The Permanent Portfolio, Investing, Finance and Random Thoughts.
The Fugger Portfolio
An interview with Rob Arnott describes the portfolio of Jacob Fugger (“Fugger the Rich”) who lived from 1459-1525. The portfolio that made him so rich sounded very familiar and I wanted to share this part of the interview with Mr. Arnott:
Rob Arnott: Where do we go from here?
Audience Question: It seems you’re simply promoting a diversified approach to investing. How is this different than basic portfolio theory?
Arnott: There’s nothing new under the sun. Questions: How many people follow a truly diversified approach? How many think of their stocks as ownership of an enterprise (à la Graham & Dodd), rather than as some assemblage of portfolio characteristics? In the 15th century, Jacob Fugger (“Fugger the rich”) put his money in shares, in loans (bonds), in property and in commodities. And he’d rebalance when the mix drifted away from one-fourth each. The shares and the real estate did well when the economy was strong; the loans and commodities did well when it was weak; the commodities and real estate did well when the government was debasing the currency; and the stocks and bonds did well when the government and the currency were sound. Old ideas have a lot of power, and keep getting rediscovered.
(emphasis added)
Here’s another quote that I’ve seen attributed to Fugger in numerous places (Although none referenced the original source. If you know of it, please let me know. This quote is suspicious without being able to attribute it to an original source.):
“Divide your fortune into four equal parts: stocks, real estate, bonds and gold coins. Be prepared to lose on one of them most of the time. During inflation, you will lose on bonds and win on gold and real estate; during deflation, you lose on real estate and win on bonds, while your stocks will see you through both periods, though in a mixed fashion. Whenever performance differences cause a major imbalance, rebalance your fortunes back the four equal parts.” (emphasis added)
- Jacob Fugger
I found it amazing that Fugger’s portfolio was so close to the 25% split that the Permanent Portfolio uses (Was this the inspiration or a rediscovery? We’ll never know.). Although, real estate is something the Permanent Portfolio avoids due to the illiquid nature of the asset and holds cash instead (if you own real estate, count it as part of your Variable Portfolio).
Note how Fugger’s approach sounds very similar to the Permanent Portfolio’s idea of holding assets that correlate to economic cycles of Prosperity, Inflation, Deflation and Recession. This insight is something that is missing from most portfolio allocation advice you see. Further, it’s also why many portfolios get blindsided by extreme events or protracted periods of underperformance in my opinion.
Now here’s something in Fugger’s quote that many people have a problem with:
Be prepared to lose on one of them [an investment] most of the time.
I get questions about some asset being too high and something being so bad that they couldn’t possibly go out and buy it. Yep. That’s pretty much how it always works. Here’s my official response:
Don’t look at asset classes in isolation. Look at your portfolio as a whole instead.
What do I mean by that? Well, it doesn’t matter if you lose 10% on an asset in a year if your total portfolio has gained in value. A 10% loss in gold but a 25% gain in stocks and bonds puts you ahead. A 20% loss in stocks but 30% gain in bonds also puts you ahead. The individual losses were offset by the winners enough to give you a profit in the total portfolio.
As it is, the Permanent Portfolio is designed to hold assets that are volatile so a decrease in one is almost always offset with gains in another. At any point in time you’re going to have something in the portfolio that is really hot and something that is a real dog. It’s almost guaranteed too happen. Why? Because the economic environments of prosperity, inflation, deflation and recession will never happen all at once. Since the assets are geared towards responding to these conditions individually you are going to have something that is always doing well and something that isn’t. It’s just the nature of the diversification.
The problem is that since we can’t predict the future we don’t know what asset is going to do well and what is going to do poorly ahead of time. So our solution is simple: We own them all no matter what.
If you don’t own all the assets, all the time, you don’t have the protection of the portfolio. It’s just that simple. You also need the guts to rebalance out of your winners and buy your losers. Something that has been talked about here in the past.
