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Yes, I agree. I'm not a mutual fund guru by any stretch of the imagination.
Don't know that much about them. But your insight about MFs holding vastly
similar stocks is dead on wrt similar volatilities and price action. Better to
diversify into totally different MFs with different objectives (large cap, small
cap, value, growth, etc.) to fill out your capital needs. My example simply
picked 3 MFs with similar volatiliites. However, if another fund you wanted to
trade had a much higher volatility, you'd buy less of it to preclude the price
movement from getting you out too soon. And, of course, the corollary is buying
a lower volatility MF would require you to plunk down more capital to risk your
1% (or whatever) because of its lower price movement. So, depending on the
volatilities, you could wind up buying more than 3 or less than 3 MFs.
<BLOCKQUOTE
>
----- Original Message -----
<DIV
>From:
Ken Close
To: <A title=amibroker@xxxxxxxxxxxxxxx
href="">amibroker@xxxxxxxxxxxxxxx
Sent: Monday, December 01, 2003 8:06
PM
Subject: RE: [amibroker] Mutual Fund
Money Management
<SPAN
>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.
<SPAN
>
<SPAN
>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.
<SPAN
>
<SPAN
>More on this
later.
<SPAN
>
<SPAN
>Ken
<SPAN
>
<SPAN
>-----Original
Message-----From: Al Venosa
[mailto:advenosa@xxxxxxxxxxxx] <SPAN
>Sent: Monday, December 01, 2003 7:54
PMTo:
amibroker@xxxxxxxxxxxxxxx<SPAN
>Subject: Re: [amibroker] Mutual Fund
Money Management
<SPAN
>
<SPAN
>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.
<SPAN
>
<SPAN
>Al Venosa
<BLOCKQUOTE
>
<SPAN
>----- Original Message -----
<FONT face=Arial
size=2><SPAN
>From:<FONT
face=Arial size=2> <A
title=closeks@xxxxxxxx href="">Ken Close
<SPAN
>To:<FONT
face=Arial size=2> <A
title=amibroker@xxxxxxxxxxxxxxx
href="">AmiBroker List
<SPAN
>Sent:<FONT
face=Arial size=2> Monday,
December 01, 2003 5:07 PM
<SPAN
>Subject:<FONT
face=Arial size=2>
[amibroker] Mutual Fund Money Management
<SPAN
>
<FONT face="Courier New"
size=2>Excuse me for asking a potentially dumb
question, but what are some<FONT face="Courier New"
size=2><SPAN
><FONT
face="Courier New">"accepted" rules of thumb for money management AFA mutual
funds are<FONT
face="Courier New">concerned.<FONT
face="Courier New">I can see that you might risk say 2%, on a position, and
know what yourstop loss would
be, and then divide the price per share of the fund
bythe loss level to approximate
the number of shares to buy.<FONT
face="Courier New">But what about some of the other rules of thumb, like do
not risk morethan 3% of total
equity on a position. Or does this apply to the
stoploss? Seems like 3%
might be a small (too small?) amount for a mutual<FONT
face="Courier New">fund position. I do not know. It depends on the
size of your portfolioof
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<FONT
face="Courier New">not "seem" to be the right "proportion", or is
it?Also, what about the
inherent volatility reduction that occurs with the<FONT
face="Courier New">multiple stocks in a fund?<FONT
face="Courier New">What about the number of funds to own at a single
time? How would yougo
about figuring this out, given high correlation among the
funds?....or given low
correlation among the funds?<FONT
face="Courier New">Is it better to divide a given amount (say $100K) among
two similarfunds ($50K each)
,or is it better to plunk the entire amount into
theone fund? Would you increase
the number of different funds given<FONT
face="Courier New">increasing size of total portfolio
funds?Again, maybe a whole
series of dumb questions but what do some of you<FONT
face="Courier New">more experienced money management folks have to say for
this? <FONT
face="Courier New">Thanks,<FONT
face="Courier New">Ken
<SPAN
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