THE STUDENT MANAGED INVESTMENT FUND ANNUAL REPORT: FALL 2011 & SPRING 2012 pdf

Seth%Borko% Portfolio%Manager:%Fall%2011%&%Spring%2012% The%Student%Managed%Inves tmen t%F u n d% % Annual%Report:%Fall%2011%&%Spring%2012% % American%University% Kogod%School%of%Business% Dear Friends,! Welcome to new friends and old supporters alike. Birthdays are a great chance to celebrate but they also pose an opportunity to stop and reflect on the past year and set goals for the future. As American University’s Student Managed Investment Fund celebrates its second birthday it is fitting that we pause to look back on our progress. This year has been an exciting one and has witnessed the fund grow and mature tremendously. Fund management made significant strides in implementing resilient organizational structures that will facilitate a higher quality learning experience and better performance. Amongst many new changes, we began to look at our investment allocations in finer, more sophisticated ways. We implemented a top down investment approach headed by our chief economist. We organized ourselves into industry and stock coverage groups which fostered deeper and broader analysis of our holdings and the broader market. We also set up new safeguards to address problematic securities and much more. The Student Managed Investment Fund has seen promising returns this past year. Since our first trades in December 2010 the SMIF has returned 4.8%. 1 Year to date, the SMIF has seen a 7.03% gain leaving us well positioned to finish out the rest of the year. The fund is careful in the risks we take onto our balance sheet and are confident our returns more than fairly compensate us for risks that we bear. Fund Structure The Student Managed Investment Fund has $281,503 in assets under management and manages this money for the US equity portion of the American University endowment. The fund has a three to five year investment outlook. The latest chapter in the funds ongoing evolution has seen the implementation of a top down investment approach. Fund management created allocation categories based on company size and industry that let us take a targeted approach to stock selection. The fund has an official economist who is responsible for shaping a long term macroeconomic outlook. This view feeds into industry coverage groups, which produce an industry outlook. Target weightings are then created for each industry based upon this outlook. The groups are also responsible for maintaining coverage on all companies within their industry. This top down approach presents students with a clear direction for stock selection. It also allows fund management to guide analysts towards, say, mid-cap technology and away from large- cap consumer staples, something we didn’t previously have the structure to do. Allocation The successful implementation of this top down approach is visible in how we have aligned the fund’s investment allocation with our market outlook. The SMIF holds a moderately bullish outlook on the US economy. Management found several internal !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 1 !All!data!is!current!as!of!April!27,!2012! inconsistencies between our outlook and our holdings that we immediately sought to address. For example, the fund had a large cash position and a defensive beta. In addition, there was a bias towards large capitalization stocks and no clearly defined industry goals. Each of these challenges was prioritized and addressed, first reducing cash and increasing beta, then creating industry allocations, and lastly reducing average market capitalization. The most striking part of the funds development is the dramatic reduction in cash. The SMIF currently holds 10.79% of our portfolio in cash contrasting with a 56% stake last year. To be so underinvested tied our hands behind our back as investment opportunities passed us by. Cash was one of our largest challenges and it has been a top priority of management both this semester and the last to become fully invested, something we are proud to have achieved. In the fall semester cash was public enemy no. 1 and accordingly we closed out the fall over 90% invested in equity securities. In the process of investing our cash we managed to nearly double the portfolio’s beta from just below .5 to where it currently stands at .94. ! Figure'1.'Changes'in'industry'allocation In the spring we remained aware of cash but focused on fine-tuning precisely where we deployed our capital. This is how our new top down industry approach comes into play. This spring, the fund created target industry weights relative to our benchmark, the S&P 500. Figure 2 