Photo Credit: Daniel Broche || To the victor goes the spoils, or, does a victory get spoiled?


I was at a CFA Baltimore board meeting, and we were talking before the meeting.  Most of us work for value investors, or, growth-at-a-reasonable-price investors.  One fellow who has a business model somewhat like mine, commented that all the money was flowing into ETFs which were buying things like Facebook, Amazon and Google, which was distorting the market.  I made a comment that something like that was true during the dot-com bubble, though it was direct then, not due to ETFs, and went to a different group of stocks.

Let’s unpack this, starting with ETFs.  ETFs are becoming a greater proportion of the holders of stocks, and other assets also.  When do new shares of ETFs get created?  When it is profitable to do so.  The shares of the ETF must be worth more than the assets going into the ETF, or new shares will not get created.

It is the opposite for ETFs if their shares get liquidated. That only happens when it is profitable to do so.  The shares of the ETF must be worth less than the assets going out of the ETF, or shares will not get liquidated.

Is it likely that the growth in ETFs is driving up the price of shares? Not much; all that implies is that people are willing to pay somewhat more for a convenient package of stocks than what they are worth separately.  Fewer people want to own individual assets, and more like to hold bunches of assets that represent broad ideas.  Invest in the stock market of a country, a sector, an industry, a factor or a group of them.

The creators and liquidators of ETF shares typically work on a hedged basis.  They are long whatever is cheaper, and short whatever is more expensive — but on net flat.  When they have enough size to create or liquidate, they go to the ETF and do that.  Thus, the actions of the creators/liquidators should not affect prices much.  Their trading operations have to be top-notch to do this.

(An aside — long-term holders of ETFs get nipped by the creation and liquidation processes, because both diminish the value of the ETF to long-term holders.  Tax advantages make up some or more than all of the difference, though.)

Does the growth in ETFs change the nature of the stickiness of the holding of the underlying stocks?  Does it make the stickiness more like a life insurer holding onto a rare “museum piece” bond that they could never replace, or like a day trader trying to clip nickels?  I think it leans toward less stickiness; my own view of ETF holders is that they fall mostly into two buckets — traders and investors.  The investors hold a long time; the traders are very short term.

As such, more ETFs owning stocks probably makes the ownership base more short-term.  ETFs are simple looking investments that mask the underlying complexity of the individual assets.  There is no necessary connection between a bull market and and growth in ETFs, or vice-versa.  In any given market cycle there might be a connection, but it doesn’t have to be that way.

ETFs don’t create or retire shares of underlying stocks or bonds.  And, the ETFs don’t necessarily create more net demand for the underlying assets.  Open end mutual fund holders and direct holders shrink and ETFs grow, at least for now.  That may make a holder base a little more short-term, but it shouldn’t have a big impact on the prices of the underlying assets.

My friend made a common error, confusing primary and secondary markets.  No money is flowing into the corporations that he mentioned.  Relative prices are affected by greater willingness to pay a still greater amount for the stock of growthy, highly popular, large companies relative to that of average companies or worse yet, value stocks.

Now the CEOs of companies with overvalued shares may indeed find ways to take advantage of the situation, and issue stock slowly and quietly.  The same might apply to value stocks, but they would buy back their stock, building value for shareholders that don’t sell out.  In this example, the secondary markets give pricing signals to companies, and they use it to build value where appropriate — secondary markets leads primary markets here.  The home run would be that the companies with overvalued shares would buy the companies with undervalued shares, if the companies were related, and it seemed that management could integrate the firms.

What we are seeing today is a shift in relative prices.  Growth is in, and value is out.  What we aren’t seeing is the massive capital destruction that took place when seemingly high growth companies were going public during the dot-com bubble, where cash flowed into companies only to get eaten by operational losses.  There will come a time when the relative price of growth vs value will shift back, and performance will reflect that then.  It just won’t be as big of a shift as happened in the early 2000s.

Photo Credit: Philipp Messner || Every culture should learn their alphabet 😉


In my view, these were my best posts written between May and July 2014:

Look to the Liabilities to Understand the Assets

Why do new asset classes work very well for a time and then fail?

I Have My Doubts

Learning to live with uncertainty and thrive amid it.

