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"Mindless momentum" strategy not working for small caps

Man falling from the sky
The portfolio's value plunged in just two months

It's a couple of months since we inaugurated the momentum investing experiment and it is time to check the performance.

In a nutshell, the idea behind momentum investment is to buy shares that are going up at a rate of knots.

READ Momentum investing: Use the Force, Luke

According to a paper published in May 2014 by Clifford Asness, Andrea Frazzini, Ronen Israel and Tobias Moskowitz, US equity data spanning more than 200 years supports the idea that a momentum-based investment strategy is, more often than not, a successful one.

The Stockpot column decided to check this theory out and while so doing to compare the relative performance of three categories of equities:

  • Stocks with a market capitalisation of less than £100mln – the tiddlers

  • Stocks with a market capitalisation of between £100mln and £1bn – the middlers

  • Stocks with a market cap of more than £1bn – the (for want of a better word) biglers

All we did was look in each category and select the 10 stocks that have risen the most (in percentage terms) in the preceding 12 months.

As with all of the Stockpot virtual portfolios, we included bid/offer spreads (buy at the high price – the offer – and sell at the lower) plus assumed dealing costs of £15 per transaction.

As one might expect, the bid/offer spread turned out to be a real handicap for the tiddlers, which tend to be less widely traded and therefore have wide bid/offer spreads. We can circumvent this by imposing a restriction of ignoring any stock with a bid/offer spread that is more than 5% of the mid-price. In short, that means no stock starts life out more than about 5% (don't forget the dealing costs) in deficit.

Before looking at each category to see how the shares did we need to set a benchmark. I have used the FTSE All-Share, which is more broadly based than the FTSE 100.

On March 12, when we kicked off this experiment, the index was 3,991.04; it is now at around 4,167, which is a 4.4% improvement.

We'll start with the tiddlers today and look at the others next week.

The tiddlers – under the Weatherly

Of the three categories, the tiddlers did the worst, turning a virtual £10,000 into £7,664 in less than two months.

Ouch.

That's a 23.4% plunge in a rising market.

Of the 10 stocks selected, only three posted a profit: Elektron PLC (LON:EKT), Rockrose Energy PLC (LON:RRE) and Zoo Digital Group PLC (LON:ZOO).

By far the worst performer was Weatherly International plc (LON:WTI), which plummeted 90%, making the spectacular falls on AorTech International plc (-26%), N4 Pharma Plc (-21%), Spectra Systems (-51%) and Univision PLC (-38%) look almost pedestrian.

It all went Pete Tong for Weatherly on March 19 when the copper producer released disappointing interim results.

Another announcement on April 4 made things worse; the company said Intrepid Mines had requested another extension on the backstop date for the transfer of the Kitumba Project in Zambia to Weatherly and also revealed it remained in discussions to effect a long-term restructuring of its secured debt facilities with Orion Finance.

The next day Craig Thomas, the chief executive officer signalled his intention to get on his bike, which is never a good sign, and then on April 24, the Jitumba Project deal fell through.

On April 26 came the dreaded “strategic review” - often regarded as the raising of the white flag – and the beginning of a formal sale process.

The whole sorry process shows the danger of driving up a stock price on the basis of hopes and dreams rather than the merits of the existing business.

Weatherly fell even faster than it rose and has dealt the Tiddlers portfolio a blow from which it is unlikely to recover.

The performance of the tiddlers

Ticker

Name

Cost

Current Value

Profit/ Loss

% change

LON:AOR

AorTech International

£1,000

£744

-£256

-26%

LON:BIOM

Biome Technologies

£999

£932

-£67

-6.7%

LON:EKT

Elektron

£1,001

£1,032

£32

3.2%

LON:N4P

N4 Pharma

£1,001

£789

-£212

-21%

LON:OMIP

One Media

£1,000

£848

-£151

-15%

LON:RRE

Rockrose Energy

£998

£999

£1

0%

LON:SPSC

Spectra (DI/S)

£999

£492

-£507

-51%

LON:UVEL

Univision

£999

£615

-£384

-38%

LON:WTI

Weatherly International

£1,000

£101

-£899

-90%

LON:ZOO

Zoo Digital

£1,001

£1,108

£107

11%

 

  • Cash: £3
  • Market value of current holdings plus cash: £7,664
  • Total profit/loss: -£2,366 (-23%)

Out with the klinker to make room for new fuel for the fire

The plan is to rejig the portfolio every two months and for the Tiddlers I suspect the implementation of a parameter that excludes any stock with a bid-offer spread that is more than 5% of the underlying share price will go some way towards limiting losses, but let's be honest, the collapse in the share price of Weatherly and Spectra had nothing to do with wide bid/offer spreads.

All but two of the above stocks will be exiting the portfolio – so that's another £120 in dealing costs – to be replaced by eight new entrants, incurring another £120 in dealing costs.

The two stocks staying in the pot are Zoo Digital PLC (LON:ZOO) and Elektron Technology (LON:EKT). The relative strength index (RSI) of the former is 58.8, which is safe enough, but Elektron's RSI is 70.4, which according to the book is approaching “overbought” territory.

Selling the pile of rubbish we got rid of raised the cash pile up to a pathetic £5,524, which means we can spend about £675 (after dealing costs) on the eight replacements, which are:

The stocks above are listed in order of percentage gain over the last year, ranging from 210% for Great Western Mining to 110% to Filta Group, which just won a tie-breaker over Cloudcall Group, which is also up 110% over the last year, by virtue of having a lower RSI value.

There are quite a few stocks in that list – Nostra Terra, Frontier IP and Symphony to name but three – that Proactive Investors has covered in depth, so you can go away and do your own research.

Remember, this is just a virtual portfolio for demonstration purposes and we're not suggesting you buy these stocks – as if any of you would after the performance in the first two months!

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