Long duration Investing

[burrow]

In Warren Buffet's recent Shareholder Letter, it seemed that no other theme was more prevalent than using long durations to get your success. Buffet looks for investments which have strong long-duration possibilities. This keeps frictional costs low and capital gains taxes minimal. The net-present-value of a 100-year earnings stream is mathematically higher than a 50-year stream, especially in an era of low discount rates. (paraphrasing Bill Smead - http://smeadcap.com/smead-strategies/smead-blog/entries/2014/03/03)

Samuel Lee (morningstar.com) comments "Both Buffett and Munger declare that their favourite holding period is forever. This seems to contradict the fact that at a high enough price, even the most wonderful business in the world will produce less-than-wonderful returns. No doubt part of their hesitance to sell wonderful businesses at any price reflects a philosophical aversion to “gin rummy” investing. I think, though, the main reason they hold on is because they truly believe wonderful businesses are persistently undervalued by the market, even when common valuation metrics suggest otherwise".

"The goal of the long-term investor is to come up with better estimates of intrinsic value than the market and buy stocks trading for below intrinsic value and sell stocks trading above it.

However, if you plug in reasonable-seeming numbers, you quickly discover that the majority of an investment’s present value is often embodied in the cash flows many years out. After inflation, the U.S. stock market has returned about 7% and grown per-share earnings by 2% over the past century. Apply a 7% discount rate to an earnings stream growing by 2% per annum in perpetuity, and you’ll find that the earnings beyond the first five years account for almost 80% of intrinsic value. Earnings beyond 10 years account for more than 60%".


The question is, which ASX listed companies can be considered in this long duration theme? Which companies will not only still be around, but earning appreciably higher profits and paying appreciably higher dividends 5, 10 and 20 years from now? Companies that seem overvalued according to traditional metrics and but deserve their 'lofty' pricing.

 

[systematic]

The question is, which ASX listed companies can be considered in this long duration theme? Which companies will not only still be around, but earning appreciably higher profits and paying appreciably higher dividends 5, 10 and 20 years from now? Companies that seem overvalued according to traditional metrics and but deserve their 'lofty' pricing.

Though familiar with the underlying philosophy, this is exactly why I won't invest this way (and I'm 50% value investor!).
I just don't believe that I am that good.

 

[DeepState]

Buffett learned from Benjamin Graham too...

For ASX listed ideas in the Buffett tradition, refer: http://www.cooperinvestors.com/index.html

Disclaimer:

This is not advice: I do not know your situation. I do not endorse Cooper Investors or take responsibility for material at this site.

 

[robusta]

Though familiar with the underlying philosophy, this is exactly why I won't invest this way (and I'm 50% value investor!).
I just don't believe that I am that good.

Ok maybe I have rose colored glasses on but it's not that hard. So a watch list that should be around in 10-20 years and earning more...

CBA, ANZ, WBC, NAB, BHP, WES, WOW, whatever QR Rail are calling themselves now, CCL, SEK, TGA, REA, CSL, SOL, AFI, ARG and a few other LIC's, most of the utilities, IMF, CRZ, CCP.... there is sure to be more I have missed. Now the only trick should be to pay a reasonable price, diversify (a little bit) and hold on.

 

[Smurf1976]

Diversification. If you bought both WOW and WES then whilst it's possible that one might struggle at some point, it's highly unlikely that both of them will given that combined they dominate an entire industry. And to the extent that one suffers, the other is the likely winner of any lost profits anyway.

Same with the banks. If you bought CBA, ANZ, WBC and NAB then even if one has a problem, it's unlikely that banks as a whole are going to disappear.

The same logic applies in any other industry where the industry itself is reasonably "safe", has only a few major players and has high barriers to entry on a large scale. The only real exception that comes to mind is anything hugely cyclical (eg construction) or airlines. In the specific case of airlines, both of the major players are losing money and the industry is exposed to multiple major risks (fuel prices, underlying economy affecting demand for travel, a plane crash in Australia would put many people off flying, airports have a virtual monopoly and charge for their services etc).

The key is buying at a good price.

 

[DeepState]

Now the only trick should be to pay a reasonable price, diversify (a little bit) and hold on.

Paying a reasonable price prospectively (as opposed to retrospectively) and having the ability to hold on when the market says your thesis about earnings stability/growth is caving in, are about the hardest things to do in investing. When DCF valuations swing 30% on the most reasonable of moves in discount rates, margins or growth assumptions - what is the right price? If you discount a 50 year indexed linked bond and changed the real rate of return assumption by just 1%, what do you get? And that's a bond.

