Building a StockRanks Portfolio - Webinar Transcript

This is a transcript of the “Building a StockRank Portfolio” Webinar.  This should not be read without reviewing the original slides downloadable from here, and while watching the video recording on Youtube.    

Hi and welcome to the webinar.  This is titled Building a StockRank Portfolio.  It’s going to be a 1-hour webinar and we’ll be covering a lot of ground.  It’s very exciting for me as I could spend a whole day on this.  There is so much material that I have gathered it’s very hard to fit it into an hour so if you are interested please do let me know as I am thinking of doing a 1 day course.  In the original webinar the recording corrupted so I am rerecording it and hopefully sending it out to everyone who registered.

My name is Ed Croft; I am Co-Founder of Stockopedia.  I am a former stockbroker, Oxford educated geek but essentially a highly motivated private investor.  I left the City, wanted to invest personally, found that there were some really terrible tools around and one thing led to another and my own research project turned into Stockopedia.  Everything we are building on the site is designed to solve investment problems and hopefully I will be showing you some of the ways which I use it and have used it to try and build market-beating portfolios.

Before we start I must put this disclaimer in place which essentially explains we are not giving financial advice, this is very much an educational webinar.  I want to explain what I’ve done and how I’ve got to the performance this year.  Our tools on the site are for information purposes.  We always say DYOR “do your own research”.  It’s very much a DIY investment tool.  A lot of the stocks that you might see in this webinar are highly ranking but there are obviously no promises that the future will be as good as the past.

Agenda

What’s the agenda?  Firstly I am going to run through the NAPS portfolio performance review.  I will explain in detail what the NAPS are, what the stand out winners and losers have been, what has gone right and what might be improved in the future.  I want to show a live demonstration of how to construct a StockRanks portfolio and I will be demonstrating this using the StockRanks portal and the Folio tools and possibly the Screener.  I will be talking about diversification approaches and lessons I have learned this year.  We will also talk about on-going portfolio management, sell rules, rebalancing etc. and we will also do some closing thoughts.  As this is not live I will be trying to answer some of your questions at the end that people have actually said to me and hopefully this will all be done in around an hour.  If anybody is not a subscriber to Stockopedia watching this webinar I will hopefully be giving you some reasons to sign up throughout the webinar and sharing some links at the end so please do stick around.

Performance Review

Let’s go straight on and look at the portfolio review of the NAPS.  Firstly this is 2015, it’s the beginning of December and we have had 11 months.This is the performance of the FTSE All Share. Now I am focused on the UK market because probably 80% of our subscribers are British and predominantly invest in the UK market but these tools can be used internationally in the US and European markets too so we are also launching Australian and Asian exposure on the site pretty soon.  This webinar is going to be predominantly about the UK.  So this is the performance of the FTSE All Share which is the benchmark that a lot of UK investors use.  As you can see it has been a pretty average year.  Nothing exciting has happened etc.  This is the performance of the New Year NAPS portfolio.  It’s a 20 stock portfolio and it’s returned almost 40%.  

It’s taken me massively by surprise and to be honest if I had known this was going to happen I would have sold my house and everything else with it and put it all in the stock market and geared up enormously.  I didn’t but I did invest my own portfolio according to very similar rules.  I actually diversify more broadly and I use a bit of short selling and my performance actually outperformed the NAPS so I know this has worked very, very well this year from a personal perspective.

Now what are the NAPS portfolios?  How is it constructed and why is it called NAPS?  Essentially [the phrase] comes from the card game Napoleon where a NAP hand is a declaration that you can take all 5 tricks.  It’s only every used when you have very, very strong odds.  It’s a phrase that actually started being used in racing tips, the NAPS and it also started being used in Tip Sheets so that is where I first came across it.  We used it in the beginning of the year actually as a bit of a riff on this idea.  We weren’t going to create our own tips for the year but what we thought is we could apply a mechanical, rules based process using Stockopedia’s statistical tools to come up with a set of stocks with a high probability of at least doing as well as the market and hopefully; if we were lucky doing better.  

There is more reading at these links (http://bit.ly/1xGuFp, http://bit.ly/1TlZAh5)and the PDF will be attached and we will try and put it on the video as well.  You can read further on these links at any time.

