lecture 8_darden capital management--the monticello fund
TRANSCRIPT
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This case was prepared by Professor Michael J. Schill. It has some fictionalized content and was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2004 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
In early April 2004, the Monticello Fund Management Team was in the midst of its first meeting of the new fiscal year. The team was part of the Darden Capital Management program at the Darden Graduate School of Business Administration, where MBA students were entrusted with managing endowment capital for the school foundation. The program sought to prepare its participants for careers in investment analysis and portfolio management, with the recognition that hands-on investment-management experience was an important aspect of professional training. The total assets under management for the Darden Capital Management program were over $3 million and were held in three funds: the Darden Fund, Monticello Fund, and Jefferson Fund. Each fund was managed independently by a small team of MBA students, with some guidance from a faculty advisor and a board of trustees.
The investment strategy of the Monticello Fund was to use fundamental analysis to identify and invest in companies that were well-positioned for growth but inexpensively valued. The fund team looked for stocks that would generate above-normal returns over a one- to four-year horizon. The new team replaced a team that had generated returns of 42.9% on their equity positions over the 12 months ending March 31, 2004. Such return performance was impressive both in absolute terms and with respect to the strong 35.1% returns over the same period on the S&P 500 market index. Exhibit 1 shows the current composition of the fund portfolio. The new team was unified in its resolve to once again beat the market index in the coming year; however, there was some debate on the most appropriate strategy to accomplish this goal. The Portfolio Allocation Decision
Prior to the meeting, Senior Manager Steve Majocha solicited from the team a list of securities for consideration as investment candidates. This request generated a list of six stocks for which there was mixed enthusiasm: Boise Cascade, Boston Beer, Micron Technologies, New York Times, and Placer Dome. Exhibit 2 shows the monthly return performance of each of the six stocks over the past five years. Exhibit 3 provides various return statistics and other risk measures. For each stock, the team had developed a financial forecast and an estimate of the fair-value of the stock in 2007. Based on these figures, the team had calculated the anticipated rate of return implied
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-2- UV0517 by the current stock price. Exhibit 4 contains the anticipated return estimates. Majocha’s suggestion that the team narrow the list to two or three stocks had generated a heated discussion.
Nandini Bose and Brian Maguire were strong proponents of buying Micron Technologies stock. The stock had declined dramatically from its 2000 peak, and they now felt it was well positioned to rebound. The team agreed that Micron offered the greatest expected return potential.
David Khtikian, however, insisted that Micron’s strong potential required accepting substantially greater risk. He backed up his claim by comparing the standard deviations of past returns. For each stock, he calculated the ratio of anticipated return to the standard deviation of returns, and found that Boise Cascade and New York Times maintained the best returns for the commensurate level of risk.
Charles Hill agreed with Khtikian that the anticipated returns should be normalized by the associated risk of the stock. He claimed, however, that a better measure of the risk faced by the investor was the correlation of the returns of the firm’s stock with those of a diversified portfolio. This correlation could be measured as the slope of a linear-regression line, commonly called the “beta.” Hill suggested that Mylan Labs and Placer Dome maintained the highest beta-adjusted returns (the anticipated return less than expected by the return model that incorporated beta, the Capital Asset Pricing Model).
Khtikian disagreed strongly, claiming that it made no sense to invest in a high-risk Canadian gold stock that was expected to generate a return of less than 9%. Hill countered that the attractiveness of Placer Dome stock was primarily in its diversification effect. He claimed that a 50–50 weighted portfolio with Mylan Labs and Placer Dome would prove to be better than simply holding Mylan Labs stock alone.
Majocha was due at a fund managers meeting in the morning and needed to be able to communicate a coherent portfolio strategy for the Monticello Fund. Majocha considered the recommendations of his team members and contrasted their views with what he knew of capital markets. (Exhibits 5 and 6 provide some data on current and historical capital market conditions.)
