“The real world presents some ordinary investments, some attractive investments, and some very attractive investments. Clearly it makes sense to invest more in the more attractive investments. This leads to a maxim on investment advantage……..The greater is your expected return on an investment, that is the larger is your advantage, the greater the percentage of your capital you should put at risk.

Most investors understand this criterion intuitively, at least once it is pointed out. But they follow it insufficiently if at all. The investment on which they expect a 30% return gets little more funding than the one where they expect to earn 10%. Investment advantage should be as important as diversification concerns in determining how one distributes one’s portfolio.”

From Investing in the Unknown and Unknowable ~ Richard Zeckhauser

Richard Zeckhauser’s paper, ‘Investing in the Unknown and Unknowable’ has had a great influence on how I approach venture investing. When I read it a few years ago, it was as if a lightbulb switched on. It put into words what I was trying to capture with the DTM5 Strategy – an organized way to engage in venture investing on a concentrated basis, to create substantial results.

When I talk about concentration, I’m talking about the majority of the DTM5 strategy (usually 80%+) being invested in 5 or less investments. This is NOT modern Portfolio Theory. This is NOT what I suggest anyone else does. This is my strategy, for which I’ve borrowed concepts from others, applied my own knowledge and experience, and added my own (continually evolving) process with which to guide me and provide guardrails so I don’t go too far off the road.

I’d like to elaborate on how I approach and manage the idea of position size – Managing a concentrated strategy for maximum growth while trying to stay out of too much trouble.

I’m a believer in diligence. That is, the more you work at something carefully, the better the outcome. Followers of my blog know I have a process – A formula for evaluating investments that looks like this:

(Merit + Asymmetry) x (Time + Price) = Best Odds Of Success

So let’s assume I have identified a list of investments that are worthy of inclusion in the strategy. How do I go about determining the size of each position in the strategy? It is all about the odds. Thinking back to what Professor Zeckhauser points out – The greater is your expected return on an investment, that is the larger is your advantage, the greater the percentage of your capital you should put at risk – I want more advantageous investments to have heavier weightings in my concentrated strategy.

To do so I’ve developed a fairly tool I call the ‘position size evaluator’. Here is an example:

• For every investment, I establish a target valuation & corresponding rate of return (eg 420%)
• I establish an ‘Odds Factor’, also expressed as a %, which is an estimation of the likelihood of the investment being successful. (eg 65%)
• I then weigh the target multiple by the odds factor to obtain an ‘odds based return projection’ (OBRP). An example:
  • Say I’ve identified an investment with a target 420% rate of return.
  • I assign an odds factor 65% chance of success.
  • The ‘odds based return projection’ would be 4.2 x 65% = 273%

So then, I weigh the investment’s OBRP against the strategy’s total OBRP to determine a weighting target by cost.

The resulting structure would look something like this:

Investment	Share Price	Target	Return X	Odds Factor	Odds based Return	Cost Base Target
1	6.75	36.18	536%	65%	3.48	28.38%
2	1.42	6.08	429%	65%	2.79	22.70%
3	0.13	0.50	385%	60%	2.31	18.80%
4	6.63	21.60	326%	65%	2.12	17.26%
5	0.19	0.50	263%	60%	1.58	12.86%
					12.27	100.00%

How do I establish a target return and odds factor? Well that is definitely a blog post (or book) onto itself. Simply put, the target return is based off my research and valuation of the company. The Odds factor is my estimation of the likelihood of things ACTUALLY GOING WELL. Summary -> Target Return = Opportunity. Odds Factor = Risk Level.

There are a lot of things you can do with a tool like this. As current share prices change, the odds based return will increase or decrease and so will the cost base target %. Positions may become less or more attractive on a OBRP basis relative to others. You can use it for a portfolio with 100 positions or with 3. I’ve presented the distilled version here, my ‘live’ version has other columns such as $ market values, $ cost base, variances, alert, watchlist constituents, and more.

In summary, the DTM5 strategy has more exposure ~ bigger positions ~ in investments that I think have better odds. Odds are determined by upside (growth potential) and odds factor (risk level). The strategy is ‘concentrated’ so only investments that have great OBRP are going to be included.

I don’t want to make this sound too easy. A lot of work / due diligence goes into determining target returns and odds of success. This OBRP process is useless – even harmful – if it is based on faulty assumptions or poor fundamental analysis. And just because diligence has been applied does not mean the outcome of any investment will be favourable.

Position sizing has a large impact on the performance of a strategy. Using a tool instead of ‘gut feel’ or ‘rote rule’ can be really beneficial for your results, and help provide some guardrails so you don’t plunge off the highway.

When you are dealing with a concentrated strategy, managing position size is critical!

GLTA!