Portfolio Allocation Framework

1.0 Position Sizing

Position size is a function of conviction and valuation. Cheaper stocks on a risk-adjusted basis get larger allocations. The framework uses a tiered system based on composite valuation scores.

Tier System

Sizing Formula

pseudocodeFor each position:

  base_weight = 1 / number_of_positions  (equal weight baseline)

  valuation_modifier:
    PEG < 1.0              → +50% weight
    PEG 1.0 – 1.5          → +25% weight
    PEG 1.5 – 2.0          → +0%  (baseline)
    PEG > 2.0              → -25% weight

  quality_modifier:
    FCF Yield > 6%         → +25% weight
    FCF Yield 3% – 6%      → +0%  (baseline)
    FCF Yield < 3%         → -25% weight

  adjusted_weight = base_weight × (1 + valuation_modifier)
                                × (1 + quality_modifier)

  final_weight = min(adjusted_weight, 0.08)  // 8% hard cap
  final_weight = max(final_weight, 0.01)     // 1% floor

2.0 Sector Constraints

Valuation-driven sizing creates sector concentration risk. If energy stocks are cheap across the board, the model will pile into energy — right before oil drops 40%. Sector caps prevent this.

Sector Limits

Handling Sector Overflow

pseudocodeAfter sizing all positions:

  for each sector:
    if sector_weight > 0.30:
      overflow = sector_weight - 0.30
      reduce each position in sector proportionally
      redistribute overflow to underweight sectors
      (prefer highest FCF yield names in underweight sectors)

  Verify: no single position > 8%, no sector > 30%
  Remainder → cash reserve

3.0 Rebalancing

Calendar Rebalancing

Rebalance quarterly on the first trading day of January, April, July, and October. Calendar-based rules remove the temptation to time the market.

Rebalancing Process

pseudocodeQuarterly rebalance:

  1. Pull current prices and updated fundamentals
     (P/E, PEG, FCF Yield for each holding)

  2. Recalculate target weights using the sizing formula

  3. Compare current weight vs. target weight:
     - If drift > ±2% → trade to rebalance
     - If drift < ±2% → no action (avoid overtrading)

  4. Check for sells:
     - PEG > 3.0 → sell entirely (valuation broken)
     - Negative FCF for 2 consecutive quarters → sell
     - Thesis invalidated (competitive, regulatory) → sell

  5. Check for new entries:
     - Scan watchlist for PEG < 1.5 + FCF Yield > 3%
     - Fund new positions from cash reserve or trims

  6. Apply sector constraints (step 2.0)
  7. Execute trades

Threshold Rebalancing (Override)

Between quarterly dates, rebalance only if:

• A single position exceeds 12% of portfolio (price appreciation drove it too high).
• A sector exceeds 35% (5% above the soft cap).
• Cash drops below 3% (margin of safety breached).
• A position drops 30%+ from cost basis (reassess thesis — hold, add, or cut).

4.0 Risk Management

Drawdown Limits

Correlation Awareness

Diversification is not about the number of stocks — it's about the number of independent risk factors. 20 tech stocks is not diversified. 15 stocks across 5 uncorrelated sectors is.

referenceHigh correlation pairs (move together):
  NVDA ↔ AMD (same sector, same demand drivers)
  JPM ↔ BAC (both rate-sensitive, same macro exposure)
  XOM ↔ CVX (both oil-price-dependent)

Low correlation pairs (independent drivers):
  NVDA ↔ JNJ (tech capex vs. healthcare demand)
  JPM ↔ KO (interest rates vs. consumer staples)
  XOM ↔ MSFT (commodity vs. subscription software)

Build the portfolio from independent risk factors,
not just different ticker symbols.

5.0 Entry and Exit Rules

Entry Criteria

A stock enters the portfolio when all of the following are met:

1. PEG ratio < 2.0 (growth is not overpriced).
2. FCF yield > 2% (business generates real cash).
3. P/E ratio below sector median (not the most expensive name in its space).
4. Positive revenue growth (business is not shrinking).
5. Adding the position does not breach sector constraints.

Exit Criteria

A stock exits the portfolio when any of the following occur:

• PEG exceeds 3.0 for two consecutive quarters (sustained overvaluation).
• FCF turns negative for two consecutive quarters (cash generation broken).
• Fundamental thesis is invalidated (competitive disruption, regulatory change, management fraud).
• Position exceeds 12% of portfolio and trimming to 8% makes more sense than holding.

6.0 Related Pages