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acamus' Investment Strategy

The purpose of this post is to answer two questions on the September Holdings thread.

I began this investment strategy in 2015, shortly after I quit my last job in Silicon Valley. Prior to this career change, I had been investing in CEFs for several years but not full time, more long-term investing than trading. I had not figured out the whole strategy when I started and it evolved as I learned. I continue to learn. This is just a summary, not a "how to."

 

Goals

My goal is high absolute risk adjusted returns. Maybe 10% annually, on average. I try to minimize taxes but not at the expense of returns. Aside from taxes, I don't care how my returns are broken down into income and capital gains. My investing returns must cover all of my personal expenses but my portfolio turnover is high enough that sales proceeds easily cover those expenses so I am indifferent towards dividends and yield.

I don't care about the volatility of individual investments, only the volatility of my portfolio as a whole. The reason I care about volatility is because I view volatility as opportunity cost. When markets swoon, if one's portfolio swoons as much as the market, much of the opportunity to take advantage is lost. That's why I pay so much attention to risk adjusted returns, volatility, Sharpe ratios, etc.


Asset Allocation

Diversification is the bread and butter of increasing risk adjusted returns.

I invest more in fixed income funds than stock funds. I think a small allocation to stocks is a good diversifier for fixed income.

After accounting for leverage, both CEF leverage and any personal margin debt, my asset allocation might be about 30-50% stocks and 60%-100% fixed income. I sometimes sell ETFs short or purchase put options to adjust my asset allocation. When you see those in my portfolio, they're hedges; I'm not using them to bet against the market.

My asset allocation is tactical and contrarian. I watch VIX throughout the day. When VIX goes up I decrease allocation to CEFs and when VIX goes down I increase allocation to CEFs. It's contrarian because I do the opposite of what most CEF investors do; I trade before changes in implied volatility are incorporated in CEF prices rather than after.

I don't use any technical indicators, just a chart of VIX, 2 days with 1-minute bars, updated in real-time. 

If VIX is trending up strongly, decreasing allocation to CEFs might mean selling. If it's a weak signal, I might just cancel all my buy orders. Vice-versa when VIX is trending down. Most days, I have 10-30 orders open at a time. I will open and cancel orders amd adjust the limit prices throughout the day as market conditions change.

 

Discount Mean Reversion Strategy

Most of my investments follow this strategy. I buy CEFs when they have a discount z-score below -2. My only goal is to sell them when they have a z-score of +1 or more. I don't care about value, fundamentals or dividends unless I think they will impact the z-score. I do this systematically and that is where most of the portfolio turnover comes from. I use 1-month z-scores most of the time but increase the lookback period to 3-months or sometimes even 6-months when markets swoon.

There are some CEFs I either don't invest in or limit exposure to with this strategy, including funds that are likely to announce rights offerings, single sector stock funds (like MLP funds), funds with governance issues, funds that have recently cut distribution, etc.

 

Event-driven Strategy

This mostly involves anticipating news that is not yet incorporated in market prices. Primarily I'm looking for hints about future market moving events like changes in distribution or investment policy, activist investors, large institutional trades, corporate actions, etc. I try to position my portfolio to take advantage of these events.

Throughout the day, as they are published, I skim or read every press release and SEC filing relating to CEFs. One doesn't have to anticipate news; sometimes one just needs to be able to react to announcements before they are priced in. The CEF market is slow to react to news and this is still something that humans can do. Experience is key; one must be able to make a gut call about how news will impact prices within a few minutes of the news going public.

 

Option Strategy

This strategy complements asset allocation. The options concerned are always SPY put options. The total notional value of SPY put options will be less than my total allocation to large cap stocks and stock funds, i.e. they're a hedge rather than a bet against the stock market.

I don't buy CEF put options because generally none are listed, though there are exceptions like DSL, which has options, or used to.

This is sort of a value investing strategy with put options. When VIX is below 12, I start to buy SPY put options, increasing allocation again at VIX 11.5, 11, and maximum allocation at 10.5. I start to sell those put options when VIX increases above 20 to 25. This is a frustrating strategy because one bleeds money rolling put options waiting for market volatility. It's also pretty scary when one sells because one is likely selling one's hedge during a market swoon.


