TO THE INVESTMENT ADVISORY BOARD OF THE
STUDENT MANAGED FUND
Prepared by Graduate Student Fund Managers
MBA Class of 2004
November 14, 2003
November 14, 2003
Dear Foundation Members and Investment Advisory Board Members,
We would like to begin by thanking the Foundation and the IAB for this unique
opportunity. It has not only given our team the experience of managing the fund as
professional asset managers, but has also taught us the benefits of diligent
investment research and teamwork.
The MBA Managers of the Student Managed Fund are excited to present our
portfolio. We have taken great care in our investment decisions and on due diligence,
analyst report preparation, and stock presentation.
Throughout this report, we will discuss how we constructed our portfolio and more
importantly the reasoning behind our decisions. We will present the portfolio
allocation, our selection criteria, our holdings, and our returns. We will also
demonstrate why we believe we have added value to the portfolio's return.
Thank you again for providing our team with this invaluable experience.
The MBA 2004 Managers
University of Connecticut Student Management Fund – MBA
November 14, 2003
Outperform S&P 500 through careful stock selection, periodic re-evaluation of sector allocation,
and consistent monitoring of our portfolio
Focus on companies with consistent historical performance and a strong business model, as well
as a positive economic projection for the overall industry
Portfolio Performance: S&P 500 MBA
Started trading as of 10/14/03, with $75,993.05 Portfolio
invested as of 11/06/03 Sep. 04, 2003 $1027.97 $251,741
Our target is to be fully invested by February, Nov. 06, 2003 $1058.05 $258,025
2004 Return 2.93% 2.50%
Fund’s overall return since inception is 2.5% including initial position in the Vanguard S&P500
Our performance is comparable to that of the S&P500
SMF Sector Allocation
10 sectors – S&P 500 based H a Ca
e lth re
Methodology: emphasis on sectors with stronger 25 %
economic outlook Consum r e
The biggest sectors represented in our allocation are: Financia
Financials, IT, Consumer Discretionary, Health Care, and Information
Invest in stocks with solid financials, strong management, high projected earnings growth,
attractive valuation, and a higher return/ risk relative to the market
Perform fundamental analysis by studying historical performance and detailed ratio analysis
Screen quantitative and qualitative factors from our investment check list for potential stocks
Our risk control philosophy is based on a 20% stop-loss and 30% upside price review
Continuous monitoring of our portfolio for a dynamic response to changes in market situations
and altering economic conditions
Business profits growing at double-digit pace
Profits are being funneled into investment
Recovery is accelerating and unlikely to stall
Our goal: Invest funds quickly, but wisely
The overriding goal of the SMF is to beat the return of the S&P 500 by careful stock selection,
periodic re-evaluation of sector allocation, and consistent monitoring of our portfolio and
underlying economic changes.
The graduate SMF managers have taken a moderate approach to investing, focusing on companies
with proven track records while looking for strong long-term (5-year) growth potential. Our goal is
to outperform the S&P 500 over the short-term while minimizing the risk of the portfolio by
selecting stocks of companies with solid fundamentals. We invest in stocks that have a potential for
a 15% compounded annualized rate of return per year over our five year horizon.
We focus on companies with consistent historical performance and a strong business model, as well
as a positive economic projection for the overall industry. We used the sector allocation of the S&P
500 as a guideline to begin our portfolio, but in order to beat its return we aim to weight our
portfolio towards those sectors with a stronger economic outlook.
As a team, we look for companies that satisfy the following criteria:
Solid financial structure relative to industry
High projected earnings growth
Attractive valuation relative to the index
Our general buying criteria involves fulfilling the above objectives as well as seeking stocks with
an intrinsic value higher than their current value, above-average yields and an upside/downside
ratio above two. In addition to criteria for buying, we also have several criteria for potential
selling, including reevaluation of fundamentals after a 30% appreciation, adjustments to our
portfolio if the industry weightings change from our predetermined limits, and alteration of our
portfolio for a change in risk/reward profile.
We use fundamental analysis to ensure the growth potential and financial stability of the
companies we consider. Our fundamental analysis has two major features:
We conduct a thorough trend analysis of all companies we consider, with a focus on
historical growth, free cash flow and profit margin.
We also conduct a ratio analysis of the firms we consider in order to judge their
profitability and liquidity.
In addition to strong growth, we look for stocks that are undervalued and are therefore likely to
exhibit strong short-term as well as long-term growth. We evaluate the stocks using several different
models and criteria:
Business Model Analysis
Internal and external risk factors
We are active fund managers, and therefore monitoring of the performance and changes in the
fundamentals of our portfolio companies is exceptionally important. Below are some of the
criteria we use to monitor our portfolio.
We implement stop-loss measures to protect any downside losses. Stop-loss measures
are in place for a 20% loss in value.
If our stock increases in value by 30%, we automatically review the stock’s fundamentals
and decide if it is still worth our investment or if better opportunities now exist.
We constantly monitor our portfolio for a dynamic response to market situations such as
new company news and changing economic conditions.
