Growth, Aggressive, Value and Other Stock Plays for the Permanent Portfolio

Over on the forum there were some questions about my latest podcast where I discuss Harry Browne’s use of “aggressive” stocks in earlier versions of the Permanent Portfolio. This is a great topic and it was good question that I think I want to talk about here.

To review, in the last podcast I answer a reader’s questions about why Harry Browne probably switched to using a broad based S&P 500 index for the stock allocation vs. his earlier advice. We have to speculate on his reasons, but my own thoughts were basically confirmed by his former business partner John Chandler that picking “aggressive” stocks is very hard to do in the market.

It is no secret that I am a Total Stock Market index guy and is what I said over and over again to use for the portfolio (or the S&P 500 if that’s what you have access to). But people sometimes want to try to squeeze some more performance out of the portfolio and value investing is usually the first place to look. Now Harry Browne did talk about “aggressive” stocks, but this is a really nebulous term. Same with “growth” stocks. They are nebulous because they require a manager often to make these calls. What is one person’s “growth” stock is another’s “Sell it because it’s gone too high” stock.  If the manager makes a good call then you make money above the market returns. If not, well you know the rest…

Counter-intuitively the best place for volatility is not growth usually, but value stock funds. This is because value funds often are filled with companies that have been the most beaten down in price. So, the idea goes, that they are more likely to benefit from a good recovery because they have the furthest to go back up to hit the mean Price to Earnings and Price to Book ratios. Whereas growth stocks have been getting all the attention and the stock prices have been driven very high already. This is usually not a good idea to invest in companies that everyone wants to buy right now.

In fact, if you look at the three IShares Russell 3000 index funds (blend, value and growth) you see that the value funds tend to have slightly more Beta and more volatility as shown in standard deviation. Beta is the measure of a funds volatility over that of the general stock market. The higher the number above 1.0 the more the fund moves in relation to the stock index. Standard deviation is a measure of how much the returns can swing up and down. The higher the standard deviation, the more volatile the fund tends to be on price swings (both in good years and bad years).

iShares Russell 3000 Blend Beta: 1.03
iShares Russell 3000 Value Beta: 1.07
iShares Russell 3000 Growth Beta: 1.00

And std. deviation

iShares Russell 3000 Blend std. deviation: 18.41
iShares Russell 3000 Value std. deviation: 19.16
iShares Russell 3000 Growth std. deviation: 18.36

Even in small cap you see a slight edge to the Value:

iShares S&P 600 Small Cap Blend Beta: 1.16
iShares S&P 600 Small Cap Value Beta: 1.20
iShares S&P 600 Small Cap Growth Beta: 1.13

iShares S&P 600 Small Cap Blend std. deviation: 22.33
iShares S&P 600 Small Cap Value std. deviation: 23.07
iShares S&P 600 Small Cap Growth std. deviation: 21.85

So in the above you can see a slight edge to the value funds for Beta and Std. Deviation which means they tend to be more volatile than the market in general. But again look at the differences in these funds. It’s negligible. Now these funds have been around less than 10 years, but you get the idea that it’s not a slam dunk as many may believe. When you wrap in the turnover costs, taxes and generally higher expenses involved with the value funds the differences become very blurry in terms of real world performance.

Now we could argue that a tilt to small value is best. And some people do this. But I prefer to optimize for my taxes and a market efficient portfolio so it’s not something I do. BUT if you really want to do it, then just use a good index fund and don’t tinker too much afterwards. Realize that you may have market tracking error and be prepared to wait it out if you are lagging the market every now and then. Most people won’t be able to do this. IMO. I think most are better served by using a broad based Total Stock Market index fund because they will have less regrets.

Lastly, Beta is a backwards looking measure. It tells you what the fund did, not what the fund will do going forward. So building a portfolio on things like Beta (or Alpha) alone is not a good idea. One year Beta could be great, but then a bad streak hits and it can go against you quickly.

The above is why I advocate the Total Stock Market style funds and not to try to get tricky trying to beat the market. When you own the Total Stock Market you hold large and small value and growth stocks together so you benefit no matter what is doing the best. The idea of picking more volatile stocks sounds great in theory, but in practice it’s almost impossible to do consistently.

Hope that explains my position a little better.

Craig Rowland

I own the place.

6 Responses

  1. Rick says:

    This type of entry is why you are on my RSS feeds.

  2. Dog Training says:

    Off topic:

    Craig: Please put your “Gear Store” link in one of the tabs at the top of your blog. I occasionally like to reference your gear recommendations, but can never find your store.

    Also– how much more marginal utility is the more expensive Mora knife, compared to the economical one? In other words– can I get away with buying the cheaper one in most cases?

    Adam “Coffee”.

  3. craigr says:

    I put up a link.

    The cheaper knife will serve you well. The more expensive one has a stronger blade. The biggest jump in quality is going from the Mora to the Fallkniven F1 by far. That’s the sweet spot for me if you just want one knife to last you a long time.

  4. Dan says:

    If someone could devise a fund of almost all non-dividend or low-dividend paying stocks (if it has not already been done), wouldn’t that work because stocks that consistantly, safely pay high historical dividends tend to be MUCH less volatile from what I’ve seen than your average growth stock.

  5. MachineGhost says:

    Beta and volatility are not the proper criteria for selecting stocks in the HBPP. Such stocks should do well in times of prosperity; the correlations of the other three assets depend on that. Value stocks do best in times of recession/tight money which is what the cash/bonds is for and underperform in periods of prosperity.

    Anyone that believes otherwise needs to preset long-run historical evidence. PP is a macro asset allocation, not slice and dice.

  6. Isn’t the purpose of having a diversified stock index in the HBPP to provide the opportunity for growth while minimizing the potential for losses in a downdraft? That is, shouldn’t the HBPP 25% stock component be diversified so as to bulletproof returns from the ravages of the business cycle.

    VTI or VT and their equivalents among SPDR, iShares and Schwab ETFs contain both value, growth and blends of both.

    Also, isn’t the purpose of the HBPP to construct a portfolio that withstands the volatility induced by the phases of the business cycle?

    My vote is to ignore the noisy conversation of the pundits and to maintain the course Harry Browne set:

    Buy the most diversified funds we can get for each asset class. Invest 25% in each of the 4 asset classes. Rebalance when the 4 positions get out of balance either once a year or when a pre-determined tolerance band is reached, say +/- 10 or 15%.

    So we construct the portfolio to maintain a structure that weathers all economic conditions and protects us from most risks, except event risk (such as the Japanese earthquake).

    The HBPP provides us a way to preserve and to increase real values of assets by being invested in them all the time. It also, with great reverence, forces us to sell out of above-average yielding asset classes and forces us to buy into the below-average asset classes.

    I sleep well at night knowing I’m structured to preserve our wealth and to take advantage of the positive phases of the business cycle employing a 50/50 split between the Permanent Portfolio Fund (PRPFX) and the Harry Browne 4 by 25% ETF portfolio that substitutes VT for VTI.

    Marshall Costantino :+>)