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Lecture 8_Darden Capital Management--The Monticello Fund

Lecture 8_Darden Capital Management--The Monticello Fund

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UV0517
This case was prepared by Professor Michael J. Schill. It has some fictionalized content and was written as a basisfor 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
sales@dardenpublishing.com.
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 MANAGEMENTTHE MONTICELLO FUND
 In early April 2004, the Monticello Fund Management Team was in the midst of its firstmeeting of the new fiscal year. The team was part of the Darden Capital Management program atthe Darden Graduate School of Business Administration, where MBA students were entrustedwith managing endowment capital for the school foundation. The program sought to prepare its participants for careers in investment analysis and portfolio management, with the recognitionthat hands-on investment-management experience was an important aspect of professionaltraining. The total assets under management for the Darden Capital Management program wereover $3 million and were held in three funds: the Darden Fund, Monticello Fund, and JeffersonFund. Each fund was managed independently by a small team of MBA students, with someguidance from a faculty advisor and a board of trustees.The investment strategy of the Monticello Fund was to use fundamental analysis to identifyand invest in companies that were well-positioned for growth but inexpensively valued. The fundteam 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 absoluteterms and with respect to the strong 35.1% returns over the same period on the S&P 500 marketindex.
Exhibit 1
shows the current composition of the fund portfolio. The new team was unified inits resolve to once again beat the market index in the coming year; however, there was some debateon 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 sixstocks 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 thestock in 2007. Based on these figures, the team had calculated the anticipated rate of return implied
 
-2- UV0517 by the current stock price.
Exhibit 4
contains the anticipated return estimates. Majocha’ssuggestion 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 Technologiesstock. 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 acceptingsubstantially greater risk. He backed up his claim by comparing the standard deviations of pastreturns. 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 thecommensurate level of risk.Charles Hill agreed with Khtikian that the anticipated returns should be normalized bythe associated risk of the stock. He claimed, however, that a better measure of the risk faced bythe 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, commonlycalled 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 thatthe attractiveness of Placer Dome stock was primarily in its diversification effect. He claimedthat a 50–50 weighted portfolio with Mylan Labs and Placer Dome would prove to be better thansimply holding Mylan Labs stock alone.Majocha was due at a fund managers meeting in the morning and needed to be able tocommunicate a coherent portfolio strategy for the Monticello Fund. Majocha considered therecommendations of his team members and contrasted their views with what he knew of capitalmarkets. (
Exhibits 5
and
6
provide some data on current and historical capital marketconditions.)
 
UV0517-3-Exhibit 1
DARDEN CAPITAL MANAGEMENTTHE MONTICELLO FUND
 Composition of the Monticello Fund (March 2004)% of portfolio Net 12-month gain %StocksPatina Oil & Gas 5.6% 101.5%General Dynamics 4.5 64.4Berkshire Hathaway B 4.5 45.6Sanderson Farms 4.3 11.5 NBTY 4.3 105.3Mentor 4.3 34.8Chicago Bridge & Iron 4.2 23.8Kellogg 4.1 10.6Chevron Texaco 3.9 2.9Pier 1 3.9 30.1Target 3.9 54.9Pepsico 3.9 36.2Pfizer 3.6 14.5Johnson & Johnson 3.6 -5.4Media General 3.6 38.2Radian 3.5 3.1Washington Mutual 3.3 23.3Microsoft 2.3 3.6Skywest 2.1 4.0Bonds 17.8% 3.9%

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