Fall 2015 Report /
1
INDEX
Letter to Foundation and IAB1
Executive Summary2
Investment Philosophy and Style3
Investment Strategy3
Risk Management4
Investment Process5
Sector Allocation5
Equity Portfolio and Allocation7
Performance9
Economic Outlook12
Sector Analysis14
Individual Positions20
1
Dear Foundation and Investment Board Members,
We would like to thank you for giving us the opportunity to participate in the 2015-2016 Student Managed Fund. It has been a wonderful and learning experience for each manager involved in the program and has allowed each of us to explore financial markets and build our portfolio under the guidance of Professor Ghosh and Professor Rakotomavo. We are thankful that each of you has volunteered your time in the classroom as well as at SMF events to provide us with an in-depth educational experience that will set us apart from our peers and instill us with valuable knowledge necessary to succeed in our post-MBA careers.
SMF has provided us with a platform to do in depth analysis on various investment vehicles. Additionally, the program has exposed many of us to valuable tools such asMorningstar Direct, ValueLine Investment Survey and Bloomberg for the very first time. The guidelines, goals and constraints set up in the prospectus helped us learn how to direct our investment philosophy and process in order to fulfill the needs of external constituencies. In order to ensure that the guidelines were followed, we built a process whereby each manager must be able to convince the group about their analysis and support the argument that their recommendation was a sound investment. With managers from different backgrounds and expertise levels, this led to a stimulating discussion that ensured all ideas were fully vetted before any action was taken.
Please enjoy the information in this report. Our intent was to shed light on our thought process, team dynamics, and logic in making our decisions. It is our hope that you find it interesting and compelling. We look forward to monitoring and continuing our progress throughout winter break and next semester.
Sincerely,
Alex Sadowski, Lead Manager
Akhilesh Kumar, Portfolio Manager
Akhil Sood
Chris Norris
Eddie Laclaustra
Jason Harris
Jifeng Hu
Lingfan Sun
Neel Munot
Yun Xie
EXECUTIVE SUMMARY
Benchmark and Style:
- The S&P 500 is the fund’s benchmark. Accordingly the fund is structured as a mid- to large-cap value portfolio. However we do consider small cap while keeping in mind their liquidity and downside risk.
- Although the fund is allowed to invest up to 20% of its value in fixed income, we made the decision not to invest in the asset class as we are in a period of historically low interest rates. It is our belief that the Fed will increase rates in the near future, which would lead to depreciation in a bond portfolio’s value.
Philosophy and Strategy:
- We consider our investment approach to be that of value investing. We sought investments in companies with solid and defendable business models, strong balance sheets, and current stock prices that were below their intrinsic value.
- We employed a bottom-up investment approach, relying on fundamental analysis of individual securities as opposed to emphasis on economic and market cycles.
Economic and Market View:
- We believe that the U.S. economy and market is in a mid-expansionary cycle.
- Some pertinent macroeconomic factors such as relative dollar strength to foreign currencies, probable interest rates hikes, over-supply effects on oil prices, slowdown of the Chinese economy and historically high U.S. employment rates played a role in our investment decisions.
Process:
- Each of the ten managers was assigned an S&P sector to research in order to establish an overall view of the market.
- We used discounted cash flow and dividend growth model analyses in order to establish individual security’s intrinsic value relative to their current market price.
- Each manager has pitched at least twice this semester, and will pitch at least four times before the end of this academic year.
- Each pitch is done with a thorough analysis presented to the other fund managers, coupled with a detailed one page report highlighting financials, relative valuations and riskiness of the companies.
- To reach the prospectus outlined 70% threshold approval, seven out of ten members must vote yes in order to invest in the recommended security.
INVESTMENT PHILOSOPHY AND STYLE
We consider the primary mandate to be value investors, to look for stocks that we believe the market is currently pricing too low (i.e., below their true intrinsic value). To determine each security's intrinsic value, we applied a discounted cash flow analysis and when appropriate the dividend growth model. We generally look for stocks trading at more than 15% below their intrinsic value.
