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Bootcamp Slides Week 1

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UCLAM

This document provides information about the University College London Asset Management Society (UCLAM), including: 1. An overview of their weekly meeting schedule from October to December, covering topics like fundamental analysis, stock pitching, and an optional stock pitch competition. 2. Summaries of the Week 1 meeting which introduces asset management and investment strategies like long/short equity. 3. UCLAM's investment philosophy which focuses on 'quantamental' analysis, long/short strategies, high conviction investing, and risk management. 4. An overview of their investment process which includes idea generation, fundamental analysis, quantitative analysis, and portfolio construction.

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UNIVERSITY COLLEGE LONDON ASSET MANAGEMENT SOCIETY Private and Confidential Please do not circulate
Before we begin Join the whatsapp group! Updated schedule : 1800 HRS - 1900 HRS ● Week 1 (Introduction to Finance and Investing, UCLAM Investment Philosophy, Fundamental Analysis): 26 Oct ● Week 2 (How to frame a pitch, Bonds, NPV, CAPM and Portfolio): 02 Nov Reading Week ● Week 3 (3 Statement Accounting & Financial Ratios): 16 Nov ● Week 4 (Valuation Foundations- Intrinsic & Relative): 23 Nov ● Week 5 (Forecasting, DCF): 30 Nov ● Week 6 (Sample Stock Pitch): 7 December ● Week 7 [Optional] (Stock Pitch Competition): 14 December
Week 1 Overview 1. Introduction to asset management 2. Investment Strategy: Long-Short Equity 3. UCLAM’s Investment Philosophy 4. Fundamental Investing 5. Time Value of Money (Discounting and Compounding)
Asset Classes Overview 4 • Hedge Funds • Private Equity • Commodities • Real Estate • Collectibles • Forex • Derivatives Long-only investments (e.g. mutual funds) Cash Alternatives Bonds Traditional Equities
Asset Management Capital Appreciation (Risk-adjusted) Maximize risk-adjusted returns whilst staying within the fund’s investment mandate and risk appetite. “Asset Management” is a blanket term applied to all buy-side investment firms. Different funds specialize in investments in different asset classes. Different asset classes have different risk and liquidity profiles. Clients investing in these funds (e.g. UHNWI, pension funds, endowment funds) spread risk by diversifying their portfolio through investing in different funds. Role of an Asset Management Firm How does AM differ from others in the industry? Firms can be split into the BUY side and the SELL side BUY SIDE SELL SIDE Asset Management Firms e.g. Hedge Funds, Private Equity Funds, Mutual Funds, etc Decision-makers who make the investment decisions. They engage the sell-side to help them in executing their investments (e.g. private equity using investment banks for M&A, hedge funds using equity research for insights and S&T to execute trades) E.g Investment Banks, Equity Research Houses, Sales & Trading Firms, Brokerages, Insurance Firms Client-facing firms/ brokers. They provide buy-side firms with a variety of services (e.g. M&A advisory, order execution, bringing in deals) and take a small percentage of the deal value as fees.
Investing Types of sectors Types of asset classes Cyclical Defensive Consumer Discretionary (Travel, Retail, Media) Consumer Staples (Personal & household goods, F&B) Industrials Telecommunications Technology Utilities Financials (Banks, Insurance) Energy (Oil and Gas) Real Estate Healthcare Basic Materials Fixed Income (Corporate bonds, Government bonds) Real Estate / Property Equities / Stocks Cash and Cash equivalents Forex (i.e Foreign Exchange), Futures and Other Derivatives Investment Strategies Value Investing (Finding undervalued stocks) Income Investing (Securities which pay out returns on a regular schedule e.g bonds and dividend paying stocks) Growth Investing (Finding companies with high growth potential, spotting the ‘next big thing’) Small Cap Investing (Investing in companies with small market capitalisation) Socially Responsible Investing (Investing in environmentally and socially responsible companies)
Long VS Short Strategy Long Trades vs Short Trades Long-Short Equity Long Trades Short Trades Entry You buy the asset You borrow an asset and sell it Wait You hold the asset and wait for it to increase in price before selling You wait for it to decrease in price before buying it back and returning it to the seller Exit You profit from the sale of the asset You profit from the buy back of the asset What is Long-Short Equity? It is an investing strategy which takes: ● Long positions in stocks which are expected to appreciate (e.g undervalued stocks) ● Short positions in stocks which are expected to decline (e.g overvalued stocks) This investment strategy seeks to minimize market exposure and exploit profit opportunities in both expected upside and downside price movements. Net Exposure It is a difference between the long positions and short positions. Example Company A employs a long short strategy with a long bias (e.g 130/30, meaning 130% long exposure and 30% short exposure). This means Company A has a net exposure of 100% (130% - 30% = 100%)
Long VS Short Strategy Long-Short Equity Strategy in Practice The Pair Trade This is a popular variation of the long-short strategy, involving a long position on a stock and a short position on another stock belonging to the same sector This strategy is commonly adopted in market-neutral funds Example: If an investor takings a long position in Microsoft and offset that with a short position in Apple. The ideal situation for this strategy would be for Microsoft to appreciate and for Apple to decline. However, even if Apple appreciates - since stocks within a sector generally tend to move up or down in unison - the strategy would still be profitable, albeit to a smaller extent Example: From the previous example, we learn that stocks within the same sector usually move in the same direction thus it might not be wise to adopt a pair trade strategy using stocks belonging to the same sector. Another common long-short strategy would be using stocks from different sectors for the long and short legs. For instance, in the case of rising interest rates, an investor may adopt a short position in interest-sensitive sectors such as utilities, and take a long position in defensive sectors, such as healthcare
