Winning By Not Losing

I believe avoiding loss is the most important consideration in this business. But don’t take my word for it – below are a few of my favorite quotes on investing (& losing), by some of the top investors in the world.

“The first rule is not to lose. The second rule is not to forget the first rule.” – Warren Buffett

“Whenever I buy or sell something , I always try and make sure I’m not going to lose any money first … my basic advice is don’t lose money. ” – Jim Rogers

“A loss never bothers me after I take it. I forget it overnight. But being wrong – not taking the loss – that is what does damage to the pocketbook and to the soul.”
-Jessie Livermore in “Reminiscences of a Stock Operator”

“I am always thinking about losing money rather than making money.” Paul Tudor Jones

I published a paper last year to focus on the topic in the title of this blog post – “A Quant Approach to TAA“. It took inspiration from the Policy Portfolios of the Harvard and Yale endowments to come up with a simple strategic asset allocation – 20% each in US Stocks, Foreign Stocks, US Government Bonds, REITs, and Commodities. This portfolio can be easily implemented with low-cost ETFs or mutual funds, and rebalanced every so often. It then applied a smiple tactical overlay to reduce risk and drawdowns – ie winning by not losing. This technique would have had you out of US Stocks the end of 2007, out of Foreign Stocks the end of January, and out of REITs way back in June of last year. And of course you would still be happily in 20% bonds, 20% commodities, and 60% cash.

I have received a handful of emails asking to post the monthly return series online, and below is a PDF you will have to click on to enlarge and view. As you can see, the returns in 2006 (when I first circulated the paper) to 2008 out-of-sample are quite representative of the previous 30+ years. 36 profitable years and counting – including this year (so far), a pretty difficult year for those who are long stocks. (All figures below are gross of any management fees, commissions, taxes, or bid/ask spreads. The original paper also understated the cash returns a bit and is corrected here.)

And at the request of a reader – returns since 2006:

LinkFest

For once I agree with Goldstein. I mean, I was driving around LA this morning and passed a billboard with a huge ticker for a pink sheets gold mining company. . .And buying a hedge fund is somehow more risky? Pffftttt. One Enron is still bigger than all the hedge fund fraud combined.

This issue hits close to home as our lawyer is very nervous about my blogging and launching some funds. I am either going to have to be very careful or shut the blog down. TBD which one.

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Interview with Marc Faber on CNBC:

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New blog added to the blogroll – The Stalwart.

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Bones are not the only fossils.

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I can’t stop singing a little Sinatra while watching commodities right now..

Fly me to the moon
Let me play among the stars
Let me see what spring is like
On a-Jupiter and Mars
In other words, hold my hand
In other words, baby, kiss me

Fill my heart with song
And let me sing for ever more
You are all I long for
All I worship and adore
In other words, please be true
In other words, I love you

Fill my heart with song
Let me sing for ever more
You are all I long for
All I worship and adore
In other words, please be true
In other words, in other words
I love … you

Watching


Buy and hold got you feeling a little queasy lately? That can (case) of Duff may only help you forget the market for a little while.

By following the simple timing model I published last year, you would be pleasantly watching this stock market dump with a 60% cash / 20% bonds / 20% commodities allocation. Not a bad portfolio for the past month. How is everything else holding up? Below is an update of a post I made in January on the listed alternatives here in the US – click on the chart to zoom in on the numbers:

Hedge Fund Masters 2008…Everyone Loves Qualcomm

Feeling a little contrarian today? Seth Klarman is, and he is buying some beaten down SLM with a full third of his portfolio. . .

The 13Fs are arriving and below I update the two tracking portfolios.

(For background on this approach, check out Show Me Your Hand – Betting on the Smart Money.)

Below is a table of updated performance figures for the two strategies we track, followed by individual fund holdings and commentary. In our previous backtests, we found that the strategies outperformed the stock indexes by 6-12% per year since 2000 with similar volatility. 2007 was the first year out of sample and the performance was quite strong.

A subjective and non-scientific observation is that the portfolios generally track the market on the downside, but have much higher upside volatility.

Performance:

Hedge Fund Consensus – Top holdings owned by 15 value hedge funds, ranked by # of funds with the same position. Google was the worst performer at -27%.

QCOM (5)
AMX (4)
AXP (3)
MA (3)
MSFT (3)
WMT (3)

The list of double repeats is at the end of the post.

