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Browne’s Permanent Portfolio Vs. Porter’s ETF Retirement Portfolio

Summary I construct and examine three ETF-based portfolios that follow Harry Browne’s “Permanent Portfolio” investment advice. I compare the best of my three portfolios with a mutual fund and an ETF that are also based on Browne’s advice. I compare my ETF retirement portfolio against the Permanent Portfolio candidates in terms of both total return and dividend yield. My last article drew some rather critical comments, some of which were quite interesting; 1 one comment in particular brought up the Harry Browne Permanent Portfolio – something I had not encountered before. 2 In this article I take a look at the Harry Browne Permanent Portfolio (hereafter, HBPP ), what it might look like populated with ETFs, and how it might perform. The Strategy Harry Browne’s strategy is articulated in his book, Fail-Safe Investing: Lifelong Financial Security in 30 Minutes . It also seems to be a regular topic of conversation on the internet. 3 The strategy is based on a simple premise: a safe portfolio will be diversified according to types of investments that provide performance during particular economic environments. Browne identified four types of holdings and the economic state each type was geared to: U.S. stocks , which will perform strongly during a prosperous economy (apparently using an index based on the S&P 500); Long-term Treasury bonds , which will do well in prosperous times, but also during deflation; Cash (money-market funds) in recessions; Precious metals (specifically gold) during inflationary periods. 4 According to Browne, the portfolio should be divided equally between the four sections: Browne felt that index funds would be appropriate for the stock portion, and preferred a fund based on the S&P 500. He also preferred that the precious metal be gold, in the form of gold bullion coins . Other than those preferences, nothing seems to have been written in stone – hence this is more of a portfolio allocation strategy , rather than a hard and fast portfolio description. HBPP is intended to be permanent ; not that the investor should expect to be able to set it up and walk away, but that it should only require minimum maintenance. Periodic rebalancing is desirable, either annually or – as suggested by many – when any section of the portfolio becomes more than 35% or less than 15% of the portfolio overall. Certainly, if any holding in the portfolio becomes unsuitable, it should be replaced. A Suggested Portfolio ETFs became popular about 25 years after Browne developed his strategy, but it seems that ETFs would be particularly well suited to HBPP ; 5 all that is needed is to choose a fund for each section of the portfolio. Here’s where we encounter some “controversy.” Browne suggests that one should use at least three funds to cover stocks, 6 but there is indication that Browne himself used only one. I tried three formulations. In one (the first one I tried) I used: SPDR S&P 500 ETF (NYSEARCA: SPY ) SPDR Gold ETF (NYSEARCA: GLD ) iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) / SPDR Barclays 1-3 Month T-Bill ETF (NYSEARCA: BIL ) 7 I will refer to the above portfolio as HBPP1 . The second portfolio I considered used three funds for stocks and two for precious metals: Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP ) First Trust NASDAQ-100 Equal Weighted ETF (NASDAQ: QQEW ) SPDR Global Dow ETF (NYSEARCA: DGT ) GLD ETFS Physical Precious Metal Basket Shares (NYSEARCA: GLTR ) TLT iShares Short Treasury Bond ETF (NYSEARCA: SHV ) I will refer to this portfolio as HBPP2 ; for the stocks, RSP receives 12.5%, with QQEW and DGT getting 6.25% each. 8 GLD receives 25% until 22 October 2010, when GLTR was issued; at that point GLD receives 15% of assets and GLTR receives 10%. The third portfolio represents an effort to simplify HBPP2 by returning to the one-ETF-per-section mode: Oddly enough, I called this formulation HBPP3 . I tracked the performance of each of these portfolios back to 1 January 2007, and ran a test through 23 October 2015 for each. I decided to “compromise” between the two rebalancing schemes suggested by Browne: I rebalanced HBPP1 in June 2007 to switch from SHY to BIL, and switched HBPP2 in October 2010 to add GLTR. Other than that, I checked distribution of assets in June and December of each year; if a fund was weighted more than 30% of the portfolio as a whole – or less than 20% of the portfolio – I rebalanced. The following chart shows how the three portfolios performed: (click to enlarge) HBPP1 (which was the first formulation I tested) turns out to lose quite decidedly to the other two formulations. I initially tried HBPP2 to see if there was a difference between using a single equity fund and the three-fund equity position. 9 I also added GLTR to broaden the precious-metal holdings a little. HBPP2 clearly defeated HBPP1 , and it seems it does so shortly after the rebalancing that was needed on 2 January 2009 – after that point HBPP1 started to gradually lose traction. All else being “equal,” it seemed the combination of three equity funds and two precious metal funds did the trick. 10 What interested me the most at this point was the extent to which swapping RSP for SPY made any difference, which was why I tried HBPP3 . And clearly, HBPP3 outperformed HBPP2 , and there is some reason to believe GLTR dragged HBPP2 down. GLTR was added to the portfolio on 22 October 2010 (at which time the portfolio was rebalanced), and it is after that point that HBPP2 begins to fall off. 11 There would not be another rebalancing until 1 July 2012(and then, for HBPP3 only – HBPP2 would not get rebalanced again until 1 July 2013), and by that time HBPP2 had noticeably diverged from HBPP3 . 