Larry Swedroe's Comments on the Permanent Portfolio

[MediumTex]

I am considering replacing my user here with an ELIZA artificial intelligence algorithm like this one:

http://www.manifestation.com/neurotoys/eliza.php3

I figure it is just as accurate talking about market timing as any advisor I've seen.

I talked to Eliza for a bit.  She didn't seem to understand the role of chaps and chainmail gloves as part of a diversified investment strategy.

I don't know how well she would do here.

[Maestro G]

Best for most folks, and most professionals, to avoid considering any of that.  But then you'd have shorter and fewer threads!

I look forward to the day when the only threads going on here have nothing to do with investing because nobody is worrying about their money and can talk about other things (like Pyramid power). Watching and worrying about the markets is one of the most boring things I can think of doing.

+1000!!! Though discussing the "art" of economics can be a fascinating subject, and I have learned a great deal at this forum.

Like Doodle, I have seen the light! As of 01/02/2012, I have simplified my Permanent Global Maestro Portfolio to a fairly traditional HBPP in the following way:

20% VTI ( at.01% ER in my wife's 401k! )
20% IAU
20% TLT/ZROZ (50/50)
20% CASH (I-bonds; TUZ; STPZ; Alliant CU Savings/Checking)
20% Variable Port (I'm keeping some powder dry here for a cheaper entry point into VXUS. I think there may be some significant pain to come here. Though, who knows, team Merkel/Sarkozy might work some magic or at least the "perception" of magic and foreign markets will soar! In any case, I'd rather be a little late then too early to this "party." So far, so good.

I'll try to be less a lurker and more a participant in 2012! Now, about that Mayan calendar.....?

Cheers!
Maestro G

[larryswedroe]

Just thought I would make a few comments as one of the Bogleheads pointed this out to me.
One time post for me though. Just not enough hours in the day

It never ceases to amaze me how people make statements about which they know little, making assumptions without any basis.

First, I am quite familiar with the PP.

Second, it is likely that I know as much about financial history as any other person on this site, and likely far more

Third, I know all about correlations, and the benefits of diversification across asset classes as well as rebalancing benefits (diversification return). I have written many books on the subject

Fourth, no one talks or writes more about the fact that returns are not normally distributed, that there are fat tails, etc. I even give a speech specifically on that subject, providing the evidence.

Fifth, I write all the time about people making the mistake of treating the unlikely as impossible and the likely as certain. In fact, those mistakes are covered specifically in my books, including the new book Investment Mistakes Even Smart People Make and How to Avoid Them

Sixth, when it comes to fixed income we in fact don't even use mutual funds, we use laddered portfolios and often as one poster noted taxables are better on the short end.
But I was addressing the PP which uses funds

Seventh, I specifically stated gold doesn't hedge inflation, which is one reason, many, if not most people buy gold, so I wanted to make sure that point  was made. Gold does have other hedging benefits, hedging geopolitical risks, but not inflation. It is not a source of inflation, while commodities, a broad basket, is and does hedge inflation well, in fact is the second best hedge of inflation after TIPS.l

Eighth, I would highly recommend TIPS as superior to other FI investments for tax advantaged accounts as they hedge both inflation and deflation, while LT bonds only hedge deflation. And the literature on the subject is all on that side, TIPS should be the preferred choice for tas advantaged accounts

Bottom line is  while there are worse strategies IMO there are superior strategies, diversifying across other sources of risks, not just beta, and using broad CCF instead of gold and using TIPS. For those really interested in the latest thinking from the academic community on building portfolios across multiple sources of returns I would highly recommend reading Antti Illmanen's Expected Returns.

I hope the above is helpful and straightens out at least the assumptions that people made.

Best wishes
Larry

[AdamA]

Second, it is likely that I know as much about financial history as any other person on this site, and likely far more.

I have no doubt that you know more financial history than I do.  I also have really enjoyed your books.

Still...I have a couple of comments.

Sixth, when it comes to fixed income we in fact don't even use mutual funds, we use laddered portfolios and often as one poster noted taxables are better on the short end.
But I was addressing the PP which uses funds.

As far as I know, the true PP does not use funds.  It uses Treasury bonds purchased either from Treasury Direct or on the secondary market.

Seventh, I specifically stated gold doesn't hedge inflation, which is one reason, many, if not most people buy gold, so I wanted to make sure that point   was made. Gold does have other hedging benefits, hedging geopolitical risks, but not inflation. It is not a source of inflation, while commodities, a broad basket, is and does hedge inflation well, in fact is the second best hedge of inflation after TIPS.l

So if the United States had 1970's style inflation again, you'd rather hold TIPS than gold?

Eighth, I would highly recommend TIPS as superior to other FI investments for tax advantaged accounts as they hedge both inflation and deflation, while LT bonds only hedge deflation. And the literature on the subject is all on that side, TIPS should be the preferred choice for tas advantaged accounts

In 2008 TIPS did not provide nearly the deflation protection that normal LTT's did.  

