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Extraordinary Value Partners, LLC Case Solution
Extraordinary Value Partners LLP was created by Weina Hedge along with a partner Minnie Kahn. EVP mostly invested in small, privately management and unknown companies that had the potential for growing into large profitable companies in the future. EVP offered two classes of the investment vehicles, the long only fund, and the short-long fund. Over a period of last five years, the long only fund had proved much more profitable than the long-short fund. Both of these funds also outperformed the Russell Microcap Index consistently throughout the investment period. Owing to this phenomenal success of the EVP, Richard Parker, the Chief Investment Officer of the SUN CAHRITIES decided to invest $10 million out of $100 million funds into EVP. However, he was confused as to which fund was more suitable and if the microcap index was a better option than the two funds. For this purpose, he needed to perform a number of statistical techniques to the historical return data of two funds and the indices.
Following questions are answered in this case study solution:
What were the properties of EVP’s Historical Returns, and how did the Russell microcap index compare?
Consider the returns of the EVP funds in excess of the microcap benchmark. What were the properties of that excess return?
Was EVP truly a microcap stock picking fund? Use Return Based style analysis to answer this question.
Within the microcap universe, did EVP focus on value or growth stocks?
Was EVP just a leveraged version of the microcap benchmark, or some other indexes available to you?
What was the style of the EVP fund returns? Did this analysis give any insight into as to how EVP added value relative to microcap benchmark?
Suppose the historical returns represented what one could expect going forward. How would a 90% in M plus 10 percent in EVP long only fund compare with 90% in M plus 10% in a Russell Microcap Index Fund?
Extraordinary Value Partners LLC Case Analysis
1. What were the properties of EVP's Historical Returns, and how did the Russell microcap index compare?
An analysis of the historical return data for the two funds of EVP, long-short fund and the long only fund shows that the two funds gave positive returns in most of the months during the investment period. In some of the months, when returns became negative, the funds quickly recovered from the losses and gave huge returns. Overall, the monthly mean return for the long-short fund remained 2.40% and the mean for the long only fund remained 3.53%. Thus, during the investment period of November 2002 till January 2007, the monthly return of long only fund outperformed the monthly return of long-short fund by 1.15% approximately. The standard deviations of the two funds remained 8.64% and 7.06% respectively. Thus, during the investment period, the long only fund was much less risky than long-short fund and return of the former fund were also higher. Since the monthly return of the long only fund was higher than the monthly return of the long-short fund and the standard deviation of the former fund was also less than that of the later, the Sharpe ratio of the long only fund was also higher. The Sharpe ratio for the long only fund remained 47.05%; whereas, the Sharpe ratio of the long short fund remained 25.32% respectively. Also, Jensen's alpha for the long only fund (2.74%) was also higher than that of long-short fund (1.96%). A comparison of the mean and standard deviation of the Russell Microcap Index and the two funds show that the mean returns and standard deviations of the Russell index remained lower than those of the two funds. However, the Sharpe ratio of the Russell index remained in the midway of the two funds, making it a safer investment option than long-short fund.
2. Consider the returns of the EVP funds in excess of the microcap benchmark. What were the properties of that excess return?
The returns of the long-short fund in excess of the Russell Microcap index can be found out by subtracting the monthly return of the Microcap index fund from that of the long-short fund. Analysis of the excess return data shows that the monthly return of the long-short fund remained higher than that of the index in most of the months during the investment period. On average, the return of the long-short fund remained higher that of the index by a margin of 1.16% approximately. The standard deviation value (8.72%) of the excess return data shows that the volatility of the excess return data remained the same as that of the overall return of the fund. Thus, it can be inferred based on this analysis that the long-short fund showed consistency in beating the market and managed to earn higher than index returns in most of the months.
Similarly, the returns of the long only fund in excess of the Russell Microcap index can be found out by subtracting the monthly return of the Microcap index fund from that of the long only fund. The mean of the monthly excess return data for the long only fund remained 2.30%, and the standard deviation remained 6.45%. Thus, the long only fund was able to beat the market more consistently and successfully as compared to long-short fund.
3. Was EVP truly a microcap stock picking fund? Use Return Based style analysis to answer this question.
There are many return based style analysis techniques to find out the style of management as far as investment criteria are concerned. One of the most effective and popular techniques of determining the style of the management is to compute the correlation of the portfolio return data with that of the indices and then find out the index to which the investment return data is most closely related. Using this approach, correlations of the monthly return data for long-short fund and long only fund can be found out. The indices that are used for the comparison are S&P 500 index, Russell Microcap Index and the MSCI EAFE indices. The results of the correlation analysis show that the long-short fund is mostly closely correlated to MSCI EAFE index and the long only fund was most highly correlated with the S&P 500 index. Neither of the two funds had very high correlations with the Russell Index; hence, it can be concluded that the EVP was not a truly microcap stock picking fund.
4. Within the microcap universe, did EVP focus on value or growth stocks?
Within the microcap universe, the extraordinary Value Partners LLP focused on value stocks more than growth stocks. The partner's ship used fundamental analysis technique to find out the companies shoe stocks were undervalued. Most of these companies were privately managed, and the shares of these companies were owned by a few investors. EVP analyzed the liquidity strength of the business, the business idea, and potential of the market to sustain the growth in the future in order to select the companies for inclusion in the portfolio.
5. Was EVP just a leveraged version of the microcap benchmark, or some other indexes available to you?
The monthly returns of the two fund of the Extra Ordinary Value Partners LLP were more highly correlated with the MSCI EAFE index than any other index. This made sense because both the EVP and the MSCI EAFE indices involved careful stock picking using various fundamental analysis techniques. The microcap index consisted of many companies that eventually failed to become large and profitable companies and hence, they failed. On the other hand, EVP selected companies that small but had strong liquidity, management style and business idea. The reason why return data of the two funds of the EVP resembled less with the Russell Microcap Index Fund was that EVP was better able to pick stocks than the market. The MSCI EAFE index consisted of stocks from Europe, Australia, and the Far East, which have high growth potential. The investment style of EVP resembled more to this index; hence, it can be said that EVP was a leveraged version of the MSCI EAFE Index.
6. What was the style of the EVP fund returns? Did this analysis give any insight into as to how EVP added value relative to microcap benchmark?
The correlation data of the various indices and the two funds indicated that the both the funds had very low correlations with all the indices. However, the correlations of the two funds of EVP were positive for all the indices. With the S&P 500 index, the long only fund and the long-short fund had the correlation value of 0.44 and 0.14 respectively. For MSCI EAFE Index, the correlation of the two funds remained around 0.40 and 0.27 respectively, and for Russell Microcap Index, the correlation remained 0.41 and 0.13 respectively. Since long only fund was a long term investment and the return of the fund was also largely affected by the macroeconomic conditions; the correlation of the indices with the long only fund was higher for all the indices than that of long-short fund.
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