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