I love equally-weighted portfolios because I like treating each stock the same.   Keeping HEDGEfolios an equally-weighted portfolio requires me to focus on each stock as if it is the only one that matters.  I don’t place more importance on a stock because of how popular it is compared to a small cap company in the same industry.  I see no difference between Microsoft losing 10% and Google losing 10% so there is no reason why I would find a difference between Intel gaining 10% and AMD gaining 10%, even though AMD’s size is about 3% of INTC’s market cap.  The best way for me to make sure the equality perspective finds its way into my portfolio management style is to keep each stock with the same weight in the HEDGEfolios universe.

As a result, the market cap weighting of the S&P 500 index and the stock price weighting of the Dow are not methodologies that I appreciate.

Most investors and fund managers focus on concentrated portfolios and there is a ton of research that will tell you that is the right way to go about it.  That may be good for them, but it is not good for me.   As I have stated repeatedly on this site, you need to figure out who you are as an investor and know what you believe in and then conduct your portfolio management accordingly.

Compare the performance of hedge funds or mutual funds with concentrated portfolios and unequal positions to the performance of HEDGEfolios and ask yourself whether equally-weighting is a stupid idea.  In my opinion, it is stupid if you believe in concentrated portfolios.  If you are more like me, then it might make sense for you.

Here’s an example of how it could work:   Let’s say you start a portfolio construction with $1 million in cash.  Equally-weighting each position in your initial portfolio is easy, but as time goes on, it is impossible to maintain those positions exactly.  As you exit a specific stock, the remaining positions have varying balances and depending upon your gains and losses, taking a new position will never be able to match existing ones exactly.  My preference is to use an average by dividing the total market value of your portfolio by the number of positions you want to hold.  If your portfolio started with 100 positions of $10,000 each and you sell a stock that has appreciated to $12,000, the position I would enter after that would be the lower of $12,000 or the portfolio market value divided by 100.  As a result, any excess cash would be held in reserve to cover for the shortfalls in any future losing trades and the ability to get close to equal weighting when you enter the replacement position.

There are two portfolio management issues that make equal weighting of portfolios problematic.

The first is transaction cost effects.  You need to make sure that the number of positions and the value of your investable assets results in a position that will not be wiped out by trading commissions.  That amount is something you have to determine but I worry about any round trip commission that would exceed 1% of the position size.

The second concern is liquidity.  If your equal weighting means that your trade will comprise too high of a percentage of average daily volume of that stock, you really need to determine the incremental cost of bidding it up on the way in and the difficulty of getting out.  Obviously, if your equal weights result in small positions of highly liquid stocks, it is not likely to be a problem.  A few years ago, a trade I made represented approximately 10% of the total volume in that stock that day.  It was costly and I never made that mistake again.

Lastly, I always look at it this way.  I spend the same amount of analytical effort on each position.   If you have a position that represents a disproportionate amount of your portfolio, do you spend that much more time on it?

Position sizing is a large determinant of overall performance.  Winning big on something that represents a large portion of your portfolio may feel great, but the opposite can be devastating.  Equal weighting of positions is a significant component of why HEDGEfolios has significantly outperformed the index each year since I started - it works for me because it is consistent with who I am as an investor and the other elements of my portfolio management.   Make sure that your position sizing matches your own style.