Larry Swedroe's Comments on the Permanent Portfolio

[EdwardjK]

Last night I attended an investment seminar where Larry Swedroe was the speaker.  Swedroe is a principal and Director of Research at Buckingham Asset Management and an author of about 10 books on low-cost investing.  Suffice it to say that Larry advocates the use of low cost index funds as the best vehicles to build your investment portfolio.

At the end of his presentation, I askede Swedroe if he was familiar with Harry Browne's Permanent Portfolio concept, and what he thought about it.  He responded by saying he was very familiar and:

1.  He thought using only four assets did not provide sufficient diversification,
2.  Gold is not a good hedge on inflation.  He pointed out that from the 1980s to the 1990s, gold prices decreased while we had significant inflation, and,
3.  It made no sense to buy short-term bonds (in lieu of cash/money market) and long-term bonds.  You might as well purchase intermediate bonds.

I did not challenge any of Swedroe's comments, but I wanted to share them with this community for feedback.

[AdamA]

At the end of his presentation, I askede Swedroe if he was familiar with Harry Browne's Permanent Portfolio concept, and what he thought about it.  He responded by saying he was very familiar...

He may be familiar with it, but his comments indicate that he does not really understand how it works.

[stone]

It is amazing to me that he apparently didn't get the concept of opposing volatilities and rebalancing gains

Gold is for negative real interest rates when STT are failing to keep up with inflation and for currency exchange rate swings (such as for Iceland in 2008 or to a lesser extent for UK or Australia etc in 2008).

[moda0306]

I hate when people "remind" me that gold doesn't track CPI... like I didn't know that already (and count on it!!).

[MediumTex]

He would have done better to say that the Permanent Portfolio is outside his realm of expertise and just leave it at that.

A little knowledge is a dangerous thing, as they say.

[moda0306]

MT,

The egos simply can't stop there.  If you don't understand gold or the PP then it's probably due to a lack of understanding of history and/or macroeconomics.

I heard one radio financial guy say that "well gold can go up like in steps, but can go down like off a cliff," and another say, simply "you don't need to be putting all your money into gold" (this was his answer to whether or not we should consider gold as part of our portfolio).  The first one was vague and wrong if he's trying to describe historical trends (it's the other way around), and the second guy didn't even answer the question.

I feel like most of the time it's like listening to John Madden fill up air time.  

"If uh, uh, uh, the CPI goes up, and the uh, uh, gold doesn't well then you have, uh, you have, uh, uh, uh, well that there's uh, ugh, negative real return!"

[craigr]

Last night I attended an investment seminar where Larry Swedroe was the speaker.  Swedroe is a principal and Director of Research at Buckingham Asset Management and an author of about 10 books on low-cost investing.  Suffice it to say that Larry advocates the use of low cost index funds as the best vehicles to build your investment portfolio.

Larry is one of the few passive investing authors that takes fat tail risks into serious consideration. He also advocates holding commodity exposure for inflation shocks. So in many respects he is on the same path, just advocating a different approach. I think the Permanent Portfolio is better, but Larry's ideas are compatible in some respects.

At the end of his presentation, I askede Swedroe if he was familiar with Harry Browne's Permanent Portfolio concept, and what he thought about it.  He responded by saying he was very familiar and:

1.  He thought using only four assets did not provide sufficient diversification,

I disagree of course. I think there is an illusion of diversification by splitting up stocks into small pieces. The major asset classes of stocks, bonds, cash and gold is extremely strong diversification as history has shown. Those assets each have very different financial drivers behind them and why investors would choose or not to choose to own them. It is much different than someone who has large cap stocks, small cap stocks, small cap value, etc. thinking they are diversified. They are not. Stocks across all market sectors share common risks. Stocks, bonds and gold share very few common risks. They are bought by people for much different reasons.

My thoughts here:

https://web.archive.org/web/20160324133 ... -approach/

2.  Gold is not a good hedge on inflation.  He pointed out that from the 1980s to the 1990s, gold prices decreased while we had significant inflation, and,

The period of 1980-1990 was a period of what is called disinflation.. The gold markets simply went down in lockstep with overall inflation. If you cut out the highest of the highest of the peak gold price the overall effect on the portfolio was not significant. Even with the highest price (if you just happened to go all in on that one particular day and one particular hour) the performance was still good real return results for the entire portfolio over that period.

3.  It made no sense to buy short-term bonds (in lieu of cash/money market) and long-term bonds.  You might as well purchase intermediate bonds.

