The random stock portfolio bogey - beating the monkey

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Browser
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The random stock portfolio bogey - beating the monkey

Post by Browser » Sat Mar 21, 2015 1:04 pm

Research has demonstrated that randomly selected equally dollar-weighted stock portfolios produce slightly higher returns over time than the aggregate returns produced by mutual funds; this is the case even accounting for the expenses of both. In other words, if you have your monkey simply randomly pick a reasonably large number of stocks and invest an equal amount of money in each one, on average you'll beat the returns of investing an equal amount of money in a reasonably large number of mutual funds.

Of course, over any given time period there will be a distribution of mutual fund returns, with some outperforming the monkey portfolio bogey and some underperforming the bogey. If we are to consistently beat the monkey portfolio, then two things have to happen: (1) some fund portfolios must consistently beat the monkey portfolio and (2) the investor must be able to pick which funds those are.

By definition, any fund that is not a random equally dollar-weighted stock portfolio must be an actively managed portfolio: that also includes passive index funds since these are not random equally dollar-weighted either. For example, cap weighted index funds have more money allocated to some stocks in the index than others.

Equity asset allocation seems to involve an endless search for the holy grail of finding the funds that will beat the monkey so that we can invest in them. Will it be large-cap, mid-cap, small-cap; or will it be value, MOM, quality, low-vol? Or will it be particular funds that engage in frequent stock picking?

I guess you have to believe that one or another of these choices, based on manager expertise, factors, different weighting schemes, or whatever will turn out to beat the monkey. Will it -- really??? Maybe what we should be doing is looking for the closest thing we can find to the monkey portfolio at the lowest cost and just go with the monkey.
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Maynard F. Speer
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Sat Mar 21, 2015 2:35 pm

Then the problem is, the more people who go with the monkey (or the cap-weighted index) the less efficient the markets become again - because they're responding less and less to their environments and fundamentals .. (Some blamed the tech crash on efficient market theory because it gave investors a basis on which to justify buying at any valuation)

Buffett of course (in The Superinvestors of Graham-and-Doddsville) showed that fund managers who consistently beat the index tended to follow the same rules - the problem today is that those rules feature in every stock screen app and financial advisor's laptop, so every player knows the same 'cheat codes', and beating the zero-sum game becomes less a case of fundamental analysis and macro predictions, and more about simply exploiting plain bad investor behaviour

Where I think fund managers can add value is in balancing risk against returns through different environments, and giving investors access to niche products and assets in less efficient markets .. So I think there's always room to add value (just so long as you're adding enough to justify the fee - which has been the difficult bit)
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes

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JoMoney
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Re: The random stock portfolio bogey - beating the monkey

Post by JoMoney » Sat Mar 21, 2015 2:55 pm

Browser wrote:...Maybe what we should be doing is looking for the closest thing we can find to the monkey portfolio at the lowest cost and just go with the monkey.
Maybe what we should be doing is forget about trying to earn excess returns by out-trading other market participants, and focus on ensuring the companies we own are being operated by trustworthy management in the interest of the owners and the community. In aggregate we'd do a lot better trying to be more efficient and more productive in actually creating something of value (or not letting it be squandered) than by trying to play the zero-sum game of "beating the market".
As a group, all we'll get out of this world is the value we create. These strategies to game the market to something "extra" are guaranteed to be fruitless in aggregate. Why do we spend so much time trying to pick trading strategies, and any time a thread is started about corporate governance or efforts by Vanguard etc.. towards that end the thread is essentially DOA.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: The random stock portfolio bogey - beating the monkey

Post by Leeraar » Sat Mar 21, 2015 3:01 pm

Browser wrote:Research has demonstrated that randomly selected equally dollar-weighted stock portfolios produce slightly higher returns over time than the aggregate returns produced by mutual funds; this is the case even accounting for the expenses of both. In other words, if you have your monkey simply randomly pick a reasonably large number of stocks and invest an equal amount of money in each one, on average you'll beat the returns of investing an equal amount of money in a reasonably large number of mutual funds.
Did I miss a news flash? Dollar-weighted will tilt more towards small-cap than cap-weighted will, so returns are higher.

L.
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Uncle Pennybags
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Sat Mar 21, 2015 3:43 pm

Leeraar wrote:Did I miss a news flash? Dollar-weighted will tilt more towards small-cap than cap-weighted will, so returns are higher.
And losses are greater. Index investing will be around as long as traders think they are smarter than other traders. Let the games continue and when you lose blame it on a "black swan".

OP, I agree, a monkey is as good as any "financial advisor".

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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Sat Mar 21, 2015 7:18 pm

Leeraar wrote:
Browser wrote:Research has demonstrated that randomly selected equally dollar-weighted stock portfolios produce slightly higher returns over time than the aggregate returns produced by mutual funds; this is the case even accounting for the expenses of both. In other words, if you have your monkey simply randomly pick a reasonably large number of stocks and invest an equal amount of money in each one, on average you'll beat the returns of investing an equal amount of money in a reasonably large number of mutual funds.
Did I miss a news flash? Dollar-weighted will tilt more towards small-cap than cap-weighted will, so returns are higher.

