1/1 Permanent Portfolio Update

I have been delayed in making this post due to some real life distractions. The year ended 2021 was a weak one for the portfolio, with a +5.70% return versus nearly +13% for a global 60/40 allocation and a blistering +28% for the S&P 500. A simple 50/50 NTSX/GLD portfolio would have returned +9.03%.

The full set of performance statistics is available here.

Current allocation:

You’ll notice I’ve made some allocation changes, notably by introducing a US small/micro cap value fund into the mix. This is a discretionary adjustment I’ve made as an initial, adaptive step in a macroeconomic and market environment that seems increasingly supportive of “value” (defined here as “statistical cheapness”). Since the purpose of this portfolio is to provide a stable core for one’s net worth, incremental adjustments are the order of the day.

2022 is shaping up to be a very interesting year so far. As I write this, this S&P 500 is -7.66% for the year. However, this bellwether belies huge dispersion across equity styles. US Small Caps as proxied by the Russell 2000 are down nearly 11.50%, and the Russell 2000 Growth index is down nearly 16% (!!). Ex-US and “value” style securities have delivered much more muted declines. Treasuries are down slightly and gold is flat.

All in all, the current market trends are relatively more favorable for a diversified portfolio such as this one. I say “relatively” because if 2022 plays out as the dominant narratives expect we are going to see rising interest rates, slowing growth and elevated inflation. A nasty cocktail for financial assets. Such an environment is one where most long-only allocations will be “taking their medicine.”

Nonetheless, a relatively stable portfolio core with some downside protection should provide a base of capital that can be selectively redeployed into the pain to scoop up some bargains in individual securities. I have a feeling there will be plenty to look at this year!

12/1 Permanent Portfolio Update

Updated performance statistics available here. The portfolio was -1.80% in November. This compares favorably with many equity market segments (US large cap being a notable exception). Relative to a “vanilla” US-equity-only implementation, ex-US equity exposure and a growth style tilt weighed on performance.

Month-to-date in December, the portfolio has been relatively flat, down 12 basis points. Overall it is shaping up to be a very mediocre year for the strategy (which I may write about more when the full year is on the books).

Current allocation:

06/21 Permanent Portfolio Update

Due to my recent data issues, I’ve moved the performance tracking for the live leveraged permanent portfolio strategy over to Portfolio Visualizer. Fortunately, I was able to recover old performance using past updates posted on the blog.

Below is data since I went live with the strategy. Portfolio 1 is the live track record for my implementation. Portfolio 2 is the performance of a static allocation to my implementation since inception. Portfolio 3 is 100% SPY.

Source: Portfolio Visualizer & Demonetized Calculations

As you can see, my implementation has underperformed the static allocation. Bummer. The reason for this is that up until 2020 I was adjusting the gross exposure based on trailing volatility. The strategy de-risked significantly in March 2020 and was slow to get invested again. I’ve since decided to drop this aspect of the strategy and stick to a relatively static allocation with occasional rebalancing going forward. I’m confident the divergence between the live implementation and the static-since-inception implementation will narrow over time.

Current allocation:

33% S&P 500 Futures

22% Laddered Treasury Futures

33% Gold

28% ex-US equity (active mutual funds)

~118% gross exposure (numbers above are rounded)

Periodically I get questions about quirks of this implementation. The lack of US small cap exposure, for example. There’s a simple reason for this. For structural reasons, this isn’t my whole portfolio. I can’t own this strategy in my 401k. Also, I invest in a concentrated portfolio of individual securities with a sleeve of my net worth. So overall, I have that exposure. If the leveraged permanent portfolio were 100% of my portfolio, I’d bring in more of that US small and mid-cap exposure. As I’ve said many times, the philosophy underlying this approach is extremely flexible.

05/21 Permanent Portfolio Update

In a tragic turn of events, a Morningstar Portfolio manager debacle wiped out my historical performance data earlier this month. So we’ll have to make do with just the backtest while I build up the live track record again (as far as I can tell the old data is unrecoverable).

I may try and go back through the old updates to rebuild the “real” track record but it’s not something I’ve put any time into yet.

Current allocation:

33% S&P 500 Futures

22% Laddered Treasury Futures

32% Gold

30% ex-US Equity

~117% gross exposure

2/21 Permanent Portfolio Update

Not much to report this month (performance as of intraday Monday).

Current allocation is roughly:

32% S&P 500 futures

21% Laddered Treasury futures

32% Gold

30% ex-US equity

115% gross exposure

A Brief Aside About Portfolios & Inflationary Regimes

Lately at work I have been helping a few people (and their clients) think about building portfolios to better withstand inflationary economic regimes. A recurring theme I come across is clients concerned about the potential impact of high inflation on their portfolios, whose first impulse is to cut or eliminate their equity exposure.

If anything, it is the bonds and cash they should be cutting. This is not to say that equities will do super well in an inflationary environment, but they are, at least in theory, capable of passing some inflation through to customers via price increases (what you really want to own in a high inflation period are companies with pricing power). Setting aside TIPS for the moment, bonds and cash are what are going to suffer badly in a highly inflationary environment.

What I think is happening here is that folks are thinking of high inflation as a Bad Thing and then thinking of Bad Things in deflationary terms. It is natural to think that if a Bad Thing is happening you ought to cut equity risk. Don’t do this! It may indeed be worthwhile to cut some risk. Just make sure you are cutting the right risk.

Again, this is not to say that equities will not suffer in an inflationary regime. It is important to disaggregate equities here. Equities I would be most worried about in an inflationary regime would be high multiple stocks with questionable pricing power and little to no free cash flow. These companies are going to be the most sensitive to substantial changes in the cost of capital/”discount rate.” They are the zero coupon bonds of the equity world.

