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Constructing An Underperforming Portfolio -- (Hard/Easy??)


JEast
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Nearly 99% of us on this board are attempting to find good/great and cheap companies to purchase that will assist in capital growth and (if we are a little lucky) exceed our selected index.  Admirable goal, but have you ever thought about how hard it is to underperform an index (invert like Jacobi)?  Not underperform for an individual stock, but for a constructed portfolio.

 

If you have a concentrated portfolio (say 25 or less), how hard is it to build a portfolio that will underperform your index by 4-5% on purpose?  I suspect the effort of constructing such a portfolio is much harder then one would naturally ruminate on.  It surely is not a random effort as the dart throwing monkey always seems to outperform on the upside versus the full time advisors. 

 

Maybe come the first week of January 2014, let us consider a contest to see who can perform the worst, on purpose!  Guidelines would be to construct a portfolio of at least 15 securities (no more than 25) and all equal weighted to keep it easy.  The comparative index would be the MSCI ACWI since this is a global board.  Start ruminating.

 

 

Cheers

JEast

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The market is efficient, so you can't underperform it consistently.

 

Fool's errand  :)

 

Hee, heee....

 

Jeast, James, You certainly have a perverse streak in your personality...  ;)

 

Thomson Reuters has under performed the market for 20 or so years. 

Thats one out of 25.  Of course, once you put it in a portfolio it will start to perform.

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Isn't this a short sellers goal.

No not at all.  A short seller normally cherry picks a few stocks or commodities and not an entire portfolio.  There is a reason that there are not a plethora of short sellers around because it is bloody hard, and getting harder.

 

From financial history, the worst looking stocks in a bear market usually perform fantastic when the bull starts to take the lead.  Conversely, some of the best looking stocks in a bull market turn at the first sign of a bear approaching. 

 

Maybe not publicly here, but try to construct a portfolio that does 10% worse than your current portfolio (difference of 5% alpha and 5% minus alpha).  I venture that over a 12 month period that on occasion your minus alpha portfolio performs better than your alpha portfolio just to spite you.  No data to prove a hunch, but the minus alpha portfolio is attempting to go "non-correlation" which is tough these days versus 20 years ago.

 

Cheers

JEast

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Really easy.

 

Go long (buy & hold) on all direxion 3X ETF's. You can go long on both bull 3x and Bear 3x, and lose money really fast. I admire the IQ of the guy who invented these products. How much trust would you have to place on the incompetency of the market participants? 

 

Take a look at FAZ, ERY...

 

Isn't this a short sellers goal.

No not at all.  A short seller normally cherry picks a few stocks or commodities and not an entire portfolio.  There is a reason that there are not a plethora of short sellers around because it is bloody hard, and getting harder.

 

From financial history, the worst looking stocks in a bear market usually perform fantastic when the bull starts to take the lead.  Conversely, some of the best looking stocks in a bull market turn at the first sign of a bear approaching. 

 

Maybe not publicly here, but try to construct a portfolio that does 10% worse than your current portfolio (difference of 5% alpha and 5% minus alpha).  I venture that over a 12 month period that on occasion your minus alpha portfolio performs better than your alpha portfolio just to spite you.  No data to prove a hunch, but the minus alpha portfolio is attempting to go "non-correlation" which is tough these days versus 20 years ago.

 

Cheers

JEast

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Really easy.

 

Go long (buy & hold) on all direxion 3X ETF's. You can go long on both bull 3x and Bear 3x, and lose money really fast. I admire the IQ of the guy who invented these products. How much trust would you have to place on the incompetency of the market participants? 

 

Take a look at FAZ, ERY...

 

Isn't this a short sellers goal.

No not at all.  A short seller normally cherry picks a few stocks or commodities and not an entire portfolio.  There is a reason that there are not a plethora of short sellers around because it is bloody hard, and getting harder.

 

From financial history, the worst looking stocks in a bear market usually perform fantastic when the bull starts to take the lead.  Conversely, some of the best looking stocks in a bull market turn at the first sign of a bear approaching. 

 

Maybe not publicly here, but try to construct a portfolio that does 10% worse than your current portfolio (difference of 5% alpha and 5% minus alpha).  I venture that over a 12 month period that on occasion your minus alpha portfolio performs better than your alpha portfolio just to spite you.  No data to prove a hunch, but the minus alpha portfolio is attempting to go "non-correlation" which is tough these days versus 20 years ago.

