So I think the author could do with reading "The long and the short of it" by John Kay. Might help him understand how NNT did what he did.

The extra takeaway is that portfolio construction should be about finding investments that will probably all in the long term give an above inflation return (else what's the point) but, and this is the key. The investments should have low (ideally negative) correlation.

This means you look carefully at the underlying wealth generating machine you plan on investing in to check it's sound, and you consider scenarios to check you're actually diverse. A common strategy is to invest largely in an index of blue chips and have a risky pool of small caps. This hardly helps you at all since a recession is bad for both (and you're most likely to lose your job and need your savings when they're low).

So what does that give us:

* 55% short term US Gov Bonds

* 15% US Short term small caps

* 15% Precious metal ETF

* 15% Oil ETF.

First up, fundamentals - the USG is currently upto it's eyeballs in debt with no obvious political will to cut spending and raise taxes. The debt is all USD denominated so they may well inflate, but they could also default - either way bad for us. You might say 'but my liabilities are all in USD!' but personally if the standard of living in my country drops everyone around me being poor too is going to be scant comfort.

US short term small caps, the US has very pro business labour laws and taxes, it's got lots of well educated workers, whilst there has been a big run up in stocks lately (hello there QE) we're not trying to time the market and can clearly see where the fundamental wealth is generated.

Precious metal ETF - This ETF holds physical gold, silver, platinum and palladium in London and Zurich under custody of JP Morgan it charges a .6% fee. Precious metals have been a store of value for ages. Whilst there's been a big run up lately we're basically betting on bad news and there's obviously still the potential for more bad news. However since we don't hold it ourself we're hoping for bad but not catastrophic news.

Oil ETF - this ones based on short term oil futures and run by DB proshares. It seems to track oil better than some others although it will naturally under-perform the underlying commodity. Oil gets used everywhere. However simply holding oil is not owning a productive asset, this is a bet on future oil shortage not an investment. Personally I agree that shortages and inflation are likely to drive the price of oil higher but it's still a bet.

So that's individual fundamentals, now we look at correlation of these 4 assets. With 55% in a single bond fund any problem with that investment is very bad news. If the fund suffers from fraud, or some of the bonds default (or look like defaulting) you'll lose a large chunk of your savings.

Then we have exposure to the US. A significant slowdown in US economic activity is bad for the price of oil, bad for US taxes (and thus bond default chances) and very bad for US stocks. 85% of the portfolio could get creamed in this scenario. Theoretically GLTR could help us here but we also have to worry in this scenario if JP Morgan will survive. Even if they do other non-physical gold ETFs may not and will our ETF suddenly be under-priced due to perceived risk?

Whilst the concepts in the article are useful, as others have pointed out the portfolio seems to be an excellent example of how smart people can get tripped up in this environment.

user:	s_jambo
created:	December 6, 2010
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