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Al: thanks; I was counting on hearing from
you on this—almost sent you a private message but hoped I would hear from
others trading funds and willing to share their perspective on this issue vis a
vis MFs.
One thing I have to give some more thought
to is the “overlapping” that might occur with mutual fund holdings
and what the “combined” volatility of several highly correlated mutual
funds might be. Don’t you agree that if the three MFs are holding
many of the same stocks, that their volatilities are not “independent”.
(Not sure that is the proper word….) It seems then one would be
buying one “larger” equivalent fund rather than three more or less
uncorrelated funds. Seems riskier. Feels riskier.
More on this later.
Ken
-----Original Message-----
From: Al Venosa
[mailto:advenosa@xxxxxxxxxxxx]
Sent: Monday, December 01, 2003
7:54 PM
To: amibroker@xxxxxxxxxxxxxxx
Subject: Re: [amibroker] Mutual
Fund Money Management
Well, Ken, I'm not experienced, but I can take a shot at your
question (remember, the only dumb question is the one not asked). The
principles of money management (MM) are the same regardless of whether or not
you are trading stocks, futures, real estate, mutual funds, or snails. Risk is
defined as the amount of money in a particular trade that you are willing to
lose on that trade. It's not the amount of money you invest in that trade.
Suppose your risk tolerance is 3%: that's how much you are willing to lose on a
trade if you are wrong about the direction of the price action. If a particular
MF's volatility over the last, say, 20 days is, say, also 3% and it's NAV is
25, then if you bought it at 25, you would sell out for a loss of 3% if the
price declined by 75 cents (3% of 25). How many shares and therefore how much
would you invest to risk that 3%? Assuming your capital is $50,000, your risk
is 3% of 50,000 or $1500. Divide 1500 by 0.75 = 2000 shares. So, you would
invest your entire capital on one MF if you risked 3% (2000 shares *
$25/share). That's why the experts say 3% risk is next to gunslinging. Using a
more rational 1% risk model, your risk is now $500. Dividing 500 by 0.75, you
get 667 shares or $16,667 invested in the MF. You can now afford to buy
more mutual funds in order to diversify. The number of funds to own at a
particular time will be determined by the volatilities of the MFs you are
buying. If you used the example above at 1% risk, you could buy 2 more MFs at
the same price/volatility relationship. Your total portfolio heat would be 3%
(1% per MF), which is fairly low. but unfortunately all your capital has been
used up in the purchase of the 3 MFs. If your starting equity were $1 million
rather than $50 K, then you would risk $10 K per MF for 1% risk. Your
proportionate amount invested in each mutual fund would still be about a third
of your equity ($333,333 per MF, assuming each MF had a 3% volatility). So,
with this volatility, you would still only buy 3 MFs. These relationships are percentage-based,
so it makes no difference how much equity you have to start with. It all works
out the same way. If it were me, I'd go with 3 funds rather than 1 fund
at 100% allocation. I hope this at least partially answers your question.
Al Venosa
----- Original Message -----
<span
>From:<font
size=2 face=Arial> <a
href="" title="closeks@xxxxxxxx">Ken Close
To:<font size=2
face=Arial> <a
href="" title="amibroker@xxxxxxxxxxxxxxx">AmiBroker
List
Sent:<font size=2
face=Arial> Monday, December
01, 2003 5:07 PM
Subject:<font size=2
face=Arial> [amibroker] Mutual
Fund Money Management
<font size=2
face="Courier New">Excuse me for asking a
potentially dumb question, but what are some<font size=2
face="Courier New">
"accepted" rules of thumb for money
management AFA mutual funds are
concerned.
I can see that you might risk say 2%, on a
position, and know what your
stop loss would be, and then divide the price per
share of the fund by
the loss level to approximate the number of shares
to buy.
But what about some of the other rules of thumb,
like do not risk more
than 3% of total equity on a position. Or does
this apply to the stop
loss? Seems like 3% might be a small (too
small?) amount for a mutual
fund position. I do not know. It depends on
the size of your portfolio
of course. What if you have a $20,000
portfolio? What if you have a
$2,000,000 portfolio. A $60,000 MF purchase
out of a $2M portfolio does
not "seem" to be the right
"proportion", or is it?
Also, what about the inherent volatility reduction
that occurs with the
multiple stocks in a fund?
What about the number of funds to own at a single
time? How would you
go about figuring this out, given high correlation
among the funds?
....or given low correlation among the funds?
Is it better to divide a given amount (say $100K)
among two similar
funds ($50K each) ,or is it better to plunk the entire
amount into the
one fund? Would you increase the number of
different funds given
increasing size of total portfolio funds?
Again, maybe a whole series of dumb questions but
what do some of you
more experienced money management folks have to
say for this?
Thanks,
Ken
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