DIY Investor Magazine
/
2015 Issue
37
The chart shows a simulation of my 180-stock Russell
2000 ‘Lazy’ portfolio from 2 January 1999 to 5 January
2015 (16 years), rebalanced every four weeks.
Data and chart: Portfolio123
The following table gives statistics of the excess return
over IWM (iShares Russell 2000 ETF) by four-week
periods. It corresponds to a market neutral portfolio
with the 180 stocks on the long side and IWM on the
short side, with a leveraging factor of 2, without the
margin and carry cost.
Average
4week
return
Average
Annual
return
Max Draw
down
Depth
Max Draw
down
Duration
Avg
gain/
Avg
loss
4week
gain
probability
Kelly
criterion
1.04% 14.4% -23.7%*
19 months 1.54 68% 0.48
* On rebalancing date, it may be deeper in real time.
On the same period the Russell 2000 ETF (with
dividends reinvested) returned about 8% annualized
with a draw down of 42 months going below -58%.
There are solutions other than IWM for shorting
the Russell 2000 index: futures, options, CFDs,
leveraged ETFs, etc. Each of these has advantages,
disadvantages and a cost.
Optimizing the strategy
Holding 180 stocks is a lot for an individual investor.
The number can be reduced by a due diligence
process or a quantitative method.
In my real portfolio and newsletter, I have excluded
the most sensitive sectors to macroeconomic and
geopolitical concerns, kept the focus on larger
companies, and optimized the quantitative models to
keep only 24 stocks.
Optimising quantitative models to a lower number of
holdings incurs a risk of curve fitting. However, with 24
holdings balanced in cyclical and defensive stocks, the
risk is quite low.
The biggest danger of optimising is not over-rating the
possible return, but under-rating the real risk. If the
return can never be predicted, a diversified market
neutral portfolio limits the risk by design.
You can contact Fred Piard via his website
His book, ‘The Lazy Fundamental
Analyst’ is published by Harriman House.
THE LONG SIDE OF A MARKET NEUTRAL PORTFOLIO
AIMS TO BEAT THE MARKET IN ALL (OR MOST) PHASES
OF THE EXPANSION-CONTRACTION CYCLE. SECTOR
TRENDS ARE LINKED TO THESE PHASES, AT LEAST IN
THEORY
IF A MARKET NEUTRAL APPROACH IS BEING USED
BY A RISK-AVERSE INVESTOR, IT IS BETTER TO AVOID
RISKS THAT ARE NOT RELATED TO THE MARKET, LIKE
BEING TRAPPED IN A SHORT SQUEEZE. THIS RISK
EXISTS IN ALL MARKET SEGMENTS, EVEN LARGE
COMPANIES.
