William Bernstein on the Permanent Portfolio

[yankees60]

For those of who have never prior seen this:

Efficient Frontier
William J. Bernstein

Wild about Harry

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

Ending paragraphs:

"Even so, in 2008 most investors would have been happy with PRPFX�s single-digit loss, and this attracted a lot of attention, as did the TPP.

PRPFX�s fund flows over the years serve as a good proxy for investor interest in the TPP. The turbulence surrounding the 1987 crash blessed the portfolio�s management, and its assets peaked out at nearly $100M in late 1989, a respectable size for that period. During the frothy 1990s stock market, however, investors abandoned the fund in droves, and presumably the TPP strategy as well. By late 2001, PRPFX languished at $52 million, a remarkable figure considering that between those two dates the return of the portfolio alone should have grown its assets by 71%, and total U.S. mutual fund assets had increased approximately seven-fold.

Since the 2008 crisis, investors have piled back into PRPFX with a vengeance, bloating its assets to over $6 billion. As you might expect, you can drive a small pickup truck between the fund's time-weighted returns (10.10% annualized for the 10-year period ending 7/31/10) and dollar-weighted returns (6.41%). Investment discussion boards now fairly bulge with TPP threads. For example, the typical topic runs a few dozen messages on the respected Vanguard Diehards board; one Harry Browne sequence weighed in at nearly 3,500 posts.

And therein lies the real problem with the TPP: because of its huge tracking error relative to more conventional portfolios, it attracts assets and adherents during crises, then sheds them in better times. There�s nothing wrong with Harry�s portfolio�nothing at all�but there�s everything wrong with his followers, who seem, on average, to chase performance the way dogs chase cars.

Investment success accrues not so much to the brilliant as to the disciplined, and the nature of the chosen strategy contributes mightily to this calculus. The very worst place an investor can find herself is, in the words of Mark Kritzman, "wrong and alone"; this is a near certainty at some point given the TPP�s huge tracking error relative to that of the overall market portfolio, approximated by a 60/40 mix of stocks and bonds. Thus, it will be nigh-impossible for even the most disciplined investors to adhere to the TPP in the long run. (And lord knows, most investors are unable to stick to even a 60/40 portfolio.)

Diversifying asset classes, as Harry Browne knew well, can benefit a portfolio. The secret is deploying them before those diversifying assets shoot the lights out. Harry certainly did so by moving away from gold and into poorly performing stocks and bonds in the late 1970s. Sadly, this is the opposite of what the legions of new TPP adherents and PRPFX owners have been doing recently�effectively increasing their allocations to red-hot long Treasuries and gold. Consider: over the long sweep of financial history, the annual real return of long bonds and gold have been 2% and 0%, respectively; over the decade ending 2009, they were 5% and 11%.

Many investors currently have the Harry Browne portfolio. The 1990s stampede of assets out of PRPFX and the more recent stampede back in suggest that few will turn out to have the Harry Browne right stuff."

Vinny

[buddtholomew]

WB has authored several pieces on HB and the PP and always in a positive light. Keep in mind the differences between PRPFX and the HBPP; especially the lack of LTT’s in the mutual fund which has hampered returns along with individual stock selection. The ER was/is also difficult to overcome.

[mathjak107]

in my opinion the fund has been a dog--yeeeech

[AdamA]

For those of who have never prior seen this:

Efficient Frontier
William J. Bernstein

Wild about Harry

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

I read that post 10 years ago prior to investing in the PP.

It's a great post because it looks at the PP through the lens of modern portfolio theory.

HB's explanation of Inflation/Deflation/Stagnation/Prosperity is good, but Bernstein's here seems more rigorous and is in some ways simpler.

Basically, the four assets are non-correlated, and that's why the portfolio works.

[Kevin K.]

IMHO the best of Bernstein's many books to read in terms of appreciating the PP is "Deep Risk," but even better is to read all three books, in order, in the series. Here's a good overview:

https://blog.betterfinancialeducation.c ... long-term/

The article from Efficient Frontiers muddies the waters unnecessarily by focusing mostly on PRPFX, a dog of a fund that ruins the PP through ill-advised tweaks.

