May 30, 2016: Swensen Portfolio And Permanent Portfolios

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Swensen Portfolio And Permanent Portfolios

We pointed out several times before that David Swensen Individual Investor Portfolio is constructed based on a similar framework of permanent portfolios – the four pillars: growth, (anti-)inflation, (anti-)deflation and safe haven (see August 6, 2012: Four Pillar Foundation Based Portfolio Review):

Swensen, the manager of Yale University Endowment, outlined the one size fit all portfolio for individual investors in his book Unconventional Success: A Fundamental Approach to Personal Investment. The following table shows how his portfolio has compared with other lazy portfolios:

Portfolio Performance Comparison (as of 5/27/2016)

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	10Yr Sharpe
P David Swensen Yale Individual Investor Portfolio Annual Rebalancing	5.0%	2.9%	7.4%	8.5%	7.4%	0.45
7Twelve Original Portfolio	4.7%	-5.7%	1.7%	2.8%	4.6%	0.26
Fund Advice Ultimate Buy and Hold Lazy Portfolio	2.4%	-3.6%	1.7%	3.2%	4.4%	0.3
Harry Browne Permanent Portfolio	6.4%	2.8%	3.7%	4.4%	6.3%	0.79
The Coffee House Lazy Portfolio Index Funds	3.9%	0.2%	5.8%	6.9%	6.3%	0.46
Wasik Nano	3.5%	1.1%	5.7%	6.9%	5.7%	0.38
AssetBuilder Model Portfolio 09	3.2%	-3.7%	1.6%	2.5%	3.9%	0.26

See detailed comparison >>

Swensen’s portfolio has consistently outperformed all other lazy portfolios proposed by other experts for more than 10 years. The outperformance can be attributed to its clear allocation for anti-inflation and anti-deflation. For the past 10 years or so, the outperformance has come mostly from long term bonds and REITs. In his book, he explicitly states the rationale why he chose long term Treasury bonds:

“The purity of noncallable, long-term, default-free Treasury bonds provides the most powerful diversification to investor portfolios”.

Similarly, he suggests to use TIPS (Treasury Inflation-Protected Securities) for anti-inflation purpose.

Putting his suggested portfolio in the above four pillar framework, we can see that Swensen suggested the following:

Growth: 70% = 50% in US, international and emerging market stocks + 20% in REITs

Anti-inflation: 15% in TIPS

Anti-deflation: 15% in long term Treasury bonds

Apparently, Swensen overweights growth (i.e. stocks). This makes sense as stocks have the highest returns in the long term. Unlike other conventional portfolios, long term Treasury bonds offer a powerful hedge when economy/growth falters.

Using the existing Swensen portfolio as a starting point, one can construct various portfolios by scaling allocation weights.

Conservative Swensen Portfolio

One can construct the following conservative portfolio by properly scaling the weights of the funds:

Buy and Hold (Annually Rebalance)
USStks VTSMX 16%
REIT VGSIX 10%
IntlStks VGTSX 7%
EmStks VEIEX 3%

=== Total Growth stocks = 36%

TIPS VIPSX 32%
LBonds VUSTX 32%

The portfolio Swensen Conservative Portfolio has performed quite well, compared with other conservative portfolios and VWINX (Vanguard Wellesley Income Inv).

Portfolio Performance Comparison (as of 5/27/2016):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	10Yr Sharpe
P David Swensen Yale Individual Investor Portfolio Annual Rebalancing	5.0%	2.9%	7.4%	8.5%	7.4%	0.45
Swensen Conservative Portfolio	5.3%	2.5%	4.4%	6.6%	6.7%	0.78
Permanent Income Portfolio	4.9%	4.6%	4.3%	6.2%	6.5%	0.97
VWINX (Vanguard Wellesley Income Inv)	5.3%	4.8%	5.8%	7.5%	7.2%	0.98

See detailed comparison >>

Notice that VWINX’s stock allocation can vary from 20% t0 40%, making it a more ‘tactical’ than a pure buy and hold fund. For example, as of 3/31/2016, the fund allocated about 37% to stocks. Morningstar categorizes this fund as a 30%-50% stocks fund.

Long term TIPS

A similar argument can be used in the anti-inflation corner: in the conventional permanent portfolio such as Harry Browne Permanent Portfolio, gold is used for this purpose. Instead, intermediate term TIPS are used here. To offer a similar hedging effect, one could try to use long term TIPS instead to have much longer duration effect.

As TIPS were relatively new securities (they were first introduced in 1997), only recently individual investors can access to a varieties of such securities. Fortunately, LTPZ (PIMCO 15+ Year U.S. TIPS ETF) is a long duration TIPS fund. We can now alter Permanent Income Portfolio to construct the following Permanent Income Portfolio with Long TIPS:

Dividend-Stocks VDIGX 12.5%
REITs VGSIX 12.5%
TIPS LTPZ 25%
Long-Treasury-Bonds VUSTX 12.5%
Long-Corp-Bonds VWESX 12.5%
Short-Term-Bonds VFSTX 25%

The portfolio’s performance has been improved:

Portfolio Performance Comparison (as of 5/27/2016):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	5Yr Sharpe	Since 9/9/2009
Permanent Income Portfolio	4.9%	4.6%	4.3%	6.2%	1.28	7.6%
Permanent Income Portfolio with Long TIPS	6.1%	4.9%	4.6%	6.9%	1.08	8.2%
VWINX (Vanguard Wellesley Income Inv)	5.3%	4.8%	5.8%	7.5%	1.57	8.7%

Notice since LTPZ started on 9/9/2009, we can only derive the portfolio data up to then.

Such a portfolio is a good alternative to the conventional permanent portfolio for investors who prefer not to deal with gold or commodities due to their high volatility and other reasons.

Conclusions

As it becomes increasingly likely that the pace of inflation might pick up (at least that is what the Federal Reserve is concerned about), investors should consider portfolios that have direct anti-inflation investments. David Swensen’s lazy portfolio uses TIPS to combat inflation while using long term Treasury bonds to combat deflation. The concept, similar to the permanent portfolio, has shown to be effective in the past decade or so – a period that’s mostly plague with deflation.

We have shown that investors can scale Swensen’s portfolio or permanent income portfolio to a risk level that’s more appropriate personally. Using long term TIPS can improve anti-inflation effect in a balanced portfolio, both in a pro growth (overweight in stocks in Swensen’s portfolio) or more neutral (permanent portfolio) portfolio.

Market Overview

Now that earnings announcement for Q1 has been largely over and the Federal Reserve has indicated in various occasions that it’s likely to raise short term rate in the summer, stocks are levitating close to its all time high (still a couple of percentages away). As economy has shown inconsistent growth and company earnings have declined, we maintain our caution.

For more detailed asset trend scores, please refer to 360° Market Overview.

We would like to remind our readers that since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Economies have heavily relied on low interest debts. Capital might be misallocated to unproductive investments and consumption. U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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