International Permanent Portfolio

[Austen Heller]

Here's a recent post (from DaveS) over at the Bogleheads website:

http://www.bogleheads.org/forum/viewtop ... 1296922766

I probably should not risk setting off another thump fest but I find the thought of a Euro based Browne Portfolio even less desirable than one here. First, if you go long euro bonds and short euro cash your 50% involved with the currency. There is going to be a lot of stress there. First the idea of a single currency i.e. facilitating trade was not bad. I have a F800 BMW motorcycle. It is assembled in Germany, but the engine is from Austria, suspension Italy, wheels Spain, only the frame and electrics are German. That would not be possible without the Euro. But the northern European countries are more efficient. Pre Euro, the southern countries made up for that by devaluing their currency periodically. Thats why it took a gazillion Lira to get a cup of coffee. So the Northerners have to bail out their less efficient southerners if there is to be a single currency. Voters somewhere are going to end it.

Then I look at Gold which is now priced at historic highs. Do you want to get in at the top? Finally the Brown portfolio de-emphasizes stocks which have been historically the best earning asset class, but did less well since Brown pronounced his portfolio. Over time it is more likely that Brown just lucked out. These last two arguments apply in the US as well as Europe. Anyway if you add the likelihood of difficult times with the euro to the other problems looking forward while considering a Brown portfolio suggest one should stay away. That is my advice.

If you just have to do a Browne thing why not do it on a world wide basis. World long bonds, Cash from several currencies, and world stocks. At least that way you have diversified currency risk. (I know other currencies may have problems but that does not auger for 100% Euro.) Dave

That last paragraph got me thinking.  The conventional US-based PP holds gold to mitigate currency exposure, and even the stock portion somewhat mitigates the exposure (since many companies are multi-national).  But the rest of the PP (between 50-75%) is exposed to the dollar.  If the dollar crashes, the PP holder may get hurt (even though I'm sure gold would be skyrocketing).  What about DaveS's suggestion to hold an International PP?  The gold position would remain unchanged from the conventional US PP, and then the other 3 components would get split 50/50 between US/International.  I know many PP holders are already splitting their stock position into US/Int'l, so then what do people think about doing the same with the Long Bond and Cash positions?  On the other hand, perhaps there is NO benefit at all for a US-based investor to be diversifying AWAY from the current world reserve currency, the dollar.

[MediumTex]

Austen Heller,

I think the post you quote from reflects a typical (and shallow) understanding of the ideas underpinning the PP.  It reminds me a bit of someone attempting to speak casually in a foreign language with which they are not that familiar.  For example, how does he know buying gold now would be buying at the top?

It's also obvious that he doesn't understand that the PP concept was based upon the premise that the dollar is the number one international currency and when the dollar starts looking bad gold normally starts looking good.  The dynamics affecting the euro are totally different.  I think a euro-based PP could work, but it would take a little more serious thought than he seems interesting in investing in the matter.

It's perfectly reasonable for someone to conclude that the PP is not for them.  What is less easy for me to understand is those who seem to believe that if the PP is not for them, it follows that it couldn't work for anyone.

The comment about HB just being lucky with the design of the PP just strikes me as ridiculous.  That's like saying that Newton was just lucky in discovering calculus.

I think it was Newton who said that if he had seen farther it was because he stood on the shoulders of giants, and I think the same is true of HB.  I think HB was a genius when it came to synthesizing politics, economics, investing and philosophy, and yet people like von Mises obviously contributed immensely to HB's thinking.  

Note that there is no precedent (or mechanism) for the "crash" of a world reserve currency.  With the trade deficits the U.S. runs, I don't understand how a dollar "crash" could ever occur.  In other words, if the dollar were falling, what would it be falling against?  Why?

Over a longer period, a secular decline in the dollar is entirely possible (and I think this is the goal of current policy), and I think this is part of what we saw in the 1970s.  The difference today, however, is that all of the other countries would apparently also like to see their currency value go down as well.

[moda0306]

Nicely put MT,

A portfolio built on extremely solid macroeconomic principals that has performed well, almost non-stop, for 39 years, and successfuly used the return and lack of volatility combination that only strongly opposing assets can bring is hardly "lucky."  Isn't the longest period of PP negative return somewhere around 16 months?  The thing is, with all the bad, scary things that have happened in the last 40 years, there's really nothing utterly horrifying, and the mid-80's through the 90's were spectacular.  All this, and the PP still matched stocks returns within a half a % CAGR.  

