APPROACH
A baboon can mimic the market with massive diversification, and yet most money managers do just that. Managers allocating large amounts of capital must do so in consequence of their scale of operations, but most others do so as insurance against themselves making mistakes. But the problem with such schemes is that as the number of stocks in an investment pool increases, the closer is that investment pool's return to the market averages. At Grinnell College, The Student Endowment Investment Group (SEIG) will not settle with such a technique. This is not to say we believe diversification has no value, only that a manager renders himself more and more irrelevant the as the number of stocks he or she invests in increases. We would agree with T. Rowe Price that at any given time, there are only a handful of companies worth investing in. The challenge for us then, is to find these companies. Of course, as a student group, our primary goal is education. We want to learn what makes a company valuable and then use this knowledge to exploit market situations where a company's value goes unrecognized. We tend to look for three things in an undervalued company:
- High Return on Equity
- Irrationally Low P/E Ratio
- Under-appreciated Assets
We concentrate our portfolio in the stocks of a handful of companies possessing these traits, because we believe companies with these characteristics will outperform the market over the long run.
PERFORMANCE
SEIG's track record is short, but nonetheless impressive. Since the group initiated more active and thorough management of its portfolio on May 15 of 2003, its portfolio has outperformed the S&P 500 Index while maintaining an approximate 30% cash position. For the seven and a half months ending December 31, 2003, the SEIG portfolio appreciated 21.62% vs. 17.46% for the S&P 500. The chart below contrasts the performance since May 15th of the SEIG portfolio with that of the S&P 500.
The $97,022.71 in the SEIG portfolio on May 15th appreciated to $116,382.60 by the end of 2003. The same amount appreciating at the rate of the S&P 500 would have risen to $113,958.92 over the same period. Yet we are not so naïve as to attribute all the success of our investment team to skill. We benefited from a favorable investment environment. Corporate earnings began to rebound in the second quarter and continued to improve throughout the year, driving the S&P 500 up 22.32% during 2003. It seems probable that SEIG's entry into the market coincided with the beginnings of a significant expansion of the U.S. economy. But still, we beat the market while maintaining a cash position of as much as $37,000. So though we've only been in operation for a short time, we believe our performance is due to more than sheer luck. The next year or so will be an exciting period during which we expect to continue learning and developing our asset allocation skills.
-Nicholas Hirschey
