1. 11
CanCan You Beat the S&PBeat the S&P
500?500?
Prepared by
Gary Crosbie
A Two Stage Investment Analysis toA Two Stage Investment Analysis to
maximize the selection of anmaximize the selection of an
Optimum Investment Portfolio thatOptimum Investment Portfolio that
will beat the S&P 500.will beat the S&P 500.
NNov 2013ov 2013
2. 22
Table of ContentsTable of Contents
1.1. -Preface-Preface ……………………………………………………………… 33
2.2. - Analytic Methodology ……………- Analytic Methodology …………… 66
3.3. -Analytic Results-Analytic Results …………………………………… 2121
– Power Coefficient ResultsPower Coefficient Results
- Monte Carlo Simulations- Monte Carlo Simulations
44.. RecommendationsRecommendations …………………………………… 3131
- Proposition 1- Proposition 1
- Proposition 2- Proposition 2
3. 33
This Section Defines the Issues:This Section Defines the Issues:
Propositions of Interest:Propositions of Interest: Is there a methodology that allows theIs there a methodology that allows the
Investor to beat the S&P 500 ? There are two questions that areInvestor to beat the S&P 500 ? There are two questions that are
often asked in the investment community:often asked in the investment community:
– Proposition 1Proposition 1-- Given previous research completed in 2011, thatGiven previous research completed in 2011, that
Midcaps(vs large Caps and Small Caps) have the best value per unit ofMidcaps(vs large Caps and Small Caps) have the best value per unit of
risk , does the results from the periods following the financial crisisrisk , does the results from the periods following the financial crisis
(2007- 2012) continue to support those results.(2007- 2012) continue to support those results.
– Proposition 2Proposition 2-- IsIs there an alternative investment process (Mix ofthere an alternative investment process (Mix of
Mutual funds in Large Cap, Midcap , Small Cap and Fixed IncomeMutual funds in Large Cap, Midcap , Small Cap and Fixed Income
Styles) chosen by the highest Power Coef’s that provide better resultsStyles) chosen by the highest Power Coef’s that provide better results
than simply a Mutual fund that duplicates the S&P 500?than simply a Mutual fund that duplicates the S&P 500?
Section-1- Preface:Section-1- Preface:
4. 44
Section-1- Preface:Section-1- Preface:
The purpose of this section is to develop an algorithm thatThe purpose of this section is to develop an algorithm that
will enumerate the best investments within each stylewill enumerate the best investments within each style
category to maximize performance.category to maximize performance.
The model developed calculates a Power CoefficientThe model developed calculates a Power Coefficient
which represents the culmination of weighted customerwhich represents the culmination of weighted customer
preferences and investment based statistics to rankpreferences and investment based statistics to rank
investment alternatives .investment alternatives .
Those with the highest Coefficients represent theThose with the highest Coefficients represent the
Optimum investment alternatives given thoseOptimum investment alternatives given those
weighted preferences.weighted preferences.
5. 55
PrPr
If there are more than one investment
ranked in a particular style (e.g. Mid Caps)
than the allocation process could take one
of the following form:
– 100% allocated to the investment with the
highest power coefficient
– the % allocated to each investment should be
based on the % weighting of the power
coefficient
Section-1- Preface:Section-1- Preface:
6. Section 2-Section 2-
Analytical MethodologyAnalytical Methodology
This section will discuss The following:This section will discuss The following:
1- Process1- Process
Filtering InvestmentsFiltering Investments
2-Modeling2-Modeling
Power CoefficientPower Coefficient
3- Monte Carlo Simulations3- Monte Carlo Simulations
Proposition 1- Best StyleProposition 1- Best Style
Proposition 2-Diversified PortfolioProposition 2-Diversified Portfolio
7. 77
Two Stage Process:Two Stage Process:
Step One:Step One:
– Initially filter with Morningstar Fund/ETF screeningInitially filter with Morningstar Fund/ETF screening
process.process.
– Choose top 3-5 investments in each style..LargeChoose top 3-5 investments in each style..Large
Cap, Mid Cap, Small Cap, ..Value, Blend and GrowthCap, Mid Cap, Small Cap, ..Value, Blend and Growth
with the highest Power Coefficientswith the highest Power Coefficients
– Choose top 3-5 investments in Fixed income-Bonds.Choose top 3-5 investments in Fixed income-Bonds.
Step Two:Step Two:
– Use the Power Coefficient defined in the next sectionUse the Power Coefficient defined in the next section
to rank investments based on personal investorto rank investments based on personal investor
preferencespreferences
2-Analytic Methodology:2-Analytic Methodology:
Step 1 - ProcessStep 1 - Process
8. 88
Definition: The Power Coefficient:Definition: The Power Coefficient:
– A derivative of 10 variablesA derivative of 10 variables
– Define the short and long run viability of aDefine the short and long run viability of a
particular Fund or ETF.particular Fund or ETF.
