Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

A 5 Stock Portfolio That Has Crushed the S&P 500 With Lower Volatility (Update)

|Includes: Apple Inc. (AAPL), HPQ, JPM, MSFT, PFE
Follow me on Twitter!

A reader asked me to revisit a previous article I wrote in March of 2010.  The original article is here and the strategy is simple: UsingAlphaClone to "clone" or track public filings of hedge funds or institutional investors I backtested a clone of 10 institutional managers selected by Mebane Faber (author of The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets).  The ten institutions in the clone are Appaloosa Management, Baupost Group, Berkshire Hathaway, Blue Ridge Capital, Eminence Capital, Greenlight Capital, Lone Pine Capital, Maverick Capital, Private Capital Management, and Tiger Global Management.  The particular clone I ran purchases the top 5 most popular stocks among these 10 managers as determined by how many managers hold a stock in their top 20 holdings (AlphaClone allows you to run a variety of strategies based on any number of clones) and the stocks are weighted within the portfolio based on popularity; in other words, the more funds hold the stock, the higher the weighting within the portfolio.  The stocks in the clone are then rebalanced quarterly.

A long only portfolio of 5 stocks invested in this clone had the following returns since 2000, soundly beating the S&P 500 every year:


Yearly Returns


Year Clone SP500 +/-
2000 -1.8% -8.2% 6.4%
2001 18.4% -11.9% 30.3%
2002 -16.5% -22.1% 5.6%
2003 41.9% 28.7% 13.2%
2004 40.8% 10.9% 29.9%
2005 21.8% 4.9% 16.9%
2006 21.7% 15.8% 5.9%
2007 12.7% 5.5% 7.2%
2008 -29.1% -37.0% 7.9%
2009 55.9% 26.5% 29.4%
2010 15.6% 7.8% 7.8%

Performance Statistics as of 2010-11-24



3 YEAR 5 YEAR INCEPTION
Total Return 29.2% 74.9% 314.3%
Annualized Return 9.2% 12.0% 13.9%
Annualized Volatility 22.8% 19.8% 19.8%
Sharpe Ratio 0.2 0.4 0.5
Max Drawdown -38.9% -42.1% -42.0%
Average Turnover 50.0% 50.0% 50.0%
Alpha 13 11.3 13.5
Correlation S&P 0.9 0.9 0.7

The year to date performance by month for the unhedged is:


Date Clone SP500
1/29/2010 -6.7% -3.6%
2/26/2010 5.0% 3.1%
3/31/2010 8.8% 6.0%
4/30/2010 4.9% 1.6%
5/31/2010 -6.3% -8.0%
6/30/2010 -6.0% -5.2%
7/30/2010 8.3% 7.0%
8/31/2010 -6.9% -4.5%
9/30/2010 11.4% 8.9%
10/29/2010 3.6% 3.8%
11/23/2010 1.0% 0.0%


For those who more risk-adverse, AlphaClone allows you to backtest returns if you hedged a clone 25, 50, 75, or 100%. I hedged the identical portfolio above 100%, which means that a short position in the S&P 500 was always in place for an equal amount of the total long positions. Given that we have gone through 2 nasty bear markets since 2000, the hedged portfolio shows slightly better returns since inception but with much lower volatility than the long only strategy and has not had a down year in the past decade:



Yearly Returns


Year Clone SP500 +/-
2000 6.9% -8.2% 15.1%
2001 30.6% -11.9% 42.5%
2002 6.6% -22.1% 28.7%
2003 10.0% 28.7% -18.7%
2004 27.5% 10.9% 16.6%
2005 16.6% 4.9% 11.7%
2006 5.4% 15.8% -10.4%
2007 7.3% 5.5% 1.8%
2008 12.6% -37.0% 49.6%
2009 21.9% 26.5% -4.6%
2010 7.9% 7.8% 0.1%
       
Performance Statistics as of 2010-11-24



3 YEAR 5 YEAR INCEPTION
Total Return 44.6% 68.5% 307.6%
Annualized Return 13.5% 11.2% 13.7%
Annualized Volatility 7.9% 8.7% 13.8%
Sharpe Ratio 1.2 0.8 0.7
Max Drawdown -3.1% -7.9% -20.2%
Average Turnover 50.0% 50.0% 50.0%
Alpha 9.4 7.2 9.3
Correlation S&P 0 0 -0.1


The year to date performance by month for the 100% hedged is:


Date Clone SP500
1/29/2010 -3.1% -3.6%
2/26/2010 1.9% 3.1%
3/31/2010 2.7% 6.0%
4/30/2010 3.3% 1.6%
5/31/2010 1.7% -8.0%
6/30/2010 -0.8% -5.2%
7/30/2010 1.3% 7.0%
8/31/2010 -2.4% -4.5%
9/30/2010 2.4% 8.9%
10/29/2010 -0.2% 3.8%
11/23/2010 1.0% 0.0%


Now matter which way you backtest this clone it has outperformed the SP 500 by a wide margin. For the risk adverse, one of the second two strategies offer a safer way to hold stocks while hedging your position. Keep in mind that this is just one clone of potentially hundreds you can run using AlphaClone and used one strategy (top 5 popularity) among many. The ability to replicate top institutional investors has a track record of success but to be honest even I was a bit surprised by how wide of a margin even the 'safe' strategies outperformed the SP 500.


For those interested in the current portfolio:


NAME TICKER CLOSE REBALANCE


11/24/2010 11/19/2010
Apple Inc AAPL $313.36 $306.73
Hewlett-Packard Co HPQ $43.25 $42.49
Pfizer Inc PFE $16.63 $16.80
Microsoft Corp MSFT $25.73 $25.69
JP Morgan Chase & Co JPM $38.51 $39.41


Disclosures: I am an AlphaClone affiliate. No positions in stocks mentioned.
 

Disclosure: none