There is no single answer to asset allocation, and it is every man for himself. One thing that I can tell you with certainty is how a hedge fund approaches the issue.
The biggest hedge funds run thousands of positions across countries, industries, sectors, and currencies that are dynamically hedged on a real time basis. To monitor this they need a global 24-hour multilingual trading desk backed by the latest mainframe computers using custom designed, cutting edge software. They have gobs of bandwidth too, as a nanosecond can make the difference between winning and losing on a trade. You can put together something like this for, oh, maybe $100 million, give or take a few dozen million. It’s all enough to send an MIT math PhD’s head spinning.
I’ll draw up a strategy that might fit a small, one-man hedge fund, with limited resources and programming abilities on a tight budget that is managing only $100,000. In other words, it will be for somebody a lot like you.
1) How Many Positions Can I Realistically Follow? I’d start out small, maybe with five. That means that you can allocate $20,000 to each on five positions. If you get comfortable with this, you can increase to 10 positions of $10,000 each later on, as I do in my model trading portfolio. Keep in mind that the more positions, the more work it takes to track it. You never want to have so many positions that you can’t follow what is going on.
2) Show Me the Money. Global macro hedge funds, like the one I run, have no hard and fast rules for where to allocate their money. Simply stated, they are 100% allocated to positions that make money. There is no other consideration. Outperformance relative to a benchmark, like the Dow or the S&P 500, is utterly meaningless. Arbitrary allocations to certain asset classes do not exist. There is no “bond/equity ratio”, owning your age in bonds, or other such nonsense like that. Funds may be entirely involved in equities one month, in bonds the following month, and in currencies the one after that.
3) The world is your oyster. You can invest in stocks, bonds, commodities, currencies, precious metals, ETF’s, and mutual funds. Hedge funds usually focus on areas that have the greatest visibility of future appreciation because of some competitive edge they posses. So you find doctors running biotech funds, Texas oilmen managing energy funds, and computer nerds advising technology funds. In the long/short global macro space, your competitive edge is me, The Mad Hedge Fund Trader.
4) Don’t Quit Your Day Job. If you have a day job and can’t check your email until you get home at night, you need a portfolio that holds positions for weeks or months, and requires minimal hand holding. If you live and breathe markets 24 hours a day and keep your trading screen in your bedroom so the trade alerts can wake you up in the middle of the night, you can afford a greater level of intensity. And whatever you do, don’t quit your day job until you get a few years of experience under your belt.
5) That’s Back Book, Not Black Book! You will often hear me talking about a back book. That is where you bury your sleeper positions that you know will go up someday, you just have no idea when. This is also where you often get your biggest returns. I put the rare earth producers Lynas Corp. (LYSCF) and Avalon Rare Metals (AVARF) on my back book a few years ago, figuring that with the world going nuts over hard assets, this obscure corner of the strategic metals market would get discovered someday. That “someday” turned out to be three weeks later, when it was off to the races for a 400% gain. Depending on your time frame and goals, you can put 20% to 40% of your portfolio in your back book.