12 So, HBPP3 , with only one ETF for each of the four sections of the portfolio, is the one which provides the best performance of the three portfolios tested. The following chart shows the performance characteristics for each of the four component ETFs: (click to enlarge) The performance for the components gives a good indication of why the performance of the permanent portfolio is fairly smooth and constant. As one component decreases the others increase, and the general trend for all of the funds is to at least stay constant. Most elements move fairly regularly, the only exception being GLD. The precious-metal fund has a dramatic rise from late 2008 into late 2011, then begins to cool off. The drop in gold prices has been persistent for the past three years, although it is expected to become somewhat bullish as early as 2016. 13 That attitude is not shared by everyone, however. 14 The only ETF that seems completely dependable is SHV, which is up just over 1% for the 8-year period tracked. Overall performance The following chart shows the overall return from HBPP3 since 2007: (click to enlarge) The portfolio earned $1,581.79 in dividends and interest over the nearly nine-year period tested, resulting in a total return on the initial $10,000.00 investment of $7,005.32, or a total return of 70.05%. This amounts to a compound annual growth rate (CAGR) of more than 6%. Its yield (TTM) is 1.80%. How HBPP Compares to “Browne’s Own” Permanent Portfolio In 1982 The Permanent Portfolio Family of Funds offered a mutual fund, Permanent Portfolio (MUTF: PRPFX ). Harry Browne was himself one of the founders of the fund; however, PRPFX is not strictly structured as Harry Browne had specified in his writings. Still, it strives to achieve the same sort of equilibrium between portfolio components; specifically: 35% Dollar Assets (government & corporate bonds) 25% Precious Metals (20% gold, 5% silver) 10% Swiss Franc Assets 15% Natural Resource & Real Estate Stocks 15% Aggressive Growth Stocks The fund’s performance is represented below: (click to enlarge) The Global X Permanent ETF (NYSEARCA: PERM ) tries to be faithful to the spirit of Browne’s writings, but still does not quite capture the essence of the four-way division of the portfolio: 57. 92% U.S. Bonds, Financials and “Other” ( 48.91% short-term bonds!) 13.26% Precious Metals (9.71% gold, 3.55% silver) 28.83% Equities (short- and large-cap & international equities, real estate & materials) PERM ‘s performance since its inception in 2012 is reflected below: (click to enlarge) PERM ‘s performance to date seems to indicate why ETF.com judges that the fund “lacks investor interest”, and why they “see high fund closure risk.” 15 A Comparison A comparison of the three representations of Harry Browne’s Permanent Portfolio would seem appropriate. Furthermore, since the discussion of Browne arose from my article on changes to the ETF retirement portfolio, I thought it would be interesting to see how the retirement portfolio stacked up. In the following chart I provide the performance and total returns for HBPP3 (I will simplify this to HBPP ), PRPFX and PERM , along with the chart for ETF/R-A . 16 The comparison runs from 1 January 2014 through 15 October 2015; all performance data pertains to that period of time only. Each portfolio began with an initial cost basis of $10,000.00. Dividends/interest were not reinvested. (click to enlarge) PRPFX clearly has not fared well over the past 20 months. Even though it is up more than 243% historically, it has seen a drop of 1.81% over the trial period. 17 On the other hand, PERM – which had been losing – actually experienced a 5.11% growth over this period. Its growth was not overly facilitated by its annual dividend, which was $0.23/share, or $101.16 for purposes of the test. 18 Both HBPP and ETF/R-A put up superior numbers, with the retirement portfolio showing a 7.82% total return, and my rendition of the permanent portfolio topping that at 9.74%. Should I switch my money to HBPP ? Good question. Assessment The answer: no – at least, not yet . The following graphic gives a clearer (at least, less cluttered ) picture of HBPP and ETF/R-A : (click to enlarge) HBPP does outperform ETF/R-A by 192bps – nearly two full percentage points – and that is significant. However, scoping the full chart, it is clear that ETF/R-A is not exactly a performance slouch. Indeed, it seems to be only during the past three or four months that HBPP has led it consistently – otherwise, it seems that ETF/R-A has the advantage. A possible reason for the retirement portfolio’s recent performance is that it is equity-heavy compared to HBPP , which has “non-performing” short-term bonds and reasonably performing long-term bonds . Could these have countered any equity-based downwards pressure? Well, that is why Browne thought a permanent portfolio should have them. The real question is: will HBPP continue to outperform the retirement portfolio? Until I get a clearer picture over the next several months, I will stay with the portfolio I have. However, HBPP seems to have a lot going for it over the long haul. It is worth keeping an eye on. A Word About Yield Some readers of my last article noted – with some displeasure – the appearance that some changes made to ETF/R-A reflected a preoccupation with yield, and the chart above illustrates another reason why I am reluctant to switch from ETF/R-A to HBPP : the retirement portfolio beats the yield of HBPP by a very healthy 417bps . So, why a focus on yield ? From the outset last year, one of the ideas behind the retirement portfolio has been achieving a yield of at least 5% . This is in response to the traditional wisdom that advises retirees to figure on withdrawing about 4% from their portfolios per year. It struck