ranking differs according to whether rules are in screen or universe

Research
1

I’ve noticed that stocks are ranked in different positions depending on whether you put a rule in the universe or the screen.

For example, create a new universe by taking the S&P 1500 index and adding the rule gics(404020,55)=false, which removes REITs and utilities. Then rank by Comprehensive: QVGM. The top 5 stocks will be THO, SANM, KORS, KELYA, and BIG. DW, for reference, is ranked #9.

Now create a new screen with the S&P1500 universe and exactly the same rule; use the same ranking system. The top 5 stocks will be THO, SANM, KELYA, KORS, and DW. BIG is now ranked #8.

If you do the top 10 instead of the top 5, you’ll see that two stocks are entirely different from one try to the other. In both results, you’d be buying THO, SANM, KELYA, KORS, DW, BIG, ALG, and HA. If you put the rule in the universe, you’d also be buying LZB and HIBB; if you put it in the screener, you’d be buying HLI and DLX instead.

Can anyone explain this discrepancy? This is not an isolated example. It happens no matter what universe or ranking system or rule you use. A rule in the universe produces different results from the same rule in the screen.

And which is the RIGHT way to do this? Which gives the more “correct” results?

2

Best shown with an example of how it could happen.
Suppose you had 10 REIT stocks in a 100 stock universe and node ranks for an equally weighted 2 node ranking system are as follows:

REIT 1: 10 99
REIT 2: 9, 98
REIT3: 8, 97
…
…
REIT 10: 1, 90
and 2 non-REIT and non-utility stocks have node ranks as follows:

Stock A: 95, 100
Stock B: 99, 89. Stock A is ranked higher with the REITs ranked in the universe.

Stock A and Stock B will switch order of ranking when the REIT stocks are removed from the universe.

Without the REITs the stocks would be Ranked closer to (not exact because it is no longer a 100 stock universe):

Stock B: 99, 99 (Higher ranked that Stock A now)
Stock A 95, 100

Of course there is no “correct” answer but usually better to exclude stocks in the universe, I think. The order is more stable (less chaotic) if nothing else. Ranking is chaotic enough as it is.

Kind of gives you an appreciation for what P123 has put together. There are a lot of subtle things going on that make Ranks work well enough to give us an edge–a rare thing. Not to be thrown away for some pie-in-the-sky Macro Trade or market-timing scheme, IMHO.

3

Thank you, Jim. Essentially, what you’re saying is that P123 ranks the stocks according to the universe and THEN removes stocks that don’t fit the screening rules, leaving the ranking order intact. That makes sense. And your example is very helpful indeed.

It seems, then, that when doing simulations or screens, we should put all our liquidity limits, accrual ratio rules, excluded GICSs, etc. in the universe rather than in our buy rules or screens. Intuitively, we don’t want to buy stocks that are ranked higher than stocks that aren’t possible for us to buy in the first place. We want to buy stocks that are ranked highest out of those that ARE possible for us to buy.

4

That’s a good way to put it. I’ve found that by doing this as much as possible, buy and sell rules based on rank (or rankpos) become much more useful.

Whereas in a larger Universe subsequently filtered by many buy rules, rank is too variable to be useful.

5

Yuval,
That is my feeling.
In a perfect world no buy rules at all in the port/sim and just one sell rule: RankPos > xx. One reason “Force Positions into Universe” is much appreciated.

P123 really has done something special that took me time to begin to fully appreciate. It is probably rare that someone like Marco would stop working for Goldman Sachs and share this with us.

6

I don’t understand the use of “force positions into universe” here, I thought it was to maintain stock positions that were de-listed from an index such as DOW or SP500…

7

Correct: but also if say the volume of trading drops below a certain level in a custom universe designed for liquidity.

If you look at some of Denny’s post for example, he used to put a lot of buy/sell rules in his ports/sims and adjust his universe so that stocks would not drop out of the universe. His universes selected stock for liquidity to a large extent, I think. He has not given up all of his secrets :wink:

Point being: P123 is relatively rare in providing ranks and it is possible to cleanly rank–generally–every stock that you are considering buying. Where else can you go for that?

A small thing. But one that P123 thought of–or responded to (Chaim had a formal feature request)-- and the small things add up.

8

In the context of a custom universe, it means that if you bought it because it used to meet the criteria but no longer does, you won’t necessarily sell it. For example, your custom Universe may have a rule like Yield > 2. If it slips to 1.9 for some reason, it’ll be sold with a reason of “NO RANK” unless you have checked that option. That may or may not be what you want, it depends.

9

Ok, I can see how “force position” would help to reduce turnover with a strictly defined universe; This is analogous to building sims without “matched” buy and sell rules, and no forced sell rule like rank<101, which also reduce turnover in some cases…