Risk Parity and the Permanent Portfolio

General Discussion on the Permanent Portfolio Strategy

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Smith1776
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Risk Parity and the Permanent Portfolio

Post by Smith1776 » Sun May 20, 2018 2:18 pm

There is quite wide recognition of the similar intellectual heritage between the Permanent Portfolio and risk parity strategies such as All Weather and the All Seasons portfolios. A query for you all: do you consider the Permanent Portfolio to be a risk parity strategy? Does it firmly fit under that umbrella term? To me it certainly seems to fit the definition quite soundly.

I would also then give Harry Browne quite a bit of credit for the origin of some of Ray Dalio's portfolio ideas...
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Re: Risk Parity and the Permanent Portfolio

Post by barrett » Sun May 20, 2018 3:25 pm

Smith1776 wrote: ↑
Sun May 20, 2018 2:18 pm
There is quite wide recognition of the similar intellectual heritage between the Permanent Portfolio and risk parity strategies such as All Weather and the All Seasons portfolios. A query for you all: do you consider the Permanent Portfolio to be a risk parity strategy? Does it firmly fit under that umbrella term? To me it certainly seems to fit the definition quite soundly.

I would also then give Harry Browne quite a bit of credit for the origin of some of Ray Dalio's portfolio ideas...
This has been discussed before. I always find the following video clip of Ray Dalio interesting:

https://www.youtube.com/watch?v=SFaRazMpxcM

From about 47:00 to 52:00 he is essentially outlining a version of the PP. He doesn't actually give percentages but the asset classes are exactly the same.
Last edited by barrett on Sun May 20, 2018 6:05 pm, edited 1 time in total.
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Re: Risk Parity and the Permanent Portfolio

Post by Smith1776 » Sun May 20, 2018 3:38 pm

barrett wrote: ↑
Sun May 20, 2018 3:25 pm
Smith1776 wrote: ↑
Sun May 20, 2018 2:18 pm
There is quite wide recognition of the similar intellectual heritage between the Permanent Portfolio and risk parity strategies such as All Weather and the All Seasons portfolios. A query for you all: do you consider the Permanent Portfolio to be a risk parity strategy? Does it firmly fit under that umbrella term? To me it certainly seems to fit the definition quite soundly.

I would also then give Harry Browne quite a bit of credit for the origin of some of Ray Dalio's portfolio ideas...
This has been discussed before. I always find the following video clip of Ray Dalio interesting:

https://www.youtube.com/watch?v=SFaRazMpxcM

From about 47:00 to 52:00 he is essentially outlining a versions of the PP. He doesn't actually give percentages but the asset classes are exactly the same.
My apologies for a respost, then. Clearly I've been spending too much time on the Bogleheads forums and not enough time here! Thanks for the video! I haven't seen this one and so listening to it now.
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Re: Risk Parity and the Permanent Portfolio

Post by ochotona » Sun May 20, 2018 4:00 pm

Great interview
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Re: Risk Parity and the Permanent Portfolio

Post by Smith1776 » Sun May 20, 2018 5:08 pm

An absolutely great interview. The Permanent Portfolio... the original in risk parity. O0
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Re: Risk Parity and the Permanent Portfolio

Post by Tyler » Sun May 20, 2018 5:48 pm

I've been working on a breakdown of different portfolio types and have been thinking about this very topic recently. Maybe you guys can help me clarify my ideas.

The term "Risk Parity" gets thrown around a lot these days, but the more I think about it the more I believe there are two different camps both using that term.

1) Volatility Risk Parity: Mathematically balancing the effects of different assets in a portfolio by scaling each asset according to their volatility. A good example would be the All Seasons portfolio, Larry portfolio, and (even if he might not describe it the same way) Desert portfolio. Look at the AAs and you'll note the similarity of how they scale up fixed income percentages to balance the high risk assets.

2) Economic Risk Parity: Spreading your risk among a variety of different types of assets and economic conditions. Good examples are the Permanent Portfolio, Golden Butterfly, and 7Twelve portfolio. Look at those AAs, and the common theme is purchasing equal portions of a variety of different assets to cover your bases rather than tinkering with percentages to balance mathematical volatility.

Dalio is interesting as he kinda straddles the line between both. Most of his talks about the All Weather fund focus on economic risk parity in terms that could be straight out of a Harry Browne book. But he also promotes some very specific volatility-focused things like leveraging cash, and the All Seasons version that Robbins promotes clearly leans toward the volatility risk parity variety if you look past the marketing to the actual AA.