– The variables are weighted based on individualThe variables are weighted based on individual
investor preferences to encapsulate :investor preferences to encapsulate :
Tolerance for riskTolerance for risk
Investment time horizonsInvestment time horizons
VolatilityVolatility
Rates of Return at different time horizons(1,3,5 yr)Rates of Return at different time horizons(1,3,5 yr)
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
9. 99
Model Algorithm:Model Algorithm:
– Generated from the following equation:Generated from the following equation:
– Equation:Equation: Power coefficient generated by thePower coefficient generated by the
following:following:
Power CoefPower Coef == a(1Gr)+b(3 Gr)+c(5 GRa(1Gr)+b(3 Gr)+c(5 GR) x) x αα
(d*(d*ЄЄ )+(e*)+(e* ββ)+)+ (F*(F*σσ))
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
10. 1010
– Where:Where:
a= Percentage weight for 1 year growth ratea= Percentage weight for 1 year growth rate
B= Percentage weight for 3 year growth rateB= Percentage weight for 3 year growth rate
c= Percentage weight for 5 year growth ratec= Percentage weight for 5 year growth rate
D= Percentage weight for Expense RatioD= Percentage weight for Expense Ratio
E= Percentage weight for BetaE= Percentage weight for Beta
F= Percentage weight for Standard deviationF= Percentage weight for Standard deviation
1GR= 1 year growth rate1GR= 1 year growth rate
3GR= 3 year growth rate3GR= 3 year growth rate
5GR= 5 year growth rate5GR= 5 year growth rate
Є= Expense ratioЄ= Expense ratio
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
11. 1111
ΒΒ= Beta for the investment indicating correlation= Beta for the investment indicating correlation
over time with the general marketover time with the general market
σσ = Standard Deviation= Standard Deviation
α= Measure of performance relative to index of
equivalent investments.
Power Coefficients generated for each fund should bePower Coefficients generated for each fund should be
used to rank funds in ascending order for each Style:used to rank funds in ascending order for each Style:
– Large Cap Picks:Large Cap Picks:
– Mid Cap Picks:Mid Cap Picks:
– Small Cap picks:Small Cap picks:
– Fixed Income Picks:Fixed Income Picks:
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
12. 1212
MethodologyMethodology::
The spread sheet to do the power coefficient calculations andThe spread sheet to do the power coefficient calculations and
Rank them in order is available by request.Rank them in order is available by request.
Otherwise you may want to look at the followingOtherwise you may want to look at the following “Quik Calc”“Quik Calc” method:method:
– Back of the “Match book Cover” Calculation of a power CoefBack of the “Match book Cover” Calculation of a power Coef
( if you don’t wish to have the spreadsheet)( if you don’t wish to have the spreadsheet)
1.1. Pick a desired list of potential investments in each of the StylePick a desired list of potential investments in each of the Style
categories discussed previously. (e.g. Morningstar)categories discussed previously. (e.g. Morningstar)
2.2. Look up the Net Asset value growth for 1 yr, 3yr and 5 yr fromLook up the Net Asset value growth for 1 yr, 3yr and 5 yr from
Morning Star for each investment in each style under consideration.Morning Star for each investment in each style under consideration.
3.3. Based on preferences weight the 1 yr , 3yr and 5 yr Grwth rate so theBased on preferences weight the 1 yr , 3yr and 5 yr Grwth rate so the
sum of the weights =1 Than do the following calculation;sum of the weights =1 Than do the following calculation;
4.4. (1yr wt)*(1 yr Grwth rate) + (3yr wt)*(3 yr Grwth rate) + (5yr wt)* (5 yr(1yr wt)*(1 yr Grwth rate) + (3yr wt)*(3 yr Grwth rate) + (5yr wt)* (5 yr
Grwth rate) =Weighted Avg Grwth RateGrwth rate) =Weighted Avg Grwth Rate
5.5. Now…do the same for the Vanguard index fund(VFINX)Now…do the same for the Vanguard index fund(VFINX)
Which is the S&P 500 proxy for comparison to the calculationsWhich is the S&P 500 proxy for comparison to the calculations
Made above for specific funds..Made above for specific funds..
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
13. 5. Look up the Standard Deviation (Morningstar) for each Investment.
6. Look up the Standard Deviation (Morningstar) for the Benchmark
Investment …. Vanguard index fund(VFINX
7. DIVIDE 4/5 for each Investment
8. DIVIDE 5/6 for the Benchmark- Vanguard Index Fund
9. The result of 4/5 will give you an estimate of the dollar per unit of
risk for each investment.
10. The result of 5/6 will give you an estimate of the dollar per unit of
risk for the Benchmark- Vanguard Index Fund 1313
• Methodology : (con)
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
14. 11. Subtract : 9-8 to get the difference. Rank highest to lowest11. Subtract : 9-8 to get the difference. Rank highest to lowest
differences for each style- LC, MC, SC , FIdifferences for each style- LC, MC, SC , FI
12. The preferred picks are the highest12. The preferred picks are the highest PositivePositive differencedifference
ranking in each styleranking in each style
13. If you like multiple picks per style, weight the picks as13. If you like multiple picks per style, weight the picks as
reflected on page 19reflected on page 19
14. If you use the above.. make certain you address the14. If you use the above.. make certain you address the
issues of :issues of :
- Expense CostsExpense Costs
- BetaBeta
- AlphaAlpha
15. On growth rates..15. On growth rates..choose investments with time testedchoose investments with time tested
(3 & 5 year) returns(3 & 5 year) returns . Results in this paper weighted 1yr 3 yr. Results in this paper weighted 1yr 3 yr
and 5 yr growth rates 30%, 40% 30% respectively.and 5 yr growth rates 30%, 40% 30% respectively.
