In our previous article published in April 2012, we introduced the Permanent Income Portfolio. The portfolio is constructed based on the principle of our four pillar foundation. The portfolio is invested in equal amounts in the four corners that accommodate four different economic cycles:
This portfolio is suitable to conservative income investors. The following are the portfolio components:
- Growth: Dividend-Stocks: Vanguard Dividend Stock Appreciation VDIGX or ETF VIG: 12.5%
- Growth: REITs: Vanguard REIT index fund VGSIX or ETF VNQ: 12.5%
- Inflation: TIPS: Vanguard Inflation Protected Securities VIPSX or ETF iShares TIP: 25%
- Deflation: Long-Treasury-Bonds: Vanguard Long Term Treasuries VUSTX or ETF iShares TLT: 12.5%
- Deflation: Long-Corp-Bonds: Vanguard Long Term Investment Grade Corporate Bonds VWESX or ETF iShares LQD: 12.5%
- Safe Harbor: Short-Term-Bonds: Vanguard Short Term Investment Grade Bonds VFSTX or ETF CSJ: 25%.
The four pillar framework is also similar to that of the Permanent Portfolio, hence the name of Permanent Income. Compared with the Permanent Portfolio, it emphasizes income by using dividend stocks and REITs in the growth corner, inflation protected bonds instead of gold (GLD or IAU). Instead of cash, it uses a solid short-term investment grade bond fund.
The portfolio has only 25% exposure in stocks. Thus in the traditional asset allocation framework, it is a conservative allocation portfolio. Investors can use hard assets such as REITs or MLPs (AMJ or AMLP or MLPI etc.). Short-term high yield bond funds or bank notes are also possible options to increase returns with bigger risk.
2012 is a year that experienced weak economic recovery and muted inflation pressure. In such a period, investments in both the inflation and the deflation corners usually have stable growth, while stocks in the growth corner should deliver a reasonable return. The following table shows how the portfolio and its representative investments performed:
Portfolio Performance Comparison
|Ticker/Portfolio Name||2012 Return||1Yr AR||1Yr Sharpe||3Yr AR||3Yr Sharpe||5Yr AR||5Yr Sharpe||10Yr AR||10Yr Sharpe|
|Permanent Income Portfolio||4.9%||5.2%||135.1%||8.9%||175.9%||6.5%||89.7%||7.3%||102.0%|
|Harry Browne Permanent Portfolio||5.5%||4.1%||73.4%||9.2%||141%||6.9%||84.4%||8.4%||103.4%|
1,3,5Yr AR (Annual Returns) are as of 1/15/2013.
See the latest comparison >>
It should be noted that even though the Permanent Income Portfolio had lower returns than Harry Browne's Permanent Portfolio, it had much higher Sharpe ratios. This is not surprising, as the nature of conservative allocation means these portfolios usually have the highest risk adjusted returns, as this risk vs. return graph shows:
Looking ahead, we believe the biggest threat to the portfolio is the upcoming inflation and elevated stock prices. However, as investments in long bonds and stocks usually hedge each other, the permanent income portfolio will navigate through this period, albeit possibly with lower returns.