Nope. People are susceptible to loss aversion. It is a good thing to have a barbell with long term bonds that are volatile and cash that is very stable. When all the assets are shifting around it's nice to know you have one part that you can look to that will be an anchor. More importantly, it can also be used to support withdrawals during market volatility without affecting the other assets and can be used for other emergencies and living expenses.

[stone]

Clive, the weird thing now is that small company stocks seem to have much richer valuations overall than large cap stocks (or at least did before this summer's correction). I'm doubtful as to how well the small cap value over performance will last. I do hold the stock part a bit overweight for small stocks but I'm just not so convinced about it.

[melveyr]

A barbell approach is far superior to intermediate term bonds.

A barbell approach allows for greater tax efficiency. This year, I am loading up my IRA with the long end of the curve, while keeping the low yielding short end of the curve in taxable. You can't do that with an intermediate term bond.

Also, using a barbell allows one to use i-bonds and ee bonds as a one year note (or longer if it is profitable to do so).

[cowboyhat]

Swedroe has made a large and positive contribution to the retail investor literature. He has obviously spent a lot of time thinking about the challenges that the little guy faces, and it is a mistake to glibly dismiss what he has to say.

One thing I don't think Swedroe takes into account in his approach is the full spectrum of possible negative outcomes waiting in the future. He seems to base a lot of his analysis on recent returns in US markets. That may blind him to scenarios like the German experience in the early 20th century, where they went from one of the most prosperous, modern, intellectually developed nations in the world to... well, you know what. This is a low probability outcome, but a very high consequence outcome, which makes this a high risk outcome. That's why I think HB's approach of including so much gold is a better way to go. The gold doesn't seem to hurt overall returns and protects against a risk that perhaps Swedroe has not wanted to think about.

There is also an inconsistency in Swedroe's work on the subject of adviser fees. He focuses on low cost investing, but he charges 1% of capital. I have yet to hear a good justification for a fee based on capital invested in situations where the investment strategy advocates low turn over and is not meaningfully different for rich and poor investors. There is an administrative cost and there is a professional cost. Although I am not a millionaire, I don't understand why such a person should be asked to pay a greater professional cost than me.

[Roy]

Re: Gold vs. Inflation Larry is not incorrect;  in isolation, it has lagged inflation for long periods.  His is a response to the claim that the Gold is in the PP "for inflation".  (Of course, it is about how the 4 assets work together that matters.)  In one thread on Bogleheads, he did adjust his negative view of Gold, admitted that it and CCF had similar correlative effects (vs. equities and bonds) at times, but said he preferred CCFs and the way he uses them.

My guess with his comment on "Intermediate" Treasuries is that he is thinking about Returns.  The problem there is that I'm unaware of any fund that represents the average maturity of a 30-year and ST Treasury fund;  most "Intermediate" funds average a much lower maturity (like 5-7 years or so, vice a 13-15 year average).

Larry, more than any authority on forums, has promoted "portfolio as a whole".  But he does not seem to be thinking from that perspective when discussing the PP, most likely because he has no interest or belief in it.  That said, I am pretty sure he has a solid understanding of how things work—far more than most advisors I've seen.

Speaking generally, advisors can't make money with the simple one-size PP, applying a traditional AUM application, unless they were providing greater overall service.  Alternatively, they would have to create a PP fund themselves.  Larry's view on advisors adding value extends far beyond the investing vehicles used and has some merit, especially with high-net-worth clients having complicated wealth management issues;  these appear to be the main target audience for his firm.
------

Last week, I pitched the HB PP to another money manager (another strength training client of mine, else they'd never listen to me).  He ordered the backtest, and was impressed such that his group held a meeting on it.  He actually admitted that he wished he had been in it all along rather than what he'd been doing with his own money (never heard that one before).  Will be interesting to see what they do going forward, if anything.  Change is hard, especially in the face of that sort of reality adjustment.

[LonerMatt]

Clive, are "International Value" stocks ones that are similar to Berkshire Hathaway: basically big, massive giant international companies?

Or something completely different?

[craigr]

10% SCV, 5% in each of international value, international small (or emerging markets i.e. foreign currencies/investments) whilst being 5% lighter in stocks than the PP has the SCV compensation effect for that as per Larry's fat tail minimisation approach.
15% gold instead of 25%
65% bonds - either total bond fund, or a collection of whatever you personally prefer or find that potentially covers your income objectives.

