There are, as you know, 3 approaches to investing:
Active, Semi-Active, Passive
Somewhere in the CFA Program we covered a topic called contingent immunization, which is a semi-active strategy for bond portfolios.
What amazed me about contingent immunization is how totally different the approach is versus what you’d do if you were implementing semi-active for stocks.
With stocks, “active” implies hand-picking companies, “passive” implies indexing. Semi-active means doing something like indexing 90% of the portfolio and hand-picking the other 10%. That’s about as brave as my bungee jump from a 7-story tower back in the 90s… which I only agreed to do because they had an air bag on the ground underneath in case something went wrong.
But I learned with contingent immunization that there’s another way to play semi-active. You can take off right out of the gate 100% full afterburner active with your hair on fire… but hit the eject button if the wings start coming off.
It’s really as simple as that. Say your benchmark is the S&P 500.
1. Start the year 100% active in 20 or so stocks you've hand-picked.
2. Monitor daily your YTD return vs. the S&P 500.
3. If a serious lag starts developing (e.g. -5%) sell all and switch to 100% index for the rest of the year.
4. Otherwise, let it ride...
Here’s an example I spreadsheeted.
I should note that just because your trigger point is, say -5%, that doesn’t mean you end the year at exactly a 5% lag if you have to bail. Play with it in a spreadsheet to see how it works. If the index moves up or down hugely after you bail, you might do a couple % better or worse than 5%.
But I think you get the picture. For the distribution of our yearly returns, we want to avoid the left tail of this…
But we certainly want something more exciting than this…
And I think this contingent immunization plan for equities might give us this…
What have I missed?