 0.08%. SPLV has paid 43 dividends since inception totaling $3.5381 per share. That works out to 14.1978% of the fund’s closing price on its first day of trading 5/5/2011. Management fees are 0.25%. In summary, it seems that volatility can be indeed be tamed but it is done so at the expense of alpha. However, for those willing to devote themselves to a low volatility S&P fund, nested in a carefully diversified portfolio for the long term, well else can be said other than all’s well that ends well. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: CFDs, spread betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.

Sell Your XLF

Summary Financials face too many headwinds going forward. Terrible Risk Reward Profile for XLF components. ETF vulnerable to a major sell-off. Quick Background Launched in December, 1998, the Financial Select Sector SPDR ETF (NYSEARCA: XLF ) is an exchange-traded fund comprised of roughly 90 securities with $18.1 billion in assets. It seeks to provide investment results that correspond to the performance of the S&P Financial Select Sector Index and attempts to provide an effective representation of the financial sector of the S&P 500 index. XLF components can be broadly classified as banking (35.5%), insurers (16.5%), real estate (REITs, 15.6%), capital markets (13.8%) diversified financial services (12.7%) and consumer finance (4.9%), as of the end of Q1, 2015. Some Concerns Concentration There is substantial concentration risk in the XLF. The top 3 holdings in the fund, Wells Fargo (NYSE: WFC ), JPMorgan (NYSE: JPM ), Berkshire Hathaway (NYSE: BRK.B ) account for a quarter of the fund’s weighting and the top ten holdings account for almost half (49%). If something goes awry for one of the major components, it would have a very disproportionate effect on the XLF. From the Select Sector SPDR Website : Housing ‘Recovery’ The housing sector has had a great rebound from the depths of the financial crisis. But we think housing is in a countertrend bounce which will work lower once again now that QE and the Feds ZIRP (zero interest rate policy) are ending. Wells Fargo is the main player in this area since it originates about 15% of mortgages in the U.S. and services mortgages with values over $1.7 trillion. Both the originations and servicing metrics are more than Chase and Bank of America (NYSE: BAC ) combined. WFC has rocketed back almost 7.5 fold from the March 2009 lows, or roughly 150% more than the broader averages. When the May numbers for new U.S. single family home sales were released a couple weeks ago, CNBC ran the headline ‘Home Prices near Prior Peak.’ It’s worth noting that Wells Fargo’s stock is about 60% higher now than when house prices peaked in June of 2006 so there is quite a bit of optimism built into that appreciation. WFC directly makes up 8.71% of the fund but if you also add in Berkshire Hathaway’s holdings of Wells Fargo stock, it’s really closer to 11% of XLF. A downturn in the housing sector could disproportionately hurt Wells and the XLF. Let’s not forget that WFC shares lost almost 83% of their value in a seven month stretch during 2008-2009. Even Wells Fargo’s Chief Economist offered some caution at a recent conference when speaking about the San Francisco market and to “put some money aside in the piggy bank.” Derivative Exposure The top 4 investment banks (JPMorgan, Bank of America, Citigroup (NYSE: C ) and Goldman Sachs (NYSE: GS )) hold 91.3% of the total derivatives outstanding ($185 trillion of the $203 trillion outstanding as of Q1 2015), according to the Office of the Comptroller of the Currency, OCC . The combined total assets for these 4 banks are just over $5 trillion which represents just 2.7% of their derivative exposure. I went and took just the cash and cash equivalents of these big 4 banks from the end of the first quarter of 2015 from Yahoo Finance and the sum was $1.97 trillion which represents just 1% of their total derivative exposure. If there is some type of shock to the system (Lehman Brothers, Bear Stearns) with derivative exposure compared to their assets this stretched, these firms are dangerously undercapitalized. Total notional value of all OTC derivatives is $710 trillion, according to the Bank for International Settlements. Granted this is worst-case scenario numbers and netting effects will mitigate much of this exposure but even if a fraction of the exposure goes awry (counterparty or a clearing firm gets into trouble) it would have a serious effect on these firm’s capital base. Just these top 4 investment banks make up 22.5% of XLF. XLF’s second largest holding, JPMorgan has derivative exposure of $52.4 trillion which is 25 times larger than its asset base of $2.1 trillion. (click to enlarge) The exposure for Goldman Sachs is truly worrisome. They rank #3 in total notional derivatives with $44.51 trillion which is a jaw-dropping 348 times larger than their total asset base, $127.77 billion, according to the OCC’s quarterly report. Goldman Sachs survived the financial crisis by (arguably) getting on the short side. Who knows if they will be able to hedge so well again with all the prop trading restrictions? The lines between market-maker and prop trader will be more severely scrutinized this time around. Goldman has made it through the financial crisis (the stock had recovered 87% of its pre-crisis value) but I think the ire of many will be directed towards Goldman the next time around, especially post ‘Muppet-Gate.’ Lastly, Goldman’s value-at-risk, VaR, measured relative to equity is very low at only a tenth of one percent, according to the OCC report. We worry this is understated because 1- they report their VaR at only a confidence level of 95% (versus Banc of America or Citigroup who disclose at a more stringent 99%) and 2- the VIX has been at very low levels for three straight years now, with only the occasional spike which is quickly retraced. VaR tends to follow the VIX and we think a large VIX increase, and more importantly, a more sustained increase is imminent. Even though the VIX has started to move up again, there is still more complacency shown than in prior spikes (the open interest in the VIX’s put-call ratio has barely budged higher). This non-confirmation indicates the VIX could have much more to run. These VaR measures are deceivingly for many of the banks, not just Goldman. They didn’t help during the financial crisis and I doubt they’ll help much during another one. Given the degree of concentration among the three largest holdings in XLF, we must mention Berkshire Hathaway. The conglomerate, with such classic brands as Coca-Cola (NYSE: KO ), Kraft (KRFT) and GEICO, has been run by an absolute legend-two actually. But it’s portfolio of blue chips and now an increased position in cyclical industries like railroads (the Burlington-Northern purchase) leave it susceptible to an economic downswing also. Even Berkshire’s portfolio wasn’t immune to the financial crisis that lopped 57.5% off its shares in 7 months, from a high in December 2007 ($101.18) to a low of $42.95 in July of 2008. It chopped around feverishly and then almost retested the low with the market, reaching $45.02 in March of 2009. Real Estate REITs are especially vulnerable going forward simply because they have been such a crowded trade in the hunt for yield during the ZIRP era. The REIT with the largest weighting in XLF is Simon Property Group (NYSE: SPG ), the giant shopping mall REIT. The U.S. consumer is struggling and shopping malls should prove to be one of the tougher roads ahead in the REIT space. Famed bond investor Jeffrey Gundlach of Doubletree warns of mall REITs and says “we’re in a secular death spiral for malls.” This REIT lost roughly 80% of its value in the financial crisis and that’s as rates were being lowered. What will happen if there’s stress and rates rise? We believe eventually rates will rise for the wrong reasons (not growth in the economy) but because investors will demand more interest for the risk of owning the various country’s or company’s bonds. When they do start to rise, there will be more competition against the alphabet soup of so-called “bond equivalents” high yielders (REITs, MLPs, BDCs, etc.) Insurance Insurers are in a riskier position than many believe. Insurance companies have been so hard-pressed to match their liabilities in a ZIRP environment they’ve been forced to take on all kinds of risky toxic securities in a hunt for yield. Their book values could get decimated when various classes of bonds, junk bonds in particular (insurance company investment portfolio staples) unravel. Life insurers are especially vulnerable ( MetLife, Inc. ( MET) and Prudential Financial, Inc. ( PRU)), both high on XLF’s list. On CNBC , Stanley Druckenmiller, the former partner with George Soros from the famous trade that broke the Bank of England has been mentioning some reservations regarding the corporate bond market. He warns that from the prior high in 2006, 28% of issued debt was B-rated, now its 71%. Covenant lite loans made up 20% of all loans in 2006/2007 and now that number is over 60%. The Barclay’s U.S. Corporate High Yield Spread will be a key metric to watch and if we break above last winter’s peak of 550, it could be off to the races for the spreads to start widening out more severely. This will be bad news for the XLF. The current consensus is that interest rate rises are good for banks because of the net interest margin increases. The net interest margin has as much to do with the shape of the yield curve as the direction of rates. When short-rates rise much faster than long rates, it doesn’t necessarily increase the net interest margin- it portends trouble. We think rates of all durations will work higher, quicker than many think, and any increase in NIM will be offset by credit concerns. A fantastic article on Seeking Alpha was recently written by Donald van Deventer talking about banks, life insurers and reinsurers and higher rates. Here is an excerpt from the article that illustrates that these entities are mostly negatively correlated to rising interest rates, measured against a set of 11 different U.S. Treasury maturities covered by