Its been no secret that 2011 has been a difficult year. A year that can make you doubt everything you’ve ever learned, tested and retested our models countless times even on vacation. (I refuse to allow the glare of the sun on the beach disable my ability to read our strategy test results on my Ipad. I know, that’s pretty pathetic.)
It should be a given to any investor that no strategy works wonderfully all the time, 2011 is enough to prove that. Long term investing has more to do with perseverance and discipline to your strategy regardless of your emotions and the market environment. With persistence, in the long run you should do quite well.
I’ve never made it a secret that I’ve been a fan of James O’Shaughnessy and his book: “What works on Wall Street”. The RMHI investment model is based on Shaughnessy’s “Trending Value” model but interpreted for Socially Responsible Investors.
But more importantly what strategy has worked the best for the past 50 years?
Well, Shaughnessy has released a new paper on “Trending Value” and it has trounced every other model that I’m aware of for the past 50 years.
“Its annualized return of 20.58% through Sept. 30 crushes the All Stocks benchmark (an equally weighted benchmark of stocks with an inflation adjusted market cap great than $200 million), which has a return of 10.71%. Plus, the Trending Value approach achieves its return with a volatility of 17.69%, lower than the benchmark’s 18.26%.
“The strategy makes use of one of the main innovations from the book: the use of a composite value factor. In the original publication, we identified price-to-sales as the most effective value factor. In this latest edition of the book, we have learned that a composite that combines several different value factors delivers stronger returns and more consistency than any individual factor.
By spreading our bets and ensuring that a stock is cheap in a variety of ways, we believe we can identify better stocks. One version of the composite value factor combines the following measures of value:
• Price-to-Sales
• Price-to-Earnings
• Price-to-Book
• Price-to-Cash Flow
• EBITDA/Enterprise Value
• Shareholder yield (dividend yield + rate of share repurchases)”
Now this gets interesting since RMHI has been using a composite model since the beginning of our model based strategy. It would be fair to say that we were one step ahead of Mr. O’Shaughnessy but now the gap is closing and I find that confirmation of research affirming our strategy a major confidence boost in a difficult environment.
Significant differences remain between O’Shaughnessy’s model and our own. Its impossible to know what the weighting of each criteria are since they have not been provided. In addition, the O’Shaughnessy model focuses on only holding stocks ranked in the top 10% of their ranking system while we have found that holding the top 1% versus the top 10% over time sharply improves returns.
Chart courtesy of American Association of Individual Investors
It should be noted at this time that O’Shaughnessy does not have a public fund that exclusively advertises itself as “Trend Value” but many of the stocks highlighted on AAII as acceptable to the TV and included in his “Tiny Titans” screen are also stocks found in our portfolios in the recent past:
Material Sciences
Core Molding Technology
Datalink
Town Sports International – current RMHI long position
While its obvious to see that the volatility of the portfolio is greater than that of the S&P 500 the returns more than make up for it in the long run.
All the best,
Brad
Long CLUB