Sunday 30 April 2017

Over Trading

I recently ran some tests on the portfolio to show the impact of turnover. This involved picking random start and end dates and then running two tests: how the portfolio itself (the 'active' portfolio) performed between those dates and how the portfolio would have performed if no changes were made to the initial portfolio at the start of the test period (i.e. just go to the beach - the 'do nothing' portfolio). 

You would hope the more actively traded portfolio would beat the do-nothing portfolio (otherwise what's the point in turning the portfolio over). I ran the test across four time periods across the last 17 months. Results were pre-tax, but post brokerage. Dividends are included, however franking credits are excluded (to make the calculation easier). I've assumed dividends aren't reinvested for the do-nothing portfolio (again, to make the calculations easier). 

The average value add of the more active portfolio was -0.7%. Yes, that' means trading has actually been a cost, not value-add. The active portfolio did perform better in three of the four periods, but one period (covering the last six months) was materially worse. Looking through the results, it is clear that some winners were sold too early and moving on to the next latest and greatest really is not always the best thing to do.

The results are even more pronounced if tax is factored in. Any capital gains from the very initial portfolio are unrealised.

These results are consistent with academic studies showing low turnover portfolios tend to beat higher turnover portfolios.

While it is not a long-time period and there could be some good/bad luck across the different portfolio, it's at least very difficult to argue that more frequent turnover is the way to go. Brokerage starts adding up. Companies need time to execute business plans. Yet, as a fairly active person myself, it is difficult at times to not take action. That's something to work on.

I should also note the individual stocks in the do-nothing portfolios at times have had a large degree of volatility. You do need a tough stomach to watch share prices bounce all over the place in the short term. 

Kristian