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Hey, Steve.:) I don't use anything like what the author discussed,
but I don't see any reason why something along those lines couldn't
be programmed into an AB system test.
The author is right about the poor performance of fund managers.
Here in the U.S., an SP500 Index fund beats most managers in most
years and the SP500 benchmark is setting the bar pretty low. Their
performance looks even worse when you consider that a fund manager's
performance isn't always benchmarked to an index appropriate to the
asset-class they're trading.
However, a 5-year track record is not significant. There's no way of
knowing if the author is really onto something without 10 years or
more of data. Also, the author's portfolio may have beaten a lot of
others but its performance can be matched by an index. The SP600
Small Cap Value Index (Yahoo! symbol ^SML) has similar average annual
returns to the author's "low risk portfolio" over a 10-year period
(instead of only 5) and it can be purchased with an ETF, symbol IJS.
Luck,
Sebastian
--- In amibroker@xxxxxxxxxxxxxxx, "steve_almond" <steve2@xxxx> wrote:
>
> An article appeared recently in the UK magazine "Investors
> Chronicle" entitled "Useless Tools".
> The gist of the article was that UK fund managers were doing a
> pathetically bad job using their tools (valuations, company
> analysis, business models, knowledge of management etc.) and were
> all (except 3) beaten over each of the last 5 years by the
> author's "Low-Risk Portfolio". This portfolio returned 86.5%
(total)
> over the past 5 years.
>
> This low-risk portfolio was quoted as "...based on simple mean-
> variance optimisation, in which the only inputs are the
volatilities
> and Betas of the share's quarterly returns since 1992..."
>
> I sent the author an email asking for further details and his reply
> is below. The question is, does anyone use this sort of analysis
and
> does Amibroker lend itself to the required calculations?
>
> Steve
>
> >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
>
> Hello. Thanks for your interest and kind words. I attach a brief
> description of what I do, taken from the website.
> To take this further, I'd recommend Modern Portfolio Theory and
> Investment Analysis, by Edwin Elton and Martin Gruber, who describe
> the process in detail.
> It's a very interesting idea to apply this to US stocks.
> One thing you'll almost certainly find is that historic (in-sample)
> efficient portfolios vastly out-perform fund managers. My portfolio
> shows that this is true out-of-sample too - though of course I've
no
> idea whether this will remain the case.
> Best wishes
> Chris
>
>
> How we form the portfolio
> At the start of every calendar quarter since 1998 I've asked a
> simple question: what set of stocks in the FTSE 100 has had the
> lowest possible volatility of quarterly returns since 1992? This
set
> has been our low-risk portfolio.
> To see how stocks get into this portfolio, consider the equation
> that tells us the variance of a portfolio. It is:
>
> Variance = 1/N x (Average variance) + (N-1)/N x Average covariance
>
> The low-risk portfolio is the one that minimizes this variance; to
> find this, I use some software called the Investment Portfolio,
> available from John Wiley & Sons.
> It's clear from this equation that there are only two ways a
> stock
> can get into our portfolio; either it has a low variance, or it has
> a low covariance with other stocks*.
> Note that low volatility on its own is not enough to get into our
> portfolio. Smiths Group has a lower variance than BAT. But it
> doesn't get into our portfolio whereas BAT is a major holding
> because it has a high covariance with other stocks whereas BAT
> doesn't.
> Conversely, low covariances with other stocks are not enough. Rio
> Tinto has these, but it's quite volatile, so it's excluded.
> Note also that equity risk can't be removed entirely. Even the
> lowest possible risk portfolio still has a standard deviation of
> almost half that of the market. This means that you can only remove
> half of equity risk by diversifying among equities. To reduce risk
> by more than this, you need other assets.
> * Actually, I use implied covariances, obtained by multiplying
> stocks' betas by the variance of the All-share index. There's
> a
> simple reason for doing this. Some pairs of stocks might have a
> negative covariance in the past simply because of luck – as one
> had
> bad news at the same time as the other had good.
> It would be imprudent to assume that such chance events will
> continue into the future, so we shouldn't use such covariances to
> measure risk.
> Instead, we ask: what fundamental reason do we have to expect that
> two stocks will move together? If you believe the capital asset
> pricing model – which says that market risk is the only
> systematic
> factor that determines stock returns – the answer can only be
> that
> the two stocks are sensitive to moves in the market. If this is so,
> we can estimate an implied covariance by multiplying their betas by
> the variance in the All-share index.
> The paradox here is that although the CAPM is clearly wrong as a
> guide to asset pricing, it produces a portfolio that delivers great
> risk-adjusted returns.
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