L.
I wasn't comparing small cap to market cap or any other cap. I was comparing small cap and all the other selection strategies to the monkey portfolio of "no strategy"; simply selecting a random portfolio of stocks (the monkey portfolio). Over short periods of time any given stock selection strategy can beat the monkey portfolio by chance, but unless that outperformance is consistent and predictable over longer time periods (it isn't) then no strategy can beat the random monkey portfolio. So why not just invest in the monkey portfolio and quit screwing around with "tilts" and other stock selection fund strategies that will only beat the monkey by luck?
We don't know where we are, or where we're going -- but we're making good time.

user5027
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Re: The random stock portfolio bogey - beating the monkey

Post by user5027 » Sat Mar 21, 2015 7:32 pm

Two questions;

1) Does the monkey charge 1% of AUM?

2) When the monkey talks, do people listen?

:wink:

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Uncle Pennybags
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Sat Mar 21, 2015 7:42 pm

user5027 wrote:2) When the monkey talks, do people listen?
NEVER listen to a monkey*, they invented the pump and dump.
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*Yes I know a chimp is not a monkey.

ShiftF5
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Re: The random stock portfolio bogey - beating the monkey

Post by ShiftF5 » Sat Mar 21, 2015 8:13 pm

I say we run with this -- "The Monkey Index"

We could do commercials with the monkey (in a suit) throwing the darts, driving his Mercedes, hanging out at his beach house, etc.

Then we IPO this thing.

This is Gold Jerry, Gold I tell Ya.

Who's IN?

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Re: The random stock portfolio bogey - beating the monkey

Post by rkhusky » Fri Mar 27, 2015 10:22 am

Browser wrote: By definition, any fund that is not a random equally dollar-weighted stock portfolio must be an actively managed portfolio: that also includes passive index funds since these are not random equally dollar-weighted either. For example, cap weighted index funds have more money allocated to some stocks in the index than others.
Is this a fund or a basket of stocks picked at random? Is the equal weighting maintained over time?

Funds have to deal with inflows and outflows of cash. A basket of stocks held forever does not.

Maintaining an equal weighting over time requires buying and selling in accordance with price fluctuations. A cap weighted portfolio does not.

I would surmise that an equal weighted randomly selected fund would require much more active management in maintaining the equal weighting than a market-weighted fund.

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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Fri Mar 27, 2015 10:29 am

Probably the only feasible way to do something similar to the "monkey" portfolio is to use an equal-weighted fund or ETF. Another way to approximate it would be to hold an equal allocation to smallcap, midcap, and largecap funds or ETFs. These are each cap weighted, but you can increase the weight of mid and smallcaps overall by doing this. I think it's pretty clear that just holding a total market fund gives too much weight to just a few megacap stocks and your fate is sealed by how this handful of stocks performs -- usually not so well.
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Re: The random stock portfolio bogey - beating the monkey

Post by rca1824 » Fri Mar 27, 2015 10:55 am

rkhusky wrote:
Browser wrote: By definition, any fund that is not a random equally dollar-weighted stock portfolio must be an actively managed portfolio: that also includes passive index funds since these are not random equally dollar-weighted either. For example, cap weighted index funds have more money allocated to some stocks in the index than others.
Is this a fund or a basket of stocks picked at random? Is the equal weighting maintained over time?

Funds have to deal with inflows and outflows of cash. A basket of stocks held forever does not.

Maintaining an equal weighting over time requires buying and selling in accordance with price fluctuations. A cap weighted portfolio does not.

I would surmise that an equal weighted randomly selected fund would require much more active management in maintaining the equal weighting than a market-weighted fund.
I agree here. We should consider the cap-weighted Total US Stock Market the "default" or "no" strategy. Doing equal weights instead of cap weights is the deviation towards active management, not the other way around.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB

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Maynard F. Speer
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Fri Mar 27, 2015 11:44 am

Well there's the monkey's global performance up against various smart beta strategies (from the The Surprising Alpha From Malkiel's Monkey and Upside-Down Strategies)

The monkey seems to beat the cap-weighted index by about 1% annually, but falls short of equal weight, and has some serious catching up to do with forward or backward-weighted fundamental strategies

My interpretation is that stock picking isn't strictly a 'random walk' - logical strategies seem to perform better than random ones .. but simultaneously, popularity (e.g. the poor performing cap-weighted index, and out-performing inverse indexes) suggest a significant 'popularity' premium

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Uncle Pennybags
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Fri Mar 27, 2015 12:08 pm

I feel it is time for another monkey in a suit picture.

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Re: The random stock portfolio bogey - beating the monkey

Post by IlliniDave » Fri Mar 27, 2015 12:32 pm

Browser wrote:Research has demonstrated that randomly selected equally dollar-weighted stock portfolios produce slightly higher returns over time than the aggregate returns produced by mutual funds; this is the case even accounting for the expenses of both. In other words, if you have your monkey simply randomly pick a reasonably large number of stocks and invest an equal amount of money in each one, on average you'll beat the returns of investing an equal amount of money in a reasonably large number of mutual funds.
Isn't the same true for low cost index funds? In other words, if you put money in a few low-cost index funds, you'd expect to out-performs some random amalgamation of mutual funds?

I ask that based on Vanguard's often discussed publication of data where they show their funds beat the majority of their peer funds over the long haul. The monkey fund is simply an index fund with the index components picked by the Monkey instead of SP or MCSI or whoever.

Maybe it's better now, but maintaining strict equal weighting is sort of a nightmare as you'd have to adjust holding on essentially a daily basis. That was the cause of the demise of the first attempt at an SP500-tracking fund (Wells-Fargo, I think). If it's an equal weight initial purchase then let it ride, it's very close to a a cap-weighted tilt towards smaller cap. Readjusting for equal weight only periodically is re-balancing to maintain the tilt.

