Archive for the Investing Category

Regarding Rebalancing a Portfolio

Posted in Investing on 10, January 2018 by nathanbusch

A client recently asked me the following set of questions:

Most stock screens typically have a high turnover of Ticker Symbols and are advertised using monthly rebalancing or updating: would annual rebalancing of the portfolio give better returns?

Also, it seems that monthly rebalancing of a portfolio necessarily increases costs of transaction, slippage and taxes. Therefore, how can the monthly rebalancing add sufficient value to a Portfolio given the inherent shortcomings.

Is there any way to obtain results of a portfolio managed according to yearly rebalanced as opposed to monthly rebalancing?

My response is as follows:

As to your question about backtesting to obtain the results of annual rebalancing: my question is why would you want to use annual “rebalancing”; do you have especial information that a portfolio that is rebalanced on an annual basis will out perform a portfolio that uses the same screen but is “rebalanced” on a monthly basis. If you have such information, then you are set to go. If you have no such information and you are relying upon a rule that some academic researcher or Wall Street guru establish, then you are in for some very poor sailing.

As to costs of transaction: if you use a large bank or brokerage house, you are lucky if your transaction costs will be any less than 111 basis points plus $45.00 per trade, and that is for each of the buy and sell. If each of your transactions is, say, $1000.00, I guarantee that you will lose money if you rebalance on a monthly basis and it is highly likely that your portfolio will suffer severely even if you “rebalance” on an annual basis. Of course, your portfolio will, most likely, suffer severely if you “rebalance” on an annual basis because it is highly likely that the average annual return on the stocks that enter the Passing List of any given stock screen will be much smaller than the average annualized return of the portfolio if you “rebalance” on a monthly basis. Use an online discount brokerage house: their transaction costs are so cheap as to be negligible.

As to slippage: this is pure nonsense. Understand the behaviour of the market in which you intend to operate and use limit stops.

As to taxes: this is also pure nonsense and an absurdity. Use tax sheltered or tax deferred accounts. You will be best if you use a Roth IRA.

To help you understand a bit better as to how to use the screens: let us consider the EPS Est., Rev. Up 5% Stock Screen. Typically, this stock screen produces, on average, about 40 ticker symbols per week. Consider further promoting the set of ticker symbols, which enter the Passing List on a given week, to the Portfolio and holding that set for a set time and then selling. Do that each week. Now, I know by now that you are screaming that I am completely off my rocker. I ask that you bear with me a bit.

Of course, for any given stock screen, it is highly probable that a single Ticker Symbol will enter the passing list over the course of several weeks. It would be absurd to purchase that Ticker Symbol and then purchase that Ticker Symbol a week later, & etc. The solution to this is to cull all repeat ticker symbols during a window of time before the week of interest. I use a 28 day look back period. That immediately eliminates about two-thirds of the ticker symbols that enter the passing list each week.

Then, screen the remaining one-third of the ticker symbols that enter the Passing List each week using one or more items of fundamental financial information or derivative information therefrom. I actually use a derivative of approximately 42 individual items of fundamental financial information each of which is averaged over the previous eight years. By this “buy rule”, I am able to decrease the average number of ticker symbols purchased each week to 2.06 between the beginning of January 2016 and 5th January 2018.

Then, I have an algorithm that maximizes the capital invested in the portfolio at any given point in time. This algorithm is based upon the utility function used by Bernoulli in his solution of the Saint Petersburg Paradox. This step alone approximately doubles the average annualized return of the portfolio.

Now, test to obtain the optimal holding period for the set of ticker symbols that is promoted to the portfolio each week.

The answer for my set of rules as applied to the EPS Est., Rev. Up 5% Stock Screen: buy every week, hold for five weeks and then sell as close to the market closing price as is possible.

My Simulated Portfolio indicates that the average annualized return on the invested capital in the Portfolio is 57% if the set of ticker symbols is held for five weeks and 12% if held for more than 26 weeks. I have been using this method since the beginning of January 2016 and have obtained a return that is within 0.15% of the Simulated Portfolio. And all of these numbers include transaction costs.

As to backtesting: there are some websites that one can use to backtest stock screens. I have found that these are incredibly difficult to program, have long waiting times for execution, and are inordinately expensive. Therefore, develop your own and I suggest that you not try to do so in MicroSoft Excel. Excel is clunky, slow, and underpowered for the computations you will need to properly backtest any stock screen. I currently use 8 macMini computers all running my algorithms in parallel and over ethernet connections. I obtain my items of fundamental financial information from the AAII Stock Investor Professional data base. My computational time for a complete Portfolio Simulation is approximately 8 hours per year of backtesting.

I hope that this helps.

Nathan A. Busch

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Cryptocurrency and Tulip Bulbs

Posted in Investing on 12, December 2017 by nathanbusch

In 1637, Dutch tulip bulbs, which had only recently been introduced, reached extraordinarily high prices: so high became the price that people were liquidating vast fortunes and borrowing to the hilt to buy a small handful of bulbs.  Then, people came to their senses and the price of the bulbs collapsed.