Asset Value Illusion

People don’t need assets as much as they need streams of income derived from the assets (dividends, capital gains) that allow them to purchase the goods and services that they want and need.  (Low interest rates mean assets aren’t worth as much.)

Illusory Investment Income

Some naively say, “Dividends don’t lie.”  Well yes, the money you receive is yours, but is the company as healthy after the dividend?  Will they be able to keep it up?  Often that is not the case.

A Bond Manager Thinks about the Equity Premium

This is a more logical way to think of the equity premium by decomposing it into three more understandable parts: yield curve slope, credit spread, and economic earnings.

A Survey on Trading/Investing

How I think about Buying and Selling Stocks

Investment Management: A Science to Teach or an Art to Learn?

It is better to have an accurate uncertainty, than an inaccurate certainty.  We are better of professing ignorance of what we don’t know, than being certain about things where we are wrong.

Self-Regulation in the Financial Markets: My Thoughts

Self-regulation is a better idea in theory than practice.  Either it needs to be regulated, or not.  Adversarial regulation is unavoidable if regulation is needed.

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that.  The SRO then has the “death penalty” hanging over the heads of those they regulate.  That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a CFA Charter.

I have no doubt that this would be a good thing.  Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

Enabling Others

Whether on a micro-level (a business) or on a macro-level (a government) the way to build value comes from a simple concept.  What can I/we do to enable the goals of others?  Growth and success come through service.

The Tails of the Distribution do not Validate the Mean

Asset classes that average in the results of astounding successes and total failures do not adequately represent what can happen to individuals in their specific investments.

Avoid Illiquidity

What are the significant costs and benefits of investing in illiquid assets?

The Value That Investment Advisers Deliver

Registered Investment Advisers [RIAs] offer value to their clients in 10 ways, most particularly helping them to not sell in a panic or buy out of greed.

On Fixed Payment Annuities

The value of having income that you can’t outlive

Pity the Multiemployer Pension Plans

Why many of these pension plans will fail

On Berkshire Hathaway and Asbestos

Why Berkshire Hathaway reinsures a huge amount of all of the asbestos claims outstanding

On Learning Compound Interest Math

Why it is important for everyone to learn it.

One More Note on Failure

What does it take for a big failure of any sort to occur, despite some planning?

The Reason for Failure Matters

How to see in advance how failures can indicate that a bigger problem is here, or not.

Understanding Insurance Float

Why most people who read Buffett don’t understand the value of insurance float properly.  It is valuable, but not as valuable as naive acolytes of Buffett believe.

Full disclosure: long $BRK/B for clients and me


There’s a lot of bits and bytes spilled in the war between Elliott Associates (and those that favor their position) and the current board of Arconic.  I want to point out a few things, having held Alcoa since prior to the breakup, and added to my positions in both new Alcoa and Arconic post-breakup.

  • Profitability will likely improve more if Elliott’s nominees are elected to the board, and Larry Lawson is CEO.
  • The existing management team does not deserve credit for the recent rise in the stock price for two reasons: a decent amount of the rise in Arconic’s stock price anticipates a rising probability that the board and management team will be replaced.  Second, a decent amount of the increase in the stock price of Alcoa has been due to a rise in the price of aluminum, for which no single entity can take credit.  Current Arconic benefited from that, at least until it sold its whole stake in Alcoa.
  • To their discredit, the existing management team and board resisted the breakup of the company into upstream and downstream for years.  (See point 2 of this Elliott letter, Was Dr. Kleinfeld the Driving Force Behind the Separation?)
  • Existing management was not a good capital allocator.
  • Prior to the agitation by Elliott, Alcoa and Arconic sold at low valuations, because earnings prospects were poor.  Now new Alcoa is in better hands, and that might be true for Arconic in the future, which may further improve valuation.
  • The existing board has low ownership in Arconic.  Many of the existing board members have been around too long.
  • The current board are late to the party of improving corporate governance.  Though their proposals are good, it looks like they were dragged there by the activists, and therefore, can’t be trusted to maintain these improvements.

That’s my short summary; it is not meant to be detailed, as Elliott’s arguments are.  In general, I agree with the arguments over at New Arconic, and will be voting the blue proxy card.  If you disagree, then you should vote the white proxy card sent out by the existing board.

