Permanent Portfolio vs. All-Weather - an in-depth analysis

[MachineGhost]

Right, but what's your exact approach? Do you go all into cash for the 25pct equities allocation if it's under the 200 day sma? Do you check monthly? Etc. Thanks!

I use absolute momentum on a daily time frame to determine when to get in and a trailing stop on a daily time frame to get out. The exact details are proprietary and will vary depending on the asset in question. If I was fully liquid in 25% public equity, then I think a better approach may be to only go into bonds on a absolute momentum sell signal rather than being fully invested in bonds all the time, but you would give up price peak to sell signal protection. My backtesting shows that 10-year T-Bonds are best for that purpose.

I don't think you need to do this if you just want to "set it and forget it". You won't miss the added stress.

[ochotona]

Just as a general rule, 40% in any one asset is too much. It really doesn't matter what that asset is. Swensen maintains that any one class should be between 5%-30%.

Do you think the Golden Butterfly violates this rule by having 40% in stocks split 20% to large cap and 20% to small value?

I believe Tyler intended to give the GB an intentional prosperity tilt, so over-weighting US equities is intentional. SCV and LCB are pretty well correlated these days, aren't they?

[Dieter]

Just as a general rule, 40% in any one asset is too much. It really doesn't matter what that asset is. Swensen maintains that any one class should be between 5%-30%.

Do you think the Golden Butterfly violates this rule by having 40% in stocks split 20% to large cap and 20% to small value?

I believe Tyler intended to give the GB an intentional prosperity tilt, so over-weighting US equities is intentional. SCV and LCB are pretty well correlated these days, aren't they?

Stocks, LTT, and Gold seem correlated this year.... (just intl in the doghouse...)

I know Vanguards SCV (VBR) isn't considered very small/value-ie, and that SP 500 includes MidCap, but what I have handy (forget from where; I think total return...)

S&P 500 TLT IAU SHY VBR
2007 5.49% 10.29% 30.36% 7.35% -6.49%
2008 -37.00% 33.93% 5.11% 6.62% -32.20%
2009 26.46% -21.80% 23.90% 0.35% 30.92%
2010 15.06% 9.05% 29.46% 2.28% 25.10%
2011 2.11% 33.96% 9.57% 1.44% -4.23%
2012 16.00% 2.63% 6.89% 0.28% 18.98%
2013 32.39% -13.37% -28.26% 0.22% 36.55%
2014 13.69% 27.30% -2.08% 0.45% 10.55%
2015 1.40% -1.79% -10.58% 0.43% -4.76%

[FF9000]

Update - I ran the PP vs. two adjusted PPs for all 7-year periods between 1972 and 2015.

Here is how the three portfolios are allocated. Note that PP2 strays from using the Total Market and splits its holdings in value stocks.


Here is how the three did over every possible 7-year period from 1972 to 2015, looking at average CAGR, min, max, and 25/50/75 percentiles.


What is really interesting is the comparison of PP2 with the Value stocks vs. PP2 with the total stock market. Picking value equities over the total market somehow improves both the average, best, and worst scenarios.


Back to PP1, PP2, and PP3. Here is a view of their worst-to-best seven-year returns - instead of CAGRs I have a $ view from a specific financial scenario I was running, but the visual point remains the same - PP2 very nearly matches the upside of the cash-less PP3 but does a better job of maintaining value in bad scenarios. PP3 with no cash tends to have better "good years", but at the cost of worse "bad years". The PP itself doesn't win on any metric.


Thoughts?

[stuper1]

I like your PP2 for two reasons:

1. 25% gold just feels like too much to me for an asset that just sits there. I've played around with enough backtesting to see that you don't need that much gold to still get a good diversification effect. 15 - 20% seems about right for my liking.

2. With interest rates looking likely to start rising at some point, I much prefer having 40% in cash/bonds to having 50% in cash/bonds. In this case, the backtesting aligns well with my own view of likely future prospects.

