What kind of investment portfolio would you hold if you did not know what the future held?

You have spent years building a career or business, and you are now approaching age 50 and start thinking about retirement and how to maximise the value of your investments.

Most investors like you are worried about their investments, and sometimes they try to forecast the future with a view they will be able to match their forecast with the right investments. The best approach for you is to accept you do not know what the future holds. Your next question would be ‘What do I do next?’

Ray Dalio* asked himself the same question in 1975, trying to find the answer for investing for an uncertain future. Most people use investing for turning retirement savings into a stream of income (pension), this is also known as “the nastiest, hardest problem in finance” (quote from prof. William Sharpe, the Nobel Prize-winning economist).

Ray Dalio realised that while the future is unpredictable, asset classes are quite predictable in how they respond to two variables: economic growth and inflation; his philosophy simplifies the complex web of market movements into these two primary drivers.

Central banks spend their lives trying to balance these two forces. Because every asset class responds differently to shifts in growth and inflation, a truly diversified portfolio must hold assets that thrive in each of the four possible environments. This creates four "seasons":

1. Rising growth: Equities (including emerging market equities) and corporate credit (including high yield) tend to perform well.

2. Falling growth: Government bonds typically act as safe havens.

3. Rising inflation: Commodities, gold (and gold miners), and inflation-linked bonds thrive.

4. Falling inflation: Equities and nominal bonds generally benefit.

A common mistake in portfolio construction is "nominal diversification." If you put 50% of your money in stocks and 50% in bonds, you are not actually 50/50 from a risk perspective. Because stocks are significantly more volatile than bonds, the stocks will account for 85% of the portfolio's total risk. To resolve this, Dalio advocated for risk parity — a framework in which each asset contributes a similar amount of risk to the portfolio. In practice, this often means:

• Reducing exposure to high-volatility assets such as equities

• Increasing exposure to lower-volatility assets such as high-quality investment grade Government and corporate bonds, so they meaningfully protect the portfolio during market drawdowns

• Increased exposure to short duration index-linked bonds to protect the portfolio during inflationary periods

• This approach may also involve a limited use of leverage (for example, via a 2x leveraged index). This topic, including volatility drag (“beta decay”), deserves a separate discussion

• Rebalance often.

At N2 Asset Management, we have adopted an adaptive approach that incorporates momentum and trend-following. For example, when bonds have little or no expected return—such as under a zero-interest rate policy—or are in a sharp drawdown (as in 2022), an adaptive model may reduce or exit bond exposure entirely, hold some cash, and reallocate risk elsewhere. A pure All-Weather portfolio, by contrast, would continue holding (and potentially adding to) bonds to preserve risk balance.

As part of this adaptive framework, we allocate approximately 20% of invested capital to trend-following liquid alternatives. This portion of the portfolio is managed by two specialist investment managers who rely on evidence-based academic research quantitative analysis. In short, the investment managers use trend following and momentum to manage investments, most of the time being market neutral or negatively corelated with the stock market. By incorporating multiple asset classes and liquid alternatives, overall diversification is enhanced.

There is, however, a common misunderstanding about diversification. As a result, constructing multi-asset portfolios is not something that should typically be undertaken on a do-it-yourself (DIY) basis.). Diversification only lowers risk; it does not improve returns. A good diversifier is one that lowers risk faster than it lowers expected return, which means it improves risk adjusted returns i.e. it increases the return per unit of risk (also known as Sharpe ratio).

Ultimately, your objective is to achieve the targeted real return identified through financial planning, while taking as little risk as possible. Diversification and some use of leverage / deleverage (cash allocation) help enormously. Beyond improving returns per unit of risk, this approach reduces drawdowns during equity market declines and helps investors remain comfortable and sleep well at night over the 20-year investment horizon that truly matters—often spanning 10 years before and 10 years after retirement.

Smoother portfolio performance helps investors:

• Stay invested during periods of crisis

• Avoid emotional decision-making

• Remain committed to long-term plans

This behavioural advantage can ultimately matter more than small differences in theoretical returns.

If you want to discuss your financial planning goals with us and how we can help, please get in contact. Please note this article is not a recommendation on how to invest, what type of assets to use or not use; always take investment advice.

*Ray Dalio is a self-made billionaire and hedge fund manager. He founded Bridgewater in 1975 in his New York City two-bedroom apartment.

IMPORTANT NOTE: The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

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