So the way that we did this we created the portfolio according to these rules.  Firstly we ranked by descending stock rank, the stock rank is Stockopedia’s proprietary core ranking method, there are other ranking methods but this is our proprietary one, that is the main one on the site, I will explain in more detail shortly.  Then we excluded small and hard to trade shares so market capitalisation of less than £20 million to keep all the real little tiddlers out and also ensuring the Bid-Ask Spread - the Spread between the buy price, what you can buy at and what you can sell at - is less than 5% because you want to make sure there is nothing super hard to trade in there.  Then what we did was pick 2 stocks from every sector so the highest ranking 2 stocks that met these criteria.  That was it and the performance has been remarkable.  I am going to be investigating where this performance has come from over the course of this webinar.

Winners & Loser

Now looking at some of the biggest winners of this 20 stock portfolio, you can see here are the top 6.  International Greetings (LON:IGR) , small card distributer and that returned 130%.  Dart (LON:DTG) which has been possibly one of the biggest winners for Stockopedia subscribers since we launched, I don’t know how many times it has multibagged  but it is still going up and I don’t think anyone expected it to go up 85% this year.  There are other good stocks in here like Character (LON:CCT) which does distribution of Peppa Pig toys and so on.  One thing about all these shares is they are not exactly the glamour stocks in the stock market and these are not the kind of shares that brokers get excited about and this is something I say again and again and again about what pays off in the Stock market is that it is often not the shares that are most exciting.  

Looking at the total spread across winners and losers in the NAPS portfolio we can see that there was only 1 loser in the entire year and that was Lamprell (LON:LAM) in the Oil and Gas sector and the 2nd worst performance was Catlin and that’s because it delisted after about a third of a year.  Almost every other share has performed remarkably well so only 1 share has underperformed the FTSE, all the rest have been winners and you can even take the top 10 stocks out of that and you would still have had a 15% return over the year.  So it’s been a remarkably consistent, and I have been so surprised by the performance myself.

User Portfolios

Now just so you know that I am not pulling the wool over anyone’s eyes, there are a couple of subscribers that have been blogging about how they have been getting on using the StockRanks and the screens on Stockopedia for the last 1 or 2 years.  Mechanical Bull is an independent blog; he has turned 67% over 2 years which is a fantastic return.  Grinder Trader in the 1 year that he has run a StockRanks portfolio in parallel with his own personal discretionary portfolio he has returned 38% in that one year.  So all we can say is there is definitely something to the system.  

Building the Portfolio

[Youtube Link]

So let’s have a little look at how we built this portfolio and I will then come back and talk a little bit more about the StockRanks.  Essentially we built it using the StockRanks [Portal].  Now I have a slide actually, which talks a little bit about the philosophy we used to build the portfolio.  I call this my Four Principles for stock market success, it sounds a bit naff but it’s my own personal evolving philosophy which I am using myself.  

The first rule being managing the monkey. We all make mistakes in the stock market and we are very, very prone to behavioural biases, it’s a legacy of our chimpanzee background, our survival spirit.  Whatever it is we are our own worst enemy and I have found and so have many, many researchers that the one thing that we can do is put rules and checklists in place that mean that we adhere to more systematic process that get a better outcome.  So number 1 rule is actually using rules.  

Secondly aligning with the payoffs.  There are certain key drivers in the Stock Market that the academics have studied for the last 50-100 years which consistently pay off and that is value investing, cheap stocks beating expensive stocks, momentum investing and quality investing that we have actually pulled together into our single StockRank ranking factor. It is very important to invest at the extremes, which is sometimes investing where others aren’t comfortable to invest, not necessarily in the glamour shares.  We can use statistical approaches to find the stocks most exposed to these payoffs.  

Thirdly giving every stock a role.  This means making sure that one is spread across sectors, that we have defensive shares, that we have cyclical shares, we have sensitive shares.  We don’t throw everything in the oil and gas sector just because everyone else seems to be.  It’s about actually making sure that our portfolio is robust.  I sometimes think of it like a football team.  

Fourthly keeping the balance.  Rebalancing, position sizing, this is all about keeping the balance in a portfolio and making sure that we are managing the risk on an on-going basis.  Over time stocks drift, they drift away from the exposures to those payoffs and if we want to keep aligning with the payoffs we have to keep rebalancing back into the more promising stocks.