Since 1972 to 2010 inclusive, 10 SCV, 5 IV, 5 IS, 15 gold, 65 Total bond for the Blend, compared to a PP that held 2 year T's for the cash holdings :

[align=center][/align]

had the more left top handedness (better risk adjusted reward). And being less rigid with the actual bonds held than the PP has the added benefit of potentially being more easily tuned to particular circumstances/conditions evident at any one time.

I'm going to quibble with you over these charts.

First of all you should start the Y axis scale at 0. When you start in the middle of the numbers it exaggerates the differences. This is because you are showing the PermPort over that period with a CAGR of 9.66% and your mixed portfolio shows over that period a CAGR of 10.02% so there is virtually no difference.

That is an annual spread of only 0.36%. 36 basis points. Basically market noise. Most expense ratios are bigger than 36 basis points.

But let's even assume it's not market noise.

What about the costs?

You are showing a bunch of expensive funds. Funds that, by the way, didn't exist over the time period being shown in a way investors could have purchased. They simply were not available.

But let's assume they were available. What would they cost compared to today's Total Stock Market index?

Total stock market and/or S&P 500 index is well below 0.20%.

The DFA small cap value fund that only goes back to 1993 is 0.52% today. Plus you need to access it through an advisor. So add on 1% asset under management fee to the portfolio.

DFA international value goes back to somewhere around 1994 only. But it costs 0.45% a year plus advisor fees.

DFA international small goes back to 1996. Expenses are 0.55% plus advisor.

Vanguard Total Bond is a solid cheap index fund. But taking it back to 1986 and comparing it to the Vanguard Intermediate Term Treasury the Total bond turned $10K into $52,552 according to Morningstar. The treasury fund turned that same $10K into $57,685.

Gold is gold so whatever those fees are will be the same.

Now just looking at the cost difference between the simpler TSM fund vs. the specialty funds you have TSM at 0.20% (or lower) and the DFA specialty funds needed to access these other indices over even part of the backtest hovering around 0.50%. So there is a -0.30% penalty to the actual returns of those funds already each year because backtest data spreadsheets never deduct the expenses. Plus they don't deduct the advisor fees you'd pay.

So right there, without needing to look any further, I'd say the chances of this more complicated portfolio actually beating the simpler PermPort is very slim.

If I roll in the higher tax costs of these specialty funds then it very likely is not beating the total stock index fund portfolio.

I believe Larry for instance holds some TIPS, some Municipal bonds...etc and moves up and down the yield curve as taxes and the yield curve indicate appropriate to do so.

And Larry is making a mistake doing this because if you think you can't time the stock market, then timing the bond market is an even worse idea. The bond markets are even more efficient than stock markets. IMO. Trying to time them is a losing strategy.

[stone]

Clive when you say five year T were as good as a barbell, isn't that quite different from saying that in the context of a PP they were as good? Volatility that can be rebalanced or that maintains low portfolio volatility in case of an emergency drawing down of the portfolio is what it is all about isn't it? If the 5yearT had less of that "good volatility" then that is significant.

[MediumTex]

Perhaps someone should put together a "Larry and Harry Contrary Portfolio" where you start off each year with 50% Larry and 50% Harry and rebalance the whole thing at the end of each year.

[stone]

Medium Tex, I think Clive has had that amoungst his zillions of recomendations of everything not quite PP .

[craigr]

backtest data spreadsheets never deduct the expenses

Simba's backtest spreadsheet, that I used to create that chart, does include expense deductions.

Including advisor fees to get into those funds? And expected tax loads due to higher turnover and distributions? I made a spreadsheet years ago that did that and it puts a lot of the higher returns in a more somber perspective.

And really finding a portfolio that did best in the past is a strawman in many respects. Look at this portfolio:

12.5% - TSM
12.5% - SCV
25% - LT Bonds
25% - ST Bonds

1972-2010 CAGR 10.2%
Sharp Ratio 0.68

So pretty close Sharpe Ratio and better performance. And chances are that approach probably was cheaper to do.

But again this is all hindsight analysis. These portfolio are so close in annual CAGR performance that it is basically optimizing around an error that is likely just market noise. One good year or bad year for any of these allocations will push the numbers to say something else. But still too close to be anything but annual noise in the data.

