2017 - 2018

Orryn Boles, Editor

SIU College of Business

February 2018

SSIF Newsletter

1

CFA REASEARCH CHALLENGE

The St. Louis Regional CFA Institute Challenge was

on February 16th, 2018 at the Edwards Jones headquarters

in St. Louis, MO. This year’s team representing SIUC

consisted of Karla Rosado, Kendall Cole, and Rachael Reid.

The CFA team is given four months to research every

detail of a specific company, putting together a financial

analysts report showing whether they would recommend a

buy, sell, or hold on the company’s stock. This year’s

selected company was Belden Inc. (BDC). They presented

their findings against four other teams in front of a panel

of judges who are professional financial analysts and

received second place overall, finishing just behind

Washington University graduate students. This is the third

time that SIU has competed in the Challenge and the third

time it has received second place. Each year of this

competition, Matt Arnold, CFA and SIU alumni, has helped

guide our team with his years of professional experience

as a senior stock analyst. The picture above shows the team giving their presentation in

front of the judges in the Edward Jones auditorium. (Left to

Right) Kendall Cole, Rachael Reid, Karla Rosado.

The picture on the left shows the team working with

Matt Arnold as they put the final pieces together in

their report.

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COBA CHALLENGE

The COBA challenge is an intensive stock

analysis competition held within the SIUC College of

Business, consisting of three teams, each with three

members from the SSIF. Members work to identify the

best stock purchase from a randomly selected sector

of the Russel 1000 index. These teams will present a

buy recommendation from the Russel 1000 index as

well as a sell recommendation from the already

existing COBA portfolio, all within the span of three

days. On the day of the presentation each team will

conduct a 10-minute buy/sell presentation, followed by

a 10-minute Q&A session. At the end of the best buy and

the best sell recommendation, spectators attending the

challenge determine the winners by majority vote. The

team with the winning buy recommendation has the

honor of having their names displayed in the Bloomberg

room.

This year the winners for the buy in the spring

were: Anthony Reed, Courtney Lucas, and Bennett

Cohen. The winners of the buy in the fall were: Gilbert

Chua, Bennett Cohen, and Holden Johnson. The winners

of the sell portion in the spring were: Anthony Reed,

Courtney Lucas, and Bennett Cohen. The winners of the

sell portion in the fall were: Parker Moses,

Elijah Mihalik, and Lu Yan.

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The SSIF is not only actively researching

stocks for the SSIF investment fund and competing

in local, national, and global investment

competitions, we also utilize our many connections

with SIU alumni to go on company visits. In 2017

members of the SSIF visited Edward Jones and NISA

in St. Louis. We also took a two day trip to Chicago

and visited Horwitz & Associates, Chesley Wealth

Management Firm, and Pritzker Investment Firm.

These trips allow us as students to speak directly

with the upper management in these companies,

allowing us exclusive opportunities that many people

will never have. The NISA Company has hired

multiple SSIF members directly after graduation and

some for internships that turned into two jobs after

graduation. Trips like this are made possible thanks

to our diligent faculty advisor Dr. Timothy Marlo and

SIU alumni such as SIUF Board Member Bill McGraw.

On the Left is SIU

Alumni Bill McGraw

RECENT FUND ACTIVITY

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Performance Summary as of December 31, 2017

Quarter

Fiscal

YTD 1-Year 3-Year

5-Year 7-Year 10-Year

Since Inception

SSIF 9.15% 9.93% 16.72% 12.40% 15.96% 14.12% 11.11% 8.78%

S&P 400

Benchmark*

6.25% 9.68% 16.24% 11.14% 15.01% 12.85% 9.97% 9.70%

Difference 2.89% 0.26% 0.47% 1.25% 0.96% 1.27% 1.14% -0.91%

Tracking Error** 3.58% 3.01% 3.14% 2.89% 3.88% 5.22%

Information

Ratio***

0.13 0.42 0.30 0.44 0.29 -0.17

Months >

Benchmark

58% 58% 53% 52% 54% 50%

Periods greater than one year are annualized.

Inception: June 30, 2000

* Performance of the benchmark is reported for the S&P Midcap 400 Total Return Index

(Source: Bloomberg SPTRMDCP Index)

** Tracking error is annualized and based on monthly return differences relative to the

benchmark.

*** Information ratio is the ratio of the annualized relative return divided by the tracking

error

SIU Foundation Portfolio value as of December 31, 2017: $1,529,187.71

2017 SSIF PERFORMANCE

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Low Volatility and Shrinking Risk Premiums

Throughout 2017, we have seen market participants flocking towards equities in their

optimism for a sustained period of global economic growth. Industrial, Technology,

Healthcare, Materials and Consumer Discretionary firms were the top performers in our

benchmark in 2017. Each of these sectors returned ~20-25% for the year. The low volatility

that we experienced in the years following 2011 continued throughout 2017, as investor

complacency seemed to overpower the requirement for risk premiums regarding possible

equity volatility and downside risk. This has pushed equity prices up across the index as

investors search for yield and seem to be disregarding much of the inherent risks that

certain companies and industries carry with them.

