Changing the Portfolio Structuring Process to Better Align with Our Investment Strategy
To determine the optimum position sizes we calculate the Kelly Fractions for each stock in our portfolio. This takes into account the correlations between the stocks we own and allows us to find the weights that minimize portfolio volatility and maximize the total portfolio returns based on our expected returns estimates.
I have rolled out the following changes to the process to make it more robust and aligned with our strategy of investing in primarily value stocks (will tilt small-cap) that we intend to hold for 1 year or longer (sometimes forever, as the case may be).
As a result of these changes, the portfolio allocations have been recalculated and can be seen on the Premium Portfolio page (accessible to Paid Subscribers). The following is a list of changes and the rationale behind them.
Expected Returns are now marked to the market: Every stock in the portfolio has a target price where we plan to exit. Over time, as the stock prices change, the expected returns also change. Occasionally, I may change the target price based on new information on the company business (a well-performing company will result in a forever stock as long as my target price keeps rising). With this change, the expected returns are recalculated once a month. The result is as the price moves up and the expected future returns decline, our allocation may go down
Correlations are now on a rolling yearly basis: Earlier we used the past 3 months of daily returns data to calculate the correlations between the stocks. We are now using 1 year’s worth of daily returns data. This removes significant noise and makes our portfolio more stable. This is also aligned with our Standard Deviation figure for each stock that is estimated by sampling 1 year worth of returns data.
I have added the correlations and Kelly Fractions/Allocations data to the Premium Portfolio page. This should give you a better picture of how allocations are determined. Correlations will give you an indication of the diversification inherent in the portfolio.
Please note that this update also adds a new stock to the portfolio