Taunting The Bear? The NAPS Portfolio Defies The Worst Quarter In Years

1st Oct '15 by Edward Croft

22 comments 25429 reads

If you’ve been reading the headlines you’d have heard it’s been the worst quarter in the stock market for years. Doom and gloom are the order of the day, Volkswagen’s been cheating, Commodities are slumping, China’s a goner and even the IMF are warning that we’re short on growth. In this environment even the most hardy could be excused for running for the stock market exits. But has it really been so bad? Let’s take a look through the lens of the two human scale portfolios I’ve been running using the Stockopedia ranking systems.

Sleepy time…

At the start of the year I very cautiously set out to illustrate how an investor could simply put together a broadly diversified portfolio using the Stockopedia StockRanks. I called this portfolio the “New Year NAPS Portfolio” as a reference to the common betting concept of a ‘nap hand’, but also alluding to the strategy’s soporific simplicity. The strategy selected the top 2 ranked stocks (using the StockRanks) above a £20m market cap from each of our 10 economic sectors. I theorised that such a portfolio, being broadly exposed to value, quality and momentum, ought to have a strong chance of outperformance.

And outperform it did. The resulting 20 stock portfolio got off to a flying start, shooting up over 25% within 6 months. In fact, the first half year performance was so unexpectedly good it made me pretty nervous. Being a risk averse fellow, I decided to split the strategy as an experiment. I’d continue running the original NAPS unchanged, but set it against a portfolio that was completely rebalanced at the half year. By comparing the approaches over time I hoped we’d learn something in the process.

On June 30th, stocks no longer qualifying for the original NAPS rules were ditched, new qualifying candidates bought in, while the rest were rebalanced back to equal weight. All in all 9 out of 20 stocks were changed vs the original portfolio. The resulting portfolio I christened the “Semi-Year SNAPS”, yes because it’s a nice wordplay but also because it requires a more proactive approach than the sleepy NAPS. You can read up in more detail about the stocks in each portfolio and the process to find them at the given links (NAPS, SNAPS).

Performance to date

For the first 6 months of the year the performance of the…

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jimbobjames2002

1st Oct '15

Hi Ed, fascinating stuff as always. When shorting low stockrank stocks, do you have a preference on the size of the companies you short? I know Paul Scott only likes to short bigger companies.

Cheers, James

Edward Croft

Adept's spread has widened considerably since the start of the year. Back then it was less than 2% so I'm not sure what's going on - that's what raised my eyebrow regarding widening spreads in the article. I spotted this yesterday.

Regarding shorting, it's almost impossible to short small caps in the UK unless you have a good broker who can find stock for loan. I short on IG and have found it best to short £1bn or larger market cap stocks or the indices. Often the only way to short individual stocks is with Daily Funded Bets (DFBs) as longer expiries are often unavailable (no stock on loan). It can be much cheaper to short the indices. Of course you do have to put down margin when shorting so it requires spare uninvested capital. Margin required can be 20% for volatile shares , 5% for large cap less volatile shares like Apple, or as low as 0.5% for the FTSE 100 ( the margin required does rise though as your bet size rises). You also pay ongoing interest as you are effectively borrowing stocks (LIBOR+2.5% from memory). If there's an extended down period I will probably unwind my remaining shorts.

My own short (hedge) exposure has wavered, but been as high as 80% of my longs this year. My most successful single stock shorts year have been in Genel Energy, Tesco, Dreamworks, Zodiac Aerospace and Vallourec. I'm just using the StockRanks for selecting single stock shorts and relying on diversification (so there's not been too much further due dil). When looking for low StockRank stocks above £1bn there are only a few in the UK, so I've found I have to often travel across the channel or pond to successfully find them. I guess the average StockRank of stocks I've shorted has been around 35 or 40.

We really should do a guide to shorting... that would probably go down well. IG does have a good guide available online - https://www.ig.com/uk/ways-to-short-sell

kalkanite

Great article Ed, one thing that I am not sure of when shorting - if the stock is suspended this would make it impossible to buy back, what happens in this case

K (never shorted...yet)

brucepackard

Thanks. I had a conversation with Gerd Gigarenzer about his 1/N diversification rule.