[Kbg]

There's been quite a bit written about the value effect debating whether it will last/has been significantly reduced. I would probably put more faith in value vs. total market numbers in the post investable ETFs/indexes time periods. You REALLY need to be careful when interpreting value performance results due to a large overlap with value and the size factor...not to mention good old fashioned arbitrage.

A little dated, but the graph on page 1 tells you pretty much everything you need to know.

https://www.hvst.com/attachments/4138?download=true

[InsuranceGuy]

[deleted]

[FF9000]

There's been quite a bit written about the value effect debating whether it will last/has been significantly reduced. I would probably put more faith in value vs. total market numbers in the post investable ETFs/indexes time periods. You REALLY need to be careful when interpreting value performance results due to a large overlap with value and the size factor...not to mention good old fashioned arbitrage.

A little dated, but the graph on page 1 tells you pretty much everything you need to know.

https://www.hvst.com/attachments/4138?download=true

Very interesting point. Was not aware of that. I'll need to look into recent Value performance to see if this holds up.

PP2 increases annualized volatility by ~1% over the PP which is compensated by the higher return (MaxDD stays the same).

PP3 on the other hand, while the longer term averages do look great, increases annualized volatility by ~3% over the PP and increases the MaxDD by ~5% so the additional return doesn't seem to compensate for the additional risk.

From a pure value perspective, value portfolios are typically negatively correlated with momentum based portfolios so it would be to your advantage to combine strategies.

You are correct that PP has an average down volatility of 2.1% across these 7-year periods, whereas PP2's is 2.4% and PP3's is 4.0%. I believe that the historical results show PP2, despite it's higher down volatility, is substantially offset by the up-side. PP3's downside risk does not seem to be offset enough to justify using it. I defined the downside risk threshold as anything that does not keep up with inflation in a given year.

What is interesting is that despite having a slightly higher down volatility, PP2 still manages to avoid the futility of PP's worst seven-year periods.

Aside from the excellent point on the "devaluing of value stocks" that Kbg made above, are there any other reasons to question whether PP2 is superior to PP1?

Thanks again for your insights.

From a pure value perspective, value portfolios are typically negatively correlated with momentum based portfolios so it would be to your advantage to combine strategies.

I'm afraid I am not quite sure of how to do a momentum-based strategy in practice (while maintaining tax-efficiency, etc.) given my lack of experience in that space, but thanks for the heads up. I've been reading up on it.

[Kbg]

At least for the past decade, growth ETFs using the S&P and Russell indexes have outpaced value.

[InsuranceGuy]

[deleted]

[Dieter]

How much of PP2 out-performance is Size vs Value?

Would be interesting how the Golden Butterfly (20% SP 500 / 20% SCV) for the 40% stocks compares for these metrics.

[Kbg]

8.22 to 9.89 for 10 year CAGR using the iShares S&P 600 ETFs...the reality is growth/value and large/small cap outperformance is cyclical. Sometimes the cycles last a very long time. Personally I just use the vanilla version ETFs and split large and small caps 50/50.

The main point to all of this though is that since the commoditization of SCV via index investing there is a reasonable chance that inefficiency is now gone or significantly reduced. If I were not using a leveraged version of the PP there is no doubt for me my ETF would be RSP. You get most of the return when small caps are outperforming and equal weighting is just a better indexing method mathematically. But for sure my view is a debatable and reasonable folks could disagree with it.

[FF9000]

8.22 to 9.89 for 10 year CAGR using the iShares S&P 600 ETFs...the reality is growth/value and large/small cap outperformance is cyclical. Sometimes the cycles last a very long time. Personally I just use the vanilla version ETFs and split large and small caps 50/50.

The main point to all of this though is that since the commoditization of SCV via index investing there is a reasonable chance that inefficiency is now gone or significantly reduced. If I were not using a leveraged version of the PP there is no doubt for me my ETF would be RSP. You get most of the return when small caps are outperforming and equal weighting is just a better indexing method mathematically. But for sure my view is a debatable and reasonable folks could disagree with it.

The assumption in going with RSP is that small- and mid-caps will outperform large-caps over the long-term, to such a degree that the higher expense ratio is justified. I understand that this has been the case since 2006. Is this an accurate statement of what you have to believe to opt with RSP over a VTI?