It seems that the majority of investors have replaced caution against downside risk with

complacency and economic optimism.

We will touch on these valuations and downside risk in more depth as we compare our

portfolio characteristics to those of the benchmark. We expect that this trend of low

volatility will end in the next 12 to 18 months and investors that initiated inherently risky

positions at unfavorable prices will see significantly lower expected returns for the future.

We believe that this higher volatility should not affect the long-term prospects of our

portfolio, as we concentrate on sustainable, long-term returns that come with investing in

quality businesses at a reasonable price.

As investors injected capital into equities, trailing multiples rose to historic levels while the

market relied upon optimistic forward earnings estimates to justify these price levels.

Forward estimates expect earnings growth to push the benchmark’s trailing P/E multiple

from ~24x to a forward multiple of ~17x. While we acknowledge that this is possible in a

period of global economic growth, we believe that the necessary economic and underlying

intrinsic business growth required to sustain these valuation levels is a risk in and of itself.

With the Federal Reserve alluding to 3-4 rate hikes in 2018, a possibility for additional rate

2017 MARKET RECAP

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hikes in 2019, and the ability to earn “real” yield on the 2-year Treasury bond, there could be

slower economic growth domestically and abroad than what optimistic investors expect. If

economic growth were to miss estimates followed by less than optimistic earnings reports,

we believe that the investors holding these riskier firms are exposed to significant downside

risk relative to the potential upside risk. We believe that one should be wary when market

sentiment is at its highest.

Our Focus on Quality at a Reasonable Price

The SSIF has and will continue to position itself to minimize downside risk by continuing to

concentrate on buying and holding high quality firms with healthy balance sheets at a

reasonable price. We look at our current holdings and prospective holdings as businesses

rather than stocks that move up and down each day. We focus on firms that display

exceptional operational ability, industry economics, management teams, and healthy balance

sheets. It is important to understand that it is not always possible to initiate positions in

these firms at an attractive price. We look to acquire firms that are under-earning their

long-term potential or out of market favor for some reason or another. We concentrate on a

long-term approach in which we look at a firm’s sustainable earning power after adjusting

for cyclical or other temporary reasons. This mindset allows us to focus on quality

businesses while finding attractive pricing opportunities to acquire them.

This focus on quality is displayed by the following portfolio characteristics when compared

to our benchmark. Our portfolio had an average return on capital of 8.27% compared to

6.40% for the benchmark. Our average return on equity was 11.06% compared to the

benchmark’s 7.36%. We believe that it is important to not only look at how profitable a

company may be in terms of margins, but also to look at how much said company earns on

the capital necessary to continue its operations. Many people seem to disregard the amount

of capital that it has taken to boost profit margins across the market. This is very important

to understand as it is indicating that average management teams are generally poor

allocators of capital. Last year’s return on capital for the benchmark of 6.40% is compared

to an ROC of 7.77% five years ago in 2012. This decline has been consistent throughout this

timeframe.

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We also prefer to hold companies with quality balance sheets. This is shown in our portfolio’s

net debt to equity ratio of 72.67% compared to 197.93% for the benchmark. We believe that

reasonable amounts of leverage within a firm can help complement growth, but as leverage

increases, we believe that the financial distress risks can cause serious issues for firms in

and environment of rising interest rates or an economic slowdown. As the yield curve

steepens, we believe that the heavily leveraged benchmark will experience further drag on

earnings as interest costs become more burdensome and firms with unstable balance

sheets could experience financial distress as we begin to exit this extremely accommodating

monetary environment.

While the two metrics mentioned above show our emphasis on business quality, we also

recognize that price is equally important. Our portfolio traded at 19.2x trailing 12-month

earnings compared to 25.5x for the index. If you were to apply forward earnings estimates

to that number, our portfolio traded at 15.8x forward earnings compared to the benchmark

trading at 19.4x. If you wish to look at valuation from an operating cash flow standpoint, our

portfolio traded at 10.10x trailing 12-month operating cash flow while the benchmark traded

at 12.01x. Using forward estimates for operating cash flow our portfolio traded at a slight

premium to the benchmark at 10.54x compared to 10.07x respectively.

We believe that our concentration on business quality at a reasonable price will provide

adequate downside protection in the event of lower than expected economic growth or less

favorable monetary policy in the future. As long-term investors, we believe that holding

quality companies with sustainable earnings power will provide the best return and

downside protection for our client. We continue to search for these firms that are trading at

a discount to intrinsic value for some reason or another.

As always, we strive to provide our client with long-term returns in excess of those

produced by our benchmark while remaining committed to protecting said client against

unnecessary downside risk.

Respectfully,

Aaron Goeckner, Portfolio Team Analyst