Complete Guide to the Dragon Portfolio

Have you ever thought about what a perfect portfolio would look like?

To be fair, that’s a tough question—perfect is oftentimes subjective and depends on the circumstances. But it isn’t a stretch to say that we can all agree that a portfolio that can give you good returns no matter what is going on in the markets is, indeed, perfect. 👌

Crafting such a portfolio is extremely difficult. Asset classes perform in different ways depending on the wider context of global and local economies, and making a portfolio that beats average returns both in inflation, deflation, high and low interest rate environments, economic booms and recessions is a monumental undertaking.

Although that might sound like a long shot, that hasn’t stopped investors from trying to construct such a portfolio—and Chris Cole’s solution is one of the most promising ones to date. His brainchild, the Dragon Portfolio, shows a lot of promise when backtested, but it has also performed incredibly well since it was put into practice. 🎯

The Dragon Portfolio is a new idea. We don’t have years and years of information to go off of—but the incredible growth of the stock market (as well as the incredible drops) that we’ve seen from the start of the COVID-19 pandemic offer us a good lens through which we can evaluate Cole’s innovative new approach.

You’ve probably heard the phrase we’re going to write here a hundred times since the start of the pandemic, and you’re probably sick of it, but it still rings true. These are unprecedented times. 

The U.S. deficit is at a historic high, the Fed’s predictions regarding inflation are gloomy, and their toolbox is seemingly ineffective. Now, more than ever, rapid and drastic changes in the economy are more than possible—they are likely. This portfolio just might be the key to safeguarding what you’ve painstakingly gained up to this point.

What is the Dragon Portfolio? 📗

The Dragon Portfolio is the brainchild of investor Chris Cole, the chief information officer of Artemis Capital. The portfolio is the result of Artemis’ 2020 research paper titled “The Allegory of the Hawk and the Serpent”.

The purpose of the research paper was to determine via backtesting what type of asset allocation would lead to the best-performing portfolio when looking at the past 100 years. However, that wasn’t all, as there was one additional stipulation—the asset allocation had to be fixed, meaning that it couldn’t be changed for the entirety of the 100-year test.

Cole’s research is thorough—his preferred asset allocation was compared to many popular mainstays of investing such as the 60/40 portfolio, the risk parity approach, as well as the strategy of investing in the equities market when it experiences a decline.

This isn’t the first attempt at constructing a portfolio that does well no matter what is going on in the market—Ray Dalio’s all-weather portfolio springs to mind, as does the wider topic of how to invest during a recession.

However, even so, the Dragon Portfolio stands out. The sheer amount of backtesting conducted by Cole and Artemis is unprecedented—and if the portfolio performs as expected, it will be the best solution to the issue that it deals with by a long shot.

The Logic Behind the Dragon Portfolio 📚

Although the rationale behind the Dragon Portfolio is rooted in backtesting and cold, hard data, it is presented in a rather uncommon way as far as the world of finance is concerned—in the form of an allegory.

The Allegory of the Hawk and Serpent 📊

The original research paper in which Cole and Artemis put forth the Dragon Portfolio is titled “The Allegory of the Hawk and the Serpent.” So, what is this allegory? Well, it’s a very creative, imaginative, and original way to present some complicated concepts—but we’ll do our best to do it justice and explain it in a simple, easily-digestible way.

The serpent is a representation of a period of secular growth. At first, this period is caused and sustained by favorable factors—prosperity, technological advance, trade, globalization, and favorable demographics lead to rising asset prices and value creation.

However, all good things must come to an end—and you won’t find an exception here. In time, this period of growth is invariably corrupted by greed, debt expansion, and fiat devaluation, which replace fundamentals as the chief causes of asset price gains. In the language of allegory, this is the serpent devouring its own tail in a fit of unreasonable hunger—a common mythological image that signals endings and oblivion.