Bottom line is  while there are worse strategies IMO there are superior strategies, diversifying across other sources of risks, not just beta, and using broad CCF instead of gold and using TIPS. For those really interested in the latest thinking from the academic community on building portfolios across multiple sources of returns I would highly recommend reading Antti Illmanen's Expected Returns.

How does the PP diversify only based on beta?

[AdamA]

I wonder if that was really even Larry...

[clacy]

Mr. Swedroe, welcome to the board and thanks for interjecting.  I think the vast majority of posters on this board appreciate a wide variety of opinions. I personally think the best way to have full confidence in a portfolio or investing strategy is to ask some very tough questions.  

[Gumby]

I wonder if that was really even Larry...

It looks like it was. He left a correct email visible on his profile.

[craigr]

Thanks for responding, Larry. As I posted earlier, Larry is one of the few passive investing advocates I've seen that does take into account fat tail risks into his portfolio advice. He is also one of the only ones (perhaps they only one?) I've routinely read that sees the value of some kind of hard asset exposure in a portfolio (even though we disagree on the gold vs. commodities). He clearly does recognize the idea that stock and bond exposure alone does have risks that need added diversification and does advocate his own methods on how to handle it.

[AdamA]

I've seen that sees the value of some kind of hard asset exposure in a portfolio (even though we disagree on the gold vs. commodities).

How does Larry recommend the average investor gain exposure to commodities?

[craigr]

I've seen that sees the value of some kind of hard asset exposure in a portfolio (even though we disagree on the gold vs. commodities).

How does Larry recommend the average investor gain exposure to commodities?

Collateralized Commodity Futures.

I don't like the products however because of the opaque nature in many of them and the fact that they do not have the monetary metal history gold has. However he is one of the few authors who recognizes the value in hard asset exposure in a portfolio even if we do not agree on the best way to get it.

[AdamA]

Thanks for responding, Larry. As I posted earlier, Larry is one of the few passive investing advocates I've seen that does take into account fat tail risks into his portfolio advice. He is also one of the only ones (perhaps they only one?) I've routinely read that sees the value of some kind of hard asset exposure in a portfolio (even though we disagree on the gold vs. commodities). He clearly does recognize the idea that stock and bond exposure alone does have risks that need added diversification and does advocate his own methods on how to handle it.

I agree, and Larry is clearly a smart guy.

I have to say, though, that I really don't understand some of the things he wrote about the PP in his post.  I guess I should let it go at that, though.  Agree to disagree.

How did his minimize fat tail portfolio do in 2008?  Does anyone know?

[MediumTex]

It never ceases to amaze me how people make statements about which they know little, making assumptions without any basis.

I know the feeling.  :D

It is likely that I know as much about financial history as any other person on this site, and likely far more.

I prefer to be shown these things rather than told.

I specifically stated gold doesn't hedge inflation, which is one reason, many, if not most people buy gold, so I wanted to make sure that point   was made. Gold does have other hedging benefits, hedging geopolitical risks, but not inflation. It is not a source of inflation, while commodities, a broad basket, is and does hedge inflation well, in fact is the second best hedge of inflation after TIPS.

So gold is, at best, the third most appropriate hedge against inflation after TIPS and a commodities basket?

I would highly recommend TIPS as superior to other FI investments for tax advantaged accounts as they hedge both inflation and deflation, while LT bonds only hedge deflation. And the literature on the subject is all on that side, TIPS should be the preferred choice for tax advantaged accounts.

Whoa!  TIPS as a hedge against deflation risk?  Are you sure that you "know as much about financial history as any other person on this site, and likely far more"?

I hope the above is helpful and straightens out at least the assumptions that people made.

It validated my basic assumptions.

***

As Upton Sinclair observed, "It is difficult to get a man to understand something when his salary depends upon not understanding it."

[FarmerD]

William Bernsteinwrote a piece for Efficient Frontier called Wild About Harry.  Since Larry is one of my favorite Boglehead authors, I would LOVE to read his critique about the PP ala Mr Bernstein.   

One thing that's always puzzled me.  In Mr Swedroe's Book Alternative Investments he discusses commodites but never mentions gold as an investment (though he does write about Gold Miners).   I would like to hear his take.

Also, in his online debates with Rick Ferri, Ferri dismisses commodities since they "have a real return of zero."  Swedroe's rebuttal was that commodities non correlation with other assets makes it it useful asset within a diversifed portfolio despite the "real return of zero."  Couldn't the same argument be made by a PP'er about gold?  What is it about a commodities basket makes it so much better than gold as a portfolio diversifier?  Perhaps the TIPS/commodities combination makes it better?

