Last month, the flagship Validea Hot List portfolio I track on my website hit its nine-year anniversary. The portfolio uses all 12 of my Guru Strategies, which are based on the approaches of such investing greats as Warren Buffett, Benjamin Graham, and Martin Zweig, to choose its 10 holdings. It gives more weight to the individual models that have had the most success over the long term, and I follow a strict 28-day rebalancing system that ensures only the highest-rated stocks are in the portfolio each month.
In its nine years, the portfolio has been a big winner. Since its July 2003 inception, it has now gained more than 140% (all returns here and below are through Aug. 1), nearly four times the S&P 500's 37.5% gain. That's annualized returns of 10.2% in a nine-plus-year period in which the S&P has returned just 3.5% annualized.
Given that the Hot List recently hit the nine-year mark, I thought it would be a good time to look back and see what has worked -- and what hasn't -- for the portfolio and the individual strategies that drive its picks over that time.
For the Hot List, the best full-year we've seen so far was 2009 -- a year that many thought was going to spell doom for America and the stock market -- when the portfolio gained 47.0%. (In the partial 2003 year, the portfolio actually gained more -- 56.9% -- but that was only a five-and-a-half-month span.) In addition to being the best year in terms of raw return, 2009 was also the portfolio's best year in terms of outperformance of the broader market. It beat the S&P 500 (which returned 23.5%) by 23.5 percentage points that year.
The portfolio's worst year, meanwhile, came in 2008, when it fell 35.0% amid the financial crisis and Great Recession. It did, however, beat the S&P that year by 3.5 percentage points. In terms of relative underperformance to the broader market, the Hot List's worst year was last year. It declined 16.2% while the S&P was flat.
Including its 2003 and 2012 partial years, the Hot List has beaten the S&P in six years, or 60% of the time. It has been more volatile than the index, with a beta of about 1.2; that's also clear from the fact that the portfolio has had three years when it has produced negative returns (2007, 2008, and 2011), while the S&P has had just one (2008). Of course, when you look at the portfolio's long-term returns, the additional volatility has been well worth it.
So, which of the strategies that go into the Hot List have done particularly well, and which have not? Well, the top overall performer has been the strategy I based on the writings of Motley Fool creators Tom and David Gardner. A 10-stock portfolio picked using this model is up nearly 200% since its inception (also July 15, 2003), or 12.8% annualized (versus that 3.6% S&P figure I mentioned above). While The Fool-based strategy is lagging the market this year, it has put together a remarkable run, beating the S&P in every year of its existence. You would think that a small-cap growth strategy would tend to be more volatile, but the Fool strategy has been successful in large part by limiting losses. Several other portfolios have had significantly better individual years, but the Fool portfolio has had only one negative year -- and that was 2008, when it still beat the S&P by more than 13 percentage points.
Another top performer has been my Benjamin Graham-inspired strategy. My 10-stock Graham-based portfolio has gained more than 170% since its July 15, 2003 inception. That's 11.7% annualized, versus that same 3.6% figure for the S&P. The portfolio was my best performer during the horrible 2008 year, losing just 14.1% while the broader market tumbled nearly 3 times that much. It has lagged the index in only two years, one of which was last year, its worst overall year -- the portfolio loss about 19%. All in all though, the strategy -- which Graham outlined more than six decades ago -- has been an exceptional performer.
Two other big winners have been my Kenneth Fisher-and James O'Shaughnessy-inspired approaches. The 10-stock Fisher portfolio has gained 10.6% annualized since its inception, while the O'Shaughnessy counterpart is up 9.9% annualized since inception (both inceptions were July 15, 2003.
Our other individual guru 10-stock portfolios aren't quite at those double-digit annualized return levels, but nearly every one has beaten the S&P since inception. In fact the lone laggard at this point is the John Neff-inspired portfolio. Since its 2004 inception, it's up 1.4% annualized while the S&P is up 2.5%. I suspect that over the long haul it will come out on top of the index, given that the strategy looks at a number of factors that are used by other successful strategies -- price-earnings ratio, earnings growth, sales growth, and dividend yield, to name a few. Time, of course, will tell.
I thought one interesting way to look at all of these portfolios was by assessing how they've done during strong years for the broader market, and during weak years for the broader market. Since 2003, we've had four years that have featured weak returns for the market: 2005 (3%); 2007 (3.5%); 2008 (-38.5%); and 2011 (0%). The other years have all featured games of at least 9%, which I think it's fair to classify it as strong years.
