Trading and Money Management in a Student-Managed Portfolio

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• Publisher: Academic Press
• Year: 2013
• eBook ISBN: 9780080911939
• Topic: Personal Development
• Subtopic: Personal Finance

Trading and Money Management in a Student-Managed Portfolio is a hands-on textbook for student-managed investment funds (SMIFs). The book presents the applied material that textbooks on portfolios and investments always overlook. Its focus on "how-to" questions summarizes the disciplines and skills necessary for trading. Covering equities, hedge funds and derivatives, and fixed income, it captures the breadth and detail necessary for developing and executing trading strategies.

Developed specifically for SMIF courses, the book features calculations, examples, and software that help you move from talking about markets to taking positions in them.

• Methodically summarizes the disciplines and skills necessary for trading
• Teaches you to build a ranking model for securities and write a research report for a sell-side firm
• Covers equities, fixed income, derivatives, and hedge funds

Chapter 1

Investment Philosophy and Process

The investment philosophy and process combine to define the investment approach of the investor or investment organization. Together, the investment philosophy and process provide a framework in which to understand markets and select investments. Without these, the entire endeavor is ad hoc. In short, the investment philosophy provides the why and the investment process provides the how with regard to an investment organization’s approach to investing. The investment philosophy and process are critical elements in providing for consistency through time in a student-managed investment fund. This chapter describes the key elements of investment philosophy and process statements and provides examples from both student-managed investment funds and institutional investment managers.

Keywords

Client; efficient markets; endowment; institutional investment manager; investment philosophy; investment process; philosophy; process; strategy

Chapter Contents

The Student-Managed Investment Fund as an Investment Management Firm

Investment Philosophy and Process

Investment Philosophy

Scope of an Investment Philosophy

Statement of Beliefs

Statement of Opportunities

Statement of Ability

Statement of Value

Examples of Investment Philosophy

Investment Process

Key Elements of an Investment Process

Initialization

Methods

Implementation

Examples of Investment Process

Internal and External Uses of the Investment Philosophy and Process

Appendix A: Common Investment Strategy Classifications

Appendix B: The Role of Investment Philosophy in Evaluating Investment Managers: A Consultant’s Perspective on Distinguishing Alpha from Noise

What Is an Investment Philosophy?

How Does Analysis of a Manager’s Investment Philosophy Aid in Distinguishing Alpha from Noise?

Common Ways of Failing the Investment Philosophy Test

Uncommon Ways of Passing the Investment Philosophy Test

References

A student-managed investment fund is a pool of real money that is managed by undergraduate or graduate students. Students have the responsibility for deciding how the money is invested. In some cases, this responsibility covers all aspects of the investment process, including asset allocation, security selection, execution and trading, and monitoring and reporting. In other funds, students are responsible for a subset of these activities, perhaps because they are given a mandate to invest in a specific asset class by a board of advisors or the beneficiary of the fund’s assets. In all cases, the common element is that students are entrusted with the responsibility and granted the authority to invest real money. As such, a student-managed investment fund is not a game. It is not a simulation. Risks are taken. Profits can be made. Money can be lost.

Given what is at stake, there are some who might question the wisdom in trusting students with real money. After all, students are not professionals. Yet in a student-managed investment fund, students are being trusted with responsibilities that are typically bestowed only on professionals with years of experience. With the help of professional and academic advisors, educational resources, such as this book, and, most importantly, a high level of diligence, students can achieve results on par with those of true professionals. In so doing, students gain valuable experience and insights that apply to business, in general, and investing, specifically – as well as a broad spectrum of other activities.

The real world experience provides the primary motivation for most colleges and universities in offering a student-managed investment fund. Likewise, it attracts motivated students who seek this experience and a more practical understanding of business and investments. The student-managed investment fund provides a hands-on learning environment in much the same way as laboratory experiments or exercises would enhance learning physics, chemistry, or biology. As with science labs, the theory that is taught in textbooks and classroom lectures becomes tangible and its relevance clearer. This book serves as a sort of “lab book” in helping to present traditional classroom material in an applied setting. As such, the emphasis is on the practice of investing. The relevant theories are not developed in as much detail as they might be in some texts. Rather, we take the approach of providing more discussion of the issues that arise in the application of such theories and offer a framework for the practice of investing. In doing so, we attempt to highlight the diversity of approaches to investing in practice by including numerous examples from student-managed investment funds and professional investment firms alike.

