After doing some analysis of the performance of ports etc. over the past few months, I wanted to see what factors have been providing the most alpha in recent times.
Interestingly, one of the best performers was something I use as a “financial strength” factor, namely “EBITDA/CurLiab”. On the basis the higher the ratio, the more easily a company covers its current liabilities relative to current cashflow. This would seem to imply we have seen something of a “flight to safety” in the last 6 months.
I guess its obvious when you think about it, with so many people shifiting their strategies to more “defensive”, they are focusing on a companies short term ability to survive above all else.
The only question is, will this be true for the next 6 months, or will something else come into vogue?
IMO, there are two main factors driving the results you highlight. On the one hand, emphasizing cash flow and avoiding liabilities tends to exclude the financial lenders that have performed so poorly. On the other hand, it tends to include a lot of energy companies that have performed very well in this time period. So my expectation is that the relative performance will continue if energy does well and financials do poorly, but not if financials do well and energy does poorly.
I think there’s also a flight-to-safety angle. I notice that a variety of things i include under a “company quality” heading also seem to be working well now (variations on return on capital, financial strength).
As to looking ahead, quality items (including EBITDA/CurrLiab) can continue to work, even if the market improves. They may not quite match momentum-type approaches during bull phases, but they can still work well.
This is yet another example of “factor drift”, that was the curse that took down several hedge funds last year. What was working before, just stop working going forward.
O’Shaughnessy in his books documented an interesting example with ROE.
In my opinion this problem has never been solved and it remains perhaps the main problem in using factor driven stock selection.
What will work in the future ? More important, how fast can we realize that something is no longer working ?
Martin
Whats been working for me is short porfolios. Not on the short side: on the long side. The portfolios which have gained the most on the long side for the last day and week are porfolios which are designed to be short. All of them performed well on th short side in June and the first two weeks of July. And now that the market is going up, they are going up more than the ports which are designed to go up.
I notice that Olikea also has two short ports which are winners in the 1 week rankings.
There is some food for thought here. What is it about the design of a short portfolio that makes it do well on the long side after a period in which the market goes down.
Some of the short portfolios which I wrote merely magnify the movements of the market. When the market is going up, they go up more. When the market is going down, they go down more.
Perhaps one could design a port using this that would go long the stocks chosen when the market was going up and go short the stocks chosen when the market was going down. You just have to come up with a proxy for when the market is going up and when it is going down.
Lots of questions here, too. For example, does the market have to be beaten down for a time, for these ports to do well on the long side?
Or, is this like one of the “pullback” models. Both of these ports pick stocks which are trending down. Are they then, oversold, and ready to go up for a time?
In any event, I think it would be good to think why some of our short models are winners on the long side at this time.
Hi,
Re. [quote]
What is it about the design of a short portfolio that makes it do well on the long side after a period in which the market goes down.
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Short covering. It might make sense to simply trade the short portfolio’s short but cover when the market starts selling off on high volume and volatility is high; or reverse and go long at these times if you really want to be aggressive.
