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Fundamental Optimization
The Modern Position Sizing Model for Fundamental Investment Managers
Compared with the rigor managers institute around security selection, position sizing can feel like an educated guess.
Even among the well-established, sophisticated institutional fund managers who build robust models, stress-test their assumptions, debate risk factors with their investment committee, when it comes to deciding how much to allocate to a name, the process often devolves down to gut feel.
“I really like this idea, let’s start with 5%”
And we get it; your intuition matters. But research alpha is ultimately expressed as a position size, so logic, not gut should be applied to make sure it is fully harnessed and unemotional.
After two decades of working with hundreds of fundamental hedge funds, we developed the concept of Fundamental Optimization. It is a position sizing framework that quantifies hard to nail down concepts such as conviction and freshness of price targets. It harnesses the nuance of your research process to maximize alpha by translating that signal into tweaks to your existing position sizes.
If it sounds simple, it is. We like to say that Alpha Theory takes what you already know and systematizes it.
Let me explain how we got here, and why it matters to your portfolio and your returns.
The Evolution of Sizing: From Intuition to Infrastructure
If you’d like to know the whole story and compare the different models of sizing available to you as an investor, we laid all this out in detail in our Ultimate Position Sizing Guide.
But here’s the gist:
Pre-Structure
Early on, sizing was ad hoc. A name either felt right (overweight) , or it didn’t (farm name). Maybe there was a mental checklist. Maybe it was based on volatility or correlations. Most of the time, sizing didn’t reflect the real conviction behind each name, nor did it account for opportunity cost or portfolio-level constraints. In fact, many funds still don’t track how closely their position sizes match their expected returns or make timely adjustments as prices and sizes fluctuate.
Enter Structure
Then some managers started adopting sizing frameworks like Position Bands, and applications of Kelly Criterion. These approaches added guardrails and, in some cases, removed emotion and minimized reliance on “gut feel” for sizing decisions. But they often traded flexibility or failed to incorporate the richness and nuance of the research team’s fundamental analysis with a structured, data driven framework for position sizing.
The Quant Layer
On the quant side, tools like Mean-Variance Optimization and Black-Litterman models pushed toward sizing precision. But for fundamental funds, they felt more like black boxes. Most PMs didn’t fully trust them and without trust, adoption suffers.
Which brings us to today.
What Is Fundamental Optimization?
It is an intuitive process that fundamental fund managers such as hedge funds, long only managers and other investors can use to optimally size their portfolio positions.
Fundamental Optimization is Alpha Theory’s answer to a simple question:
How do we translate all the research work done on stocks into sizing?
Sizing should be a structured, repeatable process that:
- Starts with your research: bull/base/bear price targets and probabilities around each
- Translates those views into probability-weighted expected returns
- Adds a checklist for the variables that influence position size that you can’t capture in a price target (research stage, conviction level, management quality, etc.)
- Optimizes position sizes across the portfolio based on your constraints, limits, and risk parameters
- Considers other drivers of sizing like risk, freshness of targets and anything else your team values as an input to sizing
- Creates a feedback loop that improves sizing process over time
But here’s the key: it doesn’t replace your judgment. It systematizes it.
You still make the call. Alpha Theory makes suggestions (presented as deltas to your current sizes) and helps you understand the implications of those sizing tweaks across your portfolio. What’s important is that we do it in a way that mirrors how fundamental PMs think so there are no surprises or “black box” trust issues. The system is transparent as to the “why” it suggests the size change and facilitates communication across the team with data at your fingertips.
Why This Matters Now
Here’s something you (and your investors) already know being a good stock picker isn’t enough anymore.
In the 90s, alpha was abundant. You could thrive without any optimization if your ideas were good. The world has changed.
Today, the process is edge. In Part 2 of the guide, we showed that managers who follow a structured sizing process outperform those who don’t by hundreds of basis points annually. It’s not even close.
We also proved that something as simple as updating price targets quarterly instead of semi-annually improves stock-level alpha dramatically. (We call this “Freshness.”) More updates lead to higher returns.
How to Get There: The Path to Best Practice
In Part 3 of the guide, we outline the journey. Not every firm starts at the same place, but the arc looks like this:
- Stage 1: No price targets
- Stage 2: Price targets exist but there is limited structure for how they impact decisions
- Stage 3: Price targets drive sizing and portfolio construction
Most firms we meet are somewhere between Stage 1 and Stage 2. But with the right tools and approach, you can move forward.
Here are the 7 best practices we’ve learned from successful clients:
- Capture everything – Price targets, assumptions, qualitative inputs.
- Agree on structure – Align stakeholders: CIO, PMs, analysts.
- Keep things fresh – Update PTs regularly (at least quarterly).
- Own the process – Don’t outsource discipline; embed it.
- Rinse and repeat – Make sizing a rhythm, not a scramble.
- Measure & improve – Compare actual vs. optimal returns.
- Get buy-in – Let skeptics see the results for themselves.
And yes, we’ll help you do all of this.
Final Thoughts
If you’re a fundamental manager who’s put years into sharpening your idea generation, and stock selection, why leave the sizing of those ideas to gut feel?
Position sizing is the transmission of alpha from your research into your portfolio.
We would love to show you how Fundamental Optimization can make your process tighter, your team more aligned, and your portfolio more reflective of your true potential.
→ Download the full Ultimate Position Sizing Guide here
→ Or better yet, let’s talk. We’ll show you what this looks like with your own data.
