ITA Wealth Management

One of my “hobbies” it to locate portfolios on the Internet and then run an analysis on them to see how they are projected to return vs. well diversified mosaic style portfolios that are set up over on the Premium side of this blog.  Here is one such portfolio.

Note the portfolio is holding a high percentage in cash (PRTBX). While that is a distinct advantage so long as the broad market continues to decline, that position will penalize the projected average annual return.  In other words, if the cash were invested in stocks, the PAR would be higher than the 9.32% that is showing up in the blue area of this insert.

The Standard Deviation (SD) of 14% is rather low for a stock portfolio, but this too would rise if not for all the money held in a cash account.

Note that most of the stocks have projected annual returns that are significantly above the portfolio average of 9.32%.  Another feature of this analysis is to check the return of this portfolio, had it been held in the same percentages three years ago.  In the yellow area, you will see the return was -2.59%.  This value is significantly lower than the projected return going forward.  Reversion-to-the-mean argues that this is a good time to be invested as the differential between the projected return (9.32%) and the lagging or historical return (-2.59%) is 11.9%.  This is a sufficiently large percentage that one should put that cash to work.

Two other measurements I want to highlight are the DM and AC values. The Diversification Metric (DM) is a respectable 46%.  We want that to be as high as possible.  Berkshire Hathaway has a DM of 67% even though the portfolio is highly concentrated in a few holdings.  Our goal is to have the DM exceed 50% so this “Club Portfolio” is just about there.

Autocorrelation (see definition below) is on the high side at nearly 40%.  Holding only a few stocks increases the chances of this portfolio having rather wild swings to both the upside and downside. Right now we are not concerned as the portfolio is position to experience a significant upward move or just what we want to occur.

What is portfolio autocorrelation?

QRP and QPP both calculate an historical statistic called portfolio autocorrelation.  This is a recent feature and is not yet included in the user manual / textbook.  Portfolio autocorrelation is the correlation in portfolio returns from one month to the next.  If it is positive then high returns tend to be followed by high returns and vice versa.  If portfolio autocorrelation is negative, then the portfolio returns tend to be ‘mean reverting’ which means that very high return months tend to be followed by returns closer to the mean–the portfolio tends to damp out periods of very high or very low returns.  Portfolio theory generally assumes that autocorrelation is zero–the random walk.  QPP and QRP model the market as though autocorrelation is zero, and the metric shown is for historical performance.  If you have a portfolio that shows a lot of positive autocorrelation, this is a flag–this means that big swings get amplified.  These effects are widely debated, but there is evidence that they can be meaningful.

Lowell Herr

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