We'll start with the weak years. The figures are the average (mean) return for the weak years (portfolio inception date are in parentheses).
Portfolio Based On
Momentum Investor (July 15, 2003): 6.65%
Motley Fool (July 15, 2003): 2.23%
James O'Shaughnessy (July 15, 2003): -3.73%
Kenneth Fisher (July 15, 2003): -6.33
Benjamin Graham (July 15, 2003): -7.70%
Martin Zweig (July 15, 2003): -8.95%
Joel Greenblatt (Dec. 2, 2005): -10.83%*
John Neff (Jan. 2, 2004): -11.43%
Warren Buffett (Dec. 5, 2003): -11.60%
Hot List (July 15, 2003): -12.08%
Joseph Piotroski (Feb. 27, 2004): -14.40%
David Dreman (July 15, 2003): -15.53%
Peter Lynch (July 15, 2003): -17.48%
S&P 500: -8.00%
(*= does not include 2005 returns due to late-year inception date)
Now, here's how the same strategies performed in the strong years. Figures are the average (mean) return for the strong years (including the partial 2003 and 2012 years, where applicable):
Hot List: 29.07%
Motley Fool: 20.13%
S&P 500: 13.23%
(*= does not include 2003 returns due to inception date)
(**= does not include 2003 or 2004 returns due to inception date)
The data shows some things that have played out as you'd expect. For example, during the weaker years, the top two performers have both been growth strategies, while several of the worst performers were deeper value strategies. That makes sense, as, during tough times investors tend to gravitate towards stocks with better, more consistent earnings growth and away from deeper value stocks, which often have some sort of problems or are the subject of fears that make them cheap, but riskier, in the short term. Conversely, during good times, when investors are taking on more risk, the top performers have included several deep value strategies and the worst performer has been the momentum strategy.
But the data also shows numerous exceptions. The Peter Lynch strategy has been the worst performer during weak years, for example, despite focusing quite a bit on earnings growth. And, while it has been the best performer during weak years, the Momentum portfolio significantly lagged the market during 2008, when it lost 45%. It's also been the worst performer during strong years, but it nevertheless gained more than 30% in the strong partial 2003 year. The hybrid O'Shaughnessy growth/value model produced very good years during tough times for the broader market in 2005 and 2011, but it lagged the market during 2008 by more than 8 percentage points. It also produced exceptional returns in 2003, 2006, 2009, and 2010, when the market was strong, but just 1% in 2004, another strong year for stocks.
So, at the end of the day, even if you knew what the broader market climate would be, it's very hard to say which strategies are more likely to be the best performers. There are likely a few reasons for that. One is that while the portfolios are in most cases nine years old, the sample size is still relatively small for strong and weak years. Another is that, while they may tilt one way or the other, almost the strategies that go into the Hot List include both growth and value components, making it difficult to classify them as exclusively a growth or value approach. And, markets are strong or weak for different reasons at different times. The 2008 market was crushed by financial stocks, so a strategy like the Graham approach -- whose rigid balance sheet requirements make it all but impossible for a financial stock to make its way into the portfolio (since financials carry a lot of debt due to the nature of their businesses) -- benefited.
There thus doesn't seem to be a clear conclusion on which strategies perform best during different environments. But I think that, combined with the long-term success of almost all of these approaches, that does lead to another more general conclusion that is critical to understand: All strategies -- even the best ones -- have ups and downs, and you never know exactly when those ups and downs are coming (particularly when you are using a more focused portfolio like the Hot List, where stock-specific issues have a much bigger impact than they do on a portfolio with, say, 100 stocks). And, as Greenblatt and O'Shaughnessy and other top strategists have stressed, that means you need to stay very disciplined. Jumping from hot strategy to hot strategy while bailing on approaches that have short-term hiccups is a recipe for trouble.
Good strategies work over time -- if you let them do their job. The hard part is understanding that good strategies will have short-term underperformance, and not overreacting to those periods, which will cause you to sell low. As Greenblatt has pointed out, his approach has had even three-year periods where it has struggled. But over the long haul, he has produced exceptional returns. In the end, there are simply too many factors to take into account to beat the market every week or month or year. But over the longer term, value and fundamental soundness win out, as history has shown. If you have the discipline to stick with a good, fundamental-focused strategy through the market's (and your portfolio's) unpredictable short-term gyrations, you should stay ahead of the game over the longer term.