Pandemic portfolio for US Investors (part 2)

The portfolio for this new paradigm needs to resist dollar devaluation, a potential increase in inflation, while positioning to capture the upside from current and future liquidity injections. Such a portfolio will have to maintain equity exposure (both US and international), position for inflation through commodities and TIPS, hedge against dollar devaluation through Gold while still maintaining some treasury (long term and intermediate term) exposure.

As described in the first part of this blog series, the typical 60/40 portfolio has a high volatility and may not work as well in the environment going forward.

In order to construct the right portfolio for the situation going forward a good starting point can be the all weather portfolio suggested by Ray Dalio. This starting point portfolio includes the following assets:

  • 30% Total Stock Market
  • 40% Long Term Bonds
  • 15% Intermediate Bonds
  • 7.5% Commodities
  • 7.5% Gold

While this may be a good starting points, I believe that there may be tweaks needed to adjust this portfolio to align with the trends described in part 1 of this blog series.

Outlined below are the specific tweaks that may be useful to consider for each of the asset classes.

30% Total Stock Market: There are a few items that may need to be considered – (1) International diversification, (2) Segmentation within the market.

International diversification may not have increased the returns in the past decade given strong performance of US stocks. However, it may make sense to assign some allocations to international market given the poles of global power splitting between US, Europe and China. Additionally, with the potential of USD decline, getting some external currency exposure may also make sense. With regards to weights, something around 5-10% allocations to international markets and 20-25% allocation to domestic markets would make sense, given the weight of US market in the global portfolio.

The other decision to consider while implementing the 30% allocation to Total Stock Market is whether to go to index funds or to do individual stock picking. Here is where the concept of Segmentation comes into play. It has been conclusively established that outperforming an SPY index portfolio is hard. One can hypothesize that there may be forward looking pockets of outperfomance, as follows.

  • Gap between high performance and fiscally prudent companies vs. highly indebted companies may grow. As a result, traditional value based investing focused on companies with a strong balance sheet and a stable income flow may finally start to make sense again.
  • Given the low rates, valuation of companies with strong growth prospects (e.g., tech companies) may become much higher. However, given the sensitivity of valuation on discount rates and the long duration of cash flows – the valuation will be expected to be highly volatile

Picking these companies can however be very hard and a safer bet might be to choose overall index funds to implement this strategy.

40% Long Term Bonds and 15% Intermediate Bonds: Prior to the pandemic, Ray Dalio had suggested a heavy (55%) allocation to the long term and intermediate term bonds. The expected returns are low given the low interest rate environments. Additionally with the prospect of inflation there is a prospect of price declines if the interest rates increase. Probably nobody understands how the long term interest rates will change going forward. I will likely keep my TLT and IEF positions, but will also start to build up a TIPS position (both long duration and intermediate duration) to position for the potential of increasing inflation. I understand that there are folks on both inflation and deflation side of the argument.

The other dimension to be considered includes allocating to the global bond portfolio as well – the logic of doing that is similar to what I described on the Total Stock market

If anyone has other thoughts on the bond portion of the portfolio – please leave below as a comment.

7.5% Gold and 7.5% Commodities: At a high level, sticking to this allocation makes sense.

To reiterate, my view on the going forward portfolio allocation is the following:

  • 20% Total US Stock Market: This may need to be allocated either fully to VTI, or VTSAX, or a combination of BRK (a or b) and QQQ.
  • 10% International Stock Market (Excluding US): VXUS or a synthetic portfolio comprising of MCHI, and VGK
  • 40% Long Term Bonds: This needs to be split into LTPZ (TIPS), TLT and VTABX.
  • 15% Intermediate Bonds: A combination of IEF and SCHP
  • 7.5% Commodities: GSG
  • 7.5% Gold: IAU or GLD

I continue to think through this asset allocation and feel that this may need to rotate out of TLT and IEF in a few years. Will continue to post my thoughts…

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