FSO Editorials: Something New Under The Sun by Robert B. Gordon 01/28/2004

Typing those words into the Google search brought 2, 910,000 responses, so I concluded that it’s probably very difficult to do or find something really new. This question came to mind after writing a recent essay on a "permanent" portfolio in which I compared one of my portfolios to that of the 22 year old Permanent Portfolio fund started by Harry Browne and Terry Coxon.

I received some new information recently from readers and the fund itself and thought it would be a good idea to write again to distinguish my personal ideas from those created earlier by the founders of the Permanent Portfolio fund. There are definitely some similarities although I did not have the other portfolio in mind when I started my series on the merits of portfolio rebalancing

This information is summarized from current fund literature. This unusual fund follows a rigid investment strategy based on historic studies of various major asset classes. They adopted a fixed portfolio made up of 6 major asset classes which I have divided into two major categories called stable and volatile.

Stable Asset Classes
35% U.S. Treasury Bill, Bonds and other dollar assets
10% Swiss franc assets
45% Total

Volatile Asset Classes
15% Aggressive Growth stocks
15% Real Estate/ Natural Resource stocks
20% Gold Bullion
5% Silver Bullion
55% Total

Our regular readers will immediately see the resemblance to the asset distribution above of the numerous portfolio examples given in my many recent essays. It is interesting to note that the Permanent Portfolio fund literature does not make a point of using rebalancing to take temporary capital gains from the volatile classes and transfer them for safekeeping in the stable asset. They do not mention capital gains, just saying that they buy and sell investments to stay in line with their Target Percentages. If they do it quite frequently as I suspect, they will not realize any major capital gains.

Apparently their founders were not thinking about taking short positions when they started the fund in 1981.They have a separate fund called the Aggressive Growth fund (perhaps like the 15% allocation above) that lost 25% in the fiscal year ending January 2003. Since we are in a known long bear market, we have not used any aggressive growth stocks and in their place use short funds for gains in down markets. However, we do recommend precious metals and natural resource stocks or funds.

I have decided to use the Permanent Portfolio fund, including the features I like and dislike, as a stable asset in one of my own portfolios. I do this because there are not too many "stable" funds you can really count on with an important part of your assets. I recently called the fund to check the status of an SEC inquiry into some old acts of Terry Coxon, the founder. I was told that there will be no loss to the fund since Coxon is prepared to make restitution if the SEC levies a penalty against him.

When the founders of the Permanent Portfolio fund planned the fund in 1981, the country had just been thru a period of very high inflation in the previous decade which also included a moderately heavy bear market. Of course my big concerns during that time period are much diminished when the 1973-74 bear market is measured against the 1929 and current manias. When any measure of the 1929 and 2000 manias are made comparable by dividing by the Gross Domestic Product, the 1973-74 period becomes a tiny blip on the chart. And this is so, despite some large mutual funds dropping 75% and there being net redemptions from funds for the next nine years. It seemed pretty big then, but now I realize it will be a very minor event vs. the huge event now underway.

I am not going to try to give an answer to the caption above because I think there is a more important question for investors to consider seriously. A truly fixed ratio of asset classes might survive the trials and tribulations of several generations, but will it retain it’s original vitality? I have thought about this and decided an astute investor needs to retain the right to make on-course changes dictated by events that could not be foreseen. The most important data on whether the portfolio needs to be changed will come to the investor from the performance of each asset class. Whenever any asset class, stable or volatile, goes into a long price decline, say more than two years, a change may be needed.

So, unlike the very passive approach of the Permanent Portfolio, I prefer a portfolio that is intelligently managed by the investor if and when needed. In most of the examples in my essays, any changes would involve a modest change in the overall ratio of stable to volatile assets or a change in the percentage of one of the volatile classes. Occasional fine tuning in this way should insure a very long and successful life for a well planned portfolio.

I encourage both new and old investors to send me any questions relating to asset classes or rebalancing. These are the important variables. But most of the questions I receive are related to the name of a specific mutual fund. The name is only important if the fund is unique - the only one of its type. For many asset classes, there are dozens of no-load mutual funds to be investigated for purchase. And, as I have noted before, there are a number of web sources for this needed information.

I have recently opened an account with Scottrade and discovered, not only their very low cost for account opening and trading, but their freely available capability to screen, select and graph thousands of mutual funds. Please go to www.scottrade.com and compare the performance of all the no load funds in important categories like foreign government bonds, precious metals etc.

I remind all readers of the need to check out the financial safety of all banks, brokers, insurers etc. at www.weissratings.com They issue independent ratings of all major firms every quarter for only $7.95 per rating, charged to your credit card. This will become very important as we get into the real bear market when many firms will become quite risky to deal with.

Please remember that the performance data of stable asset classes changes slowly and that of volatile classes may change quickly. It is beneficial to have a range of volatility even in conservative portfolios as this can lead to capital gains during rebalancing. For the expected long and severe bear market, we do not suggest any portfolios that are not based on at least 50% of stable assets.