Clearly, stats indicate that the general population times markets very poorly [Morningstar, Vanguard]. The ability to tolerate extreme pain and step in against the tide is very rare indeed. Has your thesis been destroyed? Is it a buying opportunity? These are probability statements and terribly hard to discern between, especially when you've toasted 30% on a stock. Most people, perhaps not you, don't act rationally in such circumstances.

If you do have the skill to examine stock via DCF methods (most applicable to those firms with the kinds of characteristics you have mentioned) and have the bandwidth, possibly the best way to profit from it is to build a diversified portfolio so that you get a better chance for your skill to show through. This makes it easier to act rationally if only smaller slices of your portfolio are rotating through the fear/greed extremes. You only need to be right on average to do well. So if you have skill -if- then having a number of positions makes the ride smoother. Of course, how do you know if you have skill? It usually takes years and years before you can make any statement at all which is statistically valid. Or you can do what 90% of investors do - believe they are all above average and march on out.

Not easy. But if it were, it wouldn't be interesting would it?

 

[Smurf1976]

If you need a new washing machine and someone is selling the model you want at a 50% discount to the normal price and there's nothing wrong with it (it's not damaged stock etc) then logically you should go ahead and buy the machine now, rather than waiting for the price to go back up.

Long term investing is much the same. If you want to buy stock in xyz and a broad market decline sees it fall 50% in price well then that can be a huge opportunity. It's still the same company, you're just able to by shares in it at a cheaper price than you could previously.

The key there is investing in companies that will still be around after the chaos with a sound, profitable business and not go broke in the meantime. That plus you being able to wait it out too and not getting caught up in the "sell everything now" hype.

 

[DeepState]

Washing machines.... Buffett used hamburgers and the manic Mr Market. To each their own.

So this is 'that simple'? Let's Do The Math. I'm having fun here....please don't regard this as an affront, I agree with the thrust of what you are saying. I just think you understate the difficulty of actually doing it.

The Macaulay duration of a perpetuity bond of fixed coupon with 10% yield is around, say, 14 years. This pays a fixed coupon, guaranteed by the Grand Master of the Universe himself. No need to worry about franchise strength. This drastically understates sensitivity to assumption changes for a stock which grows it's earnings, by the way. Drastically.

If your yield assumptions change by 3%, your valuation changes 50% (Approx, not allowing for convexity -- yeah yeah). Can you forecast what the right yield should be? What is 'normal' or are we in a 'new normal'. Do you know? Even the central banks don't if you've seen yield curves evolve. For a growth perpetuity guaranteed by the Grandmaster himself, depending on the rate of growth, a 3% change in yield alone would have impacts well above 50%. Maybe closer to 80% or so. Hence, if a stock falls 50%...does that make it cheap?

Berkshire Hathaway hired Todd Combes from Castle Point Capital with a view of making him the next CIO of BRK-US. The doyen of long-term investing. Take a look at the turnover in his portfolio prior to departure and you will find material turnover (Market Folly 26 Oct 2010).

Why does a long-term investor turn over their portfolios such that it is essentially churned over 5-10 years? And this guy is hand chosen....

Assume we are back in la-la bond land and these bonds deliver an expected return of 10%. The rest of the market, death bonds - because their survival is not guaranteed, also miraculously trade at 10% yield to maturity (clearly they should trade higher, but I'm loading this up in your favour). To be a long-term investor, you clearly perceive a benefit. Warren Buffett has delivered 10% over the market forever. Let's say you are modest and aim for 5%pa. If this 5% evenly amortises itself over 50 years ('Long term'), the yield needs to be 15%. In other words, from the above, you need massive mispricing on buy-hold to get this outcome. Massive.

In the event you do see this massive mispricing, which may occur during a major market dislocation, how sure can you be that your analysis is right vs the general consensus of the market vs the alternative hypothesis of self-delusion? Of course, you are above average and have a line to the Grand Master...but he's only guaranteeing bonds with fixed coupon. He has disclaimers all over the place on franchise strength, margins, quality of management, capex/depreciation ratios...Each of which would wobble your assumptions by 0.5-1% in a HeartBleed.

You write as if this were easy. The outline above is an attempt to highlight that the zone of uncertainty is wider, seemingly much wider than generally imagined. If this were easy, why is Buffett worth approx $50bn in a world were scarcity of precious resources is valued.

