The Permanent Portfolio

I´m sure most people interested in finance have come across Harry Browne´s Permanent Portfolio as it is much discussed on finance forums.  The concept is simple - 4 uncorrelated asset classes which protect the portfolio in all market conditions.  Long date government bonds to protect against deflation, gold to protect against inflation and currency devaluation, the stock market to provide long term growth and cash as the ultimate safety net.

Much discussed and also much criticised,  particularly the presence of gold which commentators say  provides no income and often has no price growth during many years.   However, gold did rise in price considerably after the stock market crashes of 73-74, 2000 and 2008 so has shown its ability to provide a portfolio with some protection during market turbulence.

25% cash earning negligible return and the prospect of increasing bond yields with falling bond prices are also commonly cited concerns.  It would appear that it is a portfolio much discussed but little adopted as evidenced by the  Permanent Portfolio Funds (PRPFX) which has a market value of US$1.95bn - compared to the overall US market capitalisation of $4.59 trillion.  There is certainly is no proliferation of funds following the Permanent Portfolio philosophy.

Two books are worth reading for an in depth look at the concepts behind the Permanent Portfolio:

"Fail-Safe Investing: Lifelong Financial Security in 30 Minutes"

by Harry Browne

by Craig Rowland and  J.M.Lawson


A Portfolio For Retirees

For many years I have been interested in the Permanent Portfolio as a possible constituent of my retirement income strategy.  Whilst probably not the best option in the accumulation phase 
the Permanent Portfolio should be of interest to retirees in drawdown due to its low volatility and reasonable performance. Using data from Portfolio Charts compared to a classic 60/40 portfolio the Permanent Portfolio  has lower real growth (PP 4.8%, 60/40 5.8%) but much lower volatility with a maximum 11% decline in value and a 4 year recovery time compared to 57% and 13.3 years for the 60/40 portfolio (these statistics should be used only for comparison as charges and dealing fees are not included in the figures).  Volatility is the killer for drawdown as redemptions during market downturns  can significantly erode the portfolio´s value and reduce its longevity.  The consequence of low volatility means that the safe withdrawal rate (the maximum one can withdraw, increasing by the rate of inflation each year for a 30 year retirement) is 5.5% for the permanent Portfolio compare with 4.2% for a 60/40 portfolio.

Permanent Portfolio - 11% Max Fall In Value Maximum of 4 Years To Recover

Permanent Portfolio - 5.5% Safe Withdrawal Rate, 4% Perpetual

This compares to a classic 60/40 stock/bond portfolio:-

Permanent Portfolio for Me?

My retirement income strategy has largely been based upon dividends mostly from Investment Trusts.  For a retiree such as me the Permanent Portfolio has many attractions as I can have assets diversified from my dividend portfolios combined with a low volatility enabling a higher drawdown % than a classic 60/40 portfolio. 

 The majority of portfolios have been designed by back testing various asset classes and applying Montecarlo probability analysis to optimise the constituents of the portfolio.  Such portfolios are 100% based upon past performance.   The Permanent Portfolio however is based upon a powerful logic -  uncorrelated assets designed to ride out and even prosper in all market conditions.  The reality is that equity investments are highly correlated - global markets will generally rise and fall together, small caps and large caps, value and growth shares will all fall in a market crash and also bring down the values of corporate bonds.  Hence the classic 60/40 portfolio only provides a modest reduction in volatility whereas the Permanent Portfolio, whilst not immune, will limit declines to a maximum of around 10% (compared to 50% or so for a 60/40 portfolio).

Perhaps there will never appear to be an ideal time to go down the Permanent Portfolio route.  The very concept of the portfolio means that there will always be at least one of its constituents that appears to be over valued or destined for a fall.  During the last decade we have had falling interest rates that have boosted bond returns but made cash very unattractive.  Many believe that bond yields can only go upwards from such a low base making bonds a high risk asset.  The stock market has recovered strongly since the 2008 crisis - surely due for a correction.  Gold is on its way up - surely not a good time to buy.  And cash with its  below inflation returns.

Well one never knows how the future will pan out and that is the very essence of the Permanent Portfolio.  Whatever the marker does there will always be at least one element of the portfolio that will win out.   So I will be complementing my income portfolio with a Permanent Portfolio and in a further post will consider the exact asserts that I will be putting into the portfolio.

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