More advisors are using the Permanent Portfolio Fund as a hedge.
Michael J. Cuggino was a teenager in 1982, the year
the Permanent Portfolio Fund was launched to battle inflation by
investing in a melting pot of noncorrelated asset classes ranging from
aggressive growth stocks to precious metals to Swiss government bonds.
"I can remember reading about short-term interest rates in the teens,
the bear market, high energy prices and the Fed trying to choke
inflation out of the economy," he says of a time marked by stagnant
economic growth and rampant inflation. "The fund was born in an
environment where investors didn't know where to turn."
That environment changed quickly as the decade matured and the stock market rose from the ashes. During the bull market of the eighties and nineties, the fund's heavy presence in hard assets and commodity stocks seemed as outdated as the long lines at the gas pump and soaring interest rates that helped inspire its creation.
Over the course of several decades, its managers resisted pressure to shed the fund's more unconventional asset classes and let it morph into a typical stock and bond asset allocation offering. The fact that its target weightings have remained intact for more than 23 years is a powerful testament to their conviction to turn a blind eye to market sentiment.
"This goes way beyond your typical asset allocation fund," says the 42-year-old Cuggino, who joined the Permanent Portfolio Family of Funds in 1991 after a six-year stint as an auditor for Ernst & Young, of which Permanent was a client. "We don't try to predict the future by jumping from asset class to asset class, and we're more committed to our categories than just about anyone out there. No matter what happens, having a broad array of noncorrelated asset classes is the best way to realize less volatile returns over the long term."
With rising commodity prices and a declining dollar, the fund these days looks a lot more in step with the times than many of its competitors. The portfolio has a target allocation of 20% of its assets in gold bullion and coins, 5% in silver bullion and coins, and 10% in Swiss Franc assets. Another 15% goes into U.S. and foreign real estate and natural resource stocks, 15% in aggressive growth stocks, and 35% in U.S. Treasury bills, bonds, and other dollar assets. If allocations deviate more than 10% beyond the target, its manager typically rebalances the portfolio to bring them back into line with those numbers. So the allocation in gold, for example, can fluctuate anywhere from 18% to 22% of assets.
Because of the atypical structure of the portfolio many people, including Cuggino himself, have trouble pegging it to any particular style box or investment category. "The reasons people invest in the fund cover the gambit. Some think of it as a core holding, and use specialized investments around it. Others think of it as more of a fixed-income investment because of its low volatility. And many people put it into the alternative investment category."
Benchmarking the fund is difficult, though Cuggino thinks a fair yardstick is the cost of money, as represented by a short-term Treasury bill index. As of March 31, the fund had a return of 5.05% over one year, compared to 1.58% for the Citigroup 3-month U.S. Treasury bill Index. Its annualized return was 13.47% versus 1.38% for the index over three years, 10.18% versus 2.64% over five years and 7.5% versus 3.91% over ten years. It has had only three down years since its inception, and the last of those was in 1994. The fund has also beaten the S&P 500 Index over the last one, three and five years, although the index comes out ahead over ten years.
A Balance Of Assets
To get a pure play on gold prices Cuggino invests in bullion and coins, rather than stocks of mining companies. The strategy, he says, allows returns to hinge solely on the price of the metal rather than earnings reports, quality of management, shareholder demands and other factors that influence stock prices.
The fund's 20% target allocation to gold bullion and coins has benefited from the marked increase in gold prices in recent years. The average price of gold for the month of July 1999 fell to a 20-year low of $256 per ounce, and by March 2001 it was still just $263. After that the price began to rise markedly. By last December the price of gold was at a 16-year high of $442, and it has recently been in the $430 range. Despite the 65% run-up from its low, Cuggino thinks that gold prices have further room for expansion. "The low-hanging fruit in gold and other commodity plays has already been picked, but I believe there are still opportunities for long-term investors," he says.
He cites a number of bullish factors for gold, such as a continued fall of the U.S. dollar, inflationary pressures on the U.S. economy, geopolitical risks and increased consumer demand from China and India. The introduction of new investment products, including two gold exchange-traded funds, should help broaden the investor base in gold and make the market more liquid. Gold mining companies have been unwinding their futures hedges, a bullish indicator that signals they believe prices will rise.
Silver, the other metal in the portfolio, represents around 5% of assets. While it has many of the same investment characteristics as gold, it is also highly sensitive to economic activity because of its use as an industrial metal. Cuggino expects to see the value of silver gradually increase as the U.S. economy grows.
At 10% of assets, Swiss government bonds serve as an offsetting anchor against a decline in the U.S. dollar and provide a balance against U.S.-dollar denominated assets. While the euro and many other world currencies are subject to political pressure, he says, the Swiss franc is less susceptible to such manipulation and has a history of protecting its value. Indeed, the fund has attracted several advisors who are using it primarily as a hedge against the precarious dollar and other potential economic disasters.
U.S. Treasuries and high-grade corporate bonds make up about 35% of the portfolio, with holdings spanning the yield curve. He describes an 18% allocation to short-term Treasury securities with maturities of less than one year as "somewhat higher than normal," a reflection of the trend toward rising rates at the shorter end of the curve that has prompted him to commit more money there than in the past.
"Until last summer the Fed had a very accommodating monetary policy, which is one reason the U.S. dollar has declined against other major currencies," he says. "Now that the economy is growing it makes sense for the Fed to raise rates to head off inflation. As long as rates go up gradually enough to avoid choking off growth, I think it's a good thing for the economy overall." Still, he maintains some of the fund's intermediate and longer-term holdings, because those rates have remained fairly stable and he prefers to avoid making any interest rate bets.
With about 30% of its assets in U.S. equities, the fund keeps its foot in the door of the stock market. About half of the equity allocation is invested in real estate investment trusts and natural resource stocks. The real estate side covers a diversified group of sectors represented by apartment, residential, retail, and office and commercial property REITs.
Cuggino believes that the impact of higher interest rates on real estate sales won't hurt REITs as much as many people think. "I'm not convinced the real estate market is overheated, and there are certainly pockets of opportunity," he says. "Apartment REITs, particularly those that invest in areas where housing prices are inflated, actually benefit from rising rates because buying a house becomes less affordable." He adds that the dividend yield on REITs, while lower than it was last year, is still favorable compared to Treasury securities.
Rising commodity prices, which have already boosted natural resource holdings such as Phelps Dodge, BP and Frontier Oil, should stay robust over the next several years. "We are in the middle of a multiyear supply-demand mismatch in everything from oil to agricultural products," he says. "And with China and India becoming real economic players, there are going to be some very real supply shortages. Clearly, this is an area to be in."
The fund balances its position in value-oriented commodity stocks with a 15% allocation to aggressive growth stocks in about a dozen industry groups. Cuggino identifies industries he thinks will outperform the broad market, then looks for companies with good growth stories. Favored characteristics include a history of earnings, new products and services, a proven ability to bring products from the research stage to profitability and a strong balance sheet.