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OPINION

Beta minus, alpha plus

Beta minus, alpha plus
January 17, 2017
Beta minus, alpha plus

That said, it does not have to be this way. It would be an exaggeration to say the performance of the Bearbull Income Portfolio gives a lie to this part of portfolio theory. However, it is quite clear how - over many years - it has combined excess rewards with low risks.

That much remains true after a full assessment of 2016's performance. Since the start of 2000, the income portfolio's monthly returns have averaged 0.56 per cent. Simultaneously, these returns have a standard deviation from the average - the most usual measure of risk in portfolio theory - of 3.1 per cent. Contrast that with returns from the FTSE All-Share index over the same 17 years - its monthly returns average is just 0.17 per cent, yet that has come with a standard deviation of 4.1 per cent.

 

 

Another way of looking at this is to examine the portfolio's 'beta', that ubiquitous tool which is a measure of risk in relation to something else; in our case, the portfolio's performance relative to the All-Share's. Over the 17 years, the portfolio's beta is 0.39, where a measure of 1.0 would mean its value bounced around as much as the All-Share's.

From this, it follows that little of the portfolio's returns get a helping hand from the market. The equation that calculates beta tells us this. In order to generate the 0.56 per cent monthly return just mentioned, the market provided 0.39 (the beta) times 0.17 per cent (the monthly return), which generated all of 0.067 per cent. Meanwhile, the rest of the return - almost all of it, actually - came from the portfolio's 'alpha', which is 0.497 per cent a month.

In portfolio theory, alpha is the clever bit of a portfolio's return; the bit that fund managers - or their marketing departments - beat their chests about and shout it loudly over the investment jungle. Well, yes, but in the linear equation from which alpha and beta are derived, alpha is just the point where the regression line - the slope that gives us beta - crosses the 'y' axis. As such, there is nothing terribly clever about alpha; it just is.

But from wherever the Bearbull portfolio's returns arise, we can conclude they are decent and stable. They will also tend to be better than the All-Share's when that index is static or falling, but they will lag the wider index when it motors. The chart shows this clearly, but let's put it into figures. Of the 17 years for which there is a year-on-year comparison, the portfolio's total return (capital changes plus dividend yield) has beaten the market's 11 times. When the market produced a positive total return - 12 times - the portfolio only beat it six times. But for the five years when the market's total return was negative, the portfolio beat it every time.

As the chart also shows, 2016 was a year when the market motored and the income portfolio couldn't keep up, even though that seemed unlikely at the start when economists were busy spotting the next recession. They reckoned, first, without those ever-obliging central bankers, who pumped even more liquidity into the developed world's economies and, second, without the hope that Trumponomics would provide a bonus fiscal stimulus.

I would guess that a market-beating return from the income fund looks a decent call for 2017. That's chiefly because, as equity markets fly at all-time-high altitudes they will find it increasingly difficult to deal with the turbulence of Brexit and Trumpery.

We shall see. More important for me is to grasp the lesson provided by the £10,000 losses sustained on the portfolio's holding in Mitie (MTO) - see table. Three times during 2015 I explained the outsourcing group's shortcomings - correctly, as it turned out - yet did nothing about it. As a result, a £10,000 profit on the portfolio's holding in Mitie was eroded to nothing by the time I sold in September. The moral is that, if I have strong and decently argued opinions about a stock, I should follow them. If I don't, there is no point in running a portfolio; I might as well put the Bearbull capital into a tracker fund.

With that in mind, my first task of 2017 has been to sell the portfolio's holding in construction-services group Carillion (CLLN) - see Bearbull 7 October 2016. The share price - at 237p - is below its stop-loss level and the disposal frees up some capital to go searching for something new in these inflated markets.

 

The performance bridge

How 2016 got to 2017£
Fund value 31.12.15293,241
Gains on: 
Boeing5,381
Elementis4,489
Record3,500
Air Partner3,042
Vesuvius2,912
Losses on: 
Mitie-10,736
Carillion-4,958
Net adjustment-1,151
Fund value 31.12.16295,720

 

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