Published on March 15, 2014
“ Page 1 of 4 March 2011 © Copyright StockTakers Limited, All Rights Reserved. Copying Prohibited. The author does not provide investment advice. In order to use reproduce or convey the material herein, in any way, written agreement must be obtained from the author or its agent Architypes Inc. StockTakers Limited is an Alberta corporation providing information on “likeables” equities. StockTakers Limited encourages your seeking tax law advisor for capital gains tax dispositions. The Grail and The Goat Portfolios The Ancient Fable of the Grail and the Goat “ ,,, all sorts of considerations enter into market valuation which are in no way relevant to the prospective yield.” - J. Maynard Keynes 1936i . The major stock markets can be shown to “separate” into two portfolios of stocks. One portfolio of equities has the very opportune properties of a (1) zero risk and (2) zero beta stock portfolio within the meaning of those terms in economics. The others remaining, or contra portfolio results from the first’s separation, with some conceptual adjustments, the Capital Asset Pricing Model (CAPM). Both parts must obtain in order that the separation rule be effective. The separated portfolios can be formally described as first, “a portfolio of stocks that tends to not lose in value” and then the second its complement, the contra, “a portfolio of stocks that tends to not gain in value”. These are the Grail and the Goat of every market as we know exist. One, the first, we can drink from endlessly while the other may waste our gardens and our forests, as well as our wallets, to which we are contra disposed. With those definitions, more appears to be true but is not guaranteed or required by the theory, namely that the first portfolio not only tends to not lose in value but to gain in value absolutely and against the market, up or down, the Grail. Whereas its complement the Goat not only tends to not gain in value but to lose in value absolutely and against the market, increasing less in a rising market and decreasing more in a falling one. A low risk tolerance investor will accept the first portfolio readily as it is his wish to not lose. That is the Grail of investment after all; it is paramount to not lose ones savings, while hopeful of making some gains. Such is the nature of a Consol is it not? Ones money at least is kept at the value roughly presumed of the natural rate of inflation long observed and respected that it be so. It is a rate in line with the rate of population growth and innovation, a rent on the money needed. There will be fluctuations in the markets, but the tendency of the first separated portfolio The Grail is calm and observed to clear result over longer terms, to zero risk and zero beta with high alpha, gains of the separated few in number which have this tendency. They do exist, we have seen them often, later after the fact, but want and need to see these sooner for this first portfolio to be realized, that we may hold it sooner and no others if we possibly can do so. It is the so often heard, “If Only I Had ...” portfolio, by another familiar name, as uttered in resigned exasperation. Its complement, however, the contra or Goat, is usually much larger by the number of eligible companies in it. These are familiar too, as these companies in it tend to gain or lose in the stock price with equal frequency and in more extreme amounts so that it is an appropriate domain for the methods of CAPM and modern portfolio theory be applied there and more appropriate there in that contra portfolio than the market as a whole. At very least because the Grail Portfolio is
“ Page 2 of 4 March 2011 © Copyright StockTakers Limited, All Rights Reserved. Copying Prohibited. The author does not provide investment advice. In order to use reproduce or convey the material herein, in any way, written agreement must be obtained from the author or its agent Architypes Inc. StockTakers Limited is an Alberta corporation providing information on “likeables” equities. StockTakers Limited encourages your seeking tax law advisor for capital gains tax dispositions. The Grail and The Goat Portfolios also a significant part of the market, in general, and acts as a substantial risk free asset within it but has no meaningful beta correlation with the market as a whole as CAPM and MPT relate. In terms of CAPM, the Grail and this complement the Goat are effectively orthogonal (in an economic sense) by definition and generalize the concepts of the risk free asset or bond in the equities market as a whole, although the Grail is itself a portfolio of stocks in the same market. Because of its apparent and demonstrated high real returns, the Grail can be used to offer risk free investment products to consumers with a reasonable prospect of high returns. Further, it offers guaranteed capital safety and liquidity to the buyer that can easily withstand a legal challenge when the conventional terms of risk, capital safety, and liquidity are properly defined. Most particularly, it is shown that the time-worn concepts of risk and reward as defined by the volatility of the expected returns, have no economic content and are implicitly defined by the tools, not by the nature of economic activity itself. First and foremost the Grail supports risk aversion and possibly but incidentally, high returns as well. That is good use of “likeables”. This Grail and the Goat Portfolios exist, for we all have seen its fabled story before, always in hind sight, unfortunately it is true. It is always such a tasty tempting meal, we have missed. We just need a suited quiver and bow and such other skills than neither CAPM nor MPT offer! The StockTakers “price of risk” is the “price of likeability” and has shown it such a tool. It's not hard to see that every stock market or group of stocks such as the Dow Industrials, Dow Transports, S&P 500, NASDAQ, etcetera, partitions naturally into exactly two portfolios of stocks that have nice properties. In the first group, include all the companies in our “sample space”, so to speak, for which the portfolio (as a whole, however weighted) that is created by the selection tends to not lose in value, and in the second, or its complement, the rest, so that that portfolio will tend to not gain in value. Obviously, the first portfolio is a kind of “holy grail”, a “money machine” made up of pieces readily available. The second is not bad either because having taken out the first, the remaining portfolio will tend to not gain in value so in some sense losing is as likely as winning and so Our risk price is calculated independently of the stock price – it is truly new information - but balance sheet data always lag the valuation by typically three to six months because that's all the market knows, in general. We show all the companies in our “sample space” portfolio created by our metric tend to not lose in value, is a kind of “holy grail.” Whereas we kept our profits and even increased them – with no change in strategy – the Dow promptly lost 40% and finished below where it was eight years previous – and nobody knows why, it went down or up. The portfolios selected in our metric tend to not lose money, but they also tend to gain money absolutely and to outperform the markets that they're in. These portfolios will gain in price, quarter over quarter, twice as often as they lose, and have the characteristic of a (1) zero risk and (2) zero beta stock portfolio and can be said to replicate a “deep discounted zero coupon bond.”