Long/Short Equity vs Long-Only Short Selling • Short selling allows for L/S investors to capitalize on the decline of a company’s stock price Higher Risk/Return Appetite • Investors commonly allocate a portion of their portfolio to L/S Equity where fund managers employ typically higher risk investing strategies with the goal of achieving higher returns for investors Absolute Returns • Aims to achieve returns regardless of market conditions and performance will hence be measured on absolute returns, instead of relative returns based on market benchmarks as is the case with long-only equity Downside Protection • L/S Equity allows for investors to protect gains and minimize losses by shorting stocks (‘hedging’) as it reduces the investor’s risk exposure to market conditions, unlike long-only equity where returns are highly correlated to market performance. Hence, if the market crashes, L/S investors might still make a profit while long-only investors will lose money Increased Opportunity Set • Ability to profit from overvalued and undervalued stocks, compared to only undervalued stocks in long only strategies Active Management • L/S funds are managed more actively than long-only funds. Investments have a shorter time horizon than long only (5-7 year holding period in a long-only fund versus 45-365 days in a long-short fund) 9
UCLAM Investment Philosophy ‘Quantamental’Analysis • Fundamentals-driven stockpicking approach backed by strong quantitative data and extensive research Long/Short Strategy • Hedged investment strategy to protect portfolio against market correlated risks High Conviction & Alpha-Generation • Handpicking high-conviction stocks in a high-concentration portfolio to maximise absolute returns Investing Framework • Rigorous investing framework with a robust investment process Contrarian Thinking • Non-traditional investment strategies and ideas which align with our core values Risk & Performance Management • Constant monitoring of our portfolio coupled with a disciplined sell strategy 10
Investment Strategy NEXT-GEN MOATS TRENDS FOCUS VALUATION • Consideration of non-traditional factors for business development disrupting status quo • Businesses with sustainable competitive advantages or disadvantages • Long-lasting global trends strongly affecting companies or industries • High conviction in the best ideas making up our portfolio • Strong focus on valuation to maximize returns and margin of safety 11
Constant idea generation coupled with a well-defined investment universe Sourcing • Individual idea generation from wide array of sources such as research reports, conversations with industry experts, internet forums, thematic trend study, top-down macro-analysis Screening • Basic screen to ensure companies fit within our investment universe (e.g., market capitalization above $3B, geography and sector considerations) Contrarian Thinking • Out-of-the-box thinking to identify new investment strategies or ideas that go against the status quo or market consensus ESG Sources • Special focus on tailwinds for ESG focused sectors and companies Step 1: Idea Generation FUNDAMENTAL ANALYSIS QUANTITATIVE ANALYSIS PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE IDEA GENERATION 12
Extensive research to determine fundamentals of company Competitive Advantage • We look for solid evidence of business advantages with driven leadership. Questions we ask are: Is there a strong economic moat? Who are the main competitors and why do we choose this company over others? What is the growth story? Key risks? Economic Trends • Macro and industry trends providing headwinds or tailwinds? Attractive Valuation • Upside potential at current price? ESG Considerations • What is the company’s environmental impact and social impact? How is the corporate governance within the company? FUNDAMENTAL ANALYSIS Step 2: Fundamental Analysis IDEA GENERATION QUANTITATIVE ANALYSIS PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE 13
Quantitative analysis to determine future value of company Phase 1 analysis: • Is the current growth sustainable? • What are its revenue drivers and margin drivers? • Financial statements forecasting • How is the company’s Free Cash Flow position? Phase 2 analysis: • New and alternative data analytics • Discounted Cash Flow valuation and Comparables analysis using multiples • At least 20% upside at current price FUNDAMENTAL ANALYSIS QUANTITATIVE ANALYSIS Step 3: Quantitative Analysis PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE IDEA GENERATION 14
Following clear rules to maintain investment discipline Initial Positions: 2-5% Maximum Position Size: 15% Maximum Industry Exposure: 30% Minimum Number of Industries: 5 Maximum Number of Holdings: 20 PORTFOLIO CONSTRUCTION QUANTITATIVE ANALYSIS Step 4: Portfolio Construction RISK AND PERFORMANCE FUNDAMENTAL ANALYSIS IDEA GENERATION 15
Step 5: Risk & Performance Management Constant monitoring of portfolio with disciplined sell strategy Target Valuation Reached or Exceeded • Price exceeding valuation resulting in realisation of returns Changes in Thesis • Changes to original assumptions resulting in change of valuation More Attractive Competitor • More attractive competitor due to changes in economic moats Retail and Media Focus • Monitoring of volatile stocks influenced by non-traditional information sources and irrationality PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE QUANTITATIVE ANALYSIS FUNDAMENTAL ANALYSIS IDEA GENERATION 16
What is fundamental investing? • Finding companies that are trading at a discount to fair value and investing in them • Idea is that over time, markets will correct themselves and stock prices will trade at fair value
What is a Moat?