me at the time – and still does – that it is possible to secure more than that in yield while still providing for a modicum of value growth. If the retirement portfolio continues to perform along its current lines, I will have achieved my goal . Why focus on earning the money in dividends, rather than capital gains? There are two reasons: First , making 5% or more in yield provides the ready cash to withdraw from the portfolio without disturbing my capital base. Otherwise, if I need funds I have to sell shares. Selling shares (if I am at all successful in choosing good ETFs) would involve capital gains (in addition to diminishing my capital). Unless the account is tax-advantaged, I’m going to have to pay higher taxes on those gains than I would on an equal amount of dividends (supposing the dividends were all eligible for the lower tax rate). If accumulated dividends become greater than foreseeable needs, I can always re-invest the excess. And since one has to pay taxes on dividends regardless, using them doesn’t constitute an extra tax burden. 19 Second , selling shares may involve transaction costs – which costs are typically due even if one has the shares in a tax-advantaged account. Investor-managed accounts may not involve large costs (and some accounts are free – at least, to a point), but transactions performed on a regular basis are going to add up. Dividends, on the other hand, do not usually incur transaction costs when withdrawn – it is simply a matter of transferring funds. Some institutions may even offer the service of automatically paying one’s dividends to one’s checking account instead of leaving them in the investment account. This would typically be done without charge. 20 Ultimately, this becomes a matter of personal taste and investment style. My concern has been with the interests and needs of retired investors who want to maximize the functionality of their investment accounts while minimizing their efforts to maintain those accounts. Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from the Company’s Prospectus, Statement of Additional Information, and fact sheets. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from Yahoo! Finance . Data from any other sources (if used) is cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. 1 ” Major Changes In My Retirement Portfolio .” 2 My thanks to the reader, Edwardjk , for mentioning the portfolio strategy – very interesting, and worth a long-term look. 3 The main website to see is Browne’s own site, harrybrowne.org , although Mr. Browne died in 2006; a record of the Permanent Portfolio’s performance is here , but it only covers from 1970 – 2003. A concise description of the strategy can be found in the article ” Harry Browne s Permanent Portfolio: When You Can’t Afford to Lose Money ,” by Jason Jenkins. A more general discussion is presented by J.D. Roth in ” Fail-Safe Investing? Harry Browne s Permanent Portfolio .” Bogleheads.org , a site catering to Jack Bogle enthusiasts, has blogs such as this , as well as discussion groups. 4 Roth, here . 5 For his part, Browne used mutual funds in the original formulation of the portfolio, and only added one mutual fund to his list of suggestions in the 2001 update. 6 Fail-Safe Investing: Lifelong Financial Security in 30 Minutes, Harry Browne (St. Martin’s Griffin, 2001), p. 160. 7 BIL, which seems particularly useful in the capacity of “money-market” fund, was not issued until May 23, 2007; to bring that part of the portfolio back to January 1, 2005, I used SHY. Since neither SHY nor BIL actually grows in value much, there is little difference between the two. Browne’s intent in specifying cash, however, was to limit exposure to interest rates, and BIL is better suited to that purpose. 8 This keeps the weight on the S&P 500, and U.S. stocks in general, while adding a few foreign equities through DGT; this strikes me as keeping in the spirit of diversified investing while staying faithful to Browne. 9 I used RSP for S&P 500 coverage because – from previous study – I knew that it would outperform SPY. See my ” Guggenheim s RSP: Equal Weight Or Dead Weight? ” 10 The shift from BIL to SHV (which was made because SHV does pay an occasional distribution, while BIL has only paid one in the past four-plus years) shouldn’t matter. Neither fund undergoes any noticeable change in value in the course of the trials. Distributions paid over the past five years have been barely noteworthy. 11 The timing is the main reason why I see GLTR as being the issue, but it is also likely that DGT and/or QQEW played a role. 12 And only HBPP3 was rebalanced in 2012; HBPP2 would not get rebalanced again until 1 July 2013 – the last rebalancing that was needed for any portfolio. 13 ” Barrick Stays Bullish as Gold Prices Head for Third Annual Drop ,” Bloomberg. 14 ” Gold, silver set for more pain into 2016: poll ,” Reuters. 15 ETF.com . 16 ETF/R-A, for those who are interested, was discussed in my article; it contains the changes in ETFs that were made, but did not include the capital injection from accrued dividends that were part of the actual portfolio. 17 The rather severe drop shown just before 2015 is the result of a nearly $800.00 loss (-7.92%) on 10 December that was offset by a dividend payment of $3.17/share ($733.80 total, for this test). The fund’s current yield of 8.21% may be somewhat misleading – historically, its yield has been much less than $1.00 per share per year. 18 PERM’s yield is currently 0.98%. 19 I am not a tax expert. Each individual should consult their own tax advisor concerning the taxability of their investment income. 20 Investment companies differ in their policies about transaction costs and fees for services. Consult with your banker and/or broker to determine how your activities are charged.

