A great discussion broke out yesterday in the comments about the merits of the Permanent Portfolio concept which has been a bit of a hot topic here of late. I wrote about this on Saturday and you can check also check out yesterday's comments here if you are so inclined.
A little later in the day one reader asked whether something like Larry Swedroe's portfolio concept of what the reader described as "using low correlated equity sectors such as 12.5% in US small value and 12.5% in international small value and 70% in short term treasuries" might be the answer. The reader said the return and volatility numbers would be very compelling.
As an administrative note the reader did not leave a link and I'm sorry for not taking the time to find an article by Swedroe on this. I don't know if the reader has his facts correct or not which will not be important for the direction I take with this post but you will enhance the conversation if you provide a link to go with your comment when a link is appropriate like with referencing someone else's work.
In the post on Saturday I talked about one reason I choose not to go with a permanent portfolio is that I believe the (investing) world continually evolves. That which worked for one period of time may not work for a different period of time. Another aspect of this that came to me as I read the Swedroe comment is the notion of complete reliance on something that should work because...
I'm not taking a poke at the permanent portfolio but generally speaking when did Browne come up with it? Was it the 1970s (really don't know)? How much has the world changed since Browne had the idea? How much do you suppose it will change in the next 30 years? It certainly could continue to work in the future but a lot of things malfunctioned in this bear market so why couldn't there be some combination of events that causes the permanent portfolio to malfunction? Complete denial of even the possibility is not well advised.
As a simpler example from this bear market; one strategy that should work is rotating into value stocks (or funds) later in the stock market cycle. The businesses tend to be more mature, obviously the valuations are cheaper and value stocks generally yield more than growth stocks. This worked in the last bear market as growthier funds were heavy in tech so people assumed it would work in this bear market.
Just as growth funds were heavy in tech nine years ago value funds were heavy in financial stocks one and half years ago so many value funds (also similar dividend-centric funds) got crushed in this bear market worse than the S&P 500.
This gets us to the title of this post. Over-reliance on something that should have worked ended up hurting people. There was a failure to see the forest which was that something was very wrong with financial stocks. This was not difficult to see from a big picture standpoint. I was on this very early in terms of there being trouble but never was correct about the magnitude but there was no need to be correct about the magnitude. "Trouble is coming for financials so I better be underweight" is easily copied. Being underweight means looking under the hood of your funds, if you use funds, and adding up the exposure to the thing you want to be underweight then selling to get to where you want to be.
Reliance on and utilization of market truthisms is perfectly valid but blind trust without verifying makes no sense to me at all. Before someone gets on me about blind faith in the 200 DMA, well we went above it a week or two ago and so far I've only bought one ETF, still have a lot of cash and a tiny little bit of SDS. Blind devotion would have me all in already.
48 comments:
Roger,
I believe taxation and inflation will have a profound effect on my investing in the future.
Capital gains will need to be avoided. A permanent portfolio that pays high dividends invested outside the US is the only solution IMO. I think there is still lots of time to implement this as that is not how my portfolio is now, but it is a change that will be necessary.
I think Browne came up with his idea in the late 70s, early 80s. After he had made a ton of money on gold in the 70s.
Random question: do you see a time when timing triggers like the 200 day moving average will change?
although I am not the original poster, ironically I came across two differemnt threads over at the bogleheads site discussing both of these strategies today. Please refer to the attached links. It definitely appears that the Swedroe portfolio of 30% equity (small value, int'l small value) and 70% ST bonds has awesome backtested results, even compared to HB's permanent portfolio.
Discussion of Permanent Portfolio that seems to have migrated to a comparison to Swedroe as well, scroll to June 8-June 10 messages:
http://www.bogleheads.org/forum/viewtopic.php?t=15434&mrr=1244639525&start=851
Discussion on Swedroe type portfolio of which Larry comments on several times:
http://www.bogleheads.org/forum/viewtopic.php?t=31166&start=0
Question for Roger: wiht all the smart people tracking the markets and these same people varying opinions on deflation, inflation, recession, prosperity, etc. how is one able to predict the future and see the forest through the trees? why not simply error on the side of a proven strategy that is able to withstand fat tails and perform admirably?
