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The Endurant Portfolio

An evolutionary step for the permanent portfolio.

Thomas Braziel Tweeted “As I start to look at a decent pile of personal money to manage, I have to say - I’m drawn to the permanent portfolio - and I only worry about ‘four horsemen of the financial apocalypse.’” I don’t know who Braziel is but he has a good following and people were curious to hear his thoughts about how he’d construct a permanent portfolio.

The Permanent Portfolio was first derived by Harry Browne in the 1980’s. It allocates 25% each to equities, long bonds, cash and gold. The big idea is that no matter what has happening in the world at least one of those four will be doing well. The idea spawned at least one mutual fund, the Permanent Portfolio (PRPFX). Michael J. Cuggino has been managing the fund since 2003. PRPFX does not maintain a static 25% to each of the asset classes but I think it is a reasonable proxy for the concept.

Over the last ten years, Yahoo Finance shows it up 9.6%. It generally went down from 2013 until 2016. I could speculate that maybe the coincidental decline in gold during that time was the driver there. In the ten-year period ending in 2014 it was up 87% compared to 94% for the S&P 500. Obstacles today for the permanent portfolio, the idea or the mutual fund, include cash that yields nothing and bond market performance that cannot be repeated.

It is fun to consider how the permanent portfolio could evolve and how the idea could possibly influence how to construct a portfolio. The influence I’ve probably taken from the permanent portfolio, as well as the Harvard Endowment under Jack Meyer is looking to include exposures that tend to not look like the stock market. Gold as an example, tends to have a low to negative correlation to equities. I saw a headline this weekend asking why gold has done poorly for the last ten years. It might be because equities have skyrocketed in a startling fashion. It tends to do well often enough during adverse equity market situations that I keep it in client and personal accounts. If that doesn’t resonate or you don’t believe in that, then obviously you shouldn’t own it.

For this post I want to turn the equities/long bonds/gold/cash labels completely inside out to not focus on asset classes but on attributes. The idea is not for anyone to run out and implement this but maybe to think about attributes beyond the obvious for the traditional asset classes especially if things will be more difficult for the traditional 60/40 portfolio. For example, equities might off more than just growth…or not, it’ll be whatever you think it is.

As I start to think about this, the allocations will start as growth, strategy, inflation and asymmetry. A static 25% doesn’t seem to fit here, certainly not to asymmetry for how I think about managing risk and volatility.

What I’m calling growth is basic equity market exposure however it is you capture it; funds individual issues, hold on no matter what indexing or anything else you can think of. One point I like to repeat is that over longer periods, equities are the best performing asset class although crypto might challenge that if it survives. At the very least, if you’ve been in markets for a while, you probably have some familiarity with how equities perform and hopefully you understand something about equity risk and volatility. I don’t think the investing world is at that point with crypto. With that in mind, growth would be the largest allocation in our conversation.

Exceptions to growth being the largest allocation include employing some sort of game over strategy, like you’re 60 and your number for retirement was $1.5 million but you have $4 million, or some perma bear somewhere has convinced you that America’s form of capitalism is dead.

There is essentially an unlimited number of funds for broad index exposure and an ever-growing number of risk or volatility managed funds, frequently they use options, if you don’t need or want this tranche to have full equity market beta. Simplify ETFs is a provider to look at if this interests you. I don’t consider these to be strategy funds in the context of this post because they attempt to mostly provide equity market-like returns. Throw in a narrow based thematic fund and maybe an individual stock or two and this part of the portfolio should generally go along for the equity market’s ride. Obviously if the individual stock or two take up a lot of your portfolio versus an index fund then yeah, you very well may not look like the market. Be smart with this tranche, what are you trying to achieve? If you’re trying to capture equity market growth with 50% of your account, then don’t put 25% into a lottery ticket biotech or faddish consumer discretionary stock.

Strategy would be where long/short could go for example. I’m a fan of long/short but not all long/short is the same. Something like a 130/30 where the fund goes long 130% and short 30% tends to target equity market like returns as opposed to more of an absolute return or something so un-volatile that it looks nothing like the stock market. The Merger Fund (MERFX) might be an example of something so un-volatile that it looks nothing like the stock market, at least that is how I view it. MERFX is a client and personal holding.