A Bond-Free Portfolio: Why Cash Should Replace Bonds To Reduce Risk And Improve Returns

Summary Most conservative investors think that bonds should hold the largest position in their investment portfolio. Cash or “near cash” has become a major investment medium that is included in the majority of individuals’ portfolios. Can replacing bonds with the current near cash alternatives provide better long-term results and reduce overall portfolio risk? In a recent interview, Howard Marks, the great investor and co-chairman of Oaktree Capital, quoted the original Dr. Doom, Henry Kaufman, who once said “There are two kinds of people who lose money: those who know nothing and those who know everything.” Those of us who are selling investment services, whether portfolio management or investment products, have a tremendous ability to locate or create research that rationalizes our approach to building and maintaining a portfolio. Because we spend so much time and effort in this process we can become one of “those” who think they know everything, and as a result, disregard our primary purpose, which is to help people preserve and grow their wealth. This month, I want to share with you some thoughts on asset allocation. These views are contrary to the conventional approach that has been used quite successfully for decades; the basic stock, bond, and cash mix. The question we will try to answer is why cash is held in lesser amounts and only used to meet current needs or as an opportunistic buying reserve for stocks and bonds. Welcome New Members Before we begin, I want to take a moment to welcome all the new and returning members into the largest investment club in the world, the “Buy High, Sell Low Club.” Given the horrendous market returns beginning in August and running wild through the end of September, the club’s membership has grown so much that it can only hold meetings in cyberspace, as there is no location in the world that could accommodate all of the members. In my early years, I was a card carrying member of the club. I first joined in the seventies and rejoined again early in the eighties. I am happy to say that since I have again let my membership expire, I have been able to resist the urge to renew. I am just as happy to say that you have also been able to resist this club’s temptations. And if you haven’t noticed, since the end of September the markets have been recovering quite nicely. Some of you may think that resisting the club’s pull is easy. However, regret and the ever-present destructive forces of “should’ve, would’ve, could’ve” can be more agonizing than watching your portfolio value decline. For me, even though I have been rewarded with a very attractive long-term return on my capital, during those times when markets acted badly, I did not know when or if my portfolio would recover its value. I had to rely on my training, experience, and yes, faith that the businesses we own would find a way to grow their profits and dividends. If you feel at any time that the sirens’ call of the club is hard to resist, please let us know. We will do all we can to help, and together we will work towards finding a solution that we hope will be best for you. Asset Allocation I would venture to say that the majority of financial professionals believe asset allocation, not security selection, is the primary driver of portfolio returns. There are also just as many who think stocks are risky, bonds are safe, and cash has little use in a portfolio. Because of this, the majority of conservative investors think that bonds should hold the largest position in their investment portfolio. This belief is reinforced through the use of target date funds, which are held by so many individual investors in their 401K plans. Most target date fund investors take the time to read the literature, which says the fund will be less risky as they get closer to their retirement date. This is accomplished by holding less stocks and more bonds. This belief is also reinforced by Jack Bogle, the well-known founder of the Vanguard Funds, who has over the years told individuals that their basic allocation to bonds should be equal to their age. If you are 50 years old, your portfolio should be invested 50% in stocks and 50% in bonds. At age 70, it should be 30% in stocks and 70% in bonds. At age 25, you should have 75% of your money in common stocks and just 25% in bonds. This belief has also been reinforced by academics whose financial research influences the asset allocation of large pension plans, endowments, foundations and trusts. For a majority of institutional investors, a portfolio with 60% in common stocks and 40% in bonds is the norm. Variations from this norm are not taken lightly, and most are done only under the guidance of professional advisors who place bets on multiple alternative investments in hopes of earning superior returns. The greatest reinforcement of all has been bonds themselves. For the past 35 years, they have performed admirably, producing results that reassure investors they are safe. They have not lost money, and depending on when they were purchased could have increased capital, all while providing a respectable rate of return as readily spendable interest payments. With all of the good things bonds have done for investors, how could I have the audacity to suggest that a bond-free portfolio for individuals is appropriate, and that cash should replace bonds to reduce portfolio risk and increase returns? My thoughts on asset allocation were highly influenced by two individuals. The first I have written about many times, the great Benjamin Graham. Through his work I learned that the safety of capital is directly related to the price paid relative to the intrinsic value of both stocks and bonds. The second was Peter L. Bernstein, whose writings gave me some basic training in understanding the nature of risk and the primary place it holds in asset allocation. Benjamin Graham and Portfolio Policy Prior to reading Benjamin Graham’s Intelligent Investor , I thought very little about asset allocation, as I was far more concerned with the problem of feeding my family. This conflict caused me to do what many in our industry continue to do today: “sell what you can.” Armed with little training and having faith in the wisdom of the firm, I sold whatever product they happened to recommend at the time. I think all of you will agree that this is not the most intellectual approach to financial advice. In Chapter 4 of The Intelligent Investor , titled “General Portfolio Policy: The Defensive Investor” Graham writes this: We have already outlined in briefest form the portfolio policy of the defensive investor. He should divide his funds between high-grade bonds and high-grade common stocks. We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums. According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the “bargain price” levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high. At the time of Graham’s writing, the options for the average investor were almost limited to individual common stocks, with only a few opportunities in high-quality bonds. Of course the world has changed, and the explosion of new product introductions from the financial engineers on Wall Street allow almost everyone, even those with limited savings, to participate in hundreds of other assets beyond stocks and bonds. However, the majority of individuals today still use the basic stock/bond portfolio. And with the popularity of target date funds, I believe this will continue far into the future. The greatest change since Graham is the ability to earn a competitive interest rate on cash. Beginning with FDIC Insured deposits, including certificates and money market mutual funds, cash or “near cash” has