What is an Economic Moat? A business' ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms - Warren Buffett
Economic Moat Importance of Economic Moat A modern economic principle says that given time, competition will erode any competitive advantages enjoyed by a firm. This is because once a firm establishes its competitive advantages, there exists a strong incentive for competing firms to duplicate the methods / strategy of the leading firm or seek improvement opportunities for their operating methods. Thus, an economic moat is important. It is a qualitative measurement of a company’s ability to keep competitors at bay for an extended period of time. This translates into prolonged profits in the future and are key success factors in a company’s long-term success. Illustrative Example Low-cost competitive advantage Without an economic moat With an economic moat (Patent) 30% Expenses 30% Juice Patented Technology
Types of Economic Moats Network Effect Switching Costs Economies of Scale Name-Brand Recognition
Switching Costs Switching costs: When it becomes too expensive / troublesome to switch away from a company’s product ● Tangible Costs: Money cost to switch ● Intangible Costs: New learning curve, time spent on administrative tasks Common in industries such as insurance, telecom providers, computer operating systems, banks etc. where the cumbersome switching costs makes it difficult for competitors to take market share away from the industry leader. Switching costs provide a company with the leverage to increase prices and deliver substantial profits over time → pricing power Switching Costs Lock-In Customers Example A leader in providing cloud-based solutions that address many aspects of customer acquisition and retention. According to Morningstar, its salesforce automation application is “mission-critical software that helps drive revenue for users.” High switching costs as it involves the high organizational risk of moving away from the platform, as well as the time, expense, and lost productivity associated with the implementation of a new application. Salesforce.com Inc. (CRM)
Network Effect As more people use a company’s product or service, the value of that product or service increases for both new and existing users. Customers may switch to a brand to interact with customers already using that brand. Especially relevant as our world becomes increasingly digitalised. The term “critical mass” is often used in connection with the network effect. In game theory, this means that not all game participants need to be convinced for a strategy to succeed, just a very specific portion of them. If this participation threshold is exceeded, the strategy is likely to succeed of its own accord. Network Effect Grows with Reach Example Visa (V) Visa dominates the global electronic payments industry, controlling approximately half of all credit card transactions and an even higher portion of debit card activity. With almost 16,000 financial institution partners, 3.4 billion Visa cards in circulation, and over 50 million merchants accepting Visa, it is great example of how the network effect creates a powerful competitive advantage. Other Example: ● Getting a cellphone that’s compatible with your friends’ phones (E.g: Apple - interconnectedness between the i_ products) ● A seller listing a product on a large e-commerce site to access its vast network of buyers.
Name-Brand Recognition Brand-loyal customers are difficult to be pulled away thus allowing the company to retain its market share. Additionally, brand equity can increase a customer’s willingness to pay for a product / service (even though the product / service itself might not be that differentiated). This allows the company to charge a significant price premium. Although name-brand asset is an intangible asset, it remains one of the primary sources of strong competitive advantage for businesses and a key economic moat source. Branding Raises Hurdles for Competitors Example Starbucks is the leading specialty coffee retailer in the world. Its wide economic moat comes from its “brand strength (evidenced by pricing power), attractive unit-level economics, successful international replication and strong results in the retail channel underpinning its brand intangible asset.” Starbucks Corp. (SBUX)
Economies of Scale (Cost + Size Advantage) Cost/Size Leadership provides Market Control Example Companies with a structural cost advantage are able to exert significant control over market-level prices while earning relatively high margins. Alternatively, they undercut competitors on price while earning similar margins. This squeezes competitors out of the industry, or at the very least, impede its growth. Cost advantages are often gained through economies of scale, lower distribution and manufacturing costs and/or access to a low-cost resource base. Cost advantage that competitors cannot replicate is a very effective economic moat. Companies with sustainable cost advantages can maintain a very large market share. However, with increasing competition in today’s global economy, this makes maintaining this competitive advantage difficult. Walmart is a dominant traditional retailer and the number-one grocer in the U.S. Walmart has become “virtually synonymous with low-cost items, a product of its unparalleled purchasing leverage and deep vendor relationships.” Furthermore, its cost leverage “allows it to be even more aggressive with pricing, sidestepping the traffic pressure that other retailers have faced as channels shift.” Walmart Inc (WMT)
Other examples of Economic Moats Patents / Regulatory Licenses Network Effect Efficient Scale Access to Capital
Bottom-Up & Top-Down Investing Bottom-Up Investing Top-Down Investing Focus Focuses on individual assets and their characteristics. Focuses on large-scale economic factors and global trends Logic If an individual stock performance within the market or their respective industry is good, then this is the right stock to invest in. if macroeconomic factors are favorable for a specific industry or the whole market, the time might be right to invest in a specific stock. Example of Factors ● Fundamental driven ● Price-to-Earnings (P/E) ratio ● Cash flow ● Revenue and/or income ● Earnings Per Share (EPS) ● Net profit margin ● Share price changes ● Company leadership, corporate culture, brand recognition, market share etc. ● Thematic trends ● Gross domestic product (GDP) changes ● Inflation rates ● Interest rates ● Environmental conditions and/or changes ● Commodity prices ● Market index performance ● Political climate
Thank you! That’s all for content. Hope you enjoyed the past 6 weeks! Next wednesday, we’ll be doing a case study and preparing for the stock pitch competition. More details on the competition as well as the sign up link will be released soon.
