A New Idea For An Old Strategy

Anything related to the Permanent Portfolio (portfolio devised by Harry Browne weighting 25% each to stocks, long bonds, cash and gold) or any of the Permanent Portfolio-inspired modern investment products are always fun to look at. I got the monthly update from the Permanent Portfolio Mutual Fund (PRPFX) which has been around for many years and although it is pretty true to Browne, it does have some leeway.

In looking at the report it is not clear what PRPFX benchmarks to, the S&P 500 is there to compare against but it is not a proxy for equities. It appears to have 37% in equities mixed between "aggressive growth stocks" and "real estate and natural resources," 25% in precious metals, a little bit in "Swiss franc assets" and the rest in "dollar assets" which are mostly bonds. For the last 15 years PRPFX has average annualized growth of 6.7%, about half that of the S&P 500. 

We've looked at the fund a few times over the years but I thought of a different way to model it, wondering if it could be a proxy for fixed income in terms of volatility contribution to a 60/40 portfolio.

Comparing it to a couple of benchmark fixed income ETFs, it looks nothing like AGG but maybe a little like TLT? There have been periods where it did track closely to TLT and times where it diverged markedly but could the mix under the hood of PRPFX when combined with plain vanilla equities have an interesting result?

The two are pretty close. The S&P+PRPFX out performs by a noticeable bit but it also is more volatile. In 2008, S&P+PRPFX did worse than 60/40 by about 300 basis points and in 2022 it did better by about 350 basis points. Some of the things we try to construct to add value versus 60/40 are like a magic bullet, I would not use that term to describe S&P+PRPFX but maybe paired with something else or maybe as a smaller part of portfolio it could offer real differentiation. 

I wanted to circle back to the ProShares S&P 500 High Income ETF (ISPY). It's a new covered call fund that sells one day options every day. Since I mentioned it, I bought a few shares to test drive but I don't really do a lot with broad based funds like this one so I'm not sure where this could go. The belief is that by selling daily and not monthly, it can capture more of the S&P 500's upside. It's too early to know if that will pan out but the first impression on this point isn't terrible.

XYLD is the Global X S&P 500 Covered Call ETF and it sells monthly call options.

I've since learned that the fund does not literally sell an option, it replicates the trade with swaps which for the end user might be a distinction without a difference. The fund is about to go ex-dividend for its first payout. A rep from the company said they think the payout will annualize out to 10-12%.

For purposes of this post, let's assume that is the case. I would still plan on reinvesting all or most of the dividend. For my test drive I will reinvest the whole thing. If it can deliver on being a less volatile proxy for the S&P 500, while tracking closer to the index than XYLD, how should we define success?

I have 75/50 in mind as sort of a benchmark. The 75/50 captures 75% of the upside with only 50% of the downside, the math on that works out favorably over the long term. If it got 75-80% of the index' upside return with lower volatility, that would be a very good result. For context, XYLD gets just under half the total return of the index which makes sense. Stocks go up far more often than not so I would expect that XYLD gets "pegged" far more often than not and the ProShares folks think the daily replication will avoid a lot of that effect, not all of it but quite a bit so we'll see. 

Back to 75/50, I don't think there is anyway it will only capture 50% of the downside. If it turned out to be 80/70 or so that would be pretty good but I don't know how realistic that is. XYLD was down about 2/3rds of what the S&P 500 was down in 2022. 2020 was a terrible year for XYLD. The index was up 18% and XYLD was down a few basis points. 

The reason I am willing to test drive these is that I think selling 0dte options or in this case, 1 day options, is a strategy that can work better than monthly options. We'll see the next time there is a serious market event. 

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