I think this topic will emit some sparks. So now we have the topic of 'portfolio timing' in addition to market timing. To put a broader tip on it, anything you invest in may or may not change over time. At any given point, any portfolio ideology can outperform another for a long period of time. As you mention, value outperforms growth generally. What if that stopped for decades? Is value outperfing growth a given forever?
[smart ass]
Random Answer: No, I think they will continue to be random in the future.
[/smart ass]
To put a broader tip on it, anything you invest in may or may not change over time.
Oops, I meant to say 'the rules of anything you invest in may or may not change over time.'
To your point, billb, small caps are a good example.
The maxim always was that you can goose your returns by adding some small caps. Small caps were very volatile but outperformed large caps over the long term.
I've read several times in the last 3 or so years that that's not true anymore because now EVERYONE knows about it.
Anon 6:37: thanks for the links, I was curious about that. Specifially what index they are using to track int'l smallcap.
Swedroe's strategy is for real. He frequently discusses it here http://www.bogleheads.org/. As the first poster mentioned, Swedroe cautions that taxes matter. He has disclosed that his taxable bonds are in high quality munis. Sweroe constantly preaches that investors need to know their willingness, ability, and need to take risks and act accordingly. Not to slam anyone, but many of the principles that Swedroe advocates like after tax returns, high quality munis, low-cost index funds, TIPS etc. really don't go over well here.
Roger, the conundrum you face if you believe investment ideas that have worked in the past may not work again in the future, how then do you identify those that will work well in the future? Maybe you'll get lucky, maybe you won't. And I believe that is exactly what it is...luck.
As I read the other comments, I can see that I'm just being repetative so I'll sign off.
Here is some more good stuff from Larry Swedroe, http://moneywatch.bnet.com/investing/blog/wise-investing/?tag=content;col2
Swedroe has said many times that his marginal utility for wealth is very low. In other words, high octane earnings from a portfolio won't bring him more happiness, so why bother and go through the gyrations? For those will a huge stash to protect, his strategy makes a lot of sense.
off to a good start today, thanks all.
SD people ask about the future utility of the 200 DMA all the time...if everone knows about it... well it can always be a line of demarcation. the consequence of evreryone knowing about it is more headfakes than before.
anon 6:37, the post is about rejecting the concept of relying on a "proven strategy" in terms of blind reliance on one type of portfolio.
anon 7:12 i'm not saying Swedroe is not for real but I am not willing to bet my financial future or that of my clients on something that should work.
thanks for all the links I will take a gander.
great thread
I see. It would create more volatility around the 200 DMA. So you might need a 5% rule or something.
This portfolio idea has come up several times in Roger's posts and it fascinates me 'cause it's simple. Naturally, I whipped out Excel.
Now, the post on the Boglehead forum goes the usual forum route. One guy proposes a portfolio with 3 pieces. Eventually that's turned into something with 6 or more pieces, some of which aren't trivial to replicate.
Swedroe is a big TIPs fan. I've divided the 70% bonds into 35% TIPs and 35% short term bonds. Pre 2001, the bond portion was all short term treasuries. The 30% equities I've divided into 15% domestic small cap value and 15% emerging markets.
Here's what I got. I didn't annualize 'cause I think my spreadsheet formula got hosed somehow.
1998 9.95
1999 10.3
2000 -8.045
2001 7.01
2002 5.37
2003 17.875
2004 10.71
2005 7.27
2006 8.76
2007 11.595
2008 -11.405
I've read several times in the last 3 or so years that that's not true anymore because now EVERYONE knows about it.
SD, great example. If smalls are going to be the same, I think the market has mis priced risk. I'm not arguing with your point though, I just think if that "given" is over because everyone knows about it, then you'd be a fool to be in small caps.
I really like today's post, it's given me something to think about. The only fear I have of questioning whether a trend or how an asset class behaves is dead is that I might meddle. Meddling is a weak spot that I've gotten largely under control over the last couple of years, but it still rears its ugly head from time to time. :>
http://money.cnn.com/2009/06/08/retirement/betting_the_farm.fortune/index.htm
Saw this potential farland investment and thought you'd find it interesting.