Bottom-Up Investing Pros Cons ● Less labor-intensive than the top-down approach, as it requires you to analyze a smaller number of factors that are mostly quantifiable ● The bottom-up approach might help you find undervalued investing opportunities that have great potential for future growth and returns ● Requires you to closely inspect every potential investment opportunity, its performance and place in the market, which leads to more informed decisions ● Focusing too much on specific companies or industries might prevent you from diversifying your portfolio ● Requires some theoretical knowledge of how financial markets and instruments function ● Can lead to largely speculative investments in some cases
Top-Down Investing Pros Cons ● By focusing on the macro factors, this approach teaches you how the global economic forces impact the stock market and how to analyze this impact ● It broadens your scope and allows you to consider investment opportunities across industries, markets and countries ● Top-down investing does not require you to have intricate financial or stock market knowledge ● Generalizing the performance data of an entire industry or country might cause you to overlook promising individual investing opportunities ● Sudden geopolitical or economic shifts can render your strategy obsolete ● This approach requires you to continuously monitor a variety of complex macro factors
Appendix - Economic Moats in Industries Retail Dining Legacy Brands Large retail stores enjoy wide economic moats due to economies of scale, meaning they can buy large amounts of inventory for low prices and pass the savings along to customers. Additionally, they often have reliable supply chains. Leveraging on these advantages allows them to prices out smaller competitors and retains customers with low prices and wide product selection. Fast food restaurants operate at low profit margins, which smaller mom-and-pop restaurants often cannot maintain. By operating at a large and efficient scale, they enjoy many millions of low-margin transactions that add up to great profits over an extended period of time. Famous brand-name companies can experience years of sustainability based on their multi-decade reputations. This grants them a cost advantage over upstart competitors that might need to scramble to introduce their brands to potential customers.
Appendix - Economic Moats in Industries Computing Insurance Large computer companies and software companies enjoy economic moats created by network effects. When a large number of customers use a product / service, they bring in and retain other customers who need those same products and services to interact with one another. The larger the customer base, the better the service works. Scrappy startups may have a hard time peeling away customers from these brands, which would require the customers to abandon parts of their networks. When it would be too inconvenient to abandon an established company, that company also has pricing power. It’s common for customers to stick with their existing insurance policies—whether it’s health insurance, homeowners insurance, or car insurance—because of the high switching costs of changing providers. These switching costs do not have to be monetary to be significant. In many cases, they describe the hassle of the administrative tasks that go along with switching providers.
Which to choose? Both strategies have their pros and cons so no matter which you choose, even if you choose to carry out both, it is not possible to accurately predict / fully eliminate the risk that comes with each investment. You can however, try to take calculated risk for each investment decision, based on the predicted returns it would generate. Taking Calculated Risks Both strategies have valid applications in different circumstances Who is top-down investing for? Managers of exchange-traded funds typically prefer top-down approach as they have resources to conduct extensive macroeconomic analysis and are looking to maximize their long-term returns. As a result, by investing in an ETF, you are effectively investing using the top-down approach. It is also perfect for beginner investors who wish to play it ‘safe’ and are looking to build a diversified portfolio or assets across industries and are also prioritizing long-term returns. Who is bottom-up investing for? Since the bottom-up approach largely deals with short-term or real-life data, it is most useful for short-term, profit-driven investments, which makes it a favourite of experienced individual investors. “Short-term investments” in this case doesn’t necessarily mean speculating. However, the bottom-up approach generally requires investors to act fast, as the financial metrics that this approach analyzes tend to change quite regularly. It could be a great way to introduce more risk into your portfolio and, potentially, more return.
Unique Selling Proposition “What makes you different from the competition?” An opinionated and deliberate USP helps focus your marketing strategy and influences messaging, branding, copywriting, and other marketing decisions. It’s a position a business takes as a whole that can be incorporated into their products, their brand, the experience they provide, and any other touch point customers have with the business. Benefits USP allows a company to to differentiate their products and brand from their competitors. A good USP shows the strengths which a company plays to and the factor which makes the brand / product uniquely valuable to customers. Why is a company’s USP important? What customers want Organisation’s strengths
Time Value and Cash Flow Time Value of Money Why does value of cash depreciate / appreciate over time? The value of money decreases over time due to inflation and opportunity cost (i.e the interest rate lost from putting the money inside a bank instead) The rate of interest determines the value of money received either today or in the future Therefore, to compare money from different time periods, we have to either: ● COMPOUND when moving cash-flow forward in time (Future Value) ● DISCOUNT when moving cash-flow backward in time (Present Value) Compounding and Discounting Compounding Process of reinvesting an asset’s earnings to generate additional earnings over time Discounting Process of determining the present value of a payment that is to be received in the future Given that: Discount Factor = Present Value (PV): While compounding exponentially increases an asset’s value, it also exponentially increases liabilities, as interest accumulates on the unpaid principal amount and previous interest charges. FV = PV * ( 1 + r)n Legend: FV - Future Value , PV - Present Value, r - C - Principal Amount,, r - annual interest rate, n - no. of years
