Starting EU PP, doubts about the bonds part

[europeanwizard]

So I'm starting a European PP, and in my last topic I was looking into the stocks part of the PP. Now I'm looking at the bonds part, and things are very confusing for me.

When I read the (2012) book, things look really simple for a European: get German bonds and be done with it. But I've done some reading here, and I hit upon the following 2016 topic:
viewtopic.php?t=8730

The conclusions of that topic are not really clear to someone like me, who's just starting out with investing and the PP. If I understand the debate correctly, most people argue that because the safe European LT bonds have yields so low, that the volatility becomes too low for the PP. Or something.

So what to do?

[Kike Moreno]

Interesting analysis on the bonds part for Europeans (in Spanish):

http://www.carterapermanente.es/bonos-europeos/

Its conclusion: stay with German bonds, or maybe Dutch, Finnish or Austrian bonds, and avoid the rest.

[barrett]

So I'm starting a European PP, and in my last topic I was looking into the stocks part of the PP. Now I'm looking at the bonds part, and things are very confusing for me.

When I read the (2012) book, things look really simple for a European: get German bonds and be done with it. But I've done some reading here, and I hit upon the following 2016 topic:
viewtopic.php?t=8730

The conclusions of that topic are not really clear to someone like me, who's just starting out with investing and the PP. If I understand the debate correctly, most people argue that because the safe European LT bonds have yields so low, that the volatility becomes too low for the PP. Or something.

So what to do?

Just wanted to say two things. When LT bond yields are so low, the basic problem (as I understand it) is that there is less upside potential than downside potential. The volatility on LT Euro bonds now is still plenty high because those low-yield bonds still have high duration. Duration is essentially a measure of interest rate sensitivity.

The second thing that I wanted to say is that the thread you linked to is, sadly, likely to be a better discussion that anything you will get going right now. Several of the members who posted on there are not currently active on this forum.

[europeanwizard]

Its conclusion: stay with German bonds, or maybe Dutch, Finnish or Austrian bonds, and avoid the rest.

I've read it, and although thorough, that piece is from 2014.

[europeanwizard]

Just wanted to say two things. When LT bond yields are so low, the basic problem (as I understand it) is that there is less upside potential than downside potential.

Thanks for clarifying that. I guess I have to think about it for a bit.

The second thing that I wanted to say is that the thread you linked to is, sadly, likely to be a better discussion that anything you will get going right now. Several of the members who posted on there are not currently active on this forum.

Well, it's not that I'd like to get a discussion going -- it's more that I have a hard time understanding the actions I can take away from that discussion.

[koekebakker]

I'm afraid I can't be of much help regarding choice of bonds.

German bonds are usually advised but as you're Dutch you could argue that there is no need for foreign bonds. Dutch bonds are considered almost as safe as German bonds.
There is no long-term bond etf for Dutch treasuries as far as I know, so you would have to buy individual treasuries.

Big question is do you want to own long-term German/Dutch treasuries? The yield is extremely low and eurozone bonds carry political risk. Personally I don't consider them suitable investments for small investors. As a small investor you can get far better risk/return by just using government insured savings accounts/CD's.

For example:
Dutch 30 year treasury yield is 1.1%
Five year CD's have equal or better rates, with no risk of principal:
https://www.spaarrente.nl/spaardeposito.aspx

When you search the forum (best to avoid the search functionality and use google: site:gyroscopicinvesting.com with your search query) you can find some more eurozone-centered topics about how to deal with the bonds part. There is no clear consensus how to deal with this problem. Some say use US-treasuries, some say only use CD's, others say forget the EU-PP altogether...

Good luck!

[barrett]

Well, it's not that I'd like to get a discussion going -- it's more that I have a hard time understanding the actions I can take away from that discussion.

Yeah, I get it. When yields on 30-year treasuries here in the US got down to 2.1% early last year, I think many of us were wondering whether to exit them or at least to lighten up a bit (I chose the latter course). I didn't see it on the thread in question but I think one suggestion on here was to maybe go with 33% stocks, 33% gold & 33% cash and skip the Euro bonds altogether.

I know that the Euro has only been in use for a little over 15 years but how closely correlated were stocks and gold in the 2000s over there? Here in the US when stocks lagged during that decade, gold really performed well. Could be a coincidence but I don't think so.

Even with those two assets, your results anywhere in Europe are likely to vary a lot (relative to results here in the US) simply because gold is priced in USD. But I'd still be curious by how much gold outperformed stocks in that decade even in the face of a strengthening Euro.