Investing in a stock-heavy portfolio now is like saying you think the next 40 years are going to be better than the last, is it not?  Who is truly willing to make that bet?

[cabronjames]

Here's a recent post (from DaveS) over at the Bogleheads website:
The conventional US-based PP holds gold to mitigate currency exposure, and even the stock portion somewhat mitigates the exposure (since many companies are multi-national).  But the rest of the PP (between 50-75%) is exposed to the dollar.  If the dollar crashes, the PP holder may get hurt (even though I'm sure gold would be skyrocketing).  What about DaveS's suggestion to hold an International PP?  The gold position would remain unchanged from the conventional US PP, and then the other 3 components would get split 50/50 between US/International.  I know many PP holders are already splitting their stock position into US/Int'l, so then what do people think about doing the same with the Long Bond and Cash positions?  On the other hand, perhaps there is NO benefit at all for a US-based investor to be diversifying AWAY from the current world reserve currency, the dollar.

Some thoughts

1. USian HBPP is 75% USD-denominated assets, with gold being the 25% non-USD piece.

2. If one uses the non-cash 3X33% stock/LT bond/gold allocation, you lower USD share to 66.7%.

AFAICT with the HBPP 4X25, the relative risk is if the USD currency becoming significantly against other currencies.  Obviously an Iceland 2008 or Argentina 2001 is the worst case scenario, very unlikely for the USD as its the world reserve currency.  However (disclaimer: my non-expert on currencies/international economics guesstimate alert) even a much smaller scenario could be a risk, for example, if a significant portion of the oil market becomes priced in another currency (SDR, Euro, etc) where the USD might decline not in an Iceland type catastrophe, but significantly relative to other major currencies.

With the non-cash 3X33%, the relative risk is the tight money recession ala US 1981.  IIRC in the 1981 real return would have been ~-15%, & Clive IIRC showed that in for a JPN 3X33% JPN's equiv CPI real return of -20%.

My WAG sense is that the downside loss potential of the currency weakening (Iceland 2008 being the extreme case) of much worse than ~-20% real return, is much worse than that of the tight money recession with the ~-20% real return.

3. If one combines #2 with foreign stocks, the USD share can be reduced from 66.7% to a range of 33.3% to 66.7%.  Note that US companies sell internationally & have non-US currency exposure, & non-US companies like Toyota sell into the US & have USD exposure, so in practice the USD exposure would never get as high as 66.7% (even with say all your STOCK portion in VTI) or as low as 33.3% (even with say all your STOCK portion in VEU).

To my knowledge, pragmatically a USian investing in US stock exchange-traded ETFs &/or mutual funds cannot get non-USD exposure in LT bonds.  Unlike country specific currency ETFs like FXC for Canadian Dollar, there is not country specific LT bond ETFs.  There's not even an "all non-US country index" LT bond ETF.  One thing I'm guessing is that there are few countries that have the international institutional investor confidence to even issue 30 year bonds.  IIRC, UK, Japan, Germany, & Canada do issue 30 &/or >30 yr bonds, perhaps only a few other countries also do.  It would be great if non-Euro, sovereign currency-having countries, with a trade surplus, reasonably low (under 100%?) govt budget deficit percentage of GDP, had country specific LT bond ETFs available.  For instance, Canada, Switzerland, S Korea.  I wonder if the US ETF industry doesn't address this asset type because it assumes demand would be insufficient to support such an ETF, or for other reasons such as high costs, sovereign country capital controls, etc?

My sense is CASH would be the last place to get non-USD exposure, since a secondary benefit of CASH in addition to tight money recession insurance, is to assist tax-efficient rebalancing operations.  It seems that one would either run a 4X25 with the CASH being entirely USD, or run a 3X33 without cash.  Running a 4X25 where you mix say FXC/CAD along with SHY/USD for your CASH portion may not make sense.

[KevinW]

The PP is based on the idea that "the economy" is always in one of four states.  Usually "the economy" is defined as whatever economy you live and work in, and the non-gold assets ought to be invested in "the economy."

One could make a principled argument that globalization means that we are all global citizens and "the economy" is the total world market.  In that case, the non-gold assets should be invested in global markets.  Global stocks are easy to buy with VT or a blend of total US stock and total ex-US stock index funds.  Cash is fairly easy with a mixture of a short term US treasury fund and an ex-US short term sovereign fund such as ISHG.

