Portfolio design ruminations

[zbigi]

I've come to conclusions that my corner of the world (Poland) is indeed too unstable to keep all my assets in it. This was inspired by some comments on this forum (thanks guys) and also chiefly by a great interview with Polish geostrategy analyst Marek Budzisz (https://www.youtube.com/watch?v=fZfJzz42hNQ), who gave his review of America's official (both Biden's and upcoming Trump's administration) policy regarding Eastern Europe - highly recommended to anyone who knows Polish. The TL;DR is that America is treating China as main competitor/threat and also believes that it cannot afford to deter both Chinese and Russian aggression at the same time - so, in broad strokes, they choose to mainly deter Chinese and not Russia. Meaning, Russia will be given much more free rein in Eastern Europe in the years to come.

I'm trying to come up with a new portfolio that will preserve a bunch of value if Russians decide to move against Poland (either militarily or diplomatically, leading to Poland joining Russian sphere of influence once again). I care about returns, but care more about security (value preservation) - at my current spending levels, my portfolio can have negative real returns and still last me until I die.

I've divided the portfolio into two section - domestic high return section for the positive scenario (no agressive moves from Russia towards my country) and value preservation for the negative scenario. Right now, the rough sketch looks like this:


I. High yield domestic papers which give good returns if nothing bad happens.

1. 5%: selected high dividend (8-9%) large cap Polish stocks.
2. 20%: high yield (9-10%) Polish corporate bonds.
3. 5%: very high yield loan to a businessman friend of mine.

This section pays very well if shit don't hit the fan. If it does though, at the very least these things happen:
- Polish currency tanks, leading to inflation. This will make real returns here much worse, possibly negative. However, the corporate bonds are all interest-rates adjusted, which means that, depending on central bank reaction, they may perform ok even in high inflationary environment.
- Polish stock market tanks real bad. The 5% in stock market could likely we halved.
- If the hit to economy is very bad, some loans (both corporate and personal) might not be fully recoverable.

I'm not considering a scenario of total war here, which makes all bets off (and me likely dead somewhere in a ditch in Eastern Poland), just a scenario of appeasment leading to Finlandisation/Belarusisation (e.g. NATO gives up Poland to Russia in exchange for promise of peace and cheap natgas for Western Europe), or a war which Poland loses so quickly that not a lot of human and material loses are incurred in the process and the country can still operate as normal, just under new management.


II. Securities which go up in value, or at least preserve value, if shit DOES hit the fan.

1. 33% Polish treasury inflation-adjusted bonds (in Polish currency). Right now, inflation is 5% and they pay 7%.
The logic behind holding Polish inflation-adjusted bonds is that, insofar as Polish state survives at all to pay them off, inflation will surely be one of major problems of the negative scenario.

2. 33% "International stuff", denominated in foreign currencies. Details are a big TBD. For now, I just have a couple of preliminary assumptions: no US stocks (too overpriced), no crypto, nothing in countries bordering Russia, no German stocks (their economy does not look great). I like French stock market, and to lesser degree Swiss and British (higher P/E there). Other than that, I'm thinking about buying some emerging markets stocks ETF, emerging market REIT ETF, and corporate bonds ETF(both emerging and developed). In other words, I have no idea what I'm doing I've never invested abroad, so I prefer to paint with an extremely wide brush.

The foreign securities, being denominated in foreign currencies, will go up in value by a lot (as local currency devalues), which will help make up a lot of the losses incurred by the first section if negative scenario does materialise.


Any comments or ideas on how to improve?

[chenda]

Whilst I think your fears are very misplaced (too political to discuss any further) restricting your investments to any small-medium sized country is risky inasmuch you run the risk of significant underperformance. I'd be inclined to use something like VHVG instead.

Another option to bring you some piece of mind would be to buy some cheap property in western Europe in a country which could serve as a bolt hole/long term investment.

Or - much easier - just open a foreign bank account and keep a pile of cash there in lieu of Polish government bonds.

