Market Master's
U-Md. Students Bring Their Real-Money Fund Home to a Surprising Finish

By Nancy Trejos
Washington Post Staff Writer
Sunday, May 11, 2008

There were some rocky moments for the 10 business-school students responsible for investing $1.2 million in a fund belonging to the University of Maryland.

In September, they bought shares of Fannie Mae, the mortgage lender that last week declared a $2.2 billion quarterly loss. "Total disaster," said College Park student Jonathan Steele, 28, who analyzes the financial sector.

They increased their holdings in Citigroup, Wachovia and E-Trade Financial, which have all felt the impact of falling home values and rising foreclosures. "Big mistake," said Bill Song, 32, one of two portfolio managers.

Still, when the fiscal year ended on March 31 for the Mayer Fund, it had a total return of 0.57 percent, according to preliminary figures. Other professionally managed funds, such as Putnam's Voyager Fund, were in negative territory. In fact, the Mayer Fund beat its benchmark, the Standard and Poor's 500 stock index, which lost ground during the period.

"We spanked their butts," Song said while practicing the speech he plans to make during his annual report to the dean of the Robert H. Smith School of Business. (It is unclear whether the spanking or butts will make it into the speech.)

While the professionals were reeling from the market downturn, these investment gurus-in-training were eking out a profit -- eking being the operative word. Still, in this volatile market, it wasn't bad for a bunch of second-year MBA students. "When they outperform their benchmark by that much, they've had a great year," said Sarah Kroncke, a lecturer in the school's department of finance and the fund's faculty adviser, after watching the students run through their presentation last week.

In doing so, they underscored this basic tenet of investing: Do your research. As investment guru-already-made Warren E. Buffett said, "Never invest in a business you cannot understand."

That advice has certainly been heeded by the two portfolio managers and eight sector analysts who run the Mayer Fund, financed through the business school's endowment and with profits earned by classes that have come and gone since 1993.

Each analyst pitched four stocks during the year and had to persuade not just a majority but the entire group to buy. They spent many hours researching the companies, reading Securities and Exchange Commission filings, looking at trading data, studying acquisitions and comparing them to others in the industry. "We get into the nitty-gritty of the company," said Song, an Iraq war veteran who plans to work for Wachovia Securities after he graduates later this month.

Investment clubs such as the Mayer Fund have become a popular tool for business schools across the country to teach students how to become future Buffetts -- or, at the very least, well-educated investors. More than 200 universities now have such student-run investment funds, ranging from several hundred thousands of dollars to several millions. Twenty-five years ago, there were only about six, said Larry Belcher, president of the Association of Student Managed Investment Programs and chairman of the finance department at Stetson University in Florida.

The theory is that students will learn more if they're not just sitting in a classroom learning about, well, theory.

"You can teach kids how to manage money, you can teach them theory about portfolio management, you can give them play money and run simulations, but what you can't do with those vehicles is teach them fiduciary responsibility," Belcher said. "What we're seeing is that schools want experiential learning, and . . . they want to train students exactly the way they'll be working."

Many colleges have been pleasantly surprised, Belcher said. While most investors have been distressed this year, some student-run funds have beat their benchmarks. For instance, the University of Virginia's $6 million Darden Capital Management fund returned -0.39 percent during the fiscal year ended March 31, said Patrick J. Connell, a first-year MBA student and chief investment officer of the fund. Yes, it was negative, but over the same time period, the S&P 500 was further in the red, returning -5.08 percent, Connell pointed out.

The $500,000 Frank Batten Investment Fund at the College of William and Mary's Mason School of Business beat its benchmark, the Russell 2500 index, by almost five percentage points, said Jim Haltiner, a professor of finance and the fund's faculty adviser. "Over this particular time period, the market went down a little bit," he said. "We went down less."

Why have they been able to outdo the professionals? The students and their advisers acknowledge that luck has a little to do with it. It also helps that they have more time to devote to their portfolios. And their decisions don't affect the market. If a big fund such as Vanguard buys shares of a company, it can actually drive up the price, whereas the students' decisions are "frictionless," said Eric Olesh, 28, the other portfolio manager at the Mayer Fund.

Frictionless, but not insignificant. The pressure to succeed is great, the students said, partly because they don't want to lose the university's money and partly because they know their performance is being judged by their professors and prospective employers. "They take it very seriously," said Haltiner.

So seriously that often their discussions get heated. Sometimes they last weeks. "If you lose one position in a portfolio, that's tuition for one year," Olesh said.

Sometimes the fact that they're young and relatively inexperienced has helped these students. Sometimes it has hurt.

The students running the Darden fund wisely invested in the fast-food chain Chipotle, which has performed well. "You see students lining up at the door. You know the stocks are going to do well," Connell said.

But popularity, said Belcher, is not always a good gauge for how well a stock will do. "There's a lot of things that are what I might call culturally relevant to them," he said. "They might say, 'We like American Eagle Outfitters or Abercrombie & Fitch because we like their clothes,' and that doesn't always make for a good investment strategy. You force them to go beyond the superficial and really look at the financials and the management of the company and say, 'Does this fit with our strategy?' "

What, then, makes for a good strategy? Here's what the students have to say: Diversify your portfolio. Take a top-down approach, analyzing the whole economy, then studying the sector. Once again, do your research. And in this age of domestic turmoil, consider some international stocks, or even diversify beyond stocks into exchange-traded funds or mutual funds. "It allowed me to sleep well at night even though the markets were getting killed," Song said.

That's not to say these funds didn't get nearly killed at times.

Ask anyone at the Mayer Fund what the biggest mistake was, and there is no hesitation: sinking 2.5 percent of the portfolio into Fannie Mae, which is chartered by the federal government to keep mortgage money flowing. Of all the firms that could survive the mortgage meltdown, Fannie Mae would have to be at the top of the list, they figured. But even Fannie has not gone unscathed. Since buying shares of the company, the Mayer Fund has lost about half the amount it put in.

Thinking it had too little money in financial stocks, the students also decided to invest more in companies such as Wachovia and Citigroup. They figured that the Federal Reserve would have to cut the overnight lending rate, helping the banks make more of a profit. But the credit problems have just been too devastating for financial stocks.

"We learned that we shouldn't trade around what the Fed is going to do with rates or any other particular event or what the 'smart money' is buying," Song said. "We should stick to fundamental analysis and make our investment decisions based on how well companies are able to execute their strategies and increase their intrinsic value over time."

Their best pick was Starwood Hotels and Resorts Worldwide, which returned 7.86 percent during the fiscal year.

They also made some good sell decisions. They got rid of Countrywide Financial before the lender imploded under the weight of defaults. They sold off Black & Decker when the company started showing the strains of the housing downturn. And they unloaded shares of Sallie Mae before the J.C. Flowers investment group rescinded its offer to buy the ailing student loan giant.

Some of those were lucky moves, the students acknowledged. Some were well-informed decisions. Either way, they're chalking up the year as a success. They made thousands of dollars for the school -- and they beat the pros.

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