1414
2-Analytic Methodology:2-Analytic Methodology:
Step 2 - ModelingStep 2 - Modeling
15. 1515
Power Coefficient Picks: (Using Model on Page 9)Power Coefficient Picks: (Using Model on Page 9)
– Large Cap:Large Cap:
1.1. *Sequoia- SEQUX-*Sequoia- SEQUX- (Highest power Coef(Highest power Coef))
2.2. YAFFXYAFFX
3.3. Wasatch - WGROXWasatch - WGROX
– Mid Cap:Mid Cap:
1.1. *Principal Midcap – PEMGX-*Principal Midcap – PEMGX-(Highest power Coef(Highest power Coef))
2.2. Rydex Midcap- RFGRydex Midcap- RFG
– Small Cap:Small Cap:
1.1. *Vulcan Value Partners- VVPSX-*Vulcan Value Partners- VVPSX-(Highest power Coef(Highest power Coef))
2.2. Brown Small Cap Mgt- BCSIXBrown Small Cap Mgt- BCSIX
– Fixed income- Bonds-Fixed income- Bonds-
1. *Metropolitan West Total Return – MWTRX-(Highest power Coef(Highest power Coef))
2. Aberdeen Global High Income - BJBHX
3. Metropolitan West High Yield- MWHYX
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – ModelingStep 2 – Modeling
16. Using the algorithm identified on page 9 the highestUsing the algorithm identified on page 9 the highest
coefficients in each style generated the following:coefficients in each style generated the following:
– Large Cap= 9.48= Sequoia Large Cap= SEQUXLarge Cap= 9.48= Sequoia Large Cap= SEQUX
– Mid Cap= 8.22= Principal Midcap=PEMGXMid Cap= 8.22= Principal Midcap=PEMGX
– Small Cap= 8.09=Vulcan Value Partners=VVPSXSmall Cap= 8.09=Vulcan Value Partners=VVPSX
Than weights are derived for each style based on the powerThan weights are derived for each style based on the power
coefficients: Thuscoefficients: Thus
– -Large Cap =Sequoia = SEQUX= weight = 35%-Large Cap =Sequoia = SEQUX= weight = 35%
– Mid Cap= Principal Mid CAP= PEMGX…….= 33%Mid Cap= Principal Mid CAP= PEMGX…….= 33%
– Small Cap= Vulcan Value Partners=VVPSX=32%Small Cap= Vulcan Value Partners=VVPSX=32%
These weights are used on page 19 to calculate theThese weights are used on page 19 to calculate the
Allocation of the base portfolio when comparing simulationAllocation of the base portfolio when comparing simulation
results with the S&P 500 .results with the S&P 500 . 1616
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – ModelingStep 2 – Modeling
17. 1717
Analytical ComparativesAnalytical Comparatives
– Proposition 1Proposition 1:: What is the best investment style compared toWhat is the best investment style compared to
the S&P 500.(LC, MC,SC)the S&P 500.(LC, MC,SC)
Generate a Power Coefficient for the S&P 500Generate a Power Coefficient for the S&P 500
Choose the fund with the highest Power Coefficients for eachChoose the fund with the highest Power Coefficients for each
style (Large Cap, Mid Cap and Small Cap) and compare tostyle (Large Cap, Mid Cap and Small Cap) and compare to
the S&P 500.the S&P 500.
Power Coefficient Analytic Comparatives:Power Coefficient Analytic Comparatives:
– Run Monte Carlo simulationsRun Monte Carlo simulations
– Use 1000 iterationsUse 1000 iterations
– Compare the results of the :Compare the results of the :
Power Coefficient Style (Large cap, Mid Cap etc)Power Coefficient Style (Large cap, Mid Cap etc)
Take the fund with the highest power Coef in each styleTake the fund with the highest power Coef in each style
vs. the Portfolio that mirrors the S&P 500vs. the Portfolio that mirrors the S&P 500
2-Analytic Methodology:2-Analytic Methodology:
Step 3 – Monte Carlo SimulationsStep 3 – Monte Carlo Simulations
18. 1818
Analytical Comparatives: Evaluation ProcessAnalytical Comparatives: Evaluation Process
– Proposition 2Proposition 2::
– Utilize Monte Carlo Simulation to develop a diversified portfolioUtilize Monte Carlo Simulation to develop a diversified portfolio
of Large Caps, Midcaps , Small Caps and Fixed Incomeof Large Caps, Midcaps , Small Caps and Fixed Income
investments with the highest Power Coefficients (seeinvestments with the highest Power Coefficients (see PropositionProposition
22 page 34) to maximize returns greater than the S&P 500.page 34) to maximize returns greater than the S&P 500.
1000 interactions were used in the simulation:1000 interactions were used in the simulation:
Given a 60% equity allocation and 40% Fixed Income ,Given a 60% equity allocation and 40% Fixed Income ,
The weights associated with each style LC, MC,SC (TakenThe weights associated with each style LC, MC,SC (Taken
from page 15)from page 15)
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – Monte Carlo SimulationsStep 2 – Monte Carlo Simulations
19. 1919
Given a $1.00 investment, generate a portfolio allocated according toGiven a $1.00 investment, generate a portfolio allocated according to
the power coefficients for each style: Large Caps, Midcaps, Small capsthe power coefficients for each style: Large Caps, Midcaps, Small caps
& Fixed Income.& Fixed Income.