It looks like Fugger had this pegged a long time ago which is why he was Fugger The Rich and not Fugger The Pauper. It’s comforting to know that good ideas really are timeless.
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Hi Tom,
Great points about the cash vs. gold of the day. Since the quotes mentioned the idea of inflation/debasement I just assumed that paper money was being used in some form at the time. But you are probably correct that gold was also used as “cash” as well so no need to double up on that component.
I think that gold is a commodity in the strictest sense. It is just easier to carry around in your pocket vs. a barrel of oil.
I do agree though that when inflation is raging that gold is what you want to own and not a basket of commodities. Real estate is also in the “hard asset” category and with REITs it is easier to own. The problem though is many REITs appear to be more like mortgage rate speculation vehicles and not property ownership vehicles. So even if you think you have real estate exposure through REITs what you may really have are a basket of companies that appear to just be mortgage holders which is not the same. The TIAA-CREF real estate fund appears to directly own property, but this fund is limited on who can own it. If you really wanted real-estate exposure, and could access the fund, that choice would be the best of most I’ve seen. Commodities in general play second fiddle to gold for bad inflation protection though. In particular, I really don’t like any of the Collateralized Commodity Future (CCF) funds that are out there. They are black boxes with high expenses. Gold is much cheaper to own and easier to understand. I also think it’s the asset most likely to perform well during times of serious currency problems.
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#3 written by Todd 2 years ago
craigr – I would like to get your opinion on this. I have taxable money I would like to invest and I am thinking about my opinions. This is money for my retirement. I would like to go the permanent portfolio route. However, since this is in a taxable account (I have very limited space in tax deferred accounts and these options wouldn’t be available) I think I am better of going with PRPFX instead of the 4 x 25. The mutual fund is very tax effcient, easy to use and I feel close enough to Mr Browne’s 4 x 25 fund. Your thoughts and comments would be appreciated. Thank you. Great site.
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Todd,
I’m in a similar situation with taxable funds. The worst offender are the bonds which throw off taxable interest but if you are using the funds for living expenses this softens the blow as you need the money anyway. There are also some tax loss harvesting strategies you can use to limit tax impacts (sell losers and harvest the losses to offset against your gains in other parts of the portfolio).
The PRPFX fund is very tax efficient which is a plus, but the minus is the higher expense ratio may bite into the tax savings you ultimately have.
In the end, both options are viable. The fund is convenient and may be more tax efficient due to how it is run. The DIY version can be made more tax efficient with intelligent rebalancing strategies.
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#5 written by stratton 2 years ago
Jacob Fugger had his commodities in what today would be mining stocks. People were quite perturbed at his copper, silver and mercuy monopolies. See:
http://www.encyclopedia.com/topic/Fugger.aspx
The MSCI REIT index Vanguard’s REIT fund follows doesn’t contain any mortgage REITs. It appears most (?) REIT investors don’t consider mortgage REITs to be “REITs” because they don’t actually own real estate.
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#6 written by MediumTex 2 years ago
I love that the permanent portfolio is actually a much older concept than Harry Browne may have known. It speaks well of the “permanent” part of the permanent portfolio.
It’s sort of like finding out that they were doing things with technology in the far east centuries before such developments made it to Europe.
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Stratton,
I need to find the references which I don’t have handy now, but both Browne in his book and radio show and David Swensen in his book discussed the problem with some REITs and how they are investing their funds. The issue, as I understand it, is some REITs invest in a way that you essentially are speculating on mortgage rates vs. property ownership. I will try to find the references if I can and post them. The Vanguard REIT index is a good choice if you want to own REITs, but I’m not sure it adds much to a portfolio that holds hard assets directly.
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#9 written by Matt 2 years ago
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#10 written by stratton 2 years ago
I think what CraigR is referring to is the leverage some REITs use. They are allowed by law to invest their money in treasuries or other real estate securities too. So a REIT with extra cash might hold them in REIT preferred stock or mortgages and leverage up on property mortgages for the ones they own. They may not be an actual mREIT, but they are getting close.
