Sunday, April 17, 2016

Benefits of the Model - Part 1

Since the beginning of 2016, we have been analyzing the performance of the Portfolio Enhancement Algorithm by applying it on a real-time, real-world investment portfolio with real-money to effectively evaluate the marketing beating, hedge fund-like ability of this model.

So far the model is up ~9%, while SP500 (including dividends) is up ~2%. In other words, model has generated Alpha of ~7% over a period of 3.5 months. Although we don't exactly know how thing will pan out in the future because past performance doesn't guarantee future returns, model's performance in an extremely volatile market is very impressive.

Alongside the impressive performance, there are several other feature that make this model very attractive for long-term/short-term retirement and/or aggressive growth investors. These range from peace of mind in times of market volatility to quantitative proof that model will perform better in the long-terms based on model performance metrics like Beta, Sharpe Ratio, Alpha and others.

In the next few posts, we will evaluate the Q1 performance of the model in light of its intangible benefits, which at times are more important than model's absolute performance.

1. Peace of Mind: 
First 1.5 months of 2016 were not only volatile but were one of the worst starts of the year in history of some of the indices. Many investors exited the market in panic, while some stayed but had to deal with extreme volatility. Others who had the money, they bought puts on their long holdings like Mike Cuban. Mark's story was published on Feb 6, while market bottomed on Feb 11th. In other words, if his puts were up to 2 months out, they would have expired worthless by now.

Peace of Mind was realized by the fact that the model based portfolio was positioned in such a way that the Beta was -0.56 during the first 3 months. This ensured that the portfolio was not only not correlated with the market, it was positioned to take advantage of market decline. At the same time, it was not very aggressively negative because it was not concentrated in one asset class. Instead, it was diversified and therefore, it was only half as volatile as the market during this time frame.

Following chart shows portfolio performance since January 1, 2016 till April 13, 2016.

As one can see, the portfolio performed extremely well in January/February till February 11th, when it was beating the market by almost ~20%. However, as the market rallied, the portfolio maintained a substantial gap with the market. In other words, 2 months of sharp market rally wasn't able to fill the gap with the portfolio. 

It is to be noted that if one had purchased an inverse market fund or leveraged market fund, they would have been negative by now. Or if they had gone with options approach and had not exercised their options, these options would have expired worthless. Or if they had shorted the SP500 futures, they would have received margin calls. 

Secondly, the model ensured that excessive trading was avoided, which reduced the stress level for investors during the volatile period. 

In the next few blog posts, we will continue to evaluate the intangible benefits of the model including:
  • Less Stress during Market Volatility & Eliminating Emotions
  • Trend/Momentum following ability
  • Diversification
  • Buy and Hold features
  • positioning for next market move
  • Quantitative benefits:
    • Beta
    • Sharpe Ratio
    • Alpha

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