The Ultimate Position Sizing Guide - Part 2: Value Drivers of Process & Getting Over the Obstacles

Most fundamental portfolio managers dedicate immense effort to security selection, yet many overlook a critical factor that can significantly impact performance: position sizing.  

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At Alpha Theory, we’ve spent two decades speaking with over 4,000 analysts and portfolio managers, and we’ve consistently found that a lack of structured position sizing is a major drag on returns.

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In Part 1 of this three-part series, we demonstrated how managers who follow a systematic sizing framework outperform those who don’t. Now, we’re diving deeper into the mechanics behind this performance gap — why it exists, and how managers can adopt a more disciplined approach to stop the alpha drain.

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Aligning Process with Performance

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Is your sixth-best idea also your sixth-largest position? For managers with a structured approach to position sizing, the answer is clear. The key to optimizing portfolio performance lies in linking expected returns (ER) to position size.  

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Managing position sizing, however, isn’t as simple as picking the best ideas. Each security must be weighed against all other opportunities while maintaining a balanced portfolio. Without structure, these decisions often default to intuition, leading to inefficiencies.  

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A structured process, on the other hand, reduces slippage by ensuring that the quality of research is reflected in returns. Just like a car’s transmission efficiently transfers engine power to the wheels, structured position sizing ensures that investment insights drive portfolio performance.

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Implementing this rigor requires updating price targets regularly and adjusting allocations accordingly. Some firms resist this discipline, finding it easier to “feel” their way through position sizing rather than “calculate” it. But without frequent re-evaluation, expected returns lose alignment with position sizes, leading to suboptimal allocations and missed opportunities.  

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Ultimately, a lack of structure weakens both position maintenance and overall portfolio construction. Failing to connect research insights with portfolio weightings leaves money on the table — something no manager can afford in today’s competitive markets.

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Why Managers Resist Structure

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Many fundamental portfolio managers forego structured position sizing in favor of the freedom to act intuitively, especially in volatile markets. While this flexibility can feel essential, it often allows fundamental biases to quietly shape portfolios. Since it’s difficult to measure sizing efficacy, managers rarely see how a structured approach might outperform their instincts. Without a clear counterfactual, blind spots persist.

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Some fundamental managers are unknowingly leaving money on the table due to weak feedback loops in portfolio construction. While forecasting stock-level returns offers fast, clear feedback, position sizing lacks that clarity. It's hard to tell if sizing was off by 50bps or just right, making improvement difficult. Without structure, learning stalls. But with the right tools and process, managers can create measurable feedback loops that sharpen sizing decisions and unlock value hiding in plain sight.

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What the Data Tell Us

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Our research spanning 300+ firms over nearly 20 years found a strong relationship between the frequency of price target updates and stock selection alpha. We analyzed firms based on how often they updated price targets, discovering that firms which updated price targets more frequently saw better returns.

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The greatest improvement occurred when firms moved from updating price targets twice a year to quarterly. This alignment with quarterly earnings boosted stock selection alpha, demonstrating that more frequent updates enhance performance.

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Firms that implemented Alpha Theory's Optimal Position Sizes, which incorporate price targets and qualitative factors, performed better than those using their actual portfolio weights. Despite outperforming hedge fund indices, clients underperformed their optimal portfolios by over 400 bps, highlighting the importance of translating price target discipline into portfolio positioning.

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This analysis underscores that a structured process, aligning expected returns with position sizes, significantly enhances returns. By continuously updating price targets and incorporating them into position sizing, firms can reduce inefficiencies and capture the full potential of their investment insights.

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The Bottom Line

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A rigorous position sizing process improves the transmission of security-level research to total portfolio return and the security-level research process by instilling discipline around continuous maintenance and monitoring of positions. Download Part 2 of the white paper to explore this topic further.  

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In the next part of the series, we'll reveal a process for sizing that was developed with the cumulative wisdom of all our Hedge Fund and Asset Manager clients. Follow Alpha Theory's LinkedIn page as we continue to explore best practices that can help you unlock position sizing alpha in your portfolio.

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