I’ve just updated my Keeping Score page for the character-building month of August. Check it out.
Tag Archives: performance attribution
acting in repsonse to last week’s market gyrations
Everybody’s first reaction to a period of falling markets is to pretend that nothing unusual is happening and not look at his/her portfolio. My experience is that “everybody” includes the majority of professional investors. There are, however, two measures we can take to strengthen our portfolios if we have the courage to analyse what has happened to our holdings during a volatile period like the past six trading days.
We can:
–gather information, and
–act to modify our portfolio structure.
gathering information
Professionals have performance attribution software, which will calculate performance vs. an index plus a holding’s contribution to overall outperformers/underperformance for any/all of their stocks/funds over any period. I do the stock by stock performance calculation by hand and then rank the outperformers/underperformers by their impact on the portfolio, rather than trying to figure out exact performance contribution. I find that’s good enough.
What I look for:
Aggressive stocks will typically outperform on up days and underperform on down days. Defensive stocks should do the opposite. Performing in line with their character is no news. But stocks that outperform on both up and down days are. So, too, are dogs that underperform no matter what the daily market direction. I think there’s inevitably a message that the market is sending through such stocks. It’s well worth trying to figure out what that must be.
Time permitting, we should also look at representative stocks not in our portfolios to figure out the same thing. (Professionals also have this comparative information, for all the stocks in the index they’re competing against, available at the push of a button.)
Note: results for ETFs may be problematic, since a computer failure at BNY Mellon, which prices many ETFs for others, made NAV quotes for many unavailable last week.
The S&P 500 was down by 2.3% over the past six days. Although this is a short time, arguably a defensive portfolio should have done better than this, an aggressive one worse. If I think I’ve built a defensive structure and my portfolio is down by 6%, I should probably rethink what I’m doing. If my “aggressive” portfolio is down by 1%, I should be thanking my lucky stars–but also trying to figure out whether this is due to excellent stock picking or to poor construction. If I’ve accidentally assembled a collection of stocks that acts contrary to what I intended, I’ve probably got to at least ponder how to change it.
Early last week I tossed one long-term clunker in my portfolio overboard and replaced it with what I consider a better stock. For trades like this, I also ask myself how that’s turned out so far. Admittedly, a week is a very short period of time. But this will give me an idea whether I have a good feel for current market action or not.
acting
I’ve often begun the process of analysis and reconstruction thinking that I should make my overall holdings either more aggressive or more defensive. Almost always, I end up making changes–but they’re virtually never the global ones I’ve intended. Instead of altering the direction of the ship, I find myself patching holes in the bottom of the boat instead. This usually improves the portfolio, and it prevents me from dong something crazy wrong during a period of stress.
My alterations tend to be one of two types:
–I trade out of stocks that are underperforming on both up and down days and into ones in the same general industry or thematic area that are performing in a healthier way, and
–I find that chronic clunkers become more visible to my eye in volatile times. (In my view, everyone’s portfolio has at least a few of these.) Because they’ve never gone up, they tend to have less downside than stars, whose owners have much more profit to take when they’re nervous. I find a time like this ideal to switch from the former to the latter. This ends up being most of what I do.
caveat
For me, the most difficult market transition to read in advance is the shift from a generally upward trend to a bear market, the garden variety of which can last for the better part of a year, and entail losses of, say, 20% in the S&P 500.
Typically, what induces a bear market is recession. I don’t think we’re in that market/economy situation today. If it were, patching leaks in the hull wouldn’t be enough. A change to a more defensive direction would be warranted.
a strange story involving the business cycle and being wrong
I once had a young colleague with lots of potential, whom I liked very much and who was an excellent securities analyst …but who had only limited stock market success despite loads of potential.
Ass an apprentice portfolio manager, this person came to me with the idea of building a significant position in a company that made carpets. The firm was well run, apparently had sustainable earnings growth momentum and was trading at a low price earnings multiple. In this instance, I didn’t do my job as a supervisor well, more or less rubber-stamped the idea and okayed the purchase.
Soon after that (this was 1993), the Fed began to raise interest rates. This is something I had been anticipating but–maybe because this wasn’t crucial to the structure of my own portfolio–was information I failed to bring to bear on the carpet company idea. Higher interest rates slow down both residential and commercial construction, something which is bad for, among other things, sales of carpets. Replacement demand slows down, too.
I went to my colleague, explained the situation–including the source of my mistake, and urged selling the stock. We did, with a modest loss. The issue ended up losing almost two-thirds of its value in subsequent months.
Now the weird part.
Eight years or so later, my colleague came into my office to rehash this trade–which I had long since forgotten. The point was not to suggest that we buy the stock again–which would have been a fabulous idea, since business cycle conditions were finally very favorable. Instead, it was to say that my colleague had in fact been 100% correct in recommending the stock all those years ago (apparently the stock has finally reached the point where its cumulative performance matched that of the S&P 500.
I didn’t know what to say. This was somewhat akin to my aunt Agnes explaining that she was switching from natural gas to oil because the gas burner in the basement was really a malevolent space alien.
Why am I recalling this strange story–much less writing about it–now?
Two reasons:
–we’re coming very close to another period of Fed-induced interest rate hikes. This is bad of early business cycle companies, including housing, commercial construction and related industries in the US, and
–it’s a life lesson about investing. My former colleague had extreme difficulty in recognizing an analysis was wrong or that a stock, for whatever reason, wasn’t working. But portfolio investors in the stock market are always acting on very imperfect information. And economic conditions, both overall and in inter-firm competition, are changing all the time. So having what one thinks is a better analysis than the other guy simply isn’t enough to ensure success. Recognizing when things aren’t going well, stepping back to regroup and seeking out possible sources of mistakes are all crucial, too. Denial may salve the ego, but it makes us poorer, not richer.
Keeping Score, July 2015
After an AWOL month, Keeping Score is back with an analysis of S&P 500 performance for July, as well as for the past 12 months.
Keeping Score, May 2015
I’ve just updated my Keeping Score page. May as a rebound month.