shows where we would like to be in an ideal world. The fund hasn’t reached its targets yet but we have made substantial progress towards realizing our goals. Please see Figure 7 for our current weights. ! Figure'2.'Target'industry'weightings'and'the'S&P'500’s'weights Notably, before we implemented a top down approach, the fund had significant exposure to consumers with a 35% combined weight in discretionary and staples. Our economic outlook favors a consumer recovery but we saw better opportunities in other sectors. We therefore drew down our consumer exposure replacing much of it with a focus on the technology sector. Technology is a key driver of the US economy and one of our country’s competitive advantages. Figure 3 shows some of the more notable changes in our industry allocations. ! Figure'3.'Selected'changes'in'industry'allocation' Last spring, large cap stocks made up 50% of our portfolio while the fund had no small cap holdings. As we reduced our cash, an increasing proportion has been invested in medium and small capitalization stocks. Our top priority in the fall was cash management over capitalization size. During the spring semester, with cash under control, the fund became more aggressive about selling down large cap holdings in favor of mid and small. Fund management believes that these allocation changes position us for the best possible performance given our moderately bullish economic outlook. Figure'4.'Changes'in'size'allocation' Performance' ! So!what!do!we!have!to!show!for!all!of!our!hard!work!this!year?!Figure!5!shows! performance!since!the!fund’s!very!first!trade!on!12/15/2010.!The!Student!Managed! Investment!Fund!has!a!4.8%!return!since!inception.!Frankly,!this!means!that!we! have!underperformed!the!S&P!500!but!a!deeper!dive!into!the!data!reveals!that!we! are!being!well!compensated!for!the!risks!that!we!are!taking.!Looking!at!the!Sharpe! ratio!as!a!measure!of!risk!adjusted!returns,!we!outperform!our!benchmark.!As!a! university!endowment!looking!for!safety!and!stability!we!find!the!Sharpe!to!be!a! crucial!metric.! ! ! Figure'5'Performance'since'inception' We!believe!underperformance!comes!from!several!factors.!Historically,!we!see! underperformance!driven!by!large!cash!positions!and!losses!over!the!summer.!An! examination!of!returns!from!when!students!retook!active!management!in!August!of! 2012!shows!a!7.16%!gain!but!this!still!underperforms!the!market.!We!attribute!this! to!a!low!market!beta!and!inefficient!industry!allocations.!Management!has! aggressively!moved!to!correct!this!and!will!close!out!this!semester!with!an!industry! tilt!we!believe!is!most!suited!to!capture!gains!moving!forward.!Figure!7! demonstrates!the!substantial!progress!we!have!made!towards!aligning!the!funds! holdings!with!our!internally!recommended!ideal!allocations.! ! ! Figure'6.'Returns'since'fall'semester' ! Absolute!performance!is!still!the!bottom!line!that!we!hold!ourselves!accountable!for! but!management!also!values!other!performance!measures.!The!SMIF’s!other!chief! measure!of!performance!is!the!Sharpe!ratio.!The!Sharpe!ratio!measures!return!per! unit!of!risk.!One!investment!may!have!a!large!return!but!only!after!months!of!wild! swings.!Another!investment!may!have!a!slow!but!steady!return.!By!normalizing!risk,! the!Sharpe!allows!a!comparison!between!two!investments!with!different!risk! profiles.!! ! The!Student!Managed!Investment!Fund!has!a!Sharpe!ratio!of!.024. 2 !Management! considers!this!an!outstanding!result!and!is!something!that!we!are!very!proud!of.!The! SMIF!not!only!outperforms!the!S&P’s!Sharpe!ratio!of!V.01!but!also!beats!many!other! wellVrespected!benchmarks.!Taken!in!context!it!becomes!clear!that!despite!the! S&P’s!larger!return,!the!SMIF!was!paid!significantly!greater!amounts!for!the!level!of! risk!that!it!took.!! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 2 !The!SMIF!maintains!a!three!year!investment!horizon.!As!such,!the!Sharpe!ratio!was! calculated!using!three!year!historical!data!and!a!three!year!risk!free!rate.!The!fund! does!not!have!enough!of!an!invested!history!for!these!calculations.!Instead!the! Sharpe!ratio!of!the!fund’s!individual!holdings!was!calculated!and!used!in!the! aggregate!to!determine!portfolio!performance.! Figure'7.'Ideal'weights'and'current'weights' If!the!fund!is!receiving!a!greater!compensation!for!its!risks!but!still!underperforming! its!benchmark,!it!follows!that!we!took!on!a!lower!level!of!risk!than!the!general! market.!The!fund’s!low!beta!over!the!past!several!semesters!corroborates!this.!Fund! management!has!consciously!tried!to!increase!our!beta!through!investment!in! cyclical!industries!poised!to!succeed!from!a!US!macroVeconomic