We employed a bottom-up approach when selecting individual securities for our portfolio, choosing to focus on companies with solid fundamentals and business models rather than emphasizing economic and market cycles. It is also important that each company we invest in displays strong corporate governance and an independent board in order to avoid principal agent problems. This being said, we did not entirely ignore macroeconomic factors when selecting securities and each individual manager was responsible for following trends within each of the ten S&P sectors.
Our focus was on mid- and large-cap stocks as we viewed them as safer and more liquid investments. Additionally, we tend to focus on companies that are late in their business lifecycle (i.e., “value” companies) as opposed to early stage companies (i.e., “growth” companies). Oftentimes high growth companies are overvalued by the market, as indicated by high P/E multiples, and harder to analyze through fundamental analysis. We generally look for companies that have recurring revenue, consistent growth, strong balance sheet, long track record of profitability, strong management and a compelling story of value and/or competitive advantage. We also adhere to the UConn Foundation’s mandate that we invest in socially responsible companies, which we measure through available CSR scores through Bloomberg.
Our goal per the SMF mandate is to outperform the S&P 500 over five years; however, our performance is measured over the nine month academic calendar. As a group we are cognizant that our investment horizon is beyond this academic year, focusing primarily on the quality of our analysis and the stories of companies we choose to invest in to sustain quality earnings.
INVESTMENT STRATEGY
We are an actively managed fund looking to select individual securities to beat the broader market. Our bottom-up investing approach focuses on fundamental analysis to identify solid investments regardless of sector or market cycles. Our primary focus is on mid- to large-cap companies with strong business models that identify customers and profitably addressing their needs and differentiated strategies. We seek to take advantage of market irrationality and short-term market mispricing to purchase securities we believe are undervalued based on our estimates of their intrinsic value. Through this strategy, our goal was to beat the S&P 500 index—seeking to generate positive alpha.
At the start of the fall semester we had approximately $1.86M in the S&P 500 ETF. Our goal was to invest in 40 securities over the course of the academic year, or approximately $46k to $50k per investment. In order to avoid having to liquidate holdings for new investments during the spring semester, we set a goal of investing in 20 securities this fall (approximately 50% invested). To date, we have invested in 17 securities and are approximately 46% invested.
The Student Managed Fund is permitted to put up to 20% of the portfolio into fixed income. We chose not to invest in this asset class due to historically low interest rates and the belief that the Fed will raise interest rates in the near future, leading to a negative effect on bond portfolio valuations. Opportunities may exist in the event that certain fixed income instruments see tightening yield spreads; however, such opportunities are difficult to identify and it is our belief that placing such bets would assume too much risk within the framework of our mandate.
RISK MANAGEMENT
Unsystematic Risk:
Unsystematic risk is the type of uncertainty that comes with the company or industry invested in and can be reduced through diversification. We instituted that each manager pitch at least one stock in the sector they initially researched. As such, we avoided our portfolio beingover weighted on historically high growing but riskiersectors such as Information Technology or Financials. To date, we have invested in all of 10 S&P 500 sectors, with highest weight of 23.47% in the Consumer Discretionary sector.
Systematic Risk:
Systematic risk is the measure of stock volatility which cannot be diminished or reduced through diversification. Our methodology to control the systematic risk is to invest in the company of which the business model is understandable, historical performance is sustainable and beta level is acceptable. We tended to avoid the company which is too focused by the entire market, because usually the market will react very strongly to such firm’s performance. For example, Amazon’s share price has risen more than two times this year and its PE ratio has reached over 900. Although all of us agreed that Amazon will continually grow in a dramatic manner, 8 out of 10 managers voted no for this company because its volatility and risk it would add to our portfolio.
