Punched In The Face


I had never expected the leveraged permanent portfolio concept to be tested so dramatically, so soon after beginning this experiment. The speed of the coronavirus-induced drawdown in financial markets has been absolutely breathtaking. Truly a punch in the face. Through 3/20/20, my leveraged permanent portfolio has drawn down materially, though to a lesser extent than global equities. It has performed much like a 60/40 portfolio in these conditions, though much of this is actually attributable to the inclusion of ex-US equity in the allocation (a US-only variant would be down about 10%).


Source: Demonetized calculations as of 03/20/20*

In the midst of the chaos, I made an important discretionary decision last week. I liquidated the entire GLD position and took it to cash well ahead of the next monthly rebalancing check (due 4/1/20).

Market conditions had deteriorated significantly, and there was a period where essentially all financial assets had become correlated (equities, Treasuries, gold). This increase in correlations is THE existential threat to the permanent portfolio and in my view it MUST be managed. There are basically two ways of doing this: 1) hedge, or 2) take a portion of the portfolio to cash. I opted for #2, and liquidated both the gold and a small residual emerging markets equity position.

Current allocation (based on a full lookthrough of NTSX’s exposures):

33% Cash

27% S&P 500 Futures

18% Laddered Treasury Futures

17% Large Cap ex-US Equity

16% Small Cap ex-US Equity

(78% notional exposure; 60% notional equity exposure)

There is an argument for reducing exposure further. For example, my Twitter friend @breakingthemark runs a somewhat similar strategy with a weekly rebalancing cadence, which has delivered extremely impressive performance. His strategy is tuned to respond more quickly to crashes, and is currently at 60% cash. I expect at 4/1/20 I will be adding more cash, as well as rebalancing some equity exposure back into gold.


* Differences between the total (time-weighted) and personal (dollar-weighted) returns are attributable to the timing of trades, as well as the fact that I reduced the overall size of this portfolio to opportunistically redeploy capital into my “lottery ticket” portfolio bucket during this period.

Silver Linings

The nice thing about big selloffs is that the lower the market goes today, the higher your future returns go for tomorrow. We have 4Q19 Fed Z.1 data now, which means I can try to roundabout ballpark S&P 500 returns for the next 10 years. As of 12/31/19 this estimate was 2.43%. After making some (very) rough adjustments for recent market moves, it has increased to 7.66% today.


With interest rates as low as they are, and the possibility of negative rates looming on the horizon, I think a 700+ bps equity risk premium probably merits some buying, somewhere. DON’T GO ALL-IN. It is very possible things get worse before they get better. My own strategy has been to focus on the shares of companies that seem inordinately dislocated based on poor liquidity conditions. This is particularly evident in small cap stocks. In the US, these stocks had drawn down approximately 50% prior to the last couple days’ bounce.

Pulling the trigger on these things is not a trivial thing to do. It is uncomfortable knowing that you could be catching falling knives. I am not arguing that people are stupid for being cautious here.

I am, however, arguing that if you have liquidity (also far from trivial), and are willing to be a provider of liquidity in a dislocated market, there are spots where you can be compensated quite well for doing so. In small cap land, there are stocks trading at double-digit discounts to announced, all-cash takeout offers. This makes very little economic sense. Is Google going to bail on its FitBit acquisition because of the coronavirus? Probably not.

Admittedly, my truest investing self is “bottom-feeding contrarian.”

Right now, I think it makes sense more than ever to put money to work in a concentrated, “lottery ticket” portfolio alongside a more conservative core.