 

[McLovin]

Diversification. If you bought both WOW and WES then whilst it's possible that one might struggle at some point, it's highly unlikely that both of them will given that combined they dominate an entire industry. And to the extent that one suffers, the other is the likely winner of any lost profits anyway.

Same with the banks. If you bought CBA, ANZ, WBC and NAB then even if one has a problem, it's unlikely that banks as a whole are going to disappear.

If the goal is just to spread across industries and across the market then why not just buy the index? Cheaper and less hassle than trying to rebalance your portfolio. Look at the comparative returns of CBA v NAB going back over the last 15 years. In that time NAB has fallen from the largest bank to the 3rd largest. This has happened despite the cosy oligopoly of Australian banks. Why would you want to put extra money into NAB as deteriorated just because you wanted to be diversified? It just seems very counterintuitive and lazy.

*When I say you, I mean one, not yourself specifically.

 

[systematic]

Samuel Lee (morningstar.com) comments "Both Buffett and Munger declare that their favourite holding period is forever.

...It might be their favourite, but it's not necessarily what they do.

A study on berkshire public stock filings showed that a surprising 30% of purchases were sold within 6 months. Half the purchases were held between 6 months and 2 years. Only 20% of purchases were held longer than 2 years.

 

[DeepState]

If the goal is just to spread across industries and across the market then why not just buy the index? Cheaper and less hassle than trying to rebalance your portfolio. Look at the comparative returns of CBA v NAB going back over the last 15 years. In that time NAB has fallen from the largest bank to the 3rd largest. This has happened despite the cosy oligopoly of Australian banks. Why would you want to put extra money into NAB as deteriorated just because you wanted to be diversified? It just seems very counterintuitive and lazy.

*When I say you, I mean one, not yourself specifically.

Hey McLovin....

An index may contain 200 names [per S&P/ASX 200] etc. That doesn't make it diversified. Genuine diversity arises when the things which can impact a portfolio are highly varied in nature, none of which is likely to be overwhelming. This would happen if there wasn't an aggregation of so-called common factors. eg. No substantive industry concentration, no hyper sensitivity to macro factors (eg. if the index is highly sensitive to changes in interest rates due to hyper leverage by the largest cap stocks) and so on. The composition of the index matters a great deal. The ASX is stupendously concentrated into financials and resources and is one of the narrower markets around. Further, it is heavily concentrated into a few names with maybe 60% of the capitalisation in just 20 names. That's not really very diversified. The top 50 names account for around 80%.

As to rotation between names, the markets display excess volatility. That is, they move around more than the underlying fundamentals say they they should. This means there is an opportunity to buy low and sell high. It turns out that if you rebalance to fixed or other non-price related weights on a regular basis, you beat the market with reasonable likelihood. This is for largely the same reason why chimps and blondes from the Playboy mansion throwing darts beat the market. If you want some examples, then Arnott, R; 2013; "The Surprising Alpha from Malkiel's Monkey and Upside Down Strategies", accessible at SSRN will give you the down and dirty. This concept is known as rebalancing, volatility harvesting or volatility pumping.

Is it worth the hassle? That's up to you to decide. You might enjoy trashing police cars and drinking beer more than rebalancing portfolios. Who could blame you? Some processes which employ this kind of idea are very hyperactive. Some rebalance only annually. The idea basically works and it's a question of how hard you want to work it.

Fogell


Disclaimer: This is not advice. Regard this as an alternative script line for a teenage house party movie. Do your own work.

 

[Smurf1976]

If the goal is just to spread across industries and across the market then why not just buy the index? Cheaper and less hassle than trying to rebalance your portfolio.

...

Why would you want to put extra money into NAB as deteriorated just because you wanted to be diversified? It just seems very counterintuitive and lazy.

I wouldn't have put extra money in - suffice to say I'm not a believer in rebalancing simply because if you do the math, and rebalance often enough, then you could in theory lose most of your wealth due to a single company going broke.

My underlying point is better described with this example. After the last major downturn (2008), you waited for the dust to settle and then invested in major banks. That's the limit of your research - you made no effort to decide which bank to invest in, just that you'd stick to the major Australian banks.

On 20th April 2009 you bought shares in ANZ, CBA, NAB and WBC at the open. You invested as close to a maximum of $5000 into each as practical, paying $30 brokerage as well. So a total investment target of $20,120.00

ANZ - 297 shares bought at $16.81 each. Total cost $5022.57 including brokerage.