Of course the Gold Bugs are screaming in protest against anyone with an adverse view and, in particular, are venting their anger against Bob Prechter who has called a top in the fifth wave of gold’s recent advance. I am neither a bull or bear on gold, but a realist. I intend to follow the Elliott Wave picture whether it is bullish or bearish. It appears to have formed some kind of a top and I am postponing further purchases.

In the section below, I am outlining one way to purchase gold regardless of whether its price is dropping or rising. In a rising market, the small mining stocks and the funds that hold them will be the big gainers. When a wild bear market resumes some day, the large investment companies will not be able to buy the small mining companies but will have to buy the few very large mining companies. This will create an opportunity for ordinary investors who buy their shares before the boom. But, if we are really in a temporary bear market prior to a huge new bull market, consider using my suggestions below. Of course, only time will bring the truth so we will just have to be patient for a while.

Instead of starting with U.S. Treasury bonds and foreign government bonds, as in recent examples, let’s build the conservative base with two funds, one using a fixed portfolio PRPFX, and the other using a fully managed portfolio HSGFX hedged to prevent loss of capital. Further, let’s give them 80% of the starting capital that will be used, over time, to increase the initial 20% volatile asset position by transfers to 40%. Let’s allocate 20% to BEARX , a short fund holding 20% in precious metals and plan to increase the short and gold allocation to 40% by transfer of capital over time from the large amount of stable assets. The starting portfolio will then be:

Stable Assets
40% Permanent Portfolio fund PRPFX
40% Hussman Strategic Growth HSGFX
80% Total

Volatile Assets
20% Short fund with 20% gold BEARX
0% Precious Metals fund (future)
20% Total

Since the stable assets are expected to grow steadily in the future, the plan involves transferring assets from them to eventually increase the volatile assets to a total of 40%. This is expected to happen regardless of the price action of gold or the short funds. So, following this sort of dollar-cost-averaging approach, the gold and short asset classes will be completed regardless of whether their price has gone down, up or down and up.

Many inexperienced investors are hesitant to build volatile asset classes into a conservative portfolio. The easiest way to solve that problem is start with just 5% of each volatile class and follow the actual market experience for a year or two until confidence in gained. In the meantime, the benefits of portfolio rebalancing will become very evident. A tremendous learning experience would be gained by using a large variety of stable assets plus small amounts of volatile assets. We can now suggest 7 quite different stable classes, each of which displays a different growth pattern and provides the opportunity for future capital gains from portfolio rebalancing between the classes.

ASSET CLASS	Percent Allocation	1 Yr Growth to 01/27/04
Stable Funds
U.S. Treasury Bond Fund	12%	3.9%
U.S. Treasury 2010 Target Bond Fund	12%	5.3%
Foreign Gov't. Bond Fund	12%	19.4%
Foreign Gov't. Bond Fund w/ Gold PSAFX	12%	12.7%
Permanent Portfolio Fund PRPFX	12%	21.7%
Hussman Total Return HSTRX	12%	9.8%
Hussman Strategic Growth HSGFX	12%	24.1%
Total	84%	9.4% (avg.)
Volatile Funds
Short Fund with Gold BEARX	5.33%	-16.7%
Precious Metals Fund	5.33%	77.4%
Diversified Energy Fund	5.33%	46.6%
Total	16%	35.8% (avg.)

The overall performance of this very conservative portfolio over the past year would have been 13.6%, thanks to the fine performance of all but one fund. Please note that, if this portfolio were to be rebalanced right now, long term gains would be take from 3 of the stable funds and two of the volatile funds that gained more than 13.6%. These gains, if not taken now, could be lost in future market fluctuations. In an unmanaged "buy and hold" portfolio, these gains plus others in the future would be lost. So rebalancing not only retains the original balance of asset classes but, over time, can capture temporary profits not being advised by your mutual fund or advisor. The reason is either that they do not know about these profits or are primarily interested in their profits not yours.

I hope that most readers will go back over this short essay so they will appreciate and understand how very simple and useful are the suggestions we have made. Although we did not invent the Permanent Portfolio, our investigation has led us to use it in our own portfolios. Its usefulness may or may not extend thru the next several decades so we very much like to use all the stable asset classes. Although their potential for capital gains is usually less than that of the volatile asset classes, they should properly be the main source of profits in conservative portfolios. This why we use all of the stable classes in our portfolios. The further you go above the 50% minimum of stable assets, the surer will be the future performance. And let us add, we like to use considerable variety in the volatile asset classes as well. In a portfolio that is not intended for quick profits or trading, having a dozen or more funds or stocks in one portfolio simply increases the likelihood of greater gains from rebalancing with little added management for the investor.

Our last essay brought a surge of e-mal from the U.S. and abroad. I did not try and count the affirmative and negative replies, but they were affirmative by about seven out of eight. The negative votes were mainly based on the length of the current bear market rally and Bob’s unpopular current stand on gold.

I wanted to be sure that Bob read the essay, so I sent him an e-mail conveying it and received a nice, friendly response.

The main reason I am writing at my advanced age is to help investors do a better, more confidant job - to enjoy it instead of fearing it. I like all your letters, even those that run to several pages but I have one small request. Please enumerate the questions you want me to answer instead of burying them in a long paragraph. My time is limited and you can help me provide better answers.