I’m not telling you what to do.  Vote the proxy that reflects your view of what will improve Arconic the most.

Full disclosure: long AA & ARNC for my clients and me (Note: Aleph Investments, LLC, is dust on the scales in this fight, representing less than 0.01% of outstanding shares.)

Photo Credit: Hanan Cohen || Anyone need a copy?


In my view, these were my best posts written between February and April 2014:

On the Structure of Berkshire Hathaway

On the Structure of Berkshire Hathaway, Part 2, the Harney Investment Trust

This set of posts is unique in going through how the insurance entities of Berkshire Hathaway allow Buffett to hold as much as he does of his stocks/businesses through his insurance companies.  It also explains as much as can be publicly known about the secretive Harney Investment Trust.

On the “770” Account

How to dress up Permanent Life Insurance as a sexy investment vehicle, and get guaranteed underperformance.

The Good ETF, Part 2 (sort of)

If you are investing in any levered, inverse, or non-equity fund exchange traded product, then read the fine print of the prospectus.  If you fail to do that, you have no right to complain if you lose money.

Why it is Hard to Win in Investing

Most profitable investing takes an uncomfortable view versus the consensus, and buys when the market offers good deals.  If there are no good deals, profitable investing sits on cash, and waits for a better day.

On Target Prices & Yields

It is better to measure investments against similar alternative investments in order to decide where to invest money, rather than using target prices or yields.

On Approximate Valuation Methods

I suggest different valuation metrics for four different types of stock.

An Expensive Kind of Insurance

Where I suggest that VIX-type products must be used tactically, if at all.  (Note: the logic of this article is fine, but the graphs have not aged well.

On Intrinsic Value

On how it is difficult to calculate, but why a CEO/CFO might experiment with calculating it to have a better idea of when to buy back or issue stock.

On Emergent Phenomena

When are negative surprises more likely to happen?  Leverage and other factors play roles.

Conservation of Liquidity, under most Conditions

Conservation of Liquidity, under most Conditions, Coda

Why the “money parked on the sidelines” (or lack thereof) argument is always bogus.

“Different from the Consensus”

What is the consensus anyway?  When is it smart to think differently than the herd?

The Stock Market Is Rigged! The Stock Market Is Not Rigged!

Never allege a conspiracy when mere stupidity will suffice to explain the problem.

Limit Repo Financing

I am a lonely voice on this, but when repo financing fails, it fails colossally.  It was a moderately large factor in the systemic risk of 2008.

Peterson’s Guide to Financial Blog Commenters

Is it any wonder the most blogs and financial websites have eliminated comment sections at the end of articles?

On a Letter From A Younger Friend

Basic advice on personal finance.

Productivity Inequality

The unpopular truth as to why many people in the US (and other developed nations) are falling behind, and losing net wealth.

The Idea of Contributory Defined Benefit Plans

Solves two pension problems — participants don’t have to make investment choices, and they get an income that they can’t outlive.  Gives them greater choice over how big of a pension to have.

Why are Pensions so Messed Up

Lists in short order the ten main problems with pensions.

And finally, I finished up the “Rules” posts.  Though later, I added two more…

The Rules, Part LVIII

Can contingent claims theory for bond defaults be done on a cash flow/liquidity basis?  KMV-type models seem to fail on severely distressed bonds that have time to breathe and repair.

The Rules, Part LIX

Productivity increases are only so when they result in an increase of desired consumer goods purchasable at prior prices.

The Rules, Part LX

Rapid upward moves in volatility almost always presage a bounce rally.

The Rules, Part LXI (The End… of the Past)

Rule: every rule has exceptions, including this one


Full Disclosure: long BRK/B for myself and clients


In my view, these were my best posts written between November 2013 and January 2014:

Advice For Would-be Bloggers

Be regular (I need that advice myself), write on what you care about, start small.  Not that much different than this recent interview of me regarding blogging.

What Life Insurance to Buy?

Depends on whether you need it for protection or as part of a tax shelter or estate plan.

Protect Your Older Family & Friends

Remember that older folks are very tempting targets for fraudsters, and very nice people delivering subpar service at a high price.

Where to Find Data

I give you my favorite sources.  Most are free.

An Internship at a Hedge Fund

Advice on what to do if you get such an opportunity.