become a major investment medium that is included in the majority of individuals’ portfolios. Peter L. Bernstein, Risk, and Diversification On just a few occasions I have shared the wisdom of Peter L. Bernstein with you. Even though I have some ideas contrary to his thoughts, there is no question of his influence on my understanding of risk, which shows in how we manage your portfolio. He is best known for his book, Against the Gods: The Remarkable Story of Risk, which sold over 500,000 copies worldwide and is still widely available. It should be required reading for all investment professionals. Bernstein was an investment manager, teacher, author, economist, and financial historian. In addition to 10 books, he authored countless articles in professional journals. One of these, titled How True Are the Tried Principles? , appeared in the March/April 1989 edition of Investment Management Review. This short article had a significant influence on my investment approach to building and maintaining balanced portfolios for conservative investors. I want to highlight a few portions of this article. Mr. Bernstein states, without reservations, that “bonds should trade places with cash as the “residual stepchild” of asset allocation to reduce portfolio risk and improve returns.” This is controversial, as there is almost universal belief that bonds are “safer” than stocks and by default will reduce risk. Risk as defined by most academics is not a permanent loss of capital, but the volatility of the market value of a portfolio. To minimize risk, we therefore just have to reduce the volatility of the portfolio’s market value. The preferred approach to accomplish this is through diversification. Mr. Bernstein’s words about diversification: Let us consider for a moment how diversification actually works. Although diversification helps us avoid the chance that all of our assets will go down together, it also means that we will avoid the chance that all assets will go up together. Seen from this standpoint, diversification is a mixed blessing. In order to keep the mixture of the blessings of diversification as favorable as possible, effective diversification has two necessary conditions: (1) The covariance in returns among the assets must be negative; if it is positive, we will still run the risk that all assets will go down together; and (2) The expected returns in all the assets should be high; no one wants to hold assets with significant probabilities of loss. Here’s a little reminder about covariance and your portfolio. If the market value of your stocks and bonds go up or down at the same time, then the stocks and bonds’ covariance is positive. If the value of your stocks goes down and the value of your bonds goes up at the same time, then the covariance is negative. To limit the volatility in your portfolio, you would want your bonds to produce positive returns when the market value of your stocks goes down. Mr. Bernstein’s words about covariance: Consider covariance first. We know that the correlation between bond and stock returns is variable, but we also know that it is positive most of the time…Stock returns correlate even more weakly with cash, but such as it is, the correlation between stocks and cash is negative. Bonds and cash also correlate weakly, but the correlation here tends to be positive. Monthly and quarterly bond and stock returns are simultaneously positive over 70% of the time. This ratio increases as we lengthen the holding period, as all assets have a higher probability of positive results over the long run. The meaning is clear: most of the time that bonds are going up, the stock market is also going up. Unless bonds tend to provide higher returns on those occasions, they will be making a reliable contribution to the overall performance of the portfolio only during the relatively infrequent time periods when the bond market is going up and the stock market is going down. Even though many of us believe when stocks go down, bonds go up, and vice versa, this has not been the case. Given that bonds fail as a diversifier to reduce risk, why do so many people hold bonds? The only reasons are that bonds, in most occasions, pay a higher current income than both stocks and cash, and historically have been less volatile than common stocks. Today is one of those few occasions when dividend yields on common stocks exceed those of bonds. The current dividend yield of the S&P 500 is 2.12%. Compare that to the yields on US Treasury Obligations: 1-Year Maturity 2-Year Maturity 3-Year Maturity 5-Year Maturity 10-Year Maturity 0.23% 0.61% 0.91% 1.36% 2.04% Source: U.S. Department of the Treasury as of 10-16-2015 If bonds provide less income than common stocks, and the benefits from diversification are limited to only a few occasions that happen infrequently, can replacing bonds with the current near cash alternatives provide better long-term results and reduce overall portfolio risk? Mr. Bernstein’s words about cash: Although cash tends to have a lower expected return than bonds, we have seen that cash can hold its own against bonds 30% of the time or more when bond returns are positive. Cash will always win out over bonds when bond returns are negative. The logical step, therefore, is to try a portfolio mix that offsets the lower expected return on cash by increasing the share devoted to equities. As cash has no negative returns, the volatility might not be any higher than it would be in a portfolio that includes bonds. …The results of a portfolio consisting of 60% stocks, 40% bonds, and no cash (are compared) with a portfolio of 75% stocks, no bonds, and 25% cash….The results are clearly in favor of the bond-free portfolio, which provides higher returns with almost identical levels of risk. As each of you are aware, we have let our bond holdings mature without reinvesting the proceeds, deferring to allocate our fixed income holdings in short-term bank deposits, CDs and, if available, stable value funds. The rationale has far more to do with our expected rates of returns of common stocks relative to bonds, and the increased risk of bonds in a period of low interest rates. Given the current rates paid, bonds are very vulnerable to negative returns. If interest rates are higher in the near future, then the market value of the bond principal could easily fall well beyond the amount of interest income received. Cash, on the other hand, will not suffer at all. In fact if rates increase, cash will add positive returns to your portfolio. As for common stocks, the income received in dividends is likely to be much higher over the next ten years than it is today. If dividends do increase, as we expect, the market value of common stocks should produce positive returns at least equal to that growth in dividends. Bonds, however, will be limited to the interest rates paid today with no increase in income at all. _______________________________________________________ Anderson Griggs & Company, Inc., doing business as Anderson Griggs Investments, is a registered investment adviser. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirement for advisors. This commentary is for informational purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part 2 to a client in an authorized jurisdiction and receive a properly executed Investment Supervisory Services Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs’ Investment Objectives, individual account, individual security or index. Upon request, Anderson Griggs Investments will provide to you a list of all trade recommendations made by us for the immediately preceding 12 months. The authors of publications are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Investments’ office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.

