Value Investing By Proxy

By many Benjamin Graham is considered to be the father of "value investing" and with his book "The Intelligent Investor", Mr. Graham brought value investing to the individual investor.

Mr. Graham advised the investor to always hold bonds in his investment portfolio:

"We recommend that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75% with the converse being necessarily true for the common-stock component."

Combining Mr. Graham's recommendation with the concept of paired switching previously discussed, leads to the following long only application:

• Intermittently rebalance a basket of VTI (stocks) and TLT (bonds) and allocate 75% of capital to the best performing EFT and the remaining 25% to the other ETF.
• The rebalancing frequency may be set for example to quarterly or monthly.
• Performance is measured using total return over the prior quarter or prior three months.

Building such a "Value Investing By Proxy" model in Excel is fairly easy using monthly adjusted closes available from Yahoo! Finance (VTI, TLT).

Especially the Quarterly model is particularly suitable for investors confronted with a minimum 90 day holding period for their accounts.

For both models the spreadsheets are available on the Google Drive connected to this blog. For backtesting on prolonged price history, the synthetically created assets come in useful (see here for details). Remember to update the price data in Excel periodically.

Instead of manually downloading, importing and sorting price data using Excel, a more sophisticated approach is achievable through AmiBroker. The software not only takes care of automated downloads and updates, but also allows for flexible asset pair compositions and quick adjustments of backtesting settings.

The below examples show AmiBroker's equity curves (semi-log scale) for the monthly respectively quarterly strategies using two long term mutual funds FDVLX and VUSTX. The backtests start on December 31, 1986 including the October 19, 1987 Black Monday world wide stock market crash.

FDVLX - VUSTX with monthly rebalancing. Backtest includes the 1987 "Black Monday" crash.

FDVLX - VUSTX with quarterly rebalancing. Again, the backtest includes the 1987 "Black Monday" crash.

If you have AmiBroker or if you want to run the trial-version, a free copy of the ValueInvesting.afl is available on Google Drive too.

Please note the AmiBroker script is intended for monthly data, hence adjust the Backtester Settings accordingly to Monthly or Quarterly Periodicity. For proper execution the user needs to set StocksTicker, BondsTicker and Momentum Length through the Parameter window too (see below screenshots).

  Settings for Monthly Model

Settings for Quarterly Model

Acknowledgment goes to "varan" for developing and sharing this naive value investing concept in a comment on SeekingAlpha. Once again SanzProphet and "fxshrat" did a great job by providing help on finalizing the code for AmiBroker.

Please share your thoughts and ideas in the comment section below. More to come after the summer break!

[Edit: Updated charts and xls' on Google Drive now match the performance metrics as reported by AmiBroker.]