I’m not the first person to identify Treasury bills, Treasury bonds, and gold as effective hedges against stock-market declines. In fact, there is a well-known strategy known as the Permanent Portfolio, developed by the late Harry Browne, which has recently been making a comeback.
Browne first referred to the idea of a Permanent Portfolio in the 1970s. Originally, however, it appears that Browne was just suggesting that each person have one portfolio that remained invested in the same manner at all times, and another, called the Variable Portfolio, which changed based on the investor’s expectations about the near future. By the early 1980s, though, Browne and an associate, Terry Coxon, offered a specific Permanent Portfolio, and a mutual fund was started which included stocks, Treasury bonds, Treasury bills, and gold, along with an assortment of other hedges including Swiss francs, real estate, silver, and natural-resource stocks. The appropriately named Permanent Portfolio Fund (PRPFX) began operations in December 1982. In the 30 calendar years 1983-2012, the fund only lost money in four of them, with only a single double-digit loss of 13.1% in 1984. It lost only 8.4% in 2008, a year in which the S&P 500 dropped 37%. It has never suffered back-to-back losses, and 1984’s drop was the only one which wasn’t fully recovered by the end of the following year, although its 12% gain in 1985 came pretty darn close.
In short, the Permanent Portfolio has done what Browne suggested it could do: protect an investor from major losses in virtually any environment (although we certainly haven’t had EVERY possible environment in the past 30 years.) So what’s wrong with it?
Well, what if I told you about the invention of a new device that would completely eliminate rear-end collisions when driving, even minor fender benders? Would you be interested? Oh, I forgot to mention that it adds $20,000 to the cost of the car and cuts your gas mileage in half, and the car won’t be able to go over 30 miles per hour.
Yes, I forgot to tell you the annual rate of return that you would have earned in the Permanent Portfolio Fund. As of June 30, 2013, it was 6.4%, compared to an 11.1% return for the S&P 500 Composite Stock Index. In fact, the Permanent Portfolio Fund had virtually the same annual rate of return that you would have gotten by keeping all your money in the Vanguard Short-Term Treasury Fund, which earned slightly better than 6% per year and whose only loss in that time period was a trivial 0.6% in 1994.
The ironic thing about the Permanent Portfolio is that it’s changed. In the late 1990s, Browne introduced a simplified Permanent Portfolio amenable to do-it-yourself investors: 25% each in U.S. stocks, short-term T-bills, long-term T-bonds, and gold. Finally in 2003, Browne’s last version of the Permanent Portfolio recommended an S&P 500 Index Fund for the stock portion. (Previously he had suggested aggressive growth stocks for the not-unreasonable reason that devoting only 25% to growth might require more growth from the growth portion.) Of course, each changed version hypothetically would have done better than the version before it, but constantly changing your strategy and then taking credit for the improved back-tested results really isn’t playing cricket. Even so, the final version of Harry Browne’s strategy would have trailed an investment in the Vanguard 500 Index Fund by around 3% per year, not much better than the real-life Permanent Portfolio Fund.
Studies that try to take the comparison back to 1972 take credit for the best 10 years the Permanent Portfolio ever had relative to the S&P 500, which is, of course, the very reason that the strategy was first published just after those 10 years. In essence, proponents of this strategy give themselves the biggest head start in history whenever they report the hypothetical results of
following their favorite version of the Permanent Portfolio, starting a decade before the strategy was first publicized.
Before ending this long discussion (which apparently took me about a year to write: sorry, I went on what I thought was only a three-hour cruise and got marooned with a bunch of very strange people without Internet access), let me note that the Permanent Portfolio is NOT an example of a well-diversified portfolio. In Browne’s final version, you’re lending half your wealth to one borrower and then putting half the remainder into one big piece of metal, leaving a mere quarter in a U.S.-only index that is dominated by a relatively small number of large companies.
Next week, I will suggest what I consider a reasonable use of the three excellent hedges that are included in the Permanent Portfolio.