The global financial crisis of 2008 affected all sectors of economic activity with no exception. It affected the business performance of companies both directly and indirectly, but the level of impact was different. This fact provides broad opportunities to find investment strategies based on differences in the long-term price reaction of, for instance, stocks on the same systematic factor.
In this article we will try to find an example of a portfolio that would statistically and graphically reflect the possibility of building a successful investment strategy based on differences in the long-term behavior of stocks. For this purpose, we selected 22 stocks of U.S. large and liquid companies belonging to the various sectors of the economy. Using the approaches of modern portfolio theory, the principles of risk diversification, as well as the method of portfolio analysis GeWorko, we will try to divide our selected assets into 2 groups: “Good” portfolio and “Bad” portfolio.
The “Good” portfolio will consist of assets with positive weights, that is, candidates for purchase. The “Bad” portfolio will include stocks on which short positions should be taken according to our analysis. The entire analysis is based on monthly closing prices recorded over the past 4 years (50 months). The composition of the assets (22 shares), selected to build a portfolio, with corresponding tickers.
There are slightly more “Bad” assets than the “Good” ones; however, such an epithet does not diminish their importance. As we will see later, these two groups of assets are able to show the most effective performance only when they are together. As for companies’ belonging to an economic sector, we could not highlight a specific pattern for the companies entering a certain portfolio. Companies, representing completely different sectors, were included in both portfolios.
Let us now display “Good” and “Bad” portfolio charts separately. We will use the method of portfolio analysis GeWorko, which is implemented in trading-analytical terminal NetTradeX. We choose 10 assets from “Good” portfolio and express its value in U.S. dollars as we
are now interested in looking at its absolute value. To do this, we introduce weight coefficient for each asset in terms of U.S. dollars, at the same time respecting the proportion, obtained previously in the solution for the optimal portfolio. For example, for AXP stocks we are entering the amount of 897 dollars and for the stock VZ, the volume of 8177 dollars. Despite that the volume was set in dollars, not in percentage, it will not affect the shape of portfolio’s curve, but only the coordinates.
In general, we have a growing retrospective structure. Since the beginning of January 2009 the value of the “Good” portfolio increased by 2.5 times, but we should also mention a significant fall in the portfolio value in 2008. Let us also note that in the beginning of March 2012 the portfolio’s value fluctuated around 52,300 dollars; this fact will help us in future for studying the dynamics of the combined portfolio.Similarly, we will construct the “Bad” portfolio consisting of 12 assets, introducing the corresponding volumes in U.S. dollars. Its retrospective dynamics is presented on the chart.
Obviously, the “Bad” portfolio justifies its name, having significantly underperformed the “Good” portfolio in terms of realized return, which is evident from the three-fold decrease in its value in 2008 and the subsequent slight growth. In addition, let us note that at the beginning of March 2012 the value of “Bad” portfolio also fluctuated around 52,300 dollars.
Finally, we will construct a combined portfolio which will include both “Good” and “Bad” assets with those weights obtained during the optimization. Note that the negative weights correspond to short selling of the asset. When building a portfolio in trading and analytical terminal NetTradeX, assets with positive weights will be included in the base part of the composite portfolio, while assets with short weights – in the quoted part. In other words, we conditionally buy assets of “Good” portfolio and sell assets of the “Bad” one – these two actions reflect the essence of GeWorko method. The result is a coefficient that reflects the value of the first (in our case – the “Good”) portfolio in the units of the second (“Bad”), and the chart allows us to track its changes during the entire period of time.
The analysis of the behavior of portfolios shows that during the most severe crisis in 2008, the “Good” portfolio lost less value than the “Bad” one. In the post-crisis period, the growth of the first portfolio also proved to be more prominent than the growth of the second. By combining these two factors, we obtained a continuous growing structure. Since the growth of the combined portfolio began in 2008 (before that the combined portfolio has been following a neutral trend), we can assume that this year has become the reversal point, when assets have started showing different degrees of reactions towards some systematic factors. Note that before the beginning of March 2012 the value of the “Bad” portfolio has been exceeding the value of the “Good” portfolio – the coefficient of the combined versions was below 1. However, in March 2012, their absolute value equaled, and the coefficient became equal to 1. Later on more and more units of “Bad” portfolio were required to buy one unit of the “Good” portfolio.