My Problems With PRPFX

[TripleB]

I have long disliked PRPFX, and was somewhat surprised to see it considered a viable alternative on this forum. Let me outline my issues and start a discussion on these points of contention:

1) High Expense Ratio. I can do the PP for a lot cheaper. If I buy treasuries and tbills at auction, 50% of my portfolio is ER free. If I use a gold ETF and stock index ETF, my total ER for the whole portfolio is 0.12%. Compare that to just over 1% for PRPFX. That's a huge mountain to overcome.

2) It's not the PP. It's using weird stuff in there like Francs and Silver. I've heard MediumTex combines PRPFX with EDV to make it react more similarly to PP. (a) It's still not the PP and (b) if you're using multiple funds, then why not just use the 4 funds and do the actual PP? The only benefit of PRPFX is that it's a one-fund solution.

3) Tax concerns. The PP can be highly tax efficient because you can put tax efficient assets in taxable. With PFPFX it just goes into one lump area.

4) Forgo increased tax-advanced space. With the PP, one can hold all their gold in taxable, and essentially expand their tax-shelter by a large margin i.e. if you have a $100k portfolio comprised of a $50k IRA and $50k taxable, by putting your $25k gold in "Taxable" using gold coins, you essentially expanded your "tax-shelter" from $50k to $75k. Can't do that with PRPFX, and this expansion is one of the huge benefits of PP, in my opinion.

5) Manager risk. There's now counterparty risk that PRPFX managers will do something stupid.

6) Fund risk. There's now risk that a large portion of shareholders will with to redeem their assets, forcing managers to sell at inopportune times, beyond their control, due simply to the actions of the other shareholders.

There's only  a few situations where I see PRPFX being a "good" idea:

1) You have a 401k and for some reason it allows PRPFX but has no access to anything else that would resemble a component of the actual PP. i.e. they have no index stock funds and only 2% active managed stock funds. I imagine this case is very rare.

2) You are making investment decisions for a family member who freaks out if you mention gold, but is too lazy to look up PRPFX to see what it holds, so you put their money into that fund.

3) You are going to prison for a long time and won't have the ability to rebalance your portfolio.

4) You have a small amount of money and it's not feasible to buy separate ETFs due to trading fees. Perhaps you have under $20k in assets.

[MediumTex]

PRPFX is definitely far from perfect, but many people simply can't or won't bring themselves to buy the individual PP assets (especially the gold).

I wouldn't think of PRPFX as a comparison to the HB PP, because it will usually come up short; rather, I would compare PRPFX to other one-stop shopping mutual funds, and from that perspective it can be a pretty good tool if you want PP-like exposure.

[smurff]

TripleB, I agree with you about all the reasons for disliking PRPFX, and I also agree with you about the few situations you mentioned.  The four pro-prpfx situations you mentioned (well, actually, three--I suspect that very few convicted felons are thinking about conservative investment strategies) are actually big reasons to try prpfx, especially if the alternative is equivalent to nothing at all (like a 100% allocation to one asset), Dogs of the Dow, Goin' Fishin' portfolio, or something really weird.  (Not that there's anything evil about these portfolios.)

But there are lots of imperfect PP solutions that work for some people, like buying ETFs instead of physical gold, buying LT treasury funds instead of individual 30-year treasury securities, putting cash into FDIC-insured savings accounts rather than buying short-term treasuries, etc.  So far that's 75% of the asset classes that are imperfect.  We still regard those as equal to the HB PP.  And that's not taking into account the differences between an S&P 500 index fund vs. a total stock index fund vs. the high volatility growth stocks HB first suggested would be best for the stock portion of the PP.

And there are two assets in the HBPP that make some people barf--gold and LT treasuries--and if they had to do it themselves, they would never take a step to invest in them.  But a mutual fund?  That's easy, especially if it's appreciating.

When I first started investing in the PP a couple of  years ago, I got my feet wet with prpfx.  It was a first step, easy enough to go unnoticed by the part of the brain that screams, "but this goes against everything they taught in bizness skool!" even though it was actually quite a wise, studied, and well-considered decision.  A few weeks after starting, I learned from the members of this forum (and the Bogleheads forum), and had ideas from here that more closely matched the original specifications of the PP.  I stopped investing in prpfx and moved to the four original assets.  But the truth is, if there had been no prpfx, it's not likely that I would have invested in the HB PP.

But you're right--it's imperfect.  But I think it still works for some people at particular stages in their investment lifecycle.

[MediumTex]

PRPFX has really hit some snags lately.

First, the dollar has been strengthening.  PRPFX is built for a weak dollar so this has not been good.

Second, the Swiss decided that devaluing their currency was in their national interest.  This approach to currency management is the exact opposite of the reasons why the Swiss franc was included in PRPFX in the first place.  From here forward, I predict that the Swiss franc will be dead weight in PRPFX. 

