Permanent Portfolio Without Rebalancing

General Discussion on the Permanent Portfolio Strategy

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MachineGhost
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Permanent Portfolio Without Rebalancing

Post by MachineGhost » Sat Nov 15, 2014 11:32 am

I was curious about the PP performance without ever rebalancing so did a backtest (click to enlarge):

[align=center][img width=800]http://i61.tinypic.com/2lxdv01.png[/img]
6.34% CAR and -55.98% MaxDD[/align]

What's also interesting is the Total Gain vs Maximum Favorable Excursion since the buy date:

Gold 3103.75% vs 4980.43%
Stocks 2024.24% vs 2071.16%
Bonds 952.66% vs 1055.75%
Cash 333.51% vs 333.57%

So rebalancing adds very little to stocks and cash, a bit to bonds and a hell of a lot to gold.  This is more evidence the risk contributions from each of the assets are not equal.
Last edited by MachineGhost on Sat Nov 15, 2014 11:39 am, edited 1 time in total.
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Re: Permanent Portfolio Without Rebalancing

Post by Kbg » Sat Nov 15, 2014 7:03 pm

What is the MaxDD with rebalancing annual and/or bands?
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Re: Permanent Portfolio Without Rebalancing

Post by MachineGhost » Sat Nov 15, 2014 9:03 pm

Kbg wrote: What is the MaxDD with rebalancing annual and/or bands?
Its around -25% with annual rebalancing; you'll have to check others work on this board for the bands.
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Re: Permanent Portfolio Without Rebalancing

Post by Kbg » Sun Nov 16, 2014 8:27 am

This is a great post...I think it amply illustrates that if you stuff a bunch of volatility in a portfolio and rebalance it periodically it's some kind of cool magic. It's also why I have dash of XIV/SVXY in my PP.
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Re: Permanent Portfolio Without Rebalancing

Post by Pointedstick » Sun Nov 16, 2014 9:26 am

I periodically toy with the idea of trying different volatility versions of the assets to get them matches up a bit better; e.g. small-cap value for stocks and zero coupon treasuries for bonds. That's pretty easy for those who can tolerate a bit more variability. But what about a low-volatility version for the gun-shy? You can easily get a low-volatility stock index or shorter-duration bonds, but is there any kind of lower-volatility gold?

If so, it would be cool because you could choose which PP suited you according to your risk tolerance: the low-volatility version of you couldn't even deal with -10% drawdowns, the high-volatility version for those with more intestinal fortitude and very long time horizons, and the standard one for tried-and-true simplicity.
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Re: Permanent Portfolio Without Rebalancing

Post by craigr » Sun Nov 16, 2014 3:02 pm

With a portfolio that holds very volatile assets that tend to move against each other, I've found that rebalancing not only reduces risk but can boost returns. It is forcing the investor to sell high/buy low. It works less well for a standard stock/bond portfolio. But one with stocks/bonds/hard assets there is an advantage to sticking to rebalancing bands to take advantage of shifting market sentiments.
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Re: Permanent Portfolio Without Rebalancing

Post by Kbg » Sun Nov 16, 2014 3:23 pm

Pointedstick wrote: If so, it would be cool because you could choose which PP suited you according to your risk tolerance: the low-volatility version of you couldn't even deal with -10% drawdowns, the high-volatility version for those with more intestinal fortitude and very long time horizons, and the standard one for tried-and-true simplicity.
P-Stick,

If you can get a hold of some long term data (or even ETF or MF data from the last 20 years) take a look at the return vs. draw down. Pretty much anything that will return something greater than cash is over time going to have draw downs at least double the return and likely in the ball park of 30-70%. Accordingly, you have just a few real options (of course there are a gazillion variations on each theme).

1. Vary the cash component
2. Seek non or weak correlation and rebalance
3. Hedge

#3 is pretty much guaranteed to reduce the real or nominal returns of the asset directly hedged and may or may not reduce the DD as it involves timing (usually). In sum, it is really hard to find a free lunch and getting more difficult to every day it seems with the "Quant Army" out in force. In my short time on the board it appears that most folks see four PP squares instead of one...one is the correct view. Four will drive you insane going woulda, coulda, shoulda.
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Re: Permanent Portfolio Without Rebalancing

Post by barrett » Sun Nov 16, 2014 3:34 pm

Kbg wrote: In my short time on the board it appears that most folks see four PP squares instead of one...one is the correct view. Four will drive you insane going woulda, coulda, shoulda.
Ah, so true. Many of us struggle with this. And now that you are posting more, I've stopped reading your handle as KGB! :)
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Re: Permanent Portfolio Without Rebalancing

Post by Peak2Trough » Sun Nov 16, 2014 7:05 pm

MachineGhost wrote:6.34% CAR and -55.98% MaxDD
I don't know what data you're using, but honestly, I think it's flawed.  I'm using daily data for all four assets going back to 1972, and as I've pointed out in the past, I get substantially different results from you based on the same initial criteria.

