Hydroelectric generators: The forgotten mechanical component
The Forgotten Component of Return The Alpha Theory Solution … · 2020-03-01 · The Forgotten...
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“Any individual decision can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.“ – Robert Rubin, Former Treasury Secretary The Forgotten Component of Return Position Size + Stock Selection = Portfolio Return Countless hours of research go into Stock Selection, only to be nullified by inefficient Position Sizes that are determined by instinct and mental calculation. Alpha Theory™ creates a repeatable system to size positions using a firm’s fundamental research. Why use Alpha Theory? More than 95% of funds do not have their 5 best ideas as their 5 largest positions. Why? Most firms do not know what their 5 best ideas are. To effectively construct a portfolio, a firm must have a top-to-bottom view of asset quality that adjusts as prices and fundamentals change. Alpha Theory creates a framework to measure every idea with probability-weighted return and points out, for instance, when your research says you should have a 4.5% position size and you currently only have 2.0% exposure. Compare two equally skilled stock picking firms with the same ability to analyze assets. The firm that closely aligns position size with probability-weighted return will dramatically outperform the firm managing the portfolio with mental calculation. Effective Portfolio Construction Money managers are in the business of selecting assets that make money. However, they are not just selecting one good asset; they are building a portfolio of good assets. Maximizing the return of a portfolio requires adherence to one simple tenet; the portfolio must have the greatest exposure to the best assets and the lowest exposure to the weakest assets. The Alpha Theory Solution Alpha Theory is a Portfolio Management Platform that provides Research Management, Position Size Optimization, Risk Management, Portfolio Analytics, and Analyst Performance Measurement. Command Center Platform. Alpha Theory’s web-based interface provides a central place to manage the entire firm's idea generation, analytical process, and decision process, both current and historic, so that they are always up to date. Research Management. Alpha Theory creates the optimal framework to capture and measure research using upside target, downside risk, and probability of each scenario. The scenarios combine to generate a probability-weighted measure of potential return. Portfolio Optimization. Once the use of probability-weighted return is employed, Alpha Theory sizes positions based on the assumption that higher probability-weighted return positions should have greater exposure which creates a portfolio with the highest potential return. Risk Management. Risk parameters specific to the fund are factored into the optimal position size including fund size, minimum and maximum long or short position sizes, minimum and optimal probability-weighted returns, liquidity, market correlation, portfolio exposure, sector exposure, analyst exposure, analyst abilities, chance for extreme loss, analysis confidence and investment time horizon. Active Administration. Real-time updates enable the firm to adjust position size quickly in response to rapidly changing market conditions, asset prices and fundamentals. Recalibration is the foundation of maintaining an efficient portfolio. Three Steps to an Efficient Portfolio 1. Create a discipline that requires every idea have a well-defined upside profit, downside risk and probability of each before considering inclusion in the portfolio. 2. Use upside, downside and probability to calculate a probability-weighted return for every asset in the portfolio. 3. Make probability-weighted return the anchor for portfolio construction (i.e. higher probability-weighted return equals a larger position in the portfolio.) Benefits of Probability-Weighted Return Position Sizing 1. Improve returns – Empirical research and common sense prove that probability-weighted return posiation sizing is the optimal way to maximize portfolio returns. Exposure goes to the best ideas and the weakest ideas are pruned. 2. Reduce risk – Every decision is now made in the context of downside potential. If downside risk increases, probability-weighted return falls, which equals a smaller position size. 3. Reduce emotion – Decisions can be made based on true measures of risk-reward and are not subject to the bias of mental calculation and heuristics. 4. Eliminate Confidence Bias – Analysts will search for information that supports their thesis. Calculating probability-weighted return forces them to consider downside potential, so the research improves because the analysts consider all information, positive and negative. 5. Rational Trading – An adage of portfolio management is, “treat every position like it is brand new every single day.” Probability-weighted return gives you an adaptive portfolio that adjusts as prices and fundamentals change. 6. Includes Conviction Level – Two assets with the same upsides and downsides are not always created equally. Probability-weighted return uses probability which allows for comparison of assets with similar risk-reward. Contact Us: (866) 482 - 2177 | [email protected] | [email protected]
Transcript of The Forgotten Component of Return The Alpha Theory Solution … · 2020-03-01 · The Forgotten...
“Any individual decision can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.“ – Robert Rubin, Former Treasury Secretary
The Forgotten Component of Return Position Size + Stock Selection = Portfolio Return Countless hours of research go into Stock Selection, only to be nullified by inefficient Position Sizes that are determined by instinct and mental calculation. Alpha Theory™ creates a repeatable system to size positions using a firm’s fundamental research.
Why use Alpha Theory?
