Correlation

Last week Mark (http://patientspeculation.blogspot.com) expressed a concern he had as he started his Portfolio Lite, a portfolio of free or 'donation' tipping services. He realised that the first service he was following, Jerry's Best Bets, might pick the same horses as he himself does. What should he do if this were to happen? Should he effectively 'double' stake such selections?

This follows a post I made post-Cheltenham in which I had bemoaned the fact that throughout the Festival I often had numerous selections running in the same race:

"The second principle is that the portfolio should be engineered in such a way that it maximises the investor's comfort zone. Essentially this means that psychologically, the services need to match neatly the mentality of the person following them. It is when pressure is exerted that mistakes are more likely to be made. Having five or six runners in one race puts me under pressure. It may not others, but it does me."

I think Mark is in a different place from me here. He is starting to build his portfolio and can therefore plan ahead in an attempt to avoid too much correlation between services in the future. I, on the other hand, have a portfolio of thirteen, and therefore a certain level of correlation is impossible to avoid. The question for me is if the correlation I experience is within reason, or if I can (or want to) tweak things slightly to minimise the correlation as much as possible. For this post though, I want to speak in more general terms that are relevant to people in either Mark's situation, or in one closer to my own.

So what factors are important to consider when making decisions where correlation is or may become an issue? I would suggest the following:

1. The set up your banks for each service followed, and the implications thereof;
2. The psychological effects of correlation;
3. The consequences of 'double' staking; and
4. The way to plan your portfolio to avoid excessive correlation.

I will address the first two points today, the second two tomorrow.


The set up of banks for each service followed

The setting up of banks for each individual service is an absolute must. Work out your £/point value and the number of points a service needs as a bank. Do this correctly and any correlation between services ultimately becomes largely an irrelevance (at least if you want it to). You are backing the same horse, yes, but from different banks, each of which should be large enough to cater for the losing runs you will face with each service. This means that you are treating each service as being exactly what they are...two completely individual sources of selection. They are two entities each with their own unique features and you are bankrolling them as such.

Of course, it is possible that there are similarities between the methodologies employed by each service that subsequently increase the chances of the same selection being chosen on occasion. Perhaps the same sort of race is targeted, or the same price range, or the adoption of each way betting as a strategy and not win only. There could be any number of factors that overlap but ultimately the portfolio investor has to accept that the methodologies of two different services are independent of each other. If they weren't, all selections would be the same and obviously this isn't so. The logical thing to do therefore is have separate financial banks attributed to each service that will each cater specifically for the methodologies utilised by each individual service, and allow for the variances between the two.

So in summary, if the investor's banks are of sufficient size, then there really should be no problems mechanically (as opposed to psychologically) if two services within a portfolio are occasionally throwing up the same selections. When the investor examines a service's track record prior to selecting it to be an active part of the portfolio, then no allowance is made for selections that may have coincided with those backed through other services already in the portfolio. No, you see the service has an historical 10% roi and therefore has an apparent edge that you can exploit to make money. And therein is the crux...provided the investor is confident in the edge that each and every one of their services possess (and if the investor isn't confident in this, then why in the hell is the service being followed at all?) then he or she ought to realise that in the long term, occasional incidences of correlation are of no importance at all. Not that is, if the psyche isn't detrimentally effected...

2. The psychological effects

Take any three from The Football Analyst, Football Elite, Football Investor and Strike Zone. At various times this season a combination of three of them have tipped the same team in the same match. I don't mind saying, it's a bloody nightmare when it happens, and I don't like it. Similarly, I didn't enjoy backing six horses in the Gold Cup.

The problem is that suddenly, you are putting on a large amount of money on the outcome of just one event. To a portfolio investor, this is not likely to (and shouldn't) sit comfortably. The whole ethos of using different services is based on the desire to seek the sanctuary of diversification to minimise risk. Eggs are better placed between many baskets, so if one is dropped all eggs are not broken. And yet here the basket spreading egg shuffler is not keeping all his plates spinning (although his head may be, reading this) but instead has just one plate spinning in one basket...or something.

You get the point.

But why does this scenario engender such feelings of unease in the investor? If we (correctly) maintain that it is the long term edge of each service that is important, why do we not find it easy to shrug our shoulders when we happen to be loading up on one selection? I'm sure some are easily able to metaphorically partake in a bit of serious shoulder shrugging, but not me, and I'm sure not with some of you either.

The simple answer to this question is that when a double/triple tipped selection wins then it's marvellous and the result is short term euphoria. Naturally if the selection loses, it leads to real doom and gloom. The two emotions are at the opposite end of the scale, and just like the the issue of diversification, this is anathema to the mindset of someone running a portfolio. We are trying to remain as balanced as we can under trying circumstances. We do everything we can to avoid exposing ourselves to extremes of emotion. We are trying to be the Switzerland of punters - forever neutral. And yet here we are, placing all eggs into one basket and desperately hoping that the one plate we have spinning in the air does not fall (nailed it!).

The solution? Planning.

We'll talk more about that tomorrow.


Today's Action

Just the three services in action, two of which made money whilst the other came out neutral.

PJA NH had four selections today, two of which won (Connectivity - Towcester - 4/1 and Lonesome Boatman - Towcester - 4/1). The other two unplaced which was a shame as a small each way accumulator was risked on all four. Still, not to worry as a profit was made.

The other money-making service was On The Nose, which picked out a 16/1 shot that finished third (Speed Bonnie Boat - Towcester).

Winning Racing Tips found a selection that finished in the frame at 5/1, so at a fifth the odds, stakes were returned.

PJA NH: Staked 3.5pts, +2.4pts.
On The Nose: Staked 1pt, +1.1pts.
Winning Racing Tips: Staked 1pt, N/A.
Total financial profit on the racing of £70.

Monday 28th March: Staked £150, +£70.
Week to date: Staked £150, +£70.
Month to date: Staked £13,745, +£962.03, roi 6.99%.


I do believe there is a Football Investor selection tonight. I'm not on it. Mmm...