Long-Short repeat trial for 1st January 2020

31st Dec '19 by William K

11 comments 844 reads

Following on from my post on 5th October, I am now repeating the work and comparing the performance a long and a short portfolio. The criteria for long and short are as before:

Short:

Price <200 MA

Stock Rank <50

Net debt > net profit x 3

Long

Price >200 MA

Stock Rank >80

Net debt <net profit x1

The shares have been picked because they meet the above criteria and I have ignored all other metrics other than size and spread.

Each share is matched with another share in the same main sector.

The companies have a capitalisation >£250 million and a spread <1% (there were 2 marginal exceptions because of difficulty in matching shares in the same sector).

The benchmark is the FTSE 350.

The portfolios are detailed below (priced as of 30th December 2019).

For the purpose of the trial I've purchased or sold shares in blocks of £2,000 or as close to that as possible.

LONG 1.1.20


Stock	Unit Cost (p)	Cost (£)
Anglo American Ordinary USD0.54945	2177	£2,002.84
Ashmore Group plc Ord 0.01	521	£2,000.64
AVEVA Group plc Ordinary 3.555p	4722	£1,983.24
Barratt Developments plc Ordinary 10p	747	£2,001.96
Bellway plc Ordinary 12.5p	3806	2017.18
Computacenter plc Ord 7 5/9p	1801	1999.11
Dart Group plc Ordinary 1.25p	1696	2001.28
Ferguson plc Ord GBP0.10	6892	1998.68
Hays plc Ordinary 1p	183.5	2000.15
JD Sports Fashion plc Ordinary 0.25p	832.8	1998.72
Medica Group plc Ord GBP0.002	159	2000.22
Rightmove plc Ord GBP 0.001	649.6	2000.768
Rio Tinto plc Ordinary 10p	4500.5	1980.22
Serica Energy Plc Ord USD 0.10	133	2016.28
Wizz Air Holdings plc Ordinary 0.01p	3940	2009.4

Totals		£30,010.69

SHORT 1.1.20


Stock	Unit Cost (p)	Cost (£)
Aston Martin Lagonda ORD GBP0.001	522.2	£2,020.91
Blue Prism plc Ordinary 1p	1104	£1,998.24
Georgia Capital Plc Ordinary GBP0.01	930	£2,008.80
Hochschild Mining Plc Ordinary 25p	175.5	£2,000.70
Horizon Discovery Group plc Ordinary 1p	146.9	2015.468
Huntsworth plc Ordinary 1p Shares	81.9	2010.645
Hurricane Energy plc Ordinary 0.1p	32.98	2021.674
IQE plc Ordinary 1p	50.35	2039.175
Pearson plc Ordinary 25p	649.9	2001.692
Provident Financial plc Ordinary 20 8/11p	455.9	2001.401
Rolls Royce Holdings Plc Ordinary 20p Shares	701.4	1998.99
Sig plc Ordinary 10p Shares	123.7	2000.229
Solgold Plc Ord GBP0.01	19.95	1985.025
Stobart Group Ltd Ordinary 10p	113	2017.05
Wandisco plc Ord GBP0.10	436	2018.68

Totals		£30,138.68

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William K

4th Apr '20

These are the results of 3 simulation portfolios with 50% Long and 50% Short investments.

Portfolio A - Commenced 1.7.19 (9 months, costs excluded, no stop losses)

Long investments (£30K) - Down 24% (£7,198 loss)

Short investments (£30K) - Down 60.9% (£18,275 profit)

Net profit £11,077 (18.46% over 9 months, 24.6% per annum)

Portfolio B - Commenced 1.1.20 (3 months, costs excluded, no stop losses)

Long investments (£30K) - Down 41.7% (£12,513 loss)

Short investments (£30K) - Down 41.3% (£12,450 profit)

Net profit - negative 0.1%

Portfolio C - Commenced 14.1.20 (11 weeks ago) using the same shares as portfolio B. This was done on an IG demo account and so includes all costs. The individual investments consisted of £5000 worth of shares (rather than £2000) using a stop loss set at 30%. All costs and spreads are included.

The portfolio was the equivalent of a £150,000 portfolio using a notational margin of £45,000 (in practice the margin was closer to £36,000)

Long investments (£75K) - Down 28.5% (loss £21,390)

Short investments (£75K) - Down 30.7% (profit £23,074}

Net profit £1,684 (1.1% or 5.2% per annum on a portfolio of £150K, or 17.3% on a margin of £45K)

Note 1: 2 weeks ago the profit was £7K but I did not bank any profit as I might have done in real life.

Note 2: A Stop Loss set at 20% would have given approximately £7,500 more profit.

Conclusions

On the basis of these results, bearing the relatively small sample sizes, my cautious conclusions are as follows:

1. A 50:50 long: short portfolio provides some protection against a market crash.

2. Stop losses are essential.

3. A stop loss set at 20% would probably have been optimal. With hindsight 15% stop loss in the above scenarios would have been about perfect.