I've began using the Permanent Portfolio model(and it's tactical counterpart) as a conceptual framework a long time ago but the notion there were actually a rather limited number of major macroeconomic scenarios and that asset classes existed that could be matched to them in designing a portfolio that was overall world-neutral was entirely novel to me at the time. I've modified the strategic model in several respects to make it more workable (for me) but I've never forgotten the way Browne described the 'real world' of investing by way of cautioning investment model builders (and those who tweak them):
• No one accurately predicts human behavior in other matters, so there's no reason to expect anyone to predict future investment prices;
Coincidence and luck play a large part in any investor's results and they can make a nonsensical technique appear to have been confirmed by history; so be skeptical of "past performance;"
• The truth often is stretched in the investment business, just as it is elsewhere — so take all claims for an adviser, trading system or method of analysis with a grain of salt;
• Any assertion that a particular method of investment analysis is "scientific" should be ignored. Controlled tests aren't possible for economic theories;
• Don't believe an investment rule simply because it seems to be widely respected;
• If there were a single trading system or school of investment analysis that could beat the market, investment advisers and system creators wouldn't be continually devising new systems they hope will beat the market;
• If anyone had found the magic key to investment riches, he wouldn't be telling you of the profits his system would have produced, he would be telling you of the profits it did produce;
• Testimonials for investment systems and advisers are of no more value than they are for gurus, astrologers and used-car dealers;
• Some people are especially talented as investors or speculators — just as some people are talented athletes or musicians. Don't expect to imitate them successfully unless you have similar talents.
Which basically boils down to his last (of 7) principle: In the investment world, as in life, almost nothing turns out as expected so planning for the unexpected is the only rational course of action. A good strategic model may not be able to account for all possibilities but it ought to give you a lift when lifts are to be had and, failing that, avoid bad falls.
thanks for the Farmland link, good read, maybe a REIT coming down the road? i have been interested for a while but if it comes; moderate exposure will suffice
"Before someone gets on me about blind faith in the 200 DMA, well we went above it a week or two ago and so far I've only bought one ETF, still have a lot of cash and a tiny little bit of SDS. Blind devotion would have me all in already"
Roger, Was this always the plan or did the market environment (overbought conditions, etc.) lead to significant deviation?
I'm sorry i don't follow you; deviation from what?
i have been saying from the beginning I don't go on defense or the other way all at once to avoid whipsaw.
Someone posted a comment on Tom Drake's Blog about the Permanent Portfolio.
Tom commented that John Hussman's HSTRX might be looked at as a "Managed Permanent Portfolio."
This led me to consider that maybe a mix of 75% HSTRX and 25% HSGFX might be a closer approximation.
Using Morningstar's new "Beta Chart" for total returns, I came up with the following results. I used PRPFX as the proxy for Permanent Portfolio.
Year to date PRPFX is ahead by 6.4% to 3.1%
In the 1yr, 3yr, 5yr, 10yr annualized returns they were:
Hussman's "Managed Permanent Portfolio": 2.1%, 5.5%, 6.2% 3.9% respectively.
PRPFX: -6,5%, 5.7%, 7,5% 5,1% respectively.
No guarantee on the mathmatics.
I think the larger Gold position made PRPFX more volatile.
Maybe I'll email this to John and try to get a response from him.
OG
I was telling a young neighbor about Nixon the other day. How many of you remember that it was Nixon who allowed trade with China, and let gold float after being fixed at $32.00/oz. since the depression?
I wish I'd been interested in investing when Johnson was president. Just how bad was the "inflation" that Nixon used as a campaign issue? It got him elected, that election was close, and nobody'd ever heard of inflation before in the context of money.
Times were good during the Johnson presidency. When I entered the labor market you could get a good job, and it you didn't like that one you could get one you did like.
Nixon went to congress and asked for a wage price freeze consistent with his campaign promises, congress wisely said no way. So, Nixon instituted wage price freeze by presidential decree, good for 100 days. At the end of 100 days we all found out what inflation really was, it roared up fast and jobs dried up.
I sure wish I had a good basis for comparison between Johnson and Obama.
Roger, There are quite a few respected managers that are still bearish on the market in general (e.g., Hussman, Mauldin, etc.) and are first and foremost concerned about consumer spending, lack of a housing bottom, lack of improvement in unemployment, inflation etc. I would love to see an article about how you attempt to determine what information/data/forward looking sediment is priced into the market. Obviously this is a big part of why investing is so difficult – I might think that we will have below average GDP for a while, but the question then becomes does everyone else have this expectation?