Hedge Fund Best Ideas – Top two holdings from each of 10 value hedge funds listed below. Apple was the worst performer at -40%. (Since AMX and QCOM are repeats, I took the next two stocks – SWN and MA.):

AMX
BBBY
CA
CVA
CVS
DISCA
GOOG
HLX
HPQ
KO
MA
MCO
NWS
ORCL
QCOM
ROST
SLM
SWN
TGT
WFC

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Baupost Group

Wow. A full third of Klarman’s portfolio is in SLM. When one of the best investors on the planet has this sort conviction, that is good enough for me. Link to a Klarman’s speech at MIT.

Top sectors in the portfolio include:

Financials 57%
Services 12%
Energy 14%

Top 10 holdings are:

SLM
NWS
LINE
HRZ
FAF
APL
UFS
EXH
ELOS
MAQ

Blue Ridge Capital

Sold off a little Discovery Holdings, and doubled positions in Target, Coach, and Starbucks.

Top sectors in the portfolio include:

Services 43%
Financials 18%
Technology 15%

Top 10 holdings are:

CVA
DISCA
SCHW
TV
AMX
LVLT
AXP
WMT
BR
TGT

Warren Buffett

Top 10 holdings are:

KO
WFC
AXP
PG
BNI
KFT
JNJ
WSC
USB
BUD

Eminence Capital

New positions in Lab Corp and Viacom, and added a bit to the largest position Ross Stores.

Top sectors in the portfolio include:

Services 33%
Technology 30%
Financials 12%
Conglomerates 11%

Top 10 holdings are:

ROST
ORCL
PHG
FISV
QCOM
AXP
SAI
AMAT
IGT
CSCO

Greenlight Capital

A big increase in the top position Target, and new positions in Walgreens and Health Management Corp.

Top sectors in the portfolio include:

Services 27%
Financial 17%
Technology 16%
Energy 15%
Capital Goods 12%

Top 10 holdings are:
TGT
HLX
AMP
MSFT
MDC
BAGL
VOV
SAI
MIM
URS

Lone Pine Capital

Beefed up the position in Qualcomm, and initiated positions in Sandridge Energy and Mastercard.

Top sectors in the portfolio include:

Services 34%
Technology 22%
Financials 9%
Basic Materials 8%

Top 10 holdings are:

AMX
QCOM
SWN
GOOG
PCLN
BAM
SLB
COH
FAST
BNI

Maverick Capital

Supposedly had an awful January. But talk about nice timing on that new purchase of $200 million in Yahoo shares. Other than adding some AMD and paring some AAPL, not much has changed.

Top sectors in the portfolio include:

Technology 27%
Services 32%
Financials 13%
Healthcare 13%

Top 10 holdings are:
QCOM
CVS
AMX
TMO
RTN
AAPL
GME
AMD
WU
BK

Okumus Capital

Lost of turnover here. 80% of the portfolio is in the top 4 holdings with BBBY accounting for almost 40%.

Top sectors in the portfolio include:

Services 95%

Top 10 holdings are:

BBBY
MCO
LTD
ODP
MHP
PZZA
ARB
M
CMCSA
HOTT
SHOO
URI

Private Capital

Sold off a bit of the top holdings, but not much.

Top sectors in the portfolio include:

Services 37%
Technology 27%
Financials 26%

Top 10 holdings are:

CA
HPQ
MGM
BEAS
SYMC
NTRS
RCL
BSC
EK
IGT

Tiger Global

New positions in Mastercard, Longtop, Priceline, and Research in Motion.

Top sectors in the portfolio include:

Services 33%
Technology 40%
Financial 11%

Top 10 holdings are:

GOOG
AMX
MA
AMT
BIDU
FMCN
LFT
PCLN
MELI
TDG

List of double repeats:

AMAT
BAM
BBBY
BIDU
BNI
BRK
CME
COH
CSCO
CVC
DGX
EMC
ETFC
EXP
GOOG
HRZ
IGT
M
MCO
MDC
ODP
ORCL
PCLN
SAI
SBAC
SLM
TGT
TMO
TT
TXT
UTX

Idiocracy and Mean Reversion

With politicians getting involved, it is no wonder people are scared of hedge funds. From AllAboutAlpha:

Politicians are – quite rightly – sensitive to “headline risk”. One such politician is New Mexico’s Teresa Zanetti. She tabled a bill in the state legislature at the end of January that would ban hedge fund investment by the $15 billion New Mexico State Investment Council (although, according to Pensions & Investments, it would have allowed the State pension plans to continue investing in hedge funds)…According to New Mexico Business Weekly, Zanetti says:

“A lot of people hitch their wagons to hedge funds to improve returns, but these can be very risky investments…We saw that last summer with the mortgage meltdown. The SIC [State Investment Council] wants to expand its investments in hedge funds, but I think that is essentially gambling with the public’s money.”