An average portfolio allocation is 55-65% Equity ,35% to 45% FixedAn average portfolio allocation is 55-65% Equity ,35% to 45% Fixed
Income. For the purpose of this analysis a Mid point allocation wasIncome. For the purpose of this analysis a Mid point allocation was
assumed. That is 60% equity, 40% Fixed Income . Further per theassumed. That is 60% equity, 40% Fixed Income . Further per the
discussion under proposition 1 (page 28) in the previous section Powerdiscussion under proposition 1 (page 28) in the previous section Power
Coef of Large Caps (LC’s) had a slight advantage over Mid Cap’(MC)sCoef of Large Caps (LC’s) had a slight advantage over Mid Cap’(MC)s
and SC’s (SC)and SC’s (SC)
The Diversified Portfolio is:The Diversified Portfolio is:
Large Caps= 35 % Power Coef weighting * 60% =21 %=SEQUXLarge Caps= 35 % Power Coef weighting * 60% =21 %=SEQUX
Mid Caps = 33% Power Coef weighting * 60% = 20%=PEMBXMid Caps = 33% Power Coef weighting * 60% = 20%=PEMBX
Small Caps= 32% Power Coef weighting* 60% =19%=VVPSXSmall Caps= 32% Power Coef weighting* 60% =19%=VVPSX
Fixed Income =40% in Fixed Income-Bonds- MWTRXFixed Income =40% in Fixed Income-Bonds- MWTRX
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – Monte Carlo SimulationsStep 2 – Monte Carlo Simulations
20. – The sum of the weights =100%The sum of the weights =100%
– For simplicity assume a portfolio of $ 1.OO thereforeFor simplicity assume a portfolio of $ 1.OO therefore
– The $1.00 Diversified Portfolio becomes:The $1.00 Diversified Portfolio becomes:
$.21 to SEQUX- large Cap$.21 to SEQUX- large Cap
.$.2 to PEMBX -Midcap.$.2 to PEMBX -Midcap
$.19 to VVPSX- Small Cap$.19 to VVPSX- Small Cap
$.4 0 to MWTRX- Fixed Income$.4 0 to MWTRX- Fixed Income
Total $ 1.00Total $ 1.00
Thus in summary:Thus in summary:
1.1. Large Caps-Large Caps- 21%21%
The best of the Large caps =Sequoia- SEQUX=The best of the Large caps =Sequoia- SEQUX= $.21$.21
2.2. Mid Caps-Mid Caps- 20%20%
The best of the midcaps =Principal Midcap- PEMGX=$.27The best of the midcaps =Principal Midcap- PEMGX=$.27
3.3. Small Caps-Small Caps- 19%19%
The best of the small caps= Vulcan Value Partner -SCETX-=$.12The best of the small caps= Vulcan Value Partner -SCETX-=$.12
2020
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – Monte Carlo SimulationsStep 2 – Monte Carlo Simulations
21. 2121
4-4- Fixed Income- Bonds- 40%Fixed Income- Bonds- 40%
Metropolitan West Total Return – MWTRX-$.40
Total of Large Caps +Midcaps +Small Caps + Fixed Income =$1.00Total of Large Caps +Midcaps +Small Caps + Fixed Income =$1.00
S&P 500 baselineS&P 500 baseline
– Vanguard Index Fund-VFINX-$1.00Vanguard Index Fund-VFINX-$1.00
– This fund replicates the S&P 500This fund replicates the S&P 500
Total $1.00Total $1.00
NOTE:NOTE: The 1 dollar investment amount was usedThe 1 dollar investment amount was used
To simplify the comparatives.To simplify the comparatives.
2-Analytic Methodology:2-Analytic Methodology:
Step 2 – Monte Carlo SimulationsStep 2 – Monte Carlo Simulations
22. Section-3 ResultsSection-3 Results
This sectionThis section discusses the results of the methodologydiscusses the results of the methodology
discussed in section 2 to the two propositions:discussed in section 2 to the two propositions:
– Proposition 1-Proposition 1- Given previous research completed inGiven previous research completed in
2011, that Midcaps(vs large Caps and Small Caps) have2011, that Midcaps(vs large Caps and Small Caps) have
the best value per unit of risk , does the results from thethe best value per unit of risk , does the results from the
periods following the financial crisis (2007- 2012) continueperiods following the financial crisis (2007- 2012) continue
to support those results.to support those results.
– Proposition 2-Proposition 2- Is there an alternative investmentIs there an alternative investment
process (Mix of Mutual funds in Large Cap, Midcap ,process (Mix of Mutual funds in Large Cap, Midcap ,
Small Cap and Fixed Income Styles) chosen by theSmall Cap and Fixed Income Styles) chosen by the
highest Power Coef’s that provide better results thanhighest Power Coef’s that provide better results than
simply a Mutual fund that duplicates the S&P 500?simply a Mutual fund that duplicates the S&P 500?
23. 2323
Power Coefficient PortfolioPower Coefficient Portfolio
100% Small Caps100% Small Caps
– Vulcan Value Partners- VVPSXVulcan Value Partners- VVPSX
$1.00 Investment$1.00 Investment
Mean Value from the simulationMean Value from the simulation
was $7.01 a 30% increase vs $5.4was $7.01 a 30% increase vs $5.4
for the S&P 500 Index portfoliofor the S&P 500 Index portfolio
The 100% SC portfolio has a 63 %The 100% SC portfolio has a 63 %
probability of exceeding the S&Pprobability of exceeding the S&P
500500
Implication: The above 100% Small Cap portfolio generated a 30%
higher Power Coefficient result of $7.01 vs. $5.40 for the S&P 500.. The
100% SC portfolio has a 63% probability of exceeding the S&P 500 Index
Portfolio
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC,What is the Best Investment Style (SC,
MC,LC) Compared to the S&P 50MC,LC) Compared to the S&P 5000
24. 2424
The mean difference between theThe mean difference between the
Small Cap (VVPSX)PowerSmall Cap (VVPSX)Power
Coefficient generated portfolio andCoefficient generated portfolio and
the S&P 500 is $1.20the S&P 500 is $1.20
57 % Probability the Mean57 % Probability the Mean
Difference Power CoefficientDifference Power Coefficient
generated portfolio will exceed 0.generated portfolio will exceed 0.