 

Cheers

JEast

 

 

Touché :)

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Really easy.

 

Go long (buy & hold) on all direxion 3X ETF's. You can go long on both bull 3x and Bear 3x, and lose money really fast. I admire the IQ of the guy who invented these products. How much trust would you have to place on the incompetency of the market participants? 

 

Take a look at FAZ, ERY...

 

If only it was that easy. I agree that this is probably a terrible strategy in the long run, but it can do pretty well in trending markets (and the other way around: you can get killed shorting both). Take the SSO (leveraged long S&P) and the SDS (leveraged short S&P) and put $10k in each anywhere the last 5 years; your short would be close to worthless but you can lose only $10k there and the other leg exploded in value. If you did this in 2009 you wouldn't do that bad ..

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You can short both the bear and the bull ETFs.  On top of that, you can rebalance daily.  So it won't matter if markets trend or have excess volatility because you rebalance.

 

This is actually a losing strategy because the ETFs have excessive transaction fees.  They are not structured to trade liquid products like S&P 500 futures.  They trade illiquid products instead.  There is probably some kickback going on (e.g. "soft dollars") because they are selling out their shareholders.

 

This is the reason why these ETFs are shorted and the borrow is in the mid single digits.

 

2- I agree with NormR that penny stocks lose an incredible amount of money, and that it's difficult to short them.  I've lost money shorting penny stocks (that have gone to zero) because I've been bought in on the borrow.  I only made very small trades just to see what the borrow is like... I never figured out how to make money shorting them.

 

Another way to lose money is to index the TSX Venture, index chinese reverse mergers, etc.

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Sure, it's pretty easy to construct a bad portfolio. You can just buy worthless shell companies like Speedsport Branding (SDSP), Stratus Media (SMDI), Insynergy (ISYG), Copytele (COPY), 22nd Century Group (XXII), Virtual Piggy (VPIG), etc.

 

Of course, the underperformance of the long portfolio doesn't guarantee the outperformance of the inverse short portfolio.

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Market returns are not exactly normal or symmetrical. A lot of the market's returns is often driven by a few stocks. How many mutual fund managers have felt the pain of not owning Apple when it ran all the way up to 700+? For every company like Apple, there are a lot of underperformers. If you pick a couple of random stocks in a risky sector, you will most likely underperform the market. But keep in mind, if you shorted Apple, you would have been killed many times over.

 

I remember a Buffett interview where mentioned that out of the 2000 auto companies before cars become popular, only 3 of them survived (Ford, GM, and Chrysler). So if you were to pick a couple of auto companies, you would mostly likely have underperformed the index greatly.

 

If you are actually trying to short such a portfolio though, you will have to deal with the cost of borrowing because such risky companies are often less liquid and hard to borrow. If the cost of borrowing were very cheap, you can rack up a lot of management fees shorting highly speculative stocks that typically underperform the index, but on that one time you choose the next Apple, you get killed.

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I remember a Buffett interview where mentioned that out of the 2000 auto companies before cars become popular, only 3 of them survived (Ford, GM, and Chrysler). So if you were to pick a couple of auto companies, you would mostly likely have underperformed the index greatly.

 

"The easier thing to do is figure out who loses. What you really should have done in 1905 when you saw what the auto industry was going to do is you should have gone short horses."

Warren Buffett

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  • 3 months later...

Since this thread was bumped I'll add;

 

It is incredibly easy to construct a portfolio of longs that would DRASTICALLY underperform, but it is not at all easy to do this with shorts. That is because there are loads of stocks that are any of the following:

 

1. Known (as in exposed, sometimes even by regulators) frauds/scams that are still trading.

2. Stocks about to go into bankruptcy, or stocks that more than likely will be bankrupt soon.

3. Trusts that are ending soon, and yet trade at crazy valuations because of the dividend yield (http://seekingalpha.com/article/1586222-sell-great-northern-iron-ore-shares-overpriced-and-dropping-fast)

 

These alone are all certainties. Meaning, if you hold for long enough you are certain to lose money. But they are impossible to borrow for shorting because, well, they are certainly going to lose money! Everyone is trying to borrow.

 

 

 

 

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