Smoothing Out Returns

Terry Flanagan

Investing is about combining one’s risk appetite with a view about how a particular stock, bond, asset class, or geographic/industry sector will perform either in the short term or long term. Absolute-return strategies seek to blunt the inherent fallibility in making predictions by investing in a mix of asset classes, with the idea of smoothing out returns.

An example is Permanent Portfolio (PRPFX), a mutual fund that seeks to preserve and increase the purchasing power value of its shares over the long term. Designed as a core portfolio holding, the fund does not attempt to anticipate short-term market activity or predict future economic events, but rather it tries to limit downside risk while providing for profit potential in any environment.

The fund seeks to achieve its objective by investing in a diversified mix of non-correlated asset classes, chosen for their long term potential to preserve purchasing power, pursue high profit potential, achieve low volatility and provide international diversification.

“The philosophy behind the fund is that we don’t believe people are very good at predicting the future, whether it’s football games or the weather or the direction of markets, interest rates, economies, political events, etc.,” said Michael Cuggino, president and portfolio manager of San-Francisco based Permanent Portfolio Family of Funds, which manages $5.7 billion. “This portfolio was designed to get around that weakness in human nature as it relates to investments and a core portfolio holding. When you start with the objective of growing and maintaining purchasing power over the long term, you’re taking into consideration multiple market environments.”

Permanent Portfolio achieves its investment objective by investing at all times in a wide variety of different and non-correlated assets. Even if an asset class is not popular, is out of favor, is being sold off, etc., it still maintains an investment to it on the theory that while it’s out of favor today, it may not be out of favor tomorrow.

“We feel that combining all these assets in one portfolio, while some of them may be volatile assets at times, may have wide fluctuations in short-term value, in the long term putting a bunch of these non-correlated and potentially vulnerable assets in one portfolio tends to reduce overall volatility and still grow gradually over time the portfolio’s base of assets,” said Cuggino, whose investment advisory firm, Pacific Heights Asset Management, has been managing the Permanent Portfolio Family of Fund’s four portfolios since 2003.

Over the last ten years, PRPFX has captured most of the return of the S&P 500 with only a third to half of the risk, according to Cuggino. “Over the last true market cycle, where you had a recession and sell-off in equities in 2000 until now, or roughly a 15-year period, we’ve almost doubled the return of the S&P 500, even with the last six years of the bull market, “ he said.

PRPFX, which was launched in 1982, “was doing this sort of multi-asset class, absolute return type of investing long before such categories existed,” Cuggino said. “It’s got a long history of operating in multiple market environments using multiple asset strategies.”

He continued, “There is a longer-term performance there that does mute the downside risk. We’ve only had four or five negative years in our 33-year history.”

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