Earlier this afternoon I was reading a copy of Investors Chronicle from a few Weeks ago (as always I am way out of date on my reading !!) and there was a couple of pages on a Regular Feature that Chris Dillow writes regarding several different Investment Strategies and how they work over time (Editor’s note - this Blog was first written in draft form back in mid 2018).
I reckon I might have done a Blog around this before or at least I have probably referred to what Chris does in this Strategy Piece and I guess that is one of the catches of having written various Blogs for nearly 4 Years now - I totally forget what I have written about and what I haven’t !!
Anyway, even if I have written a Blog around this before it probably won’t hurt to revisit the subject because there are some useful Lessons/Concepts that we can derive from what Chris does and the chances are that even if I have written a Blog on this before, I might at least be finding a new angle and updating what I would have scribbled last time.
First off some background. Chris runs 6 different Portfolios of Stocks and I think he updates them every Quarter and changes the constituents of each Portfolio. He then lets the Portfolios run and he measures their Performance with regard to Price Appreciation (or Depreciation) over time and note he does not include Dealing Costs (these must mount up if you are changing the Stocks every Quarter) but neither is the Dividend Income included (and I suspect this distorts the performance of some of the Strategies in a detrimental way also).
The 6 Strategies are as follows:
I am not totally sure on how he decides on how many Stocks to include but it looks like each Portfolio has about 20 Stocks - every time Chris writes up the Article he lists the 6 different Strategies and what Stocks are included at that time. Note it is a mechanical process - he just works out which Stocks qualify for each Quarter and then those Stocks are popped into the relevant Portfolio and left to ‘do their thing’. In many ways the work that Chris does here reminds me of the ‘Smart Portfolios’ that Stockopedia creates.
The Article I am looking at (and the Text excerpts below are taken from this) appeared in the Investors Chronicle dated 6th July - 12th July 2018 with ‘7 Steps to Healthy Profits’ on the Cover and it is on Page 40 and titled ‘Momentum Wins Again’.
First off I have copied out below Chris’ words about High Beta Stocks - remember these will be Stocks that move fast and it would probably include things like Miners, Banks to some extent, Cyclical Stocks, that sort of thing. The conclusion is that these more Volatile Stocks tend to not do as well as they should and this is something we should bear in mind when contemplating putting our Money into any Stock that comes under the High Beta label:
“This continues a pattern for high-beta stocks to underperform. In the past 10 years, for example, my high-beta portfolio has risen only 11.2 per cent while the FTSE350 has risen 45.9 per cent.
This is not a peculiarity of my portfolio - Economists at AQR Capital Management show that high-beta assets have underperformed for years not only in US shares but in other assets, too. The reason for this, they believe, lies in constraints upon borrowing. Many fund managers are prevented from borrowing much, if at all. This means that when they are bullish - and because Stock Markets usually rise they generally are - they express this sentiment not by borrowing and buying more shares generally, as economic theory says they should, but by shifting from low beta to higher-beta stocks in the hope these beat a rising market.
This, however, means that high-beta stocks are often overpriced and thus subsequently underperform.”
The next piece of text is of course the opposite of the above whereby Low Beta Stocks - i.e. Defensives - tend to do better than they would be expected to do. This includes the usual stuff like Pharma, Tobacco, Utilities, Food Manufacturers and boring stuff like that. The obvious conclusion is that we should be attracted to these sorts of Stocks and to a large extent my Income Portfolio contains Stocks in this vein (if you pop over to my ‘Portfolios’ Page then details on my Income Portfolio with its current constituents listed is near the top). It is interesting to note that as my ‘Normal‘ Portfolio has struggled so far in 2018, my Income Portfolio, with its more Defensive stance, has done pretty well and is up over 8% for the Year so far (this was back in mid 2018 remember - sadly the performance of both Portfolios got worse after this but the Income Portfolio did manage something like a 3% gain overall in a ropey year - and a considerable part of this was the Dividends received):
“The counterpart to high-beta stocks underperforming is of course that low-beta ones outperform.”
“Whether we look at three, five or 10 years, defensive stocks have beaten the market.”
