NEW YORK (TheStreet) -- During the depths of the bear market that followed the financial crisis, some investors desperately sought alternatives to the typical equity portfolio.
One solution, which dates back to the 1980s, is called the "permanent portfolio." In its purest form, this means allocating equal 25% portions to equities (via a broad-based index fund), gold, long-dated bonds and cash. The portfolio is rebalanced once a year.
The basic premise is that one of the four asset classes will always perform well.
The Permanent Portfolio (PRPFX) is a traditional mutual fund based on the permanent portfolio that started trading 30 years ago. More recently the Global X Permanent ETF (PERM) brought the concept to the market in an ETF wrapper.
Both funds are allowed to deviate slightly from the fixed allocation. PRPFX is an actively managed fund. The most recent information from Morningstar shows a bit more than 30% in equities while and the fixed-income exposure currently is invested in shorter maturities as opposed to long-dated bonds.
PERM stays pretty true to the original idea. It holds long-term bonds and uses short-term Treasuries as a proxy for cash, but it includes silver in the precious metals allocation. It also has a globally diversified portfolio of individual stocks that include REITs, instead of a simple index fund.
PERM has only been trading for two years. That isn't very long, of course, but PRPFX has a very long track record, and the long-term performance has been outstanding. For the last 10 years it has slightly outperformed the S&P 500, but with much lower volatility, and for 20 years it has lagged behind the S&P 500. Because of its very low volatility, however, it didn't go down from 2000-2002.
Contributing to PRPFX's success has been the long bull market for bonds and the 10-year rally in gold that ended in 2011.
Things have not worked out well for the permanent portfolio in 2013 regardless of how it was implemented. According to Google Finance, PRPFX is down 1.8% this year while PERM is down 7.5%. PERM's relative underperformance is probably a result of it's holdings of REITs, silver and longer-dated bonds.
An investor who built the portfolio himself or herself with the SPDR S&P 500 (SPY), SPDR Gold Trust (GLD), iShares 20+ Year Treasury Bond ETF (TLT) and a money market fund for the cash would be down 15% for the year through last Friday. Obviously stocks have had a huge rally and are up almost 30% this year while gold is down almost that much and TLT is down 15%.
Any given strategy occasionally will have bad years. The experience of the permanent portfolio seems worse because of how much the S&P 500 has gone up, but it doesn't necessarily make sense to give up on a strategy for having a bad year or two.
It is prudent however to assess a strategy's future prospects. This year provided a microcosm for what can go wrong with the permanent portfolio. The biggest problem this year was gold. The argument for gold is easy to understand and doesn't change much: The Federal Reserve is devaluing the dollar which should cause gold to go up. It also has a low and sometimes negative correlation to equities.
The argument tied to the Fed is on very weak ground as gold peaked 27 months ago while the Fed has continued to buy Treasuries hand over fist. The correlation argument is alive and well as gold has had an almost perfect negative correlation to equities this year. For now there is not much of a fundamental catalyst for gold to go up, so the permanent portfolio would appear to have 25% allocated to something that is relying on hope to go up. Of course, hope is not an investment strategy.
The biggest obstacle for the future of the permanent portfolio in its purest form would be an end to the 31-year bull market in bonds as proclaimed by Barron's over the weekend. People have been able to borrow money essentially for free, but that can't last forever. If Barron's is right and the bull market ended last May, then the permanent portfolio would appear to have 25% allocated to something that can't go up.
As is usually the case, most investors would be better off with a simpler portfolio of fixed income with a shorter duration, equities, maybe a small allocation to gold as a hedge and cash in an emergency fund.
At the time of publication, Nusbaum and clients of his firm had positions in GLD.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.