Making Variable Portfolio complementary to Permanent Portfolio

A place to talk about speculative investing ideas for the optional Variable Portfolio

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tarentola
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Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Wed Oct 10, 2012 7:30 am

The Permanent Portfolio holder is convinced that the PP assets will on aggregate increase in value in the long term. Why include any of the same assets in a VP, only to buy and sell them in the shorter term?

To avoid duplication, the VP should be complementary to the PP, ie do something that the PP does not do. A VP for dividends as already discussed in the forum makes sense from that point of view.

Another complementary idea would be to create a VP containing the asset classes which are not held by the PP. The PP holds:
• Stocks
• LT Bonds
• Gold
• Cash

So that leaves:
• REITs
• Commodities (Oil, Agriculture, Metals)
• Other stocks (foreign developed, emerging markets)
• Other bonds (Corporate, HY bonds, Em Mkts, Govt medium term)
• More exotic things like private equity, hedge funds

One could construct a simple 4-ETF VP of REIT, commodities, foreign or emerging market stocks and aggregate or world bonds. Or a more complicated version with similar asset classes but more subclasses: for example, divide commodities into oil, agriculture and metals.

What do you think? Is there a catch?

This approach avoids owing the same PP assets twice. The management of a complementary VP could be by buy-and-hold, rebalancing, or a moving average or momentum like Mebane Faber’s. Personally I would go for Faber’s 10-month moving average method, as that requires inspection only once a month, but the choice of management method is another discussion.
Last edited by tarentola on Wed Oct 10, 2012 7:33 am, edited 1 time in total.
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Jake
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by Jake » Wed Oct 10, 2012 7:45 am

I don't see any problem in holding the same asset in a VP that you hold in a PP, since I understand a VP as a defined pot with which to indulge the urge to try market timing. For example, if I wanted to make a bet on the market with my VP and I believed most strongly that gold (or stocks, or whatever) are about to shoot up, then there would not be much point in me holding REITs or something else in the VP purely on the basis that I should include something different to the PP. If a PP asset is also what I think is most worthwhile gambling money on, why not hold it in a VP? All this always assumes you don't dip into your PP to support your VP etc.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by Pointedstick » Wed Oct 10, 2012 10:23 am

Every once in a while I toy with the idea of a 100% small-cap value stock VP that I would try to time the market with in order to improve my total return during a stock boom. Say perhaps I would buy in when the P/E ratio of the stock market dropped below 9 or so, and would sell once it rose above 25. That way I wouldn't be sad when everyone else was bragging about their 13%/yr returns.

In that case, even though I would be owning an asset that's also in my PP, I would be using it for a different goal.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by MachineGhost » Wed Oct 10, 2012 1:35 pm

tarentola wrote: What do you think? Is there a catch?
I think you need to take correlation into consideration.  In my mind, I view the VP as 10% and the PP as 90%, but if the ratio is different then the correlation issue becomes more of a concern.  So it would best to slice and dice the PP itself to maintain the 25%x4 exposure rather than risk over or underweighting.  Commodities and REIT are bound to fall along with gold so there is no sense in thinking they are unique assets.  Same with any kind of equity or fixed income.  People panic and bubbles pop en mass according to the asset class not the individual investment.

In my VP, I have 13 trading strategies, majorly equity-based, but with forex and commodities also.  They range in duration from intraday up to 12-18 months, so they are complementary to the PP in the sense they provide time diversification and a little asset class diversification.  Some day I may integrate them into the PP where I do use market timing, but I find it much easier to overworry about a small 10% portion than 100%.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Thu Oct 11, 2012 2:39 am

Thanks for the replies.

Jake – Of course you might want to speculate in gold if you though it was about to shoot up. I was thinking a bit longer-term: a strategy for people who were not content with exposure to only the PP assets but wanted exposure to the rest of the market as well, as opposed to “conviction”? investors.

PointedStick – the timed small-cap value strategy is the sort of thing I meant. There could be some overlap with the PP assets as you say.

MachineGhost – I take the point about correlation. I know that diversification into other assets does is not a perfect solution, as correlations tend to 1 when there are big sell-offs. But on the other hand a complementary PP would give you exposure to any rise in real estate or non-gold commodities, for example.