[FarmerD]

I've seen that sees the value of some kind of hard asset exposure in a portfolio (even though we disagree on the gold vs. commodities).

How does Larry recommend the average investor gain exposure to commodities?

Collateralized Commodity Futures.

I don't like the products however because of the opaque nature in many of them and the fact that they do not have the monetary metal history gold has. However he is one of the few authors who recognizes the value in hard asset exposure in a portfolio even if we do not agree on the best way to get it.

Mr Swedroe has recommended CCF's such as Pimco's PCRIX and USCI in the past.  The problem is, PCRIX uses derivitives to mimic CCF returns and USCI has a one year old track record.  Using CCF's introduces a whole bunch of counterparty risk and usually entails large index tracking error.  Check out the yearly returns of USO versus the yearly spot oil price differences and you'll see what I mean.  In theory, using CCF's sounds good.  In practice, I think it's a really horrible idea.  Why screw around with CCF's when you can buy gold physically?

[craigr]

In theory, using CCF's sounds good.  In practice, I think it's a really horrible idea.  Why screw around with CCF's when you can buy gold physically?

Yes. I want every asset in my portfolio to be owned as simply as possible. I want to have a very clear view into exactly what is going on and what my risks are. I don't want surprises.

I like simple stock index funds so my risks are only in the exposure to the markets. I want these funds from well established companies that have been indexing for years and have a reputation for doing it well.

I want to own only very high quality US Treasury bonds directly (I don't recommend using funds if you can avoid it). I don't want to worry about credit and default risk or what a fund manager may try to do to beat the bond market.

I don't want to own TIPS because buying inflation protection from the people causing the inflation is a really bad idea for a multitude of reasons I've been over countless times. The idea that a product that has existed in the US since 1997 is the ultimate inflation hedge when there has been no significant inflation since 1997 is a stretch. Come back to me when they go through the 1970s or worse and we'll talk. And no, comparing foreign inflation indexed products to TIPS historically doesn't cut it because those countries are not the world reserve currency and have nowhere near presence of the dollar globally. I do not believe any person on this planet can predict how TIPS are going to behave under bad inflation.

I want to hold cash as T-Bills in simple fund or ladder so I don't have to worry about a bank going under and dealing with potential liquidity or FDIC issues.

I want to hold gold in a direct form with safe custodian control. If possible, some of that gold should be held outside the country so a catastrophic problem here does not wipe everything out in an emergency.

[Gumby]

As Upton Sinclair observed, "It is difficult to get a man to understand something when his salary depends upon not understanding it."

How true.

MT, Earlier today, you posed a question here on the forum when you said:

If you had the choice of having some of your most treasured beliefs invalidated in exchange for a more nuanced and expansive understanding of the world, would you do it?

I tend to believe that when someone has built their entire career as an "expert" who knows "as much about financial history as any other person on this site, and likely far more" then they are not in a position to have their most treasured beliefs invalidated. More likely they need to defend their most treasured beliefs as if their life and financial well-being depended on it.

One of the things about this forum is that it allows us to challenge our own beliefs about how we view our world. The truth is that none of us — not even Larry Swedroe — know the truth about everything. We are all misleading ourselves in one way or another. We just have our own beliefs and personal realities that get us through the day. And for us, the Permanent Portfolio allows us to sleep at night so we can get ourselves through the next day.

Nevertheless, it's always nice to hear different perspectives. That's what we do here.

[AdamA]

Yes. I want every asset in my portfolio to be owned as simply as possible. I want to have a very clear view into exactly what is going on and what my risks are. I don't want surprises.

But I thought the PP only diversified with regard to beta.  

[craigr]

Yes. I want every asset in my portfolio to be owned as simply as possible. I want to have a very clear view into exactly what is going on and what my risks are. I don't want surprises.

But I thought the PP only diversified with regard to beta.  

I learned a long time ago that before investors go chasing after alpha, beta and omega they had better worry first about getting the assets passively split into stocks, bonds, cash and gold and keeping those assets as simple and safe as possible.

At my last start-up the employees knew my official saying was this:

"No Drama."

That's all I asked. I didn't want any drama and nobody caused any drama. With no drama you can focus on real risks and not make trouble for yourself. I don't want drama in my portfolio either. It's a good thing to try to achieve.

[AdamA]

That's all I asked. I didn't want any drama and nobody caused any drama. With no drama you can focus on real risks and not make trouble for yourself. I don't want drama in my portfolio either. It's a good thing to try to achieve.

That's one of the the things that I think separates the PP from other investment strategies...it's focus on true risk.   Most of the other plans I hear about really only focus on market risk (at best).  You don't usually hear a lot of discussion about counterparty risk, default risk, or the best way to hold gold to make sure you don't get ripped off, etc.  

That's why I don't understand the comment Larry made about the PP not "diversifying across other sources of risk, not just beta." 