SMF Sector Allocation vs. S&P 500
Asset allocation is one of the most important investment decisions for portfolio management. In
order to beat the performance of the S&P 500, we decided to allocate funds based on an equal
allocation strategy among the sectors of the S&P 500. Each of the 10 sectors was assigned two fund
managers. Each manager was then responsible for finding the top performing stocks within their
sectors and presenting detailed stock reports for their stock picks. Recent data from the S&P 500
GICS Sector Scoreboard (as of 10/31/2003) indicate that certain industries in the index have
significantly outperformed others since the beginning of year 2003. Thus, the majority of our stock
picks in the current portfolio are from those growth sectors. In particular, industries within the
consumer discretionary, financial services, IT, and materials sectors have been growing steadily
under the current economic recovery, with the YTD growth rates of 30.0%, 22.7%, 40.6%, and
20.1%, respectively. Therefore, approximately 83% of our current stock portfolio is in these sectors.
Although health care sector does not have an impressive YTD growth rate (only 5.6%) compared to
those mentioned above, the fund managers allocated money to this sector (17% of the current
portfolio) due to the firm-specific growth potential. In the next few months, we will keep looking
for both growth and value stocks in these and other prospective sectors such as industrials and
consumer staples to further allocate our remaining fund. The telecommunications sector has been
the poorest performing sector in the S&P 500, with a YTD growth rate of -39%, and was thus
excluded from our portfolio for now. It should be noted that, as we continue to re-evaluate our
allocation approach and gain experience in investing, our current equal allocation method may
change. The current allocation of the S&P 500 Index is illustrated in figure 1.
Allocation of Capital among Sectors
A total of 7 stocks were selected from 5 different sectors based on industry research and analysis of
both macro and micro economic situations. Each of those stocks was allocated to an equal amount
of funds worth $10,000 or so. Data from the Bloomberg Service, Valueline, and a number of
financial websites such as InvestorPlus, Moneycentral, Quicken, Multexinvestor, and Yahoo!
Finance was used to screen the top stocks in each sector. The final decision on a stock was
determined by many factors, including historical (past 5 years) and projected (next 5 years) growth
rates, P/E and PEG ratios, the intrinsic value calculated from different valuation models, financial
health of organizations, competitors’ positions, management effectiveness, and corporate
governance. The overall decision is largely based on a holistic approach taking all these factors into
consideration. The current sector allocation of the SMF holdings is illustrated in figure 2, below.
Figure 1 Figure 2
S&P Sector Allocation SMF Sector Allocation
Services Utilities Materials
Financials Health Care
3% 3% 3%
Health Care Consumer Information
14% Discretionary Technology
MBA Fund Holdings
Currently, our portfolio consists of seven stocks across five sectors. Our team adopted an equal
sector weighting strategy with initial investments of $10,000 each (approx.). As the team’s
experience level increases, we intend to evaluate our strategy and re-assess sector weights based on
the economic outlook and return potential of each sector. Of the quarter million dollars allocated to
the graduate SMF team, we have invested about $75,993.05 (as of 11/06/03). The basic gain of our
portfolio since Sept. 4, 2003 is 2.50%, while that of the S&P500 is 2.93%. It is important to note
here that the % basic gain in each of the stocks shown in Table 1 is the gain since their respective
investment and hence, cannot be compared directly to the S&P performance (which is since Sept. 4,
Table 1: SMF Holdings as of 11/05/03
Date of Price Market Value % Basic
Ticker Quantity Purchase Price
Purchase (11/05/03) (11/05/03) Gain
ALV 10/29/03 300 $32.43 $32.58 $9,774 0.15%
COGN 10/31/03 300 $34.80 $35.12 $10,536 0.34%
FDC 11/04/03 280 $35.90 $35.59 $9,965.20 -1.16%
JEC 10/24/03 200 $47.86 $45.51 $9,102 -5.21%
OCR 11/05/03 350 $36.93 $37.00 $12,950 -0.04%
10/14/03 100 $34.96
TOL $40.28 $10,070 8.86%
11/04/03 150 $38.01
WFC 11/05/03 250 $55.23 $55.69 $13,922.50 0.61%
The criteria that we use to evaluate selected stocks are manifold. The primary methods indicators
that we use are contained in the table below:
Table 2: Investment Criteria
ROA Industry Growth
ROE Company Market Share
ROIC Corporate Governance
Growth in EPS Institutional Ownership
Free Cash Flow/Net Income
Income* Insider Trading
Gross Margin (%) Market Power
Retention Ratio Low - cost Producer
Note: Please find below a few definitions for the above criteria:
Free Cash Flow shown in the above table were either obtained from Bloomberg or were calculated
using the formula in the ‘Valuations’ textbook.
Economic Profit is defined as the product of invested capital and the spread between ROIC and
Cost of Capital.
Corporate Governance refers to the extent of independence of the Board of Directors of the
company. We look for more than 50% of the Board of Directors to be independent as favorable to
the choice of the stock. We view independence as not being involved in the day-to-day operations of
the company and as not receiving any pecuniary advantage for influencing the company growth.
Insider trading is calculated as the net change in number of shares owned by insiders (over a 6-
month period) as a percentage of the total number insider shares.