Implication: The Power Coefficient generated portfolio yields a higher
mean return of $1.20 (30% higher )and lower Standard Deviation 7.57 vs
9.75 (7% lower) than the Fund mirroring the S&P. The simulations yields
a 64.4% probability that the Power Coefficient generated portfolio will
exceed the S&P 500 portfolio
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC,What is the Best Investment Style (SC,
MC,LC) Compared to the S&P 50MC,LC) Compared to the S&P 5000
25. 2525
Power Coefficient Mid CapPower Coefficient Mid Cap
PortfolioPortfolio
100% Midcaps100% Midcaps
– Principal Midcap-Principal Midcap-
PEMGXPEMGX
$1.00 Investment$1.00 Investment
Mean Value from theMean Value from the
simulation was $6.95 a 29%simulation was $6.95 a 29%
increase vs $5.40 for the S&Pincrease vs $5.40 for the S&P
500 Index portfolio500 Index portfolioImplication: The 100% Mid Cap portfolio with a dollar invested
generated a 29% higher Power Coefficient result of $6.95. versus $5.4 of the
S&P 500 portfolio. The 100% Midcap portfolio had a 63% probability
exceeding the S&P 500 port of 5.46
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC,What is the Best Investment Style (SC,
MC,LC) Compared to the S&P 50MC,LC) Compared to the S&P 5000
26. 2626
The Mean Difference betweenThe Mean Difference between
thethe Mid CapMid Cap (VVPSX)(VVPSX)PowerPower
Coefficient generated portfolioCoefficient generated portfolio
and the S&P 500 is $1.59and the S&P 500 is $1.59
60% Probability the Mean60% Probability the Mean
Difference Mid Cap PowerDifference Mid Cap Power
Coefficient generated portfolioCoefficient generated portfolio
will exceed 0.will exceed 0.
Implication: The Mean Mid Cap Power Coefficient yielded a higher mean
differential return of $1.59 (24% higher )and lower differential Standard
Deviation of 7.76 than the Fund mirroring the S&P. The simulations yields a
60% probability that the Mean Mid Cap Power Coefficient generated
portfolio will exceed 0.
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC, MC,LC) Compared to the S&P 50What is the Best Investment Style (SC, MC,LC) Compared to the S&P 5000
27. 2727
Power Coefficient Mid CapPower Coefficient Mid Cap
PortfolioPortfolio
100% Large caps100% Large caps
– Sequoia-SEQUXSequoia-SEQUX
$1.00 Investment$1.00 Investment
Mean Value from the simu-Mean Value from the simu-
lation was $7.96 a 47% increaselation was $7.96 a 47% increase
vs $5.4 for the S&P 500 Indexvs $5.4 for the S&P 500 Index
portfolioportfolio
Implication: The 100% Large Cap portfolio with a dollar
invested generated a 47% higher Power Coefficient result of
$7.96 vs 6.64 for the S&P portfolio.The Large Cap portfolio had
a 72% prob of exceeding the S&P 500 index Portfoluio
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC,What is the Best Investment Style (SC,
MC,LC) Compared to the S&P 50MC,LC) Compared to the S&P 5000
28. 2828
The mean difference betweenThe mean difference between
the Large Cap (SEQUX)the Large Cap (SEQUX)PowerPower
Coefficient generatedCoefficient generated
portfolio and the S&P 500 isportfolio and the S&P 500 is
$2.46 (45%higher)$2.46 (45%higher)
65% Probability that the mean65% Probability that the mean
difference ($2.46) of the Largedifference ($2.46) of the Large
Cap portfolio will be greaterCap portfolio will be greater
than 0.than 0.
Implication: The Mean Large Cap Power Coefficient generated a higher
differential of 2.46 (45% higher) than the Fund mirroring the S&P. The
simulations yields a 65.% probability that the Mean difference Large Cap
Power Coefficient of $2.46 will be greater than 0.
3-Proposition-1- Analytic Results:3-Proposition-1- Analytic Results:
What is the Best Investment Style (SC,What is the Best Investment Style (SC,
MC,LC) Compared to the S&P 50MC,LC) Compared to the S&P 5000
29. 2929
Baseline S&P Portfolio-VFINXBaseline S&P Portfolio-VFINX
$1.00 Investment$1.00 Investment
100% Invested in S&P Fund-100% Invested in S&P Fund-
VFINXVFINX
Mean Value from theMean Value from the
simulation was $5. 40simulation was $5. 40
The measure of Risk orThe measure of Risk or
Standard deviation wasStandard deviation was
9.759.75
Implication: The above $1.00 investment in The S&P 500 Fund
yielded a Mean Power Coefficient of $5.4 with a standard
deviation of 9.75.
