Variations
On An Original Theme
by Robert B. Gordon, Sc. D.
February 4, 2004
My mind is still building new ideas on the top of old ones in the same way as when I was being paid for my professional skills. In fact, new ideas come to mind so fast that I have to write them down in order not to forget them. Sometime the ideas originate from reading or a readers suggestions and others just come out of the "blue."
This essay arose from my recent rediscovery of an old friend - the Merger fund, another unique one-of-a-kind fund. I had owned it back in the '90s at a time when it had to close to new investors because it could not find enough new mergers and acquisitions to buy. Its size has more than doubled in that time span and it may have to close its doors again to new money at sometime in the bear market future. But, regardless of its size, it has a sure way to earn profits for its shareholders. It always acquires a position where a profit is guaranteed if the deal goes through. The fund only loses money when the proposed deal is not completed for any reason. Since the fund managers have a long and successful record of picking winners, their long term performance record is both high and predictable.
My rediscovery of the Merger fund has led me to look for other possible additions to our current list of stable funds. And, possibly more important, it has led to the idea of building a portfolio which holds only stable funds with different investment policies. If we can find a group of quite different stable funds, we may be able to create a portfolio whose performance might be further enhanced thru a program of periodic rebalancing. Eureka, ultra conservative gains! But, I must caution readers that we may have to settle for a very safe and predictable portfolio without extra gains. It will be interesting to find the answer.
DO YOUR HOMEWORK BEFORE INVESTING
I would never think of investing in a stock or fund without examining its price performance over a period of years. Even if it was one-of-a-kind like the Merger fund, I would compare its chart with other funds to get a view of its relative performance. Charting services are freely available now on a half dozen internet sites. Bigcharts.com, for example offers a ten year chart for comparing the performance of 3 funds or indices that is almost as good as my FastTrack software that can compare any six stock or funds for more than15 years if desired.
For the purposes of this essay, I screened a large group of "conservative allocation" funds over the past 15 years and found just 3 suitable for use: Permanent Portfolio, Merger and a very stable 60% bond 40% stock fund from a smaller no-load fund company. To this group I added the only foreign government bond fund with a 15 year history plus a bond/income fund and a long term U. S, Treasury bond fund from a major no-load fund company.
On my FastTrack computer screen, these 6 funds displayed generally rising price curves over 11 bull years and 4 bear years. In fact it would have been impossible to tell where the bear market started from the data on the screen. The point where the Merger fund had its problem was evident as was its good recovery. The average 15 year performance was 8.9% with Permanent Portfolio fund lowest at 5.9% and the two bond/income funds highest at over 10% each. The Merger fund was just above the average value.
15 YEAR BULL AND BEAR PERFORMANCE
It was encouraging to find 6 excellent funds whose managers performed well over this long period but please remember they were picked after the fact.
| Asset Class | 1/30/1989 | 1/30/2004 | Annualized Gain |
| Foreign Gov't. Bond | $10,000 | $31,400 | 7.9% |
| U.S. Treasury Long Bond | $10,000 | $38,500 | 9.4% |
| Merger Fund | $10,000 | $36,700 | 9.1% |
| Permanent Portfolio | $10,000 | $23,600 | 5.9% |
| 60% Bond 40% Stock Fund #1 | $10,000 | $46,000 | 10.7% |
| 60% Bond 30% Stock Fund #2 | $10,000 | $43,900 | 10.4% |
| TOTAL | $60,000 | $220,100 | 8.9% |
The above results were without any rebalancing. We experimented with 4 intermediate rebalancings and the results showed only a final annualized gain of 7.9 %. It would appear from this first experiment, that either (1) volatile asset classes are needed to produce added gains or (2) more frequent rebalancings are needed.
However, despite this negative result, we would continue to advise rebalancing at any time a two to one difference occurs in a portfolio as shown above. The performance of the Permanent Portfolio fund has greatly improved in recent years, so rebalancing now would surely increase future returns.
It is doubtful that all of these funds will continue to perform as well in the expected severe bear market environment. So, for the one year performance test reported below, we replaced two of them with the Hussman Strategic Growth and Total Return Income funds which are hedged against market losses and are currently performing very well.
