Replies to post #33890 on A.I.M. Users Bulletin Board (AIMUSERS)

[Conrad]

My head is still spinning from earlier 50-50 debates and now I am not able to digest this Spin Off from the Clive's Analysis Factory, which is running on overtime. . .I bet Clive is beating his factory workers with leather whips with tiny steel nails in it. . . :-)

In order to potentially understand what you have discovered Clive, I have to understand this first:

. . .of that mechanism is that stock exposure levels decline over time.

What does this mean?

I promise not to be naughty!

I am far to exhausted to become naughty, I am also keeping track of events in Libya so I can interfere there to set things straight, if things get out of hand there, so I won't have much time to challenge you.

[OldAIMGuy]

Hi Clive, Re: Performance measures relative to possible AIM overlays..............

I like the analysis you've done putting together your tome on "ROCAR Factor." We always need to be careful not to hand out too many gold stars for performance in just one category. Thinking of our investments as a business helps to clarify such things:

- If we hand out gold stars just for buying, we could be hopelessly mired in a swamp of low quality merchandise with little resale value.

- If we hand out gold stars just for selling, we could burn through a lot of inventory and not realize the true profit potential of the properly selected merchandise.

- If we hand out gold stars for running our business strictly as a warehouse operation with little regard for cash flow, we run the risk of missing opportunities to build inventory because of lack of purchasing power when the best prices are available.

- If we hand out gold stars for running our business with primary focus on the Savings and Loan aspect, we can handicap the warehouse function.

In the analysis I did over 10 years ago I attempted to learn what impact each sort of basic AIM overlay had on performance. I didn't want to hand out gold stars for just one measure of performance, however, because doing so affects longer term aspects of portfolio management. (see http://www.aim-users.com/aimchng.htm )

Over the long term I looked not just at total return or ROCAR, but a combination of the two. Anything we do should be enchancing total return, but without inflicting excessive damage on overall management. So, I looked at those changes that added improvement to both total return and ROCAR (both total performance and risk adjusted performance).

While doing the study, it became apparent that we could push total return higher in some cases, but only at the sacrifice of ROCAR. This could be measured other ways, too, such as the changed BETA or Standard Deviation that occurs to portfolio value with each change. It then became the goal to essentially build a model where total performance is enhanced while carefully watching the effect on ROCAR. If total return rises as well as ROCAR, then a change is effective (handing out gold stars for more than one category of performance).

As we make tweaks to our business model we need to check in several areas to see if we've not done something that weakens another area of our business. I certainly learned that pushing total return had a point of diminishing or just plateau'd ROCAR. We need to have in mind what our tolerances are for the whole of our business and make sure that pushing total return isn't upsetting the other parameters of our mission.

While modeling doesn't predict the future, it does help give us a feel for how history unfolds under past circumstances. It helps us refine our overall business model. But it is only truly effective when we use a variety of business parameters as measures of effectiveness.

I'm reminded of companies where the Sales department gets huge incentives for increasing top line revenues (gold stars for only sales). While it might be good for sales, it might also be quite bad for bottom line income. (sell everything at a loss and make up the shortfall with more volume!)

Another company might have employee compensation incentives that only concentrate on bottom line income - such as profit sharing. This forces the staff to be very "company oriented" to the exclusion of being "customer oriented." Gold stars for only bottom line profits could impede overall company growth.

A better plan is to have a compensation package that includes incentives for both the revenue performance component as well as the profit sharing component. Then employees have to be both company and customer oriented (which are not mutually exclusive ideas). It tends to keep everyone more honest!

Best regards,
Tom