My reader and friend Dan asked my opinion on the rapid rise of the price of cryptocurrency and the futures market for these coins.  As a preliminary point, has anyone actually seen one of these coins?  My understanding is that the answer is a resounding NO!  That is because these things are nothing but a few bits of information in a computer.  Also, if memory serves, a considerable number of cryptocoins disappeared from a computer a few years.  Did anyone ever retrieve these “coins”.  Again, the answer is a resounding NO!  Oops!  There goes your life’s savings: too bad!

Cryptocurrency is not fungible, not readily liquidable, not recognised as legal tender by any government in the world, not negotiable, not tangible so these cannot be stored in a safety deposit box, and of use only by criminals.  These bits of information are even less valuable than Dutch tulip bulbs: at least you can plant tulip bulbs, let them grow for a year, and dig up six times as many bulbs as you planted, and you can sell the excess bulbs.

For these reasons, the Cryptocurrency Mania of 2017 is more lethal to your investment portfolio than was the Dutch Tulip Mania of 1637.

Therefore, run, as fast as you possibly can, in the opposite direction as the cryptocurrency is traveling.

I hope that this helps.

Nathan A. Busch

Entered Passing List on 20171020; Promoted to Portfolio on 20171027

Posted in Investing on 1, December 2017 by nathanbusch

The following ticker symbols Entered the Passing List on 20171020 and were Promoted to the Portfolio on 20171027. These ticker symbols will be held for five weeks at which time these will be sold at a price equal to or as close to the day closing price as is possible. In the attached table, we find the ticker symbol, the price paid as at 20171027, the price as at 20171130, the capital gain for each ticker symbol, and the average capital gain assuming that an equal amount of capital is invested in each of the ticker symbols.

Promotion/Sale Epoch
Ticker Symbol 20171027 20171130 Capital Gain
ANF 14.15 17.99 0.2624
CVTI 29.19 29.32 0.0044
EXFO 3.90 4.35 0.1153
NR 9.20 8.78 -0.0456
Average 0.0837

I hope that this is of assistance to each of my audience members.

Nathan A. Busch

Advice to My Nephew Clayton

Posted in Investing, Life in the Country on 2, May 2017 by nathanbusch

Nephew Clayton:

You will, most probably, have by now been taught to work hard, get an education, and make a moderately good living working for some company or other.  That is total bullshit!  Were I forty years younger, here is what I would have done.

Get yourself into the Physics Department of the California Institute of Technology.  There, work on your Doctorate of Philosophy in the field of Quantum Field Theory.  You will want to study systems in which spacetime is subject to random fluctuations.  Examine the Radon Transform of information deriving from such a system: specifically, you would be looking for the Riemann-Stieltjes Integral of the underlying field weighted by the probability measure of the random fluctuations.

Once you have finished that, which should take you less than three years, tell the physics world to go shove it where the Sun never shines.  Instead, get yourself some financial backers and apply what you have learned to the system that is the international financial market.

If you have accomplished what I think is the correct way of evaluating this last mentioned system, you should be wealthier than both Warran Buffet and Bill Gates combined by the time that you reach 65.

The gauntlet has been thrown down.

I hope that this helps.

Nathan A. Busch

Stories and the Trump Bump

Posted in Investing on 14, January 2017 by nathanbusch

Because of Trump, “the market is going straight up with nothing to stop it,” explicated one very excited attendee at a local investing group that I attended during the third Thursday of December 2016.

Barely able to contain himself, this lad gave the following “story” regarding Dryships (DRYS):

Trump is going to put a “huge”, G_d I hate it when the illiterate use that word, tariff on Chinese steel. Investors, that word is second from the top of my most despised words in the English language and only barely above the use of the word “scientists”, in the United States are renting large warehouses to store steel that they intend to import from China into the United States in advance of the inauguration of “The Donald”. Once “The Donald” has become president and the tariffs imposed the price of steel in the United States would skyrocket and these “investors” would make a fortune by selling the steel, which they had imported from China whilst cheap, into an expensive U.S. steel market. Thus, Dry Ships will be rolling in money because the “investors” need dry ships to transport the cheap steel from China into the United States.

Whilst nearly hyperventilating with excitement, this lad exclaimed that DRYS stock price had risen over 2000% within a few days: he called it “the opportunity of a lifetime. Then he petitioned the members of the group to announce any similar opportunities of which they might be aware. In a very calm voice, I stated the general position of the group, as I had been attending the group and knew the investment strategies of most of its members, as follows:

I use the following rule to reach a decision regarding into what I will invest my money: have a strategy that works; and stick with it no matter what happens in the world.