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Exhibit 1
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
Composition of the Monticello Fund (March 2004)
% of portfolio Net 12-month gain % Stocks Patina Oil & Gas 5.6% 101.5% General Dynamics 4.5 64.4 Berkshire Hathaway B 4.5 45.6 Sanderson Farms 4.3 11.5 NBTY 4.3 105.3 Mentor 4.3 34.8 Chicago Bridge & Iron 4.2 23.8 Kellogg 4.1 10.6 Chevron Texaco 3.9 2.9 Pier 1 3.9 30.1 Target 3.9 54.9 Pepsico 3.9 36.2 Pfizer 3.6 14.5 Johnson & Johnson 3.6 -5.4 Media General 3.6 38.2 Radian 3.5 3.1 Washington Mutual 3.3 23.3 Microsoft 2.3 3.6 Skywest 2.1 4.0 Bonds 17.8% 3.9%
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Exhibit 2
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
Monthly returns for proposed stocks (1999–2003)
Boise
CascadeBoston
BeerMicron
TechMylan
LabsNew York
TimesPlacer Dome
Jan-99 -3% 13% 54% -3% -1% -3%Feb-99 3% -21% -26% -10% -9% -2%Mar-99 5% 2% -16% 1% -8% 3%Apr-99 25% 10% -23% -17% 21% 26%
May-99 -2% -2% 2% 12% 0% -21%Jun-99 9% -3% 7% 5% 8% 6%Jul-99 -10% 15% 52% -14% 7% -13%
Aug-99 -6% -16% 21% -13% 0% 3%Sep-99 1% 2% -11% -7% -4% 43%Oct-99 -2% -2% 7% -2% 7% -17%
Nov-99 -3% -7% -6% 31% -4% -8%Dec-99 18% 0% 16% 7% 28% -6%Jan-00 -13% 3% -20% 6% -7% -17%Feb-00 -16% -2% 54% -14% -7% -1%Mar-00 17% 3% 31% 20% 2% -6%Apr-00 -6% 5% 11% 3% -4% 1%
May-00 -11% 8% 0% -5% -6% 0%Jun-00 -11% 1% 26% -32% 2% 17%Jul-00 7% 2% -7% 17% 4% -11%
Aug-00 8% 6% 0% 25% -5% 5%Sep-00 -11% -3% -44% 2% 0% 6%Oct-00 8% -14% -24% 4% -7% -14%
Nov-00 1% 4% -9% -15% -4% 11%Dec-00 17% 9% 13% 6% 13% 6%Jan-01 -2% 2% 29% -7% 9% -8%Feb-01 -3% 9% -25% 0% 2% 7%Mar-01 -2% -3% 21% 11% -7% -8%Apr-01 11% -4% 9% 4% 0% 17%
May-01 1% 8% -17% 19% 3% 5%Jun-01 0% -13% 10% -11% 0% -8%Jul-01 3% 23% 2% 20% 10% 3%
Aug-01 1% 9% -10% -2% -7% 10%Sep-01 -19% 2% -50% -1% -9% 16%Oct-01 -3% -1% 21% 13% 6% -11%
Nov-01 12% 18% 19% -7% 10% -4%Dec-01 7% 24% 14% 9% -5% 0%
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Exhibit 2 (continued)
Monthly returns for proposed stocks (1999–2003)
Boise Cascade
BostonBeer
Micron Tech
MylanLabs
New York Times
Placer Dome
Jan-02 5% -10% 9% -10% -3% 13%Feb-02 1% -15% -5% -10% 4% -5%Mar-02 1% 15% 2% -3% 9% 5%Apr-02 -7% -4% -28% -10% -3% -4%
May-02 5% 14% -1% 17% 8% 16%Jun-02 -3% -4% -14% 2% 2% -18%Jul-02 -16% -12% -4% 4% -12% -25%
Aug-02 -7% 2% -11% 1% 5% 20%Sep-02 -15% -3% -28% 1% -4% -8%Oct-02 4% 13% 29% -4% 7% -5%
Nov-02 14% 0% -1% 7% 0% 11%Dec-02 -6% -9% -38% 4% -5% 20%Jan-03 -5% 3% -16% 15% 7% -2%Feb-03 1% -11% -3% 7% -5% -13%Mar-03 -9% -4% 2% 1% -7% 0%Apr-03 5% 3% 4% -2% 7% 1%
May-03 7% 9% 33% 2% 4% 11%Jun-03 -2% 2% 4% 21% -5% 12%Jul-03 4% 5% 25% -3% -2% 0%
Aug-03 10% 4% -2% 8% 0% 11%Sep-03 2% 1% -7% 6% -2% 1%Oct-03 2% 7% 7% -6% 9% 12%
Nov-03 5% 8% -9% 5% -3% 18%Dec-03 12% -1% 4% 0% 4% -1%
Annualized Mean 8.2% 20.2% 16.6% 20.7% 11.0% 19.0%
Annualized Std. Deviation 31.2% 31.7% 76.2% 39.4% 25.8% 43.2%
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Exhi
bit 3
DA
RD
EN
CA
PIT
AL
MA
NA
GE
ME
NT
T
HE
MO
NT
ICE
LL
O F
UN
D
Cha
ract
eris
tics a
nd re
turn
stat
istic
s for
pro
pose
d st
ocks
Mon
thly
retu
rns 1
999–
2003
C
ompa
ny n
ame
In
dust
ry
Ave
rage
an
nual
A
nnua
lized
st
d. d
evia
tion
Bet
a es
timat
e1 R
aw
Val
ue L
ine
Div
iden
d Y
ield
Sa
fety
ra
ting2
PE
Rat
io3
Bon
d ra
ting
Boi
se C
asca
de
Pa
per p
rodu
cts
8.2%
31
.2%
1.
14
1.20
1.
80%
3
27.0
B
a2
Bos
ton
Bee
r
Alc
ohol
ic b
ever
ages
20
.2%
31
.7%
0.
46
0.55
0.
00%
3
22.9
N
A
Mic
ron
Tech
nolo
gies
Sem
icon
duct
ors
16.6
%
76.2
%
2.19
1.
70
0.00
%
5 N
MF
B2
Myl
an L
abs
Ph
arm
aceu
tical
20
.7%
39
.4%
0.
26
0.70
0.
