Sizing the bets in a focused portfolio

ArXiv ID: 2402.15588 “View on arXiv”

Authors: Unknown

Abstract

The paper provides a mathematical model and a tool for the focused investing strategy as advocated by Buffett, Munger, and others from this investment community. The approach presented here assumes that the investor’s role is to think about probabilities of different outcomes for a set of businesses. Based on these assumptions, the tool calculates the optimal allocation of capital for each of the investment candidates. The model is based on a generalized Kelly Criterion with options to provide constraints that ensure: no shorting, limited use of leverage, providing a maximum limit to the risk of permanent loss of capital, and maximum individual allocation. The software is applied to an example portfolio from which certain observations about excessive diversification are obtained. In addition, the software is made available for public use.

Keywords: Kelly Criterion, Portfolio Optimization, Capital Allocation, Concentrated Investing, Risk Management

Complexity vs Empirical Score

• Math Complexity: 7.5/10
• Empirical Rigor: 2.0/10
• Quadrant: Lab Rats
• Why: The paper presents a generalized Kelly Criterion with a non-linear system of equations derived from probability-weighted scenarios, showing significant mathematical density. However, it lacks any backtesting, datasets, or statistical metrics, and the empirical application is limited to a single example portfolio without performance data.

  flowchart TD
    A["Research Goal:<br>Focused Portfolio Sizing"] --> B{"Key Methodology"}
    B --> C["Data/Inputs:<br>Est. Return &<br>Probability of Outcomes"]
    C --> D["Computational Process:<br>Generalized Kelly<br>with Constraints"]
    D --> E["Outputs:<br>Optimal Capital<br>Allocation"]
    E --> F["Key Findings:<br>Excessive Diversification<br>Reduced Risk"]