Is a CAPS based Fund plausible? Attempt at Quant based strategy
January 10, 2010
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Greetings fellow fools and best wishes for 2010!
I guess I feel obligated every time the year rolls over to do a blog – it pricks your conscience to take so much and not give back( Also Hans ie portefeuille keeps bugging me about doing a blog !). Given the fact that I am so irregular in the CAPS blogosphere – I have a feeling that this post will be a long-winded and maybe at times meandering one – but hopefully you will be able to keep up with it – read the high points and take away something which maybe of use.
THE CHANGING FACE OF CAPS
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Its been 2+ years now for me over here. And what those 2 years have been – not just here – but from every which way I look at it! Personally, from CAPS – what I value the most are my online friends – something which I never bargained for.
However more importantly , with the changing leaderboard, the advent of fresh new talent ( Hans ie portefeuille, checklist34, bullishbabo, Ultralong etc), from the “Peak Oil and Commodity” blogs in early 2008 to the “Gloom and Doom” ones in late 2008 , to the Technical Analysis and Chart based “Bear Turn” call by GV ( Also I will defend my friend – who people keep ridiculing for some reason – he called the “turn”, he didn’t trade it to perfection – 2 very different things IMHO), and now the current either Ultra-bullish or Bearish polarized crowd.
Things change – yet they remain the same! My friend FloridaBuilder (FB) is coming back to blog, although Michael ( EverydayInvestor) has left, and so seems James (TDRH). But Tasty(Lunch) keeps churning out great blogs all the time – and who can’t feel for Binve – who thru his new fatherhood status and the excitement and sleepness nights – still produces excellent fundamental and technical analysis in a class by himself. Abit continues to blog in his inimitable fashion, kdakota630 is there with his Peter Schiff ones and dwot still comes up with her gems.
DOES CAPS WORK?
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There’s an amazing blog which FB wrote last year where he had asked rhetorically “Are we still an investment website?” in face of the End of Days drivel by “u-know-who- soon to be I guess 8-9-10 or something like that”
FB has been vindicated a year +from there – but he was wrong – dead wrong – short term.( I would also mention that FB’s personal strategy has always been long-short – so its more of a philosophical debate – than quantitative measurement) The volatility that the markets went thru – its was simply impossible to keep your cool. And most people thinks- its not over yet still. Who knows?
One struggle to me personally has always been – and I think its becoming increasing a law of diminishing returns – to dissociate value from the maze in CAPS. I personally think I was lucky. I think in my first week – I stumbled into Florida’s blog – and kinda challenged him on his views – and he was patient to explain and open up his encyclopedia of knowledge to me and others here. Abit – singlehandedly – was responsible for at least defensively orienting a bunch of people in Summer 2008 – including yours truly. GV, Checklist ( he had a Rolaids blog – I think) convinced a lot of folks about the impending bottom in Mar 2009. My friends in Stinkyfeet – kept chugging away at small cap investing – and we went long with the Piotroski screener in Jan-Feb 2009.
I mean does it need to be this difficult or an outcome of circumstances?
WHAT CAPS IS MEANT TO BE
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To makes things interesting and not get too insipid – I will have a tirade against the Motley Fool later here . The Gardner brothers – set this up IMHO – with one and one goal only – use collective intelligence for stock rating – and improve their own – myriads of stock advice services.
But the simple question is can you blindly pick a 5-star rated stock from MF list and put money on it – and see it perform ? The answer to that is as they say “complicated”. Personal corroboration on my own portfolio – 5 stocks bought in mid/late 2008..all still negative - heavily. But then again – you’ll say –“ hey man – you are still a certified idiot from a remote village in India – of course your choice is bound to be pathetic”. So of course in my infinite wisdom – I asked the Chimp ( you do not know who he is ? What do you mean – he throws the best poo around – by self admittance amongst the builder community in Florida. Look at FB’s avatar BTW J ) He told me – he was using it in conjunction with a TA based method he followed. So then I started this journey down the path of learning TA – and of course GV comes along the way – and turned everything on its head!
Anyway , although the illiterate fool that I am , sometimes I manage to read up some things called “papers” – especially if they come from a certain , “school” in Chicago. So Joseph Piotroski wrote this paper on Value investing – which really appealed to me in concept – so I pitched in early 2009 – all Piotroski High Scoring picks – with a CAPS score of 3+ for Stinkyfeet. The results have been much better – although some have been negative from a CAPS perspective – you made money on all of them – some were big winners ( TCK on my own call list is one – I would have liked to pick it right at the bottom on 3/3/09 – except I had the pick from Dec 08 – so I wanted to bank accuracy!) This is however from a perspective where 80-85% of stocks have gone up since – that means on a Mean Adjusted basis – you need to have at least 92+% accuracy to be considered a Non-Random event ( err ….a small little piece of statistical jargon – somehow which found a way into my ears – called test of sample proportions. Hans ie porte beats this actually on his Biotech calls – hands down! )
THE POINT and CALL TO ARMS!
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Anyway the long-winded point that I am belaboring here is simple – everyone seems to be using CAPS as an adjunct to their strategy at best – or ignore/entertainment/blowhorn purposes at worst.
This includes the Fool staff also. Other than the yearly blog/article on showing that CAPS ratings seem to be rank-ordering on an Alpha ( ie Market Index – SPY adjusted basis) and the paper ( Yale was it – not linking – Hans will read this – and do a much better and thorough job than me – I am pretty sure) – most of the stuff spewed out is individual opinionated perspective. Like my friend GV – who’s opinion you may disagree – but analysis you can’t discount – there are people on the MF who come and actually lay down an analyzed perspective – but like GV – its again personal.
