Decision process tool

A decision process tool is designed to support an investment management firm that is constructing an investment portfolio of multiple assets. Every investment manager goes through a similar process of finding potential ideas to add to their portfolio, putting them through their own proprietary analytical process and finally constructing a portfolio based on their analysis. A Decision Process Tool helps bridge the transition from analysis to portfolio construction. There are three primary choices made during the decision process: 1) based on the analysis, does the asset qualify to be in the portfolio 2) if so, then what is the appropriate amount of exposure (position size) to the asset based on analysis and 3) as the asset persists in the portfolio and price and fundamentals change, how should the exposure to the asset be adjusted based on the analysis of the asset. For many asset managers, the decision process is subjective and involves rule-of-thumb, heuristics, memory and instinct. A Decision Process Tool helps formalize how position size is determined, so that there is a high degree of correlation between position size and idea quality. This process creates a portfolio with a higher portfolio expected return than non-formal methods.

By using a decision process tool a firm makes trading decisions with a focus on the process by which decisions are made rather than a focus on the potential outcomes. The philosophy behind a Decision Process Tool is that the end result of each decision is less important than the process that produced the decision. Decision Process Tools enable this philosophy by providing a framework for making trading decisions based on fundamental analysis as opposed to emotional beliefs about the likelihood of a successful decision. See Michael Mauboussin's explanation of decision over outcome in the first chapter of his book More Than You Know.^[1]

References

1. ^ More Than You Know