Advanced Automatic Investor

[aptus]

Hi Tom,

I'm not aware of any such reviews but when I first started Automatic Investor I had wanted to build in some sort of stock selection algorithm. Unfortunately finding the data (and the algorithm) was difficult back then.

A few years later, however, I was able to build a fundamentals analyzer into AI using some data available at Yahoo! Finance. I know quite a few AI users used it to select stocks and then manage them using AIM, but I don't know if any of them did formal backtests.

I then started to read quite a bit about Benjamin Graham and Warren Buffett and came to the conclusion that selecting fundamentally strong stocks with wide moats was what was required for AIM (mostly because of AIM's long-term outlook and its algorithm that bought more when prices fell -- it seemed clear to me that it was detrimental to buy more shares of bad stocks when prices dipped but was favorable to buy more shares of excellent stocks on price declines).

And what I was reading about Buffett and Graham made me realize they had already come up with an algorithm to find the excellent stocks -- and so Value Stock Selector was born.

Shortly afterwards I made the decision to use Buffett's methods for most of VSS with a bit of Graham (and a couple of others) on the side.

Putting it all together is basically what you've alluded to. Construct portfolios of strong stocks with wide moats. Only purchase shares when they are undervalued and then let AIM manage them.

You would sell if the fundamentals (or moat strength) decreased below a certain level, otherwise you would buy and sell according to AIM's recommendations. The VSS estimated sell price would not be used because AIM would take care of the sales.

In addition, for a long time I've placed a high importance on diversification, allocation and rebalancing.

AI has a built-in allocation function and I had presented on diversification at the AIM 2001 conference and wrote an article titled, Using Modern Portfolio Theory with Automatic Investor.

VSS also has an allocation function (based on the Sharpe ratio) so the only thing left was rebalancing. In the Pragmatic Investor book I described some rebalancing techniques and also described a form of extreme rebalancing I call the Value Trading Algorithm.

Lately I've been working on including Opportunistic Rebalancing into my new Pragmatic Investor software project.

To summarize, I see starting with great stocks that are selling for less than they're worth (i.e. Graham's margin of safety), diversifying based on low correlations, allocating based on reward/risk (i.e. the Sharpe Ratio), using AIM to manage risk at the micro-level and rebalancing at the macro-level using an Opportunistic Rebalancing strategy.

It sounds simple enough, but it has literally taken years to get to this point.

Regards,
Mark.