At least that's how it all seems to me.
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Fri Mar 27, 2015 1:26 pm

IlliniDave wrote:Isn't the same true for low cost index funds? In other words, if you put money in a few low-cost index funds, you'd expect to out-performs some random amalgamation of mutual funds?

The monkey fund is simply an index fund with the index components picked by the Monkey instead of SP or MCSI or whoever.
Nobody beats the monkey for low fees. Brown bananas will do.

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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Fri Mar 27, 2015 2:26 pm

IlliniDave wrote:Isn't the same true for low cost index funds? In other words, if you put money in a few low-cost index funds, you'd expect to out-performs some random amalgamation of mutual funds?

I ask that based on Vanguard's often discussed publication of data where they show their funds beat the majority of their peer funds over the long haul. The monkey fund is simply an index fund with the index components picked by the Monkey instead of SP or MCSI or whoever.

Maybe it's better now, but maintaining strict equal weighting is sort of a nightmare as you'd have to adjust holding on essentially a daily basis. That was the cause of the demise of the first attempt at an SP500-tracking fund (Wells-Fargo, I think). If it's an equal weight initial purchase then let it ride, it's very close to a a cap-weighted tilt towards smaller cap. Readjusting for equal weight only periodically is re-balancing to maintain the tilt.

At least that's how it all seems to me.
In as far as expensive fund fees are a constant, while fund manager performance isn't ..

Limit your mutual funds to only those with low fees, however, and active's average still seems to have a slight edge (while Vanguard actives look to be offering genuine value)

Image

Remember the S&P 500 isn't a simple index .. As Faber notes "It has momentum rules (market cap weighting), fundamental rules (four quarters of earnings, liquidity requirements) and a subjective overlay (committee input). Does that sound passive to you?"
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Re: The random stock portfolio bogey - beating the monkey

Post by fortyofforty » Fri Mar 27, 2015 2:42 pm

I can understand the mechanics of an equal weight portfolio. Would that not "overweight" (based on market cap) micro, small, and midcap stocks? And wouldn't this mean an increase in volatility compared with the overall market based on market cap? I can't believe there is a "free lunch" in a randomly selected portfolio. You've got to give something to get something. What are monkey portfolios giving?
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Fri Mar 27, 2015 2:50 pm

Maynard F. Speer wrote:Remember the S&P 500 isn't a simple index .. As Faber notes "It has momentum rules (market cap weighting), fundamental rules (four quarters of earnings, liquidity requirements) and a subjective overlay (committee input). Does that sound passive to you?"
It is passive in that others do the picking and the fund only has to pay a license fee and a computer programer. If, and it is a big IF, one has the ability and time to research stock and do his own investing one has a chance to beat the S&P 500 index by a few bases points. Active managers beat their index regularly but not by enough to cover their fees. The longer one holds an investment the loss of compounding gains to fees adds up.

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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Fri Mar 27, 2015 2:57 pm

fortyofforty wrote:I can understand the mechanics of an equal weight portfolio. Would that not "overweight" (based on market cap) micro, small, and midcap stocks? And wouldn't this mean an increase in volatility compared with the overall market based on market cap? I can't believe there is a "free lunch" in a randomly selected portfolio. You've got to give something to get something. What are monkey portfolios giving?
The theoretical monkey portfolio should be the default benchmark portfolio, not a cap-weighted portfolio. A random monkey portfolio is the "nobody knows nothing" portfolio -- it's the one a complete idiot would pick. A cap-weighted portfolio is the "crowd-following" portfolio -- it's the one you'd pick if you wanted to pick the stocks that everybody else likes because that seems smarter than the monkey. I figure if you can't beat the idiot portfolio, then you need to go back to the drawing board. And the cap weighted portfolio doesn't beat it, at least over the long run. We have our terminology upside-down. We think that "tilting" means not having a cap-weight portfolio. But the cap-weighted portfolio is actually tilted -- it is tilted away from the random, monkey, idiot portfolio which should be the logical center of gravity in the first place.
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Re: The random stock portfolio bogey - beating the monkey

Post by rkhusky » Fri Mar 27, 2015 3:07 pm

Browser wrote:
fortyofforty wrote:I can understand the mechanics of an equal weight portfolio. Would that not "overweight" (based on market cap) micro, small, and midcap stocks? And wouldn't this mean an increase in volatility compared with the overall market based on market cap? I can't believe there is a "free lunch" in a randomly selected portfolio. You've got to give something to get something. What are monkey portfolios giving?
The theoretical monkey portfolio should be the default benchmark portfolio, not a cap-weighted portfolio. A random monkey portfolio is the "nobody knows nothing" portfolio -- it's the one a complete idiot would pick. A cap-weighted portfolio is the "crowd-following" portfolio -- it's the one you'd pick if you wanted to pick the stocks that everybody else likes because that seems smarter than the monkey. I figure if you can't beat the idiot portfolio, then you need to go back to the drawing board. And the cap weighted portfolio doesn't beat it, at least over the long run. We have our terminology upside-down. We think that "tilting" means not having a cap-weight portfolio. But the cap-weighted portfolio is actually tilted -- it is tilted away from the random, monkey, idiot portfolio which should be the logical center of gravity in the first place.
The Total Market fund is the easiest, choose all the stocks. No need for a monkey.