!recovery.!As!the! fruits!of!our!investment!strategy!pay!off!over!the!next!three!to!five!years!we!expect! to!see!not!only!risk!adjusted!but!also!absolute!outperformance.!! ! ! Figure'8.'Sharpe'ratio'of'the'SMIF'compared'to'selected'indices'and'equities' Moving'Forward' ' In!the!past!two!years!the!Student!Managed!Investment!Fund!has!developed!into!the! premier!finance!course!at!American!University.!Enrollment!is!limited,!and!even! though!faculty!maintains!tough!prerequisites,!there!is!consistently!a!waitlist!for!the! course.!The!Student!Managed!Investment!Fund!is!well!positioned!to!deliver! educational!and!monetary!returns.!Our!goals!for!the!future!are!to!increase!assets! under!management,!build!relationships!with!financial!professionals,!and!ultimately! create!new!student!directed!classes!with!different!fund!management!styles.! ! ! As!part!of!our!growing!emphasis!on!building!relationships!with!financial! professionals,!the!SMIF!had!several!guest!speakers!over!the!past!year.!Dennis! Gogarty,!Bill!Mann!SIS!’92,!Ira!Jersey!SPA/SOC!’93,!Eric!Green!KSB!’92,!and!Chris!Hill! SOC!‘96!all!shared!their!insights!with!the!class.!The!class!intrinsically!has!an! emphasis!on!practice!over!theory.!Regular!speakers!add!practical!depth!as!to!the! theoretical!foundation!we!learn!in!other!classes.!Students!not!only!find!this! interesting,!but!also!regularly!apply!concepts!from!guest!speakers!to!the!SMIF’s! management.! ! Looking!further!down!the!road,!management!would!like!to!see!multiple!funds!with! different!styles.!We!envision!a!fixed!income!and!a!constrained!optimization!fund.! Debt!markets!are!some!of!the!largest!in!the!world!yet!very!few!universities!have! bond!funds!and!such!a!class!would!present!a!unique!opportunity!for!students.! Constrained!optimization!is!another!rapidly!growing!field!in!asset!management.! American!University!is!notable!for!its!commitment!to!the!environment.!We!see!a! sustainable!fund!as!an!idea!that!the!schoolVwide!community!could!get!behind!while! challenging!students!to!be!innovative!investors.!Both!funds!would!expose!students! to!unique!educational!experiences!and!prepare!them!for!the!job!market.! ! The!Student!Managed!Investment!Fund!at!American!University!has!had!an! outstanding!year!of!development!and!growth.!The!fund!is!well!positioned!to!move! forward!with!robust!structures!and!a!guiding!investment!philosophy.!!We!have!seen! students!gain!handsVon!knowledge!of!the!financial!world!and!provide!investment! returns.!The!fund!has!built!connections! w ithin!both!the!Kogod!School!of!Business! and!the!broader!American!University!community!which!continue!to!strengthen!over! time.!I!can’t!think!of!a!better!birthday!present.!! ! To!touch!briefly!on!a!personal!note,!my!involvement!in!the!SMIF!was!the!most! rewarding!of!my!college!career.!!I!know!from!speaking!with!classmates!that!many! others!share!this!thought.!Professors,!staff,!alumni,!parents,!students,!and!many! others!made!this!class!possible.!I!would!like!to!personally!thank!each!one!of!you!for! your!contributions,!both!big!and!small.!I!can’t!wait!to!see!what!our!third!birthday! will!bring.! ! ! Sincerely,! ! ! Seth!Borko! ! Portfolio!Manager! American!University,!Class!of!2012! ! ! ! ! ! ! ! ! . Seth%Borko% Portfolio%Manager: %Fall% 2011% & %Spring% 2012% The% Student% Managed% Inves tmen t%F u n d% % Annual% Report:% Fall% 2011% & %Spring% 2012% % American%University% Kogod%School%of%Business% Dear. Figure'4.'Changes'in'size'allocation' Performance' ! So!what!do!we!have!to!show!for!all!of!our!hard!work!this!year?!Figure!5!shows! performance!since !the! fund s!very!first!trade!on!12/15/2010. !The! Student! Managed! Investment! Fund! has!a!4.8%!return!since!inception.!Frankly,!this!means!that!we! have!underperformed !the! S&P!500!but!a!deeper!dive!into !the! data!reveals!that!we! are!being!well!compensated!for !the! risks!that!we!are!taking.!Looking!at !the! Sharpe! ratio!as!a!measure!of!risk!adjusted!returns,!we!outperform!our!benchmark.!As!a! university!endowment!looking!for!safety!and!stability!we!find !the! Sharpe!to!be!a! crucial!metric.! ! ! Figure'5'Performance'since'inception' We!believe!underperformance!comes!from!several!factors.!Historically,!we!see! underperformance!driven!by!large!cash!positions!and!losses!over !the! summer.!An! examination!of!returns!from!when!students!retook!active!management!in!August!of! 2012! shows!a!7.16%!gain!but!this!still!underperforms !the! market.!We!attribute!this! to!a!low!market!beta!and!inefficient!industry!allocations.!Management!has! aggressively!moved!to!correct!this!and!will!close!out!this!semester!with!an!industry! tilt!we!believe!is!most!suited!to!capture!gains!moving!forward.!Figure!7! demonstrates !the! substantial!progress!we!have!made!towards!aligning !the! funds! holdings!with!our!internally!recommended!ideal!allocations.! ! ! Figure'6.'Returns'since&apos ;fall& apos;semester' ! Absolute!performance!is!still !the! bottom!line!that!we!hold!ourselves!accountable!for! but!management!also!values!other!performance!measures. !The! SMIF’s!other!chief! measure!of!performance!is !the! Sharpe!ratio. !The! Sharpe!ratio!measures!return!per! unit!of!risk.!One !investment! may!have!a!large!return!but!only!after!months!of!wild! swings.!Another !investment! may!have!a!slow!but!steady!return.!By!normalizing!risk,! the! Sharpe!allows!a!comparison!between!two!investments!with!different!risk! profiles.!! ! The! Student! Managed! Investment! Fund! has!a!Sharpe!ratio!of!.024. 2 !Management! considers!this!an!outstanding!result!and!is!something!that!we!are!very!proud!of. !The! SMIF!not!only!outperforms !the! S&P’s!Sharpe!ratio!of!V.01!but!also!beats!many!other! wellVrespected!benchmarks.!Taken!in!context!it!becomes!clear!that!despite !the! S&P’s!larger!return, !the! SMIF!was!paid!significantly!greater!amounts!for !the! level!of! risk!that!it!took.!! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 2 !The! SMIF!maintains!a!three!year !investment! horizon.!As!such, !the! Sharpe!ratio!was! calculated!using!three!year!historical!data!and!a!three!year!risk!free!rate. !The! fund! does!not!have!enough!of!an!invested!history!for!these!calculations.!Instead !the! Sharpe!ratio!of !the! fund s!individual!holdings!was!calculated!and!used!in !the! aggregate!to!determine!portfolio!performance.! Figure'7.'Ideal'weights'and'current'weights' If !the! fund! is!receiving!a!greater!compensation!for!its!risks!but!still!underperforming! its!benchmark,!it!follows!that!we!took!on!a!lower!level!of!risk!than !the! general! market. !The! fund s!low!beta!over !the! past!several!semesters!corroborates!this. !Fund! management!has!consciously!tried!to!increase!our!beta!through !investment! in! cyclical!industries!poised!to!succeed!from!a!US!macroVeconomic!recovery.!As !the! fruits!of!our !investment! strategy!pay!off!over !the! next!three!to!five!years!we!expect! to!see!not!only!risk!adjusted!but!also!absolute!outperformance.!! ! ! Figure'8.'Sharpe'ratio'of&apos ;the& apos;SMIF'compared'to'selected'indices'and'equities' Moving'Forward' ' In !the! past!two!years !the! Student! Managed! Investment! Fund! has!developed!into !the! premier!finance!course!at!American!University.!Enrollment!is!limited,!and!even! though!faculty!maintains!tough!prerequisites,!there!is!consistently!a!waitlist!for !the! course. !The! Student! Managed! Investment! Fund! is!well!positioned!to!deliver! educational!and!monetary!returns.!Our!goals!for !the! future!are!to!increase!assets! under!management,!build!relationships!with!financial!professionals,!and!ultimately! create!new !student! directed!classes!with!different !fund! management!styles.! ! ! As!part!of!our!growing!emphasis!on!building!relationships!with!financial! professionals, !the! SMIF!had!several!guest!speakers!over !the! past!year.!Dennis! Gogarty,!Bill!Mann!SIS!’92,!Ira!Jersey!SPA/SOC!’93,!Eric!Green!KSB!’92,!and!Chris!Hill! SOC!‘96!all!shared!their!insights!with !the! class. !The! class!intrinsically!has!an! emphasis!on!practice!over!theory.!Regular!speakers!add!practical!depth!as!to !the! theoretical!foundation!we!learn!in!other!classes.!Students!not!only!find!this! interesting,!but!also!regularly!apply!concepts!from!guest!speakers!to !the! SMIF’s! management.! ! Looking!further!down !the! road,!management!would!like!to!see!multiple!funds!with! different!styles.!We!envision!a!fixed!income!and!a!constrained!optimization !fund. ! Debt!markets!are!some!of !the! largest!in !the! world!yet!very!few!universities!have! bond!funds!and!such!a!class!would!present!a!unique!opportunity!for!students.! Constrained!optimization!is!another!rapidly!growing!field!in!asset!management.! American!University!is!notable!for!its!commitment!to !the! environment.!We!see!a! sustainable !fund! as!an!idea!that !the! schoolVwide!community!could!get!behind!while! challenging!students!to!be!innovative!investors.!Both!funds!would!expose!students! to!unique!educational!experiences!and!prepare!them!for !the! job!market.! ! The! Student! Managed! Investment! Fund! at!American!University!has!had!an! outstanding!year!of!development!and!growth. !The! fund! is!well!positioned!to!move! forward!with!robust!structures!and!a!guiding !investment! philosophy.!!We!have!seen! students!gain!handsVon!knowledge!of !the! financial!world!and!provide !investment! returns. !The! fund! has!built!connections!