Next, the user has the option to set additional rules at the Sector/Group/Industry level (1). For example, the user could decide to limit the number of stocks allowed in a specific sector. In this case, the user might impose a rule that allows a maximum of five stocks in the Basic Materials sector (2). This helps prevent overexposure to a particular sector, ensuring a more balanced and diversified portfolio. However, in this particular example, we will leave this field blank.
In addition, the user can exclude stocks from certain sectors by unchecking the corresponding box on the left (3). This exclusion feature allows for more refined control over sector exposure, which can be useful if the user wants to avoid certain industries due to market conditions or personal preferences.
However, it is strongly recommended not to apply rules at the Group or Industry levels, as these classifications tend to change frequently. Unlike fundamental and technical variables, which are point-in-time data in the database, the Sector/Group/Industry classifications are not. This means that the classification of a stock may change over time, but the database does not reflect these changes historically. As a result, applying rules at the Group or Industry level could lead to unreliable or inaccurate backtest results, as the classifications used in the test may not accurately reflect the market conditions during the historical period being tested.
For this reason, such rules are more appropriate for forward-looking strategies when building a Buy-Sell list for the future. Applying them to historical backtests could distort the outcome, making it difficult to assess the true effectiveness of the strategy. Therefore, it is important to use these rules cautiously and understand their limitations in a historical context.
Next, the user can choose to exclude specific stocks from the strategy. For example, let’s imagine that we are building a strategy for a C-level executive of the Canadian company CGI (GIB.A), and we want to exclude CGI stock from the strategy. To do this, first click on the Exclude some stocks from the following portfolio tab (1), then click on Select Portfolio (2). From the dropdown, choose the appropriate portfolio, which in this case is CGI (3), containing the stock GIB.A. After selecting the portfolio, click OK (4) to confirm the exclusion of CGI stock from the strategy.
This exclusion is useful in scenarios where certain stocks must be avoided, such as to comply with personal or professional restrictions, including conflicts of interest for executives or company insiders. By excluding the stock, the strategy can be tailored to align with specific guidelines or limitations while still allowing for the application of other variables and ranking criteria.
Note that you cannot directly exclude a stock from a specific strategy; you can only exclude stocks from an existing live portfolio, meaning the current holdings of that portfolio. So, if you wish to exclude CGI (GIB.A), you need to first create a portfolio containing this single position in the Portfolio Module.
For example, the portfolio CGI would consist of one stock, GIB.A, with a 100% weight. When doing this for historical purposes, ensure that GIB.A is the surviving company of the stock currently owned by the client. Be mindful that the portfolio module is created using tickers, which can sometimes cause issues in historical backtests. Tickers may change over time due to corporate actions such as mergers or name changes, so it’s important to ensure that the stock selected in the portfolio correctly reflects the historical holding, otherwise the backtest results could be inaccurate.
The same principle can be applied if you want to force a specific stock to always be held in the strategy.
To do this, click on the Include Stocks from the following portfolio tab (1) and select the relevant portfolio. Although it is less common for a client to request that a stock always be included, this option is available, and it could be useful in more complex scenarios where specific holdings must be maintained.
Once this is done, at this stage, the user has the option to review the Buy-Sell list before proceeding further. You can do this by clicking the Skip Backtest Setting & Save button (2), allowing you to examine the list of stocks that will be bought or sold according to the strategy rules before setting up the backtest. This function provides an opportunity to refine the strategy by verifying the selections before running the historical performance tests.
The Buy-List screen provides an overview of the characteristics of the stocks eligible to be included in the portfolio. It is important to note that this is not the holding list of the strategy, as some positions may be in a Hold status, and the number of stocks actually held in the strategy may be smaller than those in the Buy List.
In this example, the S&P TSX universe consists of 222 stocks, and the Buy List contains 21 stocks (1). Since the ranking rule specifies buying stocks that rank in the top 20% of the universe, we would expect 44 stocks to be included. However, three stocks have been excluded because they exhibit negative Cash Flow from Operations (CFOA), which disqualifies them from being considered.
Additionally, the P/E CYM and P/B variables each carry a 50% weight in the ranking algorithm, and CFOA is required to be greater than zero (2). This ensures that only companies with positive cash flow are eligible for inclusion.
By clicking on the Qualified button (3), you can view the list of stocks eligible to be bought by the strategy (4). The stock with the highest score, ONEX, has a score of 84% but is ranked second. This indicates that the stock ranked first in the algorithm was excluded from the Buy List. We will explore the reason for this exclusion later in the process.
The user can click on the All button (1) to view and sell all the stocks, including those in the Buy, Sell, and Hold categories. Upon doing so, it becomes clear that the stock ranked number 1 according to the ranking algorithm is Laurentian Bank – LB (2). However, the reason this stock is listed as a sell rather than a buy is because its CFOA is negative, which disqualifies it from being included in the Buy List.
By scrolling through the list, the user can identify the other two stocks that were excluded, which, in this case, would also be due to their negative CFOA values. This provides transparency regarding why certain high-ranking stocks are excluded from the strategy.
To proceed with setting up the backtest rules, click on the Edit Strategy button (3) and navigate to the Backtest module. This step allows the user to configure the historical testing parameters to evaluate how the strategy would have performed over a specific period, taking into account the defined buy and sell rules.
On the Ranking, BUY & Sell Rules page (1), click on the CONTINUE button (2) to proceed to the Backtest page. This action will take you to the next step, where you can configure the backtest settings and evaluate the historical performance of your strategy based on the criteria you've defined.
Accessing the Strategy Module
Creating a New Strategy
Defining Ranking, Buy and Sell Rules
Back-Testing the Strategy
Analyzing Back-Test Results
Sector Weights and Strategy Description