Zanetti clearly does not read World Beta – if she did she would realize the foreign listed hedge funds and FOFs returned about 10% in 2007 with 5% volatility. Maybe I should forward along the 2008 GIRY which shows that stock markets can go down. And by go down I mean by 66% in Germany, 80% in the US, and 96% in Japan.

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I updated a table of returns after a series of up or down years in asset classes and stock indexes. For example, if at the beginning of 2008 the returns for 2005, 2006, and 2007 were 7%, -15%, -3% the heading would be + – -. The obvious conclusions are to remember to rebalance, and to get aggressive after a few down years in a row – preferably three (Japan 2009?). Click on the chart and it will open in a new window.

Don’t Wake the Bear Up. . .

Feel like the Big Bear is hiding somewhere? If you’re the Nasdaq, he is only 1% away. . .(Painting is “Doubled Back” by Bev Doolittle. If you don’t see the bear, click on the picture to open it in another window.)

While domestic and foreign stocks have been getting hit hard in 2007, bonds (relatively) and commodities have been performing nicely. There is probably more misunderstanding of commodities as an asset class than any other, and I have written extensively on the subject in the past on World Beta (Links here, here, and here).

The much promoted Great Commodities Debate Part I
and II here) showed that the participants have a good understanding of commodities. However, I found it very strange that there was no mention of managed futures or a tactical approach – either long/flat or long/short. Maybe they could have a Part III of the debate and include Victor Sperandeo, author of the new book “Trader Vic on Commodities“.

I still take issue with some of the designs of the DTI (ie energy long only due to “risk factors”). He does presents data on a long/flat timing model on the S&P500 very similar to my own(with more data) – it is good to see confirming results.

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Harry Kat on a follow up to Jaeger’s alternative beta post:

“Based on the analysis above, it seems the Alternative Beta approach may sound better on paper than it does in practice. It confirms what econometricians have known for a long time: complex models often perform worse than simpler ones. It was for exactly this reason that Albert Einstein (or was it his wife Mileva?) recommended that models should always be kept as simple as possible.”

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Great quote from the just arrived book Optimal Portfolio Modeling:

“Play the game with more than you can afford to lose…only then will you learn the game.” – Winston Churchill

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Last Summer would have been a great time to buy volatility and risk and buy bond spreads. My approach to these types of trades is simple. Buy them when they are at historically low levels, and short them when they get to high levels. As Julian Robertson recently mentioned this Fall, his favorite trade was a curve steepener (long two-year, short ten-year). Looks like he is printing money on that one.

As Bespoke points out, corporates are getting near historically high spreads vs. Treasuries (although my data shows the spread spiking to above 300 bps) , so one could short that spread soon. Although it seems like we have been crisis free in the emerging markets for quite some time – and spreads are at historically low levels. Time to buy the emerging bond spread?

Below is a chart of the 10 year vs. 2 year spread, followed by the Corporate vs. 10-Year spread, followed by the Emerging bond spread.



I am Reading

Happy Birthday Darwin! Or, did T-Rex have a penis?

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Evolutionary bio part 2. The Merry Band of Wrigglers.

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This business would go under the first weekend in the US.

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Jaeger on alternative beta.

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A mildly unsafe for work interview (remembrance) with Helmut Newton.

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Swensen on keeping it simple. Long time readers know that I am a big fan of his work, but take issue with his position on market timing. An investor following the simple timing model I published last year would be sitting through this market dump quite happily. Especially today – commodities to the moon! (I still wonder why he doesn’t recommend commodities for the individual investor…)

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The Global Investment Returns Yearbook, and Ignore Momentum at Your Peril. . .