The Generation Portfolio: Target

Summary The quarter’s first full earnings week treated the Generation Portfolio kindly with the exception of Wal-Mart, whose unexpectedly dismal report blew a hole in the entire retail space. I took the sympathy weakness in big box retailers to add some Target Corporation shares, given that it is a recovery play whose situation is unrelated to Wal-Mart’s issues. Looking ahead, the Fed appears to be on hold for the time being, which is affecting the REIT and banking sectors. Background This is a weekly column that I write about an account that I manage for others, which I call the Generation Portfolio . I also discuss the current trading environment, my general investing philosophy, and any other ideas that seem relevant. Last week , for instance, I threw out some ideas about the herd-like mentality that has taken over the market due to the growth in index funds . To summarize that discussion, I have nothing against index funds in theory, and in fact own a few myself . In practice, though, the mass popularity of index funds tends to create distortions in the market. They are not quite the panacea that many would dearly love to believe they are, though they serve many investors well. The Generation Portfolio is built of stocks, not funds, because I find stocks to be easier to analyze and better suited to my cash flow objectives. So far, that strategy has worked as intended. The Importance of Cash Flow Regarding my income objectives, I have written about my own views of the importance of cash flow before . My theory is that a portfolio should be run like a business, with the cash that it generates reinvested into the enterprise whenever possible after you take out whatever expenses you need to cover. Thus, it is essential for a portfolio to generate enough cash flow to fund continuing operations – which, in the context of a portfolio, means the addition of new sources of cash flow which will keep the business thriving. It is a variation on the “buy low, sell high” mantra. The objective, in fact, is not to buy low and sell high, though of course that’s always preferable. I think that confuses some people, as not having as your objective the sale of what you buy at a higher price seems vaguely un-American or something. So, let me explain what I mean by that. The “buy low, sell high” objective is for speculators, or to use another word that annoys some people, “gamblers.” Nothing wrong with gambling, and life itself is a gamble. Some people are very good gamblers, and everyone has their own talents. However, for most people, you need to arrange matters to give you better table odds than they typically give you in Vegas (or the market) if you want to succeed at investing. My own view is that if you speculate enough and don’t have a good dollop of luck or some edge, you will speculate all your money away eventually. I’ve heard enough stories from people who have blown out accounts to reinforce that view. The speculator table is tilted against you because powerful, well-funded market interests collectively have more of whatever it is that you, the individual investor, can ever bring to the table – knowledge, brains, experience, capitalization, research tools, anything that makes a difference. They can outlast you, they have research and algorithms you’ve never heard of, and they can react faster than you. You may beat them sometimes because everything in the market is about probabilities, and even the biggest investment firms can’t control those. Those victories, though, just encourage you to continue onward until you aren’t quite so lucky. The odds are always in the house’s favor, though by a slim margin. Those with the odds in their favor are the ones with the fancy office buildings and slick marketing tactics. Some folks just learn that too late, or deny it forever. So, instead, if you want to win, the objective (as I see it) for the core of a prudent portfolio (there is always room for some fun speculation) is not to buy low and sell high, because that game is for likely losers. As the classic poker saying (repeated by Warren Buffett) goes, “If you don’t know who the patsy at the table is, it’s you.” Instead, my objective is to buy growing, dependable, and in other words quality cash flow cheap and then keep it so long as it remains quality. If you do that, the “selling high” part will take care of itself. And, best of all, you may not need to sell at all. However, you will have to ride out the shifting currents and forget about current prices except in a grand strategic fashion. That’s tough to do. There are many ways to build cash flow, and some investors just don’t like dividends. Those folks usually have studies from this, that or the other place to back up the theory that it is better to sell part of your portfolio to generate cash flow rather than rely on dividends for it. It’s a valid strategy, though I could spin out all sorts of issues with it. Whatever works for you is terrific. My preference is to generate cash flow by collecting dividends from Quality Stocks . Dividends are automatic and don’t require any transactions or thought, and the less thought I have to devote to a mundane task, the better. If you have sufficient funds to diversify across and even within sectors, that also is a good strategy to put into practice to minimize risk. Thus, the Generation Portfolio pursues an income strategy across companies and sectors that is designed to generate reliable and growing cash flow and minimize damage from random stock disasters. “It is a market of stocks, not a stock market.” If you’ve been following the market long enough, you have seen someone go on one of the financial channels and grandly announce, “it is a market of stocks, not a stock market.” Broadly speaking, my interpretation is that people who say that mean to emphasize that stock picking