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Alpha Theory Blog - News and Insights

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3 posts from July 2009

July 22, 2009

Good Sight, Good Insight: Risk Management by Ed Seykota

I was discussing portfolio management strategy with a client who runs a long/short equity hedge fund. In his former life, he worked for a large Fund of Funds where he evaluated long/short equity mangers. In that role, he frequently referenced an article on Risk Management by Ed Seykota. He had increasingly become frustrated with traditional manager measurement techniques like VaR, Sharpe Ratio, alpha, etc. He found the article's concepts to be central to evaluating the portfolio management prowess of fund managers.

Fortunately for us, the tenets of Ed Seykota's article are embodied by the Alpha Theory Portfolio Management Platform:


1. Risk is the possibility of loss (not volatility).
2. Hunch-centric betting is certainly popular and likely accounts for an enormous proportion of actual real world betting.
3. Despite almost universal agreement that a system offers clear advantages over hunches, very few risk managers actually have a definition of their own risk management systems that is clear enough to allow a computer to back-test it.
4. To maximize returns, position sizing should be based on a measurement of potential profit, potential loss, and probability of each.
5. Kelly may be sub-optimal for portfolio management because of the diversification effect.
6. Diversification relies on the average security having a profitable expected value.
7. In times of stress, investors and managers access their primal gut feelings (when they should go back to discipline).
8. In actual practice, the most important psychological consideration is the ability to stick to the system. To achieve this, it is important (1) to fully understand the system rules, (2) to know how the system behaves and (3) to have clear and supportive agreements between all parties that support sticking to the system.
9. Profits and losses do not likely alternate with smooth regularity; they appear, typically, as winning and losing streaks. When the entire investor-manager team realizes this as natural, it is more likely to stay the course during drawdowns, and also to stay appropriately modest during winning streaks.

To see the full article, Risk Management by Ed Seykota. To view how Alpha Theory help create a investment process discipline, visit www.AlphaTheory.com.

July 13, 2009

BizRadio Interview with Dan "The Money Man" Frishberg

BizRadio.Com logo  

I was recently interviewed again by Dan "The Money Man" Frishberg on BizRadio.com.  We discussed some of the mistakes that are most common amongst investors including poor position sizing, under appreciation of downside risk, over confidence in asset selection, and inefficient use of ETFs.  The conclusion of our discussion is that many of the woes of investors could be solved by simply calculating a risk-adjusted return for every asset in your portfolio.

Radio icon  Listen To Interview:  

July 8, 2009

True Transparency: More than Just Information

“The main reason investors struggle with how to react to bad news is that they really haven’t figured out why they own the stocks they own.” – Bill Nygren, Oakmark Fund



I have read several articles over the past month discussing the coming trends of transparency. The article explains, “Several hedge funds and their administrators are adopting enhanced systems aimed at fulfilling expected compliance requirements for more transparency and meeting heightened demands from investors to communicate portfolio information quicker and with more granular detail. The idea is to allow managers quicker screen-based views into their own trading and money management processes.” So effectively what we are saying is that if we had daily information we would have caught the overt risk or fraud that we could not catch with quarterly data. Sure, if you are now getting position level detail where you had veiled aggregate data before, you can isolate risk.  But, it seems that the positions themselves are only a portion of transparency.



True transparency, for the investor and the fund manager, comes from ensuring that you understand why you chose the assets that reside in your portfolio and how you determined their position size. This level of transparency is not something that reporting alone can expose because, for an overwhelming majority of firms, that critical information sits in the portfolio manger’s head and disparate Excel, Word, and email files. Transparency requires understanding more than “I have a position.”  It involves, “why I have a position.” Firms must adopt strategies to help codify their investment process and better explain to themselves (so that they can explain to investors) why they are making the decisions that they make. Alpha Theory has developed a framework, that embodies the best practices of great money managers, to provide “True Transparency” into every portfolio decision a fund manager makes.