On Position Sizing in Equity Long-Short Hedge Funds

It’s not an easy question, particularly when it comes to shorting or being levered long, but I do offer some ideas that are better than things I have read.

Risks, not Risk, Again

It is better to model the individual risks and manage them, than to rely on an academic-derived model with unstable parameters.

Unconstrained Will Get Overdone

As in any management style, typically the best managers get there first, followed by less talented wannabes.

What are Safe Assets?

It depends on your time horizon(s)

Two Good Questions

How to sort though multiple factors in investing, and is investment in the insurance industry overdone?

Two More Good Questions

On weighting position sizes by expected returns, and What are the tests I use to check if accounting is fair?

On Understanding and Valuing Financial Companies

A compendium piece to the way I reason through investing in financial companies.

Why Great CEOs Look at their Stock Price Every Now and Then

It aids in managing the capital of the company wisely, especially when doing M&A.

When to Worry — An Asset-Liability Management Perspective on Financial Macroeconomics

When those that hold risk assets predominantly have weak balance sheets, with short-dated funding/horizons, it is time to reduce risk.

Systemic Risk Stems from Asset-Liability Mismatches

More on the foolishness of the FSOC and attempts to look for systemic risk where there is none.

Lower the Cap Rate, Not

Rising stock prices does not mean that monetary policy or any other government policy is necessarily good.

A Preview of the Future in Local Government Financing

Not everything is going to fail, but the the worst 1-3% will.  Avoid municipalities under severe stress.

Equality, and its After-Effects

What do you do when the whole world becomes more competitive, and compensation in your industry comes under pressure?

Give Them a Small Bank

How could we make banking regulators more intelligent about the industry that they watch over?  Give them experience in managing a small bank.


This will be a short post, though I want to toss this question out to readers: what investment strategies do you know of that are simple, and work on average over the long-term?

Here are four (together with posts of mine on the topic):

1) Indexing

Index Investing is not Inherently Socialistic

Why Indexes are Capitalization-Weighted

Why do Value Investors Like to Index?

On Bond Investing, ETFs, Indexes, and the Current Market Environment

2) Buy-and-Hold

Buy-and-Hold Can’t Die

Buy-and-Hold Can’t Die, Redux

Buy and Hold Will Return — 2/15/2009 (what a time to write this)

Patience and a Little Courage

Risk vs Return — The Dirty Secret

3) The Permanent Portfolio

The Permanent Portfolio

Can the “Permanent Portfolio” Work Today?

Permanent Asset Allocation

4) Bond Ladders

On Bond Ladders

I chose these because they are simple.  Average people without a lot of training could do them.  There are other things that work, but aren’t necessarily simple, like value investing, momentum investing, low volatility investing, and a few other things that I will think of after I hit the “Publish” button.

That said, most people don’t need to work on investing.  They need to work on cash management, and I have written a small fleet of articles there.  Managing cash is simple, but it takes self-control, and that is what most people lack in their financial lives.

But for those that have gotten their cash under control, with a full buffer fund, the above strategies will help, and they aren’t hard.

Final note: I realize valuations are high now, so buy-and-hold is not as attractive as at other times.  I realize that interest rates are low, so bond ladders aren’t so great, seemingly.  Indexing may be overused.  Most of the elements of the Permanent Portfolio look unappealing.

But what’s the alternative, and simple enough for average people to do?  My answer is simple.  If they can buy and hold, these strategies will pay off over time, and far better than those that panic when things get bad.  There are few regularities in the markets more reliable than this.

In my view, these were my best posts written between August and October 2013:

I completed the last of my “Manager” series, on being an investment risk manager:

The Education of an Investment Risk Manager, Part VI

This is the bizarre story of how I pulled a win out of an impossible situation against my own management, and a major life insurer.

The Education of an Investment Risk Manager, Part VII

On the time that I correctly modeled a complex structured security, and the client wouldn’t listen to reason

The Education of an Investment Risk Manager, Part VIII

The time that I did a competitive study of the most aggressive life insurers, and how it did not dissuade my client’s management team from trying to imitate them.

The Education of an Investment Risk Manager, Part IX (The End)

A bevy of little tales about odd investment tasks that I succeeded with, and how many of them did no good for my clients.