In this case, I get a CAGR of 8.14% and a MaxDD of 50%.

The "normal" MaxDD with annual rebalancing is 20.24%, not 25%.  And it occurred between 01/21/1980 to 03/37/1980. 
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Re: Permanent Portfolio Without Rebalancing

Post by MachineGhost » Sun Nov 16, 2014 8:34 pm

Peak2Trough wrote: I don't know what data you're using, but honestly, I think it's flawed.  I'm using daily data for all four assets going back to 1972, and as I've pointed out in the past, I get substantially different results from you based on the same initial criteria.

In this case, I get a CAGR of 8.14% and a MaxDD of 50%.

The "normal" MaxDD with annual rebalancing is 20.24%, not 25%.  And it occurred between 01/21/1980 to 03/37/1980.
Are you using daily granularity?  There's a possibility the SPX index I'm using doesn't reinvest the dividends.  It's been awhile since I played around with the PP, so I probably forgot to remember to use that version.  The -25% MaxDD also occured before 1972.
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Re: Permanent Portfolio Without Rebalancing

Post by Jan Van » Mon Nov 17, 2014 10:29 am

Interesting article about rebalancing:

Does Rebalancing Really Pay Off??
Conclusion: no evidence as yet for a rebalancing bonus

My conclusion is that while the subject is interesting enough to warrant further research – certainly much more than has been done heretofore, given how much rebalancing is advocated by nearly all practitioners of the investment advice profession – no evidence has as yet presented itself to confirm that there is a rebalancing bonus.

Rebalancing is certainly not necessarily harmful, unless it conflicts with another risk management strategy that better suits the investor. It is better to have an investing discipline than not to have one, and rebalancing is one acceptable default discipline – especially when the investor would fail to adhere to any discipline if his portfolio’s volatility exceeded a particular level. It should not, however, be thought of as a strategy that delivers a returns bonus as compared to other strategies.
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Re: Permanent Portfolio Without Rebalancing

Post by barrett » Mon Nov 17, 2014 11:52 am

Jan Van wrote: Interesting article about rebalancing:
Just gave it quick once over and I think the most interesting part for PP'ers is on page four of the article. The author looks at a 4X25 portfolio with and without rebalancing. What strikes me is that if you don't rebalance, you then have an entire portfolio that is more volatile because you don't have equal protection against/exposure to four different economic conditions. Taking profits off the table and buying up your losers is a central part of the PP philosophy. Remember that the PP is designed to have low overall volatility...and to be agnostic toward the future. An unbalanced portfolio clearly favors one or more assets going forward.
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Re: Permanent Portfolio Without Rebalancing

Post by Xan » Mon Nov 17, 2014 12:33 pm

Rebalancing is absolutely required in the PP in order to keep the risk profile where we want it to be.  The core idea of the PP is to be widely diversified, and if you let the winners and losers ride, you end up with a very un-diverse portfolio.  So yes, rebalancing achieves that.

The question is: is there a rebalancing bonus, that is, does rebalancing necessarily increase returns?  It certainly FEELS like it should, but whenever people take a look at this question, the answer seems to be no.  Which is weird.  I can't really wrap my head around it.
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Re: Permanent Portfolio Without Rebalancing

Post by Pointedstick » Mon Nov 17, 2014 12:59 pm

As Kshartle once said, it's very context-dependent. It seems like rebalancing is worse with assets that consistently rise, but better with assets that bounce around a lot. If you visualize two assets, one which goes to zero and the other of which goes to the moon, then rebalancing between them isn't going to help you. But the PP assets tend to vary a lot, so rebalancing can turn volatile, low-yield assets into higher-yielding ones by forcing you to buy when they're low.
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Re: Permanent Portfolio Without Rebalancing

Post by Xan » Mon Nov 17, 2014 1:11 pm

The thing is, if it's context-dependent, then sometimes it'll help and sometimes it'll hurt, and you can't know which ahead of time.  Which means the bonus doesn't exist, right?

It may be that most of the time, it's a small help, and in a small fraction of cases, it's a big hurt.  That may be why it usually seems to help, even if it averages to zero.
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Re: Permanent Portfolio Without Rebalancing

Post by Pointedstick » Mon Nov 17, 2014 1:31 pm

Xan wrote: The thing is, if it's context-dependent, then sometimes it'll help and sometimes it'll hurt, and you can't know which ahead of time.  Which means the bonus doesn't exist, right?