Frow what I read in the forum, the classic VP contains individual assets that the investor believes will increase in value, for whatever reason. What I am suggesting is a longer-term true portfolio approach to the VP, in which (like the PP) there is a logic to the combination of assets chosen.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by escafandro » Thu Oct 11, 2012 1:26 pm

My inflation oriented VP if it's worth for something:

Gold
Silver
Consumer Staples
Energy
Global Real Estate
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by MachineGhost » Thu Oct 11, 2012 7:25 pm

tarentola wrote: Frow what I read in the forum, the classic VP contains individual assets that the investor believes will increase in value, for whatever reason. What I am suggesting is a longer-term true portfolio approach to the VP, in which (like the PP) there is a logic to the combination of assets chosen.
Equity, Fixed Income, Real, Cash (Forex).
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by BearBones » Sat Oct 13, 2012 10:42 am

escafandro wrote: My inflation oriented VP if it's worth for something:

Gold
Silver
Consumer Staples
Energy
Global Real Estate
Close to what I am thinking. How do you invest in the last 3?
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by escafandro » Sat Oct 13, 2012 2:19 pm

BearBones wrote:
escafandro wrote: My inflation oriented VP if it's worth for something:

Gold
Silver
Consumer Staples
Energy
Global Real Estate
Close to what I am thinking. How do you invest in the last 3?
IAU
SIVR
KXI
XOP
VNQ-VNQI

My approach is international because I don´t live in U.S.
I'm thinking to simplify and change VNQ-VNQI to RWO. And IAU-SIVR to CEF (probably when CEF lower the premium).
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by craigr » Fri Oct 26, 2012 7:31 pm

Posted from another thread:

In general I stick to broader asset class types to diversify against company risk. Assets that a variable portfolio may want to consider are:

REITs
Developed International Stock Exposure
Emerging Market Stocks
Additional Domestic Stock Exposure
Vulture Investing

The REITs can provide an almost hard asset/equity quality at times. REITs that own property directly (e.g. TIAA CREF) are much preferred over those that are basically mortgage speculation vehicles. They obviously were a much better deal in 2009 than they are today.

The three stock categories could be embodied in separate funds, or perhaps just swapping out the 25% stock allocation in the portfolio with something like Vanguard Total World and just take it up from 25% to whatever you feel comfortable holding. Mostly when people ask me what to hold in a variable portfolio (if they *really* are sure they want one), is just allocate more to the stock market. Overall I'm an optimist and believe in the ability of companies to grow and protect themselves even in bad markets and still generate profits for investors. It doesn't always happen, but the probabilities are in their favor if someone just wants to overweight an asset. 

Private equity is very risky. Most people don't qualify for it anyway. Those that do qualify should probably stay away (angel investing, etc.). It's very speculative and risky. In the vast number of cases you are probably setting your money on fire.

Then there are what I call "vulture investing" opportunities. Meaning times when some kind of very bad news is out and people overreact to it. These are situation dependent. Totally speculative as well. I would only do this with very limited funds as pure play money.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by sophie » Sat Oct 27, 2012 9:44 am

Anybody thinking about putting some VP money into Lending Club?  It's got the advantage of not requiring timing strategies, and you get to play the same game that banks do with credit card debts.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by melveyr » Sat Oct 27, 2012 1:59 pm

I am thinking that 100% VT (total world stock market) is the ultimate complimentary VP.

The PP doesn't really protect you from a total currency collapse because it has you rebalancing into a black hole. You would be selling your gold every day to buy more paper. The only way to ensure that you won't be hostage to a currency collapse is to have a portfolio that NEVER has you rebalancing into bonds. Also, the biggest risk with the PP is not losses in real terms, but relative under performance in the good times that cause you to abandon the strategy. If you have VT you can ride the emotional ups and downs of the market and take comfort in being part of the herd, rejoicing and commiserating with your friends as the market fluctuates.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by BearBones » Sat Oct 27, 2012 3:04 pm

melveyr wrote: I am thinking that 100% VT (total world stock market) is the ultimate complimentary VP.
Depends on what "complementary" means, I guess. Since 46% US, VT is going to track the stock component of the PP pretty tightly. If looking for something that is not going to predictably move in the direction of one of the PP components, would seem that a truly international fund/etf would be better.

My ideal would be:
Some land in a stable foreign country (e.g, Canada, Norway, Australia)
Some cash and CD equivalents in a bank of that country
Some gold in the SDB of that bank
Vanguard Total International Stock ETF or equivalent
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by melveyr » Sat Oct 27, 2012 3:45 pm

BearBones wrote:
melveyr wrote: I am thinking that 100% VT (total world stock market) is the ultimate complimentary VP.
Depends on what "complementary" means, I guess. Since 46% US, VT is going to track the stock component of the PP pretty tightly. If looking for something that is not going to predictably move in the direction of one of the PP components, would seem that a truly international fund/etf would be better.
Fair point. I guess for me emotionally I see VT as a bet on global capitalism, and I like that bet encapsulated in one product.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Wed Nov 14, 2012 4:17 am

Thanks for the replies and sorry for the lateness of this reply, due to travelling.

There is a 2009 study “Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes”? (Electronic copy available at: http://ssrn.com/abstract=1368689).  The authors attempt to evaluate which asset classes add diversity to a traditional portfolio of stocks, bonds and cash. It concludes

“Our mean-variance analysis suggests that real estate, commodities and high yield add most value to the traditional asset mix of stocks, bonds and cash. Basically, adding these three asset classes comes close to an all asset portfolio.”?

