I.

Case background: Beta Management Group (Beta) a small investment management company operating in Boston, USA, was founded by CEO Sarah Wolfe in 1988. The company dealt with managing individuals with high-net worth assets with combined total assets worth $25 million. In early January 1991, Sarah was considering changing her strategy because of the pressure from the clients who accuse her conservative market strategy and the requirement for higher performance. II. Sarah Wolfe A. investment strategy She uses the market timing strategy, adjusting the market exposure according to the market performance, in order to increase return but with lower risks. Therefore, she choose Vanguards Index 500 Trust as her mainly invest target. Because the whole company depends on Sarahs investment strategy and she does all time consuming work by herself, also she has no strong team to support her compared with other financial institutions, it is good for her to choose this market timing strategy rather than complicated other strategies. Sarah has to increase some exposure to earn more profit and pick up some individual stocks instead of focusing on Index Funds, thereby meeting her clients need and adding value for them. B. new strategy The new strategy she has chosen is to put more attention on smaller stocks and invest more in equity. Due to the lack of team support, she cannot compete with large financial institutions who has experienced analysts and traders, what she can do is focusing the smaller stocks they ignored in order to avoid competition with them. However, the higher exposure to equity market and smaller stock chosen will increase the portfolio overall risks. Higher risks will cause the profit higher and losses worse.

C. contrarian investor Sarah is a contrarian investor. In 1990, she invested larger amount of her funds into the market during a down market, indicating she invested when people were losing confidence and the market is pessimistic. In addition, in her new strategy, Sarah wants to invest into the two down run stocks California R.E.I.T. and Brown Group, Inc., also showing she is a contrarian investor who invests the down moving market.

III. Background of California R.E.I.T. and Brown Group, Inc. a. Core business and risk factors California REIT (CalREIT) a real estate investment company who mainly invested in retail buildings and the area is Arizona as well as California. The World series earthquake attacks the real estate market and damages its business in that time. Brown Group (Brown) the largest manufacturing and retailers of branded footwear had been undergoing a major restructuring program since 1989. It has many brand names and maintained stable cash flow as well as earnings, though it suffered a lot in 1989. b. Stock performance The stock price of California REIT (CalREIT) suffered a big loss in 1989, only three months positive and stayed low in 1990, the closed price is $2.25 on January 4, 1991. The share price of Brown Group (Brown) is more variable and sensitive to the market movement, and it had a big drop in late 1989 and 1990, the closed price on January 4, 1991 is $24. IV. Return and risk A. average return and the standard deviation of the two stocks in1989 and 1990

Figure 1:average return and the standard deviation of the two stocks in1989 and 1990
10.00% 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% Mean St Dev CalREIT -2.27% 9.23% Brown -0.67% 8.17% SP500 1.10% 4.61% Mean St Dev

The mean return and standard deviation have been calculated in Figure 1. S&P 500 has a positive mean return, while CalREIT and Brown have negative number and their volatility are higher than S&P 500. Figure 2: - Correlation Coefficient SP500 SP500 CalREIT Brown 1 0.07353166 0.65616977 1 0.16387655 1 CalREIT Brown

The correlation coefficient in Figure 2 shows that Brown has more positive relationship with S&P 500 than CalREIT does. In terms of risk, CalREIT has higher standard deviation, and lower average return, indicating it is more risky than Brown. B. standard deviations of portfolios SPC, SPB and SPF

Figure 3: standard deviations of portfolios SPC, SPB and SPF

4.620% 4.610% 4.600% 4.590% 4.580% 4.570% 4.560% 4.550% 4.540% 4.530% St Dev

St Dev

SPC 4.568%

SPB 4.614%

SPF 4.560%

Assume SPC = 99% invested in the S&P index fund and 1% in California R.E.I.T. ,SPB = 99% in the S&P index fund and 1% in Brown Group, and portfolio (SPF) with 99% in the S&P index and 1% in a riskfree asset. The standard deviation of three portfolios has been calculated in Figure 3. The incremental risks of SPC and SPB over a portfolio (SPF) are provided in Figure 4.

Figure 4: incremental risks of SPC and SPB over a portfolio (SPF)

0.060% 0.050% 0.040% 0.030% 0.020% 0.010% 0.000% Increasment SPC 0.008% SPB 0.054% Increasment

As can be seen from Figure 4, Brown increase more risk compared with CalREIT due to its higher correlation with S&P 500 and the risk cannot be diversified properly by investing in Brown. As mentioned in III, Browns share price is sensitive to market

movement, so it is not wise to add Brown into the portfolio. In conclusion, when majority of the portfolio is S&P 500, investing Brown would be more risky.

C. the coefficient of the index returns for each stock Figure 5: the coefficient of the index return for