The hawk (who hunts the serpent) is a representation of the forces of secular change that invariably lead to the downfall of the now corrupt growth cycle of the serpent. The left wing of the hawk is deflationary—a sequence that consists of an aging population, low inflation, wavering growth, recessions, crashes, and debt defaults. The right wing of the hawk, on the other hand, is a representation of inflation, fiat default, and so-called helicopter money.

The Dragon 🐉

It’s clear that the hawk and the serpent represent two radically different economic backdrops. As such, the best investments for each of these periods differ by a large degree. 

While it might seem simple enough to shuffle your investments around when you see change on the horizon, that’s not likely to happen. Hope and optimism are addictive and can easily mislead you—and if you think that’s far too cautious, just remember how large financial institutions and giant banks routinely fail to notice huge tectonic changes in the economic landscape. 

Sure, every once in a while, someone will figure out that the tides are about to turn and make a killing in the process, but this is far from an actionable strategy that the everyday retail investor can recreate. There’s a reason that Michael Burry is famous for his incredible $800 million profit in the midst of the 2008 crisis—but most everyone else got eviscerated. Being Michael Burry isn’t a reasonable strategy (for most people, at least).

In order to save your investments from the shockwaves of these eternally-recurring cycles, you need a portfolio that can not only survive but thrive in both the period of the serpent and both of the hawk’s diametrically opposed wings. 

In the colorful language of allegory, this portfolio is represented by the creature that embodies both the hawk and the serpent within itself—the dragon.

The Study 📖

The study that Cole and Artemis undertook compared a variety of investment strategies—and seeing as how that information is publicly available, we won’t be covering it or else this article would be hundreds of pages long.

However, we can give you a concise summary of what sets this study apart from most others—the sheer length of the timeframe in question. The fact is that most research conducted in the area of investing doesn’t factor in almost anything that happened prior to the 1980s. It’s a clear-cut case of recency bias.

This period saw the largest expansion and growth in stocks and bonds in the entirety of human history. Simply put, while that information is relevant, the rule of thumb that stocks and bonds always bounce back and perform as they have in the past 40 years simply isn’t true.

If we take a 60/40 portfolio and plot its course over the last 100 years (as Cole did) we would see that a staggering 93% of the price appreciation occurred in the 22 years between 1984 and 2007. This was a time of economic growth, globalization, the expansion of world trade, and favorable demographics and technological advancement.

It would be naive to think that this success story is something that is bound to repeat itself. The conditions that led to this stunning growth period simply aren’t there anymore—debt is at an all time high, interest rates can’t go much lower, and taxes are prone to increasing. Thinking that the last 40 years will repeat themselves is optimistic—but thinking that that will happen when the conditions are the exact opposite of what they used to be is foolish.

How to Make a Dragon Portfolio 👷‍♂️

Now that we’ve covered the rationale behind the allegory and the work and research that went into developing the Dragon Portfolio, we have a good basis from which to proceed to the question of the hour—what goes into a Dragon Portfolio, and how you can make one.

Equities – 24% ✅

Equities—in the case of most retail investors seeking to construct a Dragon Portfolio, these will be stocks, the asset class that offers the best returns in periods of secular growth. Starting in 2009 and ending 10 and a half years later, the S&P 500 experienced the longest bull market in history, which saw gains of +231%. However, recent events don’t paint the entire picture from— 1929 to 1946, for example, equities saw little growth.

Timing the market, buying equities in decline, and generally trying to beat the market are tall orders—and they usually don’t work. Your best and most efficient bet is to recreate the performance of the market, which is best done by using a diversified portfolio of stocks. You can easily achieve this by using ETFs and index funds.

Periods of secular growth will provide you with sizable gains due to your allocation in equities. However, periods of secular decline could lead to large drawdowns—even if you decide to invest in equities via broad ETFs, it’s still wise to research the stocks that they hold. If you know how to select a good ETF, this portion of your portfolio will bounce back faster, and continue to accrue gains once again.