As you may know, Tyler is working on European data on his site portfoliocharts.com. Could be a good idea to keep an eye on his progress.

Lastly, gold is sort of the anti-cash. It should do very well if the Euro collapses. Not sure if and when that would happen but it's certainly a more likely scenario than the USD going under. But you probably know all that.

[LazyInvestor]

I think PP is less than ideal for most Europeans. An average Western European has a solid salary but they tend to pay tons of taxes and have low after tax savings. As such, most Europeans have tons of safety net, including solid pensions. They also tend to own inherited real estate. It is critical to take a look at all assets in such cases and to quantify the value of the pension. For example, if you believe that you will be getting a pension of for example 1K/month that's 12K/year at 3% withdrawal rate you already have 400K in assets that can be considered as government fixed income. So, if you have savings of let's say 50K that you want to invest in PP, in my mind you will end up with something like 425K in government bonds, 12.5K in gold, and 12.5K in stocks. This is more than ultra conservative, that is, you are taking almost no risk with little savings you have after they took tons of money from you through taxes. I explained this to 2-3 German colleagues and I think all of them switched to 100% equity with their savings after realizing how much they have in real estate and governmental safety net compared to their total savings.

And this is not even touching the issue of EU vs US PP.

[europeanwizard]

Very discouraging answers...

I don't want to create my own kind of asset allocation. It feels half-baked to me. After reading the book, the strategy seems clear and simple. But when it's time to implement, question marks pop up at a very basic level.

I do have a pension that's indeed about 10K per year. Mortgage on the house is about 50% of the current value. But there's a personal reason I don't want stocks to be a large part of my portfolio: volatility. I'm a contractor, I've got enough risk in my life and I do not wish to see my savings go up and down with the stock market.

Now from what I understood, the PP wanted that TLT because its volatility balanced out against that of the stocks allocation. Did I understand that correctly? If so, I don't think it's replaceable with an extra wad of cash, right? What about other bonds?

Regardless of answers, perhaps there's another allocation than the PP that is better for me. I've been looking through the Bogleheads' lazy portfolios1 but I'll need to read up on that.

1 https://www.bogleheads.org/wiki/Lazy_portfolios

[frugal]

IBCL



Regards

[LazyInvestor]

Very discouraging answers...

I do have a pension that's indeed about 10K per year. Mortgage on the house is about 50% of the current value. But there's a personal reason I don't want stocks to be a large part of my portfolio: volatility. I'm a contractor, I've got enough risk in my life and I do not wish to see my savings go up and down with the stock market.

Sorry, my intention was not to discourage by any means. Being a contractor and heaving high volatility in your daily job is a whole another story and in that case you are probably right - you should stick with a conservative portfolio such as PP.

Because of the peculiar relationship between USD and gold that is in the very core design of PP, I feel good only about US PP. For non-US people, I'd go with a Bogleheads portfolio. You can make it as conservative as you want, easier to implement, and possibly easier to stick with during the bad times due to the behavioral support you get at Bogleheads forum.

[europeanwizard]

IBCL

I saw that one, but how does that help me?

Sorry, my intention was not to discourage by any means.
Because of the peculiar relationship between USD and gold that is in the very core design of PP

It's just the way it is! Gotta think about it for a bit, and I think I'll follow your advice in this regard.

[koekebakker]

But there's a personal reason I don't want stocks to be a large part of my portfolio: volatility. I'm a contractor, I've got enough risk in my life and I do not wish to see my savings go up and down with the stock market.

That's a very good reason to feel attracted to a conservative portfolio like the PP. However the gold and bond parts of the eurozone-PP don't offer the same protection as in a US-PP.

The main problem with gold in a Euro PP is that the gold price seems to react to the US-dollar, not the euro. So when the euro got stronger compared to the dollar in the 00's, gold got stronger as well. Last few years it's the other way around: gold going nowhere, euro getting weaker.
The issue with euro bonds is that imo they're really not investable anymore for small investors. Yields are being suppressed to the extent that 10 year bonds pay close to zero procent... As a small investor you can get a far 'better' deal by using CD's or even just a savings account. These accounts are government insured up to 100k per bank account.

