A Strategy for Preserving Long-Term Capital

12/30/2011 7:00 am EST

Focus: FUNDS

Michael J. Cuggino

President and Portfolio Manager, Permanent Portfolio Family of Funds, Inc.

Using a strategic model of various asset classes, Michael Cuggino is able to protect capital for his clients. Not only do stocks, bonds, and cash play a role, but Cuggino also invests in precious metals, other commodities, and real estate.

Kate Stalter: Today, I am speaking with Michael Cuggino of the Permanent Portfolio (PRPFX).

Michael, I have talked to several advisors about your fund, who have told me that they like to use it as a convenient way to give their clients exposure to a mix of asset classes, where they might not have otherwise. So I would like to hear in your words a little bit about the fund’s objectives and your investment philosophy.

Michael Cuggino: Well, that is always great to hear, and I think that they are using it in exactly the right way, although there are a number of ways that the fund could be utilized.

We view it as a core holding for anybody’s portfolio at different levels and for different reasons, but basically what we do: Our objective is preservation of capital over the long-term, and we do that by investing in a broad array of different asset classes. It is different than the typical Wall Street model of, say, bonds, cash, and stocks.

We also have dedicated commitments to non-US assets in the stock and bonds area, precious metals and commodities, real estate and natural resource-type stocks. Our view is more strategic in that we invest in these asset classes at all times in a strategic longer-term way, so that investors don’t have to worry about predicting the future and jumping around between asset classes, or assets within an asset class.

Our view is that human beings are not real good at predicting the future in anything really, whether it is football games or investments. So while we all might get lucky once in a while, most of the time we are wrong. Even if we have the idea right, if the timing is wrong you might as well be wrong. So our fund seeks to sort of get around that.

This can be a big problem for investments, obviously, especially that rainy-day money or that conservative core that every investor needs. This can be a big problem, so we seek to get around that basic flaw in human nature by investing at all times in a broad array of different asset classes.

Kate Stalter: I’m on your Web site, at the prospectus, and I do notice that gold is a pretty significant portion of the fund. That is obviously something that people are pretty fascinated with lately. Tell us a little bit about that, why you have decided to go so heavily into that area.

Michael Cuggino: Well gold acts as an inflation hedge, as a hedge against uncertainty and lack of confidence in the economic and political systems. It is valued the world over, regardless of where you grew up or where you live.

Human beings value gold. So it is a universal asset in a sense—it is a global asset in that sense. In order to protect against inflation, hyperinflation, or risk to the systems and the society we live in, we believe investors should have exposure to gold. Every investor should at some level, and we have targeted that at 20%. That is a target percentage.

Kate Stalter: Now, despite the name of the fund being called the Permanent Portfolio, I do want to ask you just about the various weightings. Are those permanent within the structure, or do you go in and rebalance at periodic points?

Michael Cuggino: Well, the strategic model—the different asset classes, the target percentages that we have—are fundamental, but it is not an index fund where we rebalance to these target percentages every day. They are targets, and we are always relatively close to them, but we are not exactly tied to them in a sense of having to index it.

Our view would be that if you start jumping around and changing your targets too much, then you are no different than any other investor trying to predict the future, and that is more of a tactical or a market timing type of investment product. There are some good ones out there, and if that is what investors want to do, I would suggest that maybe you do that in a more speculative or secondary portfolio. But that is not who we are or what we do.

So the permanent name, the permanency, comes from the strategic asset-allocation model that we employ. Then underneath that strategic model, there is a lot of flexibility and subjectivity as to the types of things we can invest in.

Kate Stalter: I also noticed that there is a fairly heavy weighting in Treasuries. That’s an area where some of the equity managers I talk to have been suggesting that clients move away from that and into dividend-yielding stocks. What is your view on that?

Michael Cuggino: Well, many people have been predicting the end of the bond-market rally that has gone on for the better part of the last 30 years, and the only thing I can say is that they are all going to be right—the question is when. I mean, we are all going to be right once in a while, and you can sit there and say the same thing over and over again and sooner or later you will hit it.

I think the one thing that has been indicative or interesting about the death of the bond rally is that the call has been premature. Investors have been able to make money playing the trading range of the yield curve generally, whether it is Treasuries or even high-grade corporates, which is another area we invest in, and probably more substantially but more risky in the higher yield and distressed debt areas. We are not involved there, but there is definitely money to be made there for people that can do that successfully.

From our standpoint, we view bonds as a necessary asset in all circumstances, due to its abilities to protect investors in deflationary deleveraging or lowered pricing environments. While we do worry about inflation, that is only one economic scenario that is out there, and deflation actually in the last few years has been more the norm. De-levering, bringing down the risk in the balance sheets, the lack of inflation—all these things provide stability to bond holdings and make bonds valuable.

So that has truly been the case; that has ebbed and flowed in the last few years. And hence, you have sort of a broad trading range in bonds on the yield curve. That may continue for quite a while, given the circumstances we find ourselves in.

I think at some point, interest rates will go up. We are at historic lows, and I don’t think anybody would argue differently. The question is: When and how do you address that?

So aggressive bets in the bond market—maybe not be the best time to do it because they may turn on you, although you can’t guarantee it. But to have a dedicated portion of your portfolio in bonds as a protection against deflation or recession or deleveraging is certainly not a bad thing.

And again, it gets back to our strategy, in that we are strategic in this macro sense, where we are trying to protect our investors from multiple downside scenarios, while also putting them in a position to profit, all without having to predict the future every day.

What is the stock market going to do, what is the Fed going to do, what is the economy going to do? We are trying to put our investors in a position where they don’t have to think about these things on a daily basis—but that they have built in protections to guard against significant declines in any scenario, but also position them to profit from any scenario. It is obviously a difficult thing to do, but I think that is what we are seeking to do.

Our view also would be, and it goes in line with this investment style I guess, in that we believe that protecting capital and minimizing losses is as much a foundation of investing as producing a yield or a return. Most people only think about that sort of balance sheet side of looking at investments when asset values get put in stress, like they did a few years ago, like maybe they still are to some degree.

Most of the time investors are only concerned about return and maximizing return, and while that is important, we think. Again, we are conservative, but we think that risk mitigation and protecting against downside risk and minimizing losses is just as important.

Our view would be that the more you can do that, the easier it is to get back to zero when you have a bad year and move on to profitable returns going forward. If you lose half of your money, it is that much harder to get back to zero, never mind making any money, so a lot of people tend to forget those lessons in good times and they get reminded from time to time.

I think they were reminded the last few years, and so investors have been paying more attention to that side of things. I coin it, “the balance sheet side of investing” and the yield side would be “the income statement side of investing.” I think investors need to pay attention to both.

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