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Re: The random stock portfolio bogey - beating the monkey

Post by Leeraar » Fri Mar 27, 2015 3:21 pm

Browser wrote:The theoretical monkey portfolio should be the default benchmark portfolio, not a cap-weighted portfolio ...
You're missing the part about the efficient frontier, which is that you should invest in the total economy which is, of course, cap weighted.

Equal weights of all the offerings at the all-you-can-eat buffet is not the best meal.

L.
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Re: The random stock portfolio bogey - beating the monkey

Post by fortyofforty » Fri Mar 27, 2015 3:22 pm

Both ways seem to claim the mantle of not "outguessing" the market. One says each and every stock is priced as correctly as possible, so owning a basket of random choices and not trading them too quickly produces above average results. The other says the price of each and every stock is valued as correctly as possible, so owning all of them in the capitalization weights assigned by all investors simultaneously, and not trading in and out of them, produces above average results after accounting for costs. Each claims not to be making guesses about stock prices or market capitalization, in its own way. :?
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Re: The random stock portfolio bogey - beating the monkey

Post by rkhusky » Fri Mar 27, 2015 4:17 pm

There are two questions: which stocks to own and how much of each stock.

How do you handle inflows/outflows? Do you buy/sell based on the current weightings or do you buy/sell based on equal weighting?

Do you maintain equal weighting? There are apt to be large swings in individual randomly selected stocks.

Equal weighting has a logical inconsistency with mergers and splits. If two companies merge into one, you no longer are equal weighted. Do you sell off half the stock or not maintain equal weighting? If you sell off half the stock, why is the merged company half as valuable compared to prior to the merge? Take it to an extreme: 100 companies merge into one - do you sell off 99% of your holding to maintain equal weighting?

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Re: The random stock portfolio bogey - beating the monkey

Post by Epsilon Delta » Fri Mar 27, 2015 5:07 pm

With the cap weighted TSM we get to ask the question "What happens when everybody does it?"
With the monkey portfolio we get to ask the question "What if 0.1% of people do it?"

Hint: there's not enough Dress Barn to go around.

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Re: The random stock portfolio bogey - beating the monkey

Post by fortyofforty » Fri Mar 27, 2015 5:37 pm

rkhusky wrote:There are two questions: which stocks to own and how much of each stock.

How do you handle inflows/outflows? Do you buy/sell based on the current weightings or do you buy/sell based on equal weighting?

Do you maintain equal weighting? There are apt to be large swings in individual randomly selected stocks.

Equal weighting has a logical inconsistency with mergers and splits. If two companies merge into one, you no longer are equal weighted. Do you sell off half the stock or not maintain equal weighting? If you sell off half the stock, why is the merged company half as valuable compared to prior to the merge? Take it to an extreme: 100 companies merge into one - do you sell off 99% of your holding to maintain equal weighting?
From the article I read recently, the suggestion was simply to sell once a year, and invest the proceeds in a new "basket" of monkey stocks. If a few merge or are taken over, so be it. If all of them merged into one, either ride it out until the end of the year or sell that one giant company and invest in a new "basket". Again, I'm certainly not advocating this, merely trying to understand and appreciate the idea. I'm a cap weight man at heart.
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Re: The random stock portfolio bogey - beating the monkey

Post by rkhusky » Fri Mar 27, 2015 6:27 pm

fortyofforty wrote: From the article I read recently, the suggestion was simply to sell once a year, and invest the proceeds in a new "basket" of monkey stocks. If a few merge or are taken over, so be it. If all of them merged into one, either ride it out until the end of the year or sell that one giant company and invest in a new "basket". Again, I'm certainly not advocating this, merely trying to understand and appreciate the idea. I'm a cap weight man at heart.
The OP claimed that the monkey beats cap weighting over the long term. How does it compare over the short term, like 1 year intervals?
Buying a new basket each year would entail quite a bit of cost - 100% turnover. Vanguard Total Stock Market has a turnover less than 3%. Costs matter.

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Re: The random stock portfolio bogey - beating the monkey

Post by JoMoney » Fri Mar 27, 2015 6:40 pm

Cap weighting makes sense as far as a simple way to manage the portfolio that doesn't require additional turnover. It also makes sense if your goal is to capture the stock markets returns - owning the market as it is (weighted by market-cap) seems logical to me.
If on the other hand your goal is to somehow garner "extra" returns, you're going to have to do something different from the market. There have been a lot of studies, and empirical evidence, that show using a random 'dart throwing monkey' as a strategy is as good (if not better) than many other strategies - especially the strategies being sold by 'professionals'... but I don't think this is adding anything to your investment strategy other than additional factors that will be the result of chance.
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Re: The random stock portfolio bogey - beating the monkey

Post by Kenkat » Fri Mar 27, 2015 6:58 pm

But the cap-weighted portfolio is actually tilted -- it is tilted away from the random, monkey, idiot portfolio which should be the logical center of gravity in the first place.
Well it is tilted away from the market weight portfolio - but isn't that just the same thing as tilting towards small cap and value? In effect, you are saying "don't waste your time doing what the monkey does - just do what the monkey does".

The reason equal weighted portfolios do better is because they have a better chance of holding the few smaller stocks that will eventually grow and become the bigger stocks that the average cap-weighted fund buys - the Dells, Microsofts and Googles that start small and get big.

