Darden Capital Management the Monticello Fund

The investment strategy of the Monticello Fund was to use fundamental analysis to identify and invest in companies that were well-positioned for growth but inexpensively valued. The fund team looked for stocks that would generate above-normal returns over a one- to four-year horizon. Steve Majocha must formulate a strategy keeping the philosophy in mind.

The fund’s ultimate goal is to outperform the S&P 500 ie. generate higher returns than the benchmark, however the strategy can’t just be to pick stocks with the highest expected returns as shown in the exhibit. As returns are directly related with risks, the fund cannot invest in risky stocks which might wipe out the capital itself. Steve Majocha should formulate a strategy, which will consider both the risk and return of each stock.

The stocks which generate highest return at minimum risk must be selected to be the benchmark. This can be done by calculating the Beta adjusted Returns. Risk adjusted return is a measure to find how much return an investment will provide given the level of risk associated with it. It takes into account beta, a measure of the volatility or the market risk of an investment compared to the rest of the stock market. Steve Majocha should select stocks based on Beta adjusted Returns – ensuring maximum return at same level of risk. The calculations and selections can be seen in answer to part 3.

Below is the summary of important data given in the case for prospective investments:

Bond Rating Expected Return Beta Standard deviation Dividend Yield PE Safety Rating

Boise Cascade Ba2 10.80% 1.20 31.20% 1.80% 27.0 3

Boston Beer NA 8.20% 0.55 31.70% 0.00% 22.9 3

Micron Technologies B2 13.00% 1.70 76.20% 0.00% - 5

Mylan Labs NA 10.90% 0.70 39.40% 0.51% 18.9 3

New York Times A1 9.00% 0.90 25.80% 1.30% 23.1 2

Placer Dome Baa2 8.80% 0.40 43.25% 0.61% 28.3 3

Approach 1: Selection based on only expected return:

Expected Return

Micron Technologies 13.00%

Mylan Labs 10.90%

Boise Cascade 10.80%

New York Times 9.00%

Placer Dome 8.80%

Boston Beer 8.20%

As per this approach we should select Micron Technologies, Mylan Labs and Boise Cascade for investments. However this approach does not consider riskiness of individual stocks and suitability for the portfolio. For example Micron Technologies has the highest return but also has highest standard deviation, which makes it inherently risky for portfolio. So as a group we do not favor using this approach for stock selection.

Approach 2: Ratio of anticipated return / SD

Expected Return Standard deviation Ratio of anticipated return / SD

New York Times 9.00% 25.80% 0.35

Boise Cascade 10.80% 31.20% 0.35