I try to discourage people from positioning portfolios specifically for extremely high inflation or hyperinflation. Doing so requires them to dump their deflation allocation. We just don’t know whether/when significantly higher inflation is going to show up, and how many more deflationary episodes we might endure in the meantime. The basic intuition underlying the permanent portfolio concept is that we are bad at predicting things. Better to strive for a balanced portfolio capable of surviving many different regimes, even if it is not the best performer in any given regime.

12/20 Permanent Portfolio Update

I am changing the name of these posts going forward since I expect to be rebalancing much less frequently and keeping the allocation relatively static. Here is the current allocation:

This is about 117% gross exposure. Going forward, I’d expect these weights to remain pretty similar, with NTSX a little overweight relative to gold and ex-US equity just for leverage purposes. I will likely be due for a small gold-to-ex US equity rebalance soon. Performance versus US large cap:

Source: Demonetized Calculations

You can see a longer-term snapshot of how this allocation would have performed here. This period favors the leveraged permanent portfolio versus a 100% equity allocation, given that it begins with a market drawdown and includes the Covid drawdown. Over time, I would expect the performance gap to narrow significantly, with a 100% equity allocation making up substantial ground in benign market environments (see the latter half of 2020 for a taste). However, I would also expect the leveraged permanent portfolio to continue to dominate a 100% equity allocation on a risk-adjusted basis.

I have written many times that I favor a portfolio that uses the leveraged permanent portfolio as a stable core to support a smaller, but much more aggressive sleeve of concentrated investments. The power of this approach was on full display in 2020 as I was able to trim from the leveraged permanent portfolio near the nadir of the Covid drawdown to buy certain individual equities at extremely attractive levels. The result was a 57% IRR in that more aggressive sleeve.

Overall, 2020 offered a magnificent stress test of the leveraged permanent portfolio concept, given the magnitude of equity market moves both up and down. The portfolio passed this test with flying colors. Performance remained robust across both mini-regimes, within an extremely simple package that required no market forecasting whatsoever. Decent drawdown performance allowed me to play offense when market sentiment was at its worst and I still captured the vast majority of the equity market rebound.

11/20 Permanent Portfolio Rebalance

November was a relatively quiet month for the leveraged permanent portfolio (at least on a relative basis). It was a tremendous month for equities, and the portfolio will tend to lag the equity markets when they rally sharply. There will need to be a rebalance this month as gold is a bit underweight after November’s moves.

After running this strategy for a little over a year, in pretty varied market conditions, I am going to make a change and abandon the 12% volatility threshold for triggering moves to cash. This has always been an arbitrary threshold, and it is only intended to safeguard against one specific risk: panic liquidation that sends all correlations to one.

We got a taste of this in March at the nadir of the Covid drawdown. But the volatility threshold didn’t help much. It only triggered adjustments after the fact. In the future I may manage this risk on a discretionary basis instead. TBD.

Updated allocation:

30% S&P 500

20% Laddered Treasury Futures

34% Gold

30% ex-US equity

~114% notional exposure

Again, on a relative basis, overall performance has lost ground to US equities recently. Nonetheless, it remains plenty attractive on an absolute basis. Since late 2018, a static allocation version of this strategy has handily outpaced SPY, with a 60/40-like drawdown and volatility profile. As I’ve written many times, I would not necessarily expect the strategy to outpace a 100% equity portfolio over very long time periods. But I think it will remain competitive. On a risk-adjusted basis, on the other hand, I don’t think there will be any comparison. The leveraged permanent portfolio will dominate 100% equity portfolios on a risk-adjusted basis.

Source: Demonetized calculations; Performance vs. Morningstar Large Cap Index

10/20 Permanent Portfolio Rebalance

The allocation changed materially this month because I had some excess cash to invest and there are some frictions with asset location as these positions are held in both retirement and non-retirement accounts. Data here.

Overall the current allocation is approximately:

27% US Large Cap

29% ex-US Equity (mix of DM & EM, large and small cap)

18% Laddered Treasury Futures

30% Gold

8% Cash

~104% nominal exposure (tiny amount of leverage)

Technically I am supposed to be adding cash to bring trailing volatility back to 12%. However, the longer I run this strategy the less enamored of the volatility threshold I have become. Perhaps it is my stubborn contrarian tendencies rearing their head. Candidly, I just don’t feel like messing with it to shave off a couple points of trailing volatility. In a significant, sustained risk-off event I would likely add cash to counteract spikes in correlation. But for this to make much of a difference the event would have to be of enormous magnitude. Even during Covid this portfolio’s max drawdown was only about 10%. So for now I am just letting it ride.

Overall performance remains in line with expectations. Again, we are getting US Large Cap returns with 60/40 drawdowns and volatility, in a much better diversified portfolio.

Source: Demonetized Calculations

One thing that these performance reports do not capture particularly well is the portfolio’s growth equity tilt. In fact, this is precisely what has kept my ex-US equity exposure from being overly detrimental to performance. I haven’t written about it much in these posts, but for portfolios designed to harvest market betas (of which this is definitely one), I am in strongly in favor of underweighting traditional “value” strategies due to the prevailing global macro environment. Getting deep down into the weeds on this is beyond the scope of this post, but in my view the key headwinds for traditional value strategies are:

  • Persistently low trend economic growth
  • Ultra-low interest rate policy (provides greater benefit for long-duration assets)
  • Muted inflation (at least in the public consciousness)

In a sustained inflationary or (acknowledged) stagflationary economic regime I would likely make a tactical adjustment and reintroduce some traditional value equity exposure back into the portfolio. All this just goes to illustrate that there are infinite variations on the permanent portfolio concept.