Tax Strategy

In order to reduce tax expenses, I try to realize a good portion of gains as long-term gains rather than short-term gains. As a general rule, all of my investments are available for sale if the price is right. I have an exception for investments that have risen to 5% or more above cost basis. I don't sell tax lots with 5% or higher gains until they are at least 12 months from purchase. There are exceptions. For example, in some cases a corporate action might force a sale or I might anticipate news where the tax expenses of selling short-term outway the anticipated investment losses from holding.

 

Other Strategies

This isn't a complete list but I'll stop here because I think I've covered everything that might be of interest to this audience.

 

@SteddyEddy, 2018 portfolio return was 2%.

 

26 Replies
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Frequent Contributor

Re: acamus' Investment Strategy

Hi acamus ....   With ceiling of Z stat rule I now understand why not too many Pimco bond CEFs show up on your monthly list.  I was confused when you said you don't care about value.  Aren't your purchases at Z stat below -2.00 considered under-valued/cheap?  Have you looked at Mean Reversion using Discount buy/sell rules or Yield buy/sell rules?  Also, where do you find 1 month, 3 month, 6 month Z-stats?  

Take care ....  a fellow Silicon Valley resident that also quit the rat race ...  I resigned in early 2013 as I had enough of my job and the commute up 101.  

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Re: acamus' Investment Strategy

Thanks for this very clear and concise set of parameters for your investing; very helpful.  Also, a TON of work and attention required; apparently all day?  When do you find time for anything else!?  ;-)

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Re: acamus' Investment Strategy

Thanks for this @acamus. Your approach is very interesting, and evidently highly effective. Much appreciated. 

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Re: acamus' Investment Strategy

Thanks for the tutorial, acamus.  It's really fascinating to me how many people optimize for different variables and use such different means to reach their goals.  There really are many ways to invest successfully, and it doesn't so much come down to right or wrong, as individual nature and personal comfort.  

Thanks for describing your process.  There really are a lot of ways to skin a cat.

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Re: acamus' Investment Strategy

Great OP and analysis but lots of work and moving parts.

My goal now as a retiree is 6+% annually with portfolio SD<3(max 4), I think I can do 8% but I will have to be at least at 50% stocks/CEFs + higher SD.  Performance + lower SD are my main goals since 2000.  

I do believe in the volatility of each investment, there are several managers that proved to me they can do it with lower SD and why Sharpe+sortino are higher.  USMV vs SPY    PCI,PDI vs its category and even SPY   PRWCX vs its category  PIMIX for several years and in 2000-2008 SGENX,FAIRX,OAKBX.  My key was always to use a limited number of funds and use these unique fund/managers.

I understand the concept of portfolio volatility but I prefer to own players that do well within their category which will take care of the whole portfolio.  I have seen over the years experts investors (think hedge funds) that were managing portfolio volatility using options and derivatives and got burned big time.

Over the years I have noticed that the following indicators are not reliable enough for me to make trades such as volume, VIX, SKEW.  I find trends, MACD, 3 line break and 50+200 MA easier to work with

I wish you good luck and I know you would do well because you have done well  :-)

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Re: acamus' Investment Strategy

@acamus , I see buying puts. Do you also sell puts for things on your buy list? 

YBB
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Re: acamus' Investment Strategy

Acamus, thank you for describing your methodology and sharing CEF news releases with us. That you place importance on Z-scores relates to my own thinking about buy and sell CEFs timing. It's good to have a hefty discount cushion to protect gains, avoid unnecessary buy/sell actions, and preserve principal, I understand the MACD thing, but TA doesn't appeal to me.  

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Re: acamus' Investment Strategy


@racqueteer wrote:

Thanks for this very clear and concise set of parameters for your investing; very helpful.  Also, a TON of work and attention required; apparently all day?  When do you find time for anything else!?  ;-)


Yes between monitoring the market and researching, it's full time. Working east coast hours while living on the west coast means I finish at 1pm though and there's plenty of day left. That's a welcome change of pace for someone who used to work in Silicon Valley :)

@yogibearbull wrote:

@acamus , I see buying puts. Do you also sell puts for things on your buy list? 


I wasn't clear in my original post what kinds of put options I invest in. I have since edited to reflect that it is SPY put options.

I'll add here that it tends to be SPY put options with a strike price 5-10% below market price and with 6-12 months to expiration when purchased. I roll them 1-3 months before expiration.

If CEFs had options listed and if they were sufficiently liquid, it's likely I would use them. Since I don't tend to invest in anything that has options, I don't sell put options as a means to buy the underlying.

