APPLIED PORTFOLIO MANAGEMENT
FIN 493 Section 001, MW 04:00 – 05:15 p.m.
Ansari Business Building Classrooms 205 & 312
College of Business Administration
University of Nevada at Reno
ALI NEJADMALAYERI
Ansari Business Building, Room 401B
Office Hours: Monday and Wednesday 2:30 – 3:45
Phone: 784 – 6993 ext. 306
Email: aliala@unr.edu
COURSE OBJECTIVE:
This course provides hands-on experience in portfolio selection and management and extends the
traditional investment management courses by delving deeper into cutting-edge topics and techniques
in portfolio management.
Besides the practical money management aspect of the course, the course is primarily discussionbased. We follow the recent developments in portfolio selection and management, while keeping in
mind all relevant historical progress in the field. Students are expected to present and discuss related
topics throughout the semester.
COURSE MATERIAL:
There are four required references for this course. The major reference for the course is “Active
Equity Portfolio Management”, by Frank J. Fabozzi (hereafter FJF). The other three references for
the course are “How to Make Money in Stocks”, by William J. O’Neil (hereafter WJO), “Value
Investing”, by Greenwald, Kahn, Sonkin, and Biema (hereafter GKSB), and “If It’s Raining in Brazil,
Buy Starbucks” by Peter Navarro (hereafter PN). You will also find valuable information in the
course page at: http://equinox.unr.edu/homepage/aliala/public_html/newfin430.htm.
There are also additional optional references for this course, as follows:

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“Asset Management: Equities Demysitified”, by Shanta Acharya
“The Inefficient Stock Market”, by Robert A. Haugen
“Beast on Wall Street”, by Robert A. Haugen
“The New Finance: Overreaction, Complexity, and Uniqueness”, by Robert A. Haugen
I also strongly urge you to follow the popular financial press and media such as:
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Programs like Kudlow & Cramer; Louis Rukeyser's Wall Street, etc.
Magazines like Business Week, Money, Fortune, Smart Money, Bloomberg Personal, etc.
Papers like Wall Street Journal, Financial Times, Investor Business Daily
Mastery of Excel, COMPUSTAT, S&P NetAdvatage, PerTrack is a definite plus!
PREREQUISITE:
Students who wish to take this course must have already passed Portfolio Management course (MGRS
416 or alternatively FIN 419) and obtain instructor’s permission.
GRADES:
Your final grade for this course is determined as follows:
Grade Activity
Class Presentation
Final Project & Exam
Industry Report
Stock Reports
Stock Selection
Portfolio Performance
Portfolio Report
Attendance
Percentage Point Range
89.5% – 100.0%
79.5% – 89.4%
69.5% – 79.4%
59.5% – 69.4%
< 59.5%
Percentage
15
15
5
5
10
30
10
10
Final Letter Grade
A
B
C
D
F
This class is entirely discussion based. To that end, students are to read assigned chapters of the FJF
book and present the material to the class. We all then discuss the merits of the arguments and provide
our own take on the matter. These presentations account for 15% of your final grade.
There will be one, mandatory final exam which represents 15% of the final grade of the course.
Students must take the final exam . If for some reason a student must miss an exam, the student must
discuss the matter with the instructor before the day of the exam. Otherwise, the student will receive a
“zero” for the missed test. Except for university–authorized absences, under any circumstance, NO
MAKE–UP TESTS will be given. Authorized absentees must arrange for a make-up test prior to the
examination date. The final exam is mandatory. THE FINAL EXAM WILL BE GIVEN ON MONDAY,
DECEMBER 13, 2004 DURING THE PERIOD OF 4:30 P.M. – 6:30 P.M. AS DESIGNATED BY THE FALL 2004
CLASS SCHEDULE.
Thanks to the generosity of Mr. Jack McLeod, we now have the opportunity to actually practice the
theory using $100,000 of donated funds. Students will be divided into five “analytics groups”. Each
group then will be randomly assigned up to five industries (sectors) to study and cover. Each group is
responsible for 1) studying and analyzing at least two of the assigned industries, 2) selecting and
recommending one or two best performing stocks from these selected industries, and 3) allocating and
managing capital.