Yahoo Finance: (click to enlarge) Empirical evidence shows that insurance stocks (and bank stocks in his other article) are, in fact, more negatively correlated to rate rises, contrary to what seems to be new conventional wisdom. I highlighted two ‘Top Ten’ holdings of XLF. I believe there is so much built in optimism in the market that almost all data points are being used only for opportunistic purposes without precaution. It’s been quite a long time since we’ve had a sustained uptrend in rates so there’s no telling how this may play out (especially with at least $59 trillion in dollar-denominated debt outstanding in the U.S. and roughly $200 trillion worldwide, see chart from McKinsey report below.) Regulatory The drumbeat of more regulation and fines from the financial crisis seem never-ending. So far, over a quarter trillion dollars have been paid by the big banks for various wrongdoings since the financial crisis. That should continue. We believe another whole round will begin and the ‘hedge clipper’ movement will continue to gain strength. When the market turns down again, populist opinion will accompany the rhetoric and amplify. Hillary Clinton’s campaign has already started the anti-hedge fund/Wall Street talking points and has even hired Gary Gensler, former top federal regulator and CFTC head, as her campaign CFO. A victory for Hillary could mean that this strict enforcer of Wall Street rules could be back in the spotlight. The greater the gap between the 1% and everyone else, the louder and longer this will continue. Many of the names in the XLF are also on the government’s SIFI list which will be a real chain around them in the next downturn, forcing them to maintain various liquidity standards and potentially refrain from ‘riskier’ (and more profitable) activities. More than any other sector, the large financials will be forced to add ever more capital by selling off assets or issuing their own equity to protect the solvency of the financial system. At least twelve XLF components are on the SIFI list, including Wells Fargo, JPMorgan, Goldman, Bank of New York Mellon (NYSE: BK ), Citigroup, State Street (NYSE: STT ), Morgan Stanley (NYSE: MS ) and Bank of America. Non-financial XLF components such as MetLife, Prudential and AIG (NYSE: AIG ) also make the list. Some companies are appealing the designation. The list could extend to asset managers, prime brokers or whoever the government deems too risky to fail in the future. This will eventually mean less lending, whether for individuals or institutions (including hedge funds). The names in the XLF will be the names probably on that list. This should remain another headwind going forward. XLF price target We have a 12-month price target for XLF at $19.75 which represents an approximate 20% discount to current share price. This downside is conservative. We modeled various assumptions including equity market sell-offs (12% U.S. equity market sell-off), interest rate rises (the 3-month LIBOR at 35 basis points, the 30-yr fixed mortgages of 4.50%, the U.S 10- year Treasury above 3%) and U.S. unemployment rate moving higher (to 5.8%, U-6 rate up to 11.3%) and a bottoming of the delinquency rate on Commercial Real Estate (FRED’s ‘DRCR’). Catalysts The main catalyst will be a sell-off in global financial markets or a macro ‘event’ that gets the ball rolling (as I’m finishing this article I see the Greece referendum has just come in with the “No” vote to further austerity prevailing). It won’t be the event specifically; the market environment is long overdue for any excuse to sell. Unlike during the financial crisis, rates don’t have further room to go down so they should actually rise during this sell-off, if for no other “reason” than funds selling the most liquid positions (Treasuries) in a time of turmoil. The extent to the crowding of the bond buying trade of the last few years (resulting in negative sovereign yields, record low junk bond yields, etc) leaves plenty of room for a sustained bond market correction that lasts for years. This will exacerbate the problem for all the various subsectors of the XLF (banking, insurance, real estate, etc). Summary Combine interest rates bottoming off a thirty year downtrend with global debt and derivative exposure pushing one quadrillion dollars and you have a highly actionable time to lessen exposure to financials and/or to sell the Financial Select Sector SPDR Fund .The risk-reward profile is very unattractive at these levels and we think XLF should be sold, reduced, or hedged. The chart below shows a similar pattern in the run up in XLF shares in 2015 compared to 2007. Observe the narrow monthly trading ranges for an extended period of time (about three years) during this run up to now. This ‘calmness’ is not the sign of healthy price action, and the lack of volatility should unwind itself swiftly. In closing, here is a look at what we believe can happen again to XLF: (click to enlarge) Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This is not an investment recommendation and I/we are not a registered investment advisor.

