Hey there, I missed you

Hope you’ve been good, and your portfolio’s been green!

Now, are you ready to get yourself some “free lunch”?

Today, I’m going to dive into the concept of uncorrelated returns being the key to a “balanced, risk-adjusted portfolio” according to Ray Dalio. His "Holy Grail" strategy (not the be confused with the existing strategy in the Community Database by the same name) could hold the key to a “free lunch” in the stock market. Let's unravel the essence of this concept and explore some practical applications in algorithmic investing.

What is the "Holy Grail" Strategy?

Ray Dalio, the founder of Bridgewater Associates, has long been an advocate for diversifying investments to achieve a stable and robust portfolio. His "Holy Grail" strategy revolves around the idea of combining 15-20 good, uncorrelated return streams (sub-strategies in our application). The aim is to reduce risk without compromising returns, leveraging the powers of diversification and rebalancing to smooth out the volatility inherent to the market.

Core Principles:

1. Diversification: The cornerstone of Dalio's strategy is diversification across multiple asset classes and instruments that have low or negative correlations.

2. Rebalancing: Periodic rebalancing smooths out returns and drawdowns from one asset or strategy to another, allowing for potentially greater cumulative returns than the sum of the individual parts.

Now, lets see some examples of this in action.

Not as focused on diversification as Mr. Bridgewater probably would have liked.

It was made with a loose eye for diversification and uncorrelation, but it was secondary to the out-of-sample performance of the strategies included. Lets take a look at something that was actually made with these principles in mind!

As you can see, there is a much more concerted effort to get a varying range of asset classes in this strategy. I’m not going to go in to too much detail, I wrote up a dedicated newsletter on an extremely similar strategy!

Long story short, these graphs generated by https://mymaestro.co/, (link to the screenshotted reports can be found here) show how correlated the various sub-blocks are. Keeping in mind the backtest is quite short, so these statistic will change over time, when the Bond block moves one direction, the Commodity block moves the same direction only 3.6% of the time. Sounds bad, until you take in to account the effects of rebalancing on a portfolio (which is the way I prefer to think about strategies like this one)

This whole video is worth watching, but the most important ~10 minutes start around the 50 minute mark.

Now, take all this information, and take a look at your portfolio.

Do you like how its constructed? Do you care about avoiding drawdowns? Are you searching for maximum total returns at the expense of just about everything else? These ideas may not be for you. However, if you don’t like the idea of watching 40% of your portfolio evaporate because you’re in TQQQ until the current price gets below the 200 day moving average in order to get out and do something else, give these ideas a second thought. They might help you avoid some pain, that’s certainly what I’m hoping they’ll do for me!

This newsletter is intended for informational purposes only and does not constitute financial advice. Always conduct your own research or consult with a professional before making any investment decisions.