INVESTMENT PROCESS
Training and Development:
Before we began with our stock pitches, Professors Ghosh and Rakotomavo organized a variety of workshops and open discussions concerningthe methodology of pitching stocks and tools that can be leveraged – such as Bloomberg, Value Line Investment Survey, S&P NetAdvantage and Morningstar Direct. FNCE 5408 (Valuation of Financial Assets) is a mandatory class for all graduate SMF managers, taught by Professor Ghosh and supplemented by Professor Rakotomavo and IAB member Chris Wilkos.
Channels of Communication:
The team regularly held weekly meetings in conference room 404 in the GBLC—either two times a week for two hours on Tuesday and Thursday or one time a week on Thursdays. The purpose of these meetings was topitch individual stocks, vote on stocks that were pitched, insight sharing, task allocation and agenda setting. Professors Ghosh and Rakotomavo regularly attended these meetings to share their insight and help establish an investment process.
Stock Pitching:
To date we have held four stock pitching rounds, each of which had five managers pitching an individual security. Each manager was required to recommend one stock of their choice regardless of sector and one stock that pertained to their assigned S&P sector. Each stock pitching round was broken into four sections: 1) The portfolio manager who is going to present his or her stock recommendation must send a one page stock pitch report to everyone 24 hours before presentation; 2) During the meeting, stock manager must conduct presentation includes but not limited to key statistics, company profile, industry overlook, investment theory, investment risk, investor conference call transcript takeaways, relative valuation, financial performance analysis and valuation; 3) Following the presentation, a Q&A session took place which usually lasted for 5 to 20 mins; 4) Voting was conducted one week after the presentation to make sure each manager have sufficient time to understand and do the research. To approve a stock for the portfolio we agreed upon 70% approval level, which means 7 out of 10 portfolio managers has to vote ‘yes’ in order for the stock to be selected.
SECTOR ALLOCATION
Our goal is to establish 35 to 40 positions representing all sectors by the end of the academic year. Initially each manager was assigned a sector and he presented sector analysis and outlook for his assigned sector. Although ourinitial stock pitches had no sector constraints, we continuously monitored the sector allocation compared to S&P 500 sector weightage so we could have a balanced portfolio. Furthermore, we temporarily stopped pitching stocks after our initial pitches in order to evaluate our weightages versus the S&P 500. In order to promote diversification in our portfolio, we decided to set sector constraints during each manager’s second pitch, requiring them to choose an undervalued company in their respective sector.
Our top three sectors by weight are Consumer Discretionary, Consumer Staples and Financials. Furthermore,our bottom three sectors by weight are Telecommunication Services, Energy and Materials. We will continue to search for undervalued companies in non-represented or underrepresented sectors as we move forward to ensure we have a diversified portfolio.
S&P 500 Sector Weights / Current Portfolio Weights / Over/UnderweightConsumer Discretionary / 13.20% / 23.47% / 10.27%
Consumer Staples / 9.70% / 11.88% / 2.18%
Financials / 16.20% / 11.79% / -4.41%
Industrials / 10.20% / 11.64% / 1.44%
Health Care / 14.60% / 11.60% / -3.00%
Utilities / 2.90% / 5.98% / 3.08%
Information Technology / 20.80% / 5.96% / -14.84%
Telecommunication Services / 2.40% / 5.92% / 3.52%
Energy / 7.10% / 5.88% / -1.22%
Materials / 2.90% / 5.88% / 2.98%
EQUITY PORTFOLIO AND ALLOCATION
As fund managers, the benchmark that we are being measured against is the SPDR S&P 500 ETF (Ticker: SPY). By shaping a well-diversified portfolio focused on a mix of growth and value stocks we intend to maximize our returns. Below is a snapshot of our current portfolio. Please note that all portfolio analysis is based on the position on December 1, 2015 at the end of the trading day.