Raining On The All Seasons Portfolio

Investors are hungry for success stories, especially tales that include high returns with low risk. And the investment industry is always happy to stoke that appetite. One of the most popular stories today is the so-called All Seasons portfolio, whose virtues are trumpeted in the massive bestseller Money: Master the Game , by motivational speaker Tony Robbins. The book has been out since last November, and I thought the hype would blow over quickly, but I’m still getting inquiries about it, so I thought I’d take a closer look. The All Seasons portfolio was created by Ray Dalio of Bridgewater Associates , one of the largest hedge fund managers in the world. It’s based on Dalio’s similarly named All Weather fund , which reportedly has more than $80 billion USD in assets. The portfolio has the following asset mix: 30% Stocks 40% Long-term bonds 15% Intermediate bonds 7.5% Gold 7.5% Commodities In a backtest covering the 30 years from 1984 through 2013, the All Seasons portfolio had an annualized return of 9.7% (net of fees) and only four years with a loss. Its worst year was a modest -4% in 2008. With a risk-return profile like that, it’s no wonder so many investors have been attracted to the All Seasons portfolio. In fact, a service run by Robbins’ own advisor has been swamped with requests from investors who want a piece of this seemingly miraculous strategy. So, is the All Seasons portfolio really a recipe for stellar returns with minimal risk? Or is it just another example of investors chasing hypothetical past performance? The reasons for the seasons The All Seasons portfolio is based on the idea that asset prices move in response to four forces: rising economic growth, declining economic growth, inflation and deflation. In each of these economic “seasons,” some asset classes thrive and others suffer. For example, when growth is strong and inflation is low, stocks are likely to perform well, whereas commodities and gold benefit from rising growth and rising inflation. Bonds do well when economic growth and inflation are both falling. By including all of these asset classes in your portfolio, you’ll do well under all conditions. It’s like travelling with sunscreen, an umbrella, a swimsuit and a parka. There’s nothing wrong with this general idea: most investors understand that a portfolio should include asset classes with low (or even negative) correlation . Nor is it an original thesis: it’s very similar to what Harry Browne wrote in the early 1980s. Browne’s Permanent Portfolio was also based on the principle that you should hold asset classes that would thrive during four economic scenarios: stocks for prosperity, cash for recessions, gold for inflation protection, and long-term bonds for deflation. (If you’re interested in learning more, read Part 1 and Part 2 of my 2011 interview with Craig Rowland, co-author of The Permanent Portfolio .) Was the performance really remarkable? But while the premise of the All Seasons portfolio is reasonable, there’s nothing astonishing about its performance during the last 30 years. Moreover, anyone expecting it to deliver 9.7% with low risk in the future is likely to be disappointed. The returns were unremarkable. A 9.7% annualized return doesn’t mean much unless you compare it to the alternatives. The truth is that all diversified portfolios performed well during the last three decades. Despite the carnage of the dot-com bust at the turn of the millennium and the financial crisis of 2008-09, most of those 30 years were extremely kind to stocks. Late 1987 to the spring of 2000 saw the longest bull market in history, and the one we’re enjoying now ranks third all-time. From 1984 through 2013, the S&P 500 returned a whopping 11.1%. And what about bonds, which make up 55% of the All Seasons portfolio? In the US, long-term government bonds returned 9.4% during the period. In Canada, they did even better: the FTSE TMX Canada Long-Term Bond Index returned 10.3% over those 30 years. Once you consider the context, a 9.7% annualized return since 1984 isn’t remarkable at all. Anyone who stayed invested in