@PaulR888 wrote:

Hi acamus ....   With ceiling of Z stat rule I now understand why not too many Pimco bond CEFs show up on your monthly list.  I was confused when you said you don't care about value.  Aren't your purchases at Z stat below -2.00 considered under-valued/cheap?  Have you looked at Mean Reversion using Discount buy/sell rules or Yield buy/sell rules?  Also, where do you find 1 month, 3 month, 6 month Z-stats?  


I should have been more clear about what I intended by "value". What I mean is, I don't concern myself with the valuation of funds' holdings. For example, if NBB was trading at a discount z-score of -2, I wouldn't concern myself with whether Build America Bonds were expensive given the recent decrease in interest rates. In terms of valuation, I would be concerned only with where price was relative to NAV.

I haven't tried buying and selling based on absolute discount or yield thresholds because my expectation is such a strategy would have little or no alpha.

I source price and NAV data from third parties and calculate CEF discount z-scores myself. Also, I don't trade based on past z-scores, such as those available on cefconnect, M*, etc. Rather, I trade based on my estimate of what z-scores will be when they are next reported. Anticipating what will happen before it is incorporated in price is everything in investing.

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Re: acamus' Investment Strategy


@acamus wrote:

 

I source price and NAV data from third parties and calculate CEF discount z-scores myself. Also, I don't trade based on past z-scores, such as those available on cefconnect, M*, etc. Rather, I trade based on my estimate of what z-scores will be when they are next reported. Anticipating what will happen before it is incorporated in price is everything in investing.

Estimates of discount z-scores require estimates of the current discount, which you get using current market prices and estimates of NAV based on the movement of correlated ETFs?

Thanks for sharing your approach and your other contributions, including CEF Analyzer.

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Re: acamus' Investment Strategy


@Beliavsky wrote:

@acamus wrote:

 

I source price and NAV data from third parties and calculate CEF discount z-scores myself. Also, I don't trade based on past z-scores, such as those available on cefconnect, M*, etc. Rather, I trade based on my estimate of what z-scores will be when they are next reported. Anticipating what will happen before it is incorporated in price is everything in investing.

Estimates of discount z-scores require estimates of the current discount, which you get using current market prices and estimates of NAV based on the movement of correlated ETFs?


Yes that's something I do. I also make lots of mental adjustments. Like for funds investing in securities listed outside of North America, I'll consider when those markets closed and how prices probably have changed between then and closure of North American markets. For covered call funds, I'll make mental adjustments the options overlay. Etc.

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Re: acamus' Investment Strategy


@acamus wrote:

Estimates of discount z-scores require estimates of the current discount, which you get using current market prices and estimates of NAV based on the movement of correlated ETFs?

Yes that's something I do. I also make lots of mental adjustments. Like for funds investing in securities listed outside of North America, I'll consider when those markets closed and how prices probably have changed between then and closure of North American markets. For covered call funds, I'll make mental adjustments the options overlay. Etc.


For CEFs owning foreign stocks, do the fund advisors use the closing prices of the foreign stocks on their home exchanges, or do they adjust those closing prices based on later price movements in the U.S., since foreign equity markets do have a positive beta to the S&P 500? In the past some traders have exploited stale pricing in foreign stock OEFs, and fund companies have improved their NAV calculations and imposed short-term redemption fees in response. CEFs don't have the same incentives to make their daily NAVs, since investors are not transacting at those NAVs.

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Re: acamus' Investment Strategy


@Beliavsky wrote:


Yes that's something I do. I also make lots of mental adjustments. Like for funds investing in securities listed outside of North America, I'll consider when those markets closed and how prices probably have changed between then and closure of North American markets. For covered call funds, I'll make mental adjustments the options overlay. Etc.


For CEFs owning foreign stocks, do the fund advisors use the closing prices of the foreign stocks on their home exchanges, or do they adjust those closing prices based on later price movements in the U.S., since foreign equity markets do have a positive beta to the S&P 500? In the past some traders have exploited stale pricing in foreign stock OEFs, and fund companies have improved their NAV calculations and imposed short-term redemption fees in response. CEFs don't have the same incentives to make their daily NAVs, since investors are not transacting at those NAVs.


