One on One: "We do a lot of things to mitigate a lot of risk"

Smaller mutual fund companies are always looking for ways to differentiate themselves from the competition.

The Permanent Portfolio Family of Funds, a fund group with $200 million in assets managed by Pacific Heights Asset Management LLC in San Francisco, stresses an investment approach that minimizes risk.

The group’s $24 million Permanent Portfolio Aggressive Growth Fund utilizes that style even within an aggressive-growth strategy, says Michael J. Cuggino, president and chief executive of Pacific Heights.

The best example of the firm’s philosophy is the $55 million Permanent Portfolio Fund, a balanced fund with an unusual investment mix. The fund maintains 20% of its assets in gold, 5% in silver, 10% in Swiss franc assets, 15% in the stocks of domestic and foreign real estate and natural-resources companies, 15% in U.S. aggressive-growth stocks, and 35% in cash, and Treasury bills and notes.

Mr. Cuggino, 40, concedes that it’s an unusual mix but maintains that diversification protects the fund in all kinds of markets.

Year-to-date as of Sept. 2, the fund’s one-year return placed it in the fourth percentile of its conservative-allocation category, according to Morningstar Inc. in Chicago. Its annualized three-year return earned a spot in the third percentile, and its five-year annualized return made the seventh percentile.

Anthony Vargo, a financial adviser at Legend Financial Advisors Inc. in Pittsburgh, which has $150 million under management, says he has never heard of the fund. But based on the fund’s investments, it’s one he would consider.

Q What is the investment philosophy of the fund group?

A Each portfolio has its own investment objectives.

The Permanent Portfolio is designed to provide growth at low risk. The other objective, which is just as important, is to preserve the purchasing power and capital of the investor.

The [Permanent Portfolio Treasury Bill Fund] seeks to achieve consistent return consistent with safety and principal protection. The [Permanent Portfolio Versatile Bond Fund] also looks to conserve and preserve capital, but it looks to achieve a little bit higher of a return than might be achievable with a Treasury, money market fund or a short-term-bond fund.

[The Permanent Portfolio Aggressive Growth Fund] is designed to really achieve greater appreciation than the broad stock market.

But there are some common themes that run throughout the organization. For example, each fund follows a diversified strategy.

Q Can you give an example of that diversified strategy?

A In the aggressive-stock fund [and the aggressive-stock portion of the Permanent Portfolio Fund], what we do is pick stocks from what we believe to be industry sectors that are going to grow over the long term. We have to be diversified among at least 12 sectors.

Q What about the unusual investment mix in the Permanent Portfolio? It seems to go beyond the usual diversification strategy.

A Basically, it’s impossible to predict the direction of the economy. In most balanced funds, the portfolio manager will make economic predictions. He or she will analyze what’s going on in the economy. They will make an estimate of what GDP will be, what sectors are going to perform and when certain industries are going to come back. They will then look into their crystal balls and will allocate among stocks, bonds and cash. Then they will periodically update their models and adjust their allocations accordingly.

Because that approach is so flexible, it calls into question how balanced an approach it really is. If they make a wrong call, you’re not really balanced.

Our philosophy is that rather than go down that route, we believe in having fixed percentages that don’t change regardless of economic conditions.

Q But why have you chosen such unusual asset classes?

A Most balanced funds are stocks, bonds and cash, and that’s it. We believe that’s a limited view of the asset classes out there that affect the economy.

What we’ve tried to do is provide a broader diversification in trying to touch on different asset classes that maybe aren’t included in the typical Wall Street model.

Q Can you explain your approach to some of the different asset classes?

A In the gold group, we hold gold bars and coins. In silver, we do the same thing.

We don’t hold the mining stocks in those areas, because they are stocks first. In the gold and the silver area, we want the true exposure to the metal.

Gold to us is an asset that provides a hedge against inflation. Gold has always preserved its value throughout human history, and it provides protection against governments’ manipulating their currency. Silver possesses some of the same characteristics.

With regard to Swiss francs, the Swiss over a long period of time have preserved the value of their currency. They protect it, they don’t inflate it. As a result, Swiss francs hold their value.

With regards to the real estate section of the portfolio, we’re looking for dividends and capital appreciation. We diversify among office REITs, apartment REITs and retail REITs.

In the natural-resources section, we’re looking at companies that have natural resources or raw materials that are used in the production process.

Q How does that investment mix translate into performance?

A Because we don’t change our allocations, there are certain times when the portfolio is not going to perform as well as funds that have more flexibility or have an ability to be fully invested in stocks.

In a bull market, we’re only going to be 30% in stocks at best. But in a bear market, like the one we just saw for the last three years, we way outperformed the S&P 500 stock index.

Q Does the fund have a benchmark?

A This fund doesn’t really have a comparable index, because it’s so diversified.

Our objective is to preserve capital and grow at low risk. Because of that, we basically look at what we consider indicators of erosion of purchasing power. That would be the cost of money and the consumer price index.

We look at how our mix is doing against that because that’s one of our key objectives. I think in all areas, it’s obviously outperformed those numbers.

Q All your funds seem to be very inflexible at a time when fund companies are coming out with funds that can invest in any mix of investments. Do you think such funds are a mistake?

A Everybody has different views. We at the Permanent Portfolio funds would probably disagree with [the flexible] approach. We’re long-term investors. We would basically say that when you get swept up in the theories of the moment, or the hot investment of the day, that’s where you get burned.

You’ve seen people get swept up in a lot of different market-type situations over the years. Our theory is totally the opposite of that. We are a firm that is more risk averse than most. We do a lot of things to mitigate a lot of risk.

Q Do you think the recent improvement in the stock market will work against you?

A If people get real excited about equities again, you’re going to see a run towards equities.

But I think there’s some commentary out there right now that asks whether the six-month bull market in stocks that we have seen is real. Is it a head fake, or are we going to have another correction? There’s a lot of uncertainty out there. Our fund protects you against uncertainty.

But clearly, if stocks move up again, the Permanent Portfolio is still going to have its fixed allocation. As a result, if the [major stock market indexes] go crazy, we’re going to lag them in that fund. That’s by design. The whole philosophy with us is to maintain our discipline.

There’s a risk we’ll get left behind in the euphoria of the stock market, but history indicates that those euphorias are usually short lived, and then there’s a sobering period after that.

SNAPSHOT

Michael J. Cuggino, 40, president and chief executive of Pacific Heights Asset Management LLC in San Francisco since May 2003

Assets under management: $200 million

Career: 1991-present, consultant and portfolio manager for World Money Managers in Petaluma, Calif., the predecessor firm to Pacific Heights; 1985-91, Boston-based auditor for ERnst & Whinney which became Ernst & Young LLP

Education: bachelor’s degree in accounting from Bentley College in Waltham, Mass., 1985

Permanent Portfolio Fund (assets, $55 million): year-to-date, 9.23%; one-year, 15.56%; three-year, 9.41%

Standard & Poor’s 500 stock index: ytd, 18.05%; 1-yr, 16.99%; 3-yr, -10.95%

Returns as of Sept. 4

Source: Morningstar Inc.