Reading Deep Risk really helped me appreciate not just the PP but the virtues of the Golden Butterfly, which takes Berrstein's key advice that it's inappropriate to allocate equal percentages of a portfolio to economic conditions that aren't equally likely to happen and aren't equally important to protect against to heart. And by the same token it also provides excellent context for other defensive approaches - Larry Swedroe's "minimize fat tails" portfolios in particular.

As for tracking error regret, I have no doubt Bernstein is correct that it's very real and probably keeps many if not most who "get religion" and convert to the PP and its kin during market crashes from staying the course, but having read what Bernstein said about his own clients with sophisticated slice-and-dice Modern Portfolio Theory approved DFA funds and detailed risk tolerance questionnaires on file panicking and going all-cash during the '08 crisis I'm not convinced that the Boglehead crowd necessarily does any better at staying the course during market panics. Bernstein's own interest in the PP and various liability matching portfolios seems in fact to have been a direct result of seeing many clients he was sure knew better abandoning ship during the last crisis.

[I Shrugged]

Budd?

[WhiteElephant]

I recently reread Deep Risk, and I think it offered compelling arguments against the 4x25 split of the PP.
It also opened my eyes to the possibility that the PP might have too much deflation protection by having three assets that can do really well during deflation: bonds, cash and gold. I'm not making any big changes in strategy because of what I read, but I will keep an eye on the duration of my LT bonds and make sure it's not too high.

Definitely worth a read for PP adherents imho.

[mathjak107]

bernstein also said he did not like the idea that equal amounts of money are bet on outcomes that have demonstrated they have anything but equal odds of playing out

[doodle]

I recently reread Deep Risk, and I think it offered compelling arguments against the 4x25 split of the PP.
It also opened my eyes to the possibility that the PP might have too much deflation protection by having three assets that can do really well during deflation: bonds, cash and gold. I'm not making any big changes in strategy because of what I read, but I will keep an eye on the duration of my LT bonds and make sure it's not too high.

Definitely worth a read for PP adherents imho.

Somewhat strange that it was created by a former gold bug during period of high inflation in US.

bernstein also said he did not like the idea that equal amounts of money are bet on outcomes that have demonstrated they have anything but equal odds of playing out

I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.

[Kevin K.]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

[Libertarian666]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

What about the disastrous effects of not being prepared for the unlikely ones?
E.g., not being prepared for hyperinflation is likely to be catastrophic.

[WhiteElephant]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

What about the disastrous effects of not being prepared for the unlikely ones?
E.g., not being prepared for hyperinflation is likely to be catastrophic.

Bernstein considers inflation the most likely risk you have to protect against, and argues that globally diversified equities are a 'good enough' long-term hedge against permanent capital loss because of severe inflation. For optional further protection he suggests tilting the equity allocation to value stocks, or adding a sprinkling of gold, gold stocks or commodity producers.

[Libertarian666]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

What about the disastrous effects of not being prepared for the unlikely ones?
E.g., not being prepared for hyperinflation is likely to be catastrophic.

Bernstein considers inflation the most likely risk you have to protect against, and argues that globally diversified equities are a 'good enough' long-term hedge against permanent capital loss because of severe inflation. For optional further protection he suggests tilting the equity allocation to value stocks, or adding a sprinkling of gold, gold stocks or commodity producers.

Fine, but that doesn't address my point, which is that hyperinflation is the most devastating situation not to be prepared for.
E.g., if there is a 5% chance of hyperinflation, can you ignore it? My answer is: No, because if that 5% turns up and you aren't prepared for it, you will be wiped out.

[ppnewbie]

Have not read the books but it does seem like Bernstein is attempting to predict the most likely outcomes and the point of the PP is that the future is unpredictable and to be equally prepared for any outcome. I've seen some compelling predictions and historical statistics that all fiat currencies are eventually debased to zero. Which would mean, put one hundred percent in gold. I definitely struggle not overly weighting charts, historical graphs, facts, patterns, etc, etc... That is probably why I chose the GB. I chose prosperity instead of admitting I have no idea.