Ben Graham Did Not Give Up on Value Investing in Theory

With quotations and links to the source documents, I show what Ben Graham really said in the article commonly cited to say that he gave up on value investing.

On Avoiding Con Men

A summary article of many of my prior articles on how to avoid being defrauded.

On Alternative Investments

Alternative investments are like regular investments, but they are less liquid, more opaque, and have higher fees.

Should You Buy Shares of Stock or Not?

Where I answer Mark Cuban the one time he tweeted to me.  Really!

Quiet Companies Are Better

Why companies should let their filings with the SEC speak for them, and abandon the media.

Two is Company, Three is a Crowd

On game theory, and how it affects politics and civil wars.

It Works, But It Doesn’t Work All The Time

On how good investment theories fail for periods of time, and then come roaring back when most people know they will never work again.

Value Investing when Debt Levels are High

On seeking a margin of safety, when very little seems safe

A New Look at Endowment Investing

I interact with a groundbreaking paper on endowment investing — a very good paper, and I give some ways that it could be improved.

Less is More

Do you want to do better in investing?  Make fewer decisions, and make them count.

Taleb Versus Reality

In which I take on Nassim Taleb’s views on how to reduce risk in investing, and show which half of his valid, and which half are fantasy.

To Young Analysts

What I contributed to Tom Brakke’s project for young investment analysts — what do I think they should know?

The Rules, Part XLIX

In institutional portfolio management, the two hardest things to do are to buy higher than your last buy, and sell lower than your last sale.

The Rules, Part L

Countries are firms that produce claims on assets and goods

The Rules, Part LI

65% of the time, the rules work.  30% of the time, the rules don’t work. 5% of the time, the opposite of the rules works.

The Rules, Part LII

ge + E/P > ilongest bond

The Rules, Part LIII

The tech market washes out about every eight years or so.  The broad market, which is a more robust beast, washes out far less frequently.  My question: are these variants of the same phenomenon?

The Rules, Part LIV

When do employee and corporate incentives line up?  Ideally, incentive schemes should reward people with a fraction of the additional profitability that resulted from the additional work that they did.  Difficulties: measurement impossible in many cases, people could receive a bonus when the firm is not profitable, neglects synergies (both positive and negative).

The Rules, Part LV

Financial intermediation reduces volatility.  In bull markets, demand for financial intermediaries drops.

The Rules, Part LVI

Leverage and risk eventually transfer to the least regulated

The Rules, Part LVII

The more that markets are united through derivatives, the more systemic risk is created.


This is a small thing, and so this will be a small post.

Learn to set your expectations right.

When you buying something and see a price like $19, $19.95, or $19.99, think $20.

When you are buying a car, and see prices like $19,000, $19,900, $19,990, or $19,999, think $20,000.  The same thing applies to homes, and be sure you have a strong estimate of all of the extra taxes and fees that will get thrown into the price.

People tend to look at the front number(s) and get mesmerized.  Learn to round it up as a buyer.  We tend to get too quick in our judgments, and be too optimistic when we buy, so round prices up — especially true if you are on a budget, and you are keeping a running total of costs.

Now, if you think this doesn’t happen in institutional pricing, it happens there as well.  I remember cases where I was trying to sell bonds, and I could not get a deal done, I would ask my sales coverage, “Why? How is the other side pricing the bond?”  If it was a dollar price like $100, I would make a note of it, and if the market fell for general reasons under that price, I would make an offer a little under the price, say $99.95.  Frequently, I would sell the bonds for my client, even if the yield spread had worsened in relative terms, and the bonds were less attractive to a more rational buyer.  The same applied to other means of pricing bonds, and applied the opposite way if I was trying to buy bonds.  You would be surprised how many were looking for a shiny price like $105, and after a general rally deals would get done at $105.01.

Buffett has sometimes had a phrase, “Your price, my terms.”  If there are other facets to the deal than merely price, try giving the other guy his price in a prominent way, with other terms that favor what you want to achieve.

You would think that people would be more rational, but they are often not, and you and I aren’t much better.  That is why I encourage you to think conservatively in your economic decisions to avoid undue optimism.

PS — remember that this happens with institutional investors in setting target prices as well — they like the glossy round numbers.