ONE YEAR PERFORMANCE OF STABLE PORTFOLIO
Here is the retrospective performance of 6 stable funds selected for suitability in a troubled economy and stock market. We show the total portfolio values after 3 rebalancings:
| Asset Class | 1/20/2003 | 3/14/2003 | 6/13/2003 | 9/30/2003 | 1/30/2004 |
| Foreign Gov't Bond Fund | $10,000 | $10,098 | $10,769 | $11,328 | $11,522 |
| Hussman Total Return Fund | $10,000 | $10,098 | $10,769 | $11,328 | $11,214 |
| Merger Fund | $10,000 | $10,098 | $10,769 | $11,328 | $11,735 |
| Permanent Portfolio | $10,000 | $10,098 | $10,769 | $11,328 | $11,966 |
| 60% Bond 40% Stock Fund | $10,000 | $10,098 | $10,769 | $11,328 | $11,745 |
| Hussman Strat. Growth Fnd | $10,000 | $10,098 | $10,769 | $11,328 | $12,307 |
| Total | $60,000 | $60,590 | $64,617 | $67,937 | $70,489 |
The total performance to 1/30/04 shown above represents a gain of about 17.5% which is very good for a conservative group of funds chosen for reliable performance. This portfolio did show some positive results of the three rebalancings done at short intervals picked from the high and low prices on my computer screen. Without any rebalancing the portfolio grew by 15.9% to $69,516, a lower return of about 1.5%.
INVESTOR RISK TOLERANCE
We have readers whose experience and risk tolerance varies widely. On one extreme, we have veteran investors with substantial experience and also a much larger group with little or no market experience. Most of our writing is aimed at those with less experience. It is hard for me to put myself in the place of the inexperienced so please forgive me for offering some suggestions that do not fit your circumstances.
With my fifty some years of mutual fund experience, I do tend to move quickly when I get new information either good or bad on any no-load fund. I do sell a fund quickly when its performance is declining noticeably but I may be quite cautious in starting a new position. I do not recommend that any new investor move a lot of money quickly into any of my suggestions and feel that a cautious approach is preferred. By that I mean building a portfolio rather slowly to its eventual size. This is especially true for retirees who are investing their nest egg which cannot be replenished.
LEARNING TO TAKE OR NOT TO TAKE LOSSES
The hardest lesson for most investors is learning to take a loss. I do not mean choosing the time to take a loss but the actual physical fact of deciding to take a loss. Many unfortunate people never learn to sell a losing investment. There will be many millions of such investors losing huge sums in the next major bear wave. Since most investors are unable to choose wise investments, they lack the knowledge and ability to make a good sell decision. A few novice investors are so jittery they sell too quickly but the great majority lack the ability to even make a sell decision. They continue to hold losing securities that have no hope of recovery. It is a well known fact that the stocks that were leaders in one bull market never do well in the next one. So much of the bear market losses are not recoverable.
Now, please read this paragraph carefully. Portfolios that are intelligently created along the lines of stable and volatile asset classes should never need to be sold. They do need management and rebalancing and, in time, may need replacement of a single asset class when a real need arises. Really sound classes for bear markets like short funds and gold funds can contribute great profits thru the rebalancing process. They are known to be volatile, so when their prices are low it is time to rebalance by transferring money from the stable assets. Any reader who does not fully understand this paragraph should write me for clarification.
CAREFUL DIVERSIFICATION IS A GOOD THING
In the examples above we have shown quite good results, both short and long term, from a well diversified portfolio of stable asset classes only. Our more conservative readers should consider building such a portfolio and holding it for the long term. The bond/stock income fund has been a fine performer over the past fifteen and one years but will have a tendency to lag during a large bearish decline. If that does happen, I would choose that as a good time to rebalance the portfolio. By transferring capital from the other five funds, it will tend to build profits in any future market move where stocks do well, as in the past year.
In the one year portfolio above, we have placed 6 funds expected to do well in both bull and bear markets. The four named funds are believed to be unique in their structure and management style and should do well. The other two funds have a number of competitive funds that should be considered before making a final selection. In recent weeks we have added the Permanent Portfolio and Merger funds to our stable fund list. The Prudent Global Income fund, PSAFX, which adds some gold stocks to its foreign government bonds is another quite stable fund to consider. We welcome further suggestions from our readers.