Long Volatility – 21% ✅

Long volatility is an active options strategy that seeks to profit off of large swings in the market. In essence, this is an active strategy that works like an insurance policy—if the market suffers from a melt-down or experiences a melt-up, no matter what the rest of your portfolio does, the long volatility portion will compensate.

Long volatility isn’t correlated to equities or bonds and has seen humble yet consistent returns, showing positive gains in 90 out of the last 100 years. This means that long volatility’s main goal, toward which it is essential, is not profit – it is wealth preservation. Cole’s approach to long volatility uses equity volatility via options—whenever a move equal to or greater than 5% occurs in either direction over the past 63 trading days, a purchase is made in that market direction.

Gold – 19% ✅

Gold’s primary purpose is to serve as a hedge against currency debasement or inflation. Although gold is commonly thought to trade sideways and experience little growth in periods of economic growth and consolidation, it has in fact outperformed the stock market in terms of price appreciation when looking at the past 50 years.

Although you might easily fall into the common-enough error of thinking that you can achieve greater gains by not investing in gold, it is a very important part of this portfolio. It occupies an important strategic role as a hedge against inflation and experiences large upswings in price during times of recession when investors commonly flock to gold.

Simple enough, right? Not so fast—not all investments made into gold are equal. We won’t go into too many specifics here—but the way that gold futures, gold stocks, and gold funds work and perform can vary by a large degree.

Cole’s methodology relies on owning physical gold. Now, that’s something that’s both prohibitively expensive and unworkable for most retail investors, seeing as how storage and liquidity issues can easily prevent you from locking in profits.

However, the performance of physical gold can easily be recreated by investing in ETFs that focus on gold bars or bouillon, with the only difference being the small fees associated with those funds.

Although they aren’t included as a separate asset class, Cole also briefly touches on the topic of cryptocurrencies, seeing as how they can fill a lot of the same roles that gold can. Nothing says that you have to apply everything from Cole’s methodology to the letter—cryptocurrency is seeing rapid expansion, but Cole is hesitant to include it in the portfolio until regulatory issues, liquidity, and custody issues are resolved. He does, however, consider them a worthwhile speculative investment in the current state of affairs.

Fixed Income – 18% ✅

Fixed-income securities include bonds and treasury notes, and provide a low-risk avenue for investing your money. No active management is required on your part, and although the returns are quite low, your money is safe.

Most fixed-income securities have experienced fantastic performance since 1984. A combination of favorable economic factors and the deliberate cutting of rates by the federal government led to a boom that is unlikely to happen again—and it won’t last forever.

As a percentage of GDP, corporate debt in early 2022 was at an all-time high, standing at a staggering 47%. On top of that, the commonly-held assumption that equities and bonds are anti-correlated is turning out to be a mistaken belief. When stocks go up, bonds go down—this is the oft-repeated mantra, but if you look back far enough, you realize that this isn’t the case, as the two asset classes are more often correlated than not.

Be that as it may, fixed-income securities still play an important role in diversification—however, traditional approaches place way too much emphasis on this asset class. Although the Dragon Portfolio allocates about half of what an average portfolio would to fixed-income securities, an 18% allocation is still nothing to scoff at.

When it comes to choosing exactly which fixed-income investments to make, Cole and Artemis suggest U.S. treasury bonds, or replicating the same effect by investing in an index fund such as the Bloomberg Barclays U.S. Treasury Bond Total Return Index.

Commodity Trend – 18% ✅

Commodities are raw products, and following commodity trends is a strategy that seeks to profit off of price changes caused by supply and demand. In order to do this, you need to identify an ongoing trend—meaning this is another active strategy. 

Identifying a trend in the commodities market falls under technical analysis—in order to get reliable insight into what’s going on, you’ll be using methods such as the fifty-day moving average.

Commodities tend to do fairly well in periods of inflation, and less so in periods of deflation. Following the commodity, trends allow you to profit in both of these cases—by either going long or going short.

That sounds fine—but why would you go through the trouble of getting into an entirely new area of investing? After all, spreading yourself too thin is generally a bad idea, and commodities trading isn’t exactly common knowledge—or a popular approach.