Personally, I think both have their place although I admit I am more personally drawn to the economic reasoning of #2. Harry Browne was definitely ahead of his time.
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Re: Risk Parity and the Permanent Portfolio

Post by Hal » Mon May 21, 2018 3:49 am

Tyler wrote: ↑
Sun May 20, 2018 5:48 pm
I've been working on a breakdown of different portfolio types and have been thinking about this very topic recently. Maybe you guys can help me clarify my ideas.

The term "Risk Parity" gets thrown around a lot these days, but the more I think about it the more I believe there are two different camps both using that term.

1) Volatility Risk Parity: Mathematically balancing the effects of different assets in a portfolio by scaling each asset according to their volatility. A good example would be the All Seasons portfolio, Larry portfolio, and (even if he might not describe it the same way) Desert portfolio. Look at the AAs and you'll note the similarity of how they scale up fixed income percentages to balance the high risk assets.

2) Economic Risk Parity: Spreading your risk among a variety of different types of assets and economic conditions. Good examples are the Permanent Portfolio, Golden Butterfly, and 7Twelve portfolio. Look at those AAs, and the common theme is purchasing equal portions of a variety of different assets to cover your bases rather than tinkering with percentages to balance mathematical volatility.

Dalio is interesting as he kinda straddles the line between both. Most of his talks about the All Weather fund focus on economic risk parity in terms that could be straight out of a Harry Browne book. But he also promotes some very specific volatility-focused things like leveraging cash, and the All Seasons version that Robbins promotes clearly leans toward the volatility risk parity variety if you look past the marketing to the actual AA.

Personally, I think both have their place although I admit I am more personally drawn to the economic reasoning of #2. Harry Browne was definitely ahead of his time.
Hi Tyler et al,

You may find this chart Kbg referred me to useful

http://www.gestaltu.com/wp-content/uplo ... erfall.png

I would consider the mainstream Risk Parity as essentially volatility matching

Eg: http://www.stableinvesting.com/2014/11/ ... on-as.html

While Harry Brownes approach, is as you say, economic risk parity.
I really do not like the term risk being used to describe volatility.
To most people, an investment risk is a risk of losing something, not so many standard deviations from the mean.

One of my methods is to use the Harry Browne definition, then try to balance the volatility between asset classes.
For instance, a long term treasury ETF is not available in Australia, so I use 25% of the longest duration intermediate bonds in my tax sheltered PP. Not, say, 70% Intermediate Bonds, 15% Gold, 15% Shares. And guess what, one of the people in a self managed superannuation fund I am in, needed to withdraw a substantial amount of cash. If it wasn't for the 25% cash component, we would have taken a substantial loss having to sell other assets - you just cannot mathematically model "real life".

Two other thoughts;

1. The All Seasons Portfolio performance varies greatly between countries. Compare the US to Australia on your Portfolio Charts site.

2. I see the PP as four distinct "insurance policies" for different economic climates. Here in Australia, having a bushfire destroy your house is very uncommon, however if it did happen to you personally, without insurance, you could be completely wiped out.
Similarly, a long 1930's depression is statistically very uncommon, but once again without "bond insurance" you could also be wiped out.

Anyway, enough rambling, must head off now ;D
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Re: Risk Parity and the Permanent Portfolio

Post by blue_ruin17 » Tue May 22, 2018 9:51 pm

Tyler is defiantly on to something when he differentiates between volatility risk parity and economic risk parity.

It seems to me that the PP is not at all a volatility parity portfolio. If it were, it would weight its constituent assets in proportion to the amount of volatility they have tended to contribute to portfolios.

For example, gold exhibits extreme volatility, historically, but does not provide returns that would seem to justify holding it, compared to other asset classes. Stocks, too, contribute a lot of volatility to portfolios - but unlike gold, they provide returns that enable even relatively small allocations (i.e. 20-30%) to positively drive portfolio returns.

A volatility parity portfolio looks at the volatility/return ratio and allocates accordingly. The Desert Portfolio is perhaps the best example of this.

The PP, on the other hand, does not appear to care about volatility/return ratios. It weights gold just the same as T-Bills. The reason for this is that the PP isn't designed to balance volatility risk. It is designed to balance systemic risk.

It is a portfolio that is willing to take on the outsized volatility/return ratios of comparatively high LTT and gold allocations in order to be fully hedged against severe economic dislocations.