a diversified portfolio would have seen similar results. The risk was not “extremely low.” OK, maybe the returns of the All Seasons portfolio were in line with a traditional balanced portfolio, but risk was much lower, right? In an article for Yahoo Finance , Robbins reports that the standard deviation of the portfolio during the 30-year period was 7.63%, which he declares is “extremely low risk and low volatility.” I’m not sure investors would agree with that assessment. If a portfolio has an average expected return of 9.7% and a standard deviation of 7.6%, that means in 19 years out of 20, its annual return can be expected to range between -6% and 25%. That’s not “extremely low volatility”: it’s about the same as that of a traditional balanced portfolio. In our white paper Great Expectations , my colleague Raymond Kerzhéro and I found that a portfolio of 40% bonds and 60% global stocks had a standard deviation of about 7.8% over a similar period (1988 to 2013). What about the fact that the All Seasons had only four negative years, all with only modest losses? Robbins and Dalio frequently compare the All Seasons portfolio to the S&P 500, which certainly saw much larger and more frequent drawdowns. But this is a totally inappropriate benchmark, as the All Seasons portfolio includes just 30% stocks. Dalio’s portfolio holds 55% bonds, which are far less volatile than stocks. More important, bonds only lose value when interest rates rise, and from 1984 to 2013, the yield on 30-year Treasuries fell from over 11% to about 3.5%. Any bond-heavy portfolio would have seen rare and modest drawdowns during that period. There were many disappointing periods. The long-term returns of almost any diversified portfolio look impressive, but unfortunately you can’t buy 30 years of performance in advance: you have to earn those returns by doggedly sticking to your plan even when it disappoints. And let’s be clear: the All Seasons portfolio would have tried your patience many times. While the portfolio never suffered huge losses, it would have significantly lagged a traditional balanced portfolio during the many periods when stocks delivered double-digit returns. That’s why this strategy – and the Permanent Portfolio, for that matter – had few followers during the 1980s and 1990s. A portfolio with just 30% stocks would have been met with derision during that long, giddy bull market. Gold would have been even harder to hold. Sure, it glittered during the most recent financial crisis, but during the 21 years from 1984 through 2004, the real return on gold in Canadian dollars was -2.3% annually. Would you have had the guts to hold it through two money-losing decades? Don’t make the mistake of thinking it’s easy to stick with a strategy when it underperforms during strong bull markets, as the All Seasons portfolio is almost certain to do. Bridgewater’s own All Weather fund returned -3.9% in 2013 , one of the best years for stocks in recent history (the MSCI World Index was up almost 34% in Canadian dollars). My guess is that Dalio’s clients took little comfort in the fact that strategy performed well in historical backtesting. Couldn’t stand the weather My goal here is not to beat up on the All Seasons portfolio specifically: on the contrary, I wanted to show that in many ways it’s not fundamentally different from other balanced portfolios. My concern is that the All Seasons portfolio is presented as a magic formula that will dramatically outperform a traditional stock-and-bond portfolio with far less risk. The very name implies that it will perform well during all market conditions. But that wasn’t true over the last 30-plus years, and it’s even less likely to be the case during a period of low interest rates. (No one knows where rates are headed, but it’s absurd to expect 9% or 10% returns on bonds when yields are 1% to 3%.) A well-diversified, low-cost portfolio executed with discipline offers your best chance of enjoying market returns with moderate volatility. But there’s no secret recipe, no optimal asset allocation, and no reward without risk. Be skeptical of anyone who suggests otherwise.