FUND CASE: THE FAIRBANKS SMALL-CAP U.S. EQUITY FUND

Background

Whittier Wealth Management, a Boston-based fundamental equity shop, specializes in running small-cap portfolios. Its specialty is a concentrated style with fewer than 50 stocks. It has one core portfolio with an eight-year record with a goal to outperform a small-cap index and other small-cap managers.

Key characteristics of the fund include these:

Russell 2000 is the index benchmark.

Fully invested U.S. equity fund, with the ability to maintain short positions.

Selection universe includes small-cap companies, plus stocks in the Russell 2000 small-cap index.

Analyst teams are organized into five sectors.

The Problem

The CIO is interested in promoting the fund with the goal of increasing assets from $10 million to $250 million. Assets are currently in a partnership structure, much like a long-biased hedge fund, but the CIO is open to new fund structures.

The Assignment

To promote the fund, a document needs to be prepared explaining the objective of the fund, operation of the fund, its current portfolio structure, and performance analysis. In addition, a review of the current operation should be conducted, including realistic suggestions for improving performance. Finally, a review of analyst performance, both individual stock recommendations and actual sector performance, must be conducted. A comparison of the live portfolio performance and paper stock recommendations needs to be completed to estimate the implementation shortfall.

Specifically, the project involves four steps:

1. Documentation of portfolio objectives and operation.

2. Portfolio analysis, including portfolio characteristics and risk model analysis.

3. Performance analysis, including live portfolio returns and analyst raw material.

4. Proposal for improving the fund's operation, increasing its visibility and asset size.

Discussion Items

Consider what the manager is being hired for:

1. Active or passive?

2. Investment process?

a. Portfolio construction.

b. Balance of risk and return.

3. Fund structure: LP, Mutual Fund, ETF, Commingled Pool, or segregated accounts?

Consider the key guidelines:

1. Specific benchmark(s)?

2. Target excess return?

3. Target risk constraints?

4. Cash level constraint?

Attachments

1. Outline of four deliverables.

2. Supplemental materials:

a. Sample portfolio characteristics.

b. Sample performance analysis.

Online Materials

1. Portfolio holdings.

2. Stock recommendations.

3. BARRA and FactSet analyses of portfolio and performance.

Outline for First Deliverable: Objectives and ConstraintsFund Case

1. Summary of fund operation:

a. Investment objectives.

b. Constraints and issues.

c. Regulatory.

2. Analysis of benchmark and potential peer groups.

3. Plans for next steps.

Outline for Second Deliverable: Product Design and SolutionFund Case

1. Current fund strategy:

a. Summary of portfolio structure.

b. Summary of active bets.

2. Sector and style analysis including interpretation:

a. Portfolio characteristics and sector weights versus benchmark.

b. BARRA analysis.

3. Steps for performance analysis.

Outline for Third Deliverable: Implementation/ MechanicsFund Case

1. Performance analysis:

a. Summarize results.

b. Provide analysis of portfolio versus benchmarks.

c. Highlight individual names.

d. Analysis and recommendations.

2. Active performance attribution:

a. Market timing.

b. Sector selection.

c. Stock selection within sectors.

d. Style influences.

e. Impact from ETF holdings.

3. Sales plan:

a. Presentation booklet summary.

b. Fund structure.

c. Fees.

d. Business analysis.

Market.

Capacity.

Outline for Fourth Deliverable: Measuring SuccessFund Case

1. Review of performance of stock recommendations:

By sector.

Compared with live fund.

2. Summary of portfolio including alpha summary.

3. Proposal for fund structure and sales plan.

4. Discussion of measuring success:

Client's definition of success.

Company's definition of success.

Performance measurement of success.

5. Formal, bound business presentation document with four tabs:

Multiple tabs including material on first three deliverables.

Include measures of success.

Include appendix of supporting materials.

Note: Make sure that observations and recommendations are summarized and that the presentation doesn't simply display data.

WHITTIER WEALTH MANAGEMENT: FAIRBANKS SMALL-CAP EQUITY FUND

Portfolio Objectives, Constraints, and Investment Process

Through a dynamic and collaborative process, analysts collectively evaluate and critique investment recommendations prepared from independent fundamental research. Portfolio holdings are determined on a consensus basis, with voting led by sector leaders and weightings set by alpha potential and portfolio diversification.

Investment Objectives The investment objective of the Fairbanks Small-Cap Fund is to maximize growth of fund value on a total return basis. Each sector team of research analysts is evaluated based on their value added to the portfolio through realized outperformance of their security selections over the relevant Russell 2000 sector index. The goals for each independent analyst include identifying stocks that they expect to outperform or underperform in their sectors over a 6- to 12-month time horizon, and to aid their sector team in achieving the highest realized alpha. In addition, the goal for the fund as a whole is to outperform a benchmark index composed of the Russell 2000 Small Stock index and a small-cap U.S. equity peer group. The investment team will manage portfolio risk and minimize loss potential through balancing active risk and potential return. There will be no attempt to time the market or actively rotate investments between sectors (except to facilitate fundamental views at the stock level).

Investment Constraints The investment team is limited to a universe of smallcapitalization stocks of less than $1 billion plus stocks in the Russell 2000 index, limited coverage by Wall Street (typically fewer than four or five street estimates), and available liquidity ($100,000 per-day dollar volume).

Investment Methodology A pro forma portfolio is created by the CIO utilizing new stock recommendations from the new class of analysts. The portfolio is structured to overweight highly (underweight poorly, short very poorly) recommended stocks with large upside potential as calculated from target prices, adjusted for individual risk and overall portfolio diversification. Sector leaders share the proposed portfolio with their teams and make recommendations to the CIO. A final portfolio composed of 25-50 actively selected stocks is supplemented with large-weight index names to meet diversification targets. Total active risk is between 5 and 10 percent, with a majority of the risk from stock selection. Cash is invested using ETFs (2.5% currently).

During the year analysts submit updated research recommendations, and an online discussion board is used as an initial discussion forum for critiquing the security analysis. Each member of the relevant sector poses questions and makes comments about the recommendation. Each analyst proposing the idea performs the necessary research to answer outstanding questions and is charged with defending her or his investment thesis to the collective group in a formal yet brief presentation. The fund is actively rebalanced as investments are added or removed or as the position weightings are altered according to the achievement of the desired alpha.

Sample Portfolio Analyses