Ray Dalio (Trades, Portfolio), the founder of Bridgewater Associates, is one of the most influential investors in the world today. At the Institutional Investors annual awards dinner in 2019, Bridgewater was recognized as the best hedge fund of the year. This is not the first time the fund was recognized for its attractive performance, and these awards have been one of the reasons behind its massive success in surpassing assets under management of $150 billion.
Dalio's portfolio is currently worth $12.75 billion, and below are the largest positions as per the second-quarter 13F filing.
| Name | Percentage of the portfolio | |
|---|---|---|
| Vanguard FTSE Emerging Markets ETF | 15.9% | |
| 15.6% | |
| 9.4% | |
| 8.7% | |
| 5.1% | |
| 4.2% | |
| 3.2% | |
| iShares iBoxx Investment Grade Corporate Bond ETF | 2.6% | |
| iShares Trust iBoxx High Yield Corporate Bond | 2.2% | |
| iShares 20+ Year Treasury Bond ETF | 2.1% |
Source: 13F filing
Two things stand out from this breakdown; the exposure to emerging markets and the significant investment of $540 million in gold.
In a LinkedIn post titled "Paradigm Shifts," published on July 7, Dalio shared his view that gold will eventually outperform other risky asset classes as a result of increasing global conflicts and the low interest rate environment.
"As a result, the world is leveraged long, holding assets that have low real and nominal expected returns that are also providing historically low returns relative to cash returns (because of the enormous amount of money that has been pumped into the hands of investors by central banks and because of other economic forces that are making companies flush with cash). I think these are unlikely to be good real returning investments and that those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets, meaning that if they just wanted to have a better-balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio."
As evident from the above statement, Dalio is bullish on gold primarily for two reasons: the possibility to generate an alpha return and the diversification benefits.
The price of gold, on the other hand, has risen 21.5% in the last 12 months to $1,493 on Tuesday, outperforming the broad equity market as measured by the performance of the S&P 500 Index.
Source: Reuters
In the remainder of this analysis, I will discuss four possible reasons behind this legendary investor’s stance on gold.
Diversification benefits of gold
In a LinkedIn post titled "Diversifying Well Is the Most Important Thing You Need to Do in Order to Invest Well," published on Aug. 12, Dalio recommended investors pay close attention to the benefits of this century-old technique.
"While you can’t know which of the items you are betting on will provide better results, you do know that they will behave differently, and by mixing them appropriately you can reduce risk. Diversifying well is a matter of knowing how to reduce your expected risk by more than you reduce your expected return (i.e., improving your return-risk ratio)."
Investing in gold is a proven way to diversify an investment portfolio to generate attractive returns under a variety of market conditions. The secret, according to Dalio, is to find securities that have negative or low correlation with each other. This way, an investor would be able to mitigate the risk of the entire portfolio performing poorly along with the broad market.
Data compiled by Bloomberg and U.S. Global Investors reveal that gold has very little correlation with small and large-cap stocks in the U.S., making this asset class one of the safest bets during times of crisis.
Source: Bloomberg, U.S. Global Investors
Dalio, whose portfolio has high exposure to equity markets, should probably be thinking about this low correlation when he advises investors to consider investing in gold.
Gold performs well in a low-interest-rate environment
The Federal Open Market Committee decided to cut the federal funds rate by 25 basis points in each of its last two meetings and is expected to further reduce the rate by the same amount in the next meeting on Oct. 30. The slowing U.S. economic growth is the reason behind this expectation. As the below chart depicts, during recessionary periods (marked in grey), interest rates tend to decline as policymakers adopt an expansionary monetary policy.
Source: Reuters
According to data from Reuters, more than 50% of analysts surveyed believe that an economic recession will hit the U.S. within the next five years, which confirms the possibility of further rate cuts in the future.
The most recent expansionary cycle began in 2008, just after the financial crisis wiped billions of dollars off markets. This triggered a massive rally in gold prices and eventually resulted in gold outperforming all other asset classes during this downturn.
Source: Sunshine Profits
This positive performance during the last rate-cutting cycle and the possibility of another such cycle in the future could be one of the reasons why Dalio is bullish on gold.
Gold has a negative correlation with the U.S. dollar
According to Fisher’s Theory, a currency tends to strengthen along with increasing interest rates and weaken when the rates decline. From this perspective, lower interest rates in the U.S. should result in a depreciation of the U.S. dollar. However, many other factors play a part in determining the direction of the dollar, including the demand for safe-haven assets.
A weakening dollar has historically provided a boost to the price of gold, which is evident from the below graph.
Source: Lear Capital
This inverse relationship could be one of the reasons why Dalio is betting big on gold to outperform other asset classes in the future. For instance, the World Bank predicts the U.S. economy to grow at much lower rates than it did in the last two years. This, in return, would lead to interest rate cuts and eventually, a lower dollar.
The recession-proof nature of gold
During economic downturns, stock prices of both good and bad companies collapse, wiping billions of dollars of wealth off investors’ portfolios. However, the historical performance of gold during recessionary periods suggests that it’s more resilient to recessions as opposed to other risky asset classes.
Source: Goldsilver.com
This positive performance of gold under dire circumstances could also be a reason for Dalio to be bullish on gold.
Takeaway for investors
Investing in gold would not only diversify an investor’s portfolio better, but would also provide the opportunity to generate attractive returns during economic crises. Dalio, one of the most influential investors in the world, shares the view that investors of all sizes and scale should allocate a portion of their investable assets to gold.
There are exchange-traded funds to simplify the process of investing in gold, including SPDR Gold Shares (GLD, Financial), iShares Gold Trust (IAU, Financial) and Invesco DB Gold (DGL, Financial).
Disclosure: I am long GLD.
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