A.I.M. Users Bulletin Board

[ls7550]

Hi Allen

Thanks for book rec.

FT = Financial Times

For instance if you look at http://markets.ft.com/research/Markets/Sectors-And-Industries/Consumer-Goods you'll see Consumer Goods sector data

The sector has 1 year gained 14.76% as of timing of writing, however within that the average gain of all of the different parts is 23%

The best part was Consumer Electronics with a 1 year up 165% relative to the equal weighted sector average gain (up 61.3% in nominal terms). The worst was Non durable Household products thats down -67.2% relative to the equal weighted sector average (up 7.1% nominal).

If you considered the average to be a inflationary uplift amount (obviously its not at least over the shorter term, but as a indicator of how considering such eliminates upward inflationary bias), the the best and worst extremes had gain factors relative to the average of

0.328 Worst
2.658 Best

i.e. part gain / sector gain figures, which for those two extreme cases produces

0.872 Product
1.493 Average

With equal weighting periodically rebalanced you'll tend to capture more towards that average figure, with buy and hold you'll tend to capture more like the product figure. With nearly 20 parts in that sector and two of them enduring such characteristics, that's 10% exposure to such characteristics. 0.1 x -12.8 = -1.28%; And 0.1 x 49.3% = 4.93%; A 6% spread relative to that sector. If the sector is 10% of the whole (assuming 10 sectors) that's 0.6% relative to the whole. And other sectors might be churning out a higher figure.

With buy and hold you in effect say OK one part has risen a lot but I'll let it ride, and another has relatively declined but I'll also let that ride. Its then relatively overweight one part that has risen a lot and underweight another part that has declined a lot. Yet often the one that has risen (or fallen) a lot isn't the best (worst) the next year.

Generally the effect of reducing the best performing holding and adding to the worst performing holding has a positive effect Which is what AIM tends to do. AIM doesn't have exclusivity on that however and there are many alternatives. Praveen's AIM board for instance strives to maintain equal amounts invested in each holding. Others have noted how such equal weighting tends to relatively outperform over the long term for instance John Mauldin wrote a article some time back that compared the equal weighted Dow since the 1920's with other choices of Dow management - and the equal weighted came out best.

Rebalancing all holdings back to equal weighting however is a costly process, you have to strive to minimise such costs - such as perhaps just rebalancing the best and worst 10% of holdings (20% of assets perhaps having half the value churned = 10% churn). It can also all get rather complicated if you try to do things yourself. The benefit is fractal and is apparent at the stock, sector and market/index levels, so if one sector has 50 stocks and another 2 stocks do you allocate the same amounts to each sector, or to each stock? A simple answer is not to concern yourself with that and just let AIM take care of things. Allocate what you think to be appropriate to each AIM and then given just the price AIM will have you add or reduce in a appropriate manner over time.

Another relatively simple and trade cost efficient choice is to equal weight a diverse bunch of stocks, sectors or indexes and whenever any one breaches 1.5 times the median weighting then reduce it by a third and add the proceeds to any that are below the median weighting