[2Birds1Stone]

After 4+ years of reading your posts, I can't help but wonder if you wouldn't be better off investing some of this time and energy into figuring out the underlying issues causing such a negative frame of reference for almost every topic you comment on.

The world is a big and scary place.........but there is sunshine outside of your borders (mental or geographical? that's for you to decide).

[suomalainen]

I dunno. I don't even live in Finland and having my homeland's border with Russia giving me the heebie-jeebies is not irrational, in my view. I can't/won't comment on zbigi's general state, but this train of thought just seems prudent.

As to the portfolio question, I don't think I have anything specific to add. I guess I would question why you have so many assets in "risk-on" assets if you've already won the game. Depending on how much cushion you have, you have options to insulate a [small/medium/large] portion of your portfolio in the most riskless assets you have available to you, which I guess for you isn't Polish TIPS if you're worried about war followed by regime change. I don't think you can buy war insurance other than by leaving the country. So I guess you're balancing war risk with fx risk if you buy assets in other currencies. Once you determine your position on that, then it's an economic / interest rate risk question and you can allocate among equities - high yield - IG - government bonds as your risk appetite allows.

[zbigi]

After 4+ years of reading your posts, I can't help but wonder if you wouldn't be better off investing some of this time and energy into figuring out the underlying issues causing such a negative frame of reference for almost every topic you comment on.

I think my frame of reference is relatively normal for a Pole. In general, people who live in countries who didn't have to suffer 0.1% of attrocities that Poles and some other Eastern Europeans suffered perceive EEs as "dark". I think it's just a matter of perspective. It's obvious that someone who lived through WW2 e.g. in peaceful and wealthy California will have much different outlook on life than someone who lived next to Auschwitz. That gets passed on through generations, some researchers in Poland even call it a post-war intergenerational trauma, which may have some truth to it (I suppose the flip side is also true - people living in areas which were wealthy and peaceful for a long time can't comprehend truly bad things happening to them). Also, there is an understanding that the whole EE is just a "crumple zone" between two overwhelming powers (Russia and Germany), so everybody is more or less waiting for a disaster to happen again. It's similar to how Jews living in Israel feel, and, as far as I met some, they seem pretty serious and "dark" too. I feel it's an adequate response to external circumstances - it's either this or emigrate and cut ties to your culture.

In more general terms, tone of my comments here reflects the subject of the conversation. We're discussing ERE - an alternative, radical approach to one's livelyhood. Mistakes made in thinking through and applying this approach to oneself can have serious consequences for one's life. As one steps way off the beaten path, it's only prudent to be very cautious, and focus more on negative than on positive scenarios (positive scenarios are great, but life's already great so who cares about "more great" - but negative scenarios can lead to serious unhappiness).

As for choosing the word "ruminations", it was a joke on how building a defensive portfolio (planning for the worst) is similar in tone to unproductive thoughts brought by mental disorders.

[zbigi]

I guess I would question why you have so many assets in "risk-on" assets if you've already won the game.

Inflation in Poland is 5% right now, so many of the safer abroad assets might have negative real returns (esp. because I have to pay 19% tax on whatever I make from them, both from capital gains and dividends/bond coupons). This is paired with significant currency risk as you mentioned, and the risk that my expenses might go up (I might pick up an expensive hobby, my aging parents might need expensive prolonged help etc.). That's why I'm reluctant to park too much abroad yet. But, maybe it's not entirely rational, thanks for bringing it up.

[loutfard]

Inflation in Poland is 5% right now, so many of the safer abroad assets might have negative real returns. This is paired with significant currency risk as you mentioned, and the risk that my expenses might go up (I might pick up an expensive hobby, my aging parents might need expensive prolonged help etc.). That's why I'm reluctant to park too much abroad yet. But, maybe it's not entirely rational, thanks for bringing it up.

You probably want to rework your investment plan to be more internally consistent in terms of risk and return and accumulation versus preservation. To me, it feels like you're doing a great job of identifying some tricky issues/risks, then not acting as consistenly on them.