4. A spread betting account provides an easy way for retail investors to set up a long: short portfolio.

5. In a crash, good and bad shares seem to fare equally badly!

jwebster

Interesting Ports B & C are flat, in the sense the debt-net profit and Stockrank rules didn't swing the balance away from 'they all dropped'. Adds credence to the view much of the recent correction is liquidity driven rather than valuation based. Bodes well for buying good firms now.

Also, it would be interesting to know the returns on Port A up to and including 21 February 2020, just before the current melt down. To get a view on Port-A during a bull market period with the crash period removed. Don't mean to be cheeky asking for extra analysis, just a thought !

Many thanks for your interest, jwebster. I can't answer your question exactly but on 1st January:

Portfolio A Long - up £4,775 (15.9%)

Portfolio A Short - down £4,977 (16.6%)

A differential of 32.5%.

Three months later the differential was 36.9% (60.9% - 24%).

I doubt if this differential is statistically significant although I haven't checked.

My impression is that during times of panic selling, most sellers don't distinguish between high quality shares and poor quality shares. As you suggest, the good quality shares may recover faster in due course and the differential should continue to widen. I shall follow these portfolios and post my findings in 3 months.

5th Apr '20

Thanks for the numbers Wilknoz

Interesting. In a regular bull market period, the strategy worked more as expected. Equal profit from both the short and long positions. So the criteria worked. If the criteria had no value, i.e. random, would expect the shorts to have made a loss, i.e. prices drifted up with the market.

Then in a bear market, the strategy comes out flat, i.e. everything sells off and the shorts cover the losses on the longs.

So actually, as long as you have criteria which works, it's not unreasonable. Means you don't have to fret about timing the market, you can stay fully invested, bull or bear market, which is a big physiological win.

As a thought, if I was to use this strategy myself, I would try to avoid using Stockrank, as this is a calculated 'magic' number which is beyond my control - Stocko could change the formula any time. But the hard data ratios should be stable.

Gromley

I can report pretty much the same with my long-short portfolios over the last few weeks - losses on the long side have pretty much balanced the 'gains' (ie falls) on the short side.

That's an okay result and in fact I was quite prepared to see the longs fall by more than the shorts as that would still protect me from the majority of the market decline.

I'm slightly weighted to the long side now having not (yet?) replaced some of the now de-minimis shorts that I closed.

Just a bit of a muse on the 'indiscriminate' selling pulling down the high SRs as much as the low.

It occurs to me that over the next few months the StockRanks are going to be pretty meaningless - those companies that have not yet reported any post covid results are going to have vastly superior VRs & QRs than those that have reported. However historic StockRanks from immediately before the crisis might be a useful basis of discrimination. Although ability to survive (or avoid) cashflow starvation will probably be a much better discriminator.

Completely agree, Gromley. My strategy will be to go long on companies that have plenty of cash in reserve, and short on companies with massive debts. It's probably wise to avoid companies in vulnerable sectors such as airlines, hotels etc as they will struggle financially. It's always unwise to generalise about the future, but large successful companies should be the first to recover. I will still look at the stock ranks out of interest, but as you say, they are meaningless is this scenario - apart from the low ranks that indicate poor performance before the crash.

Quite so. As Gromley has also pointed out, Stock Ranks are pretty meaningless at the moment. Cash is what counts above all else. The companies with a viable product and money in the bank should survive to lead the recovery. Companies with too much debt will struggle. At the moment I'm compiling a 'post crash' long: short portfolio based on these principles, and I'll focus on US companies because they have narrower spreads on the whole than FTSE companies, and I'll match every long with a short in the same sector.

The beauty of 50:50 long: short, as you've noted, is that you're trading the differential so the overall market direction doesn't matter too much. So, in theory, you benefit from strong market moves either way.

Nick Ray

But do long-short portfolios work during "normal" times? I would think there is a danger that they cancel out the market completely (beta) so all you are left with is alpha which can be very small compared with the overall market movement.

A very short sample Nick as I've only been doing this for a shade under 2 years, but from that limited period the answer was yes - I had achieved about 13% PA (I strayed somewhat from my principles so I would have to recheck the numbers in fine detail).

If there is an edge to your long short selection, then you don't cancel out, but you do need the discipline to accept 'pedestrian' returns whilst 'everyone else' is patting themselves on the back for achieving 30%+ pa.

It is not the easiest approach to adhere to, and it may not work in all markets, but I am pleased to have adopted it at a time when I thought we might be near to a market top.

akka

18th May '20

The strategy is very interesting , I tried on the German market with good performance

Hold a year ? or rebalance after six months?

@akka

Good question. I don't know the answer. My inclination would be to replace stocks that get stopped out rather than have a regular rebalancing. If the portfolio is making a steady profit, there's little point in tampering with it. (If it ain't broke, don't fix it.) In my last sample, because of the crash, the the shorts did well whilst the 13 out of 15 longs got stopped out. The model portfolio made a respectable profit that turned into a loss when the price recovery started because there were too few longs to balance the price gains on the shorts.

Long-Short repeat trial for 1st January 2020

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William K

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