Performance Review and Action Steps for 2016

An important aspect of investing is to look back and evaluate each step in your process to determine where there is room for improvement, not only in each specific step but the overall process.

With that in mind, the focus of this week’s commentary is a look back at the performance ofTWR during the 2015 calendar year and then discuss a framework for reviewing your own investment process in the hopes of improving your investment returns during 2016.

This performance and trade review requires that I honestly evaluate all of my trades, most importantly the trades that turned out to be wrong. Generally speaking, 60 to 70% of my trades are losers.

The trade ideas in TWR over the last year are no different, with 55% of the ideas being unprofitable. This ratio of losers to winners is right within the bounds of what I would expect from my process.

The one trade stat that I’m very pleased with is the ratio of average profit per winning trade ideas to the average loss of losing trade ideas, which is approximately 2.8-to-1.  This is up considerably from last year’s ratio of 1.5-to-1.

In the evaluation of your own investment decisions, this ratio should be at a minimum 2-to-1 and ideally would be closer to 3 or 4-to-1. A ratio in this range tells you two things. First, it tells you that your are keeping your losers in check. Minimizing losses is the key to consistent investment results because it is the only part of a trade that you can control. Second, it tells you that you are focused on good ideas where the reward-risk set up is skewed in your favor. I much prefer a strategy that only has to be right a third of the time to be profitable. It means there is a lot of room for error and you can still come out ahead.

One area that I would like to improve is the number of trade ideas in a given 12-month period of time. Even though the focus of TWR is a minimalist approach, I would like to have an average of 1 trade idea initiated each week. This past year we initiated 24 trade ideas, or an average of just 2 each month.

I’m going to make a concerted effort to increase the quantity of our trade ideas, while keeping the reward-to-risk characteristics of those ideas skewed in our favor. Having said all of that, I’m very pleased with the overall performance of TWR during 2015, which is 31.6%, with just 3 trading days remaining.

I’m exceptionally pleased that we were able to perform this well with about 1 trade every other week. And again in 2015, TWR performed extremely well when compared to “professional” money managers such as mutual funds and hedge funds.

Here’s how TWR’s performance stacks up relative to the competition. The 2015 performance puts TWR in the:

·      Top 0.02% of all 31,356 mutual funds tracked by Morningstar. Only 3 funds in the entire universe performed better than TWR.

·       Top 0.04% of all 461 mutual funds tracked by Morningstar in their “Alternative” category. Only 1 fund performed better than TWR this year.

·      Better performance than all 563 mutual funds tracked by Morningstar in their “World Allocation” category. The top ranked fund in this category returned just over 6% this year.

·      Better performance than all 328 mutual funds tracked by Morningstar in their “TacticalAllocation” category. The top ranked fund in this category returned 9% this year.

·     Top 8% of all 3,979 hedge funds tracked by Morningstar.

·      Top 2% of all 196 hedge funds tracked by Morningstar in their “Multistrategy” category. Only 2 funds performed better than TWR.

·      Top 4% of all 108 hedge funds tracked by Morningstar in their “Global Macro” category. Only 3 funds performed better than TWR.

TWR’s relative returns are very solid on their own.  The returns become more impressive when you factor in the low commission costs of implementing the trade ideas.  There are a low number of trades with long holding periods, 1 trade every 2 weeks with an average holding period of 22 days. 

It’s important to note that the commissions mutual funds pay to trade are not reported in the performance number that Morningstar publishes. Given the steep learning curve associated with not being able to intervene during the week; I think the future performance of TWR is quite bright.

 

The Review Framework

Several years ago, I put together a 7-part framework that I use to evaluate my trading results. This framework will help you to evaluate your own process and the performance results that it generates. A good starting place is to evaluate each of your investment decisions during 2015 and the overall results you produced. Here’s the framework: 

 

INFORMATION PROCESSING- Consistently gathering critical information that is relevant to your trading.

TRADE IDEA GENERATION- Engaging in creative thought to turn that critical information into non-consensus trading ideas.

TRADE IDEA CHARACTERISTICS- Expressing the trade ideas you generate in #2 as trades with risk-reward characteristics skewed in your favor.

EXECUTION- Entering trade ideas based on pre-determined criteria and exiting trade ideas at pre-determined targets.

POSITION and RISK MANAGEMENT– Allocating capital into each trade idea appropriately for risk control and choosing acceptable risk prices and profit targets.

OVERALL PORTFOLIO MANAGEMENT- Assembling trade ideas into a coherent whole portfolio where each trade idea is driven by a different catalyst and as such offers the potential for unique returns. Markets are dynamic and constantly changing, you should monitor correlations across positions and the ever changing risk-reward of each individual trade idea.

SELF-MANAGEMENT- Keeping yourself in optimal mental, physical, and emotional condition to make sound decisions.

 

While I have framed this as a year-end review, I use this same framework to review trades each week, month and quarter.

Using this type of process on a minimum of a monthly time frame will allow you to make minor adjustments as you see fit throughout the year, thereby making the refinement of your process a consistent factor in your improving performance.

Reviewing your trades with this type of framework will allow you to pinpoint where in your process that you’re making the most mistakes or possibly repeating the same mistake over and over again.

For example, you may find that you curate information very well and generate good trade ideas but you have a hard time following through on a trade plan because you have issues with self-management.

This type of insight will help you to focus on the parts of your investment process that can yield the best improvement in your trading results.

One final suggestion on implementing this framework is that the best time to refine your process is when the markets are closed and there is no capital at risk. You need to be sure to put yourself in an objective position to evaluate your process.

Strip the emotion out of it and evaluate each step above looking for improvement, however minor. Even minor improvements can add up into significant changes in portfolio performance.

Here’s to wishing you a prosperous year of trading in 2016! Thank you for making The Whaley Report part of your investment process!