The 3rd 2023 quarterly rebalance of the CM Low Vol portfolio goes out to Capitalmind Premium and CM Low Vol smallcase subscribers this weekend. This post covers a quarterly update of our factor portfolios: CM Low Vol and CM Momentum.
A short introduction to the two portfolios for new readers:
Capitalmind Momentum
CM Momentum is a long-term quantitative strategy that invests in stocks showing strong price and volume momentum. The underlying principle of Momentum investing, is consistently buying stocks showing stronger relative price momentum offers a strong probability of outperforming the market when implemented over three+ year timeframes. The momentum effect has been well-documented in academic and practitioner research globally.
Our portfolio is sector and market cap agnostic, holds up to 25 stocks selected from all NSE-listed stocks meeting minimum criteria in daily traded volume and market capitalization. The portfolio is reviewed weekly and rebalanced based on a set of price and volume parameters. The portfolio aims to capture the best performers in the market and let the winners run with a disciplined approach. When stocks meeting entry criteria are not found, the portfolio allocates to alternate assets like Gold, Debt or Cash.
Capitalmind Low Vol
CM Low Vol is a long-term quantitative strategy that invests in stocks that have lower volatility than the market. It is based on the principle that stocks with lower past volatility than the market, can deliver higher returns with lower risk over the long term. The Low Volatility effect has been also been documented in various research papers, like ‘The Volatility Effect revisited‘
Our portfolio is sector and market cap agnostic, holds 15 to 20 stocks selected from all NSE-listed stocks meeting minimum criteria in daily traded volume and market capitalization. Historically, the low volatility portfolio holds more large and midcaps due to the selection criteria or relative volatility. The portfolio is rebalanced quarterly based on a set of volatility and diversification parameters.
Recent Performance
Table shows the recent performance of the two portfolios over the last 1M to 12M windows.
Chart shows year-to-date performance in 2023
Markets have had a steady four-month run up since April this year finally taking a breather in August. The Nifty is up 8% in 2023. CM Premium Low Vol is up 12% and CM Premium Momentum is up 18% in the year so far.
Capitalmind Low Vol since inception
The Low Vol portfolio has now completed two years since it went live. It recovered after a rocky start and has done 11% annualised compared to 9.6% for the Nifty over the same time frame.
Capitalmind Momentum since inception
CM Momentum has been live for nearly four years eight months and counting. Chart shows cumulative performance of ₹100 invested in the CM Momentum portfolio at inception in Jan 2019.
Since the last update in May, the Momentum portfolio has crossed its previous high.
One-year rolling returns
Chart shows one-year rolling return for CM Momentum and CM Low Vol. The purple line only starts in Aug 2022 since that’s when Low Vol completed one year since going live.
A rolling return chart offers a visual sense of how often or not an active strategy has been ahead of the index in its history.
What turned Momentum around
From trailing the index a year ago to only being at par three months ago to now being ahead by a margin now, things have changed. Slower than some would have liked but also quite quickly if you consider CM Momentum was trailing the Nifty on a one-year rolling basis just 3 months ago.
So, what changed? What incredible changes did we make in the last 3 months to the portfolio rules that enabled this turnaround?
Answer: In the last 3 months, not a thing. This is going to get boring to hear, we trusted the process.
Iterative improvement is a core component of that process, but not changes in reaction to periods of recent underperformance, that would be curve-fitting that accurately predicts the past. The image below lays out the steps of our process involved in going from a quantitative thesis to a live strategy.
The backtests have shown that the strategy trails the benchmark on a 1-year horizon over 30% of the time but that changes on a 3-year and longer time horizon. And when it does outperform, it tends to do so by a wide margin. This means a three+ year timeframe is minimum when investing in a momentum-like factor strategy. And even that guarantees nothing.
Referring back to this excerpt from the May 2023 update:
Factor performance is difficult to explain in the short run and hence can be difficult to stick with when suffering. This is both a curse and blessing, as it makes factors more difficult to stick with during the difficult times (that’s the curse), but this is what allows factors to bring much-needed diversification to investors’ portfolios (the benefit).
Our message remains consistent.
Like we said in Apr 2021 when CM Momentum was up 130% in 12 months:
A great month relative-performance-wise is also a good time as a reminder that our momentum strategy can and will underperform at times.
Or in June 2021, after a +9% month:
When everything ends in the green, and you start wondering “how much” and not “if at all” about returns, that’s when markets tend to surprise.
Or in July 2021, after a +5% month:
if you expect outperformance 100% of the time, you will be disappointed. Momentum investing offers the potential to outperform net of costs and taxes. But only if one thinks of a long-term allocation and stays with it over 36 months and longer, and through the inevitable periods of underperformance because the outperformance does not announce itself before showing up.
Or in Sep 2021, after a -3% month:
Negative returns and/or underperformance versus the index should not come as a surprise to those who have consistently read our commentary about momentum investing.
The only certain way to never have a negative month is to invest in Fixed Deposits and the only certain way to always outperform the index is to make up your results. Since we do neither, there will be stretches of time where performance doesn’t look great.
Bottomline, the returns equities in general are lumpy, and those of any strategy, including Momentum and Low Vol will also be that way. If someone had asked me in May 2023, do I expect Momentum to go up over 15% in the next three months, I would have shrugged my shoulders and said “feels unlikely”.
But quantitative strategies have nothing to do with my or anyone’s feelings. Their indifference to commentary and future outlooks is what makes them potent longterm investments.
Chart below is one of our high-level gauges of strength in equities. It shows median one-year trailing returns of the universe of over 1,500 stocks, not just the handful that decide the direction of the index. The shaded band represents the range between the 75th and 25th percentile of one-year returns.
3 months ago, the median stock was barely positive on a 1-year horizon. At the time, we said
Over the last couple of weeks, the median stock has broken into positive after a while. Whether that represents a a false-start like in 2013, or a 2016-like comeback for equities, remains to be seen.
Since then, things have looked up as roughly 2 out of 3 of companies have reported growth in earnings over trailing twelve month period and that has shown in how equities in general have done. But expect things to get bumpy over the next few if the monsoon ends up being below normal, which tends to do not nice things to inflation which will impact when interest rates can start reducing.
Source: mausam.imd.gov.in
As always, we’ll know for sure only in hindsight.
A recent thread comparing over 50 Nifty indices and how they have done since their inception:
NSE has a ton of equity indices, 96 of them. Removing a bunch of the repetitive ones, we are still left with over 50.
Chart below shows their CAGR since inception. All the way from 23% (Midcap150 Momentum50) to -3% (Realty). The Nifty has clocked 14% over 24 years. (1/10) pic.twitter.com/LP43sFOkUi— Anoop (@CalmInvestor) August 14, 2023
CM Premium subscribers, please ping us your queries on #helpdesk. Or DM us on twitter @capitalmind_in
This post is for information and not a recommendation to buy or sell any stock. Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