As with cabronjames, I am not aware of any low cost ETF or mutual fund that invests in long term global or ex-US sovereign debt.  I suppose you could roll your own index and buy individual foreign bonds using a mechanical process.  Perhaps something like "buy from the top 5 entries in the Euromoney country risk index and sell after 10 years or if the issuer falls out of the top quartile."  I think this could work, but it's messy, especially where taxes are concerned.

Theoretically I believe that a domestic PP and global PP should behave the equivalently before accounting for taxes or expenses.  Currently the global portfolio has higher expenses and is more of a hassle, so I'm sticking with a domestic (US) 4x25 PP.  I may re-evaluate this if global sovereign ETFs become widespread and cheap.

[MediumTex]

One could make a principled argument that globalization means that we are all global citizens and "the economy" is the total world market.  In that case, the non-gold assets should be invested in global markets.  Global stocks are easy to buy with VT or a blend of total US stock and total ex-US stock index funds.  Cash is fairly easy with a mixture of a short term US treasury fund and an ex-US short term sovereign fund such as ISHG.

When thinkng about the global economy and the global citizenry, here are a few considerations to work into your analysis:

1. Although we may have a world economy, when trouble strikes, there is only one international policeman, and that is the U.S. (in many ways it's like a classic "protection" racket).  This factor bends many international matters in the favor of the U.S. (and creates some problems other nations don't face--note how terrorists don't target Switzerland).

2. Although we may have a world economy, much of it does business in U.S. dollars.  This factor also bends many international matters in the favor of the U.S. (see strength in U.S. bond market in face of ridiculous U.S. fiscal situation for an example).

I think the two factors above will continue to make the U.S. a top destination for world capital for quite some time.

The whole world economy dynamic has all sorts of cross-currents that keep things interesting.

[murphy_p_t]

i'm wondering if anyone has implemented some form of "international" PP and your thoughts on having done so...

[craigr]

i'm wondering if anyone has implemented some form of "international" PP and your thoughts on having done so...

The biggest risk is currency risk with the intl. cash and bonds. Gold is country neutral. If someone were to use a world index like VT I don't think much risk is there overall.

So it comes down to the bonds/cash. If I had to do this, I'd be more inclined to keep the cash local because that's what you spend and then diversify the bonds. But then, what kind of fund has long enough international bonds? And then also suppose most of those bonds are in Eurozone countries? So you could be going from one risk to a new one. However you'd probably still be more diversified thanks to the gold addition than a stock bond portfolio alone.

[Gosso]

i'm wondering if anyone has implemented some form of "international" PP and your thoughts on having done so...

I'm running a 65/35 Canadian PP (65% CAD, 35% USD and gold).  You can see my thoughts on it here: http://gyroscopicinvesting.com/forum/ht ... ic.php?t=7

I agree with Craigr that the largest concern is currency risk, which as you will see in the link above can increase volatility and reduce returns.

[cowboyhat]

A number of people have brought up variations on this question in this forum, including me, and proposed something like what was suggested.

In thinking about this approach (I finally decided against doing it as a US dollar-based investor) one theoretical consideration with regard to long bonds is that they are supposed to protect in deflation. That means you want the best possible quality because that is what people want to buy in deflation. So Greek sovereign long bonds do not fit the profile. You want to buy liquid flight-to-safety bonds. My thought is US, Japanese, and German are the only one that really fit for someone looking to make a global PP. Maybe Swiss or English bonds.

Leaving aside the practical fact that it is basically impossible for an American retail investor to buy foreign sovereign long bonds on any kind of reasonable terms, or even at all, I don't think I could bring myself to buy Japanese bonds of any duration. PP investing is supposed to be agnostic about the future. To me a global agnostic PP means holding my nose and buying Japanese bonds, and I can't bring myself to do that. Therefore I am not cut out to hold a global PP.

We seem to be getting to a crazy place anyway, no matter what you do. 10 year TIPS are selling for negative rates.

[Gosso]

Cowboyhat,

Just keep in mind that a flight-to-safety (USD) event will cause the US long bonds to rise, but may result in gold priced in USD to remain flat.  Whereas a Canadian Perm Port will see the value of their long bonds remain flat, while the price of gold will increase because the value of the CAD has decreased.

This was tested during 2008 and worked out well for both the Canadian and US Perm Ports.  Although I still like to place 10% of the Canadian Perm Port in USD, because it helps smooth things out and it's easy to do.

Currencies are a powerful force and I would feel uncomfortable with anything over 50% outside my local currency.