3-Proposition-2-3-Proposition-2-Analytic Results:Analytic Results:
Diversified Portfolio vs S&P 500Diversified Portfolio vs S&P 500
30. 3030
Power Coefficient PortfolioPower Coefficient Portfolio
$1.00 Investment$1.00 Investment
21% Large Cap, 20% Mid21% Large Cap, 20% Mid
Cap, 19% Small Cap, 40%Cap, 19% Small Cap, 40%
Fixed IncomeFixed Income
The Mean Value from TheThe Mean Value from The
Diversified PortfolioDiversified Portfolio
simulation was $6.55simulation was $6.55
vs $5.4 for the S&P 500 Portvs $5.4 for the S&P 500 Port
69% probability the Div Port69% probability the Div Port
> Than the S&P 500> Than the S&P 500
Implication: The above Power Coefficient of the diversified portfolio
with a dollar invested generated a higher Power Coefficient of $6.55 (21%
higher) vs $5.4 for the S&P 500 with a 7% lower Std Deviation of 8.76%
vs 9.75 for the S&P 500. The Diversified Port has a 69% prob of exceeding
the S&P 500 Index portfolio
3-Proposition-2-3-Proposition-2-AnalyticAnalytic
Results:Results:
Diversified Portfolio vs S&P 500Diversified Portfolio vs S&P 500
31. 3131
The Mean Difference betweenThe Mean Difference between
the Power Coefficient generatedthe Power Coefficient generated
portfolio and the S&P 500 isportfolio and the S&P 500 is
$1.16(21% higher)$1.16(21% higher)
59.4% Probability the Mean Diff59.4% Probability the Mean Diff
Power Coefficient generatedPower Coefficient generated
portfolio will exceed 0 .portfolio will exceed 0 .
Implication: The Mean Difference (Diversified Portfolio vs. the S&P
500)Power Coefficient generated portfolio yields a higher mean difference
return of $1.16 (21% higher )and lower Standard Deviation of 7.57 than the
Fund mirroring the S&P of 9.75 . The simulations yields a 57% probability
that the Mean Difference Power Coefficient generated portfolio will exceed
0.
3-Proposition-2-3-Proposition-2-Analytic Results:Analytic Results:
Diversified Portfolio vs S&P 500Diversified Portfolio vs S&P 500
32. CChapter 4-hapter 4-
RecommendationsRecommendations
3232
This section outlines conclusions:
– Proposition 1- Best Styles(LC.MC,SC, FI)
–Additional Comments:
– Proposition 2- Optimum Diversified Portfolio:
– Recommended Model Portfolio:
– Other Recommendations with High Power Coef”s:
–Additional Remarks
33. Proposition -1Proposition -1-- What is the Best Investment Style (SC, MC,LC)What is the Best Investment Style (SC, MC,LC)
Compared to the S&P 50Compared to the S&P 5000
Based on the power Coefficient and Monte Carlo simulation analysisBased on the power Coefficient and Monte Carlo simulation analysis
all the styles reflected a power coefficient higher than the S&P.all the styles reflected a power coefficient higher than the S&P.
The resulting simulationThe resulting simulation breakout allocation of the powerbreakout allocation of the power
Coefficients came out fairly even between the 3 styles.. 35%Coefficients came out fairly even between the 3 styles.. 35%
large Cap., 33% Mid Cap and ,32%% Small Cap.large Cap., 33% Mid Cap and ,32%% Small Cap.
Allocating your investment portfolio with the above allocation of theAllocating your investment portfolio with the above allocation of the
equity segment of the portfolio will give you The optimum efficientequity segment of the portfolio will give you The optimum efficient
segmentation.segmentation.
This allocation was used to develop the portfolio used in the 2This allocation was used to develop the portfolio used in the 2
proposition.proposition.
ChapterChapter 4- Recommendations:4- Recommendations:
34. Additional Remarks :Additional Remarks :
Research completed in 2011 suggested that of the three stylesResearch completed in 2011 suggested that of the three styles
LC,MC,SC …LC,MC,SC …that midcap investments over 50 years of datathat midcap investments over 50 years of data
provided the best value return per unit of risk. Includingprovided the best value return per unit of risk. Including
2011 thru 2013 into the historical timeline does NOT2011 thru 2013 into the historical timeline does NOT
change the long term results.change the long term results.
However, Given the 5 years 2007 thru 2012 , following theHowever, Given the 5 years 2007 thru 2012 , following the
financial crisis , it is of interest to verify the validity of thisfinancial crisis , it is of interest to verify the validity of this
hypothesis given significant changes in exogenous variableshypothesis given significant changes in exogenous variables
such as extremely low interest rates and simulative Fed Policysuch as extremely low interest rates and simulative Fed Policy
that have a significant effect on savings and investment.that have a significant effect on savings and investment.
The results indicate that,The results indicate that, during this period of very lowduring this period of very low
interest rates, Large Caps had a marginally better returninterest rates, Large Caps had a marginally better return
value per unit of risk over Mid Caps and Small Caps asvalue per unit of risk over Mid Caps and Small Caps as
evidenced by the higher power coefficients.evidenced by the higher power coefficients. 3434
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35. Small caps and Midcaps were approx. equivalent in value perSmall caps and Midcaps were approx. equivalent in value per
unit of risk given the relative parity of the Powerunit of risk given the relative parity of the Power
CoefficientsCoefficients..