Cole’s research shows that successfully utilizing a commodity trend strategy leads to profits that aren’t correlated with either stocks or bonds. This allows an investor to open a new, reliable channel of profit that can be leveraged both in inflationary and deflationary conditions—but unfortunately, it isn’t that simple.

There’s no going around the fact that commodity trend trading alone takes effort, patience, and a bit of know-how. Commodities are traded via derivatives, and the fees associated with them make them unappealing to holders of small accounts.

The traditional way that investors approach commodities is via private hedge funds. However, this is only an option for high-net-worth individuals, as hedge funds regularly require minimum investments of at least $100,000 and have notoriously high management fees.

So, if you’re not keen on the time investment needed to learn an entirely new trading paradigm, one that requires active management and attention at that, what can you do? Although this won’t exactly replicate the performance you’d get from following Cole’s approach, you can invest in commodity index funds and ETFs.

Dragon Portfolio Example 👨‍🏫

As you might have already gathered, Cole’s Dragon Portfolio was constructed using means that are available to experienced, high-net-worth investors. However, not all of us have access to hedge funds, commodity trading advisors, or the time to devote ourselves to active strategies.

However, you can recreate the Dragon Portfolio using ETFs. Granted, this means that you won’t be replicating the portfolio as it was made in the study, but making use of the Dragon Portfolio’s asset allocation should still give you most of the benefits discussed in the research paper.

Equities ☑️

When it comes to equities, a simple solution is to use a reputable total market index fund with a long track record. In essence, what you’re looking for is the optimal fund to recreate an index such as the S&P 500 total return index. Some of the more popular choices in this regard are Vanguard’s S&P 500 ETF (VOO), Vanguard’s Total Stock Market Index Funds Admiral Shares (VTSAX), and Schwab’s Total Stock Market Index (SWTSX).

Long Volatility ☑️

The section of the Dragon Portfolio allocated to long volatility is meant to replicate exposure to a long volatility hedge fund or the Eurekahedge CBOE Long Volatility Hedge Fund Index. Seeing as how hedge funds will be inaccessible to a large proportion of retail investors, alternatives such as the constituents of Eurekahedge’s fund index, the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL), and the Cambria Tail Risk ETF (TAIL). Unfortunately, none of these funds have stellar returns and a more involved approach seems to be preferable.

Out of all of the segments of the Dragon Portfolio, long volatility is the hardest to pull off—we’d certainly recommend booking a session with a professional rather than trying to pull this off on your own if you’re not experienced in trading. Another avenue for DIY investors who don’t have time to trade on a regular basis is to tackle this with the help of a trusted stock picking service.

Gold ☑️

Gold’s role as an inflation hedge is best served by investing in physical gold—but seeing as how storage and liquidity issues make that a tad impractical, you’ll want to find a good ETF that is backed by physical gold. Some of the more popular ETFs of that kind include the SPDR Gold MiniShares Trust (GLDM), the Aberdeen Standard Physical Gold Shares ETF (SGOL), the SPDR Gold Shares ETF (GLD), and the Central Gold Trust (GTU)

Fixed Income ☑️

To reach the desired allocation of 18% in the case of fixed-income, the easiest way to do this is to invest in BAA-rated corporate bonds with a 20 or 30-year maturity, as well as U.S. treasury bonds with a 10-year maturity. In both cases, Artemis used a strategy of holding the bonds for 6 months, selling them, and then rolling into a new bond. As is the case with the other asset classes, you can easily achieve the desired level of diversification using a bond ETF, such as the iShares 20+Year Treasury Bond ETF (TLT).

Commodity Trend ☑️

Commodity trends are another segment of this portfolio that is usually handled by professionals. However, not everyone has the means to engage the services of a commodity trading advisor (CTA). 

