Is a CAPS based Fund plausible? Attempt at Quant based strategy
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
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?
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
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!
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
The latest blog by Jake
on the risk ranked performance of CAPS ratings – I am hoping you read it. 5-Stars:
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.
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
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
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% !!!
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:
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)
(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.
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!