In a way, the PP doesn't care about math.

All it knows is that Great Depressions and hyperinflations and government collapse and societal upheaval and war are very, very devastating. Rare, yes. But utterly devastating, if they do occur.

In order to be properly hedged against these rare but extreme events, the PP sacrifices what might be considered 'logical' allocations, based on volatility/return calculations, and instead just lumps allocations in a way that ensures that, no matter what, your portfolio will survive.
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Re: Risk Parity and the Permanent Portfolio

Post by Smith1776 » Tue May 22, 2018 11:10 pm

Thanks for the insightful discussion, guys. I think you make really good points.

The Permanent Portfolio may not be mathematically "correct" or optimized -- the fact that it has a simple 1 / n allocation to the asset classes kind of testifies to that. However, I think part of the reasoning (wisdom?) behind that is the fact that consequences matter more than the risks.

We wear seat belts whenever we drive, even though the probability calculation of getting into an accident is tiny. However, the consequences of not wearing a seat belt can be devastating. As such, consideration of the consequences override everything. 25% in each of the major asset classes I think adheres to that.
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Re: Risk Parity and the Permanent Portfolio

Post by Kbg » Wed May 23, 2018 9:01 am

I think it really important to get an old copy of HB's Best Laid Plans and read it. You just get a good feel for the philosophy of what the portfolio is about and why it was constructed the way it was.

I personally think the portfolio is way too conservative for a younger investor, but HB was dead right in that no one can predict the future and that most backtests fail out of sample. If anyone pays attention to ongoing academic research much of it is now pointing out how much of the previous stuff A) was garbage or B) was not garbage but now no longer outperforms. A great daily email to sign up for is the one produced by Abnormal Returns...way too much to read, but you can stay abreast/get the gist of public developments in the investing space to include the academics.

The longer I've been at this stuff the more I believe a couple of things.

1. Success is simply finding your personal pain/gain tolerance thresholds and building a portfolio that implements it.
2. Risk and reward, overall, is relatively fixed. Stocks (or other income producing non-debt assets) will return more than bonds, bonds will return more than cash. Meb Faber calls it the 5/2/1 rule http://mebfaber.com/2016/09/27/the-521-rule/

I've never verified it, but I know it's in the ballpark (bubbles and crash deviations excepted).

I spent quite a while with risk parity a couple of years back as I like to do weird things like that just to get a "feel" for them. I think the main takeaway for me is the instability of the calculation and the simple fact that they load up on low volatility which almost always equates to a bull market which means you are loaded up on that which is about to nose over and leave you over-weighted pretty much when you don't want to be overweight. The reverse is also true. To counter this effect, one then has to start putting artificial constraints on allocation which for me resolves down to, what's the point if you have to "fudge" it? Having said that, I am a believer in using leverage to get more performance vs. an unlevered portfolio of equal risk. The fact is your stock portfolio is internally leveraged which should be pretty evident to anyone who has spent more than 30 minutes looking at stock returns vs. business cycles. Leverage kills if used stupidly, leverage can be beneficial if used prudently.
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Re: Risk Parity and the Permanent Portfolio

Post by Smith1776 » Wed May 23, 2018 3:08 pm

I personally think the portfolio is way too conservative for a younger investor, but HB was dead right in that no one can predict the future and that most backtests fail out of sample.
I'd agree in general as well. However, in my case, even though i'm in my 20's, the Permanent Portfolio is perfect for me. I happen to be self-employed as a freelancer, so my income is very lumpy. As such, the stability and low volatility of the Permanent Portfolio fits right in with my needs. I think that's one of the things that drew Craig Rowland himself to the portfolio as he's an entrepreneur.
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Re: Risk Parity and the Permanent Portfolio

Post by Kbg » Wed May 23, 2018 3:41 pm

Smith1776 wrote: ↑
Wed May 23, 2018 3:08 pm
I'd agree in general as well. However, in my case, even though i'm in my 20's, the Permanent Portfolio is perfect for me. I happen to be self-employed as a freelancer, so my income is very lumpy. As such, the stability and low volatility of the Permanent Portfolio fits right in with my needs. I think that's one of the things that drew Craig Rowland himself to the portfolio as he's an entrepreneur.