So what changed to mitigate the previous results. Primarily it has to doSo what changed to mitigate the previous results. Primarily it has to do
with the Federal Reserves manipulation of the yield curve towith the Federal Reserves manipulation of the yield curve to
uncharacteristically low rates . The result has caused a predictableuncharacteristically low rates . The result has caused a predictable
misallocation of investor resources to Large Cap stocks. The reason ismisallocation of investor resources to Large Cap stocks. The reason is
with the short end of the yield curve at uncharacteristically low levels(10with the short end of the yield curve at uncharacteristically low levels(10
year bond rate at 2.5-2.65 percent) investors who need a monthly returnyear bond rate at 2.5-2.65 percent) investors who need a monthly return
to maintain there standard of living moved to proxy bond investments withto maintain there standard of living moved to proxy bond investments with
dividend paying large Cap Value stocks. So with a dividend rate of 3-4%dividend paying large Cap Value stocks. So with a dividend rate of 3-4%
and a growth factor of 1-2% , investors sold their bonds for proxy Largeand a growth factor of 1-2% , investors sold their bonds for proxy Large
Cap Value stocks and forced a large volume move in in this vehicle. TheCap Value stocks and forced a large volume move in in this vehicle. The
primary driver to this mass movement to proxy bonds thru the purchase ofprimary driver to this mass movement to proxy bonds thru the purchase of
Large Cap dividend paying value investments was further exacerbated byLarge Cap dividend paying value investments was further exacerbated by
the simultaneous Federal reserve policy to implement the massivethe simultaneous Federal reserve policy to implement the massive
buying of mortgage back securities (QE1,2,3) .buying of mortgage back securities (QE1,2,3) . 3535
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36. To the tune of 85 billion a month..This forced Bond prices up and yields downTo the tune of 85 billion a month..This forced Bond prices up and yields down
at the shorter end of the yield curve driving even more investors to stocks.at the shorter end of the yield curve driving even more investors to stocks.
This was the main contributing factor to the temporary 5 year (2007-This was the main contributing factor to the temporary 5 year (2007-
2012)slight advantage of large Caps over Midcaps. Once the yield curve2012)slight advantage of large Caps over Midcaps. Once the yield curve
assumes a more normal trajectory (10 year at 4.- 5%) , income based riskassumes a more normal trajectory (10 year at 4.- 5%) , income based risk
averse investors will return the balance of there portfolio’s to fixed incomeaverse investors will return the balance of there portfolio’s to fixed income
investments .investments .
The key will be when(timing) the bond vigilantes decide that there is notThe key will be when(timing) the bond vigilantes decide that there is not
enough risk built into the yield curve, and the markets or the federal reserveenough risk built into the yield curve, and the markets or the federal reserve
begins to increase the discount rate . At that time the result should yield abegins to increase the discount rate . At that time the result should yield a
transference of Large Caps back to bonds and the historical relationship willtransference of Large Caps back to bonds and the historical relationship will
favor investing in midcaps.favor investing in midcaps.
When this will happen remains to be seen given the high unemployment andWhen this will happen remains to be seen given the high unemployment and
very low growth in GDP between 1.5 -1.9% %very low growth in GDP between 1.5 -1.9% %
NOTE: The % allocation is marginally higher for Large Caps than Mid CapsNOTE: The % allocation is marginally higher for Large Caps than Mid Caps
and Small caps based on research done previously and documented inand Small caps based on research done previously and documented in
Section-2Section-2
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37. ChapterChapter 4- Recommendations4- Recommendations::
Propositin -2Propositin -2 Is there a diversified Portfolio thatIs there a diversified Portfolio that
will beat the S&P 500will beat the S&P 500..
Yes…Using the allocation from the results ofYes…Using the allocation from the results of
proposition 1 , the following portfolio is defined asproposition 1 , the following portfolio is defined as
the optimum allocation (see page 19 and 20)the optimum allocation (see page 19 and 20)
1.1. Large Caps-Large Caps- 21%21%
1.1. The best of the Large caps =Sequoia- SEQUX=The best of the Large caps =Sequoia- SEQUX= $.21$.21
2.2. Mid Caps-Mid Caps- 20%20%
1.1. The best of the midcaps =Principal Midcap-The best of the midcaps =Principal Midcap-
PEMGX=$.27PEMGX=$.27
3.3. Small Caps-Small Caps- 19%19%
1.1. The best of the small caps= Vulcan Value PartnerThe best of the small caps= Vulcan Value Partner
-SCETX--SCETX-
38. 4-4-Fixed Income- Bonds-Fixed Income- Bonds- 40%40%
– Metropolitan West Total Return – MWTRX-$.40
Total of Large Caps +Midcaps +Small Caps + Fixed IncomeTotal of Large Caps +Midcaps +Small Caps + Fixed Income
=$1.00=$1.00
55- S&P 500 baseline- S&P 500 baseline
- Vanguard Index Fund-VFINX-$1.00- Vanguard Index Fund-VFINX-$1.00
– This fund replicates the S&P 500This fund replicates the S&P 500
- Total= $1.00- Total= $1.00
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39. The above Power Coefficient of the diversified portfolio with aThe above Power Coefficient of the diversified portfolio with a
dollar invested generated a higher Power Coefficient of $6.55dollar invested generated a higher Power Coefficient of $6.55
(21% higher) vs $5.4 for the S&P 500(21% higher) vs $5.4 for the S&P 500
Additionally there was a 7% lower Std Deviation of 8.76%Additionally there was a 7% lower Std Deviation of 8.76%
vs 9.75 for the S&P 500.vs 9.75 for the S&P 500.