“For example, using data on the UK’s 100 largest stocks since 1900, the team created two portfolios, one based on the 20 best-performing equities in the previous 12 months and the other the 20 worst performers. These portfolios were then re-calculated every month. The portfolio of winners produced compound annual returns of 15.2 per cent, turning £1 into more than £4.2m (€5.6m, $8.2m) by the end of 2007. In contrast, the portfolio of laggards returned just 4.5 per cent a year, turning £1 into £111.”

When Is The Time To Buy Gold Stocks?


Can something as simple as tracking a commodity give predictive insight into what commodity stocks are going to do? Below I outline an example of the possibilities behind this type of analysis.

This line of analysis was originally developed by Jay Kaeppel and published in Stocks and Commodities magazine in July 1993 (Prospecting with Gold Mutual Funds). Kaeppel also authored a few books on options and futures like The Four Biggest Mistakes in Option Trading.

His work was examined and furthered by Nelson Freeburg of Formula Research who wrote a follow up article here. Kaeppel takes a simple ratio of a commodity stock index (in this case Barron’s Gold Mining Index) to the underlying cash commodity (gold). I used to track this every week for a whole host of commodities (oil, silver, etc). More than anything it can help give perspective to how expensive or cheap a basket of stocks is relative to what a commodity is doing – kind of a “forest from the trees” analysis. (Hussman talks about a similar method here and here.)

Here is the example with gold. Weekly data since 1977. I recorded all ratio readings, and then the subsequent 3, 6, and 12 month performance of the gold stock index. I then divided the historical data into deciles. The average returns for gold stocks since 1977 were 2.2%, 3.93%, and 9.93% (3,6,12 months).

Is there any sort of relationship between the ratio and future stock index movements? Below are charts for the 3,6, and 12 month excess returns (nets out the average return for gold stocks over the time period). There is a nice stair step that you want to see with this type of analysis. The highest ratios (stocks expensive relative to the commodity) result in future underperformance, and vice versa. Oil stocks as measured by the OSX are also in favorable territory. Kaeppel suggested buying gold stocks when the ratio was below 1.4, and selling when above 1.9.

Kaeppel’s simple system tests with 16% CAGR from 1977-1994 with drawdowns of -37% vs. 6% for the GMI and -73% drawdowns. Out of sample from 1994-2007 results in 9% CAGR with 54% DD vs. 2.5% CAGR and -75% DD for buy and hold. Both tests exclude the benefits of sitting in cash which would bump the results up probably 3% p.a. for the timing model.

Where is the ratio right now? Near the historical bottom 30% of readings, a pretty good time to be in gold stocks. Future total returns (not excess) in this decile were 8.39%, 18.13%, and 31.64% (3,6,12 months out). Below is a historical chart of gold stocks vs. the ratio. I tried to highlight when the ratio was below the bottom 30% of readings in green. Look at that big block of time from 1998-2003 when it was a great time to get long gold stocks. . .but who was talking about gold in 1998?

And here is the oil/OSX chart since 1997. . .

Assets and Defending Them

Think that big acquisition and borrowing a bunch of dough was a good idea? Sometimes your good intentions can work against you. . .(PS A little Will Ferrell V-Day humor here – if anyone can find the video clip please let me know. . .)

Here is a link to a great new paper scheduled for publication later in the year by The Journal of Finance – “Asset Growth and the Cross-Section of Stock Returns” by Schill, Gulen, and Cooper. (Nod to SmartMoney article by Hough that brought it to my attention. He mentions NDAQ and BBY as a couple of stocks that pass the screen.)

Long time readers know that I am a fan of using payout yield over dividend yield, and this paper is even more encompassing. It basically says a decrease in total assets is good – things like dividends, buybacks, spinoffs, and paying down debt. Ominous signs for future stock performance – accquistions, share issuances, borrowing, and sitting on lots of cash.



Abstract:


We test for firm-level asset investment effects in returns by examining the cross-sectional relation between firm asset growth and subsequent stock returns. As a test variable, we use the year-on-year percentage change in total assets. Asset growth rates are strong predictors of future abnormal returns. Asset growth retains its forecasting ability even on large capitalization stocks, a subgroup of firms for which other documented predictors of the cross-section lose much of their predictive ability. When we compare asset growth rates with the previously documented determinants of the cross-section of returns (i.e., book-to-market ratios, firm capitalization, lagged returns, accruals, and other growth measures), we find that a firm’s annual asset growth rate emerges as an economically and statistically significant predictor of the cross-section of U.S. stock returns.

