Can the StockRanks help you underperform? (Introducing the Brokefolios)

11th Jul '18 by Gromley

10 comments 4021 reads

Update 24-Jul-2018 - I have now included the H2 rebalanced portfolios towards the bottom of this article.

16-Jan-2019 : Just for the archive - I have now published the 2019 results in a separate article which can be found by following this link

Concept

Why would one want to use the StockRanks to underperform?

Quite simply to create a short selling portfolio to “hedge” a NAPS style portfolio.

As I have alluded to elsewhere, in particular here, I have for some time been nervous about a market correction, but do not really think I can judge when one might happen (nor even perhaps recognise when it is happening or when it will end).

Late last year, whilst reading through Ed Croft’s excellent series of articles on the NAPS portfolio, the thought came to me that maybe one could use a similar approach based on low SRs to create a short selling portfolio to hedge the NAPS. I do not claim this to be a novel thought I’m sure many have had the same idea.

The pen picture I had in my mind was that if NAPS could achieve returns of c. 30% pa in a bull market, perhaps a low SR selection would only achieve perhaps 10% pa. So a 30% gain on NAPS offset by a 10% loss going short on anti-NAPS would give an overall return of 10%pa [(30-10) /2 as twice* the capital is deployed ] in a bull market, whilst giving substantial protection against a market downturn, by virtue of being market neutral.

A subsequent review of the Stock Ranks Performance suggests I was maybe being a little conservative.

Over 5 years SRs 0-20 rather than rising by 10% pa has in fact fallen by c. 10%pa. Over the same period SRs 80-100 have risen by c. 14% pa (much less than NAPS) so the differential appears to be c. 24% pa , not far away from the 20% in my mental pen picture.

Thus was born the idea for my two Brokefolios (“Broke” being a flimsy pun on the half yearly SNAPS approach) which I constructed at the turn of the year, broadly contemporaneous with Ed’s latest NAPS. I had intended to write this up in January, but unfortunate family circumstances kept me largely away from the market…

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Snoo

11th Jul '18

Very interesting. Would these results be inclusive of paying out dividends (you have to pay it when you are short) and the interest charge.

Having done a little shorting with IG, having such a big portfolio short that cost could come significant pretty quickly.

Gromley

Good point Snoo - no they don't include the dividends - that's an overlay I didn't get around to doing, but I will do so and add the impact (there's also a rights issue to take account of for DS Smith (LON:SMDS) although that doesn't fall until the second half of the year).

My experience from my real money shorts is that very few are dividend payers, but I know that there are clearly some in this portfolio, so thanks for the reminder.

A quick update (I'll put a reference back into the main article).

Of the 30 stocks across the two short folios :

14 do not currently pay dividends
A further 4 had no dividend events between January & June
12 became XD during the half year.

The net result is that the Zonal portfolio paid out 0.6% and the M4M 1.0%.

Meanwhile on another thread Velo calculated that the NAPS portfolio received 1.5%, so the net result on the hedged portfolios will be beneficial as I would have expected.

Just to clarify by the way for those not familiar with shorting. When you are a short a stock, you are responsible for paying the dividend and the amounts are deducted on the Ex-Dividend date (which irrespective of the actual payment date is when the right to receive the dividend is established and when the share price ordinarily falls by the dividend amount +/- any other changes to the price)

mmarkkj777

17th Jul '18

A good and informative article.

What do the average costs come out at, to short 18 stocks (on average, in % terms)?

I feel like I need a better strategy than I have now, if the major market correction comes soon. But like you, I don't think the actual timing is predictable, or even recognisable in the beginning.

I would need to transition to a defensive strategy, then be ready for the upturn. I know the when is a judgement call, but I'm wrestling now with the how.

Merlotman

22nd Jul '18

Hi Gromley
Thanks for your detailed write up of your shorts experiment. I found the M4M or should it be M2M marking particularly thought provoking.
As you know I have been running a real money hedge on a similar but somewhat less scientific basis and will report back on results next month but for the moment I have been pleased with the outcome.
Insofar as your score keeping question is concerned I am simply looking at the net notional position. So when the position is loss making you subtract from the notional and when in profit you add. The net notional does not therefore change and therefore rightly or wrongly it is this I am using as my denominator to calculate the return. The other way of keeping score is to use the margin requirement as the denominator (as in effect this is the capital you have put up) but this overstates winning % and understates losing %.
Mmarkkj777 looking at a few of my statements I estimate the costs of shorting are circa 1.5% p.a. Less divis but once again will try and come up with a more precise figure next month

Of course I forgot to add that the net notional is the same as the opening notional it's just easier to look at the net notional on your latest statement and I find it makes it easier to get my head round the idea that the position size reduces when you make a profit

4th Aug '18

On another thread poster pka asked : " If I used spread bets to short stocks with low Stockopedia QVM Ranks as a way of hedging my 'long' investments, are there any things I should worry about?"