Some refer to tail risk as an asset class and while I am not to that point, I do believe in the strategy, maintain a little for clients and personally and think it fits into today’s discussion. I’ve disclosed owning Amplify Black Swan (SWAN) before and right or wrong I don’t think of it as tail risk. I’d include that one in growth, even if muted growth. The Cambria Tail Risk ETF (TAIL) is the first fund I’ve heard of that owns puts (with some treasuries) as an insurance strategy. TAIL is a client and personal holding. Simplify just launched Simplify Tail Risk Strategy ETF with symbol CYA…CYA? That’s funny.

You’ll need to go into the prospectus to get a handle on what the fund will do. It says it will own “income generating ETFs” that offer yields above the two-year US treasury which could include REITs, MLPs and inverse VIX ETPs. It will also buy puts, put spreads (presumably debit spreads where the long put has a higher strike than the short put), interest rate derivatives, credit default swaps and a couple of other things. Tread VERY carefully if you don’t know what those things mean. CYA seems to be far more complex than TAIL. I have no idea if it will outperform TAIL.

Looking for the CYA info led me to another new fund and strategy that could fit, the Simplify Risk Parity Treasury ETF (TYA). Risk parity is a fascinating idea where risk is balanced between equities and fixed income such that it usually required leverage in the fixed income tranche to equal the equity risk. At least that is the basic idea, individual funds might tweak from there. The Risk Parity ETF (RPAR) is the first ETF that I’ve heard of in this space, it came out in December 2019 and AQR offers a mutual fund too that you can learn about at QRMIX.

RPAR looks like it uses leverage through the futures market. It currently has a 17% allocation to ultra-short term and 17% in 10-year futures. It has some other fixed income, a little bit of gold and about 25% in equities. TYA doesn’t appear to have listed yet, but the prospectus seemed to focus on a fixed income portfolio protected with fixed income derivatives, I see nothing about equity exposure. If I have that wrong and this catches anyone’s attention at Simplify, you guys know how to reach me.

The mental block I have with risk parity is leveraging up, one way or another, to buy an asset class that is essentially at all time highs and for which there is a price ceiling that’s not too far from the current market. RPAR has done fantastically well since it’s launch but I don’t know what will happen if something bad ever happens in the bond market so it’s not a risk that I want to take.

One more sophisticated strategy fund to mention is the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL). The very short version is that IVOL owns mostly TIPS, it hedges interest rate volatility and most importantly is it doesn’t appear to correlate with anything, less than a 0.2 correlation to the common asset classes. The fund has done will and been far less volatile than the equity market.

For my money, the strategy tranche would be the second largest allocation after growth. Things like merger arbitrage tend to have a positive return, tail risk can erode albeit slowly so keep those expectations in mind. The big debate over whether inflation is transitory or permanent goes on, I like the idea of holding TIPS and gold, but you could also own other commodities as there are plenty of ETPs that own individual, non-gold commodities and certain materials sector stocks and ETFs can also offer commodity-like protection from inflation. Of course, stocks are also considered protection from inflation. Meb Faber seems to be a fan of investing in farmland. This is something I explored many years ago. I briefly owned Cresud (CRESY) before the financial crisis but that wasn’t a great proxy. I believe in the attributes of farmland for low correlation and inflation protection and guessing from what I see from Meb’s Twitter feed, there might be investable products coming that better capture the effect. We’ll see what the look like if/when they arrive but the right type of product, and I’d be very interested.

I’ve written countless times about asymmetry where something could go to the moon or crap out entirely. Cryptocurrencies are the best current example of this opportunity, and it is this tranche where a lottery ticket biotech could fit in too. I see a lot of chatter about uranium as being positioned for asymmetry. That’s not obvious to me but you might view it differently.

If you want 10% in asymmetry, that’s way more than I want, then I’d suggest owning a bunch of uncorrelated things at 1-2% weightings. This tranche is about serious speculation, and you should be open to the idea that a proper weighting for you here is zero.

I referenced the word enduring in the title because I think this needs to be actively managed (even if it’s comprised entirely of passive products) and needs to evolve as the world evolves and as investment products evolve. In the last 20 years the number of funds targeting sophisticated strategies has mushroomed, there are dozens of them. Maybe more than dozens and I only mentioned a couple. I don’t know if even 10% are worth investing in but seeking out the few that are is time well spent in my opinion.

For my practice and our personal money, this work is never done, it is ongoing which makes for a fascinating career and endeavor. If you’re managing your own money, I would encourage you to take the same “never done” approach.