First, our favorite “Yo’ Mama” joke:
Yo’ Mama is so stupid, she stared at the orange juice carton because it said ‘concentrate.’
But seriously: today we begin an experiment in concentration. Our work – and related work – explains why indexing tends to crush active management. The problem is that active managers have a high probability of picking subsets of the index that miss or underweight the handful of winners that drive index performance. If there is a solution, it is concentration.
I don’t mean concentrating on 25 or 30 stocks. I mean concentrating on 1 or 2 stocks. The very, very, very “best” idea.
So here is our experiment:
(1) Today, Monday, June 18, 2018, we sort the S&P500 firms by last Friday’s (June 15) closing market cap, 1 to 500, from smallest to largest. Note that we will take the S&P500 as constituted at that point in time. No adjustments, for example, for firms that have been acquired if their stock has not yet been taken out of the index or for announced but not yet implemented replacements.
(2) We generate a random number between 1 and 500 using the runif function in R, which generates a random number from a uniform distribution. Today, we got 69.50213. We round that number to 70.
(3) The 70th firm is Under Armour, which has two classes of shares. Wherever we have two classes of shares, we generate another random number between 0 and 2 and pick the alphabetically-lower if below 1 and alphabetically-higher if above 1. Today we got 1.876036, so we pick Under Armour Inc Class C (UA) instead of Under Armour Inc Class A
(4) At approximately 8:45 a.m. central time, we put in an order for as close to $10,000 worth of UA at the market price as we can get. Today that was $21.08 per share for 475 shares (yes, commission is high!):
(5) We then put in an order for SPY – the S&P Index ETF. This is our benchmark portfolio. Today that was 37 shares at $275.425.
(6) Our Concentrating Chimp follows a simple rule: if his stock has outperformed the SPY over the preceding month (a determination he will make as of market close on Friday, July 13, 2018, then he does nothing and holds the prior pick. If he has underperformed the SPY, he picks a new stock as above and, at approximately 8:45 a.m. the next trading day, sells his previous stock and buys his new stock. And so on.
(7) We’ll post the Concentrating Chimp’s results against his benchmark here every Friday after close. These are real positions in a real, tax-advantaged traditional IRA. We’ll post execution images for each trade as above.
And that is the Concentrating Chimp experiment.