CONTEXT and a Proof-of-Concept
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The latest blog by Jake
on the risk ranked performance of CAPS ratings – I am hoping you read it.
5-Stars: 65.86%
4-Stars: 58.64%
3-Stars: 53.97%
2-Stars: 61.36%
1-Stars: 23.28%
SPY: 26.35%
The question is – was that just an FYI – or something actionable? Lets take a look.
On 01/01/2009 – there were 4735 CAPS rated picks ( Using the screener)
(a) 4 and 5 stars: 1942 stocks
(b) 1 and 2 stars: 1826 stocks.
The issue is any strategy ( even with obvious filtration like liquidity thru volume etc) –those are a lot of stocks. With the exception of the Vanguard Total Stock Market Index ( based on Wilshire 5000 I believe) or the Russell Index funds ( 2000 stocks) – very few funds have or can have this large a holding let alone individual investors.
Part I:
So I took a step back and did the following:
1. Known Fact: In one of the old blogs – it has been proven that IF AND WHEN they work – Stocks that are transitioning into 4 star provide the best entry points in a CAPS based long strategy
2. Took all 4 stars ( with some liquidity filters) that were not so as of 2/1/2009 but so in March 2009 …..
3. Devised a LONG only portfolio in Smartmoney.com – with a buy date of 3/6/2009 – ie assuming the BUY TIME AS GRANTED ie known beforehand!
This way I found 103 stocks and by dropping a few index ETFs was able to restrict it to the 100 limit for Smartmoney ( Jake/Chris …guys do something with the screener – I had to do hand entry on each stock – there’s no compatibility outside of the fool !) This is manageable – but still a lot for an individual portfolio. Anyway lets look at the results
Portfolio Gain/Loss
Win % age is 98% ( only 2 stocks lost money –QCOR and UFCS)
Additionally I checked fallout/rebalance would have been minimal : 82 stocks are still rated 4+- so high survival rate.
The Actual Portfolio Curve
The results obviously beat the pants out of the above numbers – however the timing makes a big difference. S&P itself is up about 70% from that date. Additionally I tracked stocks which recently in Mar 2009 slipped into 1 and 2 star status – that portfolio also would be up about 70% - very similar to what was presented above – ie even laggard stocks which the MF community went against in Feb 2009 – met the market.
Ok…now you are wondering – am I on steroids or something – this is not a valid backtest – its contrived data. No question however – keep the premise in mind – here are the takeaways
(a) Stocks that are transitioning( using 1 month or similar look-back) into a Buy in a Bull environment perform well
(b) MF bogies the Small Cap and Mid-Cap universe – hence would mimick similar characteristics. Here's the breakout for the portfolio tested
(c) There is outperformance in this 1 test window
Part II:
Used it the other way around. Chose the absolute worst day to buy stocks 9-19-2008. Did the same algorithm and found 27 stocks that qualified.
Here’s the Equity curve for holding that portfolio thru 9-19-2008 to 3/5/2009 – possibly one of the worst times ever to hold stocks ( S&P was down 46% same period) . This portfolio would have been down 15% !!!
Equity Curve
I have not tested any short strategies – because I believe like Piotroski – shorting on a broad-based levels do not work – there it has to be much more focused and timing driven.
The Motley Fool Index Fund/ETF Experiment:
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You know what – something I learnt in an obscure class called Probability – Law of Large Numbers – seems to have unfailing habit of working time and again. On I think the very first blog in Nov 2007 – showing CAPS ratings seemingly working – I proposed the Fool should start a Quant based Index fund on it. Of course 2 years have passed since and the Gardner brothers these days are more interested to sending me “personal invites” to participate in this “new option based strategy” – which will be my nirvana – BTW I have their first Fool Investing book – I think there was a chapter on Options in it – if I rejig my memory – something monikered “circus of freakish delights” comes to memory
So Hans and I were chatting on CIL ( coveritlive – the chat room from the Circle Community – you can access it from www.iamgv.com) about ways to construct a viable quantitative selection strategy for a MF Rating driven Index Fund/ETF.
The WHY: The ratings performance needs to be back-tested on a real portfolio term basis – much more exhaustively and openly and regularly. A once a year dynamic cohort ( ie allowing stocks to move in and out , every which way , possibly unknowingly introducing bias – without analyzing) – study seems lame to me.
The need is obvious – Solarisking, Tigerpack –all are experimenting with this concept. However I still think – both of these initiative – although laudable – have major selection bias.
Someone needs to run this on an open platform basis ( To showcase how good people –seem to have disappeared into the ether over time in Caps – look at players CAPS1StarIndex, CAPS5StarIndex - I am not original by any means. They were I think 2 of my FIRST favorite players – I dropped them once they became inactive)
The HOW:
(a) Run an automated Index fund on the myriads of tracking websites available
(b) Open up the MF database to true Search and Optimization possibilities. The current screener is – well words are flooding – but better left unsaid
(c) Invest in analytics and share it. Talk to SAS Institute or Oracle – make the MF database open and available for better strategy building and testing.
(d) Have someone continuously test these ideas and blog about it – rather than a crowd coming and regurgitating the same market news over and over.
PARTING THOUGHTS
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The goal should be to use the system more effectively for actual monetary participation on a low-cost basis.
There is an element of adaptive market timing –embedded in the system –if MF is bearish – it would auto-switch to cash and vice-versa. I am currently working on this – as usual excruciatingly painful – hopefully that can be another blog based on people’s interest levels.
All the best and take care!
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