Photo Credit: richard winchell  || No, don’t study the Kabbalah…

To my readers, for a little while, I am going to be doing some “best of” posts along with some smaller articles.  You should see eleven “best of” articles before this is done.  If this bugs you, just turn me off for a little while.  These articles are important, because there are some re-publishers that mine these pieces for content, and sometimes translate highlighted articles into languages other than English.

This era probably had the greatest density of “Rules” posts.  In my view, these were my best posts written between May and July 2013:

Improve Your Skills

How do you protect those whom you love and yourself from economic obsolescence?

In Defense of Concentrated Portfolios

Why it is good to have asset managers that are not closet indexers, unlike most actively managed money in the market today.

Many Will Not Retire; What About You?

Thinking about the different streams of income in society, and which might be more likely to fail.  Also, thoughts on how low interest rates fit into this picture.

On Captive Insurers

On how life insurers compromise rules on reserving using reinsurers that they own as subsidiaries.  Also examines other ways that insurers weaken solvency.

On Insurance Investing, Part 6

On Insurance Investing, Part 7 [Final]

On how insurance has changed for investors over the past ten years, Price-to-Book vs Return on Equity Diagrams, and miscellaneous issues for those investing in insurance companies.

On Long-Term Care Insurance

Really, it is not an insurable risk, which is why most companies underwriting LTC have lost money on it, and coverage has become less and less generous.

“As for those with long-term care policies, if they are old, keep paying on them, you will likely do well on them when you finally need to draw on the policies.  You have benefits that benefits that can no longer be purchased.  Enjoy the exclusive club you are in.”

On News

“In summary, all news is not equal.  The reactions to news, and the lack thereof, can tell us a lot about the intentions of large market actors.  Do your homework well, and prosper off of the knowledge that it gives you regarding reactions, over-reactions, and under-reactions.”

On Risk-Based Liquidity, and Financial Regulation

On the Designation of Systemically Important Financial Institutions

The beginning of my arguments against the pointy-headed Financial Stability Oversight Commission [FSOC] and their inability to understand the solvency of non-bank financials.

On Stock Splits

“This brings me to my conclusion: stock splits are a momentum effect, but it is larger when companies are still have a cheap valuation.”

On the Value of Writing Well

Qualitative reasoning is important.  Read a lot, and learn to write well.

Risk Control Upfront

Risk Control Upfront, Redux

All good risk management prepares in advance to avoid risk, with strategies to mitigate risk as it happens taking a distant second place.

Temporary Prosperity at the Cost of Longer-term Prosperity

It’s easier for a generation to become prosperous if they push the bills onto their children and grandchildren.  Eventually it catches up with a nation, and reduces opportunity for average people.

The Problem of Small Accounts

Is it better for small accounts to get no advice or advice that is conflicted?  It is very hard to provide quality advice to small accounts.

The Rules, Part XXXVII

The foolish do the best in a strong market

The Rules, Part XXXVIII

There is probably money to be made in analyzing the foibles of money managers, to create new strategies by taking on the opposite of what they are doing.

The Rules, Part XXXIX

The trouble with VAR and other mathematical models of risk is that if it becomes the dominant paradigm, and everyone begins to use it, it creates distortions in the market, because institutions gravitate to asset classes that the model makes to appear artificially cheap.  Then after a self-reinforcing cycle that boosts that now favored asset class to an unsupportable level, the cashflows underlying the asset can no longer support it, the market goes into reverse, and the VAR models encourage an undershoot.  The same factors that lead to buying to an unfair level also cause selling to an unfair level.

Benchmarking and risk control through VAR only work when few market participants use them.  When most people use them, it becomes like the portfolio insurance debacle of 1987.  VAR becomes pro-cyclical at that point.

The Rules, Part XL

Unions create inefficiency.  This creates an opportunity for new technologies that perform the same function, but aren’t as labor-intensive.  (E.g. integrated steel vs. mini-mills)”

The Rules, Part XLI

If businesses anticipate a flow of financing, they will depend on it.  Then a diminution or increase in the flow of investable funds will affect markets, even if the flow of investable funds remains positive or negative.