Your best starting point here is to look at the whole of the HFRX Macro Systematic Diversified CTA index and its constituents, but the simplest and most elegant solution for most investors will be to invest in a commodity index tracking such as the Invesco DB Commodity Index Tracking Fund (DBC) or the iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT).

Dragon Portfolio vs. Average Market Returns

So, how does the Dragon Portfolio perform, when all is said and done? We’ll get to that in a minute—but always keep in mind that there isn’t all too much data to go on, seeing as how the portfolio was first thought up in 2020. However, we do have the results, and they look very promising.

Based on the results of Artemis Capital’s April 2021 case study, Rise of the Dragon, From Deflation to Reflation, in 2020, the Dragon Portfolio achieved a return of 52%—which is far better than the average of the S&P 500.

In fact, the portfolio grew 10 months out of 12 in the year, was profitable each quarter, and saw a maximum decline of -11% during the Covid crash. But we can get an even better picture of the portfolio’s performance by looking at three distinct economic periods.

January – March 2020 📉

The first quarter of the year saw a deflationary crash and global recession take hold due to the COVID-19 pandemic. Liquidity quickly dried up, and the stock market saw losses of 34%. During this period, a traditional 60/40 portfolio would have lost 11%, while a risk parity portfolio would have lost 36%.

In contrast to this, the dragon portfolio saw gains of 13% during the same period. Long volatility held steady during these months, which not only allowed this portfolio to lock in gains but also to secure sizable liquidity used to put in motion growth strategies to make use of the upcoming economic rebound.

April – August 2020 📈

In April of 2020,  the grand total of $10 trillion in fiscal and monetary stimulus measures brought about an enormous rebound, and investor confidence led to an environment that most closely resembles the speculative booms of the 90s. Equities and gold performed remarkably well in these months—and the specific asset allocation of the dragon portfolio allowed it to see a growth of 32%, compared to the 21% of a typical 60/40 portfolio.

September – December 2020 ⚖

In the fall and winter months of 2020, expectations of inflation led to rising rates, as well as a drop in the price of gold. On the other hand, equities and commodities performed well. This is the only period when the dragon portfolio was outperformed by a traditional 60/40 portfolio—with returns totaling only 2% compared to 5%.

However, the disparity, on the whole, is quite notably in the favor of the dragon portfolio when looking at 2020—with the average returns of the S&P 500 being only 18.4% compared to the dragon portfolio’s 52%.

Advantages of the Dragon Portfolio 🌟

The greatest advantage of the Dragon Portfolio is its adaptability—it can offer good returns in any market conditions. Although the market is, as a whole, profitable in the long run, extended periods of losses do happen, and there’s no accounting for when you’re going to have to pull money out from your investments. 

The Dragon Portfolio doesn’t seem to experience large draw-downs, making it all the easier to pull out your money, finance large expenses, or even reinvest your profits.

 Benefits of the Dragon Portfolio:

• ☑️ Performs well in all sorts of market conditions
• ☑️ Does not experience large drawdowns
• ☑️ Fixed asset allocation that does not require rebalancing
• ☑️ Active strategies can be replaced with index-fund equivalents
• ☑️ Encompasses underutilized asset classes
• ☑️ Offers above-average returns in comparison to popular strategies

The data that we have on this portfolio mostly relies on backtesting. And while past performance isn’t necessarily an indication of future performance, the Dragon Portfolio has so far proven to be a standout success in the turbulent year when it was deployed. Whether or not that performance will hold remains to be seen—but the data is in, and the first real-life application of this investment methodology passed the test with flying colors.

Another benefit of the Dragon Portfolio is that it requires much less rebalancing than some other methods. Sure, some of the portfolio’s components (commodity trend and long volatility) require active management, but everything else more or less falls into the category of passive, long-term investing. The asset allocations are set in stone—of course, you’re free to experiment with the exact percentages, but Cole and the team at Artemis went to great lengths to find the optimal weight of each asset class.

Simply put, this is a portfolio that’s built to last—and with just a little bit of effort and attention, it will safeguard and enlarge everything you’ve worked so hard for while saving you from a lot of stress and uncertainty along the way.