THE ENTIRE PORTFOLIO MANAGEMENT PROJECT INCLUDING REPORTS,
SELECTION AND PERFORMANCE ACCOUNTS FOR A TOTAL OF 60% OF YOUR OVERALL GRADE. The
portfolio management project’s grade, however, is made up of five distinct categories: A) industry
reports and presentation, B) stock reports, C) stock selection, D) portfolio performance and E)
portfolio report. The first three activities are group based and the last two are for the entire class.
Upon studying industries and selecting the desired ones, each of the analytics groups must write a
industry report no longer than 5 pages long and present a summary report in class. Note that industry
reports and presentation account for 5% of the overall grade. Each group then must find and
recommend one or two top performing stocks from the selected industries. Prior to report dates and
before any buy or sell action can be taken, each group must rank the stocks using a “five star” system
and provide a one-page “stock report” akin to Value Line and Standard and Poor’s reports. At the end
of the semester, all group rate other groups’ industry and stock reports informativeness and efficacy.
Based on the peer evaluations and my own judgment, I then will grade these reports. Note that stock
reports and presentation account for 5% of the overall grade.
After receiving all stock reports, the entire class then determines the optimal weights for each stock,
given the limitation defined by the fund’s charter and concerns about transaction costs. The class then
approves buy and sell orders, i.e. the entire class determines if new positions are to be undertaken and
if the portfolio should be rebalanced. The remaining project’s grade consists of stock selection,
portfolio performance and portfolio report. At the end of the semester, the quality of each group’s
recommendations (i.e., selection ability) will be assessed and graded. To that end, best performing
stock will be assigned a 100% score and worst performing stock will be assigned a 0% score. The sum
of all scores for all groups then is ranked and the group with highest rank receives a 100% weight. All
other groups will receive pro-rata weights. Your grade for this part of the exercise is the group’s
weight times 10% of the overall grade. Selection accounts for 10% of your overall grade. In sum the
grade for the selection is determined as follow:
1) Stock selection: 10% of the overall grade
a) First, we rank all stocks you have invested. The top stock gets 100% score and bottom
one gets 0% score. Then you get a score weighted times 10%.
(i) e.g., there are two groups and total six stocks in the portfolio. The first and the
forth one is your recommendation. For first to sixth stocks, the scores are 100%,
83.33%, 66.67%, 33.33%, 16.67% and zero. The sum of all your scores is
(100% + 33.33%) / 2 = 66.67%.
The most important goal of the project is of course to generate wealth. The ability to produce quality
return then is highly valued. The portfolio performance accounts for 30% of your overall grade.
Portfolio performance will be assessed based on the risk-adjusted relative performance of the fund to
that of a benchmark determined by Morningstar® Style Box™. For every percentage
underperformance, you will loose 1% points from the allotted 30%. For every percentage
outperformance, you will be rewarded 1% extra credit beyond the allotted 30%. This implies that
stellar performance rewards you with extra credit toward your overall grade. In sum the grade
for the project is determined as follow:
2) Portfolio performance: 30% of the overall grade
a) First, we rank the portfolio based on Morningstar® Style Box™. This defines which of
the Morningstar® Style Box™ indices is the appropriate benchmark.
b) If the portfolio beats the benchmark, then for every percentage excess return, you will
get 1% toward your overall grade.
(i) e.g., the portfolio is of the small growth portfolio kind. Morningstar’s
corresponding index is up 8% for the semester while your portfolio is up 9.5%.
Everyone in the class receives 30% + (9.5% – 8%) = 31.5% out of 30% for
managing the fund 
c) If the portfolio falls short of the benchmark, then for every percentage excess return,
you will get 1% toward your overall grade.
(i) e.g., the portfolio is of the small growth portfolio kind. Morningstar’s
corresponding index is up 8% for the semester while your portfolio is up 6.5%.
Everyone in the class receives 30% + (6.5% – 8%) = 28.5% out of 30% for
managing the fund 
d) If the portfolio neither out- nor underperforms the benchmark, then for every percentage
excess return, you will get 1% toward your overall grade.
(i) e.g., the portfolio is of the small growth portfolio kind. Morningstar’s
corresponding index is up 8% for the semester while your portfolio is up 8%.