"I might pick up an expensive hobby" is a good example. That's a totally justifiable choice, and you can decide to take it into account when defining accumulation versus preservation goals. It should not however act as direct input for a micro investment decision. Who cares if you have negative real returns on some of your safer abroad assets, as long as you reach your capital preservation goals an optimal risk/return balance?

[jacob]

If you're [that] worried about geopolitical (or political for that matter) risk, you need to integrate it with your lifestyle.

One of the first bad things to happen to a compromised country is capital controls. As such, it doesn't matter if n% of the portfolio is "internationally invested" if the money can't be accessed from outside the country in a way that the given country or its aggressor can't block. However, this in turn requires maintaining a regular presence outside the country and that is why "worrying about geostrategic issues" easily becomes a lifestyle if done right.

OTOH, maybe the concern is more one of "powerful country says mean things about smaller country causing stock prices to dip". Frankly, I think 100% domestic investing only makes sense for very big economies [that have transnational corporations who on their own are the size of the GDP of a small country]. For example, the default FIRE choice in Denmark is just to use a 100% world index much like American FIRE enthusiasts would just do 100% VTI (benefiting even if often ignorantly so that much of the mass of that index is transnational already).

After two minutes of research I learned that Poland is actually not locked to the EUR. The biggest risk for investing abroad for you will likely be currency based rather than geopolitical impact based. However, there are funds (at least in the US) that hedge against currency risk and others that don't. I prefer the ones that do. I keep track of my NW in two different currencies and it is almost always the case that what appears to be a rise of the market in a given currency is but the decline of the currency denominator of that country.

Integrating it with one's lifestyle is easier said than done. You already said that your likely endpoint is dying battling in some trench domestically as opposed to e.g. watching from afar on a visa from a condo in Malta. As such, it wouldn't make that much sense to move the assets abroad for ultimate safety.

However, geopolitics aside, investors in pretty much any country other than the US or China should consider some international exposure.

[chenda]

Inflation in Poland is 5% right now, so many of the safer abroad assets might have negative real returns...This is paired with significant currency risk as you mentioned,

Thats the price you may pay for asset protection. The only way around it is to be willing to permanently relocate to a safer, as you see it, country.

[zbigi]

If you're [that] worried about geopolitical (or political for that matter) risk, you need to integrate it with your lifestyle.

One of the first bad things to happen to a compromised country is capital controls. As such, it doesn't matter if n% of the portfolio is "internationally invested" if the money can't be accessed from outside the country in a way that the given country or its aggressor can't block. However, this in turn requires maintaining a regular presence outside the country and that is why "worrying about geostrategic issues" easily becomes a lifestyle if done right.

That is a great point that I've considered some time ago, but has since fallen of my radar. I need to address it in my overall strategy.
I don't think you're right about the absolute need to maintain a regular presence outside the country though. It may be true in general case, but EU is more fluid in that regard, as the member countries are so tightly integrated together. For example, I can open a brokerage account in Ireland (e.g. with Interactive Brokers, a US firm) without ever being present in Ireland. That account is subject to Irish law and oversight, and Polish authorities or our potential future captors cannot do anything about my account there. I think this is something I need to seriously look into.

BTW, in 2022 I worked in an SV startup where the majority of my team were actually Ukrainians (we were all remote) and one guy once said he needs to take a day off to fly to Warsaw (from Kiev, where he lived). I was intrigued and asked him what that about, and he said he is opening an account with a Polish bank, and transferring all his funds there, as he feels the risk of war is too great. Just ten days later, Russian army invaded Ukraine.

Like you wrote, an actual "hot war" is not my greatest concern. I'm more concerned with decline in Polish currency and/or economy, caused by geopolitics. Currency-hedged ETFs would be sweet, but unfortunately, there are no ETFs that hedge on PLN (Polish currency). The best I could do is using an ETF hedged on (is that the right preposition?) EUR, as the EUR/PLN currency pair historically has had smaller swings than USD/PLN. Polish economy is very strongly integrated with the Eurozone (mostly with Germany), which makes the pair move together to some degree I think. There are of course events which affect one area and not the other, but it's probably the best I can do.

