SIF Portfolio: Has Breaking The Rules Cost Me 24%?

18th Jan '17 by Roland Head

21 comments 10065 reads

My decision last week to venture into the Russian stock market triggered quite a lot of debate. You can check out that article here if you missed it.

It’s too early to say how things will turn out with last week’s stock, RusHydro. But what I can tell you about is the impact some of my previous decisions have had on returns from the Stock in Focus Portfolio.

I’ve been through my records and put together a list of stocks which have qualified for the SIF screen since last April, but which I’ve chosen not to buy or sold prematurely.

In other words, this is a list of companies where I’ve ignored my rules for stock selection and made a subjective choice. I’ve included my estimate of the share price gain or loss I have missed by not sticking strictly to my rules. The date is linked to the original article on each stock:

Company	Date considered	What have I missed?
XLMedia*	25 May 2016	+31%
International Consolidated Airline Group	22 June 2016	-12%
Fulcrum Utility Services	17 August 2016	+67%
Plus500**	7 December 2016	+10%
		Average per stock = +24%

*I rejected XLMedia the first time, but have subsequently added it. 31% represents the difference between the profit I would have made, and the current running profit on my position.

**Plus500 was in the portfolio. I sold it ahead of schedule in December, when CFD shares crashed after the UK regulatory announced plans to limit leverage for retail customers. The shares have risen by 10% from my sale price.

These figures aren’t exact, but I think it’s pretty clear that the portfolio would be worth more if I’d obeyed my own rules blindly, rather than allowing an element of discretion.

This humbling set of figures is one of the reasons for my change of stance last week. Although the portfolio hasn’t been running long enough to be certain, the evidence so far seems to be in favour of a hands-off approach to stock selection.

So far, my manual interventions have cost the portfolio money!

The joker in the pack

There are a couple of stocks I haven’t mentioned so far. One of them is RusHydro, which I added to the…

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MichaelFBS

18th Jan '17

Hi Roland

I really enjoy your SIF column. I have not yet read the whole of this one but will do later. However there is an interesting post by Dan Egan of Betterment at

http://www.dpegan.com/better-decisions-through-blindness/

Entitled "Better Decisions through Blindness" and he is also on a recent Podcast with Patrick O'Shaunessy Invest like the Best.

Regards
Michael

Rusty2

I also have seen Carnival (LON:CCL) on your screen which was not added, not sure when it first appeared, so don't know how it would have performed. I think if you have a rules based system you should stick to it, otherwise there is no consistency. Did ED not write an article about rules based system outperforming human influenced ones? Some of your other sales have also gone up such as Go-Ahead (LON:GOG), Macfarlane (LON:MACF), Persimmon (LON:PSN) and Somero Enterprises Inc (LON:SOM). Those 4 stocks have not cost you 24% that is only on those 4, it's not over the whole portfolio. I think you need to look at is how have the ones you have bought to replace the sold ones performed. You will always have that situation, noone can time it perfectly all the time. My opinion is you are buying too late and selling too early. At the moment you fund is only the same as the FTSE All Share and thats even with the Avesco (LON:AVS) takeover.

Hot Socks

Thanks Roland, interesting to analyse the effects of your decisions as against running the rules blind.

I don't think the results are that humbling as its too early to tell whether your own decision making is definitely negative in terms of its impact on performance. If you looked again in a year's time the result might look very different.

It would also be interesting longer term to analyse the results of changing the portfolio as against not changing it - say from the point it is (was?) fully stocked for two or three years without changes, as compared to changing in accordance with the rules. If you have the stomach to run the experiment for that long ...!

Cuthbert C

Roland

Bravo. I really appreciate and value that you are reviewing your investment decisions with a dispassionate, critical and objective eye. Many (possibly most) of those who post comments on the internet or who publish blogs display a complete lack of critical thinking where their performance is concerned and big up their successes whilst forgetting their unsuccesses. If one is to improve in the field of investment or any other, it is always necessary to consider what could be improved. Well done. I will follow your blog in future.