And Larry is making a mistake doing this because if you think you can't time the stock market, then timing the bond market is an even worse idea. The bond markets are even more efficient than stock markets. IMO. Trying to time them is a losing strategy

Bonds are easier to time than stocks. Look at Shiller's yearly data since 1870 and compare the average of 1 year with the 10 year T's. The overall average is very near identical averages. In effect, on average, there's no difference to continually holding 10% in each of 1 to 10 years as there is holding 100% in a 10 year for a year, 100% in a 9 year for a year.....down to 100% in a 1 year for a year. Of course over shorter periods of time that wont always hold true, and as such the best indicator is the yield curve where the highest relative yield indicates the better value (relatively lowest price).

Bonds are not easier timed. What strategy predicted this kind of movement at the end of 2011 in LT bonds? Market timers would have been out of them the first part of the year and only got in towards the mid/end of Q3. But the entire time they were out, guys like me were pulling down interest payments! So they still lost in terms of total year's returns. Easy money!




Or how about TIPS timing, did anyone predict with confidence this was going to happen in 2011:



Market timing doesn't work. I've said it many times. But market timers are my best friends. They are handing me their money going in and out of assets while I sit back and do nothing. It's the easiest money I make.

[craigr]

Another chart comparing the Vanguard TIPS fund vs. the Vanguard Intermediate Treasury Fund from 2000-2012 (longest it goes back for this charting site and includes all interest and dividends. Both have similar durations.). The person that just bought the IT treasury fund and did nothing pummeled the TIPS fund alone. Anyone going in and out of TIPS shifting around maturities likely did worse.

Like I said, easy money!

[Roy]

One problem with a shifting strategy in fixed income—essentially, Yield Curve surfing—is that it may not work.  (Even Larry mentions this in one book.) 

Last year was a good example of it not working as legions of folks stayed short, and a famous Guru ascended into his starship and left Treasuries altogether.  In addition to being wrong—and losing money—one may also lose time in the too-smart-by-half analyses that lead to potentially losing yet more money. 

Folks who eventually will be "right" on any of this will need to account for the money lost when being wrong.  Such accounting, of course, is rarely done.

[dragoncar]

That may blind him to scenarios like the German experience in the early 20th century, where they went from one of the most prosperous, modern, intellectually developed nations in the world to... well, you know what.

LOL, trying not to end the thread?

[craigr]

One problem with a shifting strategy in fixed income—essentially, Yield Curve surfing—is that it may not work.

That's an understatement! It won't work at all.

I like Larry's books, but this shifting fixed income stuff is wrong. You can't have it both ways. Either market timing works for stocks and bonds or it doesn't. Saying it doesn't work for stocks and then implying it does work for bonds is wholly inconsistent with the idea of passive investing.

Truth is again that market timing doesn't work. I have made so much more money leaving my investments alone than I ever did by trying to time the markets. There's no comparison.

[Roy]

I like Larry's books, but this shifting fixed income stuff is wrong. You can't have it both ways. Either market timing works for stocks and bonds or it doesn't. Saying it doesn't work for stocks and then implying it does work for bonds is wholly inconsistent with the idea of passive investing.

Truth is again that market timing doesn't work. I have made so much more money leaving my investments alone than I ever did by trying to time the markets. There's no comparison.

I agree.  Sometimes folks can luck into a timing switch but can just as easily get burned. And an authority can appear to give conflicting messages, if he generally speaks against timing and tactical allocation strategies but actually promotes certain versions of them, calling them something else (risk management or whatever).

Best for most folks, and most professionals, to avoid considering any of that.  But then you'd have shorter and fewer threads!

[craigr]

Best for most folks, and most professionals, to avoid considering any of that.  But then you'd have shorter and fewer threads!

I look forward to the day when the only threads going on here have nothing to do with investing because nobody is worrying about their money and can talk about other things (like Pyramid power). Watching and worrying about the markets is one of the most boring things I can think of doing.

[Roy]

Best for most folks, and most professionals, to avoid considering any of that.  But then you'd have shorter and fewer threads!

I look forward to the day when the only threads going on here have nothing to do with investing because nobody is worrying about their money and can talk about other things (like Pyramid power). Watching and worrying about the markets is one of the most boring things I can think of doing.

I was joking, of course about the threads;  yours being my point.

Social communities do seem to arise around all sorts of boards (investing, exercise, Pyramid Power, boards, etc.), even if their primary message is a simple, set-and-forget approach that would seem to require a finite amount of explication and "shop talk" before becoming redundant, or even harmful to the original idea.

[craigr]

I am considering replacing my user here with an ELIZA artificial intelligence algorithm like this one:

http://www.manifestation.com/neurotoys/eliza.php3

I figure it is just as accurate talking about market timing as any advisor I've seen.