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Josh Brodsky, Daniel Coltun, Joe Damisch,

Alex Pochodylo, George Tsarwhas, and Cara Weingartner


Case 3 Multifactor Models
3/8/2015
PART A
1. For each of the following determine a benchmark (from the case) and justify your choice:

T Rowe Price Blue Chip Growth (TRBCX)

Goldman Sachs CORE Large Cap Growth (GLCGX)

Russell 1000 Growth: This index is a strong benchmark for the GLCGX fund
because the fund seeks growth companies with strong and predictable cash flows
and dividends, and the index is made up of larger companies with high price-tobook ratios, strong earnings, and high forecasted growth values. This includes
technology, consumer, discretionary spending, and consumer staples industry
verticals.

Diversified Special Equity Inv (DVPEX)

S&P 500: Because this index represents 500 largest companies by market
capitalization, it represents a fair benchmark for a fund built around leading
market firms, seasoned management, and strong financial fundamentals.

Russell 2000: This index is the most common for mutual funds that identify
themselves as small cap. The DVPEX fund does not consider dividends, but
instead focuses highly companies with a market capitalization value of under $2
billion.

DFA Tax-Managed U.S. Small Cap Value (DTMVX)

Russell 2000 Value: DFA funds focus on value firms and small cap stocks. This
is a perfect benchmark for DTMVX as it invests in small companies with high
book-to-market ratios.

2. Based on the chosen benchmarks, how did each fund perform in the period from January 2000
through December 2004? Would you recommend buying any of the funds? If so, which?

Based on the chosen benchmarks, each fund performed as described below from January 2000
through December 2004. It seems as though TRBCX and DTMVX outperformed their
benchmark index, while GLCGX and DVPEX did not.

Josh Brodsky, Daniel Coltun, Joe Damisch,


Alex Pochodylo, George Tsarwhas, and Cara Weingartner
Case 3 Multifactor Models
3/8/2015

We would for sure recommend buying the DTMVX fund due to the strong relative performance
and the fact that the return over this period was positive. In addition, we would recommend
buying DVPEX due to the decent positive return over this period, despite the fact that it very
slightly underperformed with relation to the index.

Josh Brodsky, Daniel Coltun, Joe Damisch,


Alex Pochodylo, George Tsarwhas, and Cara Weingartner
Case 3 Multifactor Models
3/8/2015
3. For each of the 4 mutual funds in (1), use the CAPM to evaluate the performance of the fund
manager for the period from January 2000 through December 2004. Based on your findings,
would you recommend buying any of the funds?
We determined our betas using a one factor linear regression using the market premium as the
x variable and the fund return minus the risk free rate as our y variable. We used monthly
values for our inputs. We utilized the benchmark index to represent the market and long-term
government bonds as our risk free rates.
Using the CAPM equation and our determined betas, we found expected returns for the funds.
As the market was volatile and data varied highly between months, it was very hard to
determine a monthly estimation for returns, and so we annualized all of the returns by finding
the period returns and then converting them to compound annual growth rates.
We found that the T Rowe Price Blue Chip Growth (TRBCX) fund and the DFA Tax-Managed
U.S. Small Cap Value (DTMVX) fund had outperformed the expected CAPM return, and so
they had positive alpha values, while the other two funds had negative alpha values. Based
solely on the comparison between the funds alpha values, we would suggest purchasing the
TRBCX and the DTMVX funds; however, during this time frame, we might not have
purchased certain funds because due to the economic environment, they had negative returns.

4. Do the same as in (3), but now use (a) the Fama French 3 Factor Model, and (b) the Fama French
3 Factor Model plus the Momentum Factor. Based on your results, does it look like any of the
fund managers have stock picking skill?
5. Can you think of a way to use the industry portfolios to do something like problems (3) and (4)?
If so, how do your results compare?
PART B
1. Using whichever model(s) you deem appropriate, estimate the cost of capital for Yahoo (YHOO)
and Altria (MO) in December 2004. At that time, the yield on the 10 year and 30 year U.S.
government bonds was 4.2% and 4.9%, respectively. Both firms have opportunities to make new
investments that are broadly similar to their existing assets and are expected to produce an equity
return of 10% per year. The investments would be financed with the same historical mix of debt
and equity. In other words, focusing directly on the cost of equity is sufficient. No unlevering or
relevering is necessary.
2. How do the costs of capital that you estimate compare to those of the projects? Would you give
these projects the green light?
HINTS:

Josh Brodsky, Daniel Coltun, Joe Damisch,


Alex Pochodylo, George Tsarwhas, and Cara Weingartner
Case 3 Multifactor Models
3/8/2015
Performance attribution and estimating cost of capital are related, but the former is measured over a
particular period while the latter is forward looking. Both require estimates of beta(s).
For most of the questions, you will need to estimate betas or factor loadings. You may also need an
estimate of the equity premia for various factors. To estimate betas, you will want to run a regression.
For example, running the regression Rit Rft = alpha + Beta1RP1 + Beta2RP2 + et will give me an
estimate of the alpha and betas of the fund along with the residuals.

Josh Brodsky, Daniel Coltun, Joe Damisch,


Alex Pochodylo, George Tsarwhas, and Cara Weingartner
Case 3 Multifactor Models
3/8/2015

To run a regression in Excel, you will need to use the Data Analysis Add-in (you may need to go to
Excel Options->Add-ins and add it in. It should be under the Data Tab/Analysis in Excel) and choose
Regression. The Y variable in this example would be (Rit Rft) and the X variables would be the
Risk Premia. The alpha is a constant and the et are the residuals.
An Excel spreadsheet with all of the data from the tables in the case is in the CASE folder on
ONCOURSE.