[Kbg]

Well not really. RSP contains the largest 500 companies in the US. The assumptions behind RSP are two fold. Equal weighting forces a buy low/sell high approach and that the very largest companies can not sustain the growth rates that put them in the top X of a cap weighted index and as a result of cap weighted composition/methodology the index will A) not be representative of its components and B) will suffer from the very largest caps moving to more sustainable growth rates at precisely the wrong time given their index weight.

Reason #2 is strictly a matter of timing. Sometimes it benefits you and sometimes not. Reason #1 is compelling for me, particularly using a large cap population.

[MachineGhost]

Aside from the excellent point on the "devaluing of value stocks" that Kbg made above, are there any other reasons to question whether PP2 is superior to PP1?

The annual data from Simba is of low quality, so don't draw strong conclusions from it.

The "value" effect to be exploited properly nowadays has to be done using a multi-factor screen and not just buying all the lowest P/B garbage in the market as it was done in the past (Templeton is famous for it). Vanguard SCV is a multi-factor screen and they only changed over to it a few years ago. But it is not the best approach.

And I would run your PP2 against the Golden Butterfly.

[MachineGhost]

How much of PP2 out-performance is Size vs Value?

I think I posted that in the Resort. Value was larger than the size. The size effect is an uninvestable myth, but if you can concentrate into smaller stocks that don't get Wall Street analyst attention, you are going to find value.

[MachineGhost]

You get most of the return when small caps are outperforming and equal weighting is just a better indexing method mathematically. But for sure my view is a debatable and reasonable folks could disagree with it.

I believe so, but it would need to be compared to equal volatility to be sure it is truly superior. RSP is actually the S&P 500 universe not the largest 500 stocks. That helps to keep things equal for head to head.

[Kbg]

You get most of the return when small caps are outperforming and equal weighting is just a better indexing method mathematically. But for sure my view is a debatable and reasonable folks could disagree with it.

I believe so, but it would need to be compared to equal volatility to be sure it is truly superior. RSP is actually the S&P 500 universe not the largest 500 stocks. That helps to keep things equal for head to head.

I'm surprised there hasn't been an equal volatility ETF/index created. I'm not sure I've even seen an academic paper on it. One might be able to get close to whatever the returns might be by taking the top 10 or 25 by market cap and equal volatility weighting them. Let me see if I can do a backtest using the Dow just for fun.

[FF9000]

The annual data from Simba is of low quality, so don't draw strong conclusions from it.

And I would run your PP2 against the Golden Butterfly.

What are sources other than Simba to get total returns of each asset class that are higher quality? Why is Simba low qualiy?

[Kbg]

This is a short backtest but I think interesting. From 2006 to yesterday.

1. Sort on 1 year return
2. Position size set to 5% annualized volatility of past 63 market days
3. Buy top ranked until you run out of money
3. Rebalance quarterly

4x25 7.28 CAGR/15.06 DD
5% annualized 9.03/12.75

Edit: Speaking of the DOW.

Dow B/H from 1995 is 7.39/53.24 Dow Total Rtn is 9.93/51.56.

Equal annualized vol weighting of:

1.00% is 10.32/43.00
.75% is 9.11/38.91
.50% is 6.82/27.44

1.00 has fewer than the Dow 30 normally and picks were based on 1 year return whereas .5 did not employ all cash normally.

Equal weighting was 9.91/52.28

So I'd say there might be something to an equalized volatility weighting

[MachineGhost]

This is a short backtest but I think interesting. From 2006 to yesterday.

1. Sort on 1 year return
2. Position size set to 5% annualized volatility of past 63 market days
3. Buy top ranked until you run out of money
3. Rebalance quarterly

4x25 7.28 CAGR/15.06 DD
5% annualized 9.03/12.75

How much did momo contribute and how much did the risk parity contribute?