Here's a thread that presents some of that research:

viewtopic.php?f=10&t=162172&newpost=2435377
Last edited by Kenkat on Fri Mar 27, 2015 6:59 pm, edited 1 time in total.

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Re: The random stock portfolio bogey - beating the monkey

Post by luckyduck288 » Fri Mar 27, 2015 6:58 pm

Equal weighting seems to rely on arbitrary delineations (like business entity/stock ticker, etc.) that don't really follow the underlying economic happenings. A big company is very much like lots of small companies joined together in terms of economic output. The fate of the single stock depends on the individual moving parts of a lot more pieces.

If I want to invest in "the economy" then I want an equal share in each unit of economic output. The way I think of it on a simplistic level, one person doing work for a year is worth on average $x of future growth and dividend income. A small company has a few employees. A large company has lots of employees. I want to invest my money equally to all individual units of economic output, so I give more of my dollars to the big company.

I grant that there are effects within a large company from one unrelated line of work to another, etc. that blur this simplistic view, but I think the crux of it is, bigger companies do more things than smaller companies (cap-wise), and by cap-weighting you are essentially diversifying across all the smaller pieces within each company with the appropriate value the market has determined.

As to the question at hand, I think an equal weighted (monkey) index is favoring small companies which have more potential growth and volatility. That could be part of the difference observed.

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JoMoney
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Re: The random stock portfolio bogey - beating the monkey

Post by JoMoney » Fri Mar 27, 2015 8:04 pm

Something to bear in mind... although there may be some general correlation between market-cap and firm size, "float adjusted" stock market cap size is not necessarily a measurement of the size of the business. It's only a measure of the value in the market, "large cap" stocks as a whole are considered to be more valuable by the market, but that doesn't mean the business itself is larger than a business that's considered a "small cap" stock.
There are lots of businesses that may be a "small cap" stock, but have more assets, more employees, more gross sales, more operating location, etc.. than a "large cap" stock, and vice-versa...
The relative market-cap is simply a measure of how much the company is valued as a whole, or at least how much the "float adjusted" portion of the company that is offered in the public markets is valued as a whole relative to other companies... and that doesn't necessarily relate to other measurements of firm size.

example:
Facebook has a market cap of 223.93 B and 9.2k employees
SnapOn has a market cap of 8.45 B and 11.4k employees
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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Fri Mar 27, 2015 8:47 pm

JoMoney wrote:Cap weighting makes sense as far as a simple way to manage the portfolio that doesn't require additional turnover. It also makes sense if your goal is to capture the stock markets returns - owning the market as it is (weighted by market-cap) seems logical to me.
If on the other hand your goal is to somehow garner "extra" returns, you're going to have to do something different from the market. There have been a lot of studies, and empirical evidence, that show using a random 'dart throwing monkey' as a strategy is as good (if not better) than many other strategies - especially the strategies being sold by 'professionals'... but I don't think this is adding anything to your investment strategy other than additional factors that will be the result of chance.
Here's where the thinking is backwards. I don't think we're looking for an angle to garner "extra" returns; we're looking for a way to avoid not getting the return we should be getting. The "market" is assumed to mean how the total capitalization of the market is divvied up among all the stocks being traded in the market. Most of it is allocated to a few mega-cap stocks. But if the market is viewed as being divvied up across all the stocks being traded, unless you have some information that you should invest most of your money in these few mega-cap stocks, or some other subset of stocks, then maybe you should just spread it equally across all of the stocks in the market. Then the market return will be what you get from doing that; nothing "extra", just what you should get if you invest like a dummy and follow no strategy. What is so special about the handful of stocks that attract the lion's share of capital? Is there any evidence that they will provide better returns than other stocks going forward? Not that I know of.
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Fri Mar 27, 2015 9:05 pm

Browser wrote:Here's where the thinking is backwards. I don't think we're looking for an angle to garner "extra" returns; we're looking for a way to avoid not getting the return we should be getting. The "market" is assumed to mean how the total capitalization of the market is divvied up among all the stocks being traded in the market. Most of it is allocated to a few mega-cap stocks. But if the market is viewed as being divvied up across all the stocks being traded, unless you have some information that you should invest most of your money in these few mega-cap stocks, or some other subset of stocks, then maybe you should just spread it equally across all of the stocks in the market. Then the market return will be what you get from doing that; nothing "extra", just what you should get if you invest like a dummy and follow no strategy. What is so special about the handful of stocks that attract the lion's share of capital? Is there any evidence that they will provide better returns than other stocks going forward? Not that I know of.
The evidence is the top stocks in the S&P 500 do tend to have lower returns than the average .. I've heard it likened to the way animals can only grow so large in nature (before their size becomes a detriment) ... You notice very few companies stay at the top for long - the general trend of 10-20 years is down ..

So one of the simplest 'improved' indexes should just be an S&P 500 with the top handful of companies excluded ..

What I wonder is whether smart beta (and monkeys) provide anything you couldn't synthesize through increasing allocations to small-caps and value conventionally .. Personally, I think when you're talking about exposing yourself to more volatile (potentially higher reward) investments, it doesn't hurt to diversify a bit beyond the norm
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Re: The random stock portfolio bogey - beating the monkey

Post by fortyofforty » Fri Mar 27, 2015 9:13 pm

We really can't invest an equal amount of money in every publicly traded stock. So, we need to either make a selection (random or otherwise) or accept the impossibility of equally weighting all stocks, go with capitalization weighting.