They also tested private equity, hedge funds, and inflation-linked bonds but concluded that these add negligible value.

For the variable portfolio, I will consider REIT, commodities, HY bonds and other stocks.

Stocks - Developed international stocks (EFA) and emerging market stocks (EEM) are highly correlated over the last few years so I will have only one of these two; since I am foreign myself (Eurozone), I will probably stay with Euro stocks ETF in the VP and a combination of euro and US stock ETFs in the PP.

REIT – probably Euro in my case

Commodities – could use a single Commodities ETF, but the compositions vary between indexes. There is a 2006 Merrill Lynch overview at http://gmi.ml.com/pdf/MLCXResearch.pdf.

For example, the S&P GSCI index is now almost 70% energy, of which most is crude oil, 8% industrial metals, 20% agriculture including livestock. It includes less than 4% precious metals, so adds a negligible amount to the gold in the PP. Other Commodities indexes us different percentages. The DJ-AIG is more balanced and perhaps worth considering. It might be worth separating agriculture, oil and industrial metals, as the various US commodity groups are not particularly well correlated (see http://stockcharts.com/freecharts/perf.html?[COMM])

Maybe some funds for pure speculation.

So in summary my VP choices would be:

- Non-US developed stocks or Emerging Market stocks
- HY bonds
- REIT
- Oil
- Agriculture
- Industrial metals
- Play money for speculation

There remains the question of how to manage the portfolio: rebalancing or market timing. The PP is designed for rebalancing only, as it weathers all economic conditions. This VP has no such pretensions and is more opportunistic, so I am inclined to use market timing; probably the 10-month MA, as it requires only monthly inspection and not many transactions, but am still thinking about it.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by dualstow » Thu Nov 15, 2012 8:39 am

I like REITs, muni bonds (VPAIX) and VCIT (corp bonds) in my VP.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by frugal » Sat Nov 17, 2012 5:09 am

dualstow wrote: I like REITs, muni bonds (VPAIX) and VCIT (corp bonds) in my VP.
First:

Living in Europe we should make hedge to these type of international ETF's ?

This to avoid currency risk, or it has not so much influence in the end results. 



Second:

what is your opinion about the following for VP:

REIT                      VGSIX 25.00%
Intl Developed - EAFE VDMIX 25.00%
Emerging Mkt - EM  VEIEX 25.00%
Commodities                 PCRIX 25.00%




Regards
Last edited by frugal on Sat Nov 17, 2012 5:49 am, edited 1 time in total.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Sun Nov 18, 2012 5:00 am

Frugal
If you compare the performances of VDMIX and VEIEX over the last 10 years (on Yahoo for example) you will see that there is some correlation, but  VEIEX has done a lot better (+150% to -5%) and is more volatile. I do not see what benefit VDMIX would add, and I would replace it by another asset such as a bond ETF. That would give you REIT, stocks, bonds and commodities.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by frugal » Sun Nov 18, 2012 6:46 am

Hi,
Yes US Bonds or Silver...

What about the USD currency risk? Isnt it important for an european citizen in VP and PP ?

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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Wed Nov 21, 2012 2:43 pm

Silver and other commodities are formally priced in dollars but are largely currency-independent. For US bonds, there will of course be currency risk, and as a Euro investor I would invest only a small percentage of my bond allocation in them.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by frugal » Wed Nov 21, 2012 3:48 pm

tarentola wrote: Silver and other commodities are formally priced in dollars but are largely currency-independent.
Hi,

Can you please explain me the result of the sentence above.

Please exemplify.

Thank you.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by tarentola » Fri Nov 23, 2012 4:50 am

I am sure there are others here better qualified to reply but here goes. Commodities, particularly precious metals, are considered a store of absolute value. For example, if the dollar fell relative to the euro, the price of silver in dollars would rise. The price of silver in euros would not change.  If there was inflation of 10%, the price of silver would rise 10% (all other things such as supply and demand being equal).  This is one of the roles of gold in the PP: it provides a defence against inflation and dollar (or any currency) devaluation.
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Re: Making Variable Portfolio complementary to Permanent Portfolio

Post by frugal » Fri Nov 23, 2012 4:23 pm

Perfect, now i understand.

Thank you Tarentola.

Help me here again,

VP can have:

- comodities like silver, anymore with the same behaviour that you explained, no currency risk

- bonds, which ones?

- reits from all world

- emerging markets

- land?

- house?

?...


tarentola wrote: I am sure there are others here better qualified to reply but here goes. Commodities, particularly precious metals, are considered a store of absolute value. For example, if the dollar fell relative to the euro, the price of silver in dollars would rise. The price of silver in euros would not change.  If there was inflation of 10%, the price of silver would rise 10% (all other things such as supply and demand being equal).  This is one of the roles of gold in the PP: it provides a defence against inflation and dollar (or any currency) devaluation.
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