Time Value and Cash Flow ● Most important rule when comparing cash flows: Only compare cash-flows in the SAME time period e.g. comparing PV (Present Value) cash flows. If you want to compare next year’s cash flow to the present year, then the stream of cash flow (or cash-flow forecasts) will have to be discounted. e.g. comparing FV (Future Value) cash flows, vice versa ● When dealing with calculations with stream of cash-flow, discounting/ compounding is used again to sum all the cash-flows either in PV or FV. Now, considering the time period for each cash-flow statement is published annually, and future cash-flows have a discounted rate of 5%, the sum of all cash flows in PV can be calculated as the following:

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Bootcamp Slides Week 1

  • 1. UNIVERSITY COLLEGE LONDON ASSET MANAGEMENT SOCIETY Private and Confidential Please do not circulate
  • 2. Before we begin Join the whatsapp group! Updated schedule : 1800 HRS - 1900 HRS ● Week 1 (Introduction to Finance and Investing, UCLAM Investment Philosophy, Fundamental Analysis): 26 Oct ● Week 2 (How to frame a pitch, Bonds, NPV, CAPM and Portfolio): 02 Nov Reading Week ● Week 3 (3 Statement Accounting & Financial Ratios): 16 Nov ● Week 4 (Valuation Foundations- Intrinsic & Relative): 23 Nov ● Week 5 (Forecasting, DCF): 30 Nov ● Week 6 (Sample Stock Pitch): 7 December ● Week 7 [Optional] (Stock Pitch Competition): 14 December
  • 3. Week 1 Overview 1. Introduction to asset management 2. Investment Strategy: Long-Short Equity 3. UCLAM’s Investment Philosophy 4. Fundamental Investing 5. Time Value of Money (Discounting and Compounding)
  • 4. Asset Classes Overview 4 • Hedge Funds • Private Equity • Commodities • Real Estate • Collectibles • Forex • Derivatives Long-only investments (e.g. mutual funds) Cash Alternatives Bonds Traditional Equities
  • 5. Asset Management Capital Appreciation (Risk-adjusted) Maximize risk-adjusted returns whilst staying within the fund’s investment mandate and risk appetite. “Asset Management” is a blanket term applied to all buy-side investment firms. Different funds specialize in investments in different asset classes. Different asset classes have different risk and liquidity profiles. Clients investing in these funds (e.g. UHNWI, pension funds, endowment funds) spread risk by diversifying their portfolio through investing in different funds. Role of an Asset Management Firm How does AM differ from others in the industry? Firms can be split into the BUY side and the SELL side BUY SIDE SELL SIDE Asset Management Firms e.g. Hedge Funds, Private Equity Funds, Mutual Funds, etc Decision-makers who make the investment decisions. They engage the sell-side to help them in executing their investments (e.g. private equity using investment banks for M&A, hedge funds using equity research for insights and S&T to execute trades) E.g Investment Banks, Equity Research Houses, Sales & Trading Firms, Brokerages, Insurance Firms Client-facing firms/ brokers. They provide buy-side firms with a variety of services (e.g. M&A advisory, order execution, bringing in deals) and take a small percentage of the deal value as fees.
  • 6. Investing Types of sectors Types of asset classes Cyclical Defensive Consumer Discretionary (Travel, Retail, Media) Consumer Staples (Personal & household goods, F&B) Industrials Telecommunications Technology Utilities Financials (Banks, Insurance) Energy (Oil and Gas) Real Estate Healthcare Basic Materials Fixed Income (Corporate bonds, Government bonds) Real Estate / Property Equities / Stocks Cash and Cash equivalents Forex (i.e Foreign Exchange), Futures and Other Derivatives Investment Strategies Value Investing (Finding undervalued stocks) Income Investing (Securities which pay out returns on a regular schedule e.g bonds and dividend paying stocks) Growth Investing (Finding companies with high growth potential, spotting the ‘next big thing’) Small Cap Investing (Investing in companies with small market capitalisation) Socially Responsible Investing (Investing in environmentally and socially responsible companies)
  • 7. Long VS Short Strategy Long Trades vs Short Trades Long-Short Equity Long Trades Short Trades Entry You buy the asset You borrow an asset and sell it Wait You hold the asset and wait for it to increase in price before selling You wait for it to decrease in price before buying it back and returning it to the seller Exit You profit from the sale of the asset You profit from the buy back of the asset What is Long-Short Equity? It is an investing strategy which takes: ● Long positions in stocks which are expected to appreciate (e.g undervalued stocks) ● Short positions in stocks which are expected to decline (e.g overvalued stocks) This investment strategy seeks to minimize market exposure and exploit profit opportunities in both expected upside and downside price movements. Net Exposure It is a difference between the long positions and short positions. Example Company A employs a long short strategy with a long bias (e.g 130/30, meaning 130% long exposure and 30% short exposure). This means Company A has a net exposure of 100% (130% - 30% = 100%)
  • 8. Long VS Short Strategy Long-Short Equity Strategy in Practice The Pair Trade This is a popular variation of the long-short strategy, involving a long position on a stock and a short position on another stock belonging to the same sector This strategy is commonly adopted in market-neutral funds Example: If an investor takings a long position in Microsoft and offset that with a short position in Apple. The ideal situation for this strategy would be for Microsoft to appreciate and for Apple to decline. However, even if Apple appreciates - since stocks within a sector generally tend to move up or down in unison - the strategy would still be profitable, albeit to a smaller extent Example: From the previous example, we learn that stocks within the same sector usually move in the same direction thus it might not be wise to adopt a pair trade strategy using stocks belonging to the same sector. Another common long-short strategy would be using stocks from different sectors for the long and short legs. For instance, in the case of rising interest rates, an investor may adopt a short position in interest-sensitive sectors such as utilities, and take a long position in defensive sectors, such as healthcare