The PP is not the only conservative portfolio out there though. As lazyinvestor said you can create a conservative Boglehead portfolio, or pick something in between a PP and a boglehead portfolio.
For example, another forum member, Desert, came up with the Desert Portfolio which consists of 30% stocks, 60% intermediate treasuries and 10% gold.
This is a portfolio which can easily be translated to a euro-based portfolio:
30% global stocks
60% intermediate fixed income (spaardeposito's)
10% gold

This way you still get a bit of gold's diversification while the volatility will be very low, arguably even lower than the PP. The expected return should be slightly higher as well but don't expect to get rich quickly...

[Kike Moreno]

Just to say something in favor of the Euro PP, during the 18 years of the euro the portfolio has got a 6.36% annualized nominal return ( http://www.carterapermanente.es/evoluci ... ermanente/ ). So it has been doing its job during these years. As always past returns do not guarantee future returns and all that, but it is a very decent 18 years history.

[frugal]

Acciones Bonos Oro Dinero HBPP EUR Index
Ini 100,00
1999 39,14% -11,45% 17,53% 3,06% 12,07% 112,07
2000 -2,55% 14,83% 1,12% 3,78% 4,30% 116,88
2001 -18,29% 6,20% 6,69% 4,61% -0,20% 116,65
2002 -33,77% 12,69% 4,59% 3,32% -3,29% 112,81
2003 19,10% 4,49% 1,27% 2,63% 6,87% 120,56
2004 12,67% 14,54% -2,95% 2,26% 6,63% 128,56
2005 25,38% 17,15% 34,93% 2,28% 19,94% 154,19
2006 21,92% -3,15% 11,41% 2,71% 8,22% 166,86
2007 7,82% -5,47% 17,79% 3,85% 6,00% 176,87
2008 -44,85% 22,85% 8,09% 4,07% -2,46% 172,52
2009 27,32% -4,30% 24,69% 1,61% 12,33% 193,79
2010 2,40% 17,11% 37,67% 0,77% 14,49% 221,87
2011 -14,89% 25,97% 15,35% 0,56% 6,75% 236,84
2012 19,31% 8,11% 3,66% -0,02% 7,77% 255,23
2013 23,36% -10,80% -30,84% -0,04% -4,58% 243,54
2014 4,32% 33,27% 13,07% 0,12% 12,70% 274,46
2015 9,82% 1,26% -1,24% -0,10% 2,44% 281,14
2016 4,33% 14,95% 12,73% -0,39% 7,91% 303,36

Anualizada: 3,15% 8,08% 8,66% 1,94% 6,36%

Referencia: MSCI EMU Ger Gov 30y Bullion (€) Ger Gov 1y

[frugal]

Just to say something in favor of the Euro PP, during the 18 years of the euro the portfolio has got a 6.36% annualized nominal return ( http://www.carterapermanente.es/evoluci ... ermanente/ ). So it has been doing its job during these years. As always past returns do not guarantee future returns and all that, but it is a very decent 18 years history.

hiiiiiiiiiii

yes better then US-PP

and other countries also worked well!

[europeanwizard]

Some good points about the Euro PP history -- however the question remains: should I get into bonds at this point. The topic from October 2016 had a general consensus that I shoudn't, and that sentiment is repeated here.

So, I've been re-reading that older topic, and here is a possible alternative:

My advice today would be to look into a diversified global portfolio that lowers your exposure to the Eurozone to have it represent the worldwide percentage in the global economy. Basically, think of a Permanent Portfolio, but using globally diversified assets for the cash, bonds, and stocks. Gold should remain and should have geographic diversification outside the continent where you live for emergencies.

I'd have to say, that does sound good to me.

This is a portfolio which can easily be translated to a euro-based portfolio:
30% global stocks
60% intermediate fixed income (spaardeposito's)
10% gold
(...) don't expect to get rich quickly...

Thanks for that pointer. That could be a start indeed. I'm not looking to get rich, it's more that I'm protecting against inflation.

So right now if I'd mix Craig's and Koekebakker's advice, it would look something like this:
25% global stocks
25% cash/intermediate fixed income (spaardeposito's)
25% gold
25% global government bonds

Does anyone have advice on this? For example I've noticed that there's a JP Morgan Global Government Bond Index. Is that perhaps a start? I can't find an ETF that follows it, does anyone have a pointer here?

[Kike Moreno]

What happens to this allocation if the euro appreciates for example a 20% to the level where it was just 3 years ago? 3 of the 4 assets have currency exchange risk in this portfolio.

[frugal]

What happens to this allocation if the euro appreciates for example a 20% to the level where it was just 3 years ago? 3 of the 4 assets have currency exchange risk in this portfolio.