Everyone in the class receives 30% out of 30% for managing the fund 
Lastly, any investment firm can only stay competitive, if it can verify, document and prove its results.
In an ever increasingly regulated industry, investment professional are bounded by standards of
practice which can only become more stringent as time passes. Hence, to prepare you for what is laid
ahead and give an opportunity to prove yourself, we will prepare a formal semi-annual report for the
board of trustees. I will provide a prototype of this report, but ultimately the board’s satisfaction with
your performance relies on how good you can communicate your actions. Semiannual report accounts
for 10% of the final grade of the course
ATTENDANCE POLICY:
Students are REQUIRED to attend every class. Attendance will be taken at the beginning of each class.
Students who must be absent from a class are responsible for securing any and all course work missed
from the other students in the class. Your attendance accounts for 10% of your total grade point.
Every absence will cost you half of the attendance grade. STUDENTS WITH MORE THAN TWO
ABSENCES WILL BE DROPPED FROM THE CLASS.
DISABILITY ACCOMMODATIONS:
If a student requires accommodations based on disability, the student should meet with the instructor
during the first week of the semester.
IN-CLASS RULES:
Students are not allowed to have pagers, cellular phones, laser pointers, electronic games, musical
devices, or any other device, which may distract any other student or instructor. Respect is expected at
all times and no cursing or profanity will be tolerated.
STATEMENT OF ACADEMIC DISHONESTY:
Academic dishonesty is an absolutely unacceptable mode of conduct and will not be tolerated in any
form. All persons involved in academic dishonesty will be disciplined in accordance with University
regulations and procedures. We strictly adhere to the guidelines set forth by the University Student
Conduct policies.
COURSE SCHEDULE:
Date
Agenda
Assignments Due
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Introduction
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FJF Chapter 1: Investment Management
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FJF Chapter 6: Portfolio Construction
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Discussing the Fund’s Charter
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Learning about tools and resources
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WJO Part 1
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FJF Chapter 2: Investment Analysis
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PORTFOLIO MANAGEMENT 1STREPORT
o RECOMMENDATIONS AND ORDERS
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FJF Chapter 3: Active vs. Passive
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WJO Part 2
Sep 08
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FJF Chapter 4: Investment Style
Sep 13
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FJF Chapter 4: (continued)
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WJO Part 3
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INDUSTRY ANALYSIS: PRESENTATIONS
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PORTFOLIO MANAGEMENT 2NDREPORT
o RECOMMENDATIONS AND ORDERS
Sep 20
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FJF Chapter 5: Factor-based Portfolio Management
Sep 22
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FJF Chapter 5: (continued)
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GKSB Part 1 & 2
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FJF Chapter 8: Small Cap Management
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PORTFOLIO MANAGEMENT 3RDREPORT
o RECOMMENDATIONS AND ORDERS
“I-GOT-BEST” form
Oct 04
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GUEST SPEAKER
Project Topics
Oct 06
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FJF Chapter 8: (continued)
Stock Reports
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GKSB Part 3
Oct 11
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FJF Chapter 9: Foreign Stock Portfolio
Rm312
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PORTFOLIO MANAGEMENT 4THREPORT
o RECOMMENDATIONS AND ORDERS
Oct 13
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FJF Chapter 9: Foreign Stock Portfolio
Oct 18
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FJF Chapter 10: Quantitative Methods
Aug 23
Aug 25
Aug 30
Sep 01
Sep 15
Sep 27
Stock Reports
“I-CAN-CHUZ” form
“I-GOT-BEST” form
Stock Reports
“I-GOT-BEST” form
Stock Reports
“I-GOT-BEST” form
Oct 20
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FJF Chapter 10: (continued)
Oct 25
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PN Parts 1 & 2
Rm312
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PORTFOLIO MANAGEMENT 5THREPORT
o RECOMMENDATIONS AND ORDERS
Oct 27
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FJF Chapter 11: Art of Investing
Nov 01
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FJF Chapter 11: (continued)
Nov 03
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FJF Chapter 12: Tactical Asset Allocation
Nov 08
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FJF Chapter 12: (continued)
Rm312
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PORTFOLIO MANAGEMENT 6THREPORT
o RECOMMENDATIONS AND ORDERS
Nov 10
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FJF Chapter 13: Derivatives and Portfolios
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PN Part 3
Nov 15
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FJF Chapters 14: Advanced Derivatives I
Nov 17
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FJF Chapters 15: Advanced Derivatives II
Nov 22
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FJF Chapter 16: Muti-Manager Funds
Nov 24
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FJF Chapter 16: (continued)
Rm312
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PORTFOLIO MANAGEMENT 6THREPORT
o RECOMMENDATIONS AND ORDERS
Nov 29
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Hot Topics: CFA Institutes’ GIPS†
Dec 01
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Hot Topics: Code of Conduct and Ethics†
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PORTFOLIO MANAGEMENT PROJECT ENDS
Dec 06
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o FINAL ORDERS AND EVALUATIONS
Hot Topics: Introduction to CFA Exam†
Dec 13
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†
Final Exam
 All Chapters of FJF & Hot Topics Readings
Relevant readings (a collection of articles) are posted on the course page.