The Rules, Part XLII

During a panic, it is useful to reflect on the degree to which the real economy has been driven by the financial economy.  In the Great Depression, the degree was heavy; in the seventies, it was light.  Today, my guess is that it is in-between, which makes it difficult to figure out the right strategy.

The Rules, Part XLIII

Modify Purchasing Power Parity by adding in stocks and bonds

An optimal currency board price basket would contain both assets and goods.

The Rules, Part XLIV

Expectations are a part of the game.

The Rules, Part XLV

Market rents are typically fixed in size.  When a strategy to exploit a particular market inefficiency gets too big, returns to the rent disappear, or even go negative prospectively, even if they appear exceedingly productive retrospectively.

The Rules, Part XLVI

Speculative companies should be evaluated on cash, burn rate, probability of success, size of potential market and margins at maturity.

The Rules, Part XLVII

Crashes are the result of a shift from a positive self-reinforcing cycle to a negative self-reinforcing cycle.

The Rules, Part XLVIII

If an asset-backed security can produce a book return less than zero for reasons other than default, that asset-backed security should not be permitted as a reserve investment.

The Stock Price Matters, Regardless

Roughly one dozen ways that the stock price affects the marketing, operations and financing of publicly traded companies.

What NOT to do in Job Interviews

A somewhat humorous article of mistakes that I have made in job interviews.  Also a comment on making sure that you fit the culture of the firm at which you are interviewing.

What to Do When Things are Nuts?

So you think that the market is overvalued?  How do you adapt to that condition, while still leaving some room for opportunity if the market continues to rise.


I will admit, when I first read about the Permanent Portfolio in the late-80s, I was somewhat skeptical, but not totally dismissive.  Here is the classic Permanent Portfolio, equal proportions of:

  • S&P 500 stocks
  • The longest Treasury Bonds
  • Spot Gold
  • Money market funds

Think about Inflation, how do these assets do?

  • S&P 500 stocks – mediocre to pretty good
  • The longest Treasury Bonds – craters
  • Spot Gold – soars
  • Money market funds – keeps value, earns income

Think about Deflation, how do these assets do?

  • S&P 500 stocks – pretty poor to pretty good
  • The longest Treasury Bonds – soars
  • Spot Gold – craters
  • Money market funds – makes a modest amount, loses nothing

Long bonds and gold are volatile, but they are definitely negatively correlated in the long run.  The Permanent Portfolio concept attempts to balance the effects of inflation and deflation, and capture returns from the overshooting that these four asset classes do.

What did I do?

I got the returns data from 12/31/69 to 9/30/2011 on gold, T-bonds, T-bills, and stocks.  I created a hypothetical portfolio that started with 25% in each, rebalancing to 25% in each whenever an asset got to be more than 27.5% or less than 22.5% of the portfolio.  This was the only rebalancing strategy that I tested.  I did not do multiple tests and pick the best one, because that would induce more hindsight bias, where I torture the data to make it confess what I want.

I used a 10% band around 25% ( 22.5%-27.5%) figuring that it would rebalance the portfolio with moderate frequency.  Over the 566 months of the study, it rebalanced 102 times.  At the top of this article is a graphical summary of the results.

The smooth-ish gold line in the middle is the Permanent Portfolio.  Frankly, I was surprised at how well it did.  It did so well, that I decided to ask, what if we drop out the T-bills in order to leverage the idea.  It improves the returns by 1%, but kicks up the 12-month drawdown by 7%.  Probably not a good tradeoff, but pretty amazing that it beats stocks with lower than bond drawdowns.  That’s the light brown line.

ResultsS&P TRBond TRT-bill TRGold TRPP TRPP TR levered
Annualized Return10.40%8.38%4.77%7.82%8.80%9.93%
Max 12-mo drawdown-43.32%-22.66%0.02%-35.07%-7.65%-14.75%


Now the above calculations assume no fees.  If you decide to implement it using SPY, TLT, SHY and GLD, (or something similar) there will be some modest level of fees, and commission costs.


 What Could Go Wrong

Now, what could go wrong with an analysis like this?  The first point is that the history could be unusual, and not be indicative of the future.  What was unusual about the period 1970-2017?

