Asset/Portfolio Position Size Decisions

Position sizing, whether you’re managing a single asset class portfolio or a diversified portfolio of managers, is a key parameter that managers often point to as adding alpha. Goldman Sachs and the other large wirehouses have started Investment Strategy Groups in different configurations to make tactical asset allocation recommendations, RIA’s often recommend that clients make 1% allocations to various mutual funds or even asset classes, and mutual fund managers, in the name of diversification, take small positions on a regular basis.

The question this raises for me is whether this advice is valuable. Putting aside the intellectual shenanigans of how firms measure their “alpha generating” tactical allocation services, the questions that this topic brings up are manyfold:

Is there value in ever smaller positions?
Is there an optimal position size?
Given an uncertain return regime, is equal sizing a valid alpha generator?
Assuming that positions can be classified into risk/return parameters (and that is a huge assumption), at what point does a small position imply there are better opportunities that are more “worth it”?
If there is a minimum or optimal size for positions, should rebalancing occur below that threshold? For example, let’s assume the minimum appropriate size for a position is 3%, if a target allocation is set with a 10% allocation to an asset class of position, should it be rebalanced if it’s not outside of the +/- 3% of the target (i.e. 7%-13%)?
Is trading “around” positions alpha-generating?

The questions continue for me, but you get the idea. I don’t know the answer. I’ve been looking at some of the academic literature and, quite honestly, it is sparse. The implications could be far ranging and might help avoid some classic traps such as overdiversification, closet indexing, high transaction costs, etc. and might help clients and advisors pick their spots only in opportunities that make sense (since they’ll stay away from just putting small positions for no real reason). If anyone has any research available, I’d love to see it.

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The Hard Trade

“The best lack all conviction, while the worst are full of passionate intensity.” — Yeats