Nifty Thrifty: taking the human out of the equation

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There's good news, and bad news. The good news is that the Nifty Thrifty portfolio is more valuable than it was at the time of the last update three months ago.

The bad is that it's worth 11 per cent less than it was a year ago. Since we first trusted an imaginary £30,000 to a computer algorithm, in summer 2010, it has risen in value to just £46,153 - a gain of 54 per cent.

There are two good reasons to embrace mechanical investing strategies such as the Nifty Thrifty. The first is that it takes relatively little effort. You don't have to research individual stocks, you just blindly follow the recommendations of a computer. The second is that computers are relentlessly methodical. People, on the other hand, are swayed by passion and often make poor investment decisions.

To view the Nifty Thrifty's holdings and trading chronology, click here.

WHAT IS THE NIFTY THRIFTY?

The Nifty Thrifty is invested in 30 companies plucked from the FTSE 350, the 350 largest companies listed on the main market of the London Stock Exchange.

It picks companies that are ranked most highly, using a combination of financial statistics measuring profitability (return on capital or ROC in our table), value (earnings yield or EY in our table), and financial strength (F_Score in our table).

nifty-thrifty-performanceFor six years I have benchmarked the Nifty Thrifty portfolio against an imaginary £30,000 invested in another mechanical investment: a FTSE 350 index-tracking fund designed to emulate the performance of the index from which the Nifty Thrifty's selections are drawn. This makes it a good comparator.

But investing in the Nifty Thrifty is a rigmarole compared to investing in the index. When I started both portfolios, I spread the investment in quarterly increments over the first year.

I made four investments in the index tracker: one in June, one in September, one in December, and one in March. For the Nifty Thrifty, I made 30 investments spread over the same four tranches.

nifty-thrifty-portfolio-ejections-juneSince then I have not touched the index tracker, but for the Nifty Thrifty I must check whether each share still qualifies on the anniversary of its inclusion, and replace it if it does not. The majority of the seven or eight shares that mature in this way each quarter are replaced.

The beauty of the index tracker is that I have outsourced the business of selecting and trading shares and reinvesting the dividends to the fund manager and their computers.

However, I must still manage the portfolio, juggling the tables of data you see and recording all the transactions. If I were running it for real, I'd have to make the trades too.

SHARE SLEUTH COMPARISON

To be worth the effort, the Nifty Thrifty would have to beat the benchmark handsomely. In fact, over the last year it has lost more money than the benchmark, which is down 7 per cent.

Over the past six years, the same £30,000 invested in an index-tracking fund would be worth £44,501, a gain of 48 per cent, just 6 per cent (about £1,500) less than the Nifty Thrifty (after costs have been deducted from both portfolios). The jury is out on whether it is worth the effort.

Privately, I very occasionally compare the Nifty Thrifty portfolio to another benchmark, the Share Sleuth portfolio, which is a year older.

To pick the shares for the Share Sleuth portfolio I do a lot more spadework. I analyse annual reports and quiz executives at annual general meetings.

nifty-thrifty-candidate-screeningShare Sleuth is not limited to shares in the FTSE 350, but in other respects it has similar objectives: the ownership of shares in profitable, financially strong firms at attractive valuations.

In the same way that the Nifty Thrifty must beat the index tracker to justify the effort, the Share Sleuth portfolio must beat both the Nifty Thrifty and a benchmark FTSE All-Share index tracker handsomely.

One of the reasons investors are often beaten by machines is we are too easily swayed by short-term fluctuations.

To avoid being swayed by fluctuations in the Share Sleuth portfolio's value and concentrate on the businesses it owns, I only write about its performance once every five years and I try not to think about it in between. However, the Share Sleuth portfolio is beating the Nifty Thrifty handsomely.

You cannot draw concrete conclusions from comparisons like these. The one I'd like to draw is that I'm a skilful stockpicker, but even over six or seven years I could just be lucky. The Nifty Thrifty may use a bad algorithm, but it could go on to perform very well over the next six years.

When I started these portfolios, I considered 10 years to be a reasonable length of time to judge an investment strategy. It's long enough to embrace a full business cycle, and the strategic aspirations of most of the businesses we can invest in.

PORTFOLIO UPDATE

Since one of the main benefits of mechanical investing is low maintenance, for the remaining four years until judgement day I'm going to make running the Nifty Thrifty a bit easier by going through the rigmarole only once a year.

This is the last quarterly update; you can see which shares have been added and removed in the accompanying tables. The first annual update will be in June 2017. In the transition period, the portfolio will hold some shares, those added last September, December and March, for longer than a year.

There is a small price to pay. Since I will only be reinvesting dividends once a year they will sit in the portfolio as cash for longer.

However, the backtesting that led me to create the Nifty Thrifty showed that the capital returns from the strategy should far outweigh income - and if the small drag on the portfolio from holding a fraction more cash is significant, the Nifty Thrifty will probably have failed.

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