What are we looking for?
With the recent increase of volatility in the Canadian markets (in particular the energy sector), apprehensive investors may be looking for relief through a more conservative investment strategy. Recall that beta measures the relative movement of a portfolio or stock relative to a market benchmark. Lower beta strategies sacrifice upside potential in bull markets for defensive positions in bear markets.
The screen
This week I used CPMS to create a 10-stock strategy with the goal of achieving a low portfolio beta relative to the S&P/TSX composite. Specifically, I looked at stocks with the best combination of the following five factors:
– Low five-year historic beta vs. S&P/TSX composite
– High yield on expected dividends
– Positive three-month estimate revisions
– Low trailing P/E ratio
– Low historic earnings variability (A measure that looks at how volatile a company's historical earnings are)
Stocks must also pay at least a 1-per-cent dividend and have positive reported earnings per share. Stocks trading below an average of $50-million in average monthly volume were excluded in this strategy to remove less liquid names.
What we found
I used CPMS to backtest this strategy beginning Dec. 31, 1991. During this process, the top 10 ranked stocks passing all criteria were purchased and equally weighted with a maximum limit of two stocks a sector. Stocks would be replaced if they fell outside the top 30 per cent of the database or if the stock's EPS turned negative.
Over the 23-year period, the strategy produced an annualized return of 14.3 per cent while the S&P/TSX composite returned 8.9 per cent. Annual turnover on the portfolio averaged 12 per cent a year. Over this same time period, the portfolio's beta measured to be 0.4, which signifies a strategy with lower overall sensitivity to general market movements.
Investors are always advised to conduct independent research before purchasing stocks listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.