It’s not often that faculty research is published and used in the classroom to improve student learning while also helping to enhance a university’s endowment fund. But faculty from the Reiman School of Finance at the Daniels College of Business can lay claim to this rare trifecta.
Jack Strauss, miller chair of applied economics, Chris Hughen, associate professor of finance, and JP Tremblay, teaching associate professor of finance, authored a study, “Adding Value in Student Managed Funds: Benchmark and Sector Selection,” which has been accepted for publication in the winter 2017 issue of the Journal of Trading, and is being used to give students hands-on investment experience while simultaneously achieving greater returns for the University of Denver’s endowment fund.
Hughen—who teaches the “Reiman Fund” class in which undergraduate students manage a $350,000 portfolio of mid-cap stocks—has worked with Tremblay—who teaches the “Marsico Fund” class in which graduate students manage a $1.2 million portfolio of large-cap stocks—to implement a number of strategies to enhance the pedagogical experience, while also generating “alpha,” or outperformance, for the University’s endowment fund.
In their study, Strauss, Hughen and Tremblay found that most student-managed funds invest only in large-cap stocks using the S&P 500 Index as a benchmark. However, this is a crowded space for equity investors. As a result, they recommend selecting “a universe of stocks that are under-researched by sell-side equity analysts and targeted by relatively few funds.”
Students are encouraged to perform in-depth company research and equity valuation to select the undervalued securities with the highest expected alphas. Strauss, Hughen and Tremblay found that “the ‘sweet spot’ for stocks and student learning is mid-cap stocks,” represented by the S&P MidCap 400 Index, as these often have better return characteristics.
Applying the findings from Strauss and Hughen’s previous study, “Portfolio Allocations Using Fundamental Ratios: Are Profitability Measures Effective in Selecting Firms and Sectors?” published in the spring 2017 issue of The Journal of Portfolio Management, students are encouraged to use EV/EBITDA in identifying both undervalued and overvalued stocks, as this ratio is associated with the characteristics of high quality earnings. Surprisingly, the most popular ratios among investors (like the P/E ratio) did not produce the highest returns from identifying undervalued stocks and sectors.
So, what exactly happened when these investment strategies were implemented in the classroom?
According to Hughen, almost half of the University endowment fund’s outperformance was achieved by underweighting the energy sector and overweighting the information technology sector.
Remington Kerr, a student in the Reiman Fund class explained the logic: “Our IT sector leads our portfolio in sector allocation, at 25 percent of our portfolio, resulting in a strong allocation effect, which, at 0.49 percent, indicates that our decision to seek out high-growth software, hardware and semiconductor business models have accounted for a significant portion of our outperformance.”
Kerr also noted that, “We have decided to avoid allocation to the energy sector both to avoid the volatility of current oil prices and to allocate towards higher growth opportunities in the Consumer Discretionary and IT sectors. This decision has proven extremely beneficial, resulting in a 0.67 percent allocation effect, equal to that of our overall outperformance.”
Hughen explained that the Reiman Fund portfolio scored a huge win in the financial sector by selecting stocks that outperformed other midcap financials by 3.1 percent.
Daniels student, Adam Segall, who served as the head portfolio manager for the Reiman Fund class during the 2017 summer quarter, explained the analysis. “The prospect of deregulation and tax cuts under Trump has sent the sector through the roof,” he said. “While much of this is speculation and wishful thinking, markets have priced it in nonetheless. Our decision to underweight was based on many of these valuations being simply unjustifiable. Our strategy involved staying away from overvalued banks and sticking to diversified financials, where valuations and growth prospects are much more realistic.”
Quite simply, Daniels students are using their professors’ research findings to make better investment decisions that have improved the overall performance of the University’s endowment fund.
Sounds like a win-win for all.