Countercyclical Indexing is a form of an “all weather” or “permanent portfolio”. This means that the portfolios are designed for any type of market. All weather portfolios are designed to weather any type of market environment so that investors can feel confident sticking with a strategy through thick and thin. In the case of Countercyclical Indexing we do this by focusing on the risk of the assets in our portfolios and creating better parity between those risk exposures.
For instance, a 60/40 stock/bond allocation is not really an all weather allocation because its risk comes mostly from its 60% equity portion. So, in a year like 2008 this portfolio falls almost 35% and exposes the investor to a disproportionate amount of permanent loss risk because the portfolio is, from a risk perspective, 85% stocks and 15% bonds.
Countercyclical Indexing is designed to rebalance away from stocks when they become riskier late in a market cycle. Likewise, when stocks fall in value we rebalance back towards a heavier equity market weighting. In doing so we are systematically rebalancing the portfolio to better balance the risk in the underlying portfolio. This “all weather” approach creates better alignment between the way investors actually perceive risk and the way the markets expose us to risk. And in doing so we increase behavioral alpha (good behavior) by creating a portfolio that you can feel comfortable sticking with.