By Mark Hulbert, MarketWatch
Courtesy Everett Collection
Would you interested in a strategy that appreciates regardless of how the markets perform?
Of course you would. Such a strategy represents the Holy Grail of retirement investing, allowing retirees to immunize themselves from the various asset classes’ bear markets.
But does such a strategy exist in more than our imaginations? In this column I focus on the Permanent Portfolio Fund (NAS:PRPFX) , which many have argued comes close to being this Holy Grail. Its website says the fund “seeks to preserve and increase the purchasing power value of each shareholder’s account over the long-term, regardless of current or future market conditions.”
PRPFX aims to achieve this impressive goal by maintaining relatively fixed allocations to each of several major asset classes: 25% in gold and silver, 20% in U.S. stocks, 25% in U.S. bonds, 10% in Swiss Franc assets, and 20% in real estate and natural resource stocks. The fund, created in the 1980s, was the brainchild of the late Harry Browne, then the editor of a newsletter called Harry Browne’s Special Reports. In 1996 and 2000, Browne was the Libertarian Party’s candidate for president.
How has the fund performed? Since 1986, as you can see from the accompanying chart, it has handily beaten gold, only slightly beaten bonds, and significantly lagged behind the stock market. For the stock market, I focused on the Wilshire 5000’s total return index (1083:XX:W5000) ; for bonds I chained together the Lehman Treasury Index and the Bloomberg Barclays US Treasury Total Return ; and for gold I focused on the London market’s PM fixing price.
It’s hard to know, from the 35,000 foot vantage point of this chart, how good the PRPFX’s performance really is, since coming out in the middle is to be expected—better than some of the asset classes and worse than others.
We obviously need to dig deeper.
The first step is to adjust these various returns for risk, since PRPFX is constructed to be lower risk than alternative asset classes. I use the Sharpe ratio to measure risk-adjusted performance, which divides return above the T-bill rate by volatility (as measured by the standard deviation). The table below lists the monthly Sharpe Ratios for PRPFX and the several asset classes since May 1986:
|Monthly Sharpe ratio (Average monthly return above T-bill rate divided by standard deviation of monthly returns)||Annualized return||Standard deviation of monthly returns|
|Permanent Portfolio Fund (PRPFX)||0.12%||6.2%||2.28%|
|US Treasury Bonds||0.16%||5.9%||1.34%|
It is discouraging that PRPFX came out behind both stocks and bonds on a risk-adjusted basis, since it means that regardless of whether you are a conservative investor or an aggressive trader, you could have made more money with stocks and bonds than with PRPFX.
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Consider first the stock market, which as you can see from the chart was almost twice as risky as PRPFX over the last three decades. You could have created a stock portfolio that was no more risky than PRPFX by allocating about half of it to cash and the other half to stocks. Equities’ higher Sharpe ratio means that this conservative stock-plus-cash portfolio would have made more money than PRPFX—without any increase in volatility-based risk.
The same goes for bonds, which case you can see were almost half as volatile as PRPFX. To match PRPFX’s volatility, you could have bought a bond index fund on sufficient margin. If you had done that over the last three decades, you also would have outperformed PRPFX.
Will the future be like the past?
If the future lives up to the last 30 years, therefore, you will be able to do better than PRPFX, with no more risk, by investing in stocks or bonds and mixing those assets with the proper level of cash or margin.
But will the future be like the past? That is the $64,000 question. When Harry Browne came up with the idea of a permanent portfolio, bonds were coming off a several-decade period of devastatingly poor performance. Inflation-adjusted losses produced by the bond market were being referred to as the biggest destruction of wealth in recorded history.
The stock market was coming off a period of performance that was nearly as dismal. The Dow Jones Industrial Average (DOW:DJIA) was above the 1,000 level in January 1973 and then fell below it and stayed below until 1982. On an inflation-adjusted basis, stocks performed even more poorly. Gold, in contrast, was a stellar performer in the 1970s.
In other words, the 1970s were almost a mirror opposite of what the subsequent 30 years looked like. But we would have had no way of knowing that then. Nor do we know today what the next 30 years will be like. It does seem clear that bonds will not do as well in subsequent decades, given today’s low interest rates. And stocks also will be facing some stiff headwinds owing to their current overvaluation.
The more fundamental point, however, is that no one knows for sure. The PRPFX is a response to that uncertainty.
Another test of a low-risk strategy like the PRPFX is measuring its biggest 12-month loss. Its biggest came at the end of the financial crisis, when it was 18.6% lower than where it had stood one year previously. (I calculated drawdowns using month-end values.) Though this 12-month drawdown is worse than for bonds (minus 4.3%), it is markedly better than gold’s (minus 27.8%) and a lot better than stock’s (minus 43.3%). But beating stocks and gold is little consolation if your retirement finances are dependent on not suffering that kind of a loss.
However, the picture painted by five-year holding periods is a lot better. The worst five-year stretch for the PRPFX over the last three decades was one in which it was essentially flat (an annualized loss of just 0.2%), versus a 6.1% annualized loss for gold and 8.3% for stocks. (Bonds’ worst 5-year stretch since 1986 was one in which it produced an annualized gain of 1.2%.)
If we expand our time horizon to 10 years, PRPFX looks even better. Its lowest 10 year annualized return was a gain of 3.2% annualized, better even than bonds’ 2.7% annualized gain. Gold’s worst 10-year return since 1986, in contrast, was minus 2.6% annualized; for stocks minus 5.0%.
These results provide support for the claim made on the PRPFX website that it should be judged over the long term.
The bottom line? If the next 30 years are like the last 30, then there would be no point in considering PRPFX in your retirement portfolio. But a compelling case can be made that, given the profound uncertainty about what the future will bring, retirees should at least consider the fund.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email firstname.lastname@example.org .