Here's the Dow with volatiliaty weighting (blue), volatility weighting + market timing (green) and same but only rebalancing all 30 stocks on the first of the next month after a buy or sell signal (immediate):



No idea what the CAGR is. Can you rerun your Dow stats from Oct 2013 to date? And give us the total returns.

[Kbg]

This is a short backtest but I think interesting. From 2006 to yesterday.

1. Sort on 1 year return
2. Position size set to 5% annualized volatility of past 63 market days
3. Buy top ranked until you run out of money
3. Rebalance quarterly

4x25 7.28 CAGR/15.06 DD
5% annualized 9.03/12.75

How much did momo contribute and how much did the risk parity contribute?

No idea...also see the update I just did on the Dow.

The PP was a quick and dirty BT. Eyeballing the results showed a fairly steady diet of the top three with the 4th position getting not a whole lot if anything. The picks were as expected from momentum but weighting was all over the place. You can definitely dial what you would like to see by changing the volatility parameter...more momo set the volatility higher. More risk parity set it lower. In any event, volatility weighting and momo definitely adds value since ETFs were available for all assets both in terms of return and lower DD. I tested monthly, quarterly and annual rebalancing and this version does better across the board.

[Kbg]

How much did momo contribute and how much did the risk parity contribute?

Here's the Dow with volatiliaty weighting (blue), volatility weighting + market timing (green) and same but only rebalancing all 30 stocks on the first of the next month after a buy or sell signal (immediate):



No idea what the CAGR is. Can you rerun your Dow stats from Oct 2013 to date? And give us the total returns.

This is a bit apples and oranges but I'll spell them out.

DJI Total return from 10/1/2013 returned 8.78 CAGR/26.79 Total Rtn with a 12.55 DD

Using 63d annualized volatility and recalibrating each month using ROC 252 and the new HV value

Monthly hold 9.97/30.75/-12.96DD for a .75% volatility weighting

Annual hold 11.74/35.85/-12.47DD

Upping things to 1.5% which roughly cuts you down to < 20 closer to 10 picks yields:

Monthly hold 11.47/32.46/-14.10DD

Annual hold 11.70/36.65/-13.42DD

So looks to be in the ballpark of your chart.

[FF9000]

FWIW, for anyone tracking this thread or reading it in the future, I decided on the Golden Butterfly as the most appropriate portfolio in terms of both back-testing results & theoretical rationale for my needs. Next step is to figure out how to allocate the assets across taxable and tax-free accounts, as continued in this thread: http://www.gyroscopicinvesting.com/foru ... f=1&t=8602

[FF9000]

Actually, today was the day I finally sold out of my old positions and rebalanced my portfolio. I ended up going with:

• 50% Equities (Half large-cap blend, half small-cap value)
• 20% Gold
• 20% Bonds
• 10% Cash

So I took the Golden Butterfly and re-allocated 10% from cash to equities. I mainly did this for two reasons: (1) I could sleep easier at night knowing I wasn't giving up big stock market gains over the 5-10 year timeframe just to protect capital and (2) I ran the historical back-tests which showed that 50% equity really isn't that dangerous at all for the excess return it can provide.

The charts below compare the PP with 6 versions of the Golden Butterfly (each with a different equity allocation), as well as my selected portfolio (GB50E), and a 100% Equities portfolio.

Average 7-Yr CAGR over different time periods


You can see here that the salmon bar (second to last) outperforms all the PP and GB portfolios over 7-year periods on average. And the 100% Equity portfolio usually wins (2000-2015 being the exception). No surprises there, so let's look at risk.

Minimum (Worst) 7-Yr Ending Balance


I ran a 7-year test based on a starting point and annual contributions for myself. You can see above that the 100% stock portfolio has some pretty terrible "worst" 7-year periods, no matter what decade we are looking at. On the other hand, 7 years is apparently long enough for the 50% equity portfolio (GB50E) to actually have BETTER "worst" returns than all GBs and even the PP.

Given I can handle a bit of risk and I have at least 7 years until I want to live off of my nest egg, I am comfortable with the risk and return profile of the GB50E portfolio, moreso than the others. Just wanted to provide an update.