iBankCoin
18 years in Wall Street, left after finding out it was all horseshit. Founder/ Master and Commander: iBankCoin, finance news and commentary from the future.
Joined Nov 10, 2007
17,089 Blog Posts

Advisors GET IN HERE and BEHOLD a Better Way to Invest

Late at night I like to run investment models, discerning Sharpe ratios — trying to find the best model to use for my longer term investments. Many lazy ham and eggers will simply say ‘just buy the QQQ’ and forget about it. But the problem with the Nasdaq is in its weighting. About 7 stocks make up more than 40% of the whole index. Even though they’re all mega cap stars, I’d hardly call that a diversified approach to portfolio management, especially when considering that all of them are in the tech sector.

What we want to find are high quality returns, not just throwing crap at the wall, hoping HMNY will shoot to the moon. As an advisor, ZERO smart money will invest with you with that harebrained philosophy. It’s imperative that you learn excel and get your sharpe ratio game going strong, or find some other methods to communicate that your model is, in fact, quality.

Let’s examine what the market has done over the past year.

According to Exodus,  the median return for all stocks (3,997),was 11.5%. This is the true health of the entire market. But no one invests in all stocks, instead favoring a more rational approach through ETFs.

1yr returns

SPY: 19.8%
IWM (small cap): 14.9%
DIA (Dow 30): 25.5%
QQQ (Nasdaq): 32.2% 6mo: 12.5%, 3mo: 9%, 1mo: 3.45%

Again, while the QQQ returns are impressive, they are wrought with risk. All you have to do is go back in time and bear witness to what that God forsaken index did to investors in previous markets squalls. In the 30 months following the March 2000 top, the Nasdaq slid by 78%. I rest my case.

I’ve been experimenting with ways to chase alpha (high returns) while reducing my non-systematic risk. By non-systematic, I mean individual stock risk. I can do this by diversifying amongst sectors and different stocks.

Part of the problem with analyzing returns by market cap only is that you’ll grab the same top stocks that are outperforming in the Nasdaq. You’ll find yourself with a bunch of tech stocks, running hard in a car made of dynamite heading for the sun. Through countless hours of experimentation, I’ve found the perfect combination of fundamentals that produced the best returns, using qt rev, earnings growth, gross margins, free cash flow, price to sales and PE.

On a weekly basis, I reshuffle my personal portfolio using this approach. I call it Exodus Quant. The reason why I’ve been turning over so quickly is to find the model that works best. Since it’s my own money, turnover isn’t my prime concern. But for you, the navy suit wearing monkey in a necktie, you can’t go around switching client portfolios every week. I think a reasonable time frame to reevaluate is on a quarterly basis.

Here are the returns using my ‘perfect fundamental’ criteria across market caps.

Over 50b
1 mo: 2.78%
3 mo: 11.7%
6 mo: 21.3%
1 yr: 36.4%

10-50b
1mo: 0.57%
3mo: 7.71%
6mo: 12.97%
1 yr: 28.5%

5-10b
1 mo: 2.9%
3 mo: 11.1%
6 mo: 20.9%
1 yr: 45.6%

1-5b
1 mo: 1.57%
3 mo: 12.06%
6 mo: 22.09%
1 yr: 32.31%

Under 1b
1 mo: -2.24%
3 mo: 0.45%
6 mo: 0.22%
1 yr: 7.2%

I bet you didn’t expect the top returns to be found in the ambiguous $5-10b market cap quintile, did you? It’s worth noting, my strict criteria annihilated most micro caps, which is why the returns under $1b are so poor. If you stripped away my free cash flow criteria, 1 yr returns shot up to 17.6%.

Let me remind you, those returns are the entire basket, not a truly diversified approach across different sectors. There are 8 principle sectors: Basic Materials, Consumer Goods, Financials, Healthcare, Industrial Goods, Services, Technology and Utilities. My approach is to buy 2 of each, providing they fit the criteria. If, for example, I did a quarterly review and found that stocks in the $5-10b quintile was where I wanted to allocate assets, but zero utility stocks fit the criteria, I’d simply leave it out. Reason being: I am not going to sacrifice my core beliefs just for the sake of diversification. While it might increase the Sharpe ratio of my portfolio, it would most likely reduce the overall quality and returns. If you adhere to these basis principles, you would’ve avoided the oil and gas and retail rout over the past 2 years. Those sectors do not show up in my screens because their fundamentals aren’t good enough. While technical analysis can help find good investments over the short term, over the long term, fundamentals is the only thing that matters.