Bottom line is:Bottom line is:
– The Diversified Port has a 69% probability ofThe Diversified Port has a 69% probability of
exceeding the S&P 500 Index portfolioexceeding the S&P 500 Index portfolio
– With 7% lower risk.With 7% lower risk.
– The ALPHA’s for the recommended portfolio haveThe ALPHA’s for the recommended portfolio have
high multiples( 2.7 to 7.2) compared to the S&P 500high multiples( 2.7 to 7.2) compared to the S&P 5003939
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40. 4040
ChapterChapter 4- Recommendations4- Recommendations::
1- Recommended Model Portfolio:
•Large Caps:
Sequoia-SEQUX
Present % allocation- 21%
Future Allocation: 21%
•Mid Caps:
Principal Midcap- PEMGX
% allocation- 20%
Future Allocation; As Fed tightens…increase allocation to 27%
•Small Caps:
Vucan Value Partners-VVPSX
% allocation- 19%
Future Allocation; - as Fed tightens…decrease allocation to 12%
41. Fixed IncomeFixed Income
– Metropolitan West Total Return-MWTWXMetropolitan West Total Return-MWTWX
– % Allocation- 40%...Bond durations should be < = 5 Years% Allocation- 40%...Bond durations should be < = 5 Years
– Monitor…for every 100 basis point increase in 10 year resultsMonitor…for every 100 basis point increase in 10 year results
in 5% decrease in yield(value)in 5% decrease in yield(value)
2-Other Recommendations with high Power Coef:2-Other Recommendations with high Power Coef:
Large CapsLarge Caps
– Yackman- YAFFXYackman- YAFFX
– Wasatch-WGROXWasatch-WGROX
Midcaps:Midcaps:
– Artisian Midcap- ARTQXArtisian Midcap- ARTQX
Small Caps:Small Caps:
– Brown Capital Mgt-BCSIXBrown Capital Mgt-BCSIX
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42. Fixed IncomeFixed Income
– Aberdeen Global High-BJBHXAberdeen Global High-BJBHX
– Fidelity Strategic Income-FSICXFidelity Strategic Income-FSICX
Sector –Sector – Analysis- High to LowAnalysis- High to Low --
The only Sector ETF that warrants consideration based onThe only Sector ETF that warrants consideration based on
Power Coef‘s is Industrials-PRN .Power Coef‘s is Industrials-PRN .
– Industrials-PRN- Highest Power CoefficientIndustrials-PRN- Highest Power Coefficient
– Finance-PFIFinance-PFI
– Technology-PTFTechnology-PTF
– Energy- PXIEnergy- PXI
– Basic materials- PYZBasic materials- PYZ
– Consumer Staples-PSLConsumer Staples-PSL
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43. Additional Remarks::Additional Remarks::
– Note: TNote: T here are no international investment recommendations.here are no international investment recommendations.
– The reason is……….. international investments reflect lower powerThe reason is……….. international investments reflect lower power
coefficients relative to domestic opportunities. This is primarilycoefficients relative to domestic opportunities. This is primarily
because growth in Europe(less than 1%) and the BRICS is lowerbecause growth in Europe(less than 1%) and the BRICS is lower
(tending toward deflation) than the States exacerbated by tight(tending toward deflation) than the States exacerbated by tight
monetary policy. The ECB in particular needs to loosen significantlymonetary policy. The ECB in particular needs to loosen significantly
by lowering rates to provide much needed monetary stimulus .by lowering rates to provide much needed monetary stimulus .
– The results of this excessively tight monetary policy leads to foreignThe results of this excessively tight monetary policy leads to foreign
investments re-allocated to higher growth opportunities in the statesinvestments re-allocated to higher growth opportunities in the states
which adds to higher asset pricing and more growth in earnings andwhich adds to higher asset pricing and more growth in earnings and
markets.markets.
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44. This is another reason for short to middle term optimism aboutThis is another reason for short to middle term optimism about
Stocks. Until the economic climate changes , overseas investorsStocks. Until the economic climate changes , overseas investors
see more opportunity here.see more opportunity here.
Note further when the fed decides to tighten…or even implicationsNote further when the fed decides to tighten…or even implications
thru interpretation of release transcripts of fed meeting minutes, thethru interpretation of release transcripts of fed meeting minutes, the
market is likely to drop , in the short run 5-15%. The driver tomarket is likely to drop , in the short run 5-15%. The driver to
tightening would be an unemployment rate of 6-6.5%. The besttightening would be an unemployment rate of 6-6.5%. The best
guess to Fed Tightening either thru tapering of MBS purchases orguess to Fed Tightening either thru tapering of MBS purchases or
increasing interest rates is sometime late 2015 to 2016.increasing interest rates is sometime late 2015 to 2016.
Finally….when choosing an investment or group of investments, itFinally….when choosing an investment or group of investments, it
is important to select that which invests in growth sectors. One ofis important to select that which invests in growth sectors. One of
the reasons this portfolio has positive results(per high Alpha’sthe reasons this portfolio has positive results(per high Alpha’s
discussed earlier)discussed earlier) is the correct sector diversification inis the correct sector diversification in
Financials, Cyclicals, Industrials and energy.Financials, Cyclicals, Industrials and energy. 4444
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