Navigating the Complexity of Capital Allocation

Psychology significantly influences capital allocation decisions, with managers often preferring smaller amounts of capital with higher performance fees, despite the economic equivalence. As portfolio sizes increase, concerns about implementation, liquidity, and scale become crucial, particularly when managing smaller-cap investments. Effective portfolio management usually relies on strong teams, yet most are constrained to smaller allocations. When determining capital allocation, it is vital to assess expected returns based on projected Sharpe ratios, while being cautious of relying on historical ratios due to their inherent noise. A sound understanding of the dynamics at play, especially when analyzing multiple investment opportunities, is essential for successful decision-making.