CBA - 133 shares bought at $37.50 each. Total cost $5017.50 including brokerage.

NAB - 224 shares bought at $22.30 each. Total cost $5025.20 including brokerage.

WBC - 275 shares bought at $18.15 each. Total cost $5021.25 including brokerage.

Total investment (including brokerage) = $20,086.52

Note that I have not picked the bottom here, not by any means. I've just picked a date when a reasonable person might have decided to buy, and used the opening price for each of these stocks on that day. Likewise there are brokers who charge less than $30, but it's a reasonable ballpark figure.

Almost 5 years later and you still have your bank shares. So how does this long term investment into banks look today?

ANZ - Your shares now have a market value of $10,053.45 and have thus far paid $2010.69 in fully franked dividends. The present yield is 9.8% on your original investment.

CBA - Your shares are now worth $10,288.88 and have thus far paid $2135.98 in fully franked dividends. The present yield is 10.2% on your original investment.

NAB - Your shares are now worth $7,913.92 and have thus far paid $1881.60 in fully franked dividends. The present yield is 8.5% on your original investment.

WBC - Your shares are now worth $9,531.50 and have thus far paid $2120.25 in fully franked dividends. The present yield is 10.7% on your original investment.

Totals: Market value of your $20,086.52 investment 5 years ago is now $37,787.75. Dividends to date total $8148.52 fully franked.

Whilst NAB has been the worst performing of the big banks, even if it had gone to zero then you'd still have made a profit in the above example. That is even more when you consider that if NAB actually did go bust, well then the other 3 would end up taking the vast majority of NAB's former business thus increasing their own profits.

 

[McLovin]

I wouldn't have put extra money in - suffice to say I'm not a believer in rebalancing simply because if you do the math, and rebalance often enough, then you could in theory lose most of your wealth due to a single company going broke.

My underlying point is better described with this example. After the last major downturn (2008), you waited for the dust to settle and then invested in major banks. That's the limit of your research - you made no effort to decide which bank to invest in, just that you'd stick to the major Australian banks.

On 20th April 2009 you bought shares in ANZ, CBA, NAB and WBC at the open. You invested as close to a maximum of $5000 into each as practical, paying $30 brokerage as well. So a total investment target of $20,120.00

ANZ - 297 shares bought at $16.81 each. Total cost $5022.57 including brokerage.

CBA - 133 shares bought at $37.50 each. Total cost $5017.50 including brokerage.

NAB - 224 shares bought at $22.30 each. Total cost $5025.20 including brokerage.

WBC - 275 shares bought at $18.15 each. Total cost $5021.25 including brokerage.

Total investment (including brokerage) = $20,086.52

Note that I have not picked the bottom here, not by any means. I've just picked a date when a reasonable person might have decided to buy, and used the opening price for each of these stocks on that day. Likewise there are brokers who charge less than $30, but it's a reasonable ballpark figure.

Almost 5 years later and you still have your bank shares. So how does this long term investment into banks look today?

ANZ - Your shares now have a market value of $10,053.45 and have thus far paid $2010.69 in fully franked dividends. The present yield is 9.8% on your original investment.

CBA - Your shares are now worth $10,288.88 and have thus far paid $2135.98 in fully franked dividends. The present yield is 10.2% on your original investment.

NAB - Your shares are now worth $7,913.92 and have thus far paid $1881.60 in fully franked dividends. The present yield is 8.5% on your original investment.

WBC - Your shares are now worth $9,531.50 and have thus far paid $2120.25 in fully franked dividends. The present yield is 10.7% on your original investment.

Totals: Market value of your $20,086.52 investment 5 years ago is now $37,787.75. Dividends to date total $8148.52 fully franked.

Whilst NAB has been the worst performing of the big banks, even if it had gone to zero then you'd still have made a profit in the above example. That is even more when you consider that if NAB actually did go bust, well then the other 3 would end up taking the vast majority of NAB's former business thus increasing their own profits.

Thanks for the reply, smurf.

I guess my point was that if you do that across the market then you'll just end up owning the index (which is what I thought you were trying to do) in a much more expensive way than buying an index ETF. Maybe I misunderstood your original point which it seems was to find an undervalued sector and then approach the investment on a macro level (which could again be accomplished through a sector index ETF). That has merit, although I do think you can generate more alpha by digging a little deeper into companies.

