Gyroscopic Investing

hrux wrote: In reading various posts it seems to be divided by several on what can produce the best risk adjusted return.  I would like to see Paul and Craig discuss this on a podcast.

Clive and Paul Boyer seem to favor the small cap value/emerging split.

Craigr, Medium Tex and others seem to endorse not tinkering with the stock portion and to keep in total stock market.

Which strategy will offer the maximum risk adjusted return?

KevinW wrote: I am convinced that the Fama-French model is correct, and there are small-cap and value premia.  However I am not convinced that those premia necessarily manifest themselves on timeframes that are compatible with individual investors' time horizons.  In other words, I am confident that on time scales of multiple centuries, small-cap value will exhibit a better risk-adjusted reward than the total market.  However it is entirely possible that small-cap value can lag the market for decades, and that those decades could happen to coincide with an individual's entire investing career.

So I can't condone using small cap value as the sole domestic equity position in an individual's portfolio.  However it might be appropriate in some kind of Rip Van Winkle scenario where the assets will be held longer than a single lifetime, such as an endowment or intergenerational wealth.

As discussed elsewhere I think foreign stocks can augment other kinds of portfolios, but have no place in a permanent portfolio.  That goes for emerging market stocks.

Another issue is that the permanent portfolio depends on the stock allocation to carry the portfolio in times of prosperity.  It is well established that the total market rallies under prosperity, but there is no guarantee that small cap value or emerging market stocks will rally during domestic prosperity.  It is easy to imagine a boom that favors established multinational firms with good credit, coinciding with a strong domestic currency that suppresses foreign stocks.  The "Swedroe concentrated" portfolio doesn't really care when equity rallies happen as long as they do, but a PP without a strong prosperity-stock correlation may seriously underperform during prosperity.

MediumTex wrote: Back in the "Nifty 50" days didn't you see large caps outperforming small caps for quite a while?

I would have wanted some of that Nifty 50 action if I had been wanting to benefit from stock market gains.

Roy wrote: Though, I believe SV has done better than large growth/blend over most rolling ten year periods, and that isn't a long time.

Roy wrote: In FAIL SAFE INVESTING, on my page 108, Browne says, when discussing the Stocks component, "you want funds that invest in volatile stocks in the hope they will move farther than the general stock market when times are good."  It is not unreasonable to interpret this as small cap/value, which has some component of being tied strongly to the economic cycle.  But in his recommended list, you get only Large Caps, though one Large Value fund.

Roy wrote: In FAIL SAFE INVESTING, on my page 108, Browne says, when discussing the Stocks component, "you want funds that invest in volatile stocks in the hope they will move farther than the general stock market when times are good."  It is not unreasonable to interpret this as small cap/value, which has some component of being tied strongly to the economic cycle.  But in his recommended list, you get only Large Caps, though one Large Value fund.

KevinW wrote:

Roy wrote: Though, I believe SV has done better than large growth/blend over most rolling ten year periods, and that isn't a long time.

Sure, but I don't know of any economic theory that says the SV premium must bloom within 10 years.  With investing I follow the scientific method which means I want to see a plausible hypothesis first, followed by supporting experimental evidence.  The problem with extrapolating from a backtest is that it's possible the dataset isn't exhaustive.

craigr wrote:

Roy wrote: In FAIL SAFE INVESTING, on my page 108, Browne says, when discussing the Stocks component, "you want funds that invest in volatile stocks in the hope they will move farther than the general stock market when times are good."  It is not unreasonable to interpret this as small cap/value, which has some component of being tied strongly to the economic cycle.  But in his recommended list, you get only Large Caps, though one Large Value fund.

Here's the problem with this idea. And, I'd add, that his former partner John Chandler confirmed with me when I have spoken with him. That is you can't be sure a fund with high beta will remain high beta going forward. These are all backwards looking measures. When you own the market you do so with no regrets. You capture the market returns and all the sectors it represents. You never get caught on the downdraft of a sector going out of favor. So you avoid, again, second guessing and feeling like you need to tinker.

Roy wrote: And what are the non/less-volatile stocks?  It is also clear, by extension, that if one could find "volatile stocks" that would outperform, one might also underperform "the market" using those same stocks.  Just wasn't sure what these were.