[Libertarian666]

Have not read the books but it does seem like Bernstein is attempting to predict the most likely outcomes and the point of the PP is that the future is unpredictable and to be equally prepared for any outcome. I've seen some compelling predictions and historical statistics that all fiat currencies are eventually debased to zero. Which would mean, put one hundred percent in gold. I definitely struggle not overly weighting charts, historical graphs, facts, patterns, etc, etc... That is probably why I chose the GB. I chose prosperity instead of admitting I have no idea.

I chose the lack of prosperity because my life is likely to be okay in prosperity even if my investments aren't shooting out the lights.

[dualstow]

If anyone’s curious, tech’s portfolio is quite fascinating.

viewtopic.php?f=1&t=10569

I didn’t get it at first. I thought this was just another goldbug portfolio. But, when you understand the reasoning behind it (as in your post above, tech), it makes a lot of sense.

[WhiteElephant]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

What about the disastrous effects of not being prepared for the unlikely ones?
E.g., not being prepared for hyperinflation is likely to be catastrophic.

Bernstein considers inflation the most likely risk you have to protect against, and argues that globally diversified equities are a 'good enough' long-term hedge against permanent capital loss because of severe inflation. For optional further protection he suggests tilting the equity allocation to value stocks, or adding a sprinkling of gold, gold stocks or commodity producers.

Fine, but that doesn't address my point, which is that hyperinflation is the most devastating situation not to be prepared for.
E.g., if there is a 5% chance of hyperinflation, can you ignore it? My answer is: No, because if that 5% turns up and you aren't prepared for it, you will be wiped out.

My wording probably wasn't clear enough. Bernstein includes the hyperinflation of Weimar Germany as an example where stocks offered protection against hyperinflation after the initial heavy sell off.

Maybe the difference is that most PP investors would like to have an asset that would react to unexpected and rapidly rising inflation immediately, and that would include me.
I do think Bernsteins arguments and examples were pretty convincing in that stocks can offer long-term protection against inflation, even the out of hand type of inflation.

[mathjak107]

Have not read the books but it does seem like Bernstein is attempting to predict the most likely outcomes and the point of the PP is that the future is unpredictable and to be equally prepared for any outcome. I've seen some compelling predictions and historical statistics that all fiat currencies are eventually debased to zero. Which would mean, put one hundred percent in gold. I definitely struggle not overly weighting charts, historical graphs, facts, patterns, etc, etc... That is probably why I chose the GB. I chose prosperity instead of admitting I have no idea.

I chose the lack of prosperity because my life is likely to be okay in prosperity even if my investments aren't shooting out the lights.

BUT is being okay in prosperity going to give you enough to live the way you want retired when what that "prosperity " compounds to can be key to your lifestyle in retirement... i know we would never be living where and how we do had it not been for growth investments .

if you are making big bucks and can save a bundle than great . but most of us working stiffs need good strong compounding to take the little bits we can save and make them more meaningful for later

[Libertarian666]

Have not read the books but it does seem like Bernstein is attempting to predict the most likely outcomes and the point of the PP is that the future is unpredictable and to be equally prepared for any outcome. I've seen some compelling predictions and historical statistics that all fiat currencies are eventually debased to zero. Which would mean, put one hundred percent in gold. I definitely struggle not overly weighting charts, historical graphs, facts, patterns, etc, etc... That is probably why I chose the GB. I chose prosperity instead of admitting I have no idea.

I chose the lack of prosperity because my life is likely to be okay in prosperity even if my investments aren't shooting out the lights.

BUT is being okay in prosperity going to give you enough to live the way you want retired when what that "prosperity " compounds to can be key to your lifestyle in retirement... i know we would never be living where and how we do had it not been for growth investments .

if you are making big bucks and can save a bundle than great . but most of us working stiffs need good strong compounding to take the little bits we can save and make them more meaningful for later

Our lifestyle is hardly lavish but it is about the same lifestyle in retirement as when I was working. I've never made what I consider "big bucks" but I worked from age 20 to age 65 more or less continuously other than during the 2001 tech bust and always saved a significant part of my income.