[ Youtube Link: 11:29  ]

Now I wanted to show you a little bit on the website about how I built the NAPS portfolio.  So I am first going to show you the NAPS portfolio which is here.  This is the portfolio that I have been tracking all year with an original nominal £100,000.  As we can see here are all the percentage returns, as we can see on this list.  There are quite a lot of the stocks still have very high stock ranks.  So the stock rank for example of Dart is again the highest ranking stock in the market.  At some point that has got to fall out of bed.  I don’t know when it will.  A lot of them are still ranking very, very highly.  

Some of them though as we can see BT here, has dropped off significantly.  It is now a 63 StockRank.  It’s the kind of share that personally I would be rebalancing out of because it is not exposed or aligned with the payoffs anymore.  A lot of them are still very high ranking and that is a way that when we are rebalancing that we can consider minimising the transaction costs, but we can also have a look at the market caps.  We can see that there are a few large caps here, quite a lot of mid caps but then there are a lot of much smaller caps and worse.  I think one of the things that I am personally uncomfortable with in 2016 is having too many micro-caps in the portfolio.  It is a double-edges sword obviously.  If we look at the stock report for International Greetings (LON:IGR) , International Greetings has been a fantastic performer.  It has come off a £30 million market cap and has done 130% but these kinds of small stocks are a double-edged swords.  You can do very poorly with them, as we shall see.

That is the portfolio and I would like to show you the allocation.  This shows that the portfolio is still well diversified across sectors but if we scroll down and on the right these horizontal bars show us the size of the position relative to the others in the portfolio and this shows you that International Greetings have now become 8.5% of the portfolio.  If there was a profit warning and it dropped 50% we might hurt.  And as we have seen there have been a lot of profit warnings across the whole market.  It’s been quite a bad quarter for profit warnings and let’s not pretend that the NAPS portfolio is immune to it.  So that is something that bringing these position sizes down by rebalancing would minimise the risk of if the stock still qualified.

Now let me go back.  I wanted to actually show you how I build the naps portfolio because it is very straightforward.  I need to do just a moment of prep and just make sure I have my portfolio free.  If I go back to the StockRanks portal this page shows us all of the top ranking stocks in Stockopedia in December in descending StockRank order.  Important to understand.  These other pages theStockRank Movers page and the StockRank Performance page they show us more information about StockRanks.  The performance portal is particularly useful for people who want to investigate how the stock ranks have done.  Let me flick back through the slides because I have some information here for you.  

About the StockRanks

[ Youtube Link: 15:00  ]

Learning more about the StockRanks, I have done full 1 hour webinars on the StockRanks (http://bit.ly/1i0fgDR and http://bit.ly/21E7MPW)and I am not going to repeat myself now and we will just breeze through for people that don’t know about the StockRanks but if you are interested please do look up at those links and you will find a much deeper investigation into the StockRanks.  Essentially we publish the StockRanks at the top of every stock report and we use what is called a multifactor approach to create rankings for value, quality and momentum.  So we use about 6 fundamental valuation ratios to come up with a ValueRank, we use more ratios for profitability and health and margins and cash flow to come up with a quality rank and we have a momentum rank which blends price momentum and earnings momentum.  In a nutshell this shows us and tells us if stocks are good, cheap and improving.  

This is all based on a lot of academic research, we are trying to find shares that are exposed to value, quality and momentum and the overall StockRank sits right in the middle as a blend of all 3.  Essentially we are trying to find what I call good, cheap, improving shares and our portfolio, if it is well constructed; should contain a whole set of good, cheap, improving shares across all the sectors.

Robert Haugen called these kind of shares "Super Stocks" (in his book the Inefficient Stock Market).  The opposite is the profile you really wouldn’t want in your portfolio - expensive, deteriorating junk.  These are the kinds of shares that most private investors seem to prefer.  I don’t know why, don’t ask my why but I keep investigating and I keep finding evidence of it.  Hopefully at Stockopedia most of our subscribers don’t.  

Anyway the StockRanks performance as I said has been really remarkable, this is a chart that shows all the different deciles of the rankings.  The top line here is the stocks that have been ranked 90+ and how they performed and the bottom line shows the ones that have ranked very, very poorly and they have massively underperformed.  

[ Youtube Link ]

I think that what it is even more interesting is this slide which shows you the hit rate of picking winners at different levels of stock rank.   So if I just go back here and I show you Dart (LON:DTG) .  The StockRank is up in the top right hand corner here, we can see it’s 99.  The column here on the right shows us the hit rate of winners of stocks that are ranked 90+.  The next one shows ranks 80-90 and the one far on the left is 0-10.  I am trying to think of a 0-10 off the top of my head, I am not sure that I can but let me look at something like Rockhopper Exploration (LON:RKH) .  Classic company with a very low stock rank, a 15.  