The Student-Managed Investment Fund as an Investment Management Firm

A student-managed investment fund (SMIF) is an investment organization. In many ways, it will resemble a real investment firm as it often serves nearly the same purpose. For an SMIF that manages a mandate from its university’s endowment fund, the student-managed investment fund serves the same role as any of the endowment fund’s other investment managers. As such, the endowment fund is the SMIF’s client, to whom the SMIF must answer. The student-managed investment fund has a challenge to conduct its business with the same standards in mind as the other investment firms that the endowment fund has hired. These investment firms are usually considered to be institutional investment managers, in that they cater to the institutional, as opposed to the retail, marketplace. Institutional investors include public pension plans, such as the California Public Employees’ Retirement System (aka CalPERS); corporate pension plans, such as the Boeing Company Employee Retirement Plan; Taft-Hartley (i.e., labor union) retirement plans, such as the UMWA Health & Retirement Funds; foundations, such as the Andrew W. Mellon Foundation; endowment funds, such as Harvard’s Harvard Management Company; and family offices, such as the family offices of Paul Allen or Michel Dell or group family offices like Rockefeller and Tolleson. These types of investors have many common traits, including a large size (from the hundreds of millions of dollars to tens of billions of dollars), long (often infinite) investment horizons, and professional investment staffs. It is with this clientele in mind that we model this book.

As indicated above, one reason we chose the institutional investment approach is that many SMIFs literally have their universities’ endowment funds as clients. More importantly, by catering to the professional investors in the marketplace, institutional investors are often more discerning and reliant on sound principles of finance and investing. As a result, the best practices of investing are often found among those who provide investment services to institutional clients. In addition, many students in student-managed investment fund programs seek careers in the institutional money management industry and our goal is to provide a training and educational resource that will allow student-managed investment fund members to excel as professional investors.

Key steps in meeting the standards of an institutional investor are to provide clear expectations regarding the investment approach, and to have a rational organizational and operational structure that can consistently deliver on those expectations. While this chapter addresses the former and the next chapter addresses the latter, it is important to note that these two aspects of a student-managed investment fund and, indeed, any investment firm, are not mutually exclusive. The investment approach must contemplate specific organizational and operational realities. Likewise, the organizational and operational structure must reflect the investment approach. For example, a quantitative investment approach that relies on a specific economic or financial model and requires little qualitative or subjective input would need significant technology, data, and operations to support such systems. In contrast, a fundamental investment approach that requires research by numerous individual analysts must have the depth of knowledge and headcount to provide adequate coverage of the market.

With this institutional investment framework in mind, we begin by discussing the investment approach. In short, we will be discussing investing. As indicated above, we discuss investing from the institutional or professional viewpoint and not necessarily as what is portrayed in the popular media or in commercial advertisements for trading services that are targeted at the retail (i.e., individual) investor. Indeed, investing is not something that babies with smart phones can or should do (as portrayed in a recent series of advertisements from E*trade)! Investing is appropriately a professional pursuit. Like other professions, such as medicine, law, and engineering, investments requires a base of knowledge acquired through a coherent program of study, and training on how it is practiced professionally. In short, investing should not be pursued in some ad hoc fashion or without an understanding of the field. To do so is irresponsible and unlikely to yield the desired outcomes. Investing that is practiced on behalf of a client or for one’s own personal benefit, should be done diligently and in a manner consistent with established knowledge and practices in the field. The thoughtful reader might be tempted to pause to wonder how a group of students, who are, by definition, investing novices and in the process of gaining investing knowledge, might appropriately be expected to build an institutional-quality investment approach. This book takes the view that every investor is a student of investing. Most advanced undergraduates and graduate students have learned the key fundamental material upon which to build an investment approach. Moreover, students are as capable of being diligent and building a thoughtful approach as many professionals. With the help of resources, such as advisors, mentors, and this and other books, students can leverage their own insights to build a compelling and successful fund. Our experience as professors of student-managed investment fund programs has shown us first-hand how even undergraduates can do analysis that rivals that of professional investors.

The key to initiating a program of investing resides in the development of the investment philosophy and process. Together, the investment philosophy and process represent the definition of an individual’s or organization’s approach to investing. As such, they reflect the purpose and methods that generate the investment results.

Investment Philosophy and Process

The investment philosophy and process combine to define the investor or the investment organization. The investment philosophy and the investment process provide a framework in which to understand markets and select investments. Without these, the entire endeavor is ad hoc. In short, the investment philosophy provides the why and the investment process provides the how.

To illustrate the importance of philosophy and process for an organization, such as ...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright
• Introduction
• Acknowledgments
• About the Authors
• Chapter 1. Investment Philosophy and Process
• Chapter 2. Organization
• Chapter 3. Security Selection
• Chapter 4. Portfolio Construction
• Chapter 5. Presentations
• Chapter 6. Performance Evaluation
• Chapter 7. Tools
• Chapter 8. Forums, Symposiums, and Competitions
• Chapter 9. The Present and Future of Student-Managed Portfolios
• Index