Villi Grdovich's  Instablog

I am taking an opportunity to share some experiences in relation to my last article.

I have been running a ghost portfolio on my High Beta strategy. This portfolio is run through a third party portfolio tracker which buys and sells specific volumes of stock on instruction, charges brokerage and is subject to execution risk - a complete virtual broker. Therefore, the results can be trusted as good approximations of what would have happened to my account had it been real cash.

In respect of testing the "Indicator", to cut along story short, the real time application appears worthwhile, but it cannot be assumed that immediately the "indicator" goes one way or the other, that the High Beta strategy will automatically start to perform or underperform. I have found that there are lags of up to two weeks for a portfolio to kick in with performance. This of course puts a strain on an impatient investor, but I am still OK with using "Indicator" as my primary source for timing. I also look to other indicators published on SA in terms of market breadth and the like, and take some comfort from them as supporting evidence. More on that later.

My first strategy was to use this as a ratchet strategy. Get in, reap High Beta rewards, then go to cash and wait. My best return was around 12% absolute over about three weeks, which equated to around 7% alpha. I then went to cash when my selections started to lose ground, and as the market overall declined, alpha actually hit 12% at a maximum.

"Indicator" then went negative and so I tested a Bear ETF, HDGE, on the basis that the market should decline further. This may have been a good idea, but the choice of ETF was bad and it wiped out about 5% or return. In fact I now think that it is not such a good idea to try for returns on the short side because, in that period of lagged performance mentioned above, the exposure to adverse returns is too great. I might have different thoughts if we had a period of market turmoil, but at the moment, stocks appear to be trading on merit more so than on herd instinct.

As always, stock selection isn't perfect. However there is no point looking all over the market for stocks going up. I am still OK with selecting a panel of High Beta stocks and continually screening to see which are performing as expected. To the extent that I am focused, it is on that.

Where there appears to be a good story, say as in oil shale, then I think it also a good idea to monitor stocks which might benefit, and wait for a sign of life, but that is another parallel strategy.

At the moment "Indicator" is oscillating around zero, which means I am in cash only, and in the past week it has also cost a few % in performance...but getting a better understanding of how to operate the system is what this is all about.

Finally, it is worthwhile considering what makes High Beta stocks. Are they originally deep value, are they being re-rated, are their earnings improving markedly. Whatever it is, a proper classification may assist in improving the selection process going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

King Richard has been dismounted in battle, he needs his/a horse to escape and utters a famous line "a horse, a horse, my kingdom for a horse". I feel that our current situation mirrors his.

Firstly, the TLT/SPY indicator is still firmly negative, which suggests that equities are unlikely to outperform for the moment. TLT hit around $130 in the last week which is an all time high and suggests significant risk aversion.

I have been using CAT as a stalking horse. Earnings were higher than expected, outlook neutral, so we are all in the same outlook boat. What is interesting is that day by day, the trend is TLT up, CAT down and vice versa. Despite an earnings beat, there is no sustained upwards move. I feel that my analysis is vindicated. Financial risk is a the major the price driver at the moment.

There is some commentary about "alpha" being hard to find, and "beta" being the investing strategy of the day. CAT is a prime example of this trend. CAT is a high "beta" story. If TLT starts a credible and consistent decline, then stocks such as CAT will do quite well. What might be worrying is that without QE style stimulus, "beta" may now be going missing.

In the meantime, the idea of sticking with low volatility and dividends appears sound. It is the area where I feel most comfortable at the moment.

As at 27 April, the Specialty Chemical portfolio continues to outperform very strongly, while the Pharmaceuticals are doing no better than holding their ground.

Comparative portfolio returns are:

The following graph is essentially a timing model which indicates pairs switching as between stocks and bonds. It has been quite a good model over the past few years, and it is currently heading to negative. This indicates that a switch from stocks to bonds (or to low volatility ETF's) should be under consideration.

What is surprising is that a high beta portfolio like Specialty Chemicals does not reflect a reversal yet. Nevertheless, I am concerned about future performance.