1. Success is simply finding your personal pain/gain tolerance thresholds and building a portfolio that implements it. ;)
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Re: Risk Parity and the Permanent Portfolio

Post by blue_ruin17 » Wed May 23, 2018 4:04 pm

Kbg wrote: ↑
Wed May 23, 2018 9:01 am
If anyone pays attention to ongoing academic research much of it is now pointing out how much of the previous stuff A) was garbage or B) was not garbage but now no longer outperforms.
Can you elaborate on this?
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Re: Risk Parity and the Permanent Portfolio

Post by Kbg » Wed May 23, 2018 9:57 pm

I could but there is a a lot that could be said...a good place to start is Alpha Architect which posts a lot of academic summaries.
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Re: Risk Parity and the Permanent Portfolio

Post by boglerdude » Thu May 24, 2018 12:32 am

Fama backpedals on small factor around 4min
https://www.youtube.com/watch?v=HIKO-t4vU6Q

And, once a money making strategy/factor is found, money piles in and it goes away. PEs for small value funds are higher than the market right now.

The real money is in insider trading and front running. (not legal advice)
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Re: Risk Parity and the Permanent Portfolio

Post by Hal » Thu May 24, 2018 6:27 am

Tyler wrote: ↑
Sun May 20, 2018 5:48 pm
1) Volatility Risk Parity: Mathematically balancing the effects of different assets in a portfolio by scaling each asset according to their volatility. A good example would be the All Seasons portfolio, Larry portfolio, and (even if he might not describe it the same way) Desert portfolio. Look at the AAs and you'll note the similarity of how they scale up fixed income percentages to balance the high risk assets.
That's an interesting observation. So would you, or other forum members, consider both the Desert Portfolio (10% Gold, 2:1 Bonds;Shares) and the Lemonade Permanent Portfolio https://wiki.earlyretirementextreme.com ... 9_lemonade (25% Gold 2:1 Bonds:Shares) to be both Volatility Risk Parity Portfolios?

I wonder what issues just holding intermediate bonds would present?
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Re: Risk Parity and the Permanent Portfolio

Post by Tyler » Thu May 24, 2018 9:34 am

Any time you look to categorize things there will be areas of overlap, and I certainly don't mean to over-simplify all of the thought that has gone into various portfolios. It's more about pointing out general categories to help differentiate between different types of asset allocation theories. It's also a lot more obvious when you look at the AAs side by side. I'm working on a presentation on this, and I'm sure I'll also turn it into a post sometime soon.

I agree with Pugchief's summary. Both the observation about the bullet vs. barbell and the general categorization.
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Re: Risk Parity and the Permanent Portfolio

Post by Hal » Thu May 24, 2018 12:52 pm

Thanks for your comments Pugchief and Tyler,

I must admit it's undefined as to where an Economic Risk Parity model stops and a Volatility Risk Parity Model starts.

This table from Stable Investing is informative. Ryan had stated
Although the dollar weightings might appear to offer different exposures, the risk allocation across the portfolios is almost identical.
Image

Taking the PP rule of 15% to 35% asset allocations (with cash & bonds combined) all but the EDV portfolio meets the PP requirements.

<edit> Actually, I think my above line is wrong. Only the TLH portfolio would pass - the other bonds durations don't match 50/50 Cash/LT bonds
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Re: Risk Parity and the Permanent Portfolio

Post by Smith1776 » Sun Jun 03, 2018 2:41 am

Another great Ray Dalio series of videos. This pretty much reiterates much of what has been discussed, but it is nonetheless a very interesting and entertaining series of shorts.

https://www.investopedia.com/video/play ... portfolio/
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Re: Risk Parity and the Permanent Portfolio

Post by boglerdude » Sun Jun 03, 2018 11:14 pm

Dalio on economic history, is there a decent PDF to mp3 translator?

https://www.valuewalk.com/wp-content/up ... agings.pdf

Any other good podcasts on "cycles?" Im still not convinced the Fed isnt causing them.
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Re: Risk Parity and the Permanent Portfolio

Post by Jeffreyalan » Tue Jul 03, 2018 10:27 am

So what is the harm in tweaking the PP to have more volatility parity? For example, to match volatilities over the past 10 years you would need:

25% Cash (SHV)
25% Gold (GLD)
25% LT Bonds (50% TLT 50% EDV)
25% Small Cap Stocks (SLY)

Making those tweaks gives you a CAGR of 7.23% vs 6.14% for the standard 4 ETF PP. A Sortino ratio of 1.92 vs 1.73 for the PP.

Thoughts?
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