Boston Harbor SELECT 40:
Investment Process, Margin of Safety and
Investment Return vs. Speculative Return

We demonstrate that our Microeconomic Theory of The Firm is a systematic investment strategy supported by the economic rationale that sustainable earnings drive stock prices. Its foundation is anchored to Margin of Safety. Benjamin Graham’s Margin of Safety is a concept that has several important dimensions: investment vs. speculation, price vs. intrinsic value, portfolio diversification of 20 or more stocks, high-quality dividend paying stocks, insure against loss, manage risk, and recognize both the probability of being right and the consequences of being wrong. Our Model incorporates Graham’s Margin of Safety specifications and its portfolios outperform long-term with a very comfortable Margin of Safety.

Malcolm Baker Research Paper on Performance
of Low Volatility Stocks

“We believe that the long-term outperformance of low-risk portfolios is perhaps the greatest anomaly in finance. Large in magnitude, it challenges the basic notion of a risk-reward trade-off.”

Baker, Malcolm, Brendan Bradley and Jeffrey Wurgler, “Benchmarks Limits to Arbitrage: Understanding the Low-Volatility Anomaly,” Financial Analysts Journal, Volume 67, Number 1, 2011, CFA Institute.

Warren Buffet Perspective on Berkshire Hathaway Investment Performance

An investment strategy to be successful must have a strong defense and a solid offense. This idea is discussed by Warren Buffett in the Chairman’s Letter, Berkshire Hathaway, Inc., 2009 Annual Report, page 4.

The Secret of Warren Buffet's Performance

Warren Buffett’s secret is to buy quality stocks and use leverage of 1.6-to-1 to achieve long-term equity returns that have outperformed the market for 30 years.

“We estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks.”

Frazzini Andrea, David Kabiller and Lasse H.Pedersen, “Buffett’s Alpha,” November 21, 2013, Draft Paper. New York University, Copenhagen Business School.

Standard & Poor's Persistence Scorecard 

Standard & Poor's Persistence Scorecard
The phrase “past performance is not an indicator of future outcomes” (or some variation thereof) can be found in the fine print of most mutual fund literature. Yet due to either force of habit or conviction, investors and advisors consider past performance and related metrics to be important factors in fund selection. So does past performance really matter?

Looking at longer-term performance, “of top-half funds over the five-year horizon; 9.09% of large-cap funds, 11.52% of mid-cap funds, and 5.08% of small-cap funds maintained top-half performance over five consecutive 12-month periods.

“The Persistence Scorecard, S&P Dow Jones Indices, through September 2018

Boston Harbor Whitepaper:
SELECT 40 Back-Test Protocol And Test Returns
vs. Live Returns As Predictors Of Future Performance, September 15, 2013

We explore the “live returns” vs. “back-tested returns” controversy and conclude that the Prudent Investor will find out what the past was like before investing and that there is no statistical evidence that live returns persist into the future.

Boston Harbor Whitepaper:
Boston Harbor vs Competing Equity Alternatives Strategies, January 16, 2014

Over the last 10 years SELECT 40 has been one of the top 1% performing strategies for U.S. large-cap equities. SELECT 40 with 50% leverage has demonstrated higher total absolute returns with less risk, immediate liquidity and dividends. SELECT 40 with 50% leverage is a good candidate for replacing alternative asset allocations.

Active Share Measure

Active Share is a new measure that is being used by some institutional investors to identify active managers from strategies that are really based on closet indexing.  Boston Harbor’s Active Share is 86.1% and the range for active stock pickers is calculated by the author to be 60% to 90%.

The author sorts domestic all-equity mutual funds into different categories of active management using Active Share and tracking error. He finds that over the sample period until the end of 2009, the most active stock pickers have outperformed their benchmark indices even after fees and transaction costs. In contrast, closet indexers or funds focusing on factor bets have lost to their benchmarks after fees. The same long-term performance patterns held up over the 2008-2009 financial crises, and they also hold within market cap styles. Closet indexing increases in volatile and bear markets and has become more popular after 2007. Cross-sectional dispersion in stock returns positively predicts average benchmark-adjusted performance by stock pickers.

Petajisto, Antti, “Active Share and Mutual Fund Performance,” New York University, Department of Finance, Yale School of Management, Black Rock, January 15, 2013.

Forensic Accounting Research

We use fundamental securities analysis and forensic accounting red-flag indicators to identify well managed healthy companies.  Indicators of red-flags can be found in most graduate level textbooks for courses in financial statement analysis and security valuation.

Howard Schilit is arguably America's pre-eminent forensic accountant.  He Founded the Center for Financial Research and Analysis (CFRA) in 1994.  CFRA is a global independent research business that provides forensic accounting, earnings quality, and legal research and solutions to institutional investors, underwriters, and other financial institutions. CFRA is the recognized leader in Forensic Accounting Research. He sold CFRA in 2003 and CFRA is today a MSCI Inc. (NYSE: MSCI) company. The list of companies that Schilit was either first or among the first to criticize is a rogue's gallery: WorldCom, Sunbeam, Cendant, New Century Financial, among others.

Schilit, Howard, M., Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd Edition, (McGraw-Hill, 2010)