FSO Editorials: Building a "Permanent" Portfolio for Turbulent Times by Robert B. Gordon 01/20/2004

Building a "Permanent" Portfolio for Turbulent Times
by Robert B. Gordon, Sc. D.
January 20, 2004

Some time ago I was reminded by a reader of a unique mutual fund named the Permanent Fund. I had not followed it since reading the start-up publicity many years ago. I checked my Fast Track data from 9/1/1988 and found an interesting 15 year performance chart. I made a decision to see what I could do retrospectively to create a new "permanent" fund using a conservative balance of stable and volatile asset classes. The purpose is to see what we can learn that might be useful for our readers in the difficult years ahead.

To be useful for future use, we wanted to build the historic portfolio from funds that are in business and available today. With this limitation, we were unable to go back to 1988, so our portfolio example starts on May 16,1991 and offers12 years and 8 months of bull and bear market experience.

We have had no contact with this fund and our source of information was their current literature and the historic performance read from our computer screen. The performance of this fund since 1982 certainly proves they have met their goal of capital preservation but have not fully preserved its buying power so far. They have held precious metals thru their very long bear market and, before their recent price rally, the fund was only gaining about 4% a year. This rate of increase has now increased to 6.8% over the past 12 years. This is not very exciting but would look pretty good when compared to other funds which were big losers in the bear market to date.

According to the data in Morningstar, the fund was started on 12/1/82, so it is 21 years old. It’s portfolio has been managed by the same professional manager since1991. It is in the category called conservative allocation funds and has a 4 star ranking. It currently holds about 20 percent gold bullion and has a very low turnover of its stocks and bonds of only 1% a year. It’s gain over the past five years has been 9% which is about equal to that of the S&P500 over this same period. It’s overall gain over the past 12 years has averaged 6.9% but since mid 2001 it has gained 14.8% probably due to its position in gold bullion. The fund is still quite small with only 113 million dollars in assets.

My conclusion is that this fund is doing a fine job in line with its ultra conservative objective of preserving capital. Its management costs are quite reasonable. More information is available from the fund at 800-531-5142.

For our new portfolio, we intend to stay with asset classes in which we have the most confidence and use of mutual funds with 12 years of history. When we are through we want to make a detailed comparison with the older Permanent Fund.

We have not previously favored funds with a long history, but it can add assurance for the future provided these facts are true:

1. The fund company is a major company with an excellent record.
2. The fund’s manager team has been with the fund for a long time.

It would not be wise to pick a "hot" performing fund unless it could fill a very special role in the new portfolio. However, this should not, in my opinion, rule out unique newer funds like the hedged Hussman Strategic Growth and Total Return funds or the Prudent Bear and Prudent Global Income funds which also own some gold shares.

For a demonstration of the Permanent Portfolio concept, we will use two stable asset classes, each with two funds, and two volatile asset classes, each with one fund. All of the funds are managed by large, stable no-load fund companies expected to survive any type of present or future fund industry crisis.

Stable Funds
15% U.S. Treasury Target 2015 Fund
15% U.S. Treasury Long Bond Fund
15% Foreign Government Intermediate Bond Fund A
15% Foreign Government Intermediate Bond Fund B
60% Total

Volatile Funds
20% Diversified Energy Fund
20% Diversified Precious Metals Fund
40% Total

Our 6 fund selections are all managed by major no load companies with at least 12 years of steady performance history covering many different kinds of market conditions. The Target 2015 fund holds Treasury bonds, stripped of their interest coupons, that will pay the principal value of the bonds at par in 2015.