51%
3
18.9
N
A
New
Yor
k Ti
mes
New
spap
ers
11.0
%
25.8
%
0.72
0.
90
1.30
%
2 23
.1
A1
Plac
er D
ome
G
old
and
silv
er
19.0
%
43.2
%
0.25
0.
40
0.61
%
3 28
.3
Baa
2
Sour
ce: V
alue
Lin
e (V
L), C
ente
r for
Res
earc
h in
Sec
urity
Pric
es (C
RSP
), M
erge
nt’s
Bon
d R
ecor
d.
1 T
he ra
w-r
etur
ns b
eta
is e
stim
ated
as t
he sl
ope
coef
ficie
nt o
f sto
ck re
turn
regr
esse
d on
S&
P 50
0 re
turn
(60
mon
ths)
. An
exam
ple
of th
e
regr
essi
on e
stim
atio
n is
pro
vide
d in
Exh
ibit
7. T
he V
alue
Lin
e be
ta is
an
alte
rnat
ive
estim
ate
prov
ided
by
the
Val
ue L
ine
Inve
stm
ent S
urve
y.
2 Th
e V
alue
Lin
e sa
fety
ratin
g m
easu
res t
he p
rice
stab
ility
and
fina
ncia
l stre
ngth
of a
firm
. Saf
ety
rank
s ran
ge fr
om 1
(hig
hest
) to
5 (lo
wes
t).
3 Th
e PE
ratio
is d
efin
ed h
ere
as th
e cu
rren
t pric
e di
vide
d by
ear
ning
s for
the
past
12
mon
ths.
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-
Exhi
bit 4
DA
RD
EN
CA
PIT
AL
MA
NA
GE
ME
NT
T
HE
MO
NT
ICE
LL
O F
UN
D
Mod
el fo
r est
imat
ing
antic
ipat
ed re
turn
for p
ropo
sed
stoc
ks
C
ompa
ny n
ame
Cur
rent
pric
e
Div
iden
ds p
er sh
are
2004
D
ivid
end
grow
th ra
teA
ntic
ipat
ed 2
007
Earn
ings
per
shar
e A
ntic
ipat
ed 2
007
PE
Ant
icip
ated
ann
ual
retu
rn (2
004–
2007
)
B
oise
Cas
cade
$3
3.40
$0
.60
0%
$2.0
2 23
.5
10.8
%
Bos
ton
Bee
r 17
.54
0.00
0%
1.
00
24.0
8.
2%
Mic
ron
T
echn
olog
ies
15.2
5 0.
00
0%
0.30
83
.0
13.0
%
Myl
an L
abs
23.5
5 0.
12
5%
1.46
24
.0
10.9
%
New
Yor
k Ti
mes
46
.01
0.60
4%
3.
76
16.5
9.
0%
Pla
cer D
ome
16
.43
0.10
15
%
0.75
30
.0
8.8%
So
urce
: Cas
e w
riter
ana
lysi
s.
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Exhibit 5
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
Summary statistics of annual returns for various classes of securities (Annual returns over period 1926 to 2003)
Series
Geometric mean1
Arithmetic mean2
Std. deviation
Inflation (Consumer price index)
3.0%
3.1%
4.3%
U.S. Treasury Bills (30-day)
3.7 3.8 3.1
Intermediate-term Government (5-year)
5.4 5.5 5.7
Long-term Government (20-year)
5.4 5.8 9.4
Long-term Corporate Bonds (High grade, 20-year)
5.9 6.2 8.6
Large Company Stocks (S&P 500 index)
10.4 12.4 20.4
Source: Ibbotson Associates, Stocks, Bonds, Bills, and Inflation, 2004 Yearbook.
1 The geometric mean is the compound rate of return over the 78 year sample period defined as
RGeometric= ( )1
782003 1926 1V V − , where tV is the value of the series in the respective year. 2 The arithmetic mean is the simple average of the 78 annual returns defined as
RArithmetic = 2003
178
1926t
t
R=∑ .
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Exhibit 6
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
Selected interest rates (April 1, 2004)
Security
Yield (%)
Treasury constant maturities
1-month 0.95 3-month 0.93 6-month 1.02 1-year 1.23 5-year 2.87 10-year 3.91 20-year 4.77 Treasury inflation-indexed 5-year 0.53 10-year 1.48 Corporate industrial bonds (Moody’s seasoned) Aaa 5.40 Baa
6.18
Source: Federal Reserve Statistical Release (www.federalreserve.gov/releases/h15/update).
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Exhibit 7
DARDEN CAPITAL MANAGEMENT THE MONTICELLO FUND
Regression estimates for Boise Cascade (Monthly returns over period 1999 to 2003)
Total return for Boise Cascade stock S&P 500
-30%
-20%
-10%
0%
10%
20%
30%
-30% -20% -10% 0% 10% 20% 30%
S&P 500
Boi
se C
asca
de
Ordinary least squares regression results Regression equation: (Return on Boise Cascade) = a + b* (Return on S&P500) + e Results: Coefficient Estimate t-statistic a 0.7% 0.78 b 1.14 6.13