Position Sizing is the crucial element of managing risk within a portfolio

Once we have a firm understanding about what asset classes, sectors and individual securities we are interested in, it’s time to size positions according to a different set of rules at each level:

Top Level Sizing

The first decision we face is how much CASH vs everything else should a portfolio hold. As a starting point, we prefer to average the cash position of each automated strategy, and start our allocation thesis from there.

Risk-on vs Risk-off

Portfolio construction is all about blending 2 complementary market drivers. The classic example of this is a stock and bond portfolio. There are many factors impacting a decision at this level, so we are using an average of our automated strategies again, as a starting point. Both their target allocation, and actual positions play an important role at this stage.

Specific Factors

When a specific sector or factor is selected for allocation, we pay close attention to the Nostromo strategy. Its allocation system is based on volatility parity, which overweights low-volatility sectors and underweights high-volatility ones. This method reduces overall volatility in a portfolio and increases the risk vs reward characteristics.

Stock Positions

When selecting stock positions within the bounds of a specific factor, we do so using an equal weight approach. Our backtesting suggests that volatility parity works on an asset class and sector selection level, but when we get down to specific stocks, it’s better to keep it simple. Equal weight is the way to go.