 

[DeepState]

I wouldn't have put extra money in - suffice to say I'm not a believer in rebalancing simply because if you do the math, and rebalance often enough, then you could in theory lose most of your wealth due to a single company going broke.

Hi Smurf1976

Actually, your maths needs a bit of work. So let's do some more.

If you hold 200 stocks and rebalance frequently to make them equal or any reasonable weighting scheme, then the bankruptcy of one doesn't lead to the loss of most of your wealth. It leads to a loss of maybe 0.5%. To lose your entire wealth requires all 200 to bankrupt. If you judge the chances of bankruptcy for a listed company at maybe 25% per decade, the chances of toasting your wealth in that period (assuming you never actually replenish your universe) is a number so small that Excel barely handles it. In case you are wondering, the chances of a 30-stock portfolio suffering the same fate has about 18 zeros behind the decimal point.

Alternatively, you could, as you have professed, never rebalance the portfolio. As time progresses the portfolio will asymptote towards the single stock which outperforms the rest. It will come to totally dominate the portfolio. If it were to go bankrupt, you would lose essentially your entire wealth. If the chances of bankruptcy are 25% in a decade, as assumed above for this illustration, the chances of toasting your wealth in that period are about 25%.

Which would you rather?

By the way, have you checked what would have happened to the wealth of your portfolio concept if you rebalanced it? I did some more math on your behalf. I essentially looked at the last five years worth of data for the major banks and ignored brokerage because it doesn't change the story. Cash dividends were reinvested on ex-date, franking was left out as it is not important for the illustration. I just did it Five Years to yesterday COB. So the numbers are different by a day or so from the ones you show.

Waddya know. A portfolio rebalanced amongst the most highly correlated set of stocks in the market each month by robot outperforms the un-rebalanced one by 0.2% per annum. Now, please don't get into brokerage. The turnover is tiny, these are hyper liquid securities which you can trade via siting on the limit order book. Frictions will not overcome the rebalancing profit shown here. Unless you are trading on a small pot, in which case - buy an ETF.

The Australian banks are almost homogeneous for the purposes of the rebalance concept. They move with exceptionally high correlation. This is about the worst case you could have in an equity context. It happened despite rebalancing into NAB which fell progressively over the period against the rest as they wasted more money on offshore adventures.

Yet, there is a rebalancing profit - clear as daylight. It is in the math and is essentially as strong a concept as a law of physics. So, in a way, saying you don't believe in it is like saying you don't believe in gravity. Rebalancing across more stocks, some of which are less correlated and possibly more volatile, greatly increases this figure. This is, however, a probabilistic statement which becomes more likely with the passage of time. In a narrow market like the Australian one, I imagine a bunch of you are CFD traders as well, the ability to short sell increases the ability to implement this concept.

Naturally, you may have a superior strategy to pursue or find the gains unworthy of your attention. But I wouldn't sneeze at 1-2% per annum excess profit for just taking the time to rebalance your portfolio. If you are actually born in 1976 (an assumption on my part, perhaps you were married or divorced at that date, had a child, football team won etc.) and retired at 60, or 22 years from now and presumably aim to live at least 20 years more....those extra gains are worth a heck of a lot.

It's just a thought.


Disclaimer: This is not advice. I'm not selling you anything. I don't know your personal financial circumstances. Do your own work..

 

[So_Cynical]

Rebalancing :dunno: who ever got rich rebalancing.

 

[Smurf1976]

A hypothetical but plausible scenario with re-balancing and the problem I see with it. Maybe I've missed something here, I'm just looking at the maths.

You invest $1000 each into 5 stocks, let's call them A, B, C, D and E.

Stocks A to D then rise at 1% per month and stock E declines at 10% per month. Whilst this is a simplification with only 5 stocks, rising 1% per month is plausible as is declining at 10% if the company is slowly going broke.

Now let's compare re-balancing each month versus the "do nothing" alternative (figures may not add due to rounding to the nearest cent).

After 12 months with "do nothing":
Stocks A - D = $1126.82 each
Stock E = $282.43
Total = $4789.73

After 12 moths with monthly re-balancing:
Stocks A - E = $865.13
Total = $4325.67

After 5 years with with "do nothing"
Stocks A - D = $1816.70 each
Stock E = $1.80
Total = $7268.58

After 5 years with monthly re-balancing:
Stocks A - E = $484.64 each
Total = $2423.18

I can see the logic in re-balancing, conditional on there being nothing in the portfolio that is trending downward. But if you just did a re-balance every month, six months or whatever then you could easily end up throwing huge amounts of money into something that ends up being worthless unless you've got some specific method to preclude that outcome.