Industry / Company / Date Purchased / Shares Held / Current Price / Portfolio Weight / Current Position ValueConsumer Discretionary / 23.5% / 201,182
Leisure Products / Polaris / 29-Oct-15 / 450 / 105.73 / 5.9% / 47,601
Media & Entertainment / Disney / 29-Oct-15 / 435 / 119.42 / 5.8% / 50,195
Household Durables / Toll Brothers / 29-Oct-15 / 1400 / 37.10 / 5.9% / 53,284
Specialty Retail / CarMax / 6-Nov-15 / 875 / 56.63 / 5.9% / 50,103
Consumer Staples / 11.9% / 101,809
Food & Staples Retailing / CVS Health / 17-Nov-15 / 535 / 91.56 / 5.9% / 51,066
Tobacco / Reynolds American / 19-Nov-15 / 1100 / 47.03 / 6.0% / 50,743
Energy / 5.9% / 53,406
Oil, Gas & Consumable Fuels / Marathon Petroleum / 19-Nov-15 / 900 / 56.41 / 5.9% / 53,406
Financials / 11.8% / 104,577
Consumer Finance / Capital One / 18-Nov-15 / 650 / 78.82 / 5.9% / 51,883
Real Estate Investment Trusts / AvalonBay / 19-Nov-15 / 285 / 181.50 / 5.9% / 52,694
Health Care / 11.6% / 98,423
Biotechnology / Gilead Science / 6-Nov-15 / 460 / 106.36 / 5.8% / 48,691
Health Care Equip & Supply / Medtronic / 11-Nov-15 / 650 / 76.56 / 5.8% / 49,732
Industrials / 11.6% / 98,452
Aerospace & Defense / UTX / 29-Oct-15 / 500 / 98.09 / 5.8% / 48,350
Air Freight & Logistics / UPS / 6-Nov-15 / 480 / 103.59 / 5.8% / 50102.4
Information Technology / 6.0% / 51,630
Tech Hard, Storage & Per. / Apple Inc. / 18-Nov-15 / 440 / 117.75 / 6.0% / 51,630
Materials / 5.9% / 50,989
Construction Materials / Martin Marietta / 18-Nov-15 / 320 / 159.92 / 5.9% / 50,989
Telecommunication Services / 5.9% / 50,655
Diversified Telecomm Services / AT&T / 19-Nov-15 / 1500 / 33.46 / 5.9% / 50,655
Utilities / 6.0% / 58,652
Electric Utilities / ITC Holding / 19-Nov-15 / 1,550.0 / 33.30 / 6.0% / 58,652
Below table summarize, key important ratios for our holdings along with the average for our total invested portfolio.
Weightage / Dividend Yield / (P/E) / (P/CF) / Beta / EV/EBITDA / Profit Margin / ROA / EV/SalesTotal / 100.00 / 1.91 / 16.30 / 12.29 / 0.96 / 11.12 / 9.10 / 4.85 / 2.07
Apple Inc. / 6.01 / 1.72 / 12.79 / 8.38 / 1.10 / 6.25 / 22.85 / 20.45 / 2.21
AT&T Inc. / 5.84 / 5.60 / 13.58 / 5.61 / 0.74 / 10.37 / 3.78 / 1.53 / 2.36
AvalonBay Inc. / 6.02 / 2.69 / 35.20 / 23.84 / 0.59 / 27.09 / 40.16 / 4.47 / 17.04
Capital One Corp / 5.95 / 1.90 / 10.79 / 4.06 / 1.15 / 8.91 / 16.77 / 1.31 / 3.47
CarMax Inc. / 5.82 / 19.66 / 1.27 / 18.22 / 4.23 / 4.76 / 1.44
CVS Health Corp / 5.87 / 1.48 / 20.75 / 12.95 / 0.93 / 11.68 / 3.39 / 6.10 / 0.86
Gilead Sciences Inc. / 5.76 / 0.80 / 9.84 / 8.65 / 1.09 / 6.97 / 53.78 / 42.56 / 4.87
ITC Holdings Corp / 6.06 / 2.07 / 19.55 / 9.92 / 0.57 / 13.33 / 23.94 / 3.54 / 9.09
Marathon Petroleum / 6.11 / 1.95 / 10.20 / 8.72 / 1.31 / 5.22 / 4.88 / 11.20 / 0.51
Martin Marietta / 5.97 / 0.99 / 36.25 / 21.64 / 1.06 / 16.34 / 7.59 / 3.65 / 3.36