+1

[LazyInvestor]

I'd just go with something simple like

60% VWRD
40% IEGA

or if you really want some gold:

50% VWRD
10% SGLN
40% IEGA

[barrett]

What happens to this allocation if the euro appreciates for example a 20% to the level where it was just 3 years ago? 3 of the 4 assets have currency exchange risk in this portfolio.

Exchange rate risk is very real and one probably has about a 50% chance of being adversely affected by it. My total gain on the PP since the start of 2014 is almost exactly 20%. At the beginning of 2014 the Euro was worth 1.36 USD. Now it's 1.12. So, if I held a USD denominated PP in Europe, my nominal gains would be knocked down to almost zero. Real gains would be negative. Also, the USD really tanked in 2008 relative to the Euro. If a real life failure of an investment strategy is a recent memory, I would avoid it at all costs (pun not intended).

[frugal]

What happens to this allocation if the euro appreciates for example a 20% to the level where it was just 3 years ago? 3 of the 4 assets have currency exchange risk in this portfolio.

Exchange rate risk is very real and one probably has about a 50% chance of being adversely affected by it. My total gain on the PP since the start of 2014 is almost exactly 20%. At the beginning of 2014 the Euro was worth 1.36 USD. Now it's 1.12. So, if I held a USD denominated PP in Europe, my nominal gains would be knocked down to almost zero. Real gains would be negative. Also, the USD really tanked in 2008 relative to the Euro. If a real life failure of an investment strategy is a recent memory, I would avoid it at all costs (pun not intended).

Hello

I agree with you

in many foruns in europe, investors that have lazy portfolios with a lot of diversification, lets say almost all the asset classes from all the world, say that at the end the exchange rate is not important ----> I really don't understand if a multi diversified portfolio has no problem of currency risk!

Please let me know your comments.

[frugal]

I'd just go with something simple like

60% VWRD
40% IEGA

or if you really want some gold:

50% VWRD
10% SGLN
40% IEGA

hi

interesting, why this asset allocation?

Is not a all weather portofolio...

regards

[europeanwizard]

I'd just go with something simple like
40% IEGA

But how does that fix my (and other people's) worries about the low yield of long-bonds and its associated risks?

What happens to this allocation if the euro appreciates for example a 20% to the level where it was just 3 years ago? 3 of the 4 assets have currency exchange risk in this portfolio.

Yeah that's a great question to which I don't really have an answer...

For what it's worth, in order to get some different perspectives I've opened a topic at the Bogleheads forum.

[blue_ruin17]

It is always going to be a "bad time" to get into at least one of the PP assets, by default.

That's how the system is designed: the PP accepts the damage done by the losing assets, but offsets those losses with the (usually) superior gains of the winning assets. The differential between the winners and losers of the component PP assets has historically been tilted toward the winners, providing a consistent, respectable, inflation-adjusted return. That's the Permanent Portfolio system, in a nutshell. Preaching to the choir, I know...

If you had started your PP ten years ago, would your "doubts about the bonds" cause you to sell off the LTT portion of the portfolio today?That would amount to an explicit abandonment of a strategy which served you well during that decade. In Germany, the PP hasn't had a losing three year rolling return since 2000. Its a portfolio that has worked in Europe for decades, despite there always being an asset or two which was or appeared to be a loser. But what's the difference between that scenario and going all-in on the Permanent Portfolio today, LTT included? There is none, other than the natural aversion of humans to jumping into the deep-end. Once you're in though, I promise you, the water is quite nice.

If it wasn't LTT that you were worrying about, it would be one of the other core PP asset classes. At any given time, one of the assets will be basking in the sun, and the other will be in the dog-house. But these roles often reverse suddenly and violently: you never know when an asset that looks terrible today might save your ass tomorrow. In January 2008 most people thought LTT were going to be slaughtered, but by December they turned out to be your saviour of any portfolio that held a strong position in them. In January 2009 stocks looked sickening, but they handsomely rewarded anyone who held them through the year. And so on, and so forth.

The PP system breaks the instant that you remove one of the component asset classes, period. Either you're in or you're out: either you commit to the logic, the mechanics, the system of the PP, or you find another portfolio that aligns with your style and objectives. Don't smash the PP and then glue three of the four pieces back together again, fooling yourself into believing that it will still "work". It won't. The PP requires a buy-in to all four asset classes, or it isn't the PP.

Do I like LTT right now? Nope! Am I fully invested in them, within the context of the PP? Yup. Do I sleep like a baby at night? Sure do.