Friday, 8 August 2014

A Riddle Solved

I regularly check out the very slick dashboard on Stockopedia's home page. I've been a particular fan of the Guru Screens section. This includes a Guru index, which is a composite of all 60 or so long guru screens maintained by Stockopedia.

Over the past few months I have been increasingly puzzled by the droopy looking shape of the Guru composite index versus the FTSE 100 index. I've replicated the chart below to show you what I mean:

This shows the composite Guru index steadily pulling away from the FTSE 100, accelerating away during the second half of 2013 but then falling back over the last six months or so. In contrast,the FTSE 100 has been holding its ground pretty well during 2014.

Stockopedia handily group Guru screens by 'style performance' (e.g. Value, Growth, Momentum, Income etc.) so you can dive a bit more into the detail (although this is subscriber only service). Unfortunately, this doesn't really shed much light on proceedings. The FTSE 100 outperforms every one of these style indices over the past six months. In other words, whatever you investment style, you have probably lost money over the past six months. Unless of course your guru is a monkey with a pin and a list of FTSE 100 companies. In that case, you are probably slightly ahead.

This seemed to me to be a very strange state of affairs and so I decided to really put in some effort to work out what is going on. I spent a lot of time stratifying performance data and looking for patterns, After a number of false leads, I stumbled over something very interesting. It turns out I was looking in the wrong place. I should have been looking into the benchmark rather than performance factors of the guru screens. I will just cut to the chase and show you what happens when you overlay the FTSE 250 index over the composite Guru screens:

This clearly shows that the Guru composite index has been basically tracking the FTSE 250 over this period. Of course, a lot of FTSE 250 stocks appear in these Guru screens. I have done some rough calculations (rough as there isn't a straightforward way of screening out FTSE 250 stocks on Stockopedia) and I reckon about 30 per cent of all Guru screen appearances are FTSE 250 stocks. In contrast, less than 10 per cent of appearances are for FTSE 100 stocks. Even so, the strength of the correlation between the Guru index and the FTSE 250 seems remarkable.

What this shows is that if you really want to test whether a strategy is outperforming, you need an appropriate benchmark. Ideally you want a benchmark that broadly represents the investment universe your picking from so you can determine whether you can identify stocks that systematically outperform. The FTSE 100 Index isn't ideal in this case because it represents such a small part of the investment universe from where the Guru strategies are drawn.

There is the FTSE All share index, but that just seems to follow the FTSE 100 pretty closely, so I assume that the index is weighted by market cap. What you really want is an unweighted index of all FTSE and AIM stocks, but I am not sure if there is such a thing. If anyone knows something about these things please let me know!

This also throws up the obvious question as to whether these guru screens actually help in picking winning stocks. The evidence above suggests that using the monkey with a pin method on FTE250 stocks might work just as well.

I have said before that stock screening has its limitations because it is binary blunt instrument. Stocks are either in or out and there is no differentiation between a stock that clears a hurdle by a country mile and ones that just scrape in. The same principle applies for those that just miss out. I also have a pet theory that stock screening tools have become so widely available that perhaps they no longer give the average investor much of a edge.

These things aside, I am pleased to have solved this riddle. When I see different markets moving in certain ways, I am always trying to work out where the money in the system is going from and going to. The pattern over the last six months clearly points to a net move of capital from smaller to large caps.

Portfolio update:

The MB portfolio was down 1.3 per cent in July. This pretty much followed the major indices, with the FTSE 100 falling about 0.2 per cent and the FTSE 250 down 1.4 per cent. The was one change to the portfolio with Sweett (CSG) making me reach for on 8 July to be replaced by Castings (CGS). So that was CGS replacing CSG, which has a nice symmetery about it.

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