  • 9. Long/Short Equity vs Long-Only Short Selling • Short selling allows for L/S investors to capitalize on the decline of a company’s stock price Higher Risk/Return Appetite • Investors commonly allocate a portion of their portfolio to L/S Equity where fund managers employ typically higher risk investing strategies with the goal of achieving higher returns for investors Absolute Returns • Aims to achieve returns regardless of market conditions and performance will hence be measured on absolute returns, instead of relative returns based on market benchmarks as is the case with long-only equity Downside Protection • L/S Equity allows for investors to protect gains and minimize losses by shorting stocks (‘hedging’) as it reduces the investor’s risk exposure to market conditions, unlike long-only equity where returns are highly correlated to market performance. Hence, if the market crashes, L/S investors might still make a profit while long-only investors will lose money Increased Opportunity Set • Ability to profit from overvalued and undervalued stocks, compared to only undervalued stocks in long only strategies Active Management • L/S funds are managed more actively than long-only funds. Investments have a shorter time horizon than long only (5-7 year holding period in a long-only fund versus 45-365 days in a long-short fund) 9
  • 10. UCLAM Investment Philosophy ‘Quantamental’Analysis • Fundamentals-driven stockpicking approach backed by strong quantitative data and extensive research Long/Short Strategy • Hedged investment strategy to protect portfolio against market correlated risks High Conviction & Alpha-Generation • Handpicking high-conviction stocks in a high-concentration portfolio to maximise absolute returns Investing Framework • Rigorous investing framework with a robust investment process Contrarian Thinking • Non-traditional investment strategies and ideas which align with our core values Risk & Performance Management • Constant monitoring of our portfolio coupled with a disciplined sell strategy 10
  • 11. Investment Strategy NEXT-GEN MOATS TRENDS FOCUS VALUATION • Consideration of non-traditional factors for business development disrupting status quo • Businesses with sustainable competitive advantages or disadvantages • Long-lasting global trends strongly affecting companies or industries • High conviction in the best ideas making up our portfolio • Strong focus on valuation to maximize returns and margin of safety 11
  • 12. Constant idea generation coupled with a well-defined investment universe Sourcing • Individual idea generation from wide array of sources such as research reports, conversations with industry experts, internet forums, thematic trend study, top-down macro-analysis Screening • Basic screen to ensure companies fit within our investment universe (e.g., market capitalization above $3B, geography and sector considerations) Contrarian Thinking • Out-of-the-box thinking to identify new investment strategies or ideas that go against the status quo or market consensus ESG Sources • Special focus on tailwinds for ESG focused sectors and companies Step 1: Idea Generation FUNDAMENTAL ANALYSIS QUANTITATIVE ANALYSIS PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE IDEA GENERATION 12
  • 13. Extensive research to determine fundamentals of company Competitive Advantage • We look for solid evidence of business advantages with driven leadership. Questions we ask are: Is there a strong economic moat? Who are the main competitors and why do we choose this company over others? What is the growth story? Key risks? Economic Trends • Macro and industry trends providing headwinds or tailwinds? Attractive Valuation • Upside potential at current price? ESG Considerations • What is the company’s environmental impact and social impact? How is the corporate governance within the company? FUNDAMENTAL ANALYSIS Step 2: Fundamental Analysis IDEA GENERATION QUANTITATIVE ANALYSIS PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE 13
  • 14. Quantitative analysis to determine future value of company Phase 1 analysis: • Is the current growth sustainable? • What are its revenue drivers and margin drivers? • Financial statements forecasting • How is the company’s Free Cash Flow position? Phase 2 analysis: • New and alternative data analytics • Discounted Cash Flow valuation and Comparables analysis using multiples • At least 20% upside at current price FUNDAMENTAL ANALYSIS QUANTITATIVE ANALYSIS Step 3: Quantitative Analysis PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE IDEA GENERATION 14
  • 15. Following clear rules to maintain investment discipline Initial Positions: 2-5% Maximum Position Size: 15% Maximum Industry Exposure: 30% Minimum Number of Industries: 5 Maximum Number of Holdings: 20 PORTFOLIO CONSTRUCTION QUANTITATIVE ANALYSIS Step 4: Portfolio Construction RISK AND PERFORMANCE FUNDAMENTAL ANALYSIS IDEA GENERATION 15
  • 16. Step 5: Risk & Performance Management Constant monitoring of portfolio with disciplined sell strategy Target Valuation Reached or Exceeded • Price exceeding valuation resulting in realisation of returns Changes in Thesis • Changes to original assumptions resulting in change of valuation More Attractive Competitor • More attractive competitor due to changes in economic moats Retail and Media Focus • Monitoring of volatile stocks influenced by non-traditional information sources and irrationality PORTFOLIO CONSTRUCTION RISK AND PERFORMANCE QUANTITATIVE ANALYSIS FUNDAMENTAL ANALYSIS IDEA GENERATION 16
  • 17. What is fundamental investing? • Finding companies that are trading at a discount to fair value and investing in them • Idea is that over time, markets will correct themselves and stock prices will trade at fair value
  • 18. What is a Moat?
