It was a successful first 12 months. The strategy checked off the list of expected outcomes, plus quite a few unexpected hiccups.
Total Return Year One: +36.5%
MDY is the relevant benchmark to compare MIR20 (an ETF, that reflects the S&P 400). SPY - an ETF that reflects the S&P 500 index (useful as a reflection of the large-capitalization market)
(Put option pricing will go to zero, if markets decline less than 10%. This is the cost of "insurance")
What the Strategy Experienced
The individual stocks in the strategy outperformed the broad S&P 400 index. Reasoning: MIR20 selects consistently profitable companies for portfolio inclusion. The index on the other hand has a significant number of unprofitable companies in its composition.
The strategy was more volatile on both strong and weak days relative to the index. MIRS 20 holds, on average, 18 different stocks versus 400 companies in the S&P 400 index. The strategy was, therefore, very susceptible to individual stock news (good in the long term, but makes for a choppy short-term experience).
The expense of portfolio Put insurance came in at 3.3%. I had budgeted for a 4% to 5% expense. On average, I rolled the Puts every two months at 10% out of the money. The major indexes never corrected greater than 10% during this first year of the strategy, so the insurance was never tested. I was somewhat surprised that the Puts did not decrease daily volatility in the portfolio. I could tighten the exercise price to 5% below the current S&P 500 levels (I have been using 10% OTM) to reduce daily volatility.....but at a large increase in expense). So far, I can live with the daily fluctuations.
It was relatively easy in October 2023 to select 20 companies with the required attributes. Currently, it is much harder due to the substantial stock market rally. The portfolio presently holds 14 securities. The search is on for eligible candidates.
Relative performance versus the benchmark S&P 400 confirmed the strategy benefits for the first year of this beta trial. After deducting the expense of the Puts, the strategy returned 36.5% versus the MDY index at 28.2%.
The Jury's Still Out
MIR20's risk strategy is partially managed by "stop loss" orders. They are initially set at 20% below the purchase price of the stock. This strategy successfully worked as expected. Stocks were sold if they experienced a 20% price drop. This prevents the strategy from holding on to stocks that might trade substantially lower. The most striking example of the stop-loss in action was the sale of Perrion Network at an 11.2% loss (poor EPS announcement). It has subsequently fallen a further 67%
Several stocks that were stopped out, rallied post-sale by 50% to 60%. So, this risk control is a two-edged sword. On balance, this risk control rule provided discipline
In addition to a typical stop loss (based on the purchase price), the stop price was raised lock step with any appreciation in the stock price. A stock purchased at $10 that subsequently rallied to $12 dictated that the stop price be adjusted from $8 to $9.60. Experience with this rule was decidedly mixed. Quality mid-cap stocks are very volatile. After a run-up of 30% to 50%, these stocks have frequently corrected by 20%+. The strategy would end up selling the stock on this 20% correction... at a price point that you would rather be a buyer than a seller. The strategy no longer has a "trailing stop loss" that adjusts higher when a stock rallies in price. The Hard stop remains in place based on the initial purchase price.
One-year data indicates that many of these terrific companies occasionally have missed investor expectations. The stock would then sell off, and analysts would pull in their estimates and price targets. More often than not, these stocks would fall initially and then strongly rally back. Being too quick to agree with the downgrading analysts proved to be a losing decision.
It was a good year to test out the strategy. Rising markets provided a strong tailwind. The next few years will likely have several corrections greater than 10%. This will test the Put option positioning for volatility control and capital risk.
regards, Tim
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients. For the past two years, the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your advisor for investment advice.