[ Youtube Link ]

Anyway, the probability of picking winners has been highest in the higher ranking stocks.  There has been a 70% chance of picking winners in the average year since we started tracking this which has been far higher than all the rest (of the deciles) and you can see there is this huge correlation with the StockRank for picking successful shares in the UK market.  So the NAPS portfolio has done actually remarkably well because we have only picked one loser - surprisingly it has done even better than the averages which has really taken me by surprise.  

Building the NAPS Portfolio

[ Youtube Link ]

Now I will come back to this slide in a minute.  I want to show you how we can build the NAPS portfolio [at the Top StockRank Portal].  So I mentioned at the beginning it was a portfolio that cut out all the microcaps.  So the first thing I do is go to the filter on the left, click “SIZE” and find more than £10m million minimum size.  Once I have done that I then click “SECTORS”. I wanted to pick 2 shares from each sector.  I will explain a little bit further detail why I am doing this but it’s as simple as that.  I have now found all the shares that are higher than £10 million market cap and these are the top 2 ranking (in the energy sector).  NWF and DCC, that one is a 99 but this one is an 86.

So what happens is we will go into the sectors (filter) and find the top 2 ranking shares not fussing too much about what the Stock Ranking is.  I am going to add that to my “NAPS webinar” portfolio and with any luck you will now see they are added.  I am going to do the same for all the other sectors.  

Let’s start again - click  basic materials, add to folio, select “NAPS webinar” portfolio.  What I like to do when I am clicking “Add to Folio” I click either the Cmd button [on a mac] or the Ctrl button on a PC, it opens [the Folio] in a new tab and it saves me from having to reset all my (size and sector) filters.  

So now I just need to quickly rattle through all the other sectors, Character group and Berkley Group, add to the “NAPS webinar” Folio.  Now I am going to go down to consumer defensives.  So we are going through each of 10 sectors and I am selecting the top 2 shares to each.  

A-ha, Lighthouse Group.  This one is ranking very highly and performing very well but it has a £12 million market cap.  It’s too small for my rules so I am not going to be putting that into my portfolio because I had set a £20 million market cap cut-off.  

The next one is Healthcare and again AnimalCare; I will keep going down and Universe Group.  I talked about bid-ask spread, I have already done my research on this and I know that the spread is too wide so I am actually going to miss that one (Universe Group) as I know the spreads are wide and I am just going to save myself some hassle but I will explain it when I am looking at the portfolio view in a little more detail.  

Again Zamano, I know nothing about this but it’s a £10 million market cap and I don’t want £10 million market cap stocks so I am doing the same thing (skip).  And finally Utilities and I have got 2 there.  Now we have the overall NAPS portfolio that I have created as of todays date.

Reviewing the selections

Now we can see automatically that we go through to the portfolio page.  All of my portfolios are available here from the Folios dropdown and there we can see the “NAPS webinar” Folio link.  All of those shares (selected) are now in this watch list.  I have customised this view slightly so that I can see the Bid-Ask spread.  

One of the things that people often don’t look at is the Bid-Ask spread.  Now for people who don’t know what a Bid-Ask spread is, the ask price is what you would buy a share at; the bid price is what you would sell a share at.  

A market maker would always make sure there is a “spread” between those 2 (prices) as that is how he makes money. Now some companies are illiquid which means they don’t trade very often and to manage that risk of being stuck with stock the market makers will sometimes quote a much larger spread.  

Now that means if you were going to go and trade Adept Telecom (LON:ADT) on the same day so buy it and then sell it immediately afterwards you would be 7.4% out of pocket.  That is a very tough thing to see, so if you bought that share and you went into your portfolio you would see a 7% loss immediately if it was valued on the bid price.

The spread is quoted in basis points where 100 is 1% so that is why these numbers here are much larger than a percentage.  You can see we wouldn’t be necessarily comfortable owning Adept Telecom if we were going to stick to that (spread < 5%) rule.  So I am going to go back to my StockRanks portal and I am going to find another Telecom which perhaps might not have such a wide spread.  That is actually what we do, there we go.  