Please note that, although we are using only 6 funds, they are sufficiently different in price action to be considered as separate asset classes. If you could see the price chart of these 6 funds on our computer screen, you would appreciate this fact. Hence, although it may be modest, we do expect to find some added capital gains coming from rebalancing. And, to retain the original plan of the portfolio, rebalancing should probably be done at least every two years.
HOW MANY FUNDS ARE NEEDED
In recent months, we have used portfolio examples with as few as two or three funds and an many as ten. In our studies, we have found a very limited number of kinds of stable funds. The stable asset classes listed above represent just about all we currently know enough about to recommend. And, four of the six funds in our one year portfolio are unique.
There are many more funds available in the volatile asset classes but not very many classes. There are scores of precious metals stocks and funds to choose from but they are limited primarily to gold and silver stocks, gold funds and a single gold and silver bullion fund. There are perhaps 20 short funds available which follow the reverse of various market indices and only 2 fully managed funds. which can short any stock they wish.
However, as we have stressed previously, we like to use two, three or even four different members of the short and precious metals group. The reason is that they can be selected so as to have quite different price patterns and hence will add to the capital gains resulting from rebalancing the portfolio.
If you have plenty of money, a portfolio can be as large as you wish. At my present age and health, the only hobby I enjoy is managing a group of different portfolios each of which has from 10 to about 15 asset classes. I enjoy managing them and it takes a very small part of my available time, leaving the rest of my time for reading expert views and writing.
BUILDING A PORTFOLIO
Experienced investors need not read this section but, if you are just getting started, I suggest that you start with a very small portfolio, both in number of funds and money and build it slowly over time as you gain experience. If you build a100% stable portfolio as illustrated above, with no volatile assets, it is OK to move as rapidly as you wish. Readers planning to build a stable/volatile portfolio should complete the stable asset classes and then add the volatile classes last. The stable assets with at least 50% of the money are a fortress which is key to the success of the portfolio. It provides the assets that will be used to rebuild volatile assets which have declined. If the volatile assets do not go both up and down there will not be any capital gains to be taken. A very good way for anyone with questions about the volatile classes to proceed would be to start with a portfolio that is 90% stable and holds only two volatile assets each with 5% of the money. This would provide a sort of slow motion learning experience with no loss of sleep while learning.
For the very faint of heart, there is an easy way to build the 100% stable portfolio. Start with the most stable fund and then add the rest on any desired schedule in order of their one year performance. Under this plan, the six stable funds were be added in this order: Hussman Total Return, Foreign Govt. Bond, Merger, 60/40 Bond Stock fund, Permanent Portfolio, and Hussman Strategic Growth. It should not be assumed that these six funds will perform in the same order as they did in the past year. All we can say with some confidence is that all six of these funds have a sound plan of action and experienced management to carry it out. There are always unknowns ahead in any type of market climate.
A LOOK AHEAD AT THE STOCK MARKET
Completely unknown to the general public is the grim fact that our economy and stock market are about to endure a major crash and depression similar to but almost certainly worse than that of the 1930s. We are not only starting Wave IV of a Grand SuperCycle Elliott Wave sequence but we are entering the "winter" quarter of the long Kondratieff economic cycle. Experts I read are predicting this combination will add up to a scenario more grim than the one that occurred some 70 years ago.
I have been expecting bad times and writing about them for the past two years. That is why I have developed portfolios capable of coping with the bear markets in stocks and have written many warning messages about what is about to happen to an unsuspecting nation.
It would be a good time now, after this huge bear market rally of the past year, for both new and old readers to read or re-read some of my old essays, warning of the bad times to come.
As I write, the stock market appears to be ending its bear market rally which has convinced most advisors and investors that we are in a new bull market.. Please believe me when I say they are very wrong and will be severely hurt by future events. The best thing any investor can do now is to sell all stocks and funds that are unsuited for the coming bear market. Now is the time for action before the devastating events that are about to hit an unsuspecting public.
© 2004 Robert B. Gordon, Sc. D.
Contact Information
Dr. Robert B. Gordon
c/o Roger Gordon
1488 Cynthia Lane
El Cajon, CA 92019
