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What Would You Prefer?

I have been spending some more time playing with the data set below which I looked at last week within the context of long term returns for the All Ordinaries.

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One of the issues that is difficult for traders to come to grips with is the lumpiness of returns that are generated by trading systems. I dont know of any trading system that generates regular returns aside from much touted option writing systems and these generally lead to traders suffering from the old maxim of eating like birds and shitting like elephants. Using the returns above I decided to look at the difference between a system that had the above returns and one which every year simply generated the average market return of 9.8%. The results for such a system can be seen in the table below.

100 table

As you can see it takes a good two decades before any serious differential appears but once it does appear it becomes extreme.

However, table doesn’t quite convey the magnitude of the difference between accepting a given flt return each year and the returns generated by the lumpiness of the market so I decided to graph the returns. I have had to graph them separately because of the disparity in values between the two systems.

100

In simple terms these graphs ask the question – do you want to be rich or comfortable?

 

All Ordinaries Distribution Of Returns

I have been having a bit of a play with the All Ordinaries yearly returns since 1901 and I cobbled together the table below which I have coloured red and blue. Red is those years where the return is below the average of 9.8% and blue is those years of above average return.

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What is interesting to me is that there have only been 41 years of below average returns – the clear majority of returns are above average. This once again demonstrates the interesting upward bias within the index. Allied to this is the extreme over correction in the market following a series of down years (bear market). Following down years the market springs back with above average gains.

All Ordinaries 52 Week Highs

52

The Order Of Things Matters

Every now and again I get sent a magic trading system complete with equity curve, generally these are some sort of magic system someone is flogging that promises massive returns and never has a drawdown. They are the sort of quit your job with $10,000 and intra-day trade FX and make $10,000 per week. If you have been around markets long enough you will have seen this sort of thing – I have to give them some credit because at least they include and equity curve as opposed to simply quoting some mythical average return like fund managers do. Equity curves do convey a lot of information – they tell you about the trajectory of funds that have been invested. You can get a sense of how bumpy the journey might be and whether you could stomach the trip. However, the thing they do not tell you is the role of luck in achieving those particular returns. The returns a trading system generates and in turn its equity curve are uniquely sensitive to luck – not so much in the sense that the trader may have gotten lucky and run into the largest bull market in history which is entirely possible. But rather they are completely dependent upon the order in which the returns where generated.

To give you a simple example of this consider the chart below. In this chart I map the value of $1 invested in the All Ordinaries and $1 invested in the All Ordinaries but with the returns reversed so the return for 2015 becomes the return for 1900 and so on.

True Vs Reversed

I have plotted these on a log scale so you can get a sense of the journey – you can instantly see how simply reversing the returns changes the track of the curve. The reversed values lag behind the true values for 2/3 of the time, it lags for the first 30 odd years, catches up and then begins to lag again from the mid 1970s’. The true returns have a terminal value of $437,097.87 whereas the reversed values top out at $420,087.87. Simply changing the order costs the system $16,941.77

The same is true small changes in return – in the true return the years 1985 and 1986 were power years. They were the high point of the 1980’s bull run in terms of absolute returns with a return of 44% and 52% respectively but in looking at returns the question needs to be asked as to what the curve would look like if these were just average years of 9% return. Traders tend to spend too much time thinking about all the ways it is going to go right but very little time is spent on what could go wrong.

Expanded

The true values have the same terminal value of $437,097.87 wheres the changing of 1985/86 to average years drops the return to  $264,251.37 – a difference of $172,846.50. Whilst this does make for an interesting through experiment it also has practical implications. Trend following systems are built upon the outlier years – this is what generates their returns. If you miss these outliers then your returns over time will be ordinary. Traders do have a habit of missing these years simply because they are either caught in someone else’s narrative and miss market moves, they dont believe the move when it happens because they have a preconceived view of how much an instrument/position is worth or they are caught by the limiting belief that you can never go broke taking a profit. I lost count of people in the mid 1990’s who thought that COH was overvalued at $3.00. Granted its path to $157 has not been linear but its move to $45 was as close as you can get. This move is gone forever for such traders and will never return.

The same situation applies to the random reordering of returns. The chart below is the true returns compare to a randomly reordered sample of the same returns.

Random

The randomly reordered returns show almost a century of relative under performance including a substantial initial drawdown. So when you look at an equity dont take it as gospel, think  of the ways in which the journey could have changed with a few simple alterations or slip ups along the way. The overall aim of any form of system design is to produce a system that is incredibly robust and which shows profitability over a wide range of conditions and events.  In trading you need a little luck but you do not want to be dependent upon it.

Road To Nowhere

It has been awhile since blog central  had a look at the All Ords and its staggering lack of ability to go anywhere. The full extent of the rubbish nature of the local market at present can be seen below when the performance is compared to the S&P 500 and NASDAQ 100.

performance

This lack of movement becomes more apparent when we chart price movement on a weekly basis.

Ords Weekly

The current consolidation sits within a much broader malaise that saw the market fail to puncture 6000 earlier in the year.

Ords Daily

From a trading perspective there is very little on offer when the index is simply drifting sideways. However, there is always a silver lining to these things in that the longer this compression continues the more interesting the breakout will be.

YTD Performance

As we sail past the half way point of the year I thought I look in the rear view mirror might be interesting to see how a few select markets have performed. There are no prizes for guessing that the local market has been shit.

ytd

 

The Great Idiot Tax Continues

It is at this time of the year when superannuation funds crow about how good they have done and of their inestimable benefit to mankind in general and this year was no exception.  So as is my now annual tradition I thought I would have a look at how good they have done and compare that to the real world where delusions about how good you think you are dont exist. From the article I linked to I took this table which looks at the average return of a a growth fund since 1993.

Screen-Shot-2017-07-03-at-1.44.22-pm

Source – Superannuation returns above 10% for the June Year

This piece acts as a good starting point for comparison with the market. For this I used the All Ordinaries Total Return index which used to be known as the Accumulation Index. It includes not only the price movement of the index but also folds back in the dividends of the index components so it is a good benchmark for simply passively holding an index fund or ETF.

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When the chart of the average return of a growth fund is first viewed it does create an overall favourable impression – there are only three negative years and returns seem overall to be quite robust. It is only when you compare this active management with a passive benchmark that you realise how poor local managers actually do when compared to the index. Remember these are people who are paid to beat the index and as we will see they are paid staggering sums of money. Looking at annual percentage returns is quite crude and does lack a bit of fidelity, you dont actually know what the true performance differential is so I looked at the value of $1 invested into an average growth fund and into the index and got the following.

C2

The market leaves the industry for dead – the market investment would now be worth $9.87 versus the industries $5.91 and for this privileged investors have been ripped off handsomely. The chart below looks at what my guess of the annual fee intake of superannuation funds is. For this I have assumed an average fee of 1.5% to cover not only management fees but also advisor commissions.

c3

So to produce a theoretical return of slightly better than half what the market produced  in the period above the superannuation industry has collected probably close to $310B in fees. So to once again steal from Winston Churchill – never in the field of human endevour has so much been paid to so few for so little.

General Advice Warning

The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.