“Because this fact has persisted for years after it has been pointed out, it is probably a persistent feature caused by the need for defensives to offer a risk premium. For those fund managers who are judged by relative performance, low-beta stocks are risky; there’s a danger they’ll underperform a rising market (as in fact they have for the last 12 months) and cost the fund manager his job or bonus. This causes low-beta stocks to be underpriced on average, and so to offer decent returns to investors who can take this risk.”
And now we move onto good old ‘Momo’ - Stocks with Momentum tend to keep doing well - but this works to the Upside and to the Downside. The obvious conclusion is that we should buy Stocks which are showing Upwards Momentum and part of the rationale behind the use of Stoplosses is that it gets us out of being exposed to Negative Momentum where a Stock that is falling tends to fall a lot more (I myself struggle with the concept of Stoplosses all the time but I fully appreciate this angle and see the logic for using them to avoid such continuing declines).
It is however important to understand Timeframes over which the Stock is showing Momentum. It is probably best to be Buying a Stock that is in a consistent and well-defined Uptrend Channel for at least a Year and ideally for longer. Stocks can show Upwards Momentum over a few Weeks or Months but this could be within a Larger Major Downtrend Channel which would obviously dominate over the Shorter timeframe:
“One portfolio has done even better than defensives down the years - momentum.”
“My momentum portfolio has hugely outperformed the market for years.”
“The fact that momentum exists not just in shares but in currencies, commodities and bonds suggests that the reason for it lies outside of stock markets. The most plausible candidate here is underreaction. We all tend to cleave too strongly to our pre-existing ideas (not just of course about investments). If we have an idea that a stock is a poor investment we’ll therefore stick with that idea even in the face of contradictory evidence. This means that shares that enjoy good news won’t rise as much as they should because investors will continue to doubt their merits. Which means in turn that rising stocks will continue to rise as investors gradually give in and update their prior beliefs.”
I see the concept Chris has just talked about there with regards to Investors being slow to see an improvement all the time when I am invested in what I see as ‘Recovery Stocks’. A Stock that has had problems can usually stay very cheap in P/E Ratio terms for a long time even as the Price continues to rise and there is a nicely established Uptrend. It takes a long time for People to forgive a Stock for past misdemeanours. Along those lines, I often see such a Recovery Stock do a very slow improvement over perhaps a Year or even longer and then all of a sudden it puts out some really Good News and the Share just takes off like a Rocket upwards. A good example of this recently was Entertainment One ETO which has done almost nothing for 2 Years and then suddenly went crazy as People wised up to the Value on offer.
And then following on from the Quote above, Chris writes this:
“One piece of evidence for this is the performance of negative momentum stocks - those that have fallen the most in the past 12 months. Although these did well in the second quarter, their long term performance is awful; they’ve fallen in the past five years. This is consistent with investors clinging onto bad stocks, causing them to be initially overpriced and so to drift down later.”
That is exactly my point about using Stoplosses to avoid exposing yourself to ‘Negative Momentum’.
This next bit conflicts a bit with the ‘High Beta’ type of Stocks - some of the examples Chris is using as ‘Value’ seem to be what I would think of as High Volatility Stocks. Slightly confusing but the conclusion I guess we can draw is that High Beta tends to not do so well over time and that High Dividend Yield Cyclical Stocks also can disappoint. The other conclusion is that it is Defensives and Momentum which tend to be attributes of Stocks that do best:
“One thing that seems clearer, though, is the performance of value stocks - the 20 highest dividend yielders. In the second quarter, these matched the market although they have fallen in the past 12 months. The story here is, I suspect, largely one of cyclical risk. Value stocks tend to carry lots of this; recently my portfolio has been overweight in construction and transport stocks, but miners have often also featured heavily. This means that when investors fear a downturn, such stocks do badly: the 2008-09 recession saw my value portfolio collapse. And when hopes of an upturn increase - as they did between 2009 and 2017 - value does well.”
I hope that has got you thinking with regards to the types of Stocks you are looking at and also with the Stocks you hold at the moment.
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