He admitted that although a simple rule of thumb is "simple" - actually it raises more questions than perhaps it answers (eg frequency of rebalancing, what number, and what type of investments to put in your 1/N portfolio)
I presume the portfolio started out with you buying equal £ amounts of each company?

But in general a 1/N portfolio much better than Markowitz "efficient frontier" or "risk parity" portfolio. When constructing his own portfolio, Markowitz doesn't even use his own system!

Yes - and I would be keen on you doing a guide on shorting. I have read James Clunie's book. But I still find it very difficult to implement.

Richardc

2nd Oct '15

Great article and I would also appreciate a shorting guide. I have been using StockRanks since January to select most of my investments and am very pleased with the results.

Kind regards,
Richard

Carcosa

Back in the late 1990's and mechanical investing was all the rage on TMF eg:
BTF Lite http://www.fool.co.uk/workshop/1999/ws990729.htm
RS-JT http://www.fool.co.uk/workshop/1999/ws990812.htm
RS-JT Lite http://www.fool.co.uk/workshop/2000/ws000316.htm
RS-MW http://www.fool.co.uk/workshop/1999/ws991028.htm
RS-MW FAQs http://boards.fool.co.uk/Message.asp?id=2050001001157000
RS-PG is described in three detailed installments:
http://boards.fool.co.uk/Message.asp?id=2050001001392000
http://boards.fool.co.uk/Message.asp?id=2050001001393000
http://boards.fool.co.uk/Message.asp?id=2050001001394000
Dozens and half-dozens http://www.fool.co.uk/workshop/2000/ws000323.htm
Zulu -- Part 1 http://www.fool.co.uk/workshop/2000/ws000217.htm
Zulu -- Part 2 http://www.fool.co.uk/workshop/2000/ws000224.htm
Lite Strategies and the RS-MW
http://www.fool.co.uk/workshop/2000/ws000120.htm
The PEG 5 http://www.fool.co.uk/workshop/1999/ws991125.htm

You could almost back test any strategy you could come up with and it would work... for a time

Now nobody seems to openly discuss mechanical strategies with the same fervor but perhaps this NAPS/SNAPS will get the ball rolling again.. or maybe it will not. Years ago financial data was hard to come by so the desire to create your own 'recipe' was rewarding enough. Perhaps mech investing has been largely forgotten nowadays.

Thanks for the links - I had known that the Motley Fool had some threads on mechanical investing but wasn't sure how or where to find them.

While I know it's popular, I don't like to use the term mechanical investing. It reminds me of the old man vs machine debate and often inspires Luddite responses from detractors.

I prefer "rules-based investing" or "systematic investing" as they promote the idea of sticking to a solid plan, rather than subjecting oneself to the whirring of cogs.

Many systematic strategies fall down as they stop at the stock evaluation part of the process. i.e. they pick the best stocks according to certain criteria and are done with it. But risk management constraints can help to improve stock selection from a set of candidate stocks (discarding some to improve diversification) and ultimately build a less risky portfolio. Adding optimal rebalancing and selling rules can further improve risk adjusted performance.

I'm very optimistic that we can build a set of tools here to design and automate much of this process for 'human scale' portfolios. i.e. 10-50 stock portfolios that private investors can put to work with confidence in their expected returns.

I always tell subscribers that my own driving goal is to fully automate my own investment process - so that I can actively run family accounts with not too much administration. Most families have a single person who manage JISAs, SIPPs and so on for everyone. As it's such a hassle battling with trade entry interfaces and making purchase and sell decisions, mostly people end up buying funds and settling for average (or below average) returns. That's a real shame and frankly I think the problem can be solved by better software design. I hope that we'll get to the point where anyone can set up a factor investing portfolio that diversifies & rebalances across individual stocks with very little fuss. I find that a really motivating goal but it's going to take some time :-)

On rules based investing. I went to a talk by David Harding of Winton Capital Management a couple of weeks ago. Of course, everyone was trying to get him to talk about the secret sauce (secret source?) of profits that has made Winton into a $30bn quantitative hedge fund. And he was a bit reluctant. But he did say one thing I found fascinating:

