Harry Browne's permanent portfolio is one of the classic risk parity portfolios: the equal weight 4 assets (stocks, gold, long term Treasury bonds and cash) hedge each other with each having similar risk (thus risk parity). Though there have been many studies on how to increase returns by changing portfolio compositions, such as those proposed in the recent Morningstar's article on SeekingAlpha.com or in permanent portfolio shakedown by Butler and Philbrick, many investors have asked an even simpler question:
Can one increase returns (and risk) of a permanent portfolio by eliminating the cash component?
We construct Harry Browne Permanent Portfolio Without Cash that consists of equal weights of the following funds:
The portfolio, similar to Harry Browne Permanent Portfolio, is rebalanced once a year and back tested from 12/15/1989. The following is the performance comparison:
Portfolio Performance Comparison (from 12/15/1989 to 8/29/2012)
|Portfolio/Fund Name||1 Week|
|1Yr AR||1Yr Sharpe||3Yr AR||3Yr Sharpe||5Yr AR||5Yr Sharpe||Since Inception AR||Since Inception Sharpe|
|Harry Browne Permanent Portfolio Without Cash||0.2%||8.1%||7.4%||118.6%||15.9%||184.0%||11.9%||105.3%||8.5%||75.0%|
|Harry Browne Permanent Portfolio||0.1%||6.1%||6.8%||98.4%||11.8%||174.6%||9.0%||105.6%||7.1%||76.3%|
See the latest and more detailed year by year comparison here.
From the above, the portfolio without cash has 8.5% vs.7.1% annualized return over the past 22+ years. What is more, they have about the same Sharpe ratios (0.75 vs. 0.76). If one looks at more closely on the page of the above link, one can see that the maximum drawdown of the three asset portfolio was increased to 20.4% vs. the four asset one's 15.3%.
Since both portfolios have almost the same Sharpe ratio, the three asset portfolio can be considered to be the permanent portfolio that has better returns while preserving similar risk parity -- the three risk assets are still equal weighted, as in the original four asset one. This is an example of a permanent portfolio with increased returns but without leverage.
Investors should be cautioned that by removing the cash component, this portfolio now loses the ultimate stabilizer -- cash. Although the three asset portfolio had done only slightly worse in 2001 and 2008 crises, there is no guarantee that in a severe financial disaster, the long term Treasury bonds can still act as the hedge as expected. This is especially true given at certain point in the coming years, the U.S. treasury bond vigilantes such as Chinese, Japanese and other foreign and domestic institutions might start to dump the Treasury bonds. The serious dumping of U.S. Treasury bonds certainly did not occur in the past 22 year backtest period.
In conclusion, it is interesting to see that by eliminating cash, the three asset 'permanent portfolio' has had almost the exact same Sharpe ratio with the improved returns. However, investors should only use this as a reference as future events will be different from the past.