Geoff Considine

The Do-It-Yourself Market-Neutral Portfolio

Steve:

Over the last 12 months, I get about the same result--depending on whether you drop OMM when it was delisted due to acquisition or substitute its acquirer. Either way, the portfolio is down by an amount close to the S&P500, as you suggest. That said, note that the R^2 of 20% or less over long periods of time means that it is not really a good idea to benchmark against something like the S&P500--most of the volatility in the portfolio is not due to moves in the S&P500. A "market neutral" apporoach that has fairly high volatility (like this one) may not drop when the market drops--or it may--the market direction is not the driver. In this case, the credit crisis has been a big driver because of the exposure to banks here.

This kind of portfolio is a good one to monitor over the long haul--thanks for the reminder :)

Geoff

The Do-It-Yourself Market-Neutral Portfolio

Hi Dan:

Yahoo's stock screener also gives CEF's--it is free and easy. In this case, with the P/E criteria that I used, these industries ended up with high representation--this is a consequence of looking for low Beta and low P/E.

The Do-It-Yourself Market-Neutral Portfolio

Well, you will note that several of the holdings are Canadian. Second, we have Mitsui ADR's. Oil companies tend to have performance that is correlated to emerging markets--just because a number of these economies are driven by oil. This study was performed in the U.S. currency and there are more domestic companies than non-U.S. companies, but the strategy will hold up with quite a few variations. Again, I stress that this article is a demonstration of a concept rather than being an ideal portfolio.

The Do-It-Yourself Market-Neutral Portfolio

Ralph:

Thanks for your comments. QPP's projections do depend on historical correlations, volatility, etc. I have gone to some lengths to avoid 'over fitting' but every analysis using historical data is subject to the specifics of these data. QPP's projections do not, however, simply rehash historical returns, volatilities, and correlations. I have research showing how QPP works for a real portfolio of stocks over 30+ years. Also, this idea of a very low Beta / low R^2 / low correlation portfolio using only long positions has been demonstrated in a number of my other papers. Could correlations shift so much that this approach fails? Certainly. Any analysis is subject to the potential for the world to shift.

The fact that this portfolio has done well in recent bull and bear markets AND that the monthly returns exhibit such low R^2 and Beta makes me feel that these results are fairly robust. Obviously this portfolio has too much energy exposure to be a real choice for a total equity portfolio. I would be worried about how this portfolio would do in the event that oil drops a lot...that can can tested using the correlation of the portfolio to an oil index--I didn't do that in the article, but it would be easy enough using QPP.

BTW, DIAMX has a lot of energy exposure, too. If you look on Morningstar here:

quicktake.morningstar....;Symbol=DIAMX&...

you will see that DIAMX has an R^2 with respect to the Goldman Sachs Natural Resources Index of 71%---that is quite high. This means that movements in this index explain 71% of the variability in the returns on DIAMX.