If we make a selection, we can choose a basket of ten, fifty, or a hundred stocks and put our money there. But, if we allow for selecting the stocks, we then also allow for active managers to choose the stocks.

Whether they are chosen by some system or randomly, stock prices all should be correctly valued at any point in time. Following that logic, it is only either supremely bad luck at stockpicking, a failure to look down far enough into small company stocks and deep value stocks (by responding to market noise and peer pressure) to match a truly random selection from the total universe of stocks, or higher trading costs borne by fund shareholders, that reduces active fund returns. Perhaps active fund managers should exert more effort to reduce costs and spend less time and energy on research.
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Re: The random stock portfolio bogey - beating the monkey

Post by JoMoney » Fri Mar 27, 2015 9:21 pm

Browser wrote:...What is so special about the handful of stocks that attract the lion's share of capital? Is there any evidence that they will provide better returns than other stocks going forward? Not that I know of.
Is there evidence that you believe predicts they will provide worse returns than other stocks going forward?
For me, owning a cap-weighted index fund is more a matter of it being a simple enough portfolio that anyone and everyone can hold that's as good as holding an otherwise random group of stocks. There's less turnover required, and (at least as far as the U.S. market goes) is a very well diversified portfolio. I think you could own something like the DJIA wacky price weighted portfolio, or an equal weight portfolio, and still manage to do just fine, or as good as some other portfolio (or at least as much as nobody could tell you that some other portfolio would do better or worse in advance). It's the people that think there's a special formula or trading style like equal-weighting or growth or value or whatever that they think will somehow do something "extra", that I think is off base.
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Re: The random stock portfolio bogey - beating the monkey

Post by rkhusky » Fri Mar 27, 2015 9:29 pm

Browser wrote: Most of it is allocated to a few mega-cap stocks.
That's wrong. The top ten stocks of Vanguard's Total Stock Market make up 14% of the fund. Ten is more than a few and 14% is not even close to being most.

The top ten stocks are Apple Inc., Exxon Mobil Corp., Microsoft Corp., Google Inc., Johnson & Johnson, Wells Fargo & Co., Berkshire Hathaway Inc., General Electric Co., Procter & Gamble Co., and JPMorgan Chase & Co. Why are these the largest components of TSM? Because the millions of investors in the world collectively think they will make the most money investing in these companies.

The millions of investors think the above companies will make them more money than companies like Alkermes plc, Harman International Industries Inc., Snap-on Inc., etc. What do you know that everyone else doesn't know?

Take for example, Proctor & Gamble. It has 80 brands, 23 with sales of more than $1B. If they split into 80 separate companies, do you think the combination would be 80x more profitable than P&G is now? You must if you would equal weight them with a company like P&G.

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Re: The random stock portfolio bogey - beating the monkey

Post by JoMoney » Fri Mar 27, 2015 9:49 pm

It's interesting to see how the markets weight has shifted across various time periods as well. The average or median market-cap of the total market has been shrinking since the late 1990's, less and less of a "Total Market" portfolio has been allocated to the biggest stocks. The trend since the late 1950's has been a "shrinking" market-cap as well, I cant find the data at the moment, but if I remember correctly, the top 10 stocks in the S&P500 in the late 1950's made up close to half the portfolio by weight.

10 years ago, the top 10 stocks in the S&P500 was 20.1% of the portfolio
Today the top 10 stocks in the S&P500 is only 17.7% of the portfolio

I'm not saying it means anything about the future going forward, but the time to complain about a "top heavy" portfolio was during the dot-com boom of 2000, it's been less and less of a factor since.
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Fri Mar 27, 2015 10:33 pm

fortyofforty wrote:We really can't invest an equal amount of money in every publicly traded stock. So, we need to either make a selection (random or otherwise) or accept the impossibility of equally weighting all stocks, go with capitalization weighting.

If we make a selection, we can choose a basket of ten, fifty, or a hundred stocks and put our money there. But, if we allow for selecting the stocks, we then also allow for active managers to choose the stocks.

Whether they are chosen by some system or randomly, stock prices all should be correctly valued at any point in time. Following that logic, it is only either supremely bad luck at stockpicking, a failure to look down far enough into small company stocks and deep value stocks (by responding to market noise and peer pressure) to match a truly random selection from the total universe of stocks, or higher trading costs borne by fund shareholders, that reduces active fund returns. Perhaps active fund managers should exert more effort to reduce costs and spend less time and energy on research.
You can invest in equal-weight ETF indexes these days, such as Guggenheim's Equal-weighted S&P 500 (RSP)

If you believed all stock prices were correctly valued (the strong efficient market hypothesis) there'd be little reason to look outside cap-weighted indexes .. But on that same logic, you'd have happily invested at the peak of the Japanese stock market boom in the 80s (and still not have clawed back losses), or the peak of the Tech boom in the 90s ... So it's probably prudent to consider price as part of the story, but not the whole story

And active funds have dramatically dropped their prices over the years .. In the 90s it wasn't uncommon to find mutual funds with 10% upfront fees .. These days you've got Vanguard active funds at half the price of many ETFs, and in the UK an investment trust's launching with no management fee at all, just a performance fee when the fund exceeds its 10%/annum benchmark
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Fri Mar 27, 2015 10:51 pm

How many stocks is this monkey going to pick and what index is he trying to beat?
Maynard F. Speer wrote:... in the UK an investment trust's launching with no management fee at all, just a performance fee when the fund exceeds its 10%/annum benchmark
How do I buy this fund?

