The Investment Objective
Over time, investors aim to maximize investment returns for a given level of risk. In other words, they attempt to structure an asset mix that smooths the volatility in its return stream.
Compared to traditional asset mix strategies, AGAWA believes an investor can earn comparable investment returns with less risk over the long run by:
Focusing on risk allocations when constructing a portfolio
Better balancing the core of the portfolio to the economic factors that drive asset class returns
Tactically adjusting the portfolio’s exposure to take advantage of changes in business cycle conditions
Creating more cost-effective solutions
AGAWA’s portfolio approach is modeled from the pioneering work by Bridgewater Associates. Bridgewater was the first fund manager to create a risk-balanced portfolio using risk-parity and has a successful track record dating back to 1996. Several AGAWA founders’ 20+ year relationship with Bridgewater has culminated with these important portfolio construction techniques and insights now being more widely available to sophisticated investors.
The “Balanced” Portfolio
Most investor portfolios are a combination of market risks associated with various bond and equity markets. A typical portfolio allocates 60% of its capital to equities and 40% to bonds (the 60/40 portfolio). This is commonly referred to as a “balanced portfolio”.
A 60/40 portfolio appears diversified because stocks and bonds are both volatile, to differing degrees, and the asset class returns are presumed to be uncorrelated. Therefore, the portfolio’s capital allocation appears to offer real and significant diversification.
However, capital allocations are not the same as risk allocations. A disaggregation of the risk of a 60/40 “balanced” portfolio shows it is dominated by equity risk, carrying over 90% equity risk and less than 10% bond risk. In such a portfolio, bonds offer far less diversification that one would assume. This is notably so during periods of equity market drawdown, where losses for a 60/40 portfolio map closely to the losses in equity markets.
What Should Be Balanced?
AGAWA believes that asset class returns are driven by the economic factors of growth and inflation and that undiscounted changes in economic growth and inflation result in changes in asset prices. If economic conditions are fully discounted in markets, then they are fully reflected in asset prices. The recognition that undiscounted changes, or unexpected changes, in economic factors are the drivers of asset price changes is, in AGAWA’s opinion, key to understanding how to create better balance in an investment portfolio.
In periods of “unexpected” rising growth, the assets that performs best are equities and commodities. In period of “unexpected” falling growth, those two asset classes perform worst, and nominal bonds and inflation linked bonds perform best. When inflation unexpectedly declines equities and nominal bonds outperform other asset classes.
Because the changes in these economic factors drive changes in asset prices, AGAWA believes that for a portfolio to be balanced it needs to be balanced to the changes and uncertainty in these economic conditions.
Consideration of the relationship between current asset pricing and the undiscounted changes in business cycle conditions is generally absent in the design and construction of modern-day investment portfolios. This shortcoming leads to risk weights that are dominated by equities and investment outcomes that are heavily reliant on rising economic growth. Modern day investment portfolios are often not diversified.
AGAWA believes that when structuring an investment portfolio there is a way to achieve better balance, better diversification, better protection during periods of economic and financial stress and ultimately better risk adjusted returns. Instead of structuring a portfolio as a one way bet on equities, it is better to balance it to the drivers of asset class returns; namely, the undiscounted changes in growth and inflation.
A portfolio balanced to the economic factors that drive asset class returns has earning power in each of the four quadrants that is equal, because their risk allocations are equal. In the AGAWA core balanced portfolio all four sub-portfolios (rising growth, falling growth, rising inflation, and falling inflation) have the same expected return, and an equal risk allocation (25%) as a percent of the total portfolio’s risk. So the earnings power of each sub-portfolio are equivalent. This is accomplished using the concept of risk parity.
By allocating risk, not capital, in the asset allocation process and by balancing the asset mix to the economic factors that drive asset class returns, investors can earn the market return more efficiently, earning more or less the same return while using less risk. The enhanced efficiency introduces an opportunity for the investor to use the risk that has been “saved” in other ways. The “saved” risk can be added back to the portfolio in order to increase returns; or, can be used in purchasing skill-based return. Whatever the choice made, the structuring of a more efficient portfolio can be expected to produce a better total portfolio outcome.
AGAWA Fund I Limited Partnership
We have established AGAWA Fund I Limited Partnership as an investment fund with a better asset mix portfolio for sophisticated investors.
Fund I features an asset mix portfolio whose core is comprised of exposures that are balanced to the economic factors that drive asset class returns.
At times, business cycle research and insights may lead us to take actions that tilt the portfolio away from the core positioning to take advantage of expectations about future economic conditions that markets do not yet discount.
Additionally, Fund I includes an allocation to Bridgewater’s Optimal Portfolio, giving direct access to Bridgewater’s alpha and beta insights.
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