What is PGP?
PGP stands for “Pretty Good Protection” or “Pretty Good Participation” depending on the direction of the market. PGP is designed to provide most of the gains of bull markets while significantly reducing losses in protracted bear markets. It shifts investment allocations between stocks and cash. The goal of PGP is to reduce the downside risk (protection) while keeping most of the upside (participation).
How Does It Differ from Traditional Asset Allocation Approaches?
Traditionally investors have maintained a fairly constant (i.e., static) balance between stocks and bonds. Basically stocks have historically provided more growth and bonds have provided more stability. For example, one might establish a target allocation of 60% to stocks and 40% to bonds and rebalance the portfolio occasionally when the then current portfolio allocation deviates from the target. In contrast, PGP is a dynamic approach allowing large swings between stocks and cash.
Is PGP Right for Me?
We strongly advocate PGP for investors who have a tendency to get out of the market during downturns. PGP gets out of equity markets during downturns by following a rules-based approach (see the next question) that allows it to get out of the market and back into the market in a disciplined, non-emotional way.
For investors who can stick with their static allocation during bear markets, PGP may still make sense because PGP allows for higher average allocations to stocks over market cycles than more static portfolios. Historically (see disclaimers at end) PGP has done quite well and may be attractive for your investment portfolio.
So who shouldn’t use PGP? There will be periods, as explained in the following questions on performance, when PGP and traditional investment approaches perform significantly differently. If you hate the idea of your portfolio deviating from what may seem to be the mainstream – and by this we mean that a period of underperformance to other portfolios would cause you anguish – then you should not use PGP.
Most importantly, because it allows for periods with higher allocation to stock, PGP exposes investors to greater sudden crash risk. We expect PGP to reduce the drawdowns of long bear markets (e.g., 1930s, 2000, 2008), but it will not protect against a sudden market drop (e.g., October 1987). PGP is inappropriate for investors who worry about such markets.
If you are still interested in PGP, we encourage you to continue reading paying particular attention to the questions on performance. Doing so will give you much more perspective on whether the strategy suits your risk tolerance.
When is PGP in Stocks and When is it in Cash?
PGP follows a simple yet historically effective approach to managing portfolio risk. The rule calls for owning stocks if the current value of an indicator (such as a stock market index) is at least as high as the average of the last 13 month-end values. Alternatively, PGP calls for switching to cash (or another relatively safe, short-term investment) when the value of the indicator is below the average of the last 13 month-end values. This simple rule dictates both when to enter and exit the market and is the foundation for PGP.
How has PGP Performed?
Historically it has performed well; otherwise, we wouldn’t bother presenting it. We present a wealth of performance information. Please consider carefully the important disclaimers and warnings. The following links open calculators showing the performance of PGP.
Link: What’s the Performance of PGP over the Long-Term (U.S.)? This calculator shows long-term results (over 90 years of data) using U.S. only data because that’s what we have. Under Inputs choose the weighting to PGP and Bonds, benchmark portfolios for comparison, and the date range. Then click various tabs in the middle to see different perspectives on performance. Explanatory comments are shown on the right. Reducing the weighting of PGP and increasing the weight to Bonds generally reduces risk. The PGP / Bond portfolio strategies can be compared against static allocations between stocks and bonds.
Link: What’s the Performance of PGP Globally (30 Years)? This calculator shows the results of PGP over the last 30 years using global equities
Disclaimers, Warnings, etc.
PGP stands for “Pretty Good Protection” or “Pretty Good Participation” depending on the direction of the market. The name pays homage to “Pretty Good Privacy”, an encryption/decryption algorithm used to protect computer data. The name was chosen by us to emphasize that the strategy is not perfect. For example, it is designed to protect against protracted bear markets; it will not protect a portfolio against a sudden crash. Additionally, it is geared to avoid the full brunt of bear markets, not small losses. It is also designed to participate in bull markets. Of course what has appeared to work historically may not work in the future or may work to a different degree. As a final disclosure, this strategy will underperform some of the time, particularly in two scenarios. The first is an oscillating (volatile, sideways) market. In such a market, this strategy might be subject to whipsaw. In this environment it might under-perform buying and holding stocks, but we would not expect large drawdowns. The second period of weak relative performance would be just after the end of a bear market. The PGP strategy should then be in cash and would not participate in the new bull market until a new buy signal months later.
The performance shown here is a hypothetical (a.k.a. paper) portfolio; it is not actual performance of any actual portfolio. Future performance may be worse. Importantly, these returns are not adjusted for the effect of investment management fees or commissions which would cause the performance to be less than what is shown here. Past performance is no guarantee of future performance.