Permanent Portfolio Shakedown

General Discussion on the Permanent Portfolio Strategy

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Kevin K.
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Permanent Portfolio Shakedown

Post by Kevin K. » Thu Jun 18, 2020 4:51 pm

This came my way via a post in the long thread on the Golden Butterfly over on Bogleheads:

https://investresolve.com/blog/permanen ... wn-part-2/

Some of the discussion in the piece is above my pay grade but not above that of many who post here. The author makes some points about the dangers of static portfolios in the current environment of unprecedented low rates on cash and bonds and equally unprecedented money printing by the Fed that make sense to me.

Thoughts?
pmward
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Re: Permanent Portfolio Shakedown

Post by pmward » Thu Jun 18, 2020 5:37 pm

I don't think there is anything unique to this time period that makes static portfolios detrimental. I think a static portfolio is just fine. But I also do think that having a tactical allocation can be a good thing. The whole portfolio does not need to be tactical though to benefit. For instance, one could run a golden butterfly modification where they substitute the 20% small cap value with a trend following strategy (similar to something like what Ocho does with Paul Novell's quant strategies would work just fine in this tactical bucket). Tactical strategies can perform really well over the long term. But they are not without their own unique tradeoffs. A couple thoughts:

Tactical and static allocations have opposing strengths and weaknesses. What does this mean? Those magic words "non-correlated returns". We all know how powerful it is to have non-correlated assets. So let's take a look specifically at the strengths and weaknesses of static and tactical in the context of an individual asset.

Static -
Pros: does well in strong bull markets
Cons: crashes and burns in strong bear markets

Tactical -
Pros: does really well in strong bear markets
Cons: susceptible to crashing and burning during fake out corrections in strong bull markets

So what does this mean? One out performs in bull markets, the other out performs in bear markets. So knowing what we know about non-correlation and rebalancing magic, what do we have here? A perfect pair. Combine some static buy and hold stocks and some tactical stocks and you wind up with a whole that is greater than the sum of its parts. I personally see including a tactical allocation as strategy diversification. In the PP assets you have asset diversification. Bringing in some tactical adds a whole other layer of diversification that one cannot get from any static assets.

In that article he seems to be a big fan of risk parity. If anything, March showed just how risky that risk parity can really be. When markets get illiquid risk parity blows up. So I wouldn't personally go 100% risk parity. Now, that's not to say risk parity doesn't have its uses. Risk parity is a fine non-correlated tactical strategy when combined with other strategies (like a static allocation). Ray Dalio doesn't even recommend going 100% risk parity, he advises combing risk parity with a "pure alpha" strategy. HB recommended combining a PP with a VP. So what am I getting at here? Diversification in strategy is important and it can help one out perform over the long term, as just like each asset has it's times it shines and it's times it falls on it's face, every strategy likewise has it's times it shines and it's times it falls on it's face. So if one combines a couple strategies, just like assets, that have opposing strengths and weaknesses in an intelligent way you wind up with a whole that is more robust, anti-fragile, and will perform better than the sum of its individual parts.
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Re: Permanent Portfolio Shakedown

Post by pmward » Thu Jun 18, 2020 5:54 pm

See this link here that I posted a few months back in Ocho's Tactical VP thread. This is a simple core-satellite portfolio with 40% in a PP (using QQQ as the stocks) and 60% in a simple trend following strategy where on QQQ anytime the 12 week EMA is above the 26 week EMA you are in QQQ, else you are in cash. So you can see on the comparison the PP is the core portfolio (red), the trend strategy is the satellite portfolio (yellow), the core-satellite 60/40 (blue), and even an S&P comparison (green). Notice how the core-satellite portfolio beat the S&P by over 1%, yet had a fraction of the drawdown. It also had a much higher return with only a slightly higher max drawdown to the Golden Butterfly (from 2005-present GB had 7.56% return and 16.64% max drawdown using the same site). Non-correlated returns + rebalancing = magic. https://www.portfoliovisualizer.com/tes ... odWeight=0


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Kevin K.
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Re: Permanent Portfolio Shakedown

Post by Kevin K. » Fri Jun 19, 2020 8:42 am

Thanks pmward! I had you in mind when I posted the link, knowing you'd have a lot of insight to offer and you certainly don't disappoint.

This quote from Part 1 of the series by that author makes his approach clear:

"The plain-vanilla version of this strategy is quite compelling on its own, and tough to beat. Unfortunately, the approach faces the same challenge as other static allocation approaches in the current environment: record low interest rates and expensive stocks and commodities, which suggests that returns to this approach may not be as strong over the next several years.