Limitations of the Dragon Portfolio 🚧 

So, up to now, everything has sounded swell. But things that are too good to be true usually are—but that’s only because we haven’t still talked about some of the disadvantages and limitations of the Dragon Portfolio.

This isn’t a silver bullet, and although it’s a good choice for any market cycle, it isn’t a one-size-fits-all solution. Some investors simply won’t find this portfolio to their liking, others will prefer the benefits that other approaches offer—but apart from that, there are a couple of real drawbacks to the Dragon Portfolio.

Drawbacks of the Dragon Portfolio:

• ☑️ Requires active strategies for long volatility and commodities
• ☑️ Difficult to faithfully recreate as a retail investor
• ☑️ An extremely long-term strategy
• ☑️ Sometimes outclassed by specialized portfolios
• ☑️ At risk of experiencing dead cash

Jack of All Trades 🃏

The idea behind the Dragon Portfolio is to make something that will perform well in all market conditions. But this doesn’t mean that it will outperform every other option all of the time. The Dragon Portfolio is a resilient jack of all trades, but it cannot beat specialized portfolios at their own game.

A portfolio designed to make the greatest possible use out of a market upswing and booming economy will likely see more growth than a Dragon Portfolio would in the same period. However, we’re actually hesitant to call this entire point a drawback or a con.

In truth, this is more of a trade-off. Sure, you might not be able to squeeze out the absolute maximum returns from any economic period—but on the whole, you’re much more likely to achieve consistent returns that beat the market (and you’ll have to put in much less effort to boot).

The point stands—the Dragon Portfolio will likely net you smaller returns than some alternatives in certain market conditions. However, on the whole, and in the long run, the ability of this portfolio to provide consistent returns will outclass most other approaches. We still only have a short frame of reference, so this is still speculative—but the results so far have been incredibly promising.

The Dead Cash Problem and the DIY Dilemma 🤔

While the preceding point is quite general, the Dead Cash problem is specific to the Dragon Portfolio. The roots of this problem lie in the portfolio’s allocation in long volatility and commodity trends.

Unless you plan on utilizing the services of an active manager that is familiar with your entire portfolio and the principles of the Dragon Portfolio, your only option is to reach the desired allocation via exchange-traded products or ETPs.

There’s only one (admittedly huge) problem—most ETPs are terribly cash-inefficient. Plenty of popular volatility ETPs use only between 1% to 20% of invested capital to execute their strategies. What this means, in essence, is that 99% to 80% of the money you put here is dead cash—cash that sits reinvested at near-zero rates, which often cannot even cover the fees associated with ETPs.

According to Artemis themselves, in the worst-case scenario, almost an entire third of the portfolio (28%, to be precise) can end up as dead cash. Hedge funds offer a way to sidestep this issue—but with an average entry price of $250,000, this avenue is out of reach for most investors.

So, at the end of the day, hedge funds won’t be an option for many, and ETPs and the DIY approach offer abysmal returns. When all is said and done, you have to enlist the help of a professional. Sure, this complicates things a little and adds an additional expense, but the alternative is far worse.

On top of that, successfully implementing the Dragon Portfolio requires the rebalancing of investments such as gold and hedge funds—something that is beyond the ken of most retail investors, mostly due to liquidity constraints. A professional, on the other hand, can handle this with relative ease. The Dragon Portfolio is many things—but it isn’t a DIY approach.

Conclusion 💬

So there you have it—that’s the long and short regarding the Dragon Portfolio. Thanks for sticking with us until the end of the article—we hope you’ve come away from it with a different perspective as to how you can build an investment portfolio.

Chris Cole’s work is relevant, fresh, and unconventional. This alone makes it interesting—but once you factor in the actual results that we’ve seen so far, the Dragon Portfolio becomes something that you simply can’t ignore. We look forward to seeing how this innovative approach will pan out in the medium and long terms.

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