Capital Appreciation Or Capital Protection?

rogernusbaum

In an interview on Bloomberg TV today, Christian Lawrence from Rabobank talked about capital protection versus capital appreciation which is an interesting way to think about what an investment strategy might encompass. It's also a play on words along the lines of "return of investment versus return on investment" that was popular during the financial crisis. Before the financial crisis we began looking at very extreme asset allocation ideas including Harry Browne's Permanent Portfolio (25% each to stocks, gold, long bonds and cash), Nassim Taleb's idea of 90% in t-bills from various countries and then taking extreme risk with the remaining 10% (it's evolved slightly since then but still very similar) and Zvi Bodie who similar to Taleb has looked at 90% in TIPS with the rest in equities.

The first new idea along these lines that I've seen coming from the Coronavirus event comes from Raoul Pal via Business Insider. Pal has some chops which BI explains and I think he's worth paying attention to. He think the market fallout from the pandemic will be very bad, this is allocation mix he thinks makes sense for now;

  • 25% Bitcoin
  • 25% Gold
  • 25% Cash
  • 25% Trading opportunities

It's certainly disdainful of equities. Bitcoin for now has no correlation to equities, that's different than a negative correlation, Bitcoin does its own thing which means you can't expect it to behave a certain way or rely on any sort of historical tendency.

Gold on the other hand does have a historical tendency to look different than equities. The long term correlation of the SPDR Gold Trust (GLD) which is a client/personal holding is that its correlation is low to negative the vast majority of the time. There can be no expectation of infallibility of course and that historical tendency that I believe in may not be consistent enough for you, you'd need to decide for yourself.

Cash is cash. In a portfolio sense it serves as defense and it also represents opportunity to buy broadly after a large decline or seek out an individual opportunity like a lottery ticket biotech or anything you might believe in or believe you have an understanding of. In that way, cash and trading opportunities could be the same bucket, or maybe not from Pal's perspective.

I am a big believer in the asymmetric risk opportunity provided by Bitcoin, meaning it could go to $1 million or it could go to zero. I've been saying this for ages and I don't think this dynamic has changed at all, a million or zero, I don't know which and I have a little exposure in case it turns out to be $1 million. In that light, I would not want anywhere near 25% of my money in Bitcoin. I wouldn't want 5% in Bitcoin. It could grow to that much or more and I 'd try to manage that if it happened but starting out at 25% seems astronomically high as I think zero is a distinct possibility.

Some gold makes a lot of sense and zero is not any kind of reasonable outcome but 25% is a lot. The way I've described it before, a lot has to be going badly in the world for gold to be your best performer. Maybe that's what Pal is betting on, maybe he's taking a page from Browne's playbook but if you think of gold as a type of insurance (I do) then arguably 25% in gold is like insuring a $400,000 house for $2 million.

Trading opportunities could be interchangeable with the risk bucket idea put forth by Taleb and Bodie. In that light, the trading opportunities tranche could simply be equity exposure or a mix of core equity and opportunities and of course it could be all trading for anyone who thinks they're suited to that.

If Pal's allocation is a sort of everyone into the bunker portfolio, it's interesting that bonds are missing. That might be the most interesting part of this and the most actionable. Less bonds doesn't mean more equities, it means find a way, other than bonds, to manage volatility or otherwise seek safety.

While going into the bunker with Pal could certainly turn out to be right in the short term, I have no idea, this is not the end of equities' reign as the best long term performing broad asset class. Note that Bitcoin as we now know it is a narrow based asset. Paraphrasing Peter Lynch, I don't know what direction the next 20% will be for equities but I do know what direction the next 100% is. A 100% lift from today's close would take the S&P 500 to 5500, 100% from the all time high would be just under 6800. I have no idea how long it will take to get there but have unyielding faith it will.

If you need to go into the bunker, then you should do so but I don't think Pal has permanently thrown in the towel on equities, I think he's trying to be correctly positioned for the short term and will readjust accordingly based on market developments.