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Investor Dashboards . This is an easy way to track the timing model (thanks to reader JW). Although it looks like they use BigCharts which I *don’t think* accounts for dividends and distributions correctly.

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Lots of sound advice in Vanguard’s “We Believe” series:

Vanguard We Believe #1

Vanguard We Believe #2

Vanguard We Believe #3

Vanguard We Believe #4

Vanguard We Believe #5

Vanguard We Believe #6

Vanguard We Believe #7

Vanguard We Believe #8

Vanguard We Believe #9

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As John Fitzgerald (also known as the “Worst Person in the World“) can vouch ,it is much harder to shield your personal life from public scrutiny with Web 2.0. I’d like to think I don’t need to hide anything (except maybe that BusinessWeek article my first day of my first job after college – I swear I never said that). Feel free to stop by my Facebook page here. But if you do have some skeletons to hide, there is always ReputationDefender:


ReputationDefender was created to defend you and your family’s good name on the Internet. Our goal is straightforward:

* To SEARCH out all information about you and/or your child on the Internet, wherever it may be, and present it to you in a clear report.

* To DESTROY, at your command, all inaccurate, inappropriate, hurtful, and slanderous information about you and/or your child using our proprietary in-house methodology.

Down 40% in 2007? You’re Promoted!

Travel abroad between 1996 and 2006? If you used a credit card, you are due at least a $25 refund according to a recent settlement. And if you’re the St. Tropez jetting, Ritz staying, Portillo skiing type (or international biz type), then you’re likely owed a lot more. Check out the CCF Settlement page for more info.

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Wow, I imagine this device could get you in a lot of trouble. TV B GONE. I’ll be buying one to silence any game where the Broncos are down by more than 14 points.

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The below is courtesy the good people at AlphaLetters:

Global Alpha’s Carhart Promoted At Goldman

– Despite the poor performance of Goldman’s flagship Global Alpha, which lost 40% in 2007, Mark Carhart (the co-portfolio manager of Global Alpha), is being promoted to co-chief investment officer of Goldman’s quantitative equity group, with eventual plans to succeed his co-chief, Robert Jones.
- These changes were not warmly welcomed by one top client: the Massachusetts State Pension Fund terminated its contract to run a $1.2 billion “enhanced equity” portfolio for the pension fund.
- Part of these changes will be the merger of Carhart’s group into the larger quantitative equity group(manages around 120 people) and the firing of 20 people in the process.

Massachusetts Pension Fund Fires Goldman Sachs

- The Massachusetts State pension Fund terminated its contract for $1.2 billion contract because of their board of director’s alleged discontent with performance and with staff changes.
- They expressed that Goldman had failed to outperform the S&P500 index and they will now temporarily invest money in passive funds that track indices.
- They were uncomfortable with the changes where Mark Carhart is expected to eventually head the merger of the quantitative strategies group and Goldman’s quantitative equities group.

QIM’s $2.9B Global Fund ‘Struggled’ In January

- Quantitative Investment Management, a $3bn quant fund, dropped by 7.77% in January, mainly due to market volatility, fraudulent at Société Générale and the drop of the DJ Euro stoxx 50 index
- Majority of the losses occurred during the days going into Martin Luther King Day, where the Global Program was long all of the global indices. The program’s biggest loss was in global stock indices (-7.58%) followed by a small loss in the interest rates sector (-1.18%)

Beware value traps in financials

- Although US Financial may look too cheap to pass up, strategists at Merrill Lynch are wary stocks that are “value traps” because they have further to fall.
- They believe the two industry groups that were heavily hit, financial and consumer discretionary, and only consumer discretionary is beginning to look attractive.
- According to Subramanian (quantitative strategist at Merrill Lynch), a typical Down cycle lasts around 11 months, Financials are only at their 5th month and thus too early to buy into financials.
- However, she sees signs of life in the discretionary sector

Hedge fund performance numbers in 2007Q4, including some quant funds

Shorting stocks was the way to go for hedge funds in the fourth quarter

- The most profitable strategy in the fourth quarter of 2007 is shorting equities with average performances of 13.23%.
- According to Morningstar, outperformance of emerging market specialist funds due to good returns from Russia, India and China and shorting
- Q4 performance numbers for some quant funds under the category of “Global non-trend funds”:
Balestra Capital Partners 40.42%
Clarium 30.89%
Quantitative Global Fund (3X) 28.73%

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