[craigr]

You don't usually hear a lot of discussion about counterparty risk, default risk, or the best way to hold gold to make sure you don't get ripped off, etc.  

And yet you see things like in 2008 and even 2011 with the Euro problems and MF Global fraud and that kind of stuff happens. A solid portfolio to me is much more than how it looks on a spreadsheet.

That's one thing I like about the portfolio. It strips out the unnecessary and then focuses its attention on minimizing risks where they are not needed and only taking them where they are. Every part of it has been very carefully considered and the reasoning for each piece clearly laid out. Performance and safety were both considered.

I accept that over time I may have a performance penalty by holding a hard asset in combination with those that generates a real rate of return like stocks and bonds. I have made a conscientious decision to own that asset as an insurance play and to possibly pay a fee, for years, that does nothing.

So when I'm looking at that insurance I'm just going to suck it up and get the best. That's gold. If you've already made the decision to take the potential short-coming of holding hard assets, why mess around with anything less than what the banks themselves hold in reserve?

[MediumTex]

So when I'm looking at that insurance I'm just going to suck it up and get the best. That's gold. If you've already made the decision to take the potential short-coming of holding hard assets, why mess around with anything less than what the banks themselves hold in reserve?

I'm surprised that more people don't point out that central banks don't hold wheat or pork bellies, they hold gold.

Another thing that people often seem not to understand about most commodities is that they typically respond to increases in price with increases in production, which over time tends to push the price back down.  Gold, OTOH, has seen global production stay basically flat in the last 10 years despite its dramatic rise in price, which suggests that gold may be a better store of value now than ever.  Ironically, over this time period almost the same thing has happened with crude oil--i.e., global production has barely budged in response to dramatic price increases.  What this suggests is that we may be witnessing both "peak oil" AND "peak gold" at more or less the same time, which is sort of interesting.

[craigr]

That's why I don't understand the comment Larry made about the PP not "diversifying across other sources of risk, not just beta."  

Ok I just went back and read that.

Well that's fine, but consider:

1) The portfolio uses simple and proven asset classes to minimize surprises and costs.

2) It accounted for previously unthinkable risks that many thought would never happen in the US (deflation) using a variety of assets picked specifically to do either well or poorly under these economic transitions.

3) It accounted for credit risk by concentrating fixed income in Treasuries for cash/bonds as they offer the best risk/reward thereby avoiding disaster in 2008.

4) It wrapped more of the strategy up in fail-safe procedures that went so far as to advocate geographically diversifying your money just in case, I don't know, some nuts in planes decide to try to take out the major financial center of the US (2001) or maybe a natural disaster like an earthquake threatens (2011).

4.5) Also advocated institutional diversification to protect against fraud by your broker or money manager (MF Global, Bernie Madoff) or other collapse (Lehman, The Reserve Money Market Fund, etc.).

5) All the while providing a CAGR of 9.5% with rolling 5-10 year returns in the real +3-5% range over the past 40 years.

6) While never experiencing more than a -5% drop any one of those years (-12.9% in real terms in 1981 though which other portfolios likely didn't escape either).

7) Providing a volatility that is maybe 1/3rd that of the stock market in general even during times of extreme market volatility.

That sounds pretty diversified to me.

[Reub]

Something tells me that Larry will be back.

[lazyboy]

The reason I found the PP was reading a financial blog about PCRIX, a fund Larry Swedroe touted as a hedge before the 2008 meltdown. That fund crashed in 2008. I was holding some based upon his recommendation and that fund fell harder and faster than the TSM itself. So much for Larry's hedge. ... Craig was challenging Larry's assumptions in that blog which led me to Crawling Road and the PP. Thank You, Craig!

Maybe Larry is smart but, based on his response, he seems to lacking in some basic humility.

[FarmerD]

So when I'm looking at that insurance I'm just going to suck it up and get the best. That's gold. If you've already made the decision to take the potential short-coming of holding hard assets, why mess around with anything less than what the banks themselves hold in reserve?

I'm surprised that more people don't point out that central banks don't hold wheat or pork bellies, they hold gold.

Actually, unless you're a farmer or miner, nobody can hold commodities(except precious metals).  Industries that use commoditities use them on an just-in-time basis.  They rarely store them for very long.  Individual investors can never as a practical matter, ever take possession.  Do you think you could actually take delivery of 10,000 bushels of wheat?  For investors, CCF's are NOT claims on the actual commodity. CCF's are nothing more than artificial financial constructs that mimic the price movements of the underlying commodity.  That is not the same as physically holding a commodity.  That's an important distinction - in the event of a financial crisis or market meltdown, would you rather have the commodity in your hand or would you rather own a piece of paper that tracks the price of commodities based on the derivative manipulations of some trader in Bermuda (that's where PCRIX operates.)

That's a prime reason why I can't understand why Swedroe prefers a commodities basket over physical gold.