I have got a lot of things that hook my attention this year, whether it is investing, at work or other things that I am interested in.
But the one thing that I have come across that is the most astounding is the Permanent Portfolio.
Why did it hooked me?
How would you like an easy to set up way of broad market investing that generates a return close to market, yet with drastically less volatility?
This is the permanent portfolio.
Established in 1982, in an era of stagnant economic growth and rampant inflation, Permanent Portfolio seeks to provide a sound structure and disciplined approach to asset allocation. The Fund was born in an environment where investors didn’t know where to turn. Regardless of what an investor did, they were losing money. Harry Browne, one of the founders of the fund stated, “It’s easy to think you know what the future holds, but the future invariably contradicts our expectations. Over and over again we are proven wrong when we bet too much on our expectations. Uncertainty is a fact of life.” No one can accurately predict the future.
[The] Permanent Portfolio recognizes this limitation and seeks to invest a fixed “Target Percentage” of its assets to six carefully chosen, diverse and “non-correlated” investment categories. Such diversification in a single mutual fund seeks to mitigate risk regardless of the economic climate.
How it works
Investors set up their permanent portfolio by investing in 6 major asset classes that are very low correlated.
Because of the way they are uncorrelated, they take turns to outperform. Some will outperform while others underperformed.
The end result is that based on past different market cycles, it generates very reasonable returns but with substantially less volatility.
CSSAnalytics have a very good article that illustrates how it works. We have here 4 different periods where the economic climate is vastly different.
The 4 major asset classes take turns to do well, while the others do badly.
When these 4 major asset classes are equal weighted, the returns gets evened out.
The returns and risk
Here is a chart of 1970-2012 Permanent Portfolio set up with equal weight in stocks, gold, treasuries and cash
The long term capital growth was 8.55% which is lower than that of a traditional 60 equities/40% bonds mixed, which returned 9.67%.
However, the worst year return was –6.46% versus –16% for the 60/40 equities/bonds mix.
This volatility is important because, human beings tend to be more affected by large losses and act irrationally.
If the level of loss is smaller and more bearable, they have a higher success rate to follow through the investment plan.
The different asset classes can gyrate wildly in opposite directions but when aggregated, the past returns look respectable.
How did a Singapore Based Permanent Portfolio worked in the Great Financial Crisis
The ultimate litmus test will be to put the strategy through 2003 to 2012 where we encountered 2 great bull runs and 1 really terrible bear market in 2008.
Epps guest posted at BigFatPurse and provided his research on a permanent portfolio that can be implemented at a Singapore context:
- 25% stocks: STI ETF
- 25% long term government bond: iShares Barclays 20+ Yr Bond ETF (TLT)
- 25% gold: SPDR GLD
- 25% cash: SGD cash
The result is an annualized 7.4% per annum growth without including dividends.
in the Great Financial Crisis, the loss on the portfolio was –3.9%. That’s very good. A stock heavy portfolio would have loss –49% in the same period.
Improve the permanent portfolio by rebalancing
I have no doubts rebalancing will enhance the results of the permanent portfolio. Annual selling of outperformed asset class and deploying it in under balanced asset class, would be a systematic sell high and buy low.
With 4 instruments to allocated to, it also makes management much simpler.
I feel that for investors who do not want to take the road to actively manage their monies, a portfolio strategy like this looks very attractive due to a past return that keeps above inflation yet it is not volatile enough to throw the investor off the horse, making stupid investment decisions such as selling at the lowest point and buying at the highest point.
The key mantra is still cost matters, by investing in the lowest cost ETF and selecting the right brokerage, the permanent portfolio can be a no frills wealth growing means.