Now we have our portfolio of 20 shares with any luck and I am not sure that actually worked, I will do that one again.  It’s no harm me showing you this again and there is the 4th share (in Telecoms).  Adding to portfolio, I am adding it in and I am done.  Now we can see the biggest spread (in the list) is 4%, It’s spread 2 by 2 in every sector with any luck, and that is basically what I did at the beginning of the year.  As simple as that.

Behavioural Biases

[ Youtube Link ]

Now there are a few things I wanted to quickly discuss.  Firstly when I look at this list I am filled with horror.  I don’t even know what some of these companies do, I don’t know and I feel an emotional reaction which immediately says just run a mile.  I felt it at New Year and I am trying to train myself away from it.

One of the things I have always found is that people find buying high ranking stocks very hard.  I think it comes down to the fact that it is contrary to human nature.

• Nobody likes buying cheap stocks, mainly because cheap stocks have got problems.  They might be cyclical, they often have problems.  
• No-one likes buying good stocks because they tend to be boring so most of these shares on that list will be profitable companies and they are often in really boring business sectors.  Frankly they are all pretty boring shares, I don’t find anything exciting about that list.  
• Also nobody likes buying momentum stocks or leading stocks because they tend to be scary.  If we go and have a look a the price charts and if you go back to the portfolio and if you see up here in the top right corner you can click the charts symbol and yes there we go.  Classic example.  Almost all the stocks in this portfolio have got rising share prices over the last year.  They are momentum shares.  They have done well.  They look scary to buy.  Very few of them like Indivior there are actually looking like they are coming down.  Now anybody going to try and buy shares, how many people are going to go and buy Computer Centre or Dark Group or DC or Gamma Communications when they have got charts like this?  Not very many.  

So it’s very difficult to buy these kinds of shares for those 3 reasons and this is one of the reasons why I have faith that the StockRanks may well continue to outperform even when they are widely adopted and people are using them.  My experience is that people will tend to buy the wrong stocks in the list.  That is my experience, we see it time and again.

Diversification

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1. Breadth

Ok, a few quick questions.  People often ask me “why 20 stocks ?  You always go on about diversification, why diversify so broadly, it’s about having 10 sticks in a portfolio or I want to own 8 stocks, I want to make sure I get rich.”  I can answer this question very simply.  

Firstly there is this phrase from Warren Buffet that I think is the most dangerous quote in finance.  He says “diversification is a hedge for ignorance”.  Unfortunately that plays to our overconfidence because none of us like to admit we are ignorant.  Well the truth is anybody investing part time basically is quite ignorant about what is going on in companies.  No matter if we are business analysts, accountants, trained consultants, really the time that we have to really investigate the shares to the depth of someone like Warren Buffet is minimal and he has a huge team behind him.  

I am very happy to know that I am ignorant about most of the shares in a list that I buy as I know that I have understanding of other things.  I have an understanding of what pays off in stock markets - I understand that value investing pays off,  I understand that momentum investing pays off - and I don’t mind a certain element of ignorance on certain (individual) stocks.  In fact because I am ignorant I am going to make sure I diversify broadly but in the stocks most exposed to the factors and the payoffs.

The risks of concentration

I want to just show what happens when someone picks 5 stock portfolios because having a concentrated portfolio leads to very, very wide outcomes. Every grey line in this chart is a 5 stock portfolio picked totally randomly from Stockopedia’s highest stock ranking decile.  So that means that throwing darts at stocks with a rank of 90+, and you pick 5 that you throw a dart at, this is the kind of range of outcomes you could have had.  

I did this study last year so this is up to last September but it shows you the range of outcomes that you could see.  You could underperform, you could do very well.  Who knows where you will end up?

Next is random 15 stock portfolios and as you can see the range here of outcomes becomes tighter and as we add more stocks, 25 stock portfolios, the range of outcomes becomes tighter and tighter and tighter, eventually ending up very similar to the (90+ StockRank) decile return.  

The thing is people have got to ask themselves, do you really want to have a high risk of underperformance or risk of ruin by investing in 5 stock portfolios?

These are random portfolios remember.  The portfolios where people have picked 5 stocks and selected them often do much worse.  Why?  People have a tendency to buy shares that are very familiar and they tend to buy shares which are most discussed and they tend to buy shares that have most excitement.  These are all behavioural biases that tend to gear us away from the boring shares that actually often tend to pay off the most in the stock market.  