The quantitative analysis is used to compare the historical performance of each stock. While this is a
good predictor of future performance, we recognize that it is also important to understand the
position of the company within its respective industry. The qualitative analysis provides us with
insight into more tacit qualities such as the company’s market power or the competitive advantage
with respect to its competitors. We measure market power as a function of three parameters:
product differentiation, low-cost producer and customer relationship. They are ranked as High,
Medium or Low compared to their peers in the industry, with High being the preferred status. Being
‘High’ in at least one of the three areas is a prerequisite for our stock selection.
A summary of the graduate SMF team holdings according to these criteria is shown in tables 3 &4.
Table 3: Quantitative Investment Criteria
ALV COGN FDC JEC OCR TOL WFC
ROA 3.72% 9.13% 5.00% 5.30% 3.50% 7.67% 1.41%
ROE 7.30% 15.80% 26.93% 13.67% 7.00% 20.83% 15.53%
ROIC 10.12% 16.93% 18.17% 23.93% 19.93% 13.04% 10.54%
Cost of Capital 7.29% 8.94% 8.00% 7.87% 6.80% 7.02% 6.68%
Economic Profit 3.89M 40.4M 718M 73.05M 19.08M 90.29M 2.091B
EPS Growth 63.70% 6.96% 23.51% 34.53% 44.77% 29.43% 16.29%
FCF/NI 68.30% 152% 129.46% 71.20% 46.3% -109% n/a
Gross Margin 17.91% n/a 42.17% 13.73% 29.64% 8.95% n/a
Ret. Ratio 51% 100% 96% 100% 90.67% 100% 61%
Debt/Equity 0.54 0 0.71 0 0.65 0.69 1.45
Beta 1 1.2 1.13 0.95 0.78 1.1 1.05
Table 4: Qualitative Investment Criteria
ALV COGN FDC JEC OCR TOL WFC
Industry Growth 23.23% 6.80% 10.81% -5.0% 6.12% 20.34% 6.90%
Company Market 15% steering
0.40% processing 12.58% 1.4% 4.78% 17.71%
Product High High High Medium Medium High Medium
Low-cost High High High Medium High High Medium
Customer High High High High High High High
Corporate Data not
8/11 7/8 5/9 6/9 6/12 7/11
99.05% 66.60% 95% 77.80% 95.6% 60.30% 67%
Insider Trading 0.07% 0% 1.13% 2.70% 25% 5.5% 0.11%
As can be seen, we have invested in companies that have a strong historical performance and can be
considered to have a dominant position in their respective industry (with the exception of COGN).
For instance, Autoliv (ALV), a Sweden based company, is the largest supplier of safety components
(airbags, seatbelts, etc…) to the automobile industry in the USA, Europe and Japan. This company
differentiated itself from its competitors by performing relatively well under discouraging market
conditions such as declining auto production in the triad region of Japan, Europe and the USA.
ALV has combated these adverse forces by decreasing its cost of production (e.g. transferring 30%
of its labor to low labor-cost countries), introducing new safety products, and venturing into
emerging markets like China and India.
Similarly, our portfolio contains Cognos (COGN), the world leader in business intelligence, which
has successfully created a niche market in the field of business intelligence. This company has shown
strong revenue growth over the past five years, and we expect the company to continue this trend,
particularly after the release of its new first-of-its-kind product “Reportnet” (a tool to collectively
report on all aspects of company data). ALV and COGN are prime examples of stocks with very
strong qualitative and quantitative attributes.
At the same time, the fund managers invested in the shares of Jacobs Engineering Corporation
(JEC), a strong company in a difficult industry with a negative growth rate. Our decision to invest in
JEC was based on its strong quantitative features. The company has had a strong positive growth
rate for the past eight years. We believe that JEC will perform well in the future due to the following
Long backlog of contracts (for next 10 years).
New government contracts
Relationship-based business model (long-term customer relationships and alliances)
Thus, our portfolio reflects a dynamic strategy of investing that stresses financial performance along
with value/growth inclinations, rather than market cap or country of origin.
Economists had been predicting modest economic growth throughout 2003, but few had expected
the 7.2% explosion in third-quarter real annualized GDP growth. Many credit the growth to special
one-off factors, such as personal income tax cuts and rebates, which helped consumer spending
jump 6.6%. However, doing so ignores other more sustainable factors that suggest that solid gains
in GDP are likely. First, business profits are growing at a double-digit pace. With dollar
depreciation, rising productivity, and cost reductions still a high priority, more profit gains are
expected. With excess capacity outside the manufacturing sector mostly eliminated, these profits are
finally being funneled into investment as the 15.4% rise in machinery, equipment and software
spending in the third quarter attests. The recovery is not only accelerating; it is broadening out
beyond consumer spending, thus limiting the risks that the recovery will stall once more.1
The graduate SMF team sees this economic outlook as a call to fully invest the SMF funds quickly.
Of course we all agree that this must be done prudently, so our desire to invest the funds rapidly will
not outweigh adherence to our established stock evaluation practices.
RBC Financial Group: Financial Markets Monthly, Vol. 7, No. 11, November 2003.