Stock Reports
“I-GOT-BEST” form
Stock Reports
“I-GOT-BEST” form
Stock Reports
“I-GOT-BEST” form
Portfolio Report
PORTFOLIO MANAGEMENT PROJECT:
OBJECTIVE:
The objective of this project is to give the student a “real” feel of how fund management works.
HOW TO BEGIN:
Students will be divided into ten “analytics groups” of three to five people per group. Each group then
will be randomly assigned up to five industries to study and cover. Each group is responsible for
selecting best performing stocks from the universe of assigned industries. To achieve your advisory
status, you need to file forms “ICANCHUZ” and “IGOTBEST” with me by August 30, 2004. On
August 30, 2004, we will take a tally and determine what stock and how many shares we should
purchase. I will put forth the orders by the next morning. From this point on, the fund is active until
such time, late November or early December of 2004, that all positions are liquidated. Each group
must assign a managing director to represent the group. Managing directors are “on-call” for the entire
semester as the point of contact in case I need to contact group members. Every class, we will discuss
for 10 – 15 minutes the most urgent issues relating to the fund. One session prior to any reporting date,
you MUST disseminate your stock reports to me and all other groups. On each reporting session, you
formally report your ranked selections and the entire class votes on what actions should be taken next.
The entire class then signs and seals order confirmations, which give me the authority to execute your
orders accordingly.
GUIDELINES:
1. Safety of Principal: It is believed that safety of principal is a primary objective. As a primary
standard the principal should grow at a rate in excess of inflation. As a secondary standard the
principal should grow at or above appropriate index as defined by Morningstar® Style Box™
over any given semester and any given year.
2. Types of Assets: The approved assets that the investment managers can select to investment are
as follows:
a. Approved Investments:
o Common stocks: listed on principal U.S. exchanges and over the counter markets
o Exchange traded funds
o Foreign Equity securities (ADR): If traded on the New York Stock Exchange
(NYSE), and U.S. over the counter market (NASDAQ)
o Writing covered stock options
o Certificates of deposits
o Cash and cash equivalent: All cash, wherever and whenever possible, should be
invested in interest bearing securities. These securities should be free of substantial
price fluctuation and instantly salable.
All other assets, financial vehicles, and investment opportunities are prohibited.
3. General Asset Allocation Guidelines: The assets contributed to the Portfolio are to be managed
to attain the highest absolute return without undue risk consistent with the preservation of the
capital. Emphasis will be on intermediate- and long-term growth of the capital. The
investment managers will have discretion as to asset allocation within the following:
Maximum:
Minimum:
90% Equities (and Exchange Traded Funds)
0% Equities (and Exchange Traded Funds)
Maximum:
Minimum:
20% Covered stock options
0% Covered stock options
Maximum:
Minimum:
100% Large Equity Index Funds: DIA, QQQ, SPY
0% Large Equity Index Funds: DIA, QQQ, SPY
Maximum:
15% of market value in any one industry
25% of market value for any one industry as a result of appreciation
8% of market value for any one asset item (stock, bond, or exchange
traded funds) at time of purchase
15% of market value for any one asset item (stock, bond, or exchange
traded funds) as a result of appreciation
4. General Trading Guidelines: The trading year is from January 01 till December 15 of each year
for equity and index funds. All options positions must be closed before December 01 of each
year. No intra-day trading is allowed. All trades must be approved by the investment
management team and the Faculty before they are executed. Investment managers must inform
the Faculty of their intended trades in writing in the reporting sessions. Upon approval of the
order, The Faculty will execute the order in a reasonable and timely manner.