I love this quote from Joel Greenblatt who made 50% a year on the Stock Market (in Gotham Capital over a 10 year period).  He said “If you are doing a limited amount of work on individual stocks or no work at all like most investors, diversifying with 20 or 30 (magic formula) stocks is most definitely the right plan for you.”  He wrote this in his book, The Little Book That Beats the Market, and his magic formula is similar to the Stockopedia StockRanks in the sense that it tries to find good, cheap shares.  It is a systematic strategy and he is a very wise man.

20+ stocks?

Just to prove another point to you, occasionally I get people trolling me on the website and someone was saying the original article was only about the “top 10 stocks”.  Well it was about the top 10 stocks but I also said in that article we would be tracking the performance of the top 20.  There were 20 stocks listed in the original NAPS article but 10 of them had slightly more detail.  This is the performance of the top 10.  The top 10 did 31% which is still a pretty stunning return over the course of the year.   Personally I believe in diversification and my own portfolio has around 35 in it.  I don’t believe owning more shares leads to worse returns.  It is a myth.  Also any fund manager who had a 20 stock portfolio would probably be seen as madly concentrated so why private investors always believe they should have only 5 or 10 stocks I do not know.  What happened in the 20 stock portfolio is that some shares like International Greetings crept in.  International Greetings returned 130/140% and has driven a lot of that extra outperformance.  If you have a slightly wider net you might be more able to catch the truly stunning returns and truly big winners.

How many stocks?  Portfolio Size

The one thing is diversification is a problem for people with small portfolios.  I have created this spreadsheet online, please do go and read this article.  It really might help people think about their costs.  I always say that the average (investor in a) fund manager has about 2.5% cost of investing and I think if your process actually has a similar level of costs or less and you are investing yourself then it is very sensible to “be your own fund manager” as it were.  

People with smaller portfolios - I think to be honest there is a huge amount of education that people can get investing in 5 stock, 10 stock portfolios.  Obviously if you are investing in a 25 stock portfolio with about £5000 it could end up costing you 12% a year which is not an overcome-able hurdle but it is very difficult.  One needs to sort of slightly weigh up how many stocks are in a portfolio depending on the size.  There is a Google spreadsheet that people can go and look at there.

2. Sectors

[Youtube Link]

Now I hope that answers why I believe in diversification or the breadth of a portfolio.  The next point is how many sectors.  A lot of people say look, why do I want to invest in all these other sectors.  I don’t want any utilities, I don’t want any of this, I want to put all my stocks in the sectors that have the best companies in it.  That is fair enough and I think what some of these people do is they like to set up a stock screen to find high ranking shares with maybe 1 or 2 other factors (e.g. Yield, Relative Strength etc) and they will put the top 25 in their portfolio.  

If you look down at the right hand column you will see that there are 6 industrials in the top 20 shares here, there are 6 cyclicals.  These are sensitive cyclical companies which you would be putting the majority of a portfolio in when who knows what is around the corner next year !

I want to make sure that in my own portfolio I have a robust portfolio that can weather bad market environments.  Now that is why I like having defensive shares in my portfolio.  We use a sector classification schema from Thomson Reuters.  It has 10 economic sectors, it has 28 business sectors, 54 industry groups.  At the moment we are only publishing the 10 sectors and the 54 industry groups but we might publish the others in the future.  What these 10 sectors allow us is to invest more broadly across a lot of economic areas.  Remember utilities used to be the growth area of the market back in the 60s.  They are now very much a defensive part of the market.  So you get some defensive sectors and you also get the more cyclical sectors.  So investing across more sectors actually could make a more all-weather portfolio.  

I wanted to show what happened if somebody had invested in the top 20 stocks by StockRank at the beginning of the year.  This is the return they would have got.  (That is the top 20 shares by StockRank above a £20 million market cap.)  It would have been a 22% performance.  So just investing in a tight portfolio which is quite concentrated in certain sectors might not have done as well.  Sometimes diversification can actually pay off better.  I very much believe in it.

3. Size

[ Youtube Link ]

Now also one of the other things that people do is often get stuck in small micro caps.  Most of the chat in the stock market is about micro cap shares and (micro-caps) are a double-edged sword.  Yes we have invested into International Greetings and it has done exceptionally well - up 130% over the year.  This was a £30 million market cap company and it has done exceptionally well but these kinds of companies are a double-edged sword.  When they fall and they have profit warnings they hurt really badly.  We have seen some recently, some high-ranking stocks, that have had profit warnings and we actually had one recently which dropped 75%.  

