Permanent Portfolio

Investment author William Bernstein from Efficient Frontier recently wrote an article about the Permanent Portfolio:

Wild About Harry

He states:

In many respects, this allocation is a thing of beauty. Not only does it provide some protection against all but the most dire of scenarios, but its correlation grid is one rarely seen in finance: four non-derivative assets populated entirely by near-zeros…

- William Bernstein – Efficient Frontier “Wild About Harry”

He continues:

And therein lies the real problem with the TPP (ed: Theoretical Permanent Portfolio): because of its huge tracking error relative to more conventional portfolios, it attracts assets and adherents during crises, then sheds them in better times. There’s nothing wrong with Harry’s portfolio – nothing at all – but there’s everything wrong with his followers, who seem, on average, to chase performance the way dogs chase cars.

…

Sadly, this [buying assets before they have gone up in price] is the opposite of what the legions of new TPP adherents and PRPFX owners have been doing recently – effectively increasing their allocations to red-hot long Treasuries and gold. Consider: over the long sweep of financial history, the annual real return of long bonds and gold have been 2% and 0%, respectively; over the decade ending 2009, they were 5% and 11%.

- William Bernstein – Efficient Frontier “Wild About Harry”

His point about people not sticking to an investment plan is well taken, but hardly unique to the Permanent Portfolio. As for whether gold or LT bonds are a good buy now: I learned a long time ago that whenever I think I know what the markets are going to do I’m usually surprised later.

I read articles back in 2007 saying how expensive gold was when it was $600 an ounce and would crash any day now (it’s over $1200 now). I read articles over a decade ago about avoiding LT bonds because of the inevitable rise in interest rates (30 year bonds yielded 5.9% in 2000 – today they are 3.5% giving big profits to long bond holders over this time). In fact, I’ve read investment books going back over 20 years saying the exact same thing about the inevitable destruction of the long bond (30 year bonds in 1990 yielded 8.6% BTW).

The above is to say nothing of the copious amounts of doom and gloom stock predictions in 2009 that proved to be horribly incorrect as the market recovered so sharply it could give you whiplash. All of these predictions have been dead wrong and highly unprofitable if followed.

As it were, Harry Browne actually got this type of question about avoiding this or that asset over the years and I made this audio clip of him answering it:

http://crawlingroad.com/blog/wp-content/uploads/2010/01/HarryBrowne-WhichAssetWillDoBest.mp3

This clip was made in 2004 but could have been recorded last week (Browne even mentions about the Dow being 10,000 back then and it’s there again right now in fact – It’s de ja vu all over again). These debates about what to buy and sell are raging constantly in the market and will do so forever. Investors just need to ignore all of them.

The point is not to be a cheerleader for some particular asset because eventually every investment has a bad spell. It’s simply that we can’t predict the future and the reason we own different assets in the portfolio is to provide protection against the unknown.

Diversifying asset classes, as Harry Browne knew well, can benefit a portfolio. The secret is deploying them before those diversifying assets shoot the lights out.

- William Bernstein – Efficient Frontier “Wild About Harry”

I disagree. Investors can’t possibly position their portfolio in a way to take advantage of an asset before it goes up in price. It just doesn’t happen that way.

What’s the real secret? Simple:

Just own everything at once because we have no way of knowing what is going to do best going forward.

It was investors who owned assets like gold and long bonds all the time, regardless of what was being predicted, that were able to reap these rewards the past few years. They may continue to do well, or maybe not. Maybe stocks will finally come out of their funk and go gangbusters again as they did in the 1980s and 1990s. Nobody knows.

We just don’t know when the markets will move one way or another. Investors therefore must diversify, and must stay diversified, all the time regardless of what their opinion is about the future. We simply cannot know what asset is going to do best ahead of time and allocate accordingly.

The correct strategy then is to hold fast to your asset allocation. If something has gone up enough in price to trigger a rebalancing band, then sell it down and use the profits to buy the laggards. But never time the buying or selling of an asset in the portfolio because of how you feel about it. That’s a sure way to run into big problems. The Permanent Portfolio is designed to hold volatile assets together in the form of 25% each stocks, bonds, cash and gold. If you take out any one piece you lose the protection of the portfolio.

Performance chasers will always performance chase and will always show poor results for their efforts. The Permanent Portfolio is not designed to be a hot rod so the performance chasers will eventually be disappointed. What the portfolio provides however is moderate growth with wide diversification and low volatility even in very bad markets. At the same time the strategy has shown reasonable real after-inflation returns for the level of risk involved with no market timing nor close monitoring required. For people looking for those attributes, the strategy may make you wild about Harry, too.