In Part 2 of this series we are going to explore some simple techniques that might further improve the performance of this approach, including volatility management, risk parity, moving averages and finally Adaptive Asset Allocation."

And I also noted on rereading Part 2 that his baseline results for the "plain vanilla" PP are based on rebalancing it quarterly, which no one I know would do. Gotta wonder about the real-world tax implications of the trading this guy and his associates do. They claim (in their FAQ's) that avoiding market lows more than makes up for such costs but they clearly haven't been in business long enough to really say that's true across the board.

Too much complexity for me in any case but I admire those with the intelligence and skills to take Mr. Browne's insights about holding uncorrelated assets that do well in specific conditions and using them in innovative ways.
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Re: Permanent Portfolio Shakedown

Post by pmward » Fri Jun 19, 2020 11:29 am

Kevin K. wrote:
Fri Jun 19, 2020 8:42 am
Thanks pmward! I had you in mind when I posted the link, knowing you'd have a lot of insight to offer and you certainly don't disappoint.

This quote from Part 1 of the series by that author makes his approach clear:

"The plain-vanilla version of this strategy is quite compelling on its own, and tough to beat. Unfortunately, the approach faces the same challenge as other static allocation approaches in the current environment: record low interest rates and expensive stocks and commodities, which suggests that returns to this approach may not be as strong over the next several years.

In Part 2 of this series we are going to explore some simple techniques that might further improve the performance of this approach, including volatility management, risk parity, moving averages and finally Adaptive Asset Allocation."

And I also noted on rereading Part 2 that his baseline results for the "plain vanilla" PP are based on rebalancing it quarterly, which no one I know would do. Gotta wonder about the real-world tax implications of the trading this guy and his associates do. They claim (in their FAQ's) that avoiding market lows more than makes up for such costs but they clearly haven't been in business long enough to really say that's true across the board.

Too much complexity for me in any case but I admire those with the intelligence and skills to take Mr. Browne's insights about holding uncorrelated assets that do well in specific conditions and using them in innovative ways.
In the quote from part 1 I would very much argue that commodities are not expensive in any way. After a decade of underperformance, commodities are ripe for a turn around bid. I think commodities are going to be where it's at going forward over the next decade. I still do think the PP is fine as is, even with everything he says. If interest rates do go up drastically (which is extremely unlikely because the Fed would quickly implement yield curve control if this happened with the current debt load) the PP at this point would probably see one of its largest drawdowns. BUT it would still out perform a standard 60/40. Once again, odds are not in favor of this happening. It think the high volatility environment we are in is not going to change any time soon. So it is a great time to be in a PP, and an incredible time to start a PP for anyone that is new to this board. Stocks have went basically all of nowhere in 2 1/2 years now. Food for thought: we could be only 1/4 of the way through another "lost decade". The jury is still out on that one. Even if stocks do go higher over the next year or two, if they reverse all those gains in a secular bear market, it still equates to lost time in the grand scheme.

From the quotes on part 2 I will say that all the strategies he mentions are fine, and intelligently implemented can help increase risk adjusted returns, especially if the high volatility swings continue, as this is the type of environment that tactical strategies really shine. But I wouldn't put all of my eggs in one basket is my main point above. All tactical strategies out perform at certain times and blow up at certain times, just like buy and pray does. We all have learned from Harry Browne just how important and powerful diversification can be. So if one is going to implement a tactical strategy, I would do so in a diversified way, using at least 2 strategies, one of which, as I mentioned above, can be a PP. If you follow that link you can play around with the percentages in the core and satellite portfolios. I posted 60% satellite / 40% core, but you see surprisingly similar numbers out of 50/50, 60 core / 40 satellite, 70/30, 80/20, etc. You really can't go wrong with a portfolio that is that diversified. It also happens to fit very neatly into the PP/VP framework just like a GB. The tactical bucket is more diversified than the GB's small crap value, as small crap value is still highly correlated to the total stock market. The main drawback is any tactical bucket does require more attention than a static portfolio, and that would turn a lot of people here off. Also, there can be tax implications that need to be considered. When I need to sell I have to decide where to sell. My tactical is 30% of my total portfolio so I can choose to sell all in tax sheltered if need be, but sometimes I do choose to realize some long term capital gains in taxable as I do not believe that the 15% LTCG rate will be in place for my entire life. This tax implications can be challenging if you're 100% in a tactical though, as sometimes you would have to sell for a short term capital gain in taxable if you're all in on tactical. Just some food for thought at least, and another point in the diversification of strategy column. There are benefits to tactical, and there are benefits to buy and hold. From the extensive research I have done, I have come to the conclusion that combining the two strategies are a perfect way to negate the weaknesses of one directly with the strengths in the other.
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Re: Permanent Portfolio Shakedown