So concentrating in micro caps can be a bit of an issue.  So one of the things I like to do - I can go and either click into these sectors and try and focus just on large caps and try and select just a few large caps in different sectors, then I could select mid caps and actually spread more carefully across more different sized groups.  Also sometimes small caps massively outperform but sometimes (in the later stages of bull) markets as Ken Fisher has said large caps can actually outperform.  So being exposed to different (size) areas of the market can again build a more robust all weather portfolio and that is what I am particularly interested in.

Building a Dividend Yield Portfolio using the screener

I also get the odd question about how people should use the StockRanks with things like Dividend Yield.  I will go and actually add the yield.  Lets cut out all stocks £100 million and less and then I want to save this, there is a little button on the left  that says “save to my screens”.  If you click it, it creates a screen; this is the best StockRank above £100 million.  

I can now edit these rules and I can now add a new basic rule and I can add the yield.  I will add the historic yield.  I can ask for a yield for example greater than 2.5%.  When I click “get shares” the yield column will ask me if I want to add it.  Done.  

The yield is here and now we can see a lot of these shares are coming through.  This is how I suggest people who want to implement their own strategies using StockRanks would go in and use it and customise it, use different ratios.  If you wanted to edit your table view you can click on this tab, click the blue button, click profile and I will add Sector and the Industry.  I want to add the spread as we said this is very important.  Save the changes.  There we go.  We have a nice customised view which gives us lots of information there.  

You could use the same process for going down and finding for example the energy shares, a couple of financials, a couple of industrials to build up a good, strong, high yielding portfolio which has reasonable spreads with a high StockRank.  Our testing on this shows that it has been a very good performing strategy too.  That is a little bit about the spin on the NAPS portfolio that might be interesting.

Rebalancing strategies

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Now I wanted to talk again about rebalancing.  This is something very, very important and I get a lot of questions about it.  Keeping your balance.  If you remember over the course of a year what happens?  If we go back and look at the NAPS portfolio and I click the allocation tab we looked at this earlier and we can see this broad spread of different position sizes, International Greetings at 8.5%, you have Lamprell at 3%, it’s a bit wishy washy.  There’s nothing massive to be concerned about but if International Greetings had a profit warning we might lose 4 or 5% maybe more, who knows.  We want to minimise that risk of individual stock risk.  That is something that rebalancing can do.

Personally I prefer to position size equally.  It keeps things simple, it avoids overconfidence.  Yes a lot of investors might like to put larger bets in high conviction shares and I know great investors like Leon Boros do that.  I know plenty of investors who have and who have done (focused investing) very successfully but you do need great stock specific (research) skills.  For people that are looking for a simpler approach I believe in equal weighting positions.

I wanted to talk before that about why we rebalance.  Obviously prices drift and position sizes drift but it’s not only those, the exposure to the payoffs; quality, value, momentum also drifts.  If I was to go back and look at the holdings we can see that yes, a lot of them are still 90 ranked, but some of them are slipping back to the 80s, some of them are slipping back to the 60s in terms of the StockRank.  They are no longer qualifying for the original rules that we set out.  We might want to actually go and find stocks which are much more exposed to those (StockRank QVM) factors.  

Obviously we did that when we built this NAPS webinar portfolio which is here and we can see that these in general have much higher StockRanks.  Rebalancing into this set one hopes would do better than staying with the original ones so that is the kind of theory behind it but obviously whenever  you rebalance there are costs.  One has to pay commission, one has to pay the spread, it can be high like we said and could be 1.5 % of the portfolio and you might have to pay tax and stamp duty of 0.5% so the cost could actually end up being 2 or 3% for a rebalance.  So one wants to minimise this over time.  I really suggest people read this article by Ben Hobson about rebalancing.

The SNAPS - rebalanced

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Now those with a good memory will be going “Ed’s being a bit tricky here as he actually did some rebalancing half-year”.  That’s right, I did.  I wrote an article which actually set up a rebalanced portfolio called the SNAPS.  We said in the article that we would compare it with the NAPS as the year progressed.  Now in the SNAPS we basically did just what we did in the current webinar and we rebalanced in pure equal weight into what was the new portfolio on the 1st July.  This is the performance.  