MediumTex wrote: Volatility visits every sector sooner or later.

moda0306 wrote: High vs. Low dividend yield maybe?

Growth Stocks?

Clive wrote:

Gumby wrote: The problem with using Emerging Markets in a Permanent Portfolio is that it's simply performance chasing, and nothing more than adding speculation (on foreign markets and currencies) into an otherwise neutral portfolio. That would easily break the warranty on a Permanent Portfolio.

In other words, the reason why HB never considered Emerging Markets is because Emerging Markets are not directly tied to "Prosperity" — one of the four pillars of the PP. Emerging Markets did their poorest from 1995 to 2000 — during what was perhaps the greatest 6-year stretch of prosperity, ever.
....snip

The performance of EM's over that period is entirely as you might expect.  Being foreign currency and somewhat commodity driven they're more like gold than stocks.  In times of USD crisis EM's might be expected to do relatively well for the offshore currency and commodity like qualities as can be seen from more recent EM performance figures.

Blended with perhaps SCV and you have a sort of 'neutral' holding or a mini-PP with SCV acting as the 'stocks' and EM as the 'gold'.

For a fair comparison you should really compare between two periods when both assets had achieved the same overall gain (or loss), unless that is you expect one of the assets to never re-align with the other in which case you'd just hold the better choice.

Given two assets that achieve the same gain between two points in time (such as over a period when they both achieved the same rewards), then holding equal amounts of both and periodically rebalancing back to equal weightings when deviations became apparent, has you add-low/reduce-high and will produce higher rewards overall than having held one or the other alone, and also likely do so with less risk (assuming volatility or standard deviation is considered as a measure of risk).  Having two assets that individually have relatively high volatility, but zig and zag in somewhat opposite directions has the effect of reducing the overall combined volatility, but you're rewarded on an individual 'higher risk' basis (average of the two gains).

Clive wrote: Hi Gumby

By replacing your Prosperity pillar of the Permanent Portfolio with a "mini-PP" you would not have done very well during the great prosperity of 1995 to 2000. That's the undeniable consequence

As with the PP you have to consider the collective rather than the individuals alone

Small (Growth) and Value - combined SCV, might be considered as a combination of stocks (small) and LT's (value).  Each can do OK alone, as a pair they tend to have a degree of low correlation

EM's might be considered a form of gold play.

So a blend of 50% SCV, 25% EM and 25% 5 year treasury (as a 'cash' proxy)

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produced some reasonable gains over the 1995 to 2000 period.

The ride was quite bumpy however, so an option might be to water that down by halving the amount of exposure in SCV and EM's to

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Or perhaps even water down to a third and :

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The water down to a third did relatively OK, but did have some real (after inflation) volatility during the 1970's which could have been reduced by taking some of the cash and investing in gold for a bit more high inflation/domestic currency crisis protection

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That overall provided somewhat similar risk (few down years and down only a little in those years) and relatively consistent real gains over time.

I've been told that the most challenging part of holding the Permanent Portfolio is that you may be tempted to ditch the strategy during times of prosperity to chase higher returns. So, imagine holding the EM/SCV split in your PP from 1995 to 2000 and underperforming a traditional Permanent Portfolio when everyone else is making enormous amounts of money

Compared to the Coffee House (60/40 stock/bond type blend), having included SCV and EM's to me looks potentially less likely to have been capitulated than the PP, including over the 1995 to 2000 period.

Clive wrote:

Gumby wrote: can you explain — using language alone — how replacing the PP's stock allocation with a simple SCV/EM split will save my hide during times of Prosperity?

No

Gumby wrote: In other words, the reason why HB never considered Emerging Markets is because Emerging Markets are not directly tied to "Prosperity" — one of the four pillars of the PP. Emerging Markets did their poorest from 1995 to 2000 — during what was perhaps the greatest 6-year stretch of prosperity, ever.

Clive wrote:

Gumby wrote: Which, again, brings me back to my point. You are so far unable to explain — in simple terms —

In simple terms



For the explanation read Fama and French

Gumby wrote:Which, again, brings me back to my point. You are so far unable to explain — in simple terms — how a PP with a SCV/EM stock allocation should perform during a period of prosperity.