Third, long term treasuries have been in an incredible rally for the last couple of months.  PRPFX doesn't have nearly enough long term treasury exposure, and thus the fund missed most of the recent rally.

In short, a lot of PRPFX's tailwinds have turned to headwinds lately.

The next snag may be mass redemptions, since I suspect a lot of recent PRPFX investors are just performance chasing and don't really know that much about what they own.  I wonder how that will go if it happens.

[AdamA]

The next snag may be mass redemptions...

MT--

I often wonder about this.  Wouldn't the only real problem caused by this be taxes on the distributions?  PRPFX would have to own a gigantic share of all of it's asset classes for it to affect the price of any of the assets. 

[MediumTex]

The next snag may be mass redemptions...

MT--

I often wonder about this.  Wouldn't the only real problem caused by this be taxes on the distributions?  PRPFX would have to own a gigantic share of all of it's asset classes for it to affect the price of any of the assets. 

PRPFX has grown so large that it's not inconceivable that mass redemptions could actually disrupt the underlying market for certain assets.

Take gold, for example.  PRPFX owns around $2.4 billion worth of gold ($12 billion x 20%).  If PRPFX began liquidating a significant portion of this holding, it could create downward pressure on the price of gold, presumably in addition to the downward pressure that triggered the mass redemptions in the first place.

Overall, other than bad tax consequences for taxable investors, maybe it wouldn't be that big a deal.

[AdamA]

Take gold, for example.  PRPFX owns around $2.4 billion worth of gold ($12 billion x 20%).  If PRPFX began liquidating a significant portion of this holding, it could create downward pressure on the price of gold, presumably in addition to the downward pressure that triggered the mass redemptions in the first place.

But just like with the DIY PP, the money has to go somewhere, so if gold tanks, presumably something else within the fund would make up for it (which I guess highlights the problems with the limited LTT exposure). 

All the more reason to own the 10% TLT or EDV.

[Ariadne22]

PRPFX has a limit on how much gold it can sell, depending on the profits therefrom.

This from its prospectus:

Under federal tax law, the Portfolio may not earn more than 10% of its annual gross income from gains resulting from selling precious metals.  Accordingly, the Portfolio may be required to hold its precious metals or to sell them at a loss, or to sell securities at a gain, when for investment reasons it would not otherwise do so.

This statement has kept me up at night.  Should I be concerned?  Although I have a small investment in PRPFX right now, I may just revert to the PP for more control.

[MediumTex]

PRPFX has a limit on how much gold it can sell, depending on the profits therefrom.

This from its prospectus:

Under federal tax law, the Portfolio may not earn more than 10% of its annual gross income from gains resulting from selling precious metals.  Accordingly, the Portfolio may be required to hold its precious metals or to sell them at a loss, or to sell securities at a gain, when for investment reasons it would not otherwise do so.

This statement has kept me up at night.  Should I be concerned?  Although I have a small investment in PRPFX right now, I may just revert to the PP for more control.

I don't know what that statement means...or maybe I should say that statement could mean a lot of different things. 

Given the growth the fund has seen in recent years, I doubt if Cuggino has sold ANYTHING in a long time.  In a mass redemption scenario, the language above would probably just trigger a technical redemption of PMs "in kind", which the fund would typically assist the shareholder in liquidating in conjunction with the share redemption (based upon the elections the shareholder made when setting up the account).

I wouldn't worry about this item too much.  The way I read it, the fund is just managing its tax situation as efficiently as possible.

[Ariadne22]

PRPFX has a limit on how much gold it can sell, depending on the profits therefrom.

This from its prospectus:

Under federal tax law, the Portfolio may not earn more than 10% of its annual gross income from gains resulting from selling precious metals.  Accordingly, the Portfolio may be required to hold its precious metals or to sell them at a loss, or to sell securities at a gain, when for investment reasons it would not otherwise do so.

This statement has kept me up at night.  Should I be concerned?  Although I have a small investment in PRPFX right now, I may just revert to the PP for more control.

I don't know what that statement means...or maybe I should say that statement could mean a lot of different things. 

Given the growth the fund has seen in recent years, I doubt if Cuggino has sold ANYTHING in a long time.  In a mass redemption scenario, the language above would probably just trigger a technical redemption of PMs "in kind", which the fund would typically assist the shareholder in liquidating in conjunction with the share redemption (based upon the elections the shareholder made when setting up the account).

I wouldn't worry about this item too much.  The way I read it, the fund is just managing its tax situation as efficiently as possible.