It may be that most of the time, it's a small help, and in a small fraction of cases, it's a big hurt.  That may be why it usually seems to help, even if it averages to zero.
If we knew what was going to go to zero, we wouldn't invest in it, and obviously we would just buy whatever was supposed to rocket up forever. To me, rebalancing is just part and parcel of trying not to predict the future. We rebalance because we don't know which thing is going to do great and which thing is doing to suffer, and we have reasonable faith that none of the assets are going to go to zero. And if they do, that's why we have gold, because if U.S. stocks, currency, or long-term debt goes to zero, that probably bodes poorly for a whole heck of a lot of other things.
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Re: Permanent Portfolio Without Rebalancing

Post by Xan » Mon Nov 17, 2014 1:47 pm

I mean the rebalancing bonus goes to zero, not any particular asset and certainly not the portfolio.  Yes, rebalancing is entirely about not predicting the future, and staying more-or-less even in all four assets.  The question is whether there's a return bonus from doing so.
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Re: Permanent Portfolio Without Rebalancing

Post by stuper1 » Mon Nov 17, 2014 1:54 pm

Someone posted a graph maybe about six months ago that showed that about 90% of the time rebalancing had boosted returns by 0.5% or more.  That seemed like pretty good evidence that rebalancing usually boosts returns, although there is no guarantee.

Does anybody else remember that thread enough to be able to find it?
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Re: Permanent Portfolio Without Rebalancing

Post by Pointedstick » Mon Nov 17, 2014 1:55 pm

I was saying that I think the rebalancing bonus is closer to zero when you use it on assets that consistently move in opposite directions with no convergence, i.e. one goes to zero and another goes high. For assets that are volatile, but neither go to zero nor go up forever, it would make sense to me that there is a bonus. Ryan Melvey actually wrote about this: http://www.stableinvesting.com/2013/04/ ... demon.html
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Re: Permanent Portfolio Without Rebalancing

Post by Xan » Mon Nov 17, 2014 2:06 pm

stuper1 wrote: Someone posted a graph maybe about six months ago that showed that about 90% of the time rebalancing had boosted returns by 0.5% or more.  That seemed like pretty good evidence that rebalancing usually boosts returns, although there is no guarantee.

Does anybody else remember that thread enough to be able to find it?
Yes, there might be a small bonus 90%, when things are behaving as PS described in his last comment.  The other 10% of the time, there might be a penalty big enough to neutralize the small bonus 90% of the time.  This would account for why we all seem to believe that there is a bonus, even when "really" there isn't.  Although that would be up for interpretation.
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Re: Permanent Portfolio Without Rebalancing

Post by stuper1 » Mon Nov 17, 2014 2:20 pm

Here's the previous thread:

http://gyroscopicinvesting.com/forum/pe ... /#msg96809

I interpret that as saying that rebalancing gives you a better chance of a higher CAGR than not rebalancing.
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Re: Permanent Portfolio Without Rebalancing

Post by Xan » Mon Nov 17, 2014 2:42 pm

stuper1 wrote:I interpret that as saying that rebalancing gives you a better chance of a higher CAGR than not rebalancing.
That's a truly excellent way to put it, and looking at it that way, there definitely is a rebalancing bonus.  (It just may not be there if you need it at a particular time.)
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Re: Permanent Portfolio Without Rebalancing

Post by buddtholomew » Mon Nov 17, 2014 4:17 pm

Perhaps re-balancing the lagging asset with cash will result in a re-balancing bonus; We are not reducing those assets that are on the rise, but rather using the asset class as a trigger to purchase the lagging asset/s to 25%. This is what I intend to do in a taxable account to avoid capital gains as equities reach 35% of the portfolio. How scalable this approach is depends on the amount of cash accumulated before a re-balancing event is reached.
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Re: Permanent Portfolio Without Rebalancing

Post by dragoncar » Mon Nov 17, 2014 5:55 pm

buddtholomew wrote: Perhaps re-balancing the lagging asset with cash will result in a re-balancing bonus; We are not reducing those assets that are on the rise, but rather using the asset class as a trigger to purchase the lagging asset/s to 25%. This is what I intend to do in a taxable account to avoid capital gains as equities reach 35% of the portfolio. How scalable this approach is depends on the amount of cash accumulated before a re-balancing event is reached.
This is what I do.  Sophie has shown that this has historically reduced returns.  But I think this approach will do well if there is a lot of volatility over the period of your contributions (e.g. monthly volatility for monthly contributions) and poorly if the volatility is of a different timescale (e.g. annual volatility for weekly contributions -- you lose out on the momentum).
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Re: Permanent Portfolio Without Rebalancing

Post by buddtholomew » Mon Nov 17, 2014 7:59 pm

dragoncar wrote:
buddtholomew wrote: Perhaps re-balancing the lagging asset with cash will result in a re-balancing bonus; We are not reducing those assets that are on the rise, but rather using the asset class as a trigger to purchase the lagging asset/s to 25%. This is what I intend to do in a taxable account to avoid capital gains as equities reach 35% of the portfolio. How scalable this approach is depends on the amount of cash accumulated before a re-balancing event is reached.
This is what I do.  Sophie has shown that this has historically reduced returns.  But I think this approach will do well if there is a lot of volatility over the period of your contributions (e.g. monthly volatility for monthly contributions) and poorly if the volatility is of a different timescale (e.g. annual volatility for weekly contributions -- you lose out on the momentum).
I suspect having a larger cash allocation would reduce returns as the other assets outpace the riskless short-term instruments. I wonder whether the results would disappear for the taxable investor who pays capital gains and transaction fees?
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