The No-Thought portfolio loses its edge

It began with pessimism crumbling into fear, as a meltdown in UK gilts coincided with a nadir in risk sentiment across asset classes. A rally then followed, and the quarter ended with something approaching balance, as investors wrestled with skittish projections for 2023, enduring caution, and the odd sign of softening inflation.

Our No-Thought portfolio screen was last refreshed at the start of October, after a strong third quarter in which its chunky weighting to short strategies (namely, bets against FTSE 350 stocks with the greatest one-year negative momentum or five-year volatility) paid off. But in the final three months of 2022 this strategy backfired, as the negative momentum and high-beta portfolios lost 13.9 and 16 per cent, respectively.

While the other four screens-within-a-screen – those trained on stocks with the greatest positive momentum, lowest volatility, largest market capitalisation, and the highest-yielding dividends – all did well, the net result was a mere 0.6 per cent gain, or 0.9 per cent with dividends factored in. The FTSE 350, by contrast, climbed 8 per cent in the period, or 8.6 per cent on a total return basis.

The recent swing means the No-Thought portfolio now lags its benchmark on a five, three and two-year basis, assuming a hypothetical investor evenly rebalances their capital across all six screens every quarter. The effect of dividends – something of a complicated question for such a trade-heavy portfolio – is slowly beginning to show after we started tracking total returns at the start of April, although their impact has been more notable in the performance of the buy-and-hold FTSE 350 index.

Like all the screens that appear in these pages, the No-Thought was never designed as an off-the-shelf portfolio. But its high number of holdings, contradictions, redundancies and dealing costs mean it is more theoretical than most. Its real-world construction would be a tricky process, to put it lightly.

The past quarter has revealed another possible flaw in its design, concerning its responsiveness to momentum. By buying or selling the shares of stocks that have climbed or fallen the most over the past year, the quarterly screen runs the risk of continually selecting stocks that have bounced from steep declines. The result is that several of the negative momentum picks in the boxout below – including Aston Martin (AML), Synthomer (SYNT) and Ocado (OCDO) – were among the FTSE 350’s strongest performers in the fourth quarter of 2022.

Is three months or one year a better lead indicator of share price momentum? The answer is that it depends on the stock. Either way, for our screen’s purposes and the above names, we’ll know come April.