Profiting from Hedge Funds: Winning Strategies for the Little Guy

Chapter 15

Equal Allocation Models

The primer in the preceding chapter looked at the work involved in selecting managers to shadow and mechanically assembling portfolios based on their stock picks. Such portfolios are pieced together from a set number of stock picks based on some criteria, and the assets are distributed equally or in a ratio among the selections. Models founded on the equal allocation method are the simplest to implement and are discussed in this chapter.

This chapter focuses on managing and analyzing model portfolios of the three shortlisted managers: Bill Ackman, Warren Buffett, and David Einhorn. They are presented individually and combined, using the Equal Allocation method. For illustration purposes, these portfolios employ minimal three-stock models based on their largest positions. The three managers chosen are known to run concentrated portfolios making reasonable coverage possible with three-stock models. The combined models use one selection each from the three managers for the largest positions and the largest new positions portfolios to bring to the table a taste of real-life implementation with multiple managers. The tables track the evolution of the model portfolios over a period of three years and indicate back-tested performance for the same time period.

The models offer no recommendation as to when to rebalance. Rebalancing on a fixed schedule can result in unnecessary trades, even when the components of the portfolio have not diverged much. Here, ...