Right now, Oct 2009, REITs are deleveraging and issuing new shares while retaining. The market has reacted favorably to the share dilution because the lower leverage is seen as more favorable. As in the REIT will survive and not go bankrupt.
I wish someone would have a REIT index fund for low leverage REITs.
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#11 written by stratton 2 years ago
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#12 written by stratton 2 years ago
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Stratton and Matt,
Thanks for the updates. I’m actually not quite as opposed to REITs as Browne. If you are investing in a REIT index that is a proxy for property ownership it can have some uses. I’d consider this more in the variable portfolio however and not part of the core permanent portfolio holding. Earlier this year I considered buying some REITs for my variable portfolio. They aren’t up as much as the overall stock market (about +11% YTD but still almost -50% from their 2007 high), but if the real estate situation gets sorted out there is a real possibility that REITs could recover strongly.
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#14 written by Jim 2 years ago
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Jim,
I have no idea. I found a few references about Fugger’s ideas and thought it sounded interesting in principle but didn’t go much further. The main thing really is that other people apparently have considered diversification among stocks, bonds, cash and hard assets a worthwhile strategy in the past. I mention it mainly to illustrate that principles of diversification based on economic environments has worked in many times and places.
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#16 written by Clive 1 year ago
Had great foresight that Fugger. Considering that the first stock exchange never started until around 75 years after his death (Amsterdam 1602).
More likely the quotation is a translation error. Fugger’s ‘Bonds’ were in the form of Crown loans to Charles V and Emperor Maximilian I in return for regular payments. As for property he achieved rental income against Agriculture and Mines. He sought out to monopolise copper in order to keep prices high and achieved such in Hungary, but didn’t quite achieve global monopolisation. He was also into mercury mines, silver etc.
So in some respects he did own shares in businesses, had a form of bonds through Crown loans, rented agriculture (property) and did have a high interest in metals (precious and other). Not sure however that he might have even been aware of inflation/deflation concepts.
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That was VERY cool to read. Let me point something out to you, though, that I think you missed. In fact, the Fugger Portfolio is exactly identical to the Permanent Portfolio. Why? Because Jacob didn’t have to contend with fractional reserve banking! He was holding gold coins partly as an inflation hedge but also because the gold coins were CASH, the only real cash of his time. He would have taken it for granted that his gold coins would do very well during deflation since they were the cash of his time, and his purchasing power would have gone up just as USD bills would do today during a serious deflation. Cash was king then, cash was king now during deflation.
The money aspect of gold is still true today. There have been numerous looks at gold during the depression, and had gold traded freely, there is no doubt that purchasing power of gold would have gone up during the deflation that ensued. A gold coin in 1932 bought a lot more than it did in 1928.
So, for Jacob Fugger to really do well during an inflation, real estate was actually a great addition to the portfolio. Now that I’m thinking about it, if the USD really does crap out in the next few years, and we get gold again working in it’s proper role as money (which it still is doing, by the way), then the Permanent Portfolio is going to need something else as an inflation hedge. Gold will no longer be an inflation hedge per se. It will be CASH, money.
Interesting, I just re-read Rob Arnot’s commentary. He said Fugger had his money invested in stocks, bonds, real estate and COMMODITIES. Arnot is wrong about that. Gold was NOT a commodity in Fugger’s time. It was money. Not commodities. Real estate was serving as the commodity portion of the portfolio.
I’m sure you know the history, but when Harry Browne was designing the PP, he looked at all manner of inflation hedges, and he concluded that nothing worked better than gold. But you have to realize that he did this in an environment where we have fractional reserve banking. Once gold becomes a circulating currency again, we are going to have to look at things like copper, oil, agriculturals, etc, to find a good alternative. Fugger might be right. Real estate is a very good long term inflation hedge.
Thanks for bringing this to my attention.