I thought it best to answer that here.

At the outset I should stress that I'm relatively early into this approach - so whilst I have given it a lot of thought, there may still be unforeseen nasties waiting to bite me on the bum.

FWIW though, here are my thoughts.

Your losses on any given position are unlimited, you don’t want to be short a ten bagger. So I’d suggest that even if you do not routinely use stop losses, you need to here even if they are quite far out. That one is hopefully obvious, but definitely bears repeating.
On the same note, being as diversified as possible helps to limit your exposure to the potential multi-bagger that may be lurking within your short-portfolio. Remember, the success of StockRanks is statistical so the broader your selection the better. (Personally I'm aiming to build up a short portfolio of at least 30 stocks, to balance a slightly smaller number of 'longs')
You will not be able to short all of the low SR candidates - as per the main article I wrongly assumed a correlation between Market Cap and 'shortability'. My thought here is not to be too dismayed by the number of 'excellent opportunities' that you are denied - remember the objective here is not to select a portfolio of stocks 'guaranteed to tank' but rather to select a balanced portfolio that will materially underperform both your long portfolio and the market. If your short portfolio actually rises by 10% in a bull market , this can still be okay if the market, is up 20% and your selection of 'longs' by 30%. There is though clearly a 'red-line' to be drawn, as I mention above I would not have shorted £SDMS and probably some others that made it into the theoretical portfolio - probably a cut-off of SR <30 feels like the right limit to me currently.
There is also a group of stocks (again including many of the 'best' candidates) that you can short, but only at an additional cost. This has been one of my learning points with my real money version of this portfolio. IG Index (just for example) often give the message " This market may not be sold to open Due to a potential stock borrowing charge, this contract cannot be sold to open. You may wish to re-attempt to place your order on the DFB contract, whereby a daily borrow charge may be applied to your account. Alternatively please call our dealing desk for more information."

To attempt to understand this better I have taken out shorts on some of these stocks and whilst I cannot readily see how the "borrow charge" is derived, it seems to run at roughly 7% pa. This seems like too much of a headwind to make these shorts viable, but so far from an admittedly small sample , these shorts have performed excellently - so maybe, just maybe, there is a correlation here that these are in fact the 'best' available shorting opportunities. If I understand this correctly, these are the stocks where the SB company is unable to hedge your position against other clients being 'long' so they have to actually have to short the shares in the 'real' market. As the vast majority of stocks in the H2 Brokefolios fall into this category, I will take this into account when reviewing performance in January -I'm also minded after the summer break to create an additional paper portfolio of stocks on which it is possible to open and "ordinary SBet short"- ie with manageable costs.

Considering Newsflow : I am trying hard to adopt a "strategic ignorance" approach to my shorts, relying on the statistical power of SRs to deliver the right results overall. However, I have been unable to resist the temptation to follow the news-flow of the stocks on which I am short. My diversification and therefore small position size have though enabled me to be quite "chilled" about positive developments that lead to share price rallies (which mostly so far seem to have been quite short-lived). I am though tentatively thinking that there may be a differentiation between "promising news" that merely supports the "bullish story" and news of actual profit improvements - the latter potentially being a reason to close the position and look for another candidate. I shall be looking at this a lot over the coming weeks and months as I feel this may be an answer to the stop-loss quandary that I identified earlier.

And that is really all I've got so far - I hope it is food for thought for anyone considering such an approach. It is certainly far from being conclusive.

I would though greatly welcome; thoughts, questions, criticisms and most particularly thoughts from anyone else doing something similar.

And thank you pka for asking the question that prompted to this further analysis of what I am doing here - as is often the case I suspect, writing this piece has benefited me at least as much as the readers.

brballs

Very interesting write up Gromley. I’ve also noticed quite a few excellent comments from you on SVCR’s etc. Perhaps Ed should consider you for a bit of freelancing!

letap73

Great article.
The new ESMA regulations which came into play at the end of last month means that margin rates have gone up for EU based spread bet providers.
For IG the minimum margin for equities is 20% this means the daily charge could be significant for a DFB.
If you don't use a DFB then I assume the spread is much larger.
Have you accounted for the new ESMA regulations?

Nick Ray

The change in minimum margin will not affect the DFB cost. When you bet you effectively borrow the whole implied stake and they charge you interest on that amount. The increased margin simply means that you have to have that extra cash in your account (so you can't have it somewhere else, or use it to fund a bigger position.)

Can the StockRanks help you underperform? (Introducing the Brokefolios)

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Gromley

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