Anon, I thought there was a 'good' comparison between the good ol' days and now. It's called the Misery Index. Surely you remember that from the Carter days, eh? :)
It was pretty darn low for Johnson at 6.77. Bush averaged 8.10, Carter was 20.27. But surely you don't believe the President has this much effect on the economy? And if you do, why would a president ever want a bad economy?
http://en.wikipedia.org/wiki/Misery_index_(economics)
I think I flubbed up the link. Try this one.
sediment? lol
Freudian?
where sentiment is concerned I try to be a little contraian (buying SDS at SPX 903 as an example of that) but objectives info is more important to me (200 DMA as an example.
sometimes these work together, somtimes not.
Thanks for reminding me of the misery index.
Carter's misery was inherited. I moved to the town I now live in, in '79 and I remember the prime rate being over 20%, but that started with that Nixon wage/price freeze.
Very few homes were built, and very little land was developed. In January of that year the local Ford dealer (a big dealer) only sold 1 new car.
So falling interest rates made Regan look good, but they could only fall from the +20% level.
I've waded through much of the Boglehead forum link while on conf calls. Much of it is over my head but I have finally found 1 thing....
The "3 piece portfolio" idea mentioned here yesterday starts with Swedroe's idea of a 70/5/25 portfolio involving TIPs, a covered call fund (took me forever to figure out what CCF was) and small value.
He says that he expands it to use other things mostly because the average investor can't really understand the original 70/5/25 idea.
So I learned a few things today, which is good.
SD, great example in that I rarely agree with Swedroe, apparently but the TIP, SC and CCF is something I'd like to hear more about why he likes that.
if you have a link could you post it
I love CCFs. I hold some BEP and lots of PBP. My google skills are apparently lousy today, but can one of you ETF gurus tell me is a covered call fund exists for foreign?
BillB you know there are CEFs in that space right?
For Swedroe's response on the 3 part portfolio go here to page 2 and then search on "visvx". That should take you to a post by user james22, then the response by Swedroe. Note that in that post he refers to the portfolio as 35/5/60 instead of the usual 25/5/70. Not sure why.
thank you
I like the idea of a permanent portfolio, but despite what the back testing indicates I have a hard time putting money into long term bonds for the long term now. Interest rates are at a low. Gold and commodities are more appropriate for managed portfolios not permanent portfolios.
Lastly I think a permanent portfolio is better started after we reach the next bottom of this down turn not now. Now is a good time to enjoy the rally (potential bull market).
But this financial crisis will not go away with just one run down. Forget the 1930's look at Japan. The US will not have the exact same outcome Japan had, but they are the most relevant model of a stock market bubble followed by a housing bubble. This will not end over night.
Inflation will eventually be a big problem, but it is not on the horizon now.
interesting if one were going to swtich, and I am NOT, to a perm portfolio i'd think it would be better to do so late in the next bull market
Re: Forget the 1930's look at Japan.
Found this Permanent Portfolio reference data for Japan
http://i39.tinypic.com/k51gz4.jpg
The 1st table shows returns for the Japanese market in Yen and $ and the US market returns in $.
Stock is total returns for Japan standard core and S&P500.
Bond - Unfortunately I only have data for 10 year Japanese treasuries which I used for Japan. For the US I used 20 y US treasuries.
50/50 - 50% stock 50% long bond rebalanced monthly.
Gold - Source: COMEX, London Bullion Market Association
PP – Permanent Portfolio 25:25:25:25 rebalanced back if an asset goes above 35% or below 15%. In both cases the portfolio had to be rebalanced 4 times over the 20 years.
It also shows the real inflation adjusted value of 1Yen/$1 invested at the start of the 20 years.
The second table shows the annual returns for the Japan market over the 20 years.
The analysis does not take transaction costs into account.
Stephen D, Roger, All- For clarification purposes, Swedroe does not advocate a covered call fund. CCF refers to Collateralized Commodities Futures, a fund such as Pimco Commodity Real Return.
Swedroe would never advocate a covered call stategy- a complete waste!