is still important. I tend to agree, because someone has to choose among and between stocks. Plus, there are so many index funds these days that advising someone to buy an index fund is pretty meaningless. If everyone simply bought the same index fund, there wouldn’t be much of a stock market left, and different index funds can have vastly different performance. If everyone buys different index funds, that creates the same type of performance differentials between them that individual stocks themselves offer. Ultimately, the whole rationale behind index funds collapses and you get a market of stocks, um, funds again. As the monastery leader in James Hilton’s “Shangri La” said, “moderation in all things.” This week was a good example of the need for such moderation. The herd was moving one way – the broader market was up – but parts of the herd went the other way (down). The biggest part heading lower was being led by a mad cow, and if you had all your calves in that particular group, your family wound up in the prickly bushes. Ultimately, the misled followers will rejoin the main herd, but it’s a painful experience until they do. I think you’ll figure out what I mean by all that by reading on. The Week That Was The market dipped slightly in the middle of the week. Ultimately, though, it surged higher despite some earnings weakness. The move higher was likely due to growing consensus that the Fed will not raise interest rates in the current weak economic environment. The market now has been up for three straight weeks, but the losses of August and September have not been fully recovered. The Nasdaq is up 3.2% this year, but the Dow is down 3.4%, and the S&P 500 is down 1.3%. Transactions I prefer to buy on weakness and the overall market didn’t provide much of that this past week. I did pick up some Target Corporation (NYSE: TGT ) due to its price decline following a terrible Wal-Mart Stores, Inc. (NYSE: WMT ) earnings report. Target is recovering from its Canadian discontinued business charges, but its core operations appear sound. Generation Portfolio to Date Below are the transactions to date in the Generation Portfolio. The Generation Portfolio as of 17 October 2015 Stock Purchase Date Purchase Price Latest Price Change Since Purchase WFC 8/25/2015 $ 51.75 $ 52.88 2.18% DIS 8/25/2015 $ 98.75 $108.16 3.26% BMY 8/25/2015 $ 59.75 $ 64.49 7.93% MFA 8/25/2015 $ 7.05 $ 7.03 0.28% OHI 8/31/2015 $ 33.95 $ 36.28 6.86% CVX 9/02/2015 $ 77.90 $ 91.20 17.19% PG 9/03/2015 $ 69.95 $ 74.90 7.08% CYS 9/04/2015 $ 7.68 $ 7.93 3.26% KO 9/09/2015 $ 38.50 $ 42.02 9.14% MPW 9/10/2015 $ 10.89 $ 11.73 7.71% WMT 9/10/2015 $ 64.40 $ 58.78 (8.56%) VTR 9/10/2015 $ 52.80 57.09 7.90% KMI 9/11/2015 $ 29.95 $ 32.43 7.55% WPC 9/14/2015 $ 56.75 $ 61.46 8.30% T 9/17/2015 $ 32.50 33.78 4.09% VZ 9/17/2015 $ 44.95 44.80 (0.56%) MMM 9/18/2015 $139.90 $148.66 6.29% JPM 9/22/2015 $ 60.89 $ 62.43 2.87% PX 9/23/2015 $101.30 $109.43 8.03% VER 9/25/2015 $ 7.87 $ 8.34 5.97% WMB 9/28/2015 $ 39.48 $ 42.28 7.09% MAIN 9/28/2015 $ 27.47 $ 29.32 6.73% PFE 9/28/2015 $ 32.69 $ 34.41 5.26% TGT 10/16/2015 $ 75.15 $ 75.05 (0.13%) Latest prices and percentages are those supplied by the broker, TD Ameritrade, as of the close on 16 October 2015. A large legacy position in Ford Motor Company (NYSE: F ) and some other small legacy positions are omitted. There currently are 21 positive positions and three negative positions in the Generation Portfolio (I go strictly by the broker’s calculations of gain and loss, as they know best). According to a spreadsheet that I maintain, the Generation Portfolio overall currently is up between 5-6%, just as it was last week. That does not include dividends received to date, and some of the positions may have gone ex-dividend but not yet paid the distributions. Dividends One of the aims of the Generation Portfolio is to generate dividends, hence the name. Some will hit the account this week, but there was no change from last week. Dividends Received To Date Stock Date Received Type VTR 9/30/2015 Ordinary KO 10/01/2015 Qualified CYS 10/14/2015 Ordinary VER 10/15/2015 Ordinary MPW 10/15/2015 Ordinary WPC 10/15/2015 Qualified For now, at least, I am receiving the dividends in cash and will use them opportunistically as they accumulate. Analysis of Holdings While there were many earnings reports delivered during the week, the only one that really rocked the establishment was Wal-Mart’s on Wednesday. In some ways, that one should have been the most foreseeable, but it took everyone by surprise. Wal-Mart is the country’s largest private employer , and giving even a fraction of its workforce a raise will always have consequences for its bottom line. Those consequences did show up in its lowered guidance for the next few fiscal years. Wal-Mart gave no updates to its guidance before earnings to suggest this, which puzzled some analysts. Wal-Mart is the best possible example of why I keep individual positions relatively small and diversify. Since Wal-Mart dragged the entire big box retail sector lower, I decided to take advantage of the lower prices and add some Target. It may not have been at an ideal price, but Target’s issues are completely different than Wal-Mart’s. I had to ignore headlines such as “Wal-Mart’s Disappointing Sales And Earnings Forecasts Spell Doom For The Industry,” but someone has to provide goods to communities across the country. I wrote up an article on my reasons for adding Target here . Aside from Wal-Mart, my personal biggest surprise of the week was how well oil/gas energy stocks held up after their bonanza performance a week ago. Just goes to show how oversold the entire sector was. The REITs also are moving higher, which is gratifying. I’ve spent the past year studying them, and they appear to have stabilized for now. The banks had some difficult moments during the week after Generation