How This Manager Played Offense and Defense to Crush the S&P

Bill Belichick is the head coach for the New England Patriots and is famous for telling his team, "the best offense is a good defense."

He would never tell the Patriots to just play only offense and not bother playing any defense. Yet, nearly all the mutual fund managers on Wall Street only play offense, always betting that stocks will go up no matter how bad the economic conditions get.

They stick with this "buy and hold" practice even when it is obvious to them that the economy is in recession or the Fed is raising interest rates drastically.

If they can convince their clients to just "hold," they can keep charging them fees non-stop.

Unfortunately, this stubborn belief cost the investors in these "offense only" funds dearly with the Nasdaq 100 Index down -32.5% for 2022.

There Is Obviously a Better Way

In his book Principles, multi-billionaire hedge fund manager Ray Dalio called diversification the "Holy Grail of Investing." The diversification he is referring to is not owning a portfolio that is a one way bet on the direction of the S&P 500.

If you own hundreds of stocks and the stock market is down a lot, you are still down big. That isn't diversification. That is putting all of your eggs in one basket.

Ray Dalio's version of "real" diversification made him a fortune that exceeds 22 billion according to Forbes. This type of diversification between equities, commodities, currencies, and bonds makes him money in bull markets and bear markets.

Ray Dalio's Holy Grail of Investing

Below is Dalio's explanation of the holy grail of investing that made him wealthy far beyond what he could spend in his lifetime.

That simple chart struck me with the same force I imagine Einstein must have felt when he discovered E=mc2: I saw that with fifteen to twenty good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns... I called it the "Holy Grail of Investing" because it showed the path to making a fortune.

Here is how the math works:

• If you have 1 return stream, like the S&P 500, you earn a 1x return/risk ratio.
• Combining 2 uncorrelated return streams, like stocks and bonds, earns a 1.41x return/risk ratio.
• Combining 4 uncorrelated return streams, like stocks, commodities, currencies, and bonds, can earn a 2x return/risk ratio.

How Diversification Can Make Your Returns Fly Without Increasing Your Risk

Traditional investments like stocks make big money during a boom and lose big during a recession. The key to getting beyond this boom and bust cycle to create a steady path towards financial freedom is balancing offensive strategies that do well when the economy is growing with defensive strategies that generate big returns during a recession.

It should be common sense that you could easily beat something like the S&P 500 that only plays offense and gets clobbered during a downturn with a balanced strategy that makes money steadily rather than making it and giving it back.

Applying Offense and Defense to Build Dalio's All Weather Portfolio

The key to building an all weather portfolio that can make money whether the economy is booming, in recession, inflating, or deflating is deploying a strategy that works for each of these "seasons."

A) Economy Booming: Equities do very well

B) Economy Tanking: Trend following strategies that short markets that are tanking typically thrive during bear markets like 2022, 2008, and 2000–2002.

C) Inflation: Investments in commodities thrive when inflation is ripping

How To Invest in Your Own All Weather Portfolio

The largest French Bank BNP Paribas created an index called the BNP Paribas CASA Index II, which combines equities, currencies, commodities, and bonds applying both offensive and defensive strategies. The results of the BNP index shine with a 20.9% annualized return versus the S&P 500 annualizing just above 10%. The math for combining uncorrelated returns worked like it was supposed to, creating a 2x return/risk ratio.

A mutual fund was created to track this BNP Paribas CASA Index II called the Catalyst Systematic Alpha Fund (Ticker ATRFX). The results deliver on the concept as expected, notching a 5 star rating from Morningstar and a top 1% performance vs the peer group on the year to date, three year, and 5 year histories.

It did what it was supposed to do: with the S&P 500 TR down -7.77% over the last 12 months, the fund was up 13.7%. Over the past three years, the fund delivered an 15.22% annualized return vs 11.97% for the S&P 500. It was both up with the S&P 500 down and up more with the S&P 500 up. That is real diversification in practice and a better way to invest.

The fund invests in the same way that Dalio suggests, getting far beyond a simple bet that equities will just go up. The Catalyst Systematic Alpha Fund (Ticker ATRFX) invests in equities, currencies, commodities, and fixed income both long and short.

How to Start Properly Diversifying Your Portfolio

Done for you the easy way:

In your brokerage account, purchase a mutual fund like the Catalyst Systematic Alpha Fund (Ticker ATRFX) or similar products from Goldman Sachs orAQR that will equally balance between offensive and defensive strategies in equities, bonds, commodities, and currencies.

Do it yourself:

It is also possible to open an account to create a portfolio of risk balanced positions between equities, commodities, currencies, and bonds. The key is balancing the risk exposure between each category of investment and utilizing trend following strategies to go long those markets that are thriving and short those that are tanking.