5. Diversification: The Portfolio assets should be diversified in order to minimize the effect of any
loss in any individual investments. However, it is not necessary that the equity securities held
represent a cross section of the economy. The investment managers will be allowed to choose
reasonable degrees of concentration, or lack thereof, in any one industry or security consistent
with guidelines set in this article and further modified by the Faculty.
RULES OF CONDUCT:
You are subject to all rules of conduct set forth by the Security Exchange Commission (hereafter SEC)
and other regulatory bodies governing securities markets. You shall announce any conflict of interest
to the class. If you are in any way or form related to a company which you or any other group is
covering, you shall publicly declare such relationships to the class. Violations of these rules would
result to immediate withdrawal from the course and a grade “E” for the class.
EVALUATION:
You will be graded according to the scheme described earlier in the syllabus.
Form “ICANCHUZ”
Analytics Group Number:
Managing Director:
Managers:
1. Name:
Email:
Phone:
2. Name:
Email:
Phone:
3. Name:
Email:
Phone:
4. Name:
Email:
Phone:
5. Name:
Email:
Phone:
Form “IGOTBEST”
Analytics Group Number:
Report No:
Date:
Buy Recommendations:
STOCK
Symbol
Rank
Target
Stop Loss
PE
SIZE
Rank
Target
Stop Loss
PE
SIZE
1
2
3
4
5
Sell Recommendations:
STOCK
Symbol
1
2
3
4
5
Signature and Seal of Analytics Team:
Name: _______________________________ Sign: ___________________________________
Name: _______________________________ Sign: ___________________________________
Name: _______________________________ Sign: ___________________________________
Name: _______________________________ Sign: ___________________________________
Name: _______________________________ Sign: ___________________________________
Here's a question that pops up from time to time on our Socialize boards: "According to its style-box diagram,
my fund is a large-cap blend offering, but Morningstar includes it in the large-cap growth category. Which one is
right?"
Actually, they're both correct. Here's why: The Morningstar style box is a snapshot that tells you the
characteristics of a fund's current portfolio. Morningstar categories are analogous to the style box, but they are
based on how a fund has invested over the past three years, not just its most recent portfolio. The two are often
the same, but sometimes they are different.
The Morningstar style box was a result of our efforts to devise a more meaningful way to describe the
"investment style" of mutual funds. As Morningstar president Don Phillips noted at the time,
discussing mutual funds can be perplexing. There are growth funds, aggressive-growth funds, value
funds, as well as funds that focus on companies from a particular sector or companies of a certain size.
(And that's just on the stock side.) The problem with these prospectus-based descriptions of investment
style is that frequently they are too broad to provide investors with much useful information about the
way a fund invests its assets. Further, even if a particular fund describes itself accurately, no two fund
companies are likely to have the same definition of "value" or "small-cap."
One way to resolve this dilemma is to look beyond how funds describe themselves and examine what
the fund actually owns--their underlying portfolios. In the past, "style boxes" based on a portfolio's size
and investment characteristics were devised for portfolios of stocks. If you think of the equity universe
as a cake in a pan, these boxes used two cuts to divide the cake into four pieces:
This four-box matrix is useful, but it falls short of our needs. With only two choices for each
dimension, such a matrix results in groupings that contain a great deal of variation. Four segments
simply aren't sufficient to divide the equity market into meaningful groups. Morningstar refined this
box by adding two more "cuts" to produce a box with nine segments, with the vertical divisions based
on the size of companies in the fund's portfolio, and the horizontal divisions made according to the
portfolio's valuation ratios relative to a market benchmark:
Here's how we place a fund within the style box: Market capitalization is fairly easy is to determine.
