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David,
How do you account for the mis-assigning of a benchmark when calculating position size? I would argue that it appears that to get a real alpha based on your methodology you would need to benchmark it to an equal weight global index. I’m not aware of one, so perhaps the Value Line index would be a suitable proxy?
Off topic; but I hope Cimarex (XEC) is worth a post or possible Real Money column as Nat Gas producers are finally moving. There is also a good interview on real Money with the manager of Fidelity Select Natural resources and Energy portfolios. Maybe the 11 month decline in these stocks (as well as drilling/services) is over?
James, maybe I’ll write an article on benchmarking in the future. To me, a benchmark should represent the aspects of the market that one can’t control. I can vary my position sizing, but I choose not to because I believe it will add value. I’m happy to be benchmarked against almost anything, so long as it is consistent, and broad market, like the Wilshire 5000.
Paul, yes, that might be worth an article. I still own XEC, and wish I still held DVN. That said, my tech names have done better, though. Saw the interview; wish there had been more time to ask more detailed questions.
I would argue that anyone benchmarking to a cap weighted index that isn’t a closet or enhanced index is comparing apples to oranges. Just as you do in practice, I have not come across a single manager who things in cap weighted terms when picking stocks. This is an important factor in calculating alpha and is directly applicable to how you calculate your position sizes. I would be curious what your alpha was over the past few years using the S&P equal weight index or the Value Line index and what impact that new alpha would have on how you calculate your position size. With your foreign exposure and significantly lower average and median market cap (I am assuming) it just seems to me that benchmarking to a cap weighted index like the SPX or Wilshire 5000 is like comparing apples to oranges and creates a junk in/junk out risk when calculating position size.
James, I think we’re trying to answer two different questions. I’m competing against all of the money in the market, not the average stock in the market. I prefer larger stocks to smaller ones, though I usually end up fairly mid-cap. Small caps have almost always been a small portion of my portfolio. I do this partially for conservatism and safety. Small caps are more risky.
My only rule on size is rule #4 — “Purchase companies appropriately sized to serve their market niches.” I like to see that their size doesn’t inhibit their business prospects.
Cap size is a fallout of my process. Equal-weighting for me is just a risk control mechanism due to lack of knowledge. This strategy in its present form could handle at least $1 billion dollars. Above that, I would keep fixed rates, but have the weights edge toward market capitalization.