Geoff Considine

Tactical Asset Allocation, Part II

Oleg:

QPP uses three years of data to initialize the model as the baseline input--but projections have been extensively tested out of sample over decades. Black Swans may exist that defy the model---no one did well with 9/11 or 1987 crash---fair points. I have written about testing for extreme tails in a range of articles if you are interested.

Using Default Risk to Limit Downside in Individual Stock Investing

Quaazy1:

Any Monte Carlo model that does not account for correlation between positions is essentially pointless. QPP has a sophisticated tool for capturing and managing the correlations between all positions. QPP is actually considerably more sophisticated that a tools based on Style Analysis in this regard because it captures all correlation effects and not just correlations due to mutual correlation to indexes.

I have performed long-term out-of-sample tests on portfolios of assets and have shown that QPP does a solid job of generating expected risk and return in total portfolios of correlated assets.

Using Default Risk to Limit Downside in Individual Stock Investing

Hi Quaazy1:

The current version of QPP assumes no serial correlation in return in the simulation. This is measured historically, however. This is okay for investors with time horizons beyond about a year because the dcay time scale for autocorrelation is about a year in most studies. QPP is not intended to be a momentum investing tool.

Using Default Risk to Limit Downside in Individual Stock Investing

Bear Stearns Part 2: The comment above is especially notable given that Moody's had BSC rated at A2 until 3/14/08, at which time Moody's downgraded BSC to Baa1. QPP's projected 1% / 1 year risk as calculated at the end of February is in line with credit ratings right on the edge of junk (see chart in this article).

Using Default Risk to Limit Downside in Individual Stock Investing

FYI: Bear Stearns had a 1-year, 1% ile projected return in QPP of -75% for the period ending 2/29. In the article above, I suggested that individual investors avoid stocks with 1% ile projected return worse than -50% to -60%. BSC would have been avoided on this basis.

Using Default Risk to Limit Downside in Individual Stock Investing

Hi Manhapf:

The idea of using QPP as a leading projection of upgrades or downgrades is an interesting one--and you can look for future articles on this. I have been doing some testing and it appears that QPP has shown very high tail risk prior to some recent downgrades.

American Express: Watch the Dividend

Hi George:

Unless I recall incorrectly, Buffett has repeatedly stated that he believes that his job is to make use of earnings by reinvesting the best way he knows--he feels that this is what his investors are paying him for. I am inclined to agree. He has done a heck of a job. I do not own BRK, but if I did, I'd prefer to have him reinvesting net earnings rather than giving them back in cash.

So You Want To Invest Like Buffett? Here's An Easy Trick

Nice article. I am always interested in trying to copy the strategies of good managers. When I analyzed Berkshire Hathway's top holdings using Monte Carlo, they also came out looking really good on a forward-looking basis:

financial.seekingalpha...

I believe that this is very important for anyone thinking about trying to benchmark Berkshire Hathway's performance.

One thing to bear in mind. Buffett is a value investor and believes strongly in the value of strong consumer brands. If you are going to benchmark a portfolio like this, you should use an index that is refelective of his style. The years included in your study have been very good ones for a value-oriented style, so value indices are much better benchmarks than the S&P500. If you wanted to get a bit more sophisticated, you could create a composite benchmark that also has a higher weight to consumer products and other indices that capture the persistent style of BRK. Value indices have out-performed the broader S&P500 quite dramatically, so this would temper the results that you show that seem to suggest out-performance somewhat.