Post by pmward » Fri Jun 19, 2020 12:23 pm

Decided it would probably be good to include data from an 80 PP core / 20% tactical VP satellite since the 80% PP 20% VP framework is already very familiar to most here because of the GB. It at least gives a nice comparison. You can see that the CAGR is still very close to the 40/60 I posted earlier, but the largest drawdown dropped from ~19% down to ~13%, making the drawdown very similar to a GB, but with a significant out performance in returns, and a HIGHER Sharpe and Sorrentino ratio than even the PP. I will call this the Tactical Butterfly: https://www.portfoliovisualizer.com/tes ... odWeight=0


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Kevin K.
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Re: Permanent Portfolio Shakedown

Post by Kevin K. » Sat Jun 20, 2020 4:45 pm

Thanks pmward! Your posts here (and in general) add a lot to this board.
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Re: Permanent Portfolio Shakedown

Post by mdwilson1991 » Sun Jun 21, 2020 10:48 am

I think it is important to note that what the author of the linked post has proposed is in no way a version of the PP.

He has addressed what he views as the flaws of the PP by introducing various modeling techniques which attempt to improve performance by predicting what the next periods results will be based on some arbitrary recent periods.

Of course, there is no shortage of authors who have developed similar tactical modeling approaches, and they may well prove to be superior to the PP over some period of time. However, they are all based on adjusting allocations, predicting what will happen based on what has happened.

But the PP at its heart is based on the four asset classes responding differently to economic conditions, without any attempt or ability to predict what will happen next.
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Re: Permanent Portfolio Shakedown

Post by Kbg » Mon Jun 22, 2020 11:55 am

mdwilson1991 wrote:
Sun Jun 21, 2020 10:48 am
I think it is important to note that what the author of the linked post has proposed is in no way a version of the PP.

He has addressed what he views as the flaws of the PP by introducing various modeling techniques which attempt to improve performance by predicting what the next periods results will be based on some arbitrary recent periods.

Of course, there is no shortage of authors who have developed similar tactical modeling approaches, and they may well prove to be superior to the PP over some period of time. However, they are all based on adjusting allocations, predicting what will happen based on what has happened.

But the PP at its heart is based on the four asset classes responding differently to economic conditions, without any attempt or ability to predict what will happen next.
You grossly undersell the analysis that was performed in the series. If one is interested in ultra simplicity then 25x4 is as easy as it gets. But I think most impartial observers would say the PP 25x4 allocation is anything but truly neutral as to risk and as to properly weighting economic conditions probability. For these reasons alone, I would never recommend it to anyone under 50 unless they were comfortable with leverage. I also assume you understand how the PP was invented (shocking, get ready for it...it was designed through backtesting)
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Re: Permanent Portfolio Shakedown

Post by mdwilson1991 » Thu Jun 25, 2020 8:26 am

Kbg wrote:
Mon Jun 22, 2020 11:55 am

You grossly undersell the analysis that was performed in the series. If one is interested in ultra simplicity then 25x4 is as easy as it gets. But I think most impartial observers would say the PP 25x4 allocation is anything but truly neutral as to risk and as to properly weighting economic conditions probability. For these reasons alone, I would never recommend it to anyone under 50 unless they were comfortable with leverage. I also assume you understand how the PP was invented (shocking, get ready for it...it was designed through backtesting)
I am not selling it at all. I'm pointing out that although it may be interesting, or show good performance over some period, it is not in any way a version of the permanent portfolio as defined by Browne. Browne recommends a PP for investment focused on capital preservation, and a variable portfolio for any other speculation activities. The PP is for money that you cannot afford to lose and thus it has a goal of capital preservation. He states in "Best Laid Plans..."

An investor does make a number of decisions in planning his portfolio. But he doesn't try to decide which investment will do best. Nor does he try to time his purchases and sales.

A speculator attempts to earn more than what the market is paying an investor. He tries to be in a market when it's going up, and out of it when it's going down. And he attempts to choose stocks or other investments that will outperform a market, rather than just reflect it.


The approach in the link relies on entering and exiting market positions based on moving averages, making allocation adjustments based on measured historical volatility, and also using intermediate treasuries instead of long term treasuries. This is clearly designed to time the market and vary asset allocation - none of those aspects are found in the PP, and instead would be used in a VP per Browne's definitions. The model in the link is a tactical asset allocation model, and the permanent portfolio is not.

You may well never recommend a PP to anyone under 50 who is not comfortable with leverage. There are plenty of other people who find it unsuitable as well. In fact, probably the majority of the investing world doesn't like it. However, this is the permanent portfolio forum, so many people here do find it suitable.
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