Integrating it with one's lifestyle is easier said than done. You already said that your likely endpoint is dying battling in some trench domestically as opposed to e.g. watching from afar on a visa from a condo in Malta. As such, it wouldn't make that much sense to move the assets abroad for ultimate safety.

This might not be by choice. Note how Ukraine banned military-aged men from leaving the country the day the war started. Then they started conscripting them. Of course, you could try to leave the country before SHTF to avoid the draft (assuming I wouldn't want to fight in the war, which largely depends on the chances of it not being another pointless human sacrifice which produces zero net benefits for the country - of which there are many in history of recent Polish wars), but timing that event is tricky and can easily fail.

[chenda]

Poland is part of schengen so it shouldn't be too difficult to sneak out west if you really had too. Besides you'll soon be 40+ and outside of military age. Not that I'm trying to depress you.

[zbigi]

Poland is part of schengen so it shouldn't be too difficult to sneak out west if you really had too. Besides you'll soon be 40+ and outside of military age. Not that I'm trying to depress you.

I'm 43 already, but, with changing demographics, the age of combatants changes as well. For example, Ukraine has so little people aged 18-26 that they are exempt from the draft altogether (see their population pyramid: https://commons.wikimedia.org/wiki/File ... yramid.svg), as the country tries to make sure it has any kind of future. The fighting is on older men. Average age of Ukrainian soldier in the war is 43, and plenty of them are pushing sixty.

[loutfard]

If you're [that] worried about geopolitical (or political for that matter) risk, you need to integrate it with your lifestyle.

This is what my wife and I try. I'm from western Europe. She is from the Baltics. We live there part of the year. Integrating our risk assesment into our lifestyle was necessary for preserving our mental sanity.

- We've mentally written off our place there. Living there sometimes feels like cherishing good times with a terminally ill cherished relative. Not knowing how long this will last forces one into a wonderful intense mode. That's really not as bad as it sounds. There's a lot of upside.
- We've got a written out plan should SHTF in the Baltics. Example from the preparedness chapter. My wife has dual citizenship for flexibility. I am not getting it to avoid conscription risk.
- Both countries are € zone. Different currency and capital controls risk.
- The equities part of our investment portfolio is in a € denominated single world investable market index fund.
- Our broker is an Irish subsidiary of a US giant. It allows us to move our portfolio between countries worldwide quickly.
- We do ever more arbitrage between western Europe and the Baltics. Mushrooms and berries. Honey from our friends and neighbours there. Specialist construction labour. Some health care procedures. The hair dresser in the village. Sauna vists. Learning some wonderful woodworking techniques. Playing music and being the foreign guest of honour. Deeply knowing both countries, languages and culture.

OTOH, maybe the concern is more one of "powerful country says mean things about smaller country causing stock prices to dip".

That is reality already in the Baltics since a few years. Just not super visible with the rising tides.

Integrating it with one's lifestyle is easier said than done. You already said that your likely endpoint is dying battling in some trench domestically as opposed to e.g. watching from afar on a visa from a condo in Malta. As such, it wouldn't make that much sense to move the assets abroad for ultimate safety.

My trench avoidance plan is super low effort and price, using social capital. My godchild's father is the founder and CEO of a non-weapons tech company with plenty of defense customers. He hires me should I be at risk of trenches.

Also, a question.

DISCLAIMER: I've hesitated a lot to ask the following question here. This is a porftolio question. I've tried my very best to formulate it in as politically neutral a way possible. When replying, please do not mention any past or current political evolution anywhere. I hope the question has some merit in this abstract form. I'm happy to delete it if not appropriate.

