As investors we are always searching for the holy grail of investing.
What does it mean by holy grail of investing?
- Decent return
- Consistent returns
- Minimal work
Investors ask whether there is such an instrument around. And in recent years there have been one answer: The permanent portfolio or the all weather portfolio.
The beauty of the permanent portfolio is the idea how it was constructed: 4 different asset classes that have a positive expected returns over time, but are not correlated over 4 different secular market scenarios.
If you look at the returns of PERM versus the other expert portfolio allocation the compounded average growth rate (CAGR) is comparable BUT the stdev is one of the lowest. The stdev stands for standard deviation, or the positive and negative swing from the mean. A smaller standard deviation shows more predictability.
The all weather portfolio looks like a god send and its something we talked about in the past:
- The Permanent Portfolio– The holy grail for investing?
- Tony Robbins writes a Money Book centred on the All Weather Portfolio
- Ray Dalio’s All Weather Portfolio–How Investor’s Should Setup their Portfolio
A challenging 2015 for the all weather portfolio
While 2015 have not been a good year for equities heavy portfolio like mine, it has been even more challenging for a portfolio with 4 asset class like the all weather portfolio.
An allocation like this is down -2.3%. If you compared that to a balance fund return of 1.8% there is really not much movement.
The success of any portfolio allocation is that each asset class have positive expected returns, but what may be critical is the secular nature (15-20 years) of each of the asset class.
What may have gone un-noticed is that a large part of the returns are driven by long term bonds.
If you are a fund manager and diversify away from long term bonds, which have been in a bull market for 30 years, you are taking on a lot of career risks.
Novice investors might look at this result and say “this is not the consistent returns that I was expecting!”
The way I look at it is that, you are getting what you get. The diversification is buffering a volatile equity market this year, and a poor commodities and gold market for the past years.
If you are expecting a 7%, 7%,8%,6% linear portfolio performance, then the disappointing answer for you is that things don’t always work like that. The std deviation for this all weather portfolio still looks respectable!
As investors, your job is to understand all these and make the sound decision:
- make sure you understand if these stuff you put in your portfolio are really asset classes with various correlations
- are you using the low cost instruments to take advantage of them (because cost matters in investing!)
- how should you accumulate: meaning which asset classes to add more monthly, quarterly
- how should you rebalance your portfolio
The challenge for the all weather portfolio is that 2 of the components have some issues.
Commodities or gold go through a secular bull and bear. Can we believe enough to put an asset that loses 60-70% of its value over 15 years in an asset allocation?
Bonds have been on a 30 year run and the future outlook may look rather different. Absent of this good performance, in a period where the experience bond managers have never seen a period of rising interest rate, how would this asset class look?
It is why I think for the permanent portfolio, there could be greater volatility ahead than we realize.