It's like water tanks. If at the same level and connected together by pipes then they will naturally balance to the same level. That's all well and good, until one tank develops a leak and thus drains the whole lot via constant re-balancing. That's when you wish you'd isolated them.

 

[DeepState]

Rebalancing :dunno: who ever got rich rebalancing.

So_Cynical...you're clearly a smart guy/gal. I've enjoyed your posts.

I gotta say, the number of posts I'm putting up on this makes me seem evangelical on it. It's just one part of good investment practice and you may wish to consider doing it in the absence of an overriding edge. Therein lies the catch.

Apart from the fundies and hedge fund managers who run this stuff and do get rich, it is not a get rich method. It is a method to basically tilt the odds in your favour in a sub-zero sum game. If you let loose 1,000 investors and traders and let them go for 10 years or more, 80% or so will be underwater against this strategy for equivalent risk taken. There will be some, maybe you, who will slaughter it. Congrats.

But, if you (generic) actually are not overconfident in your abilities and understand what the odds are and can properly calibrate and understood the size of the edge required to usurp simple rebalancing, you'd be shocked. If you are, say, a B-grade investor then rebalancing is right for you. If you are an F-grade investor...just rebalance and you'll get a borderline A. Of course, it I not possible for everyone to rebalance so the strategy has limitations but the supply is rich.

Only the true A-graders will beat it. Naturally everyone thinks they are there. And this is one of the reasons the effect exists.

So_Cynical, this is not a method of getting rich. It's just a method to offer a high probability of being amongst the winners without being amongst the super-performers who might or might not actually have skill. It represents a good point of departure because it is so easily done and, yet, surprisingly difficult to beat.

 

[DeepState]

A hypothetical but plausible scenario with re-balancing and the problem I see with it. Maybe I've missed something here, I'm just looking at the maths.

You invest $1000 each into 5 stocks, let's call them A, B, C, D and E.

Stocks A to D then rise at 1% per month and stock E declines at 10% per month. Whilst this is a simplification with only 5 stocks, rising 1% per month is plausible as is declining at 10% if the company is slowly going broke.

Now let's compare re-balancing each month versus the "do nothing" alternative (figures may not add due to rounding to the nearest cent).

After 12 months with "do nothing":
Stocks A - D = $1126.82 each
Stock E = $282.43
Total = $4789.73

After 12 moths with monthly re-balancing:
Stocks A - E = $865.13
Total = $4325.67

After 5 years with with "do nothing"
Stocks A - D = $1816.70 each
Stock E = $1.80
Total = $7268.58

After 5 years with monthly re-balancing:
Stocks A - E = $484.64 each
Total = $2423.18

I can see the logic in re-balancing, conditional on there being nothing in the portfolio that is trending downward. But if you just did a re-balance every month, six months or whatever then you could easily end up throwing huge amounts of money into something that ends up being worthless unless you've got some specific method to preclude that outcome.

It's like water tanks. If at the same level and connected together by pipes then they will naturally balance to the same level. That's all well and good, until one tank develops a leak and thus drains the whole lot via constant re-balancing. That's when you wish you'd isolated them.

Did you just step out and get a Maths degree this evening? This is great. And you get it.

Under certain conditions, there will be scenarios where rebalancing does not work relative to not rebalancing. There has to be. This is not pure arbitrage. It is a form of statistical arbitrage....it works probablistically.

Your scenario is totally reasonable. It's the Achilles heel and you shot an arrow into it. That's great because you have clearly seen through it. So let's move it out of the napkin drawing into what might be implementable in real life.

This concept works best if: You have more stocks, less correlation between them and the stocks individually display greater volatility.

You wouldn't buy a portfolio of 5 stocks. Maybe 50? You'd make sure they were very well diversified across different industries, capitalisations and other characteristics that you thought mattered. And you'd churn away each whatever period seemed right to you.

Whilst there will be stocks that trend down towards zero, the vast bulk won't and the chances of the scenario you painted actually developing in a more diversified portfolio diminishes. It would occur, but the impact would be much milder. Meanwhile, the benefits of volatility harvesting (which is a name that better describes what is going on) are chipping away but with a much greater and more profitable field to work in.

