The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged bonds
iShares Treasury Long Term Bond Index ETF Lending Securities and Risk
2 months ago
Recently it’s become clear that iShares is doing a lot of securities lending behind the scenes in their TLT Treasury ETF. This is a Treasury ETF they offer to hold bonds in excess of 20+ years. While not a perfect solution for the Permanent Portfolio, it is recommended by myself if you want to build a portfolio with just ETFs and cannot buy bonds directly.
However, tax documents from the fund for 2011 showed low levels of income from government obligations. This means that interest is being received from non-government bond sources. Which further means that if they are getting paid interest from non-government bond sources, then who are these sources?
This was discussed on the forum: TLT – Why Is Income from Govt Obligations so LOW? Thanks to Moda0306 and other readers for digging into the problem.
Sadly, this activity is common in the industry. It may boost returns slightly, but it makes a mess for taxable account holders because the income could be taxable at both the state level along with the federal level. It also introduces counter-party risk due to the lending activity. I don’t believe this risk is likely very big, but it is there.
Any fund can succumb to this kind of behavior (called manager risk). This is why I always advocate holding the bonds directly if you can. It just eliminates another problem. I’ll comment more on it in the future. This is just the compromise that happens for the convenience of ETFs or bond funds.
Again, just as Harry Browne recommended, hold Treasury bonds directly if possible. It is easy to do at most brokerages. Best of all, you not only eliminate annual expenses of a bond fund but also the managers that may be doing things behind the scenes that are not in your interest.
Fed Bank Failure Stress Test
2 months ago
by Craig Rowland
in Investing
Normally I don’t pay much attention to these things, but this story on bank failure stress testing caught my eye:
Fed Unveils Doomsday Scenario for Banks
The Fed will look at how the nation’s 19 largest banks would survive a world with a 13 percent jobless rate, a 50-percent drop in stocks, a 21-percent decline in housing prices and a significant contraction of other major world economies.
The Fed conducts the tests on banks every year, but this is the first time since 2009 that it will release its results to the public. In 2009 the Fed found billions in insufficient funds on bank balance sheets.
(emphasis added)
It’s stories like this which is why the Permanent Portfolio chooses to hold only the safest of cash and bond assets issued by the government. The fractional reserve banking system is inherently unstable during a crisis. You don’t want to hold a bunch of bank paper if you can hold the safer t-bills and bonds from the US Treasury. Unlike a bank, the US government can always pay back its debt with more taxes or (worst case) printing money.
I’d hate to think how FDIC would handle the situation if there was a very large banking crisis in the country. I’m not a big doom and gloomer, but I suspect delayed payments or maybe even pennies on the dollar back for depositors in the worst case. This is not out of the realm of possibility if a crisis were really bad.
When the report is released it will be interesting to see how the banks rank. It may be worth looking to see how your own bank fares. If they look weak, it might not be a bad idea to take your business elsewhere until they get their act together.
Risk and the Future
2 months ago
Let’s talk about risk and the future.
Sometimes I get a question about event X or event Y or event Z. These can sometimes be extreme events that someone is worried over. They often want to know how the Permanent Portfolio will deal with one or all of them.
My answer is that nobody knows what every possible hypothetical event will lead to in terms of unintended consequences. Even a portfolio you think will do best under event X may in fact do quite poorly if you guess incorrectly how the markets will react. Many investors in fact have been burned in just this very way. In other words, you can be right about a bad event happening, but totally wrong on how to invest to protect yourself from it. I never assume I know how the markets will react to a piece of news myself. I’ve been surprised often enough to know it just isn’t very profitable.
However what I most appreciate about the Permanent Portfolio is the fact that it is a way to diversify against a wide variety of serious or not-so-serious economic risks without having to guess about anything. As an entrepreneur, I like having options at all times to deal with the uncertain and the Permanent Portfolio does that. I don’t however spend a lot of time considering every possible scenario that could play out because it likely won’t happen that way. At least that’s what I’ve found in the business world and life in general. I think the best strategy continues to be one in which it makes no assumptions about any particular future, but at the same time gives an investor access to assets to accommodate even extreme situations if they show up.
For instance, let’s say the stock market dives by 50% tomorrow. If your portfolio was very heavy into stocks this would be a disaster. But if your portfolio is more Permanent Portfolio style the damage is limited. The 25% division of the four major assets of stocks, bonds, cash and gold limit your downside overall. Further, you would also have access to options to deal with the disaster (such as rebalancing into stocks with your cash, bonds and gold which is very likely the best option).
The Permanent Portfolio gives you options to deal with various contingencies if they should happen.
Or let’s say that happy days are here again and gold drops by 50%. That will be bad news for gold, but probably pretty good news for stocks. Take those profits and buy the yellow metal that everyone now hates because eventually they’ll want it again. Portfolio damage is limited because the downside of the gold can be absorbed by the upside in the stocks.
On the opposite end, if Treasury bonds tank and yields rise to 10% tomorrow the gold allocation will be there to deal with the very high inflation. This will allow a rebalancing into what is likely going to be lucrative high yields on your bonds once inflation comes back down. The gold gives you that option that a concentrated portfolio alone might not.
Finally, if you find out in 10 years that the US has gone to pot and a very dangerous government is rising to power you can make a decision to keep the gold separate and not rebalance. Instead you can hold the asset for the perceived emergency. There is nothing set in stone that says you must rebalance out of gold if you thought there was a extremely serious danger and you thought you’d need it. The future is unpredictable and because you hold the gold at least you have an option that other investors may not.
Each situation needs to be addressed when it comes about. However, the Permanent Portfolio gives you options to deal with various contingencies if they should happen.
I’ve never found that dwelling on doomsday scenarios to be very useful because the future rarely ever works out the way we think. Usually it is new and surprising outcomes that nobody expected that are the problem. Instead when you think about risk and the future, think of how useful a flexible portfolio with a wide range of assets is to deal with it. When I look at the problem that way, I’m glad I run the Permanent Portfolio and don’t concentrate my bets. I like having options and the Permanent Portfolio gives them to me.