Within a few days of the pronouncement of our hyperventilating lad, DRYS crashed from about 100 per share to barely above 1.87. What our lad seemed to have missed is the following: that DRYS had a 52-week high of 278.40 and a 10-year high of 3000.00 per share. The Ticker Symbol closed on 12th January 2017 at 1.84. Even without the glut of ocean shipping capacity and the bankruptcy of Hanjin, I would have never purchased shares in a company such as DRYS: its gross profit for the year ended December 2015 was less than half of its gross profit for each of fiscal year 2013 and 2014; its net income applicable to common shares was deep in red territory for 2013, 2014, 2015, and through third quarter of 2016. No one, except shorts, in their right mind would ever consider purchasing so much as one share of a company showing a market capitalization of 68.00MM that had a fiscal year 2015 net income in the red by more than 2.8B.

My call for the rise from a few dollars to over 100 dollars per share following the election of “The Donald”: this was a classic short squeeze. No one in their right mind would ever come within a country mile of such a Ticker Symbol.

The moral of this story: run, as fast as possible, from any one with a “story” about a “good” Ticker Symbol.

I hope that this helps.

Nathan A. Busch

They Were Informed

Posted in Investing on 4, April 2014 by nathanbusch

About four years ago I told my nephew, who was about 29 at the time, the following: open a Roth IRA; contribute $5,500 the first year; contribute $5,500 the second year; that is all the money that you will ever have to save for the rest of your life; invest precisely the way I tell you to; and, by the time you are 72, your Roth IRA will be valued at approximately $2.44 billion with probability 0.85.

I do not have $5,500 for each of two years, said he.

I will give you the $5,500, said I.

He did not take me up on the offer: seems that his interests lay elsewhere.

I said the same to my niece at about the same time. She was about 28 at the time.

I do not have the $5,500, said she.

I will give you the $5,500, said I.

How can you guarantee that it will work, said she.

No guarantee, but merely probabilities, said I.

What about the other 0.15 probability, said she.

In that case, you will have somewhat less, said I.

She did not believe anything that I said.

Actually, with a relatively simplistic hedge, the efficiency can be increased three fold. Since the efficiency is the natural logarithm of the change in the underlying yield ratio, then a three-fold increase in efficiency represents a mere 2.5 percentage points increase in the annual yield ratio of the investment strategy over a 43 year investment horizon.

No one believes that this can be done.

But I am doing it.

Nathan A. Busch

CAPM, EMH, and other such Bunkum

Posted in Investing on 22, March 2014 by nathanbusch

I recently came across a fellow investor who was using beta to measure volatility of an asset in order to decide whether to purchase that asset. The following is my response.

***************

Beta is used in the Capital Asset Pricing Model to provide the expected return on an asset given the standard deviation of the price of that asset about its mean, which may vary with time, and the expected return on a benchmark asset, such as a zero-risk asset. The proper interpretation is as follows. Suppose you chose the 10-year treasury as your zero-risk asset. You immediately know your expected return on that asset. Now, consider a high risk asset such as GSS. Here, it is not simple to know what the expected return should be. The Capital Asset Pricing Model provides that answer: it is simply r_a = r_f + beta (r_m – r_f), where r_a is the expected return on the asset of immediate interest, r_f is the rate of return of a risk-free asset, and r_m is the expected rate of return of a benchmark asset, such as the S&P 500.

To compute beta requires simple linear regression which can be performed in Excel or any other relatively sophisticated spread sheet. Simply obtain the daily values for the market and compute the value of r_m = ∂S(t)/S(t) where S(t) is the value of the market at any given time and ∂S(t) is the change in the value of the market between any “base point” and the given time t. Perform the same simple computation for the price of the asset of interest. Then, do a linear regression with the quantity (r_m – r_f) as the abscissae values (x) and r_a as the ordinate (y) values. beta will be the slope of that regression result.

Personally, I think that the Capital Asset Pricing Model is extraordinarily useless as a measure of anything in the market. Of course, I know that Mr. William Sharpe won the Nobel Prize in Economics in 1990 for developing the model, but that does not mean that the model is of any practical use. Even if the Efficient Market Hypothesis and the Capital Asset Pricing Model had any basis in reality, what does the value of beta tell us about whether to invest in any given asset, say KO? In my humble opinion, it tells us nothing. I am not alone in my opinion. In 2004, E.F. Fama, another Nobel Prize Winner, observed that the empirical evidence demonstrated that the CAPM was invalid in real world application. He observed that passive funds that were invested in low beta, small or value, stocks tended to produce positive abnormal returns relative to CAPM predictions. Yes, one can fiddle with the CAPM to adjust for such real-world problems. Perhaps the better choice of action is to throw the entire CAPM, including beta, into the round file and use something that actually gives you some useful information about the stock that you are thinking of purchasing.

Perhaps you should leave your cash where it is for the next six months and carefully study the following two books very carefully: (1) Benjamin Graham: The Intelligent Investor; and, (2) John Burr Williams: The Theory of Investment Value. For some light reading, throw in Graham and Dood: Securities Analysis. It is worthwhile to set every thing in your world aside, except for your day job, until you have throughly understood every word in all three works. Then you will have all of the tools that Warren Buffet uses to select a company to buy.

Once you have done this, you will never, ever again think about using beta except for a late night joke.

I hope that this helps.

Nathan A. Busch