The pink line shows the semi-year rebalanced SNAPS portfolio.  It’s underperformed the one that we didn’t touch which I think either says to people don’t mess with something if it’s not broken or don’t fiddle too much.  There are other lessons in here.  In theory rebalancing is a very wise idea.  In practice if you rebalance into a lot of other micro caps stocks you might get unlucky.  Clearly the SNAPS have not done badly.  They have actually done very, very well.  They have still dramatically outperformed the FTSE and they have outperformed a lot of other approaches too but they haven’t done quite as well as our original untouched one - but it won’t necessarily stop me from trying again in my own portfolio.  

Personally I rebalance a quarter of my portfolio every quarter and that is just the way I like to do it and it has been proving quite effective for me so I continue to do it.  But, when rebalancing there are some really important things to think about.  The frequency of rebalancing, the more frequently that one rebalances the more that there are frictional trading costs, if you are in small caps that can be very expensive.  Portfolio size.  Larger portfolios can afford to rebalance more regularly especially if they invest in large caps partly because the commission as a proportion of costs becomes much, much smaller so larger portfolios have an advantage.  Obviously if you are in a tax efficient vehicle you will avoid your CTG costs etc. ISA’s and SIP’s might be able to do more trading.  I think that is all very important to understand.  

Joel Greenblatt says annual rebalancing is ideal, I like staggered (annual) rebalancing as it keeps me busy.  I like being able to do something every quarter.  If I was to buy all my shares at one point in the year I would go mad for the rest of the year.  That is really what (people who do) annual rebalancing do, they will buy at one point in the year and then rebalance a year later but all the rest of the year they just watch that portfolio and that “need to do something” can be quite detrimental, it’s like an itch that you have to scratch so I like quarterly rebalancing a quarter of my portfolio as this works for me.  

To be honest I don’t personally bring everything back to equal weighting.  I like to let things grow and if things get too far I will use what is called a threshold-based approach to rebalancing.  So if something gets too big I will cut it and bring it back down to half the size.  

I owned some Indivior (LON:INDV) earlier in the year and that did very well and I actually rebalanced it and still held it.  When it started coming off it actually meant that I actually saved a lot of the performance (profit).  This is an important point.  Andrew Ang is one of the top professors about factor investing and rebalancing and he has a lovely quote “rebalancing is one of the simplest and yet one of the most powerful ways of buying low and selling high.”  I think that is a very important point.  It’s a way of actually profiting from volatility.  The market is too volatile.

I think that is an interesting thing.  Personally I don’t like to average down.  I am much more likely to sell when things go the wrong way.  I use Stop Losses.  I would personally only buy shares back and add to them if for example something pulled back and the StockRank remained very high but that is because I use the StockRanks for my system but I actually prefer to edge out of shares that are going the wrong way.  I use personally a combination of systematic clockwork rebalancing but in order to minimise transaction costs I don’t tend to brutally bring everything back to equal weighting.  I do that more on an annual basis but I don’t do it within (during) the year.

Right here is a little slide which shows all of the portfolios that we have discussed.  I hope I haven’t missed anything.  You can see here the very best portfolio is the one we didn’t touch, the 2 from each sector.  The 2nd best was the half year rebalanced portfolio.  The 3rd one was the 10 stock portfolio and the one that didn’t do as well was the top 20 by StockRank undiversified.

Now I am coming to the end of what I wanted to talk about so I am going to just check a couple of things.  If anybody is interested in learning more about anything we have been talking about it’s not that easy to find but if you go over the home menu and you can see there are some regular columns over here, if you click on portfolio tips you can often find a lot of discussion and great articles by Ben and I have done some about managing a portfolio which we are hoping to put into an eBook.  Also there is one called the StockRank reviews and in there you can find a lot of information on how to use the StockRanks, a lot of articles, we have a good archive there.  We are always publishing something every month about it so it’s a good place to go and dig around in the archives and obviously stay tuned on the discussion boards.

One more thing I wanted to say is please do send feedback through the site, please do send feedback if I have e-mailed you and let me know your thoughts.  A lot of people were joining the webinar who wanted to have a little look at the site and learn more about what we do, you can take a 5-day trial at that link there.  Please do have a good look around - we won’t be maintaining that link for very long.  I hope you can go and start learning how to use the site.  If you do and you are in there we will see if we can find any introductory rates for you if you want to get started.  Anyway, I hope this has been a really useful session and let me know if you have any feedback.