Permanent Portfolio is not a dividend portfolio. In other words, the gains for this portfolio relies on simultaneous buying and selling of its components during portfolio re-balancing. Only the stocks and bonds provide dividends and coupon payments respectively. But they are not significant. Cash in the bank does not generate significant interest payments. Lastly, gold is a negative yielding asset. It does not generate dividends but incur storage costs. Hence, Permanent Portfolio is not a dividend yielding portfolio.
But what happens if we tweak the portfolio a little to improve the yields?
Replacing Gold with REITs
There are concerns about the volatility in gold prices and the long term viability of the precious metal. Many readers and audience have proposed to replace gold with another hard asset. Questions like, “can we use properties instead of gold for Permanent Portfolio?” Without a doubt, REITs are often touted as a good alternative since REITs mainly hold properties. The other advantage of REITs over gold is that the former pays regular and decent dividends.
I have done a short study of replacing Gold with Singapore REITs. This is built on the traditional Singapore Permanent Portfolio which BigFatPurse has been tracking. The components of STI ETF (stocks), SGS Bonds (bonds) and cash remain unchanged. I have selected the 3 REITs with the largest market capitalisation, and are not part of the STI components or reserve list. The 3 REITs are Suntec REIT, Keppel REIT and MapleTree Commercial Trust.
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Singapore Permanent Portfolio (with REITs) Performance
How did it fare?
The portfolio started with $100,000 on 3 Jan 12 and ended with $116,671.63 on 31 Jul 13. The average annual returns is about 10.23%. In contrast, the traditional Singapore Permanent Portfolio has an average annual returns of 0.32% for the same period. The lacklustre performance is due to the poor performance of gold and bonds in recent months.
The Singapore Permanent Portfolio (with REITs) was re-balanced once on 13 May 13, when its REITs component was worth 35% of the portfolio. REITs were sold down to 25% and some of the profits were used to purchase bonds, increasing the bond component from 19% to 25%. This re-balancing was timely as profits were taken before REITs suffered a correction in Jul 13.
REITs have Strong Correlations with Stocks
The above chart shows that Singapore REITs have strong correlation with STI ETF (in fact, there are 2 REITs in the STI currently). Remember that Permanent Portfolio relies on re-balancing to make gains. And re-balancing requires strong inverse correlations among each component. With REITs and STI ETF, the exposure to stocks is essentially 50% of the portfolio. Instead of equal exposure, the portfolio becomes stocks heavy. The immediate implication is that the volatility of the portfolio will go up! Either stocks had a good run and the stock-heavy Permanent Portfolio beats the traditional Permanent Portfolio, OR stocks had a bad run and the stock-heavy Permanent Portfolio suffers larger losses.
1.5 Years is a Short Time
Due to the lack of data for SGS Bonds, the study was limited to a time frame of 1.5 years (Jan 12 to Jul 13). This is a short period and not really meaningful to assess the impact of swapping gold with REITs. I may conduct another study with US Permanent Portfolio to expand the period of study.
REITs had a Good Run in the past 2 years
The period of study is bias because REITs had a good run in the past two years. The returns are expected to beat the traditional Permanent Portfolio. However, we cannot expect REITs to continue to outperform at this rate as it isn’t sustainable. Over the long run, mean reversion is a powerful force. Interest rates may go up and the cost of borrowing erodes the REITs’ profitability. An economic downturn may also reduce the occupancy rates in the REITs’ properties. These are some possible scenarios that lead to lower returns from REITs.
As mentioned in the post, there is a need to lengthen the period of study before we can conclude the suitability of REITs as a replacement of Gold. My intuition tells me that it isn’t. The good results shown in this post is a result of REITs bull run.