.... much of his Intellectual Property, is in testing his models, seeing what works, and really trying to disprove things (he used the word “falsify”, in reference to the philosopher Karl Popper) that seem superficially true. Most results are inconclusive, results of significance are enormously valuable, and, he said, “We haven’t had many."
http://brucepackard.com/so-whats-it-like-to-manage-30-billion-dollars-you-dont-feel-like-a-lucky-chicken/

I saw David Harding speak at the London Value Investor conference a couple of years ago and he gave what was possibly the best presentation I've ever seen on investing in my life. It was rather amusing, as here was a guy who built his fortune by momentum investing lecturing a group of rather skeptical, old fashioned value investors.

I'll summarise briefly. He explained a simple moving average momentum strategy and applied it to the gold market over 25 years. He generated a chart a bit like this.

Then he did the same for the copper market, generating a chart a bit like this.

He then continued on across 64 different markets ending up with a matrix of charts like this:

560e3942e6433New_Mockup_1_-_Global_Views

Then he merged all the return series into a single chart that looked precisely like this:

And that's how he became a billionaire.

I presume all the value investors in the crowd got back to their desks the next morning and refocused on their priorities, like wondering whether or not to buy Tesco !

Ha ha ha. That's hilarious. Now I know the secret sauce!

iwright7

David Harding sounds a really interesting guy - A modern day trend follower of the Livermore, Baruch, Loeb and Darvas persuasion? I ran a Google search and couldn't find a lot other than a Guardian article mentioning his use of momentum, algorithms and a slow to sell approach. Does anyone know of a book, or good article that covers his style in greater depth? Ian

cadmunkey

Articles like this are the reason I have a Stockopedia subscription. The geek in me loves the virtual portfolios! The stockranks are superb, makes stockpicking decisions so much easier these days.

Yeah - the plan is to get these portfolios more public as soon as possible and findable from the menus. Basically by merging the Fantasy Funds with the Folios system to have a public portfolios area (which will either have audited histories, broker downloaded histories, or point in time trade entries). Then add to that systematic portfolios like the Guru Screens and we'd have a great man v machine live portfolio area. Would be pretty nifty.

The hardest thing is keeping the navigation simple while the features grow - 2016 is going to be really exciting here... whole site is being rebuilt. Sneak peak of compare page on tablets here.

rick

Good work!

Would still like the visual charts of StockRank vs. Time for individual stocks. We have seen some stills months ago but nothing is up yet. I guess they might be very noisy for some small cap stocks etc. but would be very useful for more liquid stocks. Hope you can include them soon..ta

jjis

There was a repeat of an interesting Horizon documentary on BBC 4 the other day which featured a piece on David Harding and is still available on the I player here:

http://www.bbc.co.uk/iplayer/episode/b01rt4c7/horizon-20122013-11-the-age-of-big-data

cig

As a short you're not paying interest, because in a spread bet you're in effect lending to your opposite number, who's long the stock while having only committed margin. So you're the bank to them and thus they pay you LIBOR. The broker then takes a spread on both sides, so they charge LIBOR +x to the long and pay the short LIBOR -x. When x is 2.5% and LIBOR is 0.5% the short is actually out of pocket, but it's not interest, it's pure intermediary commission.

(Same in a physical, the short gets LIBOR on the cash balance of the sale proceeds.)

Re automation, the "basket trader" window in Interactive Brokers' trading software does that already. Pick an index (a few factor ones are there, they could add more, or you can upload yours), choose a sampling method, and it creates an order list of individual stock buys sized to make a portfolio with beta 1 to the index. Press "send" to execute all the orders, done.

Mercurius

Worth pointing out that Harding was seed investor for a quite large (at least now) value fund (coincidentally, they own Tesco). I am assuming that is the connection as someone from the company he funded spoke last year (or maybe the year before). Amazing record though, AHL then Winton.

hawkipa

5th Oct '15

Enjoyable article and NAPS have made me a few quid too. Thanks!

Taunting the bear? The NAPS portfolio defies the worst quarter in years

Sleepy time…

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Edward Croft

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