Volatility weighted versus exposure weighted

[Clive]

?

[simata]

Please post link to data and formula you used.

The Permanent Portfolio might be considered as a blend of 50% long duration and 50% short duration, where cash and gold are considered as the short end and LT's/Stocks considered as the long end.

Such a equal weighted long and short durations is a barbell and will have some benefits in both rising and falling interest rate periods.

Stocks generate variable profits, LT's generate fixed returns.  Changes in inflation or predicted inflation has different effects on LT and stock prices.  Whilst both generally rise over time, LT and stocks tend to move in a somewhat inverse correlated manner.  A blend of the two therefore lowers volatility (which in turn helps uplift compound benefits).

The 25% gold acts as a form of domestic currency hedge.

In many respects the 25% equal weightings to stocks, gold, LT and cash looks reasonable.  However another alternative variation might be to balance the set based on volatilities.

Generally gold is more volatile that stocks, and stocks are more volatile that LT's.  If you run through the rigours of volatility based weightings then you can volatility weight the allocations which in turn has gold and stock much closer in opposing price wave motions, as does it between stocks and LT price motions.

What you end up with is very similar total rewards, but achieved much more linearly over time.



In Japan for example at some historic dates the PP has pulled relatively ahead of itself only to later fall back down again.  Had you started a PP at one of those pull-aheads then subsequent benefits might have been relatively poor.  In contrast the volatility weighted allocations has the PP progress in a much more linear way over time, and from what I've seen so far it looks like similar allocations can be used across Japan, US and UK with equal effect.

When you have a smoother overall value progression line over time, then the risk of buying in at a relative high and suffering subsequently is reduced.

A reasonable overall guideline seems to be to use a 50 50 split between PP and a long/short barbell e.g. 12.5% gold, 12.5% stocks, 37.5% long dated, 37.5% short dated.  For the short dated you might use either 2 year treasuries, or perhaps 12.5% in each of T-Bill, 2 year and 5 year treasuries, or possibly even 7.5% in each of a 1 to 5 year treasury Ladder.

This does fall short on domestic currency hedge relative to the conventional PP, so holding 12.5% of cash in foreign currencies or perhaps holding foreign stocks might help restore that hedge/protection to similar levels as the conventional PP.

What's quite interesting is that when you compare the rolling 3 and rolling 5 year averages with that of the rolling 3 and 5 year inflation averages, a bar chart of those teases that there is an apparent lag between the inflation based and investment based returns i.e. shift the inflation bars right 3 or 5 years, uplifting those values by 4% p.a. real gains and you have a very close fit of the adjusted inflation bars fitting with the investment based bars i.e. a form of predictor based on actual historic inflation.  This appears to have held reasonably across time.  Whilst far from 100% accurate, the general fit is reasonable.

[macclary]

Hi Clive, I think you might be interested in these trading systems. There were created by a H.B. fan based in London I think. The more aggressive systems use options to capture the volatility / re-balance profit.

http://isonomy.collective2.com/
http://isonomyplus.collective2.com/
http://isonomyturbo.collective2.com/

[SmallPotatoes]

Hi Clive, I think you might be interested in these trading systems. There were created by a H.B. fan based in London I think. The more aggressive systems use options to capture the volatility / re-balance profit.

http://isonomy.collective2.com/
http://isonomyplus.collective2.com/
http://isonomyturbo.collective2.com/

Cool. Definately a good VP suggestion. Anyone else think the Isonomy auto-trade using PP fundamentals isn't a bad idea?