ASSET CLASS	5/16/1991	1/15/2004	REBALANCED
Stable Funds
U.S. Treasury Target 2015 Fund	$3,000	$8,971	$9,908
U.S. Treasury Long Bond Fund	$3,000	$11,790	$9,908
Foreign Gov't. Int. Bond Fund A	$3,000	$9,000	$9,908
Foreign Gov't. Int. Bond Fund B	$3,000	$7,650	$9,908
Total	$12,000	$37,411	$39,632
Volatile Funds
Diversified Energy Fund	$4,000	$13,320	$13,210
Diversified Precious Metals Fund	$4,000	$15,320	$13,210
Total	$8,000	$28,640	$26,420
Grand Total	$20,000	$66,051	$66,052

It was a pleasant surprise to find during this retrospective demonstration that the portfolio was well balanced for all but the last two years when the gold fund performed exceptionally well. As shown in the two columns at the right above, the balance was easily regained with just one rebalancing on 1/15/04.

The overall steady gain thru approximately.9 bull years and 3 bear years was an average of 10.6% per year, with all four of the stable funds plus the energy fund providing steady year to year gains. If, in the future, either of the volatile funds has a big up or down year, it should be followed by portfolio rebalancing. All this involves is adding up the total value of each asset class and redistributing the money in accordance with the original percentages. Or, the owner at any time can change the ratios in any way to seek better results.

I have enjoyed my trek down a memory trail checking up on the performance of the Permanent Fund. It’s 12 year plus return of about 6.9%/ year would not win any prizes, but I suspect many losing investors over the past 4 years wish they had done as well.

It was gratifying to find a group of 4 stable bond funds and two volatile sector funds that performed so well over this lengthy time period. Five of the funds had rising prices curves thru the entire time period while the gold fund lagged badly and then caught up in the last few years.

I derive considerable satisfaction from the performance of the 6 fund combination of stable and volatile asset classes over this period of 8 bull years and 4 bear years. It suggests the possibility of gaining a similar result over a future time period made up of bear market declines and bullish rallies.

The big lesson I take from this experiment is that it is possible to create a portfolio that will work in up and down markets and provide a good return with a mix of 60% stable and 40% volatile assets. And, please note, that this portfolio example did not use any short position to help in down markets. It relied primarily on the management skills of 4 veteran bond funds and one energy stock fund.

My only purpose in writing this essay was to make two important points. First, there are a very small number of ultra conservative funds available if you can find them. Right now I cannot think of any other with a 21 year record like that of the Permanent fund. The two new Hussman Funds are designed to use hedges to protect your assets but they have not been subject to the test of many years of market time as yet.

I’m sure that we have many readers who would be interested in putting all their assets in a safe fund like the Permanent fund, but let me be the devil’s advocate for a minute and point out reasons for not doing that. First, it is a small one man operation. What happens if he leaves for any reason? Second, I believe that successful investing requires some attention by the investor. I would greatly prefer to see a conservative portfolio resembling the following:

Stable Assets
34% Permanent Portfolio
33% Hussman Total Return
67% Total
Volatile Assets
33% Hussman Strategic Growth
100% Total

In my opinion, this three fund portfolio is infinitely better than just one fund. Viewing the performance over time of these 3 funds will give a much better idea of what is going on in the financial markets and will permit the investor to change the ratios to take advantage of each funds actual performance in the market. It is interesting to note that, since data became available on all 3 funds on 9/18/02 thru 1/15/04, this version of a Permanent Portfolio has gained at an annualized rate of 15.1%. as follows:

20.6% Permanent Fund
9.3% Hussman Total Return
15.5% Hussman Strategic Growth
15.1% Portfolio Total

In view of the fact that the Hussman fund charters include the right to purchase both gold and foreign government bonds, this simple 3 fund portfolio offers a broad range of investment options.

I would be pleased to hear from any reader who can lead me to any other ultra conservative no load fund like the Permanent Fund.

For our readers who are not keeping abreast of current opinions of bearish market commentators, I want to suggest that they do not get involved in this replay of the 1999 and 2000 market mania top. Along with all the experts whose opinions I value, it is impossible to predict how long this huge rally can continue. There are strong forces that would like it to continue to the November election. So please practice prudent investing until the bear market resumes as it surely will. Read the current week’s market observation of Dr. John Hussman on www.hussmanfunds.com and get his expert views.