Ray Dalio’s Holy Grail of investing was recently put forward in an Investopedia Youtube video, entitled Ray Dalio breaks down his “Holy Grail”.
Ray Dalio is ranked 67th richest person in the world, according to the Forbes rich list 2018. He is the founder of Bridgewater Associate which wasfounded in 1975 out of his spare room apartment. Bridgewater Associate today is the world’s largest hedge fund with $160 billion in assets under management (as of October 2014).
“Ray Dalio is ranked 67th richest person in the world, according to the Forbes rich list 2018. He is the founder of Bridgewater Associate which wasfounded in 1975 out of his spare room apartment”
Ray Dalio’s Holy Grail of investing makes interesting viewing, bearing in mind that the legendary investor has cemented his spot as the top performing hedge fund in 2018. Ray Dalio’s Bridgewater Associate has a proven track record of alpha returns in all market conditions.
Ray Dalio’s Holy Grail of investing is a cocktail of diversification and correlation of assets
Ray Dalio points to his Holy Grail chart, which has an annual portfolio, standard deviation running vertically on one side. On the other side is the return to risk ratio and the number of assets runs horizontally.
“Let’s assume that you have an investment with a 10% risk standard deviation”, said Ray Dalio.
For simplicity, Ray Dalio is assuming that the asset provides a 10% return. “Let’s say I add in another asset, then I add in a second third fourth and so on,” said Ray Dalio.
“How would that reduce my risk, if on average it has a 60% correlation?” asks Ray Dalio.
“Ray Dalio cemented his spot as the top performing hedge fund in 2018.”
“Image you have a 10% average return, you don’t know which bet is going to be better, 10% average return and a 10% risk and you add in a second and a third and so on. You are not going to lose the 10% you are still going to have that 10% return but you are going to have a reduction in risk,” said Ray Dalio.
Ray Dalio’s Holy Grail of investing highlights the fact that assets with the same correlation will not reduce significantly the risk factor in an investor’s portfolio
“If you have 3 or 4 more assets with a 60% correlation you get a reduction of about 15 %.You could add in a 1000 other assets if they are 60% correlated you are not going to reduce your risk by much,” added Ray Dalio.
“I cut my risk in half, that means I have doubled my return relative to my risk” – Ray Dalio
Ray Dalio’s Holy Grail of investing explains how risk is reduced by investing in a diversified portfolio of uncorrelated assets
By adding seven or eight assets with a 10% correlation “I cut my risk in half, that means I have doubled my return relative to my risk” said Ray Dalio.
“As I go down the risk-reward curve I start to understand the power of diversification in terms of the things I am going to look for. What that taught me is that the magic is in only having to do this simple thing,” said Ray Dalio.
The simple thing, Ray Dalio’s Holy Grail of investing, is to diversify your investment portfolio with assets of uncorrelated return streams
“Find 15 or 20 uncorrelated return streams, things that are probably going to make money but you don’t know but are uncorrelated, or that have low correlation,” said Ray Dalio.
“That told me that is what I have to go after. That is the key,” he said.
“A lot of people think the most important thing you can do is find the best investments that are important but there is no one great investment that can compete with something like this,” said Ray Dalio as he points to his Holy Grail chart.
“So look at this line,” said Ray Dalio as he points to his chart. “When this line comes down you can improve your return to risk ratio by a factor of five,” he said. That is five times expected return for that unit of risk, you can’t pick any investments that are five times as good individually” added the legendary investo.
So Ray Dalio’s Holy Grail of investing highlights the power of diversification in balancing risk.
“the power of portfolio construction and the power of diversification, it tells me what I have to go after” – Ray Dalio
Ray Dalio Holy Grail suggests that investors should reduce the correlation of assets in their portfolio
“If I can get zero correlation and I have 15 to 20 assets then I have a return to risk ratio of 1.25. That means my probability of losing money in a year is only 11% as distinct from 40% with a 60% correlation” said Ray Dalio.
“So that is the power of portfolio construction and the power of diversification, it tells me what I have to go after” said the legendary investor.
Ray Dalio Holy Grail chart for managing risk and optimizing profits is identical to
Dr. Dieter Rentsch (Germany) Co-Founder and Chief Investment Officer at Aquila Capital, investment strategy.
Dr. Dieter Rentsch holds a Doctorate in Physics. Moreover, Aquila Capital was named Europe hedge fund of the year from 2010 to 2012.
Dr. Dieter Rentsch believes like Ray Dalio that real diversification can only be achieved with asset classes that are largely uncorrelated.
Ray Dalio Holy Grail investment strategy is about seeking out asset classes which behave differently in various phases of the business cycle and changing capital market conditions
These assets could be defined as sub-asset classes of government bonds, corporate bonds, inflation-linked bonds, and emerging market currencies.
In short, Ray Dalio’s Holy Grail is about focusing on correlations which are permanently changing in relation to each other. Risk off, risk on assets are an example of uncorrelated assets.