Q: I’m a professional money manager running an open-ended mutual fund, with subscriptions and redemptions on a daily basis, which has a mandate to be at least 95% invested in stocks at all times.

How do you think about position sizing in a case like mine (which can obviously be applied to anyone with a portfolio whose assets are subject to inflows/outflows)? If I start off with USD 10M and invest it equally into say 50 stocks with a 2% position in each, what happens if after say 3 months the portfolio receives a USD 5M inflow. During those times the stocks have all moved, and some are trading below my ‘in’ price, others have done well. My feeling has always been that rather than add 50% more to each and every position, you add only to the ‘winners’. The problem is that you then end up with a portfolio which is no longer equally-weighted, as you’ve maybe doubled the investment in say 25 winners and done nothing with the say 25 losers.

Sometimes I feel that unless you have a discreet pot of money where there are no inflows/outflows, the system breaks down because of things like this. What do you suggest?

A: You are in a big bind without your mandate to be 95% invested at all times and my guess is that many money managers with such a mandate will be out of business within the next ten years. What are you going to do when the baby boomers retire in a big way and you constantly have a net outflow of funds? And when that happens to all the fund managers, the major indices (that everyone is holding) will go down big time.

My big question to you is how can you get your mandate changed? It’s something you’ll have to do eventually and it’s much better now than later.

Anyway, I have a specific solution for you in my new book The Definitive Guide to Position Sizing. Basically you have to buy the index that is your benchmark. Position sizing will be how much you under or overweight any stocks in the benchmark, with an underweight being a short position. Specific details are in the Definitive Guide (out soon) and it’s also in an article I did with a mutual fund manager (An Interview with Steven O’Keefe) which appeared in Market Mastery and back issues are currently available for sale through IITM.