More than 95% of funds do not have their 5 best ideas as their 5 largest positions. Why? Most firms do not know what their 5 best ideas are.
To effectively construct a portfolio, a firm must have a top-to-bottom view of asset quality that adjusts as prices and fundamentals change. Alpha Theory creates a framework to measure every idea with probability-weighted return and points out, for instance, when your research says you should have a 4.5% position size and you currently only have 2.0% exposure. Compare two equally skilled stock picking firms with the same ability to analyze assets. The firm that closely aligns position size with probability-weighted return will dramatically outperform the firm managing the portfolio with mental calculation.
Effective Portfolio Construction
Money managers are in the business of selecting assets that make money. However, they are not just selecting one good asset; they are building a portfolio of good assets. Maximizing the return of a portfolio requires adherence to one simple tenet; the portfolio must have the greatest exposure to the best assets and the lowest exposure to the weakest assets.
The Alpha Theory Solution
Alpha Theory is a Portfolio Management Platform that provides Research Management, Position Size Optimization, Risk Management, Portfolio Analytics, and Analyst Performance Measurement.
Command Center Platform. Alpha Theory’s web-based interface provides a central place to manage the entire firm's idea generation, analytical process, and decision process, both current and historic, so that they are always up to date.
Research Management. Alpha Theory creates the optimal framework to capture and measure research using upside target, downside risk, and probability of each scenario. The scenarios combine to generate a probability-weighted measure of potential return.
Portfolio Optimization. Once the use of probability-weighted return is employed, Alpha Theory sizes positions based on the assumption that higher probability-weighted return positions should have greater exposure which creates a portfolio with the highest potential return.
Risk Management. Risk parameters specific to the fund are factored into the optimal position size including fund size, minimum and maximum long or short position sizes, minimum and optimal probability-weighted returns, liquidity, market correlation, portfolio exposure, sector exposure, analyst exposure, analyst abilities, chance for extreme loss, analysis confidence and investment time horizon.
Active Administration. Real-time updates enable the firm to adjust position size quickly in response to rapidly changing market conditions, asset prices and fundamentals. Recalibration is the foundation of maintaining an efficient portfolio.
Three Steps to an Efficient Portfolio
1. Create a discipline that requires every idea have a well-defined upside profit, downside risk and probability of each before considering inclusion in the portfolio.2. Use upside, downside and probability to calculate a probability-weighted return for every asset in the portfolio.3. Make probability-weighted return the anchor for portfolio construction (i.e. higher probability-weighted return equals a larger position in the portfolio.)
Benefits of Probability-Weighted Return Position Sizing
1. Improve returns – Empirical research and common sense prove that probability-weighted return posiation sizing is the optimal way to maximize portfolio returns. Exposure goes to the best ideas and the weakest ideas are pruned. 2. Reduce risk – Every decision is now made in the context of downside potential. If downside risk increases, probability-weighted return falls, which equals a smaller position size.3. Reduce emotion – Decisions can be made based on true measures of risk-reward and are not subject to the bias of mental calculation and heuristics.4. Eliminate Confidence Bias – Analysts will search for information that supports their thesis. Calculating probability-weighted return forces them to consider downside potential, so the research improves because the analysts consider all information, positive and negative. 5. Rational Trading – An adage of portfolio management is, “treat every position like it is brand new every single day.” Probability-weighted return gives you an adaptive portfolio that adjusts as prices and fundamentals change.6. Includes Conviction Level – Two assets with the same upsides and downsides are not always created equally. Probability-weighted return uses probability which allows for comparison of assets with similar risk-reward.
Contact Us: (866) 482 - 2177 | [email protected] | [email protected]
“Any time you make a bet with the best of it, where the odds are in your favor, you have earned something whether you actually win or lose the bet. By the same token, when you make a bet with the worst of it, where the odds are not in your favor, you have lost some-thing, whether you actually win or lose the bet.” – David Sklansky, The Theory of Poker
Measure each Asset’s Impact on the Portfolio: Probability-Weighted Return (PWR) calculated based on analysts’ price targets and conviction level
Position Sizing: Portfolio Manager defines how Risk-Reward, Liquidity, Short vs. Long, Time Horizon, Sector Exposure, Beta, Volatility, etc. impact position size and Alpha Theory builds an Optimal Size formula based on those inputs
Centralized Management: Alpha Theory is accessible from anywhere in the world and allows management of the entire investment process from one centralized interface
Analysts use an easy Web-based interface to enter Price Targets and Probabilities which are translated into a Probability-Weighted Return
Recalibration: Know exactly which positions are furthest from Optimal Position size in real time, so that you can focus on value-add activities like performing research, not managing position size
