Can a handpicked group of twenty stocks outperform a 400-stock benchmark? Or will the randomness of return within the S&P 400 index prove difficult to compete with?
Over the decades I interacted with very smart, experienced and dedicated portfolio managers. The reasoning behind their stock selection and portfolio design was compelling. Why then did so many fail to outperform their benchmark index? (industry data shows that roughly 80% underperformed).
It is unlikely that their stock selection was worse than the index, in terms of quality. Were they just bad at buying and selling and got the timing wrong? How did they protect the portfolio from excessive risk? I suspect there are a number of factors involved, but from my observation, the most important missing factor was risk control. It is easy to pick on the ARK Innovation ETF as a strategy tilted toward enormous risks. (this ARK ETF is down from $160 per unit to $37 over the past year).
Ark's most obvious Risks
A lack of liquidity in many of the holdings
Extreme sector concentration
Little regard for valuations (which means that when it goes wrong, it goes really wrong)
(Note, these risks could be positive in the short term if devastated portfolio share prices bounce back).
Perhaps it is not knowable which stocks will outperform a passive index. An index composed of stocks of various descriptions and valuations. Are analyst efforts then without value? I would agree that a handful of managers have beaten their respective indexes over the years but they are few in number. The factors that caused the outperformance can be difficult to ascertain.
MIR20 was designed to try to limit the damaging factors that can defeat active stock picking. It will take some time to measure the success of the strategy. The belt and suspender rules are in place for desired risk control and return maximization.
MIR20 In Action
The following twenty securities have been purchased in the current MIR20 portfolio
Companies that in aggregate, meet the strategy's financial criteria, as set out in prior posts. (See note #1)
I was pleasantly surprised to find numerous securities that appear to be so well-priced. Perhaps this mid-capitalization sector of the market has been overlooked as investors focused on the mega-cap favourites (that hurt them badly in 2022).
I will report back on the strategy over time as the data comes in.
I am currently reading American Icon, (the recent history of Ford Motor Company). I was captured by a Henry Ford remark that seems relevant to the potential success of MIR20.
"It is failure that is easy. Success is always hard"
best regards, Tim
Thoughts, agreement/disagreement? email me at tim@mortonir.com
Note #1
Desired Financial criteria versus Actual MIR20 Characteristics
Return on Equity target of +>15%. Actual 26% ROE
Price/ Earnings Multiple of <20X. Actual 11X
Earnings Stability < 20 (1 being best, 100 worst). Actual 19
Positive Thomson / Reuters Research Coverage (10 best, 1 worst). Actual 8
Strong balance sheet (10 best, 1 worst). Actual 6.5
Stocks purchased trading above 50 & 200-day moving averages. Yes
Relative Strength >70 (1 worst, 100 best). Actual 94.5
Capitalization between $1 billion -$20 billion. Actual; average capitalization rate of $6.5 billion(companies ranging in size from $1b to $19b)
Multiple institutional research coverage. Yes, with average coverage per security of 7 analysts
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients and is the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your registered advisor for investment advice.