Social Security pays most of our expenses so we are at about a 2.5% withdrawal rate from savings. I'm not too worried about running out of money.

I will say that if my current project pans out, my portfolio will probably change quite a bit. I may go to 1/3 gold, 1/3 cash, 1/3 stocks. I'm not interested in bonds at these absurdly low interest rates.

[doodle]

Commodities are tough to invest in. And depending on causes and rates of inflation equities can suffer badly. I think productive land might be an appropriate fifth piece of permanent portfolio. Although illiquid it's the only asset that provides benefits outside of monetary system.

[dualstow]

...
I think productive land might be an appropriate fifth piece of permanent portfolio. Although illiquid it's the only asset that provides benefits outside of monetary system.

VP maybe. It’s not that Harry didn’t consider it when designing the pp. He gave his reasons.

[ppnewbie]

I’ve been thinking about about productive land with a clean fresh water source as well. Also if you have not already done this solar panels seem to be an amazing investment. In my case the ROI is over 12 percent (forever). Plus I think the return is likely to go up if power rates increase over time.

Anyway back to the subject. It may be a real mental feeling of comfort knowing you have never lost any purchasing power throughout your productive life if you just purchased gold. In real terms you saved every dollar you made (after your expenses).

Finally I was thinking about the dynamic of stocks asset values increasing with inflation. But I am not sure about the stresses a business undergoes when it has to deal with a rising cost structure. Is it a pass through and an investor just sees the end result of an inflated stock? Or does it create some kind of system stress and the business breaks? Not sure.

[pmward]

I think farmland is a wonderful investment. But it's not part of a portfolio. I think owning farm land, even if you just rent that land out and never actually touch it, should be looked at as more of a business than anything.

[Kevin K.]

“ I would argue that what we think of as 'odds' are really just being calculated from a relatively short time frame of late twentieth century technological development and prosperity. Taken from a longer term viewpoint human history is much more fraught with upheavel. The later half of the twentieth century is not an accurate representation of the wide spectrum of eras in human development and there is not an appropriate timeframe by which to measure the odds of certain economic outcomes.”

But Bernstein’s book points out not only that are the 4 economic conditions the PP is designed to address not equally likely to occur but also that the costs of and even ability to address them are very different as well.

What about the disastrous effects of not being prepared for the unlikely ones?
E.g., not being prepared for hyperinflation is likely to be catastrophic.

Bernstein considers inflation the most likely risk you have to protect against, and argues that globally diversified equities are a 'good enough' long-term hedge against permanent capital loss because of severe inflation. For optional further protection he suggests tilting the equity allocation to value stocks, or adding a sprinkling of gold, gold stocks or commodity producers.

Fine, but that doesn't address my point, which is that hyperinflation is the most devastating situation not to be prepared for.
E.g., if there is a 5% chance of hyperinflation, can you ignore it? My answer is: No, because if that 5% turns up and you aren't prepared for it, you will be wiped out.

Bernstein does in fact address this in detail in the last chapters of his booklet. He points out that:

1. Gold (contrary to what Harry Browne postulated) isn't a very good inflation hedge.
2. Stocks are a good hedge and they become a great one if internationally diversified and tilted towards value.
3. Commodity-producing equity assets - especially those that produce precious metals - do exceptionally well.
4. TIPs or (worst choice) inflation-adjusted annuities work in some situations - especially for retirees - as supplements to the above assets.

But again - inflation is (historically) likely, hyperinflation (or prolonged deflation) are not.

[yankees60]

I think farmland is a wonderful investment. But it's not part of a portfolio. I think owning farm land, even if you just rent that land out and never actually touch it, should be looked at as more of a business than anything.

Exactly. Land is too illiquid with extremely high transaction costs and high carrying costs.

Vinny