  • 19. What is an Economic Moat? A business' ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms - Warren Buffett
  • 20. Economic Moat Importance of Economic Moat A modern economic principle says that given time, competition will erode any competitive advantages enjoyed by a firm. This is because once a firm establishes its competitive advantages, there exists a strong incentive for competing firms to duplicate the methods / strategy of the leading firm or seek improvement opportunities for their operating methods. Thus, an economic moat is important. It is a qualitative measurement of a company’s ability to keep competitors at bay for an extended period of time. This translates into prolonged profits in the future and are key success factors in a company’s long-term success. Illustrative Example Low-cost competitive advantage Without an economic moat With an economic moat (Patent) 30% Expenses 30% Juice Patented Technology
  • 21. Types of Economic Moats Network Effect Switching Costs Economies of Scale Name-Brand Recognition
  • 22. Switching Costs Switching costs: When it becomes too expensive / troublesome to switch away from a company’s product ● Tangible Costs: Money cost to switch ● Intangible Costs: New learning curve, time spent on administrative tasks Common in industries such as insurance, telecom providers, computer operating systems, banks etc. where the cumbersome switching costs makes it difficult for competitors to take market share away from the industry leader. Switching costs provide a company with the leverage to increase prices and deliver substantial profits over time → pricing power Switching Costs Lock-In Customers Example A leader in providing cloud-based solutions that address many aspects of customer acquisition and retention. According to Morningstar, its salesforce automation application is “mission-critical software that helps drive revenue for users.” High switching costs as it involves the high organizational risk of moving away from the platform, as well as the time, expense, and lost productivity associated with the implementation of a new application. Salesforce.com Inc. (CRM)
  • 23. Network Effect As more people use a company’s product or service, the value of that product or service increases for both new and existing users. Customers may switch to a brand to interact with customers already using that brand. Especially relevant as our world becomes increasingly digitalised. The term “critical mass” is often used in connection with the network effect. In game theory, this means that not all game participants need to be convinced for a strategy to succeed, just a very specific portion of them. If this participation threshold is exceeded, the strategy is likely to succeed of its own accord. Network Effect Grows with Reach Example Visa (V) Visa dominates the global electronic payments industry, controlling approximately half of all credit card transactions and an even higher portion of debit card activity. With almost 16,000 financial institution partners, 3.4 billion Visa cards in circulation, and over 50 million merchants accepting Visa, it is great example of how the network effect creates a powerful competitive advantage. Other Example: ● Getting a cellphone that’s compatible with your friends’ phones (E.g: Apple - interconnectedness between the i_ products) ● A seller listing a product on a large e-commerce site to access its vast network of buyers.
  • 24. Name-Brand Recognition Brand-loyal customers are difficult to be pulled away thus allowing the company to retain its market share. Additionally, brand equity can increase a customer’s willingness to pay for a product / service (even though the product / service itself might not be that differentiated). This allows the company to charge a significant price premium. Although name-brand asset is an intangible asset, it remains one of the primary sources of strong competitive advantage for businesses and a key economic moat source. Branding Raises Hurdles for Competitors Example Starbucks is the leading specialty coffee retailer in the world. Its wide economic moat comes from its “brand strength (evidenced by pricing power), attractive unit-level economics, successful international replication and strong results in the retail channel underpinning its brand intangible asset.” Starbucks Corp. (SBUX)
  • 25. Economies of Scale (Cost + Size Advantage) Cost/Size Leadership provides Market Control Example Companies with a structural cost advantage are able to exert significant control over market-level prices while earning relatively high margins. Alternatively, they undercut competitors on price while earning similar margins. This squeezes competitors out of the industry, or at the very least, impede its growth. Cost advantages are often gained through economies of scale, lower distribution and manufacturing costs and/or access to a low-cost resource base. Cost advantage that competitors cannot replicate is a very effective economic moat. Companies with sustainable cost advantages can maintain a very large market share. However, with increasing competition in today’s global economy, this makes maintaining this competitive advantage difficult. Walmart is a dominant traditional retailer and the number-one grocer in the U.S. Walmart has become “virtually synonymous with low-cost items, a product of its unparalleled purchasing leverage and deep vendor relationships.” Furthermore, its cost leverage “allows it to be even more aggressive with pricing, sidestepping the traffic pressure that other retailers have faced as channels shift.” Walmart Inc (WMT)
  • 26. Other examples of Economic Moats Patents / Regulatory Licenses Network Effect Efficient Scale Access to Capital
  • 27. Bottom-Up & Top-Down Investing Bottom-Up Investing Top-Down Investing Focus Focuses on individual assets and their characteristics. Focuses on large-scale economic factors and global trends Logic If an individual stock performance within the market or their respective industry is good, then this is the right stock to invest in. if macroeconomic factors are favorable for a specific industry or the whole market, the time might be right to invest in a specific stock. Example of Factors ● Fundamental driven ● Price-to-Earnings (P/E) ratio ● Cash flow ● Revenue and/or income ● Earnings Per Share (EPS) ● Net profit margin ● Share price changes ● Company leadership, corporate culture, brand recognition, market share etc. ● Thematic trends ● Gross domestic product (GDP) changes ● Inflation rates ● Interest rates ● Environmental conditions and/or changes ● Commodity prices ● Market index performance ● Political climate
  • 28. Thank you! That’s all for content. Hope you enjoyed the past 6 weeks! Next wednesday, we’ll be doing a case study and preparing for the stock pitch competition. More details on the competition as well as the sign up link will be released soon.
