The Capacity of an Equity Strategy

Abstract

Capacity is an intuitive concept linked to diseconomies of scale in equity investing. As assets under management grow beyond realization of full economies of scale, liquidity and ownership constraints erode the ability of an equity investment strategy to add value. Two ways to estimate the capacity of a quantitatively managed equity strategy are proposed in a refined definition of the term. A controlled experiment to determine the effect on performance of varying only one variable—assets under management—indicates capacity estimations are sensitive to various assumptions, first and foremost about market impact costs. Capacity should thus not be thought of as a specific number, but rather as a variable whose range must be estimated.

TOPICS: Equity portfolio management, quantitative methods, portfolio construction