The financial markets are like the Ocean. Prices go up and down. The energy of these random movements can be captured to generate additional returns by portfolio rebalancing and option premium writing. The value of uncorrelated assets is an often overlooked value component of financial assets. Harvesting this value requires active rule based portfolio management and strong discipline. It is easy, but psychologically very difficult in reality.


Portfolio Value
106.07
Average Annual Return
32.52%
Average Annual Volatility
9.6%
Sharpe Ratio
3.3

Sharpe Ratio Challenge

We started managing a real investment portfolio with the objective to prove that it is possible to achieve a Sharpe Ratio above 1 from trading randomness. The starting value on January 1, 2019 was 100. The actual returns and Sharpe Ratio are published on this website and in monthly reports.
January 2019 Report

Sources of Value
• Excess Cash
• Assets
• Earnings Power
• Compounding Growth
• Volatility
• Correlation
• Profit Netting

If you have questions you can send an e-mail to info at profitfromrandomness.com.

Low Risk, High uncertainty
Mohnish Pabrai decribes in his book The Dhandho Investor: The Low-Risk Value Method to High Returns the strategy to invest in low risk high uncertainty businesses. The future returns of such is a business is highly uncertain due to commodity prices, legal claims, new future blockbusters. However because of the uncertainty the quoted prices of these business are sometimes depressed and you can buy these business below tangible book value, which lowers the risk of permanent capital loss.


Maximizing Geometric Returns: The Kelly Formula
The Kelly formula states that the optimal betting fraction in a binary game to maximize the expected geometrical growth is edge / odds. This can be written as (p*b-q)/b. b are the odds, p is the probability of succes and q is 1-p.


Proof that hedging can provide high expected returns
Edward Thorp and Sheen Kassouf prove in the book Beat the Market: A Scientific Stock Market System that a covered call strategy will generate positive return. Assume the stock price is 0.5E and a call with a strike price of E costs 0.2E. P(Xt) is the chance that the stock price is X at time t. If P(X0+t) >= P(X0-t) for all t, the covered call strategy return will be at least 0.2E. In this case the gain is 0.7E if X > E and X-0.3E if X < E. This is always >= 0.2E.


Maximizing the rabalancing bonus
Selecting a portfolio with volatile and uncorrelated assets is the most important prerequisite to generate returns from rebalancing and option premium writing. We developed a program which calculates the optimal weights of a portfolio with maximum diversification from about 600 assets given as input. The following portfolio was generated by the program:
• TLT 33.7%
• FXY 17.4%
• HTZ 5.1%
• ACAD 4.9%
• UNG 4.6%
• WTW 4.4%
• PPC 4.1%
• ACLS 3.8%
• CECO 3.1%
• ACHC 3.0%
• JBSS 2.5%
• FOSL 2.4%
• DNR 2.2%
• AKRX 2.1%
• MBI 1.9%
• EXEL 1.7%
• AEM 1.2%
• CAR 0.6%
• STMP 0.4%
• VRTX 0.2%

This portfolio was generated based on historical correlations. Correlations change in time. There is no guarantee that this portfolio will be optimal in the future. This portfolio doesn't take into account the other sources of value, including excess cash, earnings power, growth and profit netting.


Shannon's Demon
William Poundstone Describes in his book Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street a trading system which generates returns from volatility even when the retuns of the underlying assets is 0. This trading system was developed by Claude Shannon and consisted of an investment of 50% in cash and of 50% in a risky asset and constant rebalancing to keep the weights at 50-50. The theoretical bonus return of this strategy is (0.5) * (0.5 * σ) 2 which equals 0.125 * σ 2, where σ is the standard deviation of the risky asset. How is this possible? As long as the arithmetic return is higher than zero, it is possible to increase the geometric returns by changing the allocation of the risky asset and by rebalancing.




© valuefromrandomness.com