  • 29. Bottom-Up Investing Pros Cons ● Less labor-intensive than the top-down approach, as it requires you to analyze a smaller number of factors that are mostly quantifiable ● The bottom-up approach might help you find undervalued investing opportunities that have great potential for future growth and returns ● Requires you to closely inspect every potential investment opportunity, its performance and place in the market, which leads to more informed decisions ● Focusing too much on specific companies or industries might prevent you from diversifying your portfolio ● Requires some theoretical knowledge of how financial markets and instruments function ● Can lead to largely speculative investments in some cases
  • 30. Top-Down Investing Pros Cons ● By focusing on the macro factors, this approach teaches you how the global economic forces impact the stock market and how to analyze this impact ● It broadens your scope and allows you to consider investment opportunities across industries, markets and countries ● Top-down investing does not require you to have intricate financial or stock market knowledge ● Generalizing the performance data of an entire industry or country might cause you to overlook promising individual investing opportunities ● Sudden geopolitical or economic shifts can render your strategy obsolete ● This approach requires you to continuously monitor a variety of complex macro factors
  • 31. Appendix - Economic Moats in Industries Retail Dining Legacy Brands Large retail stores enjoy wide economic moats due to economies of scale, meaning they can buy large amounts of inventory for low prices and pass the savings along to customers. Additionally, they often have reliable supply chains. Leveraging on these advantages allows them to prices out smaller competitors and retains customers with low prices and wide product selection. Fast food restaurants operate at low profit margins, which smaller mom-and-pop restaurants often cannot maintain. By operating at a large and efficient scale, they enjoy many millions of low-margin transactions that add up to great profits over an extended period of time. Famous brand-name companies can experience years of sustainability based on their multi-decade reputations. This grants them a cost advantage over upstart competitors that might need to scramble to introduce their brands to potential customers.
  • 32. Appendix - Economic Moats in Industries Computing Insurance Large computer companies and software companies enjoy economic moats created by network effects. When a large number of customers use a product / service, they bring in and retain other customers who need those same products and services to interact with one another. The larger the customer base, the better the service works. Scrappy startups may have a hard time peeling away customers from these brands, which would require the customers to abandon parts of their networks. When it would be too inconvenient to abandon an established company, that company also has pricing power. It’s common for customers to stick with their existing insurance policies—whether it’s health insurance, homeowners insurance, or car insurance—because of the high switching costs of changing providers. These switching costs do not have to be monetary to be significant. In many cases, they describe the hassle of the administrative tasks that go along with switching providers.
  • 33. Which to choose? Both strategies have their pros and cons so no matter which you choose, even if you choose to carry out both, it is not possible to accurately predict / fully eliminate the risk that comes with each investment. You can however, try to take calculated risk for each investment decision, based on the predicted returns it would generate. Taking Calculated Risks Both strategies have valid applications in different circumstances Who is top-down investing for? Managers of exchange-traded funds typically prefer top-down approach as they have resources to conduct extensive macroeconomic analysis and are looking to maximize their long-term returns. As a result, by investing in an ETF, you are effectively investing using the top-down approach. It is also perfect for beginner investors who wish to play it ‘safe’ and are looking to build a diversified portfolio or assets across industries and are also prioritizing long-term returns. Who is bottom-up investing for? Since the bottom-up approach largely deals with short-term or real-life data, it is most useful for short-term, profit-driven investments, which makes it a favourite of experienced individual investors. “Short-term investments” in this case doesn’t necessarily mean speculating. However, the bottom-up approach generally requires investors to act fast, as the financial metrics that this approach analyzes tend to change quite regularly. It could be a great way to introduce more risk into your portfolio and, potentially, more return.
  • 34. Unique Selling Proposition “What makes you different from the competition?” An opinionated and deliberate USP helps focus your marketing strategy and influences messaging, branding, copywriting, and other marketing decisions. It’s a position a business takes as a whole that can be incorporated into their products, their brand, the experience they provide, and any other touch point customers have with the business. Benefits USP allows a company to to differentiate their products and brand from their competitors. A good USP shows the strengths which a company plays to and the factor which makes the brand / product uniquely valuable to customers. Why is a company’s USP important? What customers want Organisation’s strengths
  • 35. Time Value and Cash Flow Time Value of Money Why does value of cash depreciate / appreciate over time? The value of money decreases over time due to inflation and opportunity cost (i.e the interest rate lost from putting the money inside a bank instead) The rate of interest determines the value of money received either today or in the future Therefore, to compare money from different time periods, we have to either: ● COMPOUND when moving cash-flow forward in time (Future Value) ● DISCOUNT when moving cash-flow backward in time (Present Value) Compounding and Discounting Compounding Process of reinvesting an asset’s earnings to generate additional earnings over time Discounting Process of determining the present value of a payment that is to be received in the future Given that: Discount Factor = Present Value (PV): While compounding exponentially increases an asset’s value, it also exponentially increases liabilities, as interest accumulates on the unpaid principal amount and previous interest charges. FV = PV * ( 1 + r)n Legend: FV - Future Value , PV - Present Value, r - C - Principal Amount,, r - annual interest rate, n - no. of years
  • 36. Time Value and Cash Flow ● Most important rule when comparing cash flows: Only compare cash-flows in the SAME time period e.g. comparing PV (Present Value) cash flows. If you want to compare next year’s cash flow to the present year, then the stream of cash flow (or cash-flow forecasts) will have to be discounted. e.g. comparing FV (Future Value) cash flows, vice versa ● When dealing with calculations with stream of cash-flow, discounting/ compounding is used again to sum all the cash-flows either in PV or FV. Now, considering the time period for each cash-flow statement is published annually, and future cash-flows have a discounted rate of 5%, the sum of all cash flows in PV can be calculated as the following: