The Cockroach Portfolio
How satisfying would it be to have a portfolio that can sustain in all seasons? Wouldn’t it be a dream to invest in a portfolio after which you can just relax and have a drink in your retirement? As unrealistic as it sounds, all of this is possible and is derived from something so basic that it may make one question its applicability. It’s impossible to predict what the economic scenario will be when we decide to retire. Moreover, with the recent shocks, booms, and busts that have hit the financial markets in recent decades, planning is only going to get trickier.
The traditional approach of having a portfolio with 60% stocks and 40% bonds is more on the offensive side and does well in the periods such as 1980-99 or 2019-19 where it put on a good show. But this is quite vulnerable to market shocks such as inflation and stocks and bonds do well only during periods of growth and deflation. Offensive wins games but when the offence has an off day, the championship goes out of sight. This 60-40 strategy destroyed the value of portfolios in the 1970s. The defence can make one-win championships and this is where the Cockroach Portfolio comes into the picture.
This idea was devised by Dylan Grice who was a lead strategist at investment bank Société Générale. He outlined it in a 2012 piece for the bank. Cockroaches aren’t the most attractive or exciting of creatures but if there’s one thing that sets them apart, it has to be the fact that they survive. This is exactly the cornerstone of the concept as the cockroach portfolio has the same quality: to survive when things go south. Grice believed that diversification has to be done in a way that it comprises four assets: stocks, bonds, gold, and cash to sail through every economic outcome. Cockroaches use a simple algorithm to survive with their physical hardiness and this four-way equal split is as simple as it gets.
Thus, the money will be spent equally across all four assets (25% each) and this would help address the loopholes that existed with the 60-40 split between stock and bonds. We can categorize any period of recorded economic history, in any country in the world, in one of the four quadrants: Growth, Deflation, Inflation, and Decline. We have discussed how the traditional portfolio fares well only during periods of growth and deflation, thus thriving in only 2 of the 4 quadrants. With cash and gold, there’s the cushion to tackle recession and inflation respectively. Grice tested this portfolio and reviewed how it would have performed since the 1970s, taking into account 2 upsets in the early 2000s recession and 2008 crash, it performed well as it produced average investment returns of about 5% a year, in excess of inflation, truly living up to its task of survival in some fashion.
Another benefit of the cockroach portfolio is that the four assets are relatively uncorrelated with each other. In addition to maximizing diversification, this provides an opportunity to rebalance from a well-performing asset into a poor-performing one and this can be beneficial in a choppy market.
On conducting a back-test of the cockroach portfolio, we see that it hasn’t performed great but earning massive returns wasn’t the primary objective. It exists to survive during massive downturns. Now let’s have a look at how the cockroach portfolio performed during the COVID selloff.
Thus, the fact that during the worst market selloff in recent memory, the cockroach portfolio didn’t slump as much as the 60-40 portfolio validates our point. Once things start to recover and normalize, the 60-40 portfolio had a good jump but our portfolio isn’t really designed to thrive, but to survive when no other portfolio does.
This robust yet simple idea has proved that it can exist in this complex environment. Making high returns is always great but it would all amount to nothing if one market crash can wipe off our entire wealth. The cockroach portfolio ensures that you have the capacity to survive which is the starting point when it comes to the path to prosperity. As Grice rightly points out in his original piece:
“Cockroaches may not be able to build nuclear bombs, but they can withstand a nuclear war.”
and that’s the entire agenda right there.
Author: Mayank Kedia
Illustration by: Khatwang Gupta