Keep it simple: the permanent portfolio

Keep it simple: the permanent portfolio

There are few portfolio management approaches that have the simplicity and excellent risk-adjusted returns of the Permanent Portfolio (PP).

The PP was developed and championed by Harry Browne, an American investment analyst, author and the two-time US Libertarian Party’s presidential nominee. He devised an investment strategy which is easy to implement, has had consistent and excellent long-term returns, has low risk and low correlation to traditional investments.

Indeed, $10,000 invested in the PP in 1971 would have yielded $429,000 in 2012 – a 9.6 per cent compounded annual return. In Browne’s 1998 book titled Fail-Safe Investing, he outlines a simple investing philosophy which invests 25 per cent equally in four asset classes: US large capitalisation stocks; long-term US treasury bonds; cash; and gold. The strategy can best be summarised as the lazy investors ‘all-weather’ portfolio that is designed to prosper and withstand all market conditions. The PP is, in fact, nothing more than a diversified buy-and-hold portfolio which needs to be re-balanced only once a year, at year end.

The initial concept behind the permanent portfolio is an acknowledgment that market timing is difficult and, as a result, positioning oneself to be “financially safe no matter what the future brings” is the way to go.

Predicting which market condition will ensue at any given time is a challenging and unpredictable task, so why not invest proportionally in all pertinent asset classes?

The PP should protect against cycles generated by shifts in economic forces which cause economic expansion, inflation, recession and deflation. The portfolio is intended to both withstand financial shocks and to prosper in the best of time.

In 2008, for example, when the global credit crisis hit financial markets, even though most portfolios were hit hard, the PP was down just 0.7 per cent. Even during the disastrous 2001-2003 stock market meltdown, the permanent portfolio returned solid positive returns.

The portfolio’s worst year would have been in 1981 with a manageable four per cent loss.

Exchange traded funds (ETFs) can be utilised to build the necessary exposure to all four of the asset classes. ETFs are funds which trade on exchanges and are designed to track the return of a particular index or portfolio. They are typically low-cost and passively managed, and will post returns very close to the underlying index the fund tracks.

Twenty-five per cent of the portfolio should be invested in US stocks, preferably through the SPY ETF which tracks the S&P500. Assuming reinvested dividends, US stocks have historically returned roughly 10 per cent annually. Stocks do well typically as economic activity expands and company earnings grow.

During recessions, stock prices decline, often precipitously

Recessions, on the other hand, bring with them an increase in unemployment and lower spending which in turn creates uncertainty and reduced corporate turnover.

During recessions, stock prices decline, often precipitously, however, the portfolio’s bond leg should do well considering central banks tend to lower interest rates during these times which are naturally good for bond prices.

Another 25 per cent of the portfolio should be invested in gold, ideally via the GLD ETF which invests directly in the metal. This portion of the portfolio should feature positively, during inflationary times or when ‘safe haven’ buying arises due to economic or political turmoil. Although global inflation has averaged some three per cent annually, there have been times where inflation has escalated to double-digit levels.

The portfolio’s other two quarters are also designed to be somewhat defensive, do well in low inflation or deflationary times and to generate income.

Twenty-five per cent should be invested in long-term US government securities. The TLT ETF invests in 20-year maturities and will do well as interest rates decline usually during economic slowdown or recessionary times. Because these bonds are backed by the US government, default risk is virtually non-existent. Conversely, as an economy overheats, inflation often becomes a concern which hurts both bond and cash holders.

The last quarter should consist simply of cash, preferably in the ultra-safe BIL ETF which invests in US Treasury Bills having three- to six-month maturities. Admittedly, US Bills are currently earning nothing, with interest rates so low. However, historically, US cash does earn in the region of five per cent. This leg is designed to be the portfolio’s ‘safety net’ and will be effective dampening market volatility.

In short, the permanent portfolio has historically offered investors the best of all worlds: excellent returns and downside protection, low volatility and low correlation to traditional assets. It is an investment portfolio you should well consider.

Joseph Portelli is the managing director and chief investment officer at FMG Funds (Malta). He also is a lecturer at the University of Malta and Institute of Investment Analysis.

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