Canadian Investment Review

Triumph of the Backtesters

Written by Scot Blythe on Wednesday, April 21st, 2010 at 4:32 pm

346025_3478Earlier this year, Standard & Poors launched an index tracking how well a 130/30 strategy would have worked using the S&P/TSX 60. A 130/30 strategy is a fully invested quantitative method where 30% of the portfolio stocks are shorted, and the cash from the short sales invested in long-term stock picks.

But shorting isn’t always possible; sometimes underweights will have to do. In its application to Toronto stocks, S&P says: “The index overweights a long basket of 10 stocks versus its S&P/TSX 60 benchmark weight by 3% each, and underweights a short basket of 10 stocks versus its S&P/TSX 60 benchmark weight by 3% each. The remaining stocks retain benchmark weights.”

The backtested results indicate “that the index delivers risk-controlled outperformance. Over 1-, 3-, and 5-year periods, the index outperforms the benchmark S&P/TSX 60 with beta exposures close to one. The rolling 30-month information ratio since inception is 0.51.”

So that’s better beta for the buck – or market performance with less risk.

Now comes a “contrarian index,” created by Dow Jones.

The method, applied across a portfolio of 125 stocks with equal weight, provides: “a transparent, rules-based tool for benchmarking contrarian investment strategies. The index is designed to systematically measure the performance of stocks that lag behind the broader market in terms of recent performance, but that outrank their peers based on fundamentals-based and other qualitative criteria.”

In the rear-view mirror, it certainly boasts impressive results: 92% over one year, 21% since inception in 1991.

And, like 130/30 indexes, it has a comprehensive methodology.From a universe of 2,500 stocks, “the selection pool is ranked by each of the ten qualitative factors defined below, where the best-ranked stocks receive the highest scores. The scores for all ten variables are summed to a composite rank.”

Of course, just as there was an ETF for the S&P/TSX 130/30 index, there is now one for the Dow Jones Contrarian Opportunities.

Turning qualities into quantities is the magic of the dialectic. Still, are contrarians, like a herd of cats, quantifiable?

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