“ Page 3 of 4 March 2011 © Copyright StockTakers Limited, All Rights Reserved. Copying Prohibited. The author does not provide investment advice. In order to use reproduce or convey the material herein, in any way, written agreement must be obtained from the author or its agent Architypes Inc. StockTakers Limited is an Alberta corporation providing information on “likeables” equities. StockTakers Limited encourages your seeking tax law advisor for capital gains tax dispositions. The Grail and The Goat Portfolios becomes a more appropriate domain for the methods of CAPM, VaR, and portfolio managementii . That it can be done is also not in doubt. The portfolio that is shown in Exhibit 1: Zero to Hero, is exactly of that sort. Any company in the DJIA during the time frame year 2000 through 2008 was in the portfolio if and only if its stock price (SP) exceeded its risk price (SF)iii and that became the surrogate for “tending to not lose in value” and its contra, “tending to not gain in value”. Although we don't suggest it, there are “brute force ways” to discover portfolios like that, though without theory there is no way to ensure that once we have found one it will continue that way. For example, in the thirty companies of the Dow Industrials, at any time, there are exactly a mere 2^30=1,073,741,824 “portfolios”, equal-weighted, to check (plus the contra position), to see for how long the properties obtain in each case; that is, the top portfolio tends not to lose in value while the complement tends not to gain in value. We do not have enough money for that test. Clearly, without a theory to explain the past, that's all that one can do is to look at the past and just as clearly, when the test fails, the past is no longer the future, by definition. We note in passing that the “differential” methods of most of economics are only a substitute for a search algorithm that hopes to make a robust distinction. For example, in the Capital Asset Pricing Model (CAPM) the distinction is made by optimizing a utility function of Sharpe-Markowitz type and the search is made easier by assuming that the utility function is differentiable and that the domain, stock prices, is continuous, neither assumption of which is true in practiceiv . Zero to Hero and 29% IRR Exhibit 1: Portfolio Values and Cash Balances – From Zero to Hero
“ Page 4 of 4 March 2011 © Copyright StockTakers Limited, All Rights Reserved. Copying Prohibited. The author does not provide investment advice. In order to use reproduce or convey the material herein, in any way, written agreement must be obtained from the author or its agent Architypes Inc. StockTakers Limited is an Alberta corporation providing information on “likeables” equities. StockTakers Limited encourages your seeking tax law advisor for capital gains tax dispositions. The Grail and The Goat Portfolios This Grail Zero to Hero portfolio can be described in more detail but we notice right away that the portfolio value (which is the sum of the equity values in green and the cash balance in yellow or pink) starts at zero and increases more or less steadilyv to $11.6 million whereas in the same period, the Dow Jones Industrial Average (on the same scale) starts at $11.6 million and ends up at $9.5 million ten years later, $2 million lighter and a much more “exhilarating” ride (so much for index investing and passive “couch potato” portfolios). We also note, for example, that whereas the Dow ran between $10 million and $15 million (+50%) in 2004-2007, our portfolio ran between $5 million and $10 million (+100%) during that time. It's also noteworthy that whereas we kept our profits and even increased them – with no change in strategy – the Dow promptly lost 40% and finished below where it was eight years previous – and nobody knows why. Nobody knows why it went up. And nobody knows why it went down. Where the returns are sufficient we may drink well from this Grail Portfolio without more effort of ourselves, children or heirs. Our theory has provided the necessary for determining the Grail Portfolio. The StockTakers “price of likeability” has shown such Grail Portfolios exist in every market, and even with greater internal rates of return. That is a very robust distinction. This Grail, we may also call a “Perpetual Bond” because of both its high returns and of its capital safety and liquidity. Both of these may be guaranteed in practice, with benchmark portfolio returns of 30% per year as we have shown, which are often exceeded in practice as we have continued to show, but are not guaranteed by the applicable theory of CAPM, VaR, and portfolio management. StockTakers provides the necessary new theory of the firm that gives us that insight, obtaining high AlphaSmart gains, nearing zero risk Beta, Capital Safety and Liquidity. We can create such an investment product in future, which is reasonable. In fact that is without doubt, and we shall. For now, we welcome creating wealth for our clients in their portfolios, and gain for ourselves. We wish to create the legally requiredvi actuarial reserve for such a “Perpetual Bond” guarantee, as can be backed by the Grail Portfolios sought by every investor. That is the story for another day, soon enough. i J. M. Keynes, The General Theory of Employment, Interest and Money, New York, 1936. ii The same could be said for the first or top portfolio; however, there is an implicit bias here towards winning that (we will show) is actually rewarded. One could seek “losing” in the same way but it is not deemed “economic”. iii The “risk price” is a technical term to be defined herein. iv The “domain” dilemma is actually much worse that we have indicated. For example, what space is the space of prices? It is certainly not a “linear vector space” because adding the market value of two companies does not give the market value of the two companies combined. To put it another way, a stock price has an economic meaning but the sum of two stock prices (for different companies), doesn't. v There are three losing quarters in the first three years (and one much later in 2008 of $60,000 in $11 million) when the equity holdings are small in number – that's predictable and avoidable – we're not ”stock pickers” and the more that we're in the market, bull or bear, the better. vi Necessary law, as prior theory to ours has not existed to account for any means to obtain consistent return for the long term.
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