Virtual Portfolio Management: Building & Managing $20M Hedge Fund Portfolio (Finance 450) , Study Guides, Projects, Research of Finance

Download Virtual Portfolio Management: Building & Managing $20M Hedge Fund Portfolio (Finance 450) and more Study Guides, Projects, Research Finance in PDF only on Docsity! Finance 450 Virtual Portfolio Management Project Virtual Portfolio Management Project General Comments and Guidelines Finance 450: Security Analysis Spring 2005 Final Report Binders Due: Friday, May 20, 2005, at 3:00 p.m. “First control your risks; the returns will talk care of themselves” — Benjamin Graham — Goal: The lecture component of the Security Analysis class introduces the students to numerous concepts regarding portfolio and security analysis. However, the implications of these concepts cannot truly be understood until they are put into practice. Thus, the goal of this project is to enable you to put into practice the entire process of: 1. Portfolio construction 2. Portfolio management 3. Portfolio evaluation and performance assessment 4. Portfolio revision During the course of this project, which will run almost the full length of the semester, you will conduct all the analysis underlying the portfolio management process and apply this analysis to a simulated $20,000,000 portfolio that you will track throughout the semester. Introduction and Scenario: To conduct this project, you will work as part of a five-member team. The scenario for your team is that you are the management team for a start-up hedge fund with $20 million in seed capital. You want to attract additional investors to your fund (and hence additional management fees into your own pockets), so you want to start investing your seed capital and establish a good track record that will draw the attention of potential investors. Before starting to invest, however, there are a few administrative details that you must first take care of – namely, the development of your fund’s mission statement, objectives, and constraints. Some items to consider in developing these are described below. o Mission statement – The mission statement describes to both yourself and your investors the overall vision that will guide how you run your fund and create value for your investors. In addition to provide a guiding vision for those inside your organization, your mission statement also serves as a marketing tool that helps to define the types of investors you want to attract to your fund. Finance 450 Virtual Portfolio Management Project o Objectives – Your objectives and constraints (see next bullet point) operationalize your mission statement, providing the specifics that will shape your portfolio. In general, this entails some decision about the desired tradeoff between risk and expected return. The objectives can be described in more quantitative terms, such as is seen with Markowitz portfolio optimization, or more qualitative terms (e.g., “capital preservation” or “growth of income”), or some combination of the two. o Constraints and Benchmark – The constraints serve two general purposes. First, following Graham’s dictum quoted above, they help to control the risks involved with the portfolio. Secondly, they serve to define the characteristics or “shape” the portfolio will have. Some questions to consider as you develop the constraints for your portfolio include: 1. What characteristics do you want the portfolio to have (remember that these have to be consistent with your mission statement)? 2. What is your investment universe? I.e., what is the set of securities from which the securities in your portfolio will be chosen? 3. What specific characteristics should your stocks or other securities have in order to allow or create the characteristics you want for your overall portfolio? E.g., if you want your portfolio’s beta to be equal to one, will you require every stock in the portfolio to also have a beta near one, or will you instead follow Haugen’s Caesar salad analogy? If you are going to hedge your market risk through a long/short strategy, will you hedge all of the market’s risk (suggesting a net portfolio beta of zero), or will you only hedge part of the risk (leaving a portfolio beta somewhere between zero and one)? Will you engage in a pairs-trading strategy, where each stock purchased needs to be hedged via a specific stock that is sold short, or is your portfolio satisfactory so long as your portfolio of shorts, on net, cancels out a predetermined portion of the market risk of the portfolio of long positions? 4. What rules do you need to have in place in order to control risks while allowing you to create your desired portfolio? 5. What benchmark do you view as appropriate for your portfolio, given your mission and objectives? This latter question is especially important to consider, because the benchmark for comparison helps define the fund for investors. Moreover, once the benchmark has been determined, it can provide the basis for some of the portfolio’s constraints. This is because the constraints can be stated in either absolute terms or in terms relative to the benchmark. Some examples of portfolio constraints from Haugen’s book include:  Maximum stock weight is 5%  No more than 3X S&P 500 cap weight in any stock  Industry weight to within 3% of S&P 500  Turnover controlled to 20% to 40% per annum