Vad's Best Ideas

"October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February" Mark Twain

As promised before I am going to continue to explain fundamentals of my regular investment strategy that I try to use in my other longer term funds at Marketocracy and personally. link to Part 1 for anyone interested
I am also going to do that in the same way I would, if I was having a conversation with prospective investors trying to decide whether they are going to entrust me with their hard earned capital...

Implementing a successful investment strategy requires more then just good stock picking. I personally divide my money management process into three core parts:

1. Portfolio management
2. Stock selection
3. Trade Execution and Risk Management

I have already started covering my stock selection portion in some of the previous posts but today I want to cover the first fundamental part- portfolio management.

Here is how "the long side" of my "guideline" hedge fund should look like:

50% of the fund would be devoted to a core group of roughly 10 stocks with initial weighting of about 5% each. This group would be selected utilizing a group of core quant factors with main emphasis on cash flow and growth. I would only overrule this fundamental methodology if the "quant group" becomes too heavily weighted in one sector. To me the threshold for concentration is 35%. This group would be rebalanced quarterly.

30-35% of the fund would be devoted to "micro trends and event" picks. Basically a group of 5-6 stocks that I believe would benefit from the specific short term events or trends that I identified using on my "big picture" view of the economy in general. These stocks are likely to be turned over more quickly than the rest of the portfolio.

15-20% of the fund would be devoted to a "conviction contrarian" bet. This contrarian bet in addition to having a compelling story behind it, has to also make it on the least of most active highest % losers of the day on the NYSE or Nasdaq at least once, preferably several times in a short period of time. As I mentioned before - I believe that fear triggers overreaction which in turn presents a rare opportunity to make a quick double digit return on the bounce. This contrarian bet is also subject to a very quick exit once it makes a heavy volume double digit move up. In addition, the initial position in this contrarian bet is likely to be of similar size with the "event" picks or roughly 7% or so. Picking an absolute bottom is quite difficult and thus the position is expected to grow to the target 15-20% through averaging down. I usually set exit limits below my first entry price, even though most of these beaten down stocks gap up routinely.

To sum it up - my fund should be expected on average to consist of roughly 16-17 long positions with only one position larger than 10%. All losers with an exception of the "contrarian bet" will be eliminated mercilessly upon breaching a 7-10% loss (depending on stock's volatility) level even if that means higher turnover.

On the "short side"- maximum initial position is 40% of "the long side". Smaller average positions of roughly 2% each should be expected. No upper sector concentration limit, losers are mercilessly cut with maximum 10% downside. Picks will be predominately quant based on a multi-factor model with high leverage, negative cash flows and high short as a percent of float as significant drivers. I will add to the winning positions at the expense of losing but not to exceed the double of the initial position.

My fund should be expected to invest (both long and short) in domestic, foreign equities and any US traded ETFs. Tax considerations while important for the individual investors will not significantly influence my investment management process. I am running my portfolio with the goal of delivering above average positive returns and thus short term capital gains are to be expected.

To sum up the principles of my portfolio management strategy- 1.4 to 1 expected total leverage, 16-17 long positions, 15-20 short positions, no single stock over 25% of the portfolio, losses cut at 7-10% depending on individual volatility, significant short term capital gains and higher than average turnover are to be expected.

To be continued with more on individual stock selection...

Trade safe and cheers,
Vad

Comments: View Comments |  Wednesday December 26, 2007