Portfolio stock JPMorgan Chase delivered a sketchy earnings report . As I have written elsewhere, my view is that REITs and banks will tend to move in opposite directions . Bank weakness was in part due to the growing belief that the Fed will remain on hold at least until next year; banks want higher interest rates to increase their spreads. However, another factor behind their stability was simply that banks were already oversold and haven’t really recovered like some other sectors since the August sell-off. General Discussion This is the section where I basically just ramble on about what I am seeing in the investing world that might affect my investments. I don’t expect everyone (or anyone) to agree with my perspective, but it is how I see things right now. There is growing saber rattling in the world. Events in Syria are in flux, Putin is on the loose, North Korea is making its usual noises. Defense stocks have been showing some life recently. That also, in my opinion, is why oil stocks have recovered a little ground despite the continuing supply/demand situation; good sectors to be in if things get worse. The key to the next Fed move in my view lies in the next two jobs reports. If those reports are strong, the Fed may gather up its courage and raise rates. In my humble opinion, that would be the wrong move, but they typically don’t ask me. However, I don’t expect strong reports and don’t expect the Fed to raise rates. Taking a more strategic perspective, in my opinion, the next Fed move is completely up in the air now. Everyone assumes that the Fed will raise rates. However, the market has forced treasury yields lower recently, not higher. That is not a good environment for the Fed to raise rates, because they would be fighting the market. That can lead to an inverted yield curve, as in 2004-2006, which can be a precursor to a recession – as in 2004-2006. (click to enlarge) As the chart shows, the 10-year Treasury bond yield has fallen recently. It currently sits at 2.04%. Not only is it down from the heights of the summer, but it is even down slightly from its 2.06% rate at the end of the third quarter just a few weeks ago. I can’t tell you how many times over the past year someone has said to me with great authority that rates are headed higher, and soon. The simple fact is that, at least so far, they’re not trending higher unless you cherry-pick dates. Whenever I see someone state with great confidence that the Fed’s next move must be to raise rates, because everyone says that and we are all supposedly waiting in great trepidation of the great event, I like to pose a simple question: what if the economy weakens further? What does the Fed do then? Raising rates in the teeth of a weakening economy or, knock on wood, a recession would be foolhardy. It’s simply unrealistic at the moment. If the economy does weaken for whatever reason, the Fed doesn’t have a lot of tools left to fulfill its dual mandate of stable prices and full employment. It does have one that it could always resort to again that nobody seems to expect: another round of quantitative easing. Since nobody is talking about it, it can’t happen – right? We shall see. Returning to energy stocks again, I find it amusing that now some folks are starting to question the viability of the entire solar sector. This is one of those hot-button cult areas that invites negative comments whenever I go near it, but I like to provide alternate viewpoints and welcome them in comments. Solar has its place, but it is not quite the end-times panacea its proponents wish. Back in 2014, when I wrote my positive article about Hawaiian Electric – shortly before it rose about 50%, that is – people were predicting the doom of the entire utility sector and lambasting me for questioning the inevitable hegemony of solar and the temerity to recommend a dinosaur utility in a Mesozoic-era industry. Now, strangely enough due to events in Hawaii , that wheel has turned. Go figure. Actionable Ideas l have been watching defense stocks such as LMT and RTN closely, and would add one on a buying opportunity. I also have a couple of more high quality REITs on the radar screen, there still are some good values in the sector. The healthcare sector also still has some opportunities, though the Generation Portfolio has a couple in there already. Still, I’m not averse to over-weighting a defensive sector that is undervalued. I am watching a few other stocks like Honeywell International Inc. (NYSE: HON ), which sold off despite a fairly decent earnings report, and a few other big names. So far, earnings reports for the third quarter have been a touch weak, which fortunately were somewhat expected . The market can handle anything, it just doesn’t like unnecessary surprises (Wal-Mart). We’ll see how the coming week’s earnings go, led by IBM (NYSE: IBM ), Google’s parent Alphabet (NASDAQ: GOOG ), Microsoft (NASDAQ: MSFT ), Boeing (NYSE: BA ), GM (NYSE: GM ) and Caterpillar (NYSE: CAT ). Of particular interest to the Generation Portfolio will be: Verizon Communications on Tuesday before the open; Coca-Cola Company on Wednesday before the open; CYS Investments, Inc. after the close on Wednesday; 3M Company on Thursday before the open; and Procter & Gamble Co. and Ventas, Inc. before the open on Friday. Conclusion It was an upbeat week for the market despite some weak earnings reports from industry bellwethers. A dismal earnings report from Wal-Mart sent it sharply lower and induced sympathy selling in other big box retails. I took the weakness as an opportunity to add some Target stock $10 below its very recent price. Looking ahead, the Fed appears to be on hold for now, which should give some strength to interest-sensitive sectors such as REITs. Overall, the Generation Portfolio had another good week despite the Wal-Mart disaster, and dividends are starting to accumulate.