That being said, it is, IMHO, not enough to look at the outcome which was achieved, one also needs to consider the risks. if someone offers you a million dollars to play Russian roulette with a revolver loaded with one bullet and five blanks, then the odds of success (ie not dying) are 5/6 and the odds of failing (and dying) are only 1/6. So we might expect to hear from many previous players that they succeeded and made a million. IT DOES NOT MEAN THAT THEY WERE RIGHT TO TAKE THE RISK. AND IT DOES NOT MEAN THAT WE SHOULD TAKE THE RISK OURSELVES.

It is relatively easy to analyse the risks involved in playing Russian roulette. It is much harder to get our heads around the risks of investing in company X. That does not mean to say that we should judge the success or failure of our decision only by looking at the investment outcome any more than we can judge the roulette player's decision by reference to the million dollars he makes by playing or the million dollars he loses by refusing to play. The magnitude of the risk exposure is the value of our investment - what we would lose if it blew up. That is different from the profit we made or did not make.

PS

I have had a number of experiences where I have invested without fully appreciating the risks and without realising the random nature of the outcomes. I can cite an uncomfortably large number of experiences where my investment "genius" led me to invest in amazingly successful companies which delivered life changing returns which I misattributed to good decision making on my part. In a painful number of these the life changing profits flipped into losses which took away all the gains and in some cases most or all of the original stake. I came to the uncomfortable realisation that both the gains and the losses resulted from poor decision making on my part. I could not take credit for the gains and offload blame for the losses. Both outcomes were down to me.

I resolved to place risk management at the centre of my investment activity rather than at its periphery. I can't say I've succeeded but I'm trying.

simoan

HI tournesol,

Honestly, I couldn't agree more. I believe we have possibly been reading the same books :) It's important to differentiate blind luck from skill. Lookng back, in the past 12 months it seemed a bit too easy to make money from stock market investments and I am wary lest I start believing I have suddenly turned into some kind of stock picking genius. I have not. These days I keep a copy of the James Montier book next to the bed and read the odd chapter on a regular basis.

All the best, Si

JohnEustace

Hi Roland,
You say you won't be adding any more Russian stocks to the portfolio. I'm not disagreeing, but do you have a rule that stops this or is this your judgement at work again?
When you next review your rules do you need to add one that defines the allowable split between say U.K., developed overseas markets and emerging markets?

For a rules based approach I think you need to work on improving the rules and not second guessing the outcomes. So you write the programming and execute the results. If you don't like the results then change the programme but don't inject your judgement on each result - otherwise it's not really rule based

Roland Head

Hi John,

Good point, I could see I was opening myself up to suggestions of inconsistency with that final remark!

The rules of the screen don't require me to add every single eligible stock. For example, I wouldn't add three banks. So any Russian stocks qualifying for the screen in the near future would have to really justify its selection in terms of diversification, for me to accept it.

Diversification is something that is quantifiable, so I'm hoping it won't be a question of judgement, but of numbers.

A second consideration is that the portfolio is mainly intended to focus on UK-listed companies. I think that GDRs for Russian-listed stocks are stretching that definition slightly.

Regards,

Roland

ls2g08,

Thanks for your comment. In my case I haven't yet reached the point where the portfolio has ever been fully invested, so the argument about returns from reinvestment doesn't apply. But it's certainly valid and is a consideration I often face in my own portfolio.

Regards, Roland

Hi Michael,

Thanks for your comment. Selective blindness is an interesting idea. It's certainly relevant to investment, in my view.

For example, not knowing the running loss/profit on a stock holding might make it much easier to objectively decide whether to sell it or buy more.

Regards,
Roland

gus 1065

Hi Roland.

Interesting and thought provoking follow up. As others have commented, always good to be self critical and try and determine what a better outcome might have been and how to set about achieving it in the future.

While factor based lending does seem to offer superior returns over a widely spread portfolio, I can see why it is difficult to ignore subjective considerations when you have a relatively small portfolio and look to analyse beyond the headline traffic light ranking scores. This is especially true where the rankings appear to suggest the best shares to buy have some "hair" attached.

