The Ultimate Position Sizing Guide - Part 2 - The Value Drivers of Process

Hi, this is Cameron Hight from Alpha Theory.

In my last post, I started talking about our new white paper, The Ultimate Position Sizing Guide.

And I discussed how our managers on average generate about 2% return from their sizing and the average fund generates about 33 basis points or six times better performance.

In this post, I'll talk a little bit about the mechanics of why they do a better job of sizing positions.

It comes down to some fairly simple things.

They will eliminate positions that don't have price targets because they're process oriented. They don't own as many positions where they haven't taken the time to come up with a price target.

Why does that matter?

Well, we've measured across our clients over you know more than a decade, hundreds of managers.

The names with price targets generate about 11% of Return on Invested Capital.

The names without price targets generate about 6%.

So, 5% of additional return just from coming up with a price target.

And it's probably because they've spent the time to think about. Is this a name that I should be invested in?

And it comes from a little bit more complex things like what we call trading around positions.

So, imagine you have a $30 stock that goes to $33, back down to $27, back to $30.

You own the same number of shares for the entire trip.

Your total profit is $0, starts at $30, ends at $30.

Well, in the Alpha Theory framework and process-oriented position sizing, the stock goes from $30 to $33.

Your probability weight of return decreases.

So you can decrease your position size.

The stock goes from $33 back down to $27.

Your probability weight of return goes up.

You increase the position size and the stock goes back to $30.

You own the same number of shares at the beginning and the end as the previous firm that made zero, but you generate about 50 basis points of additional return from that position.

These things add up over time.

And lastly, it's about making sure that your 6th best idea is your 6th largest position.

Your 16th best idea is your 16th largest position.

The way Alpha theory works and the way process-oriented position sizers work is they have a real time system that is telling them every name in the portfolio, what is the appropriate position size based on my rules and my research.

And now compare that to the position size that I actually have.

If there's a big discrepancy, I want to isolate that, figure out why, and close that gap.

So those are some of the reasons why Alpha Theory managers outperform.

And I hope you get a chance to read The Ultimate Position Sizing guide.

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