  • Went off the gold standard; individual holding of gold legalized.
  • High level of gold appreciation was historically abnormal.
  • Deregulation of money markets allowed greater volatility in short-term rates.
  • ZIRP crushed money market rates.
  • Federal Reserve micro-management of short-term rates led to undue certainty in the markets over the efficacy of monetary policy – “The Great Moderation.”
  • Volcker era interest rates were abnormal, but necessary to squeeze out inflation.
  • Low long Treasury rates today are abnormal, partially due to fear, and abnormal Fed policy.
  • Thus it would be unusual to see a lot more performance out of long Treasuries. The stellar returns of the past can’t be repeated.
  • Three hard falls in the stock market 1973-4, 2000-2, 2007-9, each with a comeback.
  • By the end of the period, profit margins for stocks were abnormally high, and overvaluations are significant.

But maybe the way to view the abnormalities of the period as being “tests” of the strategy.  If it can survive this many tests, perhaps it can survive the unknown tests of the future.

Other risks, however unlikely, include:

  • Holding gold could be made illegal again.
  • The T-bills and T-bonds have only one creditor, the US Government. Are there scenarios where they might default for political reasons?  I think in most scenarios bondholders get paid, but who can tell?
  • Stock markets can close for protracted periods of time; in principle, public corporations could be made illegal, as they are statutory creations.
  • The US as a society could become less creative & productive, leading to malaise in its markets. Think of how promising Argentina was 100 years ago.

But if risks this severe happen, almost no investment strategy will be any good.  If the US isn’t a desirable place to live, what other area of the world would be?  And how difficult would it be to transfer assets there?


The Permanent Portfolio strategy is about as promising as any that I have seen for preserving the value of assets through a wide number of macroeconomic scenarios.  The volatility is low enough that almost anyone could maintain it.  Finally, it’s pretty simple.  Makes me want to consider what sort of product could be made out of this.


Back to the Present

I delayed on posting this for a while — the original work was done five years ago.  In that time, there has been a decent amount of digital ink spilled on the Permanent Portfolio idea of Harry Browne’s.  I have two pieces written: Permanent Asset Allocation, and Can the “Permanent Portfolio” Work Today?

Part of the recent doubt on the concept has come from three sources:

  • Zero Interest rate policy [ZIRP] since late 2008, (6.8%/yr PP return)
  • The fall in Gold since late 2012 (2.7%/yr PP return), and
  • The fall in T-bonds in since mid-2016 (-4.7% annualized PP return).

Out of 46 calendar years, the strategy makes money in 41 of them, and loses money in 5 with the losses being small: 1.0% (2008), 1.9% (1994), 2.2% (2013), 3.6% (2015), and 4.5% (1981).  I don’t know about what other people think, but there might be a market for a strategy that loses ~2.6% 11% of the time, and makes 9%+ 89% of the time.

Here’s the thing, though — just because it succeeded in the past does not mean it will in the future.  There is a decent theory behind the Permanent Portfolio, but can it survive highly priced bonds and stocks?  My guess is yes.

Scenarios: 1) inflation runs, and the Fed falls behind the curve — cash and gold do well, bonds tank, and stocks muddle.  2) Growth stalls, and so does the Fed: bonds rally, cash and stocks muddle, and gold follows the course of inflation. 3) Growth runs, and the Fed swarms with hawks. Cash does well, and the rest muddle.

It’s hard, almost impossible to make them all do badly at the same time.  They react differently to changes in the macro-economy.


There are a lot of modified permanent portfolio ideas out there, most of which have done worse than the pure strategy.  This permanent portfolio strategy would be relatively pure.  I’m toying with the idea of a lower minimum ($25,000) separate account that would hold four funds and rebalance as stated above, with fees of 0.2% over the ETF fees.  To minimize taxes, high cost tax lots would be sold first.  My question is would there be interest for something like this?  I would be using a better set of ETFs than the ones that I listed above.

I write this, knowing that I was disappointed when I started out with my equity management.  Many indicated interest; few carried through.  Small accounts and a low fee structure do not add up to a scalable model unless two things happen: 1) enough accounts want it, and 2) all reporting services are provided by Interactive Brokers.


Besides, anyone could do the rebalancing strategy.  It’s not rocket science.  There are enough decent ETFs to use.  Would anyone truly want to pay 0.2%/yr on assets to have someone select the funds and do the rebalancing for him?  I wouldn’t.