With a more diversified portfolio of say 200 stocks picked solely on the basis of their high rankings, I suspect it would be easier to bite the bullet and invest in apparently "dodgy" shares safe in the knowledge that even if one or two go bad, the severity of the individual loss is not too bad and the expectation that the home runs will more than compensate for this. Using tournesol's analogy in the above post of Russian Roulette, if the consequence of finding the chamber with the bullet in is a headache rather than termination, it becomes easier to play the percentages and go all in with a "warts and all" factor based approach.

The follow up question then would be how often is it necessary to re-balance the portfolio to adapt to changing rankings and how far do the associated transaction charges eat in to the expected superior returns?

Best,

Gus

tournesol,

Absolutely. It's very easy to claim with hindsight that a speculative punt was a far-sighted investment. We've all done it, I suspect.

I'm also trying to gain a better understanding of risk in my investment activities this year, but it's tough to be sure that you're succeeding.

Regards,

Roland

Hi herbie47,

Carnival (LON:CCL) has been a close-run thing, but I've not written about it and rejected it on a specific date before. I don't have the facility to look at historic screen results so I'm not able to pinpoint a date where I considered the stock and then rejected it.

As for the issue of timing my entry and exit points, these are dictated by the screening rules and my six-month review period. In some cases so far you're right -- I've been too late and too early. But the portfolio has been running less than a year so far.

When I reach the anniversary date in April, I will consider whether to tweak the rules for both buying and selling, but I'm going to give it a full year before doing this.

Regards,

Roland

Howard Adams

Roland

Once again, thank you for an extremely interesting article and particularly for the really interesting posts which your work has generated from the other readers (above).

I find your documented journey very informative and these post-mortems of particular value.

Regards
Howard

Jon1958

19th Jan '17

Roland, all really interesting stuff.

Last year, I ran a fantasy portfolio of Stacks picked randomly across all sectors with a stockrank over 90. It performed as well (but no better) than my real self-run discretionary portfolio.

This year I have dipped a toe in the water by running a real portfolio where buying is discretionary but I am not allowed to buy a stock UNLESS its stockrank is 90 or more. I then hold for 6 months and thereafter until the stockrank falls below 90 - unless my original investment rationale changes.

In this way I am trying to inject a bit more discipline into my decisions.

Will let you know how I get on.

Ardipithecus

To clarify on foreign stocks.
"stocks priced in foreign currencies can’t be held in ISAs."
The rules allow one to hold stocks listed on any recognized market in an ISA. I have at one time or another held European, US and Canadian stocks in my ISA which were not London listed. What you can hold is in practice determined by which markets your broker / ISA provider trades in. However as far as I know ISAs can only be held in sterling, so capita transactions, dividends and cash have to be exchanged into sterling.

gh1409

Roland

During your analysis did you examine the level of low interest foreign currency liabilities Tinkoff holds and the concentration of its loan / investment assets? Don't forget 1998!

brucepackard

Roland - to be clear, are you actually investing your own money like this?

With my own money, I would not invest in Russia until Sergei Magnitsky's killers have been put on trial, the FSB has been reformed and Bill Browder is warmly welcomed back. That's an ethical thing...but I think over the long term ethics make you money. Eg. look at the non conformists and Quakers.

My single largest holding is BGEO (LON:BGEO) so I'm not scared of places where they have funny handwriting. But there are some places where you can't trust the business culture, where fraud is deeply embedded in the society, where many criminals are actually in positions of authority in the Government.

Those countries are where stockopedia's algo's have a weakness, and some simple heuristics will do much better over the long term than blindly following the algos.

20th Jan '17

Hi Bruce,

Just to be clear: The SIF Portfolio is a virtual portfolio and does not reflect my personal stock holdings.

The goal of the SIF portfolio is to try and develop a rules-based approach to stock selection that delivers satisfactory returns (i.e. ahead of the wider market).

One of the areas I'm keen to understand better is how much weight to place on subjective concerns about corruption/earnings quality. I do share some of your concerns about investing in Russia. But I'm starting to wonder if it's no longer fair to tar all Russian stocks with the same brush, especially those that are keen to attract Western institutional investors.

Regards,

Roland

Ardipithecus,

Thanks for the clarification.

Roland

SIF Portfolio: Has breaking the rules cost me 24%?

The joker in the pack

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Roland Head

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