One thing which we have not mentioned but is probably the biggest issue in your choice between non-rebalanced and volatility harvesting portfolios is a concept of trend/drift returns. The portfolios will clearly be different or you can't get differential performance. At the outset, it is generally assumed that all stock returns are expected to be equal in the period ahead. It may sound ridiculous, but it turns out to be very reasonable for the most part. Nonetheless, the actual realization of what the drift rate is for one portfolio vs another can differ even if the stocks were all drawn from a barrel where all contents were guaranteed to have equal drift rate expectations. This can buffer relative portfolio returns. Over short periods, this effect will dominate the volatility harvesting profits. 'Noise'. But over time, these effects wash out and the profits come to dominate. Hence, when I mention probabilistic stuff, that's why. The chances of volatility harvesting beating cap-weighted increases with time.

Smurf1976, I just reckon this idea is a good point of departure and a possible add-on. You could apply it by deciding what you are prepared to hold and then regularly rebalancing, as an example. I hope it has added to your armory of knowledge and finds a way to adding alpha to your portfolio even if obliquely.

 

[DeepState]

Statistics: 127 Closed Trades since July 07, Winning Trades: 103, Losing Trades: 24, Expectancy/$1 Risked: $0.58.

Hi So_Cynical, since you've put up your stats, I noticed them and was intruiged.

The Hit Rate you have achieved is as likely as 1:840 billion if these are linear bets. Tell that to your dinner guests and forum readers. Wow! Given that there are less than 8bn people alive today, if all were to trade linear instruments against each other including those who can't read or write let alone have a decent meal, not only must you be the best in the world, but best in over 100 such worlds. And...with such strong expectancy.

But rather than the cynical possibility that you are posting rubbish, the figures and frequency are consistent with Theta decay/Neg-Gamma/Vega selective trading on various underlying on tight stops but otherwise deep OOTM. Prob ETO, but you might be a whale with an appetite and happy to enter swaptions or write CDS or go hard at prop related action in exotic strategies. Let me not be so cynical for the moment and believe you are in this type of trade in one way or another. By the way, if these is even vaguely in the park, since you are receiving premium, what is your idea of a dollar at risk? It can't be face value.

Part of long duration investing for real is being able to survive the journey. Keynes said something on that.

Care to shed some worldly wisdom on:
- risk deployment in a portfolio, particularly downside protection under conditions of steep skews; and
- stepping in when fear dominates (in your case, I'm just guessing it's taking neg-vega/gamma when things look bad)?

From your prior posts, I get the sense you might know a thing or two. You've posted your results for all to see and be impressed by. If you are into that sort of thing as above, you have to be rock solid, or just mucking around with loose change. Or, I find myself doubting, betting big with no idea. So, I'm hoping to hear a little from you - if willing.

Cheers

 

[systematic]

Ok maybe I have rose colored glasses on but it's not that hard. So a watch list that should be around in 10-20 years and earning more...

CBA, ANZ, WBC, NAB, BHP, WES, WOW, whatever QR Rail are calling themselves now, CCL, SEK, TGA, REA, CSL, SOL, AFI, ARG and a few other LIC's, most of the utilities, IMF, CRZ, CCP.... there is sure to be more I have missed. Now the only trick should be to pay a reasonable price, diversify (a little bit) and hold on.

I missed your post, hence the late reply.

It might not be rose coloured glasses for you; but it would be for me.

Besides, the question wasn't just who would be around and earning more, but appreciably more. And also paying appreciably higher dividends. AND are currently deserving of a seemingly expensive price based on traditional metrics.

Regardless; a core tenet of my investing is that I am not that good (in the sense you describe above. That doesn't come from a low self-esteem, it comes from the belief that we generally have a bias to thinking we are something special when picking stocks (or horses, or sports teams) - and it's a potentially dangerous bias. So, I don't predict, forecast or estimate anything; and that goes for so-called "charts" or fundamentals (same thing to me, data is data - but that's another story). I think Brent Penfold (in one of his books) talks about being the best loser. I don't frame it that way. Maybe mine is more akin to trying to be the most humble investor(!) Or at least better at recognising my own behavioural biases more than the next investor.

Thankfully, as it turns out...you don't have to be *that* good. You can do pretty ordinary things instead, and outperform. Heck, you can invest in an index fund for that matter and outperform a heap of investors!

So, which of your list of 19 will (in 5,10 and 20 years from now) meet all 3 additional criteria?

I'd have no idea. But I don't need to.