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Re: The random stock portfolio bogey - beating the monkey

Post by Leeraar » Fri Mar 27, 2015 11:19 pm

Maynard F. Speer wrote:The evidence is the top stocks in the S&P 500 do tend to have lower returns than the average .. I've heard it likened to the way animals can only grow so large in nature (before their size becomes a detriment) ... You notice very few companies stay at the top for long - the general trend of 10-20 years is down ..

So one of the simplest 'improved' indexes should just be an S&P 500 with the top handful of companies excluded ..
Yes, you could exclude "The Dogs of the S&P". :P

That's the problem with indexing, you have to buy the bad stocks too.

L.
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Fri Mar 27, 2015 11:35 pm

Uncle Pennybags wrote:How many stocks is this monkey going to pick and what index is he trying to beat?
Maynard F. Speer wrote:... in the UK an investment trust's launching with no management fee at all, just a performance fee when the fund exceeds its 10%/annum benchmark
How do I buy this fund?
For the best recent research paper I've found on the monkey, search The Surprising Upside From Malkiel's Monkey and Upside-down Strategies

Here's that fund in a bit more detail - if it's a success I'm sure the fee structure will catch on .. And I think a lot of worthless fund managers will shrivel
https://woodfordfunds.com/our-funds/wpct/
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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Sat Mar 28, 2015 12:50 am

Actually, the first passive index fund was a monkey fund, begun in 1969 by Wells Fargo Bank. It was based on academic models which resulted in the construction of an index account for the pension fund of Samsonite Corporation, with a strategy based on an equal-weighted index of stocks listed on the NYSE. However, back in those days it was very difficult to implement, so it was replaced with an index fund based on cap-weighting. Cap-weighting has a benefit to both investment companies and investors - it is easier and cheaper to implement and administer; or at least it was back in the 1970s for Wells Fargo and later for Vanguard. But the downside of low overhead is underperforming the monkey. The question is: can you approximate a monkey fund that will still beat the cap-weighted fund inclusive of expenses? I'll bet Vanguard could do it if they wanted to -- but not likely. Here's the interesting narrative by John Bogle that describes the evolution of the cap-weighted index fund:

http://www.vanguard.com/bogle_site/lib/sp19970401.html
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Sat Mar 28, 2015 7:07 am

Browser wrote:Actually, the first passive index fund was a monkey fund, begun in 1969 by Wells Fargo Bank. It was based on academic models which resulted in the construction of an index account for the pension fund of Samsonite Corporation, with a strategy based on an equal-weighted index of stocks listed on the NYSE. However, back in those days it was very difficult to implement, so it was replaced with an index fund based on cap-weighting. Cap-weighting has a benefit to both investment companies and investors - it is easier and cheaper to implement and administer; or at least it was back in the 1970s for Wells Fargo and later for Vanguard. But the downside of low overhead is underperforming the monkey. The question is: can you approximate a monkey fund that will still beat the cap-weighted fund inclusive of expenses? I'll bet Vanguard could do it if they wanted to -- but not likely. Here's the interesting narrative by John Bogle that describes the evolution of the cap-weighted index fund:

http://www.vanguard.com/bogle_site/lib/sp19970401.html
I'd say a lot of smart beta funds could appear very monkey-like .. They're generally more even weight; they break you out of the relationship with market cap; and it can be hard to work out the logic behind something like minimum variance from the outside

The assumption a fund which weighted companies by how many board members wore bow ties should still beat a cap-weighted fund may suggest the monkey effect (the more even distribution of value, momentum, cap - and possibly an unknown factor) explains a large part of smart beta's success

The problem is soon as everyone buys the monkey fund, it becomes the cap-weighted fund .. Cap-weighted is the only one the whole market could hold at once .. But I think it makes a lot of sense for an individual to hold a combination of cap-weighted and fundamental-weighted (or cheap active) .. Anything to make your portfolio a bit different still seems likely to pay off
Last edited by Maynard F. Speer on Sat Mar 28, 2015 7:09 am, edited 1 time in total.
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Re: The random stock portfolio bogey - beating the monkey

Post by fortyofforty » Sat Mar 28, 2015 7:08 am

Maynard F. Speer wrote:If you believed all stock prices were correctly valued (the strong efficient market hypothesis) there'd be little reason to look outside cap-weighted indexes .. But on that same logic, you'd have happily invested at the peak of the Japanese stock market boom in the 80s (and still not have clawed back losses), or the peak of the Tech boom in the 90s ... So it's probably prudent to consider price as part of the story, but not the whole story.
If you believed all stock prices were correctly valued you would have invested in your monkey basket of thirty Japanese stocks, if you were a happy Japanese investor. They also likely would have plummeted, along with the market indexes. Or you could have chosen your basket of thirty tech stocks in the 1990s, if you believe all stocks are correctly valued. The logic applies equally to cap weighted and monkey basket (my term) investing. Who is to say basket X of stocks is better than basket Y of stocks? If stock prices are correct, why (other than because we want to control risk through diversification) choose a random group of stocks instead of a focused group of stocks? Would a basket of S&P 500 stocks move you away from the random monkey basket? Too far, or is 500 enough diversification to simulate randomness?
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Sat Mar 28, 2015 9:38 am

Maynard F. Speer wrote:Here's that fund in a bit more detail - if it's a success I'm sure the fee structure will catch on .. And I think a lot of worthless fund managers will shrivel
https://woodfordfunds.com/our-funds/wpct/
That is very difficult to understand. It appears that one has to hold the fund through a broker who charges 1.09% yearly fees or more; there also is a 1.5% load paid to buy into the IPO from the market maker. If it sounds to good to be true it probably is.

http://www.clubfinance.co.uk/Woodford-income-fund.php

It appears the monkey fund beats them on fees, brown bandanas sell at a deep discount.