Medtronic Plc / 5.76 / 1.79 / 24.93 / 16.46 / 1.05 / 22.09 / 11.28 / 3.69 / 5.40
Polaris Industries Inc. / 5.51 / 2.01 / 14.95 / 11.41 / 0.88 / 7.66 / 9.82 / 22.23 / 1.44
Reynolds American / 5.97 / 2.91 / 15.23 / 162.79 / 0.72 / 12.24 / 32.00 / 9.04 / 8.37
Toll Brothers Inc. / 6.15 / 18.83 / 41.34 / 0.87 / 21.69 / 8.51 / 4.10 / 2.35
United Parcel Service / 5.80 / 2.80 / 20.36 / 11.83 / 0.89 / 12.09 / 6.81 / 10.59 / 1.75
United Technologies / 5.61 / 2.64 / 13.63 / 13.50 / 1.08 / 9.04 / 9.41 / 6.31 / 1.70
Walt Disney Co. / 5.80 / 1.15 / 22.33 / 17.86 / 1.06 / 13.37 / 15.98 / 9.73 / 3.96
Below are the key ratios for the portfolio compared to S&P 500. As evident from below table most of the ratio for SMF portfolio is very close to S&P 500. Our dividend yield is 1.91 compared to 2.09 for S&P 500, further Beta for our portfolio is 0.96, compared to 1 for S&P 500.
SMF Portfolio / S&P 500 / DifferenceDividend Yield / 1.91 / 2.09 / -0.18
Price to Earning / 16.30 / 18.66 / -2.36
Price to Cash flow / 12.29 / 10.90 / 1.39
EV/Sales / 2.07 / 2.22 / -0.15
EV/EBITDA / 11.12 / 12.68 / -1.56
Profit Margin / 9.10 / 8.32 / 0.78
Return on Assets / 4.85 / 2.72 / 2.13
Beta / 0.96 / 1.00 / -0.04
INVESTED PORTFOLIO
Below table gives the induvial return of each stock on standalone basis and also as compared to S&P 500. As on December 1, 2015 worst performing stock in our portfolio was Polaris ( unrealized loss of –ve 5.00%) and best performing sock in our portfolio was ITC Holding ( unrealized gain of 14.7%).
Buy Date / Company / Buy Price / CP / Gain Loss / S&P 500 / S&P 500 Gain Loss / +/- Comparedto Benchmark
29-Oct-15 / Polaris / 111.29 / 105.78 / -5.0% / 2089.41 / 0.63% / -5.6%
UTX / 99.24 / 96.70 / -2.6% / 2089.41 / 0.63% / -3.2%
Disney / 114.34 / 115.39 / 0.9% / 2,083.58 / 0.91% / 0.0%
Toll Brothers / 36.21 / 38.06 / 5.1% / 2,089.17 / 0.64% / 4.5%
6-Nov-15 / UPS / 103.95 / 104.38 / 0.4% / 2,089.17 / 0.64% / -0.2%
Gilead / 107.59 / 105.85 / -1.6% / 2,083.58 / 0.91% / -2.5%
CarMax / 57.24 / 57.26 / 0.0% / 2,083.58 / 0.91% / -0.9%
11-Nov-15 / Medtronic / 76.40 / 76.51 / 0.1% / 2,089.17 / 0.64% / -0.5%
17-Nov-15 / CVS Health / 94.67 / 95.45 / 0.8% / 2,089.17 / 0.64% / 0.2%
18-Nov-15 / Apple Inc. / 115.75 / 117.34 / 1.4% / 2,099.20 / 0.16% / 1.2%
Martin Marietta / 157.00 / 159.34 / 1.5% / 2,075.00 / 1.33% / 0.2%
Capital One / 77.06 / 79.82 / 3.6% / 2,099.20 / 0.16% / 3.4%
20-Nov-15 / AT&T / 33.8 / 33.77 / 0.0% / 2,099.20 / 0.16% / -0.1%
AvalonBay Comm. / 178.0 / 184.89 / 3.9% / 2,089.17 / 0.64% / 3.3%
ITC Holding / 33.0 / 37.84 / 14.7% / 2089.41 / 0.63% / 14.1%
Marathon Petro / 55.8 / 59.34 / 6.3% / 2089.41 / 0.63% / 5.7%
Reynolds American / 46.3 / 46.13 / -0.3% / 2,050.44 / 2.55% / -2.8%
Below is the graphical representation of individual stock returns.
