Is Permanent Portfolio a Fleeting Success?

Michael Cuggino’s mutual fund is Wall Street’s latest Cinderella story, and he’s not so sure he likes it. "If people are here for the wrong reasons, we’d just as soon not take their money," says Cuggino. "I’ve talked people out of investing with us."

Cuggino, 48, manages Permanent Portfolio (symbol PRPFX), a San Francisco–based fund that struggled to keep shareholders during the go-go years of the 1990s but is now the darling of fund investors. The fund, which had just $52 million in assets in 2001, now boasts $10.6 billion under management -- double its size at the beginning of 2010.

What transformed Permanent Portfolio from wallflower to belle of the ball? Results. The fund returned 19.3% last year, compared with 15.1% for Standard & Poor’s 500-stock index. Even more impressive, it delivered superior returns during Wall Street’s “lost decade.” Over the past ten years through February 2, Permanent Portfolio returned 11.0% annualized, compared with 1.6% annualized for the S&P 500. What’s more, it achieved those results without a lot of volatility. When the index plummeted 37% in 2008, Permanent Portfolio lost just 8.4%.

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But that’s also what makes Cuggino uncomfortable. He’s popular because his portfolio has been a success of late. Yet it’s essentially the same portfolio that caused many investors to snub him in the 1990s. And investors who chase performance are likely to be turned off again.

Staying the course

Nevertheless, Cuggino isn’t changing his focus. The whole point of Permanent Portfolio is to be, well, permanent. The fund’s goal is to beat the rate of inflation in both good times and bad. It does so by investing heavily in hard assets, such as gold (20% of holdings), silver (5%) and Swiss-franc-denominated assets (10%). But the fund also holds 35% of its investments in Treasury securities, and it has 15% in natural-resources and real estate stocks, and another 15% in aggressive-growth stocks.

With investors jittery about the economy and interest rates falling steadily over most of the past decade, assets such as gold and Treasuries experienced record-breaking bull markets. But chances are slim that these assets will continue to beat growth investments in the future. In the case of Treasuries, for example, historically low interest rates (despite a recent increase) make it mathematically impossible to repeat the gains of the past decade in the near future.

Meanwhile, with corporate earnings still rising, even Cuggino thinks there may be better opportunities in U.S. stocks. But Permanent can dedicate only 30% of its assets to stocks. That could mean the fund’s performance will suffer over the coming years, just as it did in the 1990s, when it eked out a ten-year annualized return of 4.5%, compared with 18.2% for the S&P 500. In fact, with gold and Treasury-bond prices under pressure lately, Permanent Portfolio has performed poorly so far in 2011. Year to date, the fund lost 0.4%, while the S&P 500 gained 3.8%.

Cuggino hopes that today’s investors are more sophisticated and actually believe in Permanent’s philosophy, which is about beating inflation -- not the stock market -- with an asset mix that doesn’t change in response to market conditions. “We want people who understand how we fit into a portfolio, not people who are performance-hopping,” he says.

Good luck with that, says Morningstar analyst Ryan Leggio. “Investors are chasing returns,” he says. “They should have bought this fund ten years ago, but that’s when no one wanted to own it.”