Permanent Portfolio Shakedown, Part II
Butler|Philbrick & Associates | Aug 28, 2012 01:01AM ET
In whitepaper in 2005. In it, he describes an approach that applies a 10-month moving average to basket of 5 asset classes: stocks, Treasuries, commodities, REITs and international stocks. While there is nothing magical about the 10-month moving average, this approach is ubiquitously cited elsewhere, and in our testing we observed no material difference with other moving averages. The following simulations apply monthly rebalancing.
Chart 7. Simple Permanent Portfolio, 10-Month MA, 1970 - 2012
Source: Faber, Ken French, Shiller, FRED
Chart 7. delivers a pretty compelling equity line. You will note that returns rise above 10% annualized over the period while volatility and drawdowns remain similar to the original simple approach. The majority of losses to this approach occurred during the tumultuous 1970s and 1980, with the largest drawdown occurring in March of 1980 as gold and stocks collapsed at the same time while both were far above their respective 10-month moving averages.
We stated above that risk adjusted returns are almost always improved by managing portfolio level volatility, so below we tested the Faber 10-month moving average approach but also applied a 7% target volatility overlay. Chart 8 shows the results of this combination.
Chart 8. Simple Permanent Portfolio, 10-Month MA, 1970 - 2012
Source: Faber, Ken French, Shiller, FRED
Now we are really cooking! While the absolute performance of the approach drops by about 0.4 percentage points per year, the risk profile drops dramatically; volatility drops to 5.5% annualized and the maximum drawdown drops to 9% from 19%. Even better, investors would have realized positive results over 98% of rolling 12-month periods!
Conclusions
Permanent Portfolio adherents are right to be proud of the performance of their approach over the past 40 years. Of all the static asset allocation approaches we have tested, the PP ranks near the top of the list in terms of risk-adjusted returns. Further, the philosophy behind its construction is consistent with the goal of resilience in the face of any economic environment.
Get The News You Want
Even PP zealots would be silly not to consider some of the simple volatility-based overlays that we presented however. Simple volatility management techniques are philosophically and empirically coherent, and deliver similar results with much smaller drawdowns.
While risk management is important, it does not address the most important challenge to the traditional portfolio: what happens next. That is, how will the traditional model behave going forward in the current environment, where all assets have been artificially inflated at once via coordinated global central bank intervention. Will the portfolio prove resilient to a period of sustained global deflation with Treasury yields already at record lows?
Tactical overlays to the traditional approach may help address this problem by systematically exiting asset classes that are exhibiting strong and/or sustained negative price trends.
The simple Faber moving average approach on its own does not seem to deliver much value above the profile of the traditional PP approach. However, combining a tactical moving average approach with simple volatility management delivers similar high returns, but without the major drawdown characteristics of the simple MA approach.
Further, this approach delivered positive returns over 98% of periods since 1970.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.