One portfolio preservation risk I rarely see discussed is large market cap equity markets getting hollowed out due to oligarchy/kleptocracy. ERE will certainly do wonders to help deal with the consequences, but I wonder about well-researched ways to avoid some of the portfolio damage itself. Is there any answer for small investors apart from geo diversification in the stock market? Any ideas?

[chenda]

@zbigi - interesting.

@loutfard - Gold. Preferably in Switzerland or Australia.

[jacob]

One portfolio preservation risk I rarely see discussed is large market cap equity markets getting hollowed out due to oligarchy/kleptocracy. ERE will certainly do wonders to help deal with the consequences, but I wonder about well-researched ways to avoid some of the portfolio damage itself. Is there any answer for small investors apart from geo diversification in the stock market? Any ideas?

Yeah, but it requires active market research instead of buying blind/being a whole market passive buyer. I know this is not a super-actionable response but paying attention beyond "everything always goes up" does avoid the worst damage when it no longer does [go up]. Simple answer, for example, would be to replace a world index with a set of country-ETFs and just sell the troublesome ones. This works when paying attention to world politics. Paying attention to world politics is difficult though since it's easy to get biased by the internal bias/propaganda of the country/media bubble one lives in. And so on and so forth ...

[ertyu]

One portfolio preservation risk I rarely see discussed is large market cap equity markets getting hollowed out due to oligarchy/kleptocracy. ERE will certainly do wonders to help deal with the consequences, but I wonder about well-researched ways to avoid some of the portfolio damage itself. Is there any answer for small investors apart from geo diversification in the stock market? Any ideas?

Here are my thoughts, for what they are worth:

In the short run, the stock market will probably like an oligarchy/kleptocracy. The first thing a good oligarch would do is regulatory capture. This looks like an attack on worker rights, an attack on environmental regulations, an attack on product safety, etc. It is likely to boost profit margins. It also looks like tax reduction/elimination for businesses and the wealthy, which also leads to higher profit margins. Some might argue the cost savings will be passed along -- I believe they won't be, because an oligarchy is a cartel and can act like a monopolist.

I don't know how long the long run would take, but in the end, we have governments for a reason, and that reason isn't just to mess with the ability of the wealthy to make money. Without taxation and regulation, the workforce is poor and uneducated and can't buy your products. Infrastructure suffers: brown-outs and increased transportation costs (fingers crossed for the falling cost of renewables here). Resources--e.g. water--get diverted towards the use of businesses belonging to the wealthy, rather than towards households, even if this diversion is sub-optimal and wasteful from a social standpoint. Russia and South Africa come to mind as models. Both of these have a wildly successful oligarchy and neither of them is a thriving economy or a thriving stock market.

As for what particular companies and industries would do well under these long-term conditions, I leave it to others to theorize.

[Bankai]

Alright, a lot to unpack here. First, your premise of Poland being unstable. Compared to other big European countries (UK, France, Germany, Italy, Spain) - Poland is the most stable politically (the fewest government collapses and pre-term elections in the last 20 years other than France which has a presidential system so it's a different fish), has by far the lowest crime (while countries like France and the UK see semi-regular riots every few years or so) and unemployment rates, by far the best GDP growth (in fact, second only to China over the last 30 years among bigger economies), spends the most on military and is well on the way to build the strongest land army in Europe West of Russia, and sees continuous increase in foreign direct investments. And has very decent healthcare - having two decades of experience with Western (UK) healthcare, I'd choose the Polish one in a heartbeat. Yes, there's a lot of scaremongering in TV/YouTube bubbles (including from Mr Budzisz) but the data doesn't support Poland being unstable relative to its European peers.