As you say, there's no impetus for foreign stock CEFs to adjust NAV for changes after foreign markets close. Most such CEFs don't make an adjustment so they're like mutual funds in the old days. There are exceptions. Some foreign stock holdings might be American Depository Receipts trading in US markets, for example. With foreign stock funds, I also make adjustment for holidays. For example, one needs to be careful with Asia Pacific funds while NAVs are stale for several days over Chinese New Year.

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Re: acamus' Investment Strategy

Acamus, thank you for this post.

How would you have handled 08-09? Or specifically the next 40% down recession?

I am primarily interested in what triggers you would use to determine buy points in the heart of a recession? 

I know you mentioned 6 month Z scores, but I would like more color on any specifics you can offer about how to handle the next one. Assume an all cash position pre recession. 

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Re: acamus' Investment Strategy

Acamus your willingness to share your ideas, data, and time is quite wonderful.  Individuals giving freely to one another was the promise and the beauty of the internet once.  It is inspiring to see this sort of community building still thrive.

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Re: acamus' Investment Strategy


@shipwreckdalone wrote:

Acamus, thank you for this post.

How would you have handled 08-09? Or specifically the next 40% down recession?

I am primarily interested in what triggers you would use to determine buy points in the heart of a recession? 

Hypothetically, I think my cash would have incrementally increased during September '08 as VIX trended up. I think cash would have been 100% some time before the end of September '08. I would like to think earlier rather than later because that was critical. VIX started to trend down late '08. I expect I would have picked up on that late '08 or early '09 and slowly got back in again. It wouldn't have been a neat monotonical change in asset allocation though; I routinely make big changes to asset allocation on a daily basis. It also wouldn't have been binary buy everything then sell everything; I would have made incremental changes to asset allocation.

This is my return this year so far with VSCGX and PCEF as benchmarks. SPY is also there for context but it's not a benchmark.

return2019.PNG

Hopefully one can see that market timing made a positive contribution to both portfolio volatility and return this year. On the two occasions when PCEF sold off, my portfolio lagged on the down side. I find that most of my portfolio's outperformance comes in times of market volatility. I hope market timing would have helped similarly during the GFC.

I know you mentioned 6 month Z scores, but I would like more color on any specifics you can offer about how to handle the next one. Assume an all cash position pre recession. 


A problem with short term z-scores during a market swoon is they'll turn very negative across the board and it's hard to pick out values. When that happens, my approach is to choose a z-score look back period that extends back to before the swoon started. I continue to use the longer time period z-score until markets conditions return to normal. Since the GFC itself and the recovery took a long time, it's possible I would have been using 1 or 2-year z-scores during the recovery.

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Re: acamus' Investment Strategy

Nice explanation of your style.

I think everyone can benefit from putting down on paper/word.doc their general framework for how & why they invest.

For a variety of reasons, I hold a much more conventional portfolio, with a sliver of CEFs, and limited turnover.

But I have different constraints.

========

Considering your performance I would have thought RiverNorth would have done much better given that your results show some of the potential returns available to high effort and trading flexibility.

 

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Re: acamus' Investment Strategy

 

Acamus...thanks for sharing.

May I ask your age?...and you are now retired (not working), right?

And whew...how much time per day do you spend on this?  Yes, I was foolish trading off spending time investing, for playing golf, but one goal I had was minimal time on investing when retired, even though I made investing my hobby since age 23.

So let me ask how you relate to this anecdote:

In my golfing community there is a now 80 year old guy who still has a longstanding seat on the NYSExchange.  A single, multi-millionaire, he is addicted to trading.  He trades daily from his computer...making money...more money.  We can't get him to come play golf, or go to Polo, or go to a charitable event at Trump's Mar-a-lago.  Seems sad at times, but he is doing what he likes!!

R48

 

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Re: acamus' Investment Strategy

RiverNorth would have fees and expenses to extract (ERs). We don't know if Acamus withdrew from his portfolio for living expenses during this period. Is cash part of the portfolio, counted in returns or not?

"Considering your performance I would have thought RiverNorth would have done much better given that your results show some of the potential returns available to high effort and trading flexibility."

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Re: acamus' Investment Strategy

One could gross up RN returns to account for fee drag.  

I'm just thinking they should have had better returns.

Presumably they are doing something vaguely similar to acamus, with maybe the added nuances of having to provide daily in/out liquidity in some of their products, but they do they get the potential plus of being able to engage in activism and fire off 13D nastygrams.

==========

Comparison is the thief of joy, but I do it constantly!

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