A few weeks ago, Michael O’Higgins and I, along with our wives, left a popular restaurant. We had ordered water (tap, instead of the recommended Italian bottled) and planned to have dinner. But we lost our appetites when seeing the price of the steak: $171.
If you recall a 1989 book called Beating the Dow, then you might be familiar with O’Higgins. He popularized the Dogs of the Dow investment strategy, where investors choose five of the least popular stocks on the Dow, hold them for a year, and then trade them when they no longer meet the doggish requirement.
O’Higgins is a value hunter—whether he’s investing or dining out. And he isn’t afraid to step away from the crowd.
We left that restaurant, chuckling, and O’Higgins went on to describe his latest value investment strategy, something any couch potato investor could warm to. He coined the new strategy MOAR, for Michael O’Higgins Absolute Returns. And he plans, one day, to write a book about it.
It’s a diversified, indexed portfolio with a contrarian’s twist that would have averaged 14 percent returns since 1973. O’Higgins designed it for investors who want decent gains and a good night’s sleep. Over the past forty one years, it would have had only three losing periods:
- -5.07 percent in 1981
- -4.35 percent in 1990
- -0.71 percent in 2008
Back-testing investment methods (often known as data mining) can disappoint investors who expect future results to equal past success. O’Higgins’ latest strategy might not reap 14 percent annual returns over the next forty one years, but it’s tough to argue with the approach. Unlike the concentrated methods he described in Beating the Dow, and in his 1998 follow-up, Beating the Dow with Bonds, his latest strategy is diversified across asset classes, it’s low cost, and it’s similar to the couch potato portfolio hybrids that are gaining popularity among savvy investors.
Here’s what O’Higgins shared.
First, you’d find the worst-performing first world stock market indexes over the previous year. I won’t kid you. Value based platforms like this take plenty of guts. The first index you’d choose is Spain’s—a country with unemployment at 25 percent.
You’d choose four more of these dismal market indexes to add to your portfolio. Call them the dogs of the world. Forget your notion of promising markets; O’Higgins guides you to barrel scrapers.
Then you’d add 1/3 cup of the following ingredients: a gold or platinum index, a long term government bond index and an intermediate term government bond index.
Here’s how the portfolio would usually look:
- 25% Dogs of the world
- 25% Platinum or Gold
- 25% Long-term government bonds
- 25% Intermediate term government bonds
O’Higgins calls for an annual rebalancing, back to the original allocation—with one exception. If the dogs of the world show overall losses for the year, further assets are shifted to the stock indexes. Fifteen percent would be removed from the other asset classes in equal proportion: 5 percent from the gold/platinum; 5 percent from the long term bonds and 5 percent from the intermediate term bonds. The proceeds would be distributed equally among the dogs of the world.
Following this approach would have given this portfolio a 27 percent gain in 2009 and a 12 percent gain in 2010, after losing less than 1 percent in 2008. If the stocks dropped for a second year, and you really have the nerve for this, a further 15 percent would be removed from platinum/gold or bonds, and added to the faltering international stock indexes.
Following such a strategy would ensure that investors are always greedy when others are fearful and fearful when others are greedy.
In 2011, the MOAR strategy gained 8.6 percent. Most of the world’s stock market indexes had double digit losses that year, with the exception of the U.S, which recorded a small gain.
Because the stock portion of the strategy fell in 2011, the portfolio takes on a heavier weighting of the dismally performing international indexes for the beginning of 2012.
Here’s what the portfolio would look like in January, 2012, along with the respective ETFs.
- 40% Dogs of the world: 8% France (EWQ); Poland (EPOL); 8% Spain (EWP); 8% Russia (RSX) ; 8% Italy (EWI).
- 20% Platinum (PPLT)
- 20% Long term government bonds (TLT)
- 20% Intermediate term government bonds (IEF)
Passive investing strategies such as this one, according to O’Higgins, make plenty of sense. Few professional investors can beat the market after fees and bid-ask spreads. Toss in a contrarian’s nerve to step away from a popular table and you should have the elements of a solid portfolio.