Our first investment was made on October 29, 2015. From the first investment till December 1, 2015, our invested portfolio has generated return of 1.54% compared to 0.88% for S&P 500.
Below is the performance summary of our invested portfolio. As evident from the table SMF invested portfolio has given superior returns compared to S&P 500. Further for SMF portfolio, Risk / Return ratios as Sharpe Ratio, Jensen Alpha and Information Ratio are in a very respectable range.
Portfolio Statistics / SMF Invested Portfolio / S&P 500› Return
Total Return / 1.54 / 0.88
Mean Return (Annualized) / 28.73 / 16.21
Mean Excess Return (Annualized) / 10.78
› Risk
Standard Deviation (Annualized) / 12.28 / 12.18
Downside Risk (Annualized) / 8.48 / 7.90
Tracking Error (Annualized) / 4.04
› Risk/Return
Sharpe Ratio / 1.60 / 0.92
Jensen Alpha / 8.98
Information Ratio / 1.88
Total Portfolio Snapshot:
Sep 22, 2015 / December 1, 2015ETF / $1,860,328.77 / $1,146,099
Equity / - / $869,774
Cash / 327 / $8,067
Total / $1,860,655.77 / $2,023,940
Return / 8.78%
Below is the performance summary of our invested portfolio. As evident from the table SMF invested portfolio has given superior returns compared to S&P 500. Further for SMP portfolio, Risk / Return ratio as Sharpe Ratio, Jensen Alpha and Information Ratio are in a very respectable range.
Portfolio Statistics / SMF Portfolio / S&P 500› Return
Total Return / 8.78 / 8.69
› Risk
Standard Deviation (Annualized) / 12.85 / 14.13
Downside Risk (Annualized) / 8.80 / 9.59
Skewness / -0.16 / -0.07
Tracking Error (Annualized) / 2.24
› Risk/Return
Sharpe Ratio / 4.07 / 3.96
Jensen Alpha / 1.83
Information Ratio / -1.07
To date, the invested portfolio has outperformed the S&P 500. Our invested portfolio has returned 1.54% compared to 0.88% for S&P 500. Furthermore, our total portfolio has returned 8.78% compared to 8.69% for S&P 500.
To date, we have been able to invest 45.9% of initial ETF portfolio given to us. Also at this point of time we are invested in all the 10 S&P 500 sectors. Current portfolio beta is 0.96 and P/E ratio is 16.30 compared to S&P 500 P/E ratio of 18.66. Since each manager is required to make at least two investment pitches per semester, we purposefully aimed to be about 50% invested in order to avoid having to liquidate holdings second semester—doing so would be against our established value investor approach.
ECONOMIC OUTLOOK
Global growth is forecasted at 3.3 percent in 2015 and 3.8 percent in 2016, with uneven prospects across the main countries and regions. Growth in emerging market economies is softening, reflecting an adjustment to diminished medium-term growth expectations and lower revenues from commodity exports, as well as country-specific factors. The outlook for advanced economies is showing signs of improvement, owing to the boost to disposable incomes from lower oil prices, continued support from accommodative monetary policy stances, and more moderate fiscal adjustment. The distribution of risks to near-term global growth has become more balanced. The decline in oil prices could boost activity more than expected. Geopolitical tensions continue to pose threats, and risks of disruptive shifts in asset prices remain relevant. In some advanced economies, protracted low inflation or deflation also pose risks to activity.