Investors rushed to rediscover the permanent portfolio after suffering from painful losses caused by the crash of 2008. It promises a soothing combination of relative safety and reasonably good returns.
The portfolio is the brainchild of Harry Browne, who passed away in 2006. Mr. Browne was an investment adviser, prolific author and Libertarian candidate for president of the United States in both 1996 and 2000.
His permanent portfolio is easy to describe. It invests equally in stocks, long-term government bonds, cash and gold. The idea is to use simple low-fee index funds (or exchange-traded funds) to gain exposure to the different asset classes, where applicable, and to rebalance once a year.
Author William J. Bernstein studied the long-term performance of the U.S. version of the permanent portfolio shortly after the crash of 2008. He figured that it would have returned an average of 8.53 per cent annually from 1964 through 2009 with a volatility (standard deviation for the statistically minded) of 7.67 per cent.
By way of comparison, Mr. Bernstein calculated that a more conventional portfolio with 60 per cent in U.S. stocks and the remainder split equally between 30-day U.S. Treasury bills and long-term U.S. government bonds would have gained an average of 8.83 per cent annually over the same period with a volatility of 11.25 per cent.
The volatility difference between the two is particularly evident when examining market downturns. For instance, in 2008 the permanent portfolio lost 1.31 per cent whereas the more traditional mix lost 16.52 per cent.
The ride was much smoother for the permanent portfolio because the four assets it holds are weakly (or even negatively) correlated with one another. For instance, in inflationary times long-term bonds usually crash while gold surges higher. The opposite tends to be the case in deflationary times. Or at least that's the theory.
The good U.S. results got me wondering about how a similar approach would have fared in Canada.
To make a Canadian version of the permanent portfolio I swapped the U.S. T-bills and long-bonds for their Canadian counterparts. But, due to our small stock market, the equity component is split equally between the S&P/TSX composite index, the S&P 500, and the MSCI EAFE index of international stocks. The portfolio is rebalanced annually and the calculations are based on annual data without currency hedging.
Overall, the results are pretty good. The Canadian permanent portfolio would have gained an average of 9.1 per cent annually over the 40 years through to the end of 2016 with a volatility of 8.1 per cent.
Amazingly, it suffered a loss in just one annual period, when it declined by 5.4 per cent in 1981.
By way of comparison, a global couch potato portfolio with 40 per cent in the FTSE TMX Canada Universe Bond index with the rest split equally between the S&P/TSX composite, the S&P 500, and the MSCI EAFE index would have gained 10.4 per cent annually with a volatility of 9.7 per cent over the same period.
The couch potato portfolio's somewhat higher volatility came with more severe crashes. For instance, it lost 14.6 per cent in 2008 and 10.4 per cent from 2001 to 2002.
Still, the couch potato fared pretty well and its wilder ride provided an extra 1.3 percentage points worth of annual return, which really adds up over time. Mind you, it's impossible to say with certainty how either approach will fare in the future.
Risk-averse investors who want to follow the permanent portfolio should be aware that its returns will vary a great deal from those of the stock market over long periods. That might be comforting during market crashes when losses should be limited but it could be painful during bull runs when more conventional portfolios are likely to surge ahead.
Nonetheless, the permanent portfolio is worth considering.
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