Raphael Fiorentino
Raphael Fiorentino
Oct 16 - 4 min read

Winning by doing almost nothing

Over confidence, over trading, and over reaction to market noise, are unrelenting enemies of successful, long term active investing. Butterwire resolves these by encouraging an unwavering focus on what matters for long term wealth, helping investors find opportunities with less effort, take risk without speculating, stay ahead without over trading, and get an edge without overpaying.

Volatility is back

The events of this past week have highlighted once again how uncertain markets can be – in one week, half of the world’s largest public equities lost over 4% of their market capitalisation. Of the 14 shares (out of the 2,788 in the MSCI Global Index) that managed to gain over 10% last week, half were precious metals stocks (gold miners lost 25% of their value year to date, twice as much as physical gold has) and half were Indian stocks (whose country index lost 20% of its value in the last 2 months). Meanwhile, the best performing European stock was jewellery producer Pandora, up 8% after losing over half of its value since 2017. Spot a pattern?

Do you know the risks you are taking?

The key here is not to confuse (market) uncertainty with (portfolio) risk. Risk is what you decide to take with a view to profit from it, uncertainty is what you can only try and minimise the impact from when it hits. Is your portfolio a collection of, largely unrelated, mostly company-specific risks, or is it dominated by a few large uncertain bets that might suddenly go hard against you? How will your portfolio perform if global growth expectations tanks, if oil price expectations rise, if value stocks rally? How well do you know the risks you are taking?

The Butterwire approach aims at constructing portfolios where risk is targeted and uncertainty contained, so that in periods of high market volatility users merely need to tend to any alert requiring attention, possibly investigate an unchecked source of risk concentration that may be dragging portfolio performance down, and otherwise bless/curse one’s good/bad luck for not having taken money off the table sooner!

“Mindless” passive investing is starting to hurt... a little

Back in May, we reported on fast declining global growth and market return expectations since a peak in January, as reflected by our proprietary indicators (see below). In the article, we commented on what we believed to be unsustainably favourable market conditions for passive investors: as index tracking in effect represents a bet on the ever-rising price of the largest stocks and on low market volatility, the unfolding development didn’t bode well for passive strategies.

Graph which charts global equity index expected return over three years, from 2016 to 2018

We went on to publish a list of 20 large cap and 20 mid-cap stocks analysed by Butterwire as “stocks with interesting fundamentals and high recession resilience scores”. It was an opportunity to showcase our app as we started our crowdfunding campaign and report on the stocks’ returns when the campaign ended in mid-September. It turned out that 72% of the stocks listed generated positive excess return (+8.7% average relative to the Eurostoxx 50 index). The 28% that lost out -5.4% on average relative to the index. Intriguingly, there were 82% of winners amongst the larger stocks and only 62% amongst the smaller ones.

Why such an unusual difference between larger and smaller stocks? Whereas market returns did turn negative since May (-5% for global equities, -8% for European equities and even -16% for Emerging Markets), money has continued flowing into index tracker funds, and this may have contributed to granting the very largest (and hence most owned by tracker funds) stocks an exorbitant privilege: that of outperforming an average mid-size stocks by 4% over the past month, despite unfavourable earnings revision. The fact that larger stocks tend to pay a higher dividend due to their lower growth must have played a part, but it remains that for now, passive investors are still in relatively good shape and seemingly holding their nerves (sometimes with some unwanted help from technology.)

So how is an active investor to win in such barmy market conditions?

How does one navigate in an environment when for instance in Europe, an average EU stock lost -6.5% of its value in one month, when large out-of-favour value stocks vastly outperform one day, only for small high growth volatile stocks to rip in concert the next? When using Butterwire, it consists of being prepared for it and… keep doing almost nothing:

  1. Keep addressing holdings with alerts or red/amber flags or negative technical indicators assigned by Butterwire and keep preferring stocks with above-average base/recession resilience scores – this alone would have given you an even chance of matching the index this past month, never mind if you actually invested the time to get knowledgeable about your holdings!

  2. Keep avoiding portfolio risk concentration on large bets (size, industry, momentum, macro, etc.) that are liable to rapidly swing against you. Over the past month for instance, holding only small-size, non-dividend paying (ie. high growth) EU stocks would have yielded a 65% chance of your portfolio losing over 10% of its value. Butterwire’s portfolio assessment feature would have highlighted this risk and suggested ways to mitigate it.

  3. Keep reviewing your decision to (not) take (some) money off the table, aided by Butterwire’s proprietary market signals (iGDP, iEMR) – these indicators started alerting users in April. It is, simply, the most strategic and hence most crucial decision one can make.

Simply upload your portfolio to the application and let Butterwire provide some useful insights.