The Permanent Portfolio Influences Everything

Man Institute had a short post titled Not All Alts Are Created Equal. The paper itself wasn't too in depth but they did provide a little bit of a framework for portfolio construction with alts. They suggested 50% in "dynamic traditional assets" which is some combination of "risk managed" stocks and bonds. They didn't provide detail for what they meant by those terms. They would put the other half in a combination of trend following and market neutral and although they didn't say it I took it as 50/50 between the two alt strategies. 

That sort of reminds me of the Permanent Portfolio or at least inspired by the Permanent Portfolio which allocates an equal 25% to equities, long bonds, gold and cash. The big idea is to have uncorrelated return streams or more simply, always having at least one thing going up no matter what is happening.

Not an original thought from me but almost all of these portfolios we look at and play around with here are inspired by the Permanent Portfolio. Obviously, I am pretty down on the diversification benefits of long bonds and Man may have dug up a contributing factor to support my opinion. They note that correlations between equities and long bonds go up when price inflation persists above 2.7%. It has been so long since inflation persisted above 2.7% that I don't know if that stands up but maybe and either way, getting a yield in the fours for 10-20-30 years seems like uncompensated risk or maybe better to say, inadequately compensated risk. 

Each of the following have 25% allocated to AQR Diversified Arbitrage Fund (ADAIX) for market neutral and 25% allocated to American Beacon AHL Managed Futures (AHLPX). You can see the rest of the allocation of the three portfolios and I benchmarked to the Permanent Portfolio Mutual Fund (PRFPX).

The version with VOO is straightforward, market cap weighted equities. SPMO is the Invesco S&P 500 Momentum ETF which has a higher standard deviation which could be thought of having the effect of increasing the equity exposure a little bit but fair if you disagree. NTSX is the WisdomTree US Core Efficient ETF also known as the 90/60 ETF. It leverages up such that a 67% allocation to the fund equals 100% into a 60/40 fund like VBAIX. Putting 50% of Portfolio 3 into NTSX adds capital efficiency (leverage) to the mix, it leverages up 25%.

The CAGRs and standard deviations are all close with a series of small tradeoffs. The version with SPMO compounds 96 basis points higher than the version with VOO but the SPMO version is more volatile by 33 basis points. That's probably worth it but it's not night and day better. The version with NTSX has considerably lower volatility but the CAGR is also quite a bit lower. The numbers for Calmar Ratio and kurtosis are more interesting. Calmar Ratios: Portfolio 1 1.05, Portfolio 2 1.17, Portfolio 3 0.53 and PRPFX is 0.67. For Calmar, higher is better. For kurtosis: Portfolio 1 -0.06, Portfolio 2 -0.60, Portfolio 3 -0.35 and PRPFX is +0.61. Lower is better for kurtosis.

Calmar Ratio and kurtosis are fancy words for similar concepts and can be useful points of understanding. Calmar measures the risk of large losses and kurtosis captures vulnerability to negative, outlier events. The Calmar/kurtosis make sense if you believe in using alternatives. That stats show them providing protection that PRPFX doesn't necessarily do. That fund diversifies with gold and to a lesser extent silver. The other day I mentioned gold as being a less reliable second responder than managed futures and I think we might be seeing that in the metrics. 

Here's a fun study using the VOO version above compared to a different idea using client/personal holding Standpoint Multi-Asset (BLNDX).

Hopefully it goes without saying that I'm never putting anywhere near 85 or 90% in BLNDX. Bitcoin went down a ton in 2022 and then bounced back pretty hard in 2024 and is merely having a very good year in 2024. The effect of including Bitcoin adds 133 basis points to the growth rate but the tradeoff is to increase the volatility by 178 basis points. In terms of risk adjusted returns Bitcoin didn't help but that would change if Bitcoin went on another tear. BLNDX has the attributes of a core holding and catastrophe bonds are very handy at suppressing portfolio volatility. 

The allocation to Bitcoin (asymmetry) is small enough that a 64% decline in 2022 really did not hurt Portfolio 1, it was only down 39 basis points that year. Portfolio 2 is interesting, it is far ahead of VBAIX with much less volatility. It also did better than Portfolio 3 but longer term, I would expect it to lag VBAIX for sure, but with less volatility, and I think it would lag Portfolio 3 but am less certain of that. I think it could be close in most years and take turns being the outperformer but in 2023 when the market was up a lot it trailed VBAIX by 1000 basis points. Maybe I'm wrong about Portfolio 2 lagging though, this year, it is ahead of VBAIX by 200 basis points.

Interestingly the Calmar ratios for portfolios 1 and 2 are very good but kurtosis numbers are not good. Can't please everyone. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.