A ‘portfolio investment’ is a hands-off type of securities investment within a portfolio. Along with its creation comes the expectation of earning a substantial return. This return correlates directly with the risk which that investment can expect to encounter. Portfolio investment is a distinct concept from direct investment and typically involves taking a hefty stake in a target company. Moreover, it could possibly entail involvement with its daily management.
To put simply, portfolio investment is a strategic investment strategy.
Among these portfolio types is the ‘permanent portfolio’. Its origins date back to the 1980s, but its presence and reputation are still going strong. This article will describe what it is and how crypto can be a valuable addition.
What are they?
A ‘permanent portfolio’ is a type of investment portfolio whose design helps it perform well in all economic conditions. A common description of this portfolio is that it is a “fail-safe or bulletproof portfolio.” Its construction in the 1980s was thanks to free-market investment analyst, Harry Browne. This particular portfolio type consists of an equal distribution of stocks, bonds, gold, and cash, or Treasury bills.
Browne put together what he believed would be a portfolio that is safe and profitable in any economic climate. By employing a variety of efficient market indexing, he states that a portfolio with an equal splitting would be an ideal investment mixture. Specifically, for investors that are actively looking for substantial safety and growth.
The components that would receive this division are growth stocks, precious metals, government bonds, and Treasury bills. Growth stocks would flourish in expansionary markets, precious metals in inflationary markets, bonds in recessions, and T-bills in depressions. Browne’s reasoning was that this portfolio mix would end up being very lucrative in any type of economic situation.
Taking initiative, Browne would go on to create the Permanent Portfolio Fund. This consists of an asset mix that shares similarities with his theoretical portfolio in 1982. This mix contains the following:
- 35% government securities
- 20% gold bullion
- 15% aggressive growth stocks
- 15% real estate and natural resource stocks
- 10% Swiss franc bonds
- 5% silver bullion
During a period of 25 years, the fund went on to average an annual return of 6.38%. Overall, there were only three instances of it losing money. In addition, it would surpass the S&P 500 in the following years after the dotcom bust.
From 1976 to 2016, a theoretical permanent portfolio would produce an annual return of 8.65%. This would ultimately equate to a total return of 2,600%. A conventional 60/40 portfolio will generate an annual return of 10.13% for a total return of 5,050%.
This period was not without its advantages, however. The 60/40 portfolio had a definitive divergence of 9.6; to compare, the permanent portfolio’s was 7.2. During the market crash of October 1987, the 60/40 portfolio would dwindle in value by 13.4%. On the other end of the spectrum, the permanent portfolio would decline by only 4.5%. The permanent portfolio would generate considerably lower returns throughout the long term, though the ride would have been smoother. With that in mind, the permanent portfolio becomes a much more appealing option in the eyes of cautious investors.
The construction of a permanent portfolio consists of 25% in…
- …U.S. stocks. This is to provide a strong return during prosperous times. For this particular portion of the portfolio, Browne recommends a basic S&P 500 index fund. Two examples of this are VFINX (Vanguard 500 Index) and FSMKX (Fidelity Spartan 500 Index).
- ….long-term U.S. Treasury bonds. These tend to do very well during times of prosperity. Not only that, but they also flourish during periods of deflation. However, the same cannot be said for other economic cycles.
- …cash. This will allow for the hedge against time periods that consist largely of “tight money” or recession. In this case, ‘cash’ basically means short-term U.S. Treasury bills.
- …precious metals (gold). This will provide sturdy protection during periods of inflation. Browne recommends that you use gold bullion coins.
It’s important to note that Browne recommends rebalancing the portfolio once a year. That way, it will effectively preserve the 25% target weights.
Modern Portfolio Theory
The low volatility of a permanent portfolio makes it one of the better examples of the ‘Modern Portfolio Theory’ (MPT). It is a theory that centers on how the more risk-averse of investors can construct portfolios. To elaborate, how they can enhance or maximize the expected return by drawing from a given level of market risk. This emphasizes that risk as being an inherent component of a much higher reward.
According to this theory, the creation of an ‘efficient frontier’ of optimal portfolios that provide the maximum expected return for a given risk level is possible. For context, Investopedia defines ‘efficient frontier’ as the following:
“The “Efficient Frontier” is a modern portfolio theory tool that shows investors the best possible return they can expect from their portfolio, given the level of risk that they’re willing to accept.”
The pioneer behind this theory was Harry Markowitz in his paper “Portfolio Selection.” Its initial publication was in 1952 by the Journal of Finance. Sometime later, he would receive a Nobel prize for his development of the MPT.
This theory states that the general risk for individual stock returns has two key components:
- Systematic Risk – These are market risks that one cannot possibly diversify away. Such notable examples of this specific kind of risk are Interest rates, recessions, and wars.
- Unsystematic Risk – Alternate title is ‘specific risk’. This risk is in association with individual stocks, like a management change or a noticeable decline in operations. You can diversify this risk away as you boost the stock number in your portfolio. It is indicative of the component of a stock’s return that doesn’t correlate with general market movements.
Permanent portfolio and the link to crypto
When you look at permanent portfolios as a whole, it’s a creation that assigns equal weightings to various factors. The primary ones are – as you may recall – equities, long bonds, cash, and gold. The dominating idea is that regardless of what’s happening in the world and in markets, at least one will prosper.
This idea is something that one can easily connect to the innovative sensation that is cryptocurrency. In the beginning, like with most trends and phenomenons, there were initially very few to choose from. With the progression of time came more virtual currencies that aspire to mirror the success of Bitcoin, Ethereum, Litecoin, XRP, and many others climbed up the ranks and became just as prominent.
So, to make the connection to the dominating idea of permanent portfolios, if one cryptocurrency fails, there are others to choose from.
With the seeds of this conjunction planted, there comes the inquiry about the incorporation of crypto with permanent portfolios. Is it possible? And for that matter, would it be lucrative and beneficial for all parties?
First and foremost, a clarification must be made; that being that a “crypto-ready” permanent portfolio doesn’t exist. At least not yet. A new technology of any kind is not necessarily a smooth transition. This is especially true if a pre-existing innovation is aiming to integrate with a separate innovation. So, if a “crypto-ready” permanent portfolio were to become a strong possibility in the eyes of creators, then its completion will be gradual.
Now, with this in mind, the theoretical merge between the two innovations could potentially prove to be advantageous.
One of the most common features of many cryptocurrencies is their commitment to making their currency secure. On top of that, they are constantly developing their structures as a means to adapt and improve their functionality. If you remember, Browne believes that the employment of various efficient market indexing would make for an ideal investment mixture. Therefore, it would make the ideal portfolio for investors seeking out safety and growth.
By adding cryptocurrency to permanent portfolios, the probability of a secure portfolio that’s also experiencing frequent expansion in its operation escalates. Moreover, the portfolio’s aim to function regardless of economic conditions can draw crypto users in, as well. The risks with cryptocurrency are plentiful, so a portfolio working in the face of whatever the climate brings sounds appealing.
Finally, the most obvious reason for crypto’s incorporation is the sheer amount of attention it will bring. Virtual currency is constantly growing in popularity, and a merge can extend that popularity to permanent portfolios. This logic is admittedly not as intricate, but it does bring up – or at the very least imply – long-term effects.
Permanent portfolios are making great strides in their operation, similar to how cryptocurrency continues to develop at a rapid rate. Currently, the union between the two innovations has yet to go beyond a basic idea. Despite that, the possibilities are there, the benefits are noteworthy, and curiosity is on the rise.