Three Things Professional Money Managers Do to Protect Their Investments That You Probably Don’t Do

Three Things Professional Money Managers Do to Protect Their Investments That You Probably Don’t Do

by Zach Marsh on Mar 6, 2018

Three Things Professional Money Managers Do to Protect Their Investments That You Probably Don’t Do


1.)  Balance Investments According to Risk

Ray Dalio, head of the largest hedge fund in the world, Bridgewater Associates, with over $110 billion under management, originally designed The All-Weather Portfolio to passively manage his personal fortune.  The portfolio is now an integral part of Bridgewater’s fund offerings.  What made this portfolio revolutionary at the time of its launch in 1996 was its approach to asset allocation. 

It began with a question, “explored by Ray with co-Chief Investment Officer Bob Prince and other early colleagues—what kind of investment portfolio would you hold that would perform well across all environments, be it a devaluation or something completely different?”[1]  Dalio sought a passive strategy that did not try to predict market environments or events, instead be prepared in the event that any of these environments should occur.  Instead of naively balancing between stocks and bonds, Dalio analyzed all the distinct economic environments and which investments do well in each environment.  As he looked to allocate among these assets he determined that bonds, with positive expected return provided a decent counterbalance to equities, and that “low risk/low-return assets can be converted into high-risk/high-return assets…Investing in bonds, when risk-adjusted to stock-like risk, didn’t…sacrifice return in the service of diversification.”  He determined that leveraging the bond allocation to match the risk of the stock allocation would create a more efficiently balance the risk of being overexposed to one particular outcome, stock market appreciation. 

While this method of balancing portfolios according to asset and outcome risk has been adopted by many professional money managers since 1996, this method of portfolio construction is still relatively unknown outside of institutional money management and hedge funds. 

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2.)  Rebalance Portfolio Allocation


Selling high and buying low may be the Holy Grail of successful trading, but it’s often more easily said than done.  One way to achieve this is by systematically rebalancing your portfolio allocation.  Rebalancing means that you periodically resetting your portfolio back to the original asset allocation.  Over time, as some assets go up and others go down, the overall percentage allocation to these assets changes.  If, over 6 months, stocks have gone up 15% while bonds declined 5%, your overall portfolio has shifted.  If you started with a 60% stock/40% bond portfolio this would’ve changed to 65% stock and 35% bond.  If we fail to rebalance this allocation shift can be quite dramatic.  Left unattended for years, your original allocation may have completely altered the risk of your portfolio and needlessly subjected you to greater losses when markets correct. 

Consider a portfolio consisting of 60% S&P 500 stocks and 40% Core US Aggregate Bonds.  Over the last five years the bond portfolio has appreciated 7.3%, while the stocks have appreciated 91%.  An unattended portfolio would now be weighted 73% stock and 27% bond, causing greater potential loss should the stock market fall 50% as it did following the Tech Bubble and the 2008 Financial Crisis.  If the stock market fell 50% as it did in 2008-09, your portfolio which over 5 years grew 57% in value would give back nearly all the previous 5 years gains. 

There are a few different ways to monitor and rebalance your portfolio.  The easiest way is to set periodic times for rebalancing (i.e. quarterly, semi-annually, or annually).  Another way would be to set variance thresholds and once the allocation drifts a specified amount away from the original allocation then you rebalance.   


3.)  Add Optionality


Long convexity, or optionality, is an investment feature which can give your portfolio exponential returns and the ability to profit from abnormal market climates.  Most of the investments typical investors have in their portfolio are designed to do well in normal, orderly market climates.  However, when volatility hits, high risk investments like stocks can suffer tremendous losses and the returns from our safer investments like bonds fail to offer much support.  In highly volatile markets environments, many institutional money managers and hedge funds receive protection from long convexity trades utilizing options to gain leverage to upside potential while managing their downside cost.  Additional types of convexity trades include utilize more obscure products like the Cboe Volatility Index to create opportunities to profit from more chaotic market environments. 

One thought leader, on the subject of optionality, is Nassim Taleb.  Taleb writes, “optionality frees us from the straightjacket of direction, prediction, plans and narratives.”[2]  His point being, that to combat the fragility caused by relying on plans, predictions and narratives we need to add opportunity to gain from things not going according to plan.  Only by adding optionality to your investment portfolio will you offset the danger from the random events designed to tear apart your plans. 


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For more information please contact:

David Rasmussen

C: 515-371-5316


Zach Marsh

C: 773-501-4965





[1] Bridgewater, “The All Weather Story”

[2] Conversation:  Culture  Understanding is a Poor Substitute for Convexity (Anitfragility)  Nassim Taleb 12/12/2012