Let’s have a look at what a $5-10b portfolio would look like, using this approach.

1 yr median returns of 56.5%

Now the actual screen produced a lot more stocks — but I would only accept the top two of each sector — ranked by our Hybrid score (a combo of technical and fundamental factors).

Here are the returns for the above portfolio over different time frames.

1mo: 7.4%
3mo: 15.8%
6mo: 21.1%

Going forward, it would be important to analyze the quality of the returns on a quarterly basis, using said criteria, and adjusting the portfolio accordingly.

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36 comments

  1. metalleg

    Do you have a predetermined sell price for VUZI?

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    • Dr. Fly

      You’re such a degenerate. Here I hashed out a truly great investment philosophy and your only question is regarding one of my micro cap shit stocks.

      Unreal.

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      • dock581

        Fly. Do you reevaluate which market cap to use quarterly? Do you use any stops? If one sector has no picks ( I.e. utilities)do you leave that amount in cash or take larger positions in the other stocks? Thx

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        • Dr. Fly

          Market caps are now evaluated weekly for my quant strategy, which has thrashed the SPY in 16 of 23 weeks.

          For this, I would review quarterly and if a sector doesnt meet the 2 stock criteria, weighting will be evenly distributed elsewhere.

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      • metalleg

        While I don’t deny my degeneracy, sorry for asking.

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  2. masteroneass

    You want to get the 1-5 mc before they turn into 5-10. Also its well documented the reason for the dotcom bust was the clinton tax breaks. capital gains and dividend tax were decoupled and a bunch of crap entered the market. now you have a group of 4 mostly deregated monopolies running the entire index. same thing goes for crypto and icos unregulated crap. icos are fuel to the fire for that bubble. and yes it is a bubble duh. if you have a model which is well defined and structured ie canslim you an definitely bag some winners and diversify your loser risk. it can be any model just as long as you follow it for everything. takes the pressure off second guessing yourself. why do traders lose money?

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  3. sarcrilege

    That sounds like a great gambling strategy, not investing strategy, a gambling strategy that disregards owners of the casino. It would be great to get into the minds of the crooks that run the casino and break the “bank”, so to speak.

    The second point is this: If we are going to discuss investing, we cannot ignore commodities and money (sound money). What in this article applies to BTC applies to silver/gold, something that is grossly under-priced today, as well:

    The second scenario precisely describes the state of the “gold” market today. According to the Reserve Bank of India’s estimate, the ratio of “paper gold” trading to physical gold trading is 92:1, meaning that the price of gold on the screens has almost nothing to do with the buying and selling of physical gold. This makes the gold market and, therefore, the gold price something of a mockery.

    https://tinyurl.com/y7sxjumt

    Why gold is being ignored on this site is beyond me. On the other hand, just as well. More left for me at great price.

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    • moosh

      Makes you wonder how much phyzz China and India actually have, even on the citizen side?

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      • sarcrilege

        Russia, iran, turkey, saudi and no doubt north korea. I would venture as far as saying that NK will have a shitload of gold. Why? Because their central bank is not controlled by hofjuden. And that’s one of the main reasons why NK is targeted lately. Not their funny ICBM. Same with Iran.. no hofjuden bank; thus, tons of gold the synagogue usurers do not control.

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        • Dranged

          Sarc, can you recommend where/how to purchase phyzz?

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          • ferd

            ….and where precisely is the best place you your yard to hide it? I’m thinking of investing in a shovel.

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          • sarcrilege

            There’s no universal “fits all” recommendation. It depends on your objectives, means and conviction this is the right thing for you. However, you simply cannot go wrong by visiting small, private coinshops/dealers and making small, frequent, under the radar, inconspicuous, unreported cash only purchases of bullion coins (krugs, maples, eagles, etc.) – recognizable and easily tradeable and/or sold w/o assaying. Make a list of shops/dealers b4 you go on business trips, vacations, friends/family visits, etc. and keep stacking. And be prepared to hang on to it for a long time and sell only if you must. At the end, this will be the only money you will have that cannot be impaired and you control 100%. At the very least, historically speaking, gold holds its value and its value is not debatable.

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    • tonka

      As someone that wants to earn a positive real return I have to ignore commodities that long term have a real return of around 0%. Putting money in commodities means I have to stretch for yield elsewhere to make up what non productive assets are unable to provide.

      I guess you could argue for tactical allocations and trend following strategies in commodities. But anything else would be illogical.

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      • sarcrilege

        To ignore blatantly downwards manipulated and patently mispriced assets (au/ag) appears to be incomprehensible. To stretch for “yield” in rigged markets is like picking up fake pennies in front of the FED steamroller.