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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Sat Mar 28, 2015 10:17 am

fortyofforty wrote:If you believed all stock prices were correctly valued you would have invested in your monkey basket of thirty Japanese stocks, if you were a happy Japanese investor. They also likely would have plummeted, along with the market indexes. Or you could have chosen your basket of thirty tech stocks in the 1990s, if you believe all stocks are correctly valued. The logic applies equally to cap weighted and monkey basket (my term) investing. Who is to say basket X of stocks is better than basket Y of stocks? If stock prices are correct, why (other than because we want to control risk through diversification) choose a random group of stocks instead of a focused group of stocks? Would a basket of S&P 500 stocks move you away from the random monkey basket? Too far, or is 500 enough diversification to simulate randomness?
That's conflating two different ideas .. You'd have done better in a monkey portfolio (through the Japanese or US Tech crashes) because you'd likely have held more value stocks; but the point about EMH is that when price has deviated too far from underlying value, it's generally been wrong .. Demonstrating that, at least at the extremes, markets probably aren't strictly efficient

Human behaviours - risk aversion, greed, group hysteria, crowding, etc - show up as tiny, daily pricing inefficiencies .. and while much of a monkey portfolio's apparent out-performance can be explained by exposing you to slightly more risk, there appears to be some Alpha creeping in ... And that Alpha *may* simply be that holding the cap-weighted index exposes you to slightly more inefficient group behaviour
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Re: The random stock portfolio bogey - beating the monkey

Post by Maynard F. Speer » Sat Mar 28, 2015 10:37 am

Uncle Pennybags wrote:That is very difficult to understand. It appears that one has to hold the fund through a broker who charges 1.09% yearly fees or more; there also is a 1.5% load paid to buy into the IPO from the market maker. If it sounds to good to be true it probably is.

http://www.clubfinance.co.uk/Woodford-income-fund.php

It appears the monkey fund beats them on fees, brown bandanas sell at a deep discount.
I think it's probably doing a bad job of explaining itself then .. You can hold the fund through brokers which charge 0.15-0.25% (such as Charles Stanley Direct) or less, with no load I'm aware of (my broker doesn't even charge for buying these shares)

So you could hold the fund for effectively 0.3% total, and it only takes a fee when it exceeds 10% compounded - and it only takes the fee in the form of issuing new shares ... It should be very cheap to own .. There's no reason you can't get the best fund management in the world on an ETF fee - I think Vanguard demonstrate that

https://www.charles-stanley-direct.co.u ... al_Report/
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Re: The random stock portfolio bogey - beating the monkey

Post by Browser » Sat Mar 28, 2015 11:02 am

"Tilting" toward factors like small and value are like taking investment "vitamins." Nutritionists came up with the idea that you could ingest certain synthetic concoctions that represented nutritional substances that would improve your health, called vitamins. In investing we have the same idea: there is vitamin B, or Beta; and there is vitamin S, or smallcap, and vitamin V, or value. There are various funds that represent different synthetic formulations of these nutritional investment factors. If you add some of these to your investment diet, or "tilt", it is supposed to improve the health of your investment portfolio. Investigators have been busy discovering a lot of new investment vitamins lately, such as vitamin P, or profitability and vitamin Q, or quality. Some investigators are recommending that we take a supplement that will lower the vitamin B in our investment system, called LB, or low-beta.

But many medical professionals argue that a much better way to insure that you are ingesting all the important nutritional factors is to consume a broad, diversified array of foods in their natural form. That way you are getting everything that is important in the most beneficial human-ingestible form. That includes any known nutritional factors both singly and in complex combinations, as well as perhaps hundreds or thousands of unknown, undiscovered, and perhaps undiscoverable factors, such as micronutrients that are critical to good health. You avoid synthetic concoctions made with various formulations that may or may not be effective and good for your health and the unnecessary cost of manufacturing expensive urine.

Likewise, rather than adding synthetic investment supplements (and worrying about their formulation and effectiveness), an investor might be better off with a broad, diversified array of investment elements in his/her financial diet. The way to do that is to eat a little bit of everything in balanced proportions and don't overweight any particular elements; as in the monkey portfolio diet. Original source, natural complex combinations, includes dozens, hundreds, of "factors" both known and unknown, discovered and undiscovered. Go natural with the monkey!
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Re: The random stock portfolio bogey - beating the monkey

Post by Uncle Pennybags » Sat Mar 28, 2015 11:29 am

Browser wrote: In investing we have the same idea: there is vitamin B, or Beta; and there is vitamin S, or smallcap, and vitamin V, or value.
If "advisers" didn't come up with these investments they would have noting to sell. It appears there will always be a market for the snake oil.

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Re: The random stock portfolio bogey - beating the monkey

Post by peppers » Sat Mar 28, 2015 12:03 pm

Since monkeys are global, I wonder if they would exhibit a home country bias.
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