The market capitalization of a stock is equal to the number of shares outstanding multiplied by the
current price of the stock. For a portfolio of stocks, the "median market cap" is often used to describe
the size of companies in the portfolio. To determine the "median" company, you can rank the
companies from largest to smallest, and then pick the one in the middle. There is, however, a potential
drawback to this method. For example, if a fund held a large number of relatively small positions in
companies at either end of the scale, these companies could "distort" the median market cap. Such a
median market cap might not accurately reflect the fund's true investment style.
For this reason, Morningstar uses an alternate method for determining the median market cap of a
portfolio. We rank the companies in a portfolio from largest to smallest, and move down the list until
we reach the point at which half of the fund's assets are invested in larger companies and the remainder
is invested in smaller companies.
Setting the boundaries for investment style--the horizontal axis--is a bit more complicated. Two
commonly used methods to measure value (or lack thereof) are price/earnings ratios and price/book
ratios. However, if you group funds according to these ratios, you often get vastly different results.
One fund might have a "growth" strategy according to its P/E ratio, while its P/B ratio might point to a
value investment strategy. So instead of choosing between one or the other, we made the decision to
use both. And, because of continuous change in the market, we use relative ratios. For example, based
on the long-term averages of the stock market, a P/E ratio of 25 is somewhat high, but in comparison
with the current market, it's actually less than that of broad market indexes.
To determine a fund's investment style we divide its current P/E ratio by that of the S&P 500 and
divide its current P/B by that of the same benchmark. We then add those two numbers together. If the
resulting sum is less than 1.75, we consider the fund to have a value investment style. If the sum is
more than 2.25, we consider the fund to have a growth investment style. Anything between 1.75 and
2.25 is considered a "blend" style.
Here's how it works: Currently, the Oakmark fund has a median market cap of $14.7 billion, which
places it in the top row of our style box. And, based on its most-recent portfolio, it has a P/E ratio of
25.6 and a P/B ratio of 4.3. If we divide the fund's P/E ratio by that of the S&P 500, we get 0.91. Its
P/B ratio relative to the index is 0.64. If we add them together, we get 1.55, which represents a value
investment style:
We also produce a style box for fixed-income funds. Instead of market cap and valuation levels,
though, credit quality and interest-rate sensitivity are used to assign bond portfolios to one of nine
segments.
We introduced our style box in 1992, but we continued to categorize funds by their prospectus-stated
investment objectives. However, in 1995, we made the decision to replace the old prospectus-based
investment objectives with investment categories based on the way funds actually invest. For domestic
stock funds, these categories corresponded with the nine segments of our style box. Assigning funds to
these categories, though, is a bit more involved than using a fund's style box to determine its category.
That's because funds don't always land in the same area of the style box. A fund that is “mid-cap
growth” according to its current portfolio might be a large-cap growth fund with its next portfolio. Our
definitions are not arbitrary, but they are artificial, and some funds will not consistently land in the
same square with each of their portfolios. For some funds, this is the result of changes in investment
style, while for others, normal fluctuations in their portfolio are enough to bump the fund into a
different segment of the style box. For these reasons, funds are assigned to categories based on their
style boxes over the past three years. Once a category is assigned, a change in one subsequent portfolio
alone will not cause us to move it, but if the fund consistently shows up in a different area of the style
box, we will move it to the respective category.
So are all of our efforts worth it? The answer is a qualified yes. There is still variation within any
segment in the style box, but our style-based fund categories produce groupings of funds that have
more in common with each other than did the funds within the old prospectus-based investment
objectives. Moreover, some very clear risk and return patterns emerge when we look at the long-term
performance of funds by their style-box location. On average, funds in the three upper-left-hand
segments of the box have the mildest risk scores, funds in the center row have somewhat higher risk
scores, and the funds in the three lower-right-hand segments of the box have by far the highest risk
scores.
The style box doesn't tell the whole story, but when cooking up a portfolio, it's a good place to start.
The style box can help you size up the investment style of a fund, its risk and return potential, and how
it fits with the other funds in your portfolio.
Posted: 03-13-98
David Harrell is an editorial analyst for Morningstar.com. He can be reached at
dharrel@morningstar.net.