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        • tonka

          But if the long term real return is 0%, are you saying they have been manipulated…forever?

          So we’re waiting for some kind of repricing that has never happened?

          I’d rather invest in businesses that take commodities and turn them into something more expensive and useful.

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          • sarcrilege

            Yes, phyzz is a huge bet on repricing when the riggers ‘pull it’. When? Next week, next month, next…. However, the bond market will come unglued and implode under its own weight of uncontrolled and exponential debt regardless. It’s overdue for that. The market will follow. Straight down the elevator shaft.

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          • tonka

            But if every past crisis hasn’t resulted in this said repricing, why would this time be different?

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          • sarcrilege

            I dont have an answer for that. It’s a bet. But it’s not a losing bet. Phyzz will always be worth something. We all cannot be on the same side of the boat. I despise communism. Centrally controlled economy and politics is communism. And that’s what we have. FED is a central controller. And their Achilles heel is ppl taking delivery of phyzz. That’s what the chineez, russians, iranians, etc. are doing. I am with them. Helping them fight the FED.

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  4. tonka

    If I could short one industry itd be the advisory business. Can’t tell you how many times I’ve been pitched generic mutual funds that are running strategies that would’ve been locked away charging 2 and 20 less than 10 years ago. Even had one that was scraping the internet to calculate daily CPI…all for a $500 minimum.

    What can an advisor provide other than maybe talking people off the ledge of doing really stupid things?

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    • Dr. Fly

      You’d be surprised. Many people simply do not have the time to do it themselves. While the trend to self direct is there, families of wealth will always hire professional to oversee their fortune.

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  5. fxtradepro

    Sarcrelige is secretly William Devane

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    • metalleg

      Sarc is right. It’ll be the bond market and the US dollar. That’s why it will be different next time. In the past, they would lower interest rates, inflate, etc.

      The debt wasn’t Walmart is now is and interest rates could be lowered. I believe they only raised rates a tad in order to have somewhere to go when the market crashes the next time.

      But the root of the problem is the US dollar and when that goes, its game over.

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      • tonka

        lots more the fed can do. You’d have to imagine they’d try everything other Central banks have done already. Negative rates and changing their mandate to buy corporates and stocks.

        Personally I think they’ll start pinning the curve. I’m surprised they don’t already. Instead of buying 30 year treasuries to try and lower rates they could have just pinned it to whatever they want…like 0%…or -5%.

        Hard to bet against an unlimited balance sheet that hasn’t exhausted it’s options

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  6. lapens

    I can but dream that one day Monsieur Le Fly will provide this level of analysis in the crypto space. Still, I love reading these posts.

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  7. ironbird

    If that disgusting freak Kathy Griffith does not get some action in these hallowed halls. Something is wrong. Bald anorexic and toxic. And from the North. Gotta be fair. That thing is Gold.

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  8. joseph25

    Very impressive. Thanks.

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  9. the dude

    I like the quarterly timing. Did you backtest for the great recession bear market? Many methodologies can beat the S&P during bull markets but also sadly underperform during bears. Are bonds part of the approach like now with the weekly?

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    • numbersgame

      That’s the real key to any investment strategy: robustness.

      ” But the problem with the Nasdaq is in its weighting. About 7 stocks make up more than 40% of the whole index.”

      The problem isn’t just the market cap weighting. A related but bigger problem is that stocks with higher PEs actually end up with higher weighting: dollar-cost averaging and portfolio-rebalancing in reverse. These same high flyers drop the farthest during downturns.

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  10. soupbone

    Safe Haven performance during crisis since 1950’s to now:
    Top two assets and return under crisis type…
    Financial Event: [email protected]%, 10 year [email protected]%
    Geopolitical Event: [email protected]%, [email protected]%
    Business Cycle: [email protected]%, 10 year [email protected]%
    (source BCA Research)

    Interesting that gold works for recessions but apart from that, holding has not been much of an idea. Some nice real estate in the country would be better.

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  11. badduck

    Any mildly sophisticated and long term strategy should involve shorting as well. No need to just get stopped out when fundies and trends reverse. Ride them both ways.

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  12. one-eighty

    “About 7 stocks make up more than 40% of the whole index.”

    They are real and they are making spectacular profits.

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  13. bushwacker2

    Wow! You outlined a very sound and robust MM process! How did I miss this? Granted, it was a weekend post and I’m usually doing other things such as little bing off the grid and hunting wild meat this time of the year. Save one of these next time for a business day!

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