Next, what are the odds of Poland being at war with Russia in the foreseeable future? We used to fight on average every generation or so (and were mostly winning until the collapse in the 18th c., including becoming only the second after the Mongols faction to conquer Moscow) but that was long ago. The relative power level is now the most favourable for Poland in at least 2.5 centuries - of course, Russia is still stronger in most metrics, but for example, in nominal GDP we're almost at half of Russia's already. Being a member of the EU and even more importantly NATO adds a massive layer of security (NATO GPD is 20x and military expenses 10x that of Russia - less in PPP but still many times higher) - we'd need to see a collapse of the American empire before NATO members are attacked in full-scale invasion. And even then, Poland won't be attacked first or directly - it needs to be flanked first by subjugating Ukraine and the Baltic states. Considering how things are going, the former might happen but it is far from guaranteed, but the writing will be on the wall years in advance. Also, Poland's rapid modernisation of armed forces will see us having an army capable of stopping Russia in about a decade even with only limited help of allies. Meanwhile, Russia chewed through over half of its stockpiles inherited after the USSR and is still stuck in Ukraine 3 years and 600k men later. It also has no desire, and certainly no means (currently) to wage another way, never mind against a NATO member. Considering all this, even though the probability of war has certainly increased compared with pre-2022, it is still relatively low (my best guess is <1% in 2021 growing to <5% currently).

Also, diversifying assets across countries is not a free lunch. There are things to consider such as additional work/mental load to keep oneself updated on second (and third's etc.) countries legislation, tax code etc. For instance, a very popular vehicle for foreigners to park money in the West is buying a property in Spain - either for a holiday let or a holiday home. However, Spain just announced plans to introduce a 100% tax on homes owned by foreigners. Implications aren't clear yet but I bet many are sweating and wish they kept their assets in their own country instead. And then there's the risk of confiscation (see Cyprus not that long ago) etc. All in all, it will almost certainly add a substantial cost in time, fees and mental load. Lastly, spreading assets means lowering the risk of everything going wrong but increasing the risk of 'something' going wrong. So it's just a different type of worry. And it might not even help as capital controls and border closures are very likely to be introduced in the worst case.

Now, from a different angle. There was never a better time to be Polish and live in the motherland in all our almost 11-centuries history. We are the most stable, equal and safe country we've ever been in and are ahead of many Western countries in many metrics (see above). Economically, we've overtaken some Southern European countries and will catch up with Spain and Italy by the end of the decade (for the first time ever!) and likely by another decade with France and the UK. This is truly the golden age! Personally, we're almost set on returning from 20-year long emigration over the next few years, despite any geopolitical risks.

[chenda]

This is verging too much into politics.

[zbigi]

@Bankai - I just see a lot of those things differently, and also don't see the relevance of some of your arguments (how is low crime or decent healthcare going to protect us against foreign influences?).
Note how Polish's stock market's P/E is barely at 11, whereas for example German's at 16.75. And that's whilst Poland is projected to have one of highest GDP growth in Europe in 2025, while Germany will have one of the worst. That's not random IMO, that's just markets pricing in the geopolitical risk. People with money vote with money, and they voted that Poland is a risky place to store assets in.

And it might not even help as capital controls and border closures are very likely to be introduced in the worst case.

I think I covered it somewhere above already. You can just store your assets in an brokerage abroad, it's apparently quite popular and described on some Polish blogs.

[jacob]

Note how Polish's stock market's P/E is barely at 11, whereas for example German's at 16.75. And that's whilst Poland is projected to have one of highest GDP growth in Europe in 2025, while Germany will have one of the worst. That's not random IMO...

This has a lot more to do with the way "equity" is both treated and used in the given country as well as the "traditions and culture" of stock investing. If you look at P/Es from country to country they vary by over an order of magnitude in ways that have little to do with the economy or its growth prospects as compared to other countries. It may simply be that corporations are not funded with public equity as much as they're funded with e.g. private equity or bank loans. The only valuation that makes sense is relative to itself and even then it's kinda dubious in terms of picking the right value.

For example, the US is historically valued around 15, but since the 1980s, that value has risen so much that it's arguable that it would never return to those earlier years again. What happened in the meantime? Basically, investing in stocks changed from something for the few (millionaires) to part speculative gambling, part "there's no alternative to ultra low interest rates", part tax-preferred/subsidized pension plan. None of that happened in other countries in the same way.