Well, right now, I own PRPFX in an IRA at TRowePrice, so I have no shareholder elections, I don't think.   Not worried about tax consequences.  Am worried about PRPFX having its hands tied on gold liquidation in the event of massive redemptions  - if said liquidation would trigger profits in excess of 10% of the fund's overall profits.  They'd have to hang on - or might even be prevented from properly rebalancing - if the sale/rebalancing would generate excessive gains.

[longeyes]

I started two PP portfolios at the beginning of the year, one in PRPFX, one an HB PP.  Color me disenchanted with PRPFX and re-considering.

[MediumTex]

Well, right now, I own PRPFX in an IRA at TRowePrice, so I have no shareholder elections, I don't think.   Not worried about tax consequences.  Am worried about PRPFX having its hands tied on gold liquidation in the event of massive redemptions  - if said liquidation would trigger profits in excess of 10% of the fund's overall profits.  They'd have to hang on - or might even be prevented from properly rebalancing - if the sale/rebalancing would generate excessive gains.

I don't think this would be a problem.

If there are mass redemptions, the fund would distribute in kind and assist shareholders in liquidation.

If there was another scenario, in a pinch the fund would perhaps sell equity holdings with capital gains in order to offset PM gains.

In any case, it just seems like a tax management issue.

[Gumby]

Given the growth the fund has seen in recent years, I doubt if Cuggino has sold ANYTHING in a long time.  In a mass redemption scenario, the language above would probably just trigger a technical redemption of PMs "in kind", which the fund would typically assist the shareholder in liquidating in conjunction with the share redemption (based upon the elections the shareholder made when setting up the account).

I think they do a better job of tax management than not selling anything. Here's what Cuggino said during the April 20, 2011 Conference Call:

James Aughenbaugh, Morgan Stanley/Smith Barney
Thanks for doing the call. Can you discuss what we should expect with regard to tax efficiency and distributions, especially with the gold position?

Michael Cuggino, President & Portfolio Manager, Permanent Portfolio
Sure. As a general rule we try to minimize taxable distributions as much as possible to produce the best after tax return we can. Having said that, we are a mutual fund and mutual funds are subjected to an arcane regimen of taxation, which all mutual funds have to follow and we’re no different. So it’s probably too early in the year. We’re in mid-April now, our fiscal year is January 31, so we’re not even done with our fiscal first quarter yet, so it’s a little premature to be able to talk about expected distributions.

James Aughenbaugh, Morgan Stanley/Smith Barney
In the past, you’ve been very tax efficient. I’m just trying to get my arms around how you’ve done that, especially with gold being taxed as a collectible.

Michael Cuggino, President & Portfolio Manager, Permanent Portfolio
Well, managing gains and losses and managing gains and losses of commodities versus other things and timing, those are primarily how you manage gains and losses. That’s what we do.

James Aughenbaugh, Morgan Stanley/Smith Barney
You’re trying to be as tax efficient as possible?

Michael Cuggino, President & Portfolio Manager, Permanent Portfolio
Yes. It’s one of the things that we consider in our investment process as well, the tax effect of making a trade. So it’s one thing we think about. I’m not sure all money managers do that.

Based on other things I've read from Cuggino, it sounds like they are constantly managing their tax situation (i.e. selling losers to offset winners). It sounds like that's what Cugginno spends most of its time doing.

[moda0306]

Remember that gold isn't a tax shelter like an IRA or Roth is, so don't over-consider that.

$10k in gold in a taxable account that eventually growt to $20k will have $10k taxable gain associated with it when sold to reach a NRV of as little as $16,700 if you toss in a 5% state tax rate.

$10k in a Roth that grows to $20k will have a NRV of $20k.

$10k in an IRA gave you a tax-benefit at contribution of ??%, and if it's the same tax rate at distribution, will net to the same relative benefit as a Roth IRA.

Gold has the advantage of having a tax-deferred nature to its gains, but it isn't in the same class as a Roth or Traditional IRA.  It's simply very tax-efficient.  You will have a realizable wealth of almost 20% more if you were able to get that gold into a Roth IRA than in a taxable account.

It helps to view every number in your accounts as a "face value," and to apply a NRV on that amount based on your tax situation.  Only then do you really visualize what the advantages of tax-vehicles truly is.

[stone]

Isn't the silver market much smaller than the gold market so a mass PPRFX redemption might cause the whole silver market to plunge??? If silver is kept at 5% of the fund, then they will have been buying a lot of silver lately. I wonder what proportion of the market they own?

[longeyes]

Over the last three years the HBPP leads PRPFX 35 to 33.1 per cent in total return (per ETFreplay.com).  Whatever the internal differences both have performed very well compared to alternatives.

[WildAboutHarry]

I don't know what that statement means...or maybe I should say that statement could mean a lot of different things.

I recall reading somewhere that PRPFX does not have to pass through the 28% collectibles capital gain rate on CG distributions due to gold sales.  Is the trading limit on gold related to that?