Swedroe's own portfolio consists of intermediate muni and tips for the bond allocation (note: he uses munis due to limited tax advantaged space since tips are not tax friendly). Here is a direct quote from Swedroe: "For the record
My portfolio is TIPS (no RE due to limited space in tax advantaged accounts) and intermediate munis (about 5 years duration) for the fixed income and then about 50% US SV, 35% ISV and 15% EMV
Though I have gone in and out of TIPS-now 100% TIPS with that money and I have moved more to 60% international because of other assets I own have higher domestic loading than 50% and I would like 50% total."
Anon 4:52
Yes you are correct as that quote is direct from the boglehead site, see attached dated Jan. 16, 2009 @ 11:14pm
Roger- I would put my money in the perm portfolio anytime since whom knows which direction the market is headed?
http://www.bogleheads.org/forum/viewtopic.php?t=31166&start=0
thanks for the clarifcatrion 4:52
4:57, maybe perm port is right for you, not questioning that but help me understand something, would you do any sort of forward looking analysis or any assessment at all of what is going on in the world or would you just do it because since whom knows which direction the market is headed?
Concerning the 200 dma. What is anyone's opinion of using the 50 over the 200 (golden cross) instead of 200 by itself. And if using the golden cross, should one use the SMA or EMA?
Any opinions would be appreciated.
Well cool, if it refers to an existing mutual fund then I can calculate returns farther back.
I correct my numbers using 70/5/25 TIPs, Pimco real return, and Vanguard small camp value.
2003 16.4%
2004 12.5%
2005 4.3%
2006 4.9%
2007 7.5%
2008 -12.2%
It avoids the nasty low last year and of course doesn't reach some of the highs of the last few years. If I understand correctly, that's Swedroe's goal.
Interestingly, the returns are not quite as "good" as my earlier guess (small value, emerging markets, short term bonds, TIPs) based on the anon question from yesterday.
OG:
I played around with using the two Hussman Funds to achieve a "smooth ride" and couldn't get what I was looking for. I really respect Hussman's intelligence and discipline and currently use the growth fund and will use the income fund in the near future. RR has taught me to look "under the hood" and I like what I see with his income fund. He's also transparent in his weekly commentaries, allowing you to follow his consistent logic. If you can derive a model incorporating JH's funds please post it on this blog. I'd like to study it.
Roger, visited Morocco this past week, and it may be a good candidate for RR list of foreign country's that have less moving parts and a good budget surplus. The kingdom is a happenin place right now. I can't figure out how to own a piece of it though. Construction is everywhere, both infrastructure and commercial residential. The King is growing jobs around tourism and agriculture, with capital from phosphate sales. There were recent natural gas deposits discovered, which will provide energy independence. Are you aware of any ETF's that are available for this country?
Thanks,
Sam
Stephen D- for a detailed comparison of Swedroe's portfoli versus PP since 1970, refer to the following link. The post is by Trev H dated Wed Jun 10, 2009 @ 6:46 am
http://www.bogleheads.org/forum/viewtopic.php?t=15434&mrr=1244674671&start=851
Sam,
I can remember glancing at Morocco but certainly don't know it. It seems to me that one or two ETFs have a fair bit of Morocco; maybe the Market Vectors Africa???
Thanks for the direction to the post. There's a ton of info in that post.
I understand the general theory. Really, Swedroe is trying to do the same thing that the permanent portfolio is trying to do.
My brain being, well, my brain, I immediately ask about implementation. The only int'l small value thing I can think of is maybe the Wisdomtree ETF.
Man there's a lot to learn. I didn't even start looking at the different types of treasury bonds until a couple of years ago.
Hi Stephen
Re: I understand the general theory. Really, Swedroe is trying to do the same thing that the permanent portfolio is trying to do.
My interpretation is that they’re both a form of Taleb style in some respects. Swendroe’s is closer having 25% in volatile holdings and 75% in low volatile holdings. So if the 25% side loses 50% in any one year the overall loss is reduced down to 12.5% of the whole, which to a reasonable extent is countered by perhaps 4% income across the whole and/or some capital gains on the low volatility holdings.
PP is more obscure in that it has 50% in highly volatile holdings (stocks and gold) but those two tend to move in a low or possibly even inverse correlation.
This is an experimental posting for me, so I hope it works, apologise if it doesn't
Here's some java script that approximates annualised returns given the yearly average and standard deviation.
You need to cut and paste the following text into notepad, then use EDIT, REPLACE and replace all occurrences of [ with <
and the replace all occurrences of ] with > and then finally save that with a html filename - perhaps cagr.htm
When you open that file in your browser you'll need to have javascript enabled for the calculator to work
[html][head]
[script language = JavaScript]
function calc(inputs)
{
m = eval (document.inputs.mean.value);
s = eval (document.inputs.SD.value);
m=m/100;
s=s/100;
a = (1+m)*(1+m) - s*s;
a = Math.pow(a,0.5)-1;
a = Math.round(1000*a)/10;
document.inputs.Result.value=a}
[/script]
[/HEAD]
[BODY BGCOLOR="#DDDDDD"]
[table]
[tr][td]
[TABLE BORDER="1" BGCOLOR="#DDDDDD" CELLPADDING="2"][TD]
[FONT FACE="arial" SIZE="-1"]
[FORM NAME="inputs"]
Average Return (example 10.75) =[INPUT TYPE="number" NAME="mean" SIZE=4 VALUE="10.75"]%
[BR]
Standard Deviation (example 20) =[INPUT TYPE="number" NAME="SD" SIZE=4 VALUE="20"]%
[BR]
[FORM]
[INPUT TYPE="button" VALUE="CALCULATE" SIZE = "8" ONCLICK= "calc(inputs); return true"]
[I][U]Approximate[/U][/I] Annualized Return =
[INPUT TYPE="number" NAME="Result" SIZE=5]%
[/FORM]
[/TD][/TABLE][p]
You can play around with a range of averages and standard deviations.
[p]
For example
[p]
A) 11% average, 20% standard deviation is somewhat like a stock index fund and produces a 9.2% CAGR.
[br]
B) A emerging markets or small cap value might have something like a 13% average, 29% stdev and again a 9.2% CAGR.
[br]
C) Bonds might have 7.4% avg, 5% stdev and 7.3% CAGR.
[br]
If we blend 50/50 of a) and b) we might have a 12% average, 24.5% stdev = 9.3% CAGR[br]
An equal blend of a) and c) has 9.2% avg, 12.5% stdev = 8.5% CAGR[br]
An equal blend of b) and c) has 10.2% avg, 14.5% stdev = 9.2% CAGR[br]
[p]
This is all very approximate and doesn't really account for correlations etc. But a bit of fun to play with.
[p]
We can extend this test to also do an approximate likely draw-downs.
[p]
Generally prices will hit lows of the average minus 2 standard deviations at times so in this case we have for each of the above
[p]
a) -29%[br]
b) -45%[br]
c) -2.6%[br]
a) + b) -37%[br]
a) + c) -15.8%[br]
b) + c) -18.8%[br]
[p]
We can also approximate Sharpe Ratio's by just using the CAGR divided by the standard deviation (generally given two with the same average, the one with the higher Sharpe is the better choice)
[p]
a) 0.46[br]
b) 0.31[br]
c) 1.46[br]
a) + b) 0.38[br]
a) + c) 0.68[br]
b) + c) 0.63[br]
[p]
Note in this particular set, how stocks (A) has 9.2% CAGR, -29% drawdown whilst a blend of Emerging Markets and Bonds (b)+(c) has a 9.2% CAGR (same) but with only 18.8% drawdown (and a higher approximate sharpe ratio).
[p]
Have fun!
Taking my previous posting one step further. A Permanent Portfolio is in many respects one blend of gold with cash and another of stocks with bonds. Each of those two pairs might have something like a 9.5% average and 12% standard deviation perhaps. The low/inverse correlation of stocks and gold however might result in the overall standard deviation being reduced down to maybe 8%, which produces a CAGR of 9.2%. The draw-down however might be approx 9.5% average - 16% (2 standard deviations) = -6.5%
Actually I should have perhaps said one blend of gold with bonds and the other of stocks with cash.
I'll shut-up now as I've taken far more than my fair share of Roger's blogspace.
Clive, that works and it's awesome. Thanks!
Following up from the farmland REIT mentioned earlier and in the crazy speculation department...
Would there eventually be a garbage REIT for all the waste of people eating the farm REIT's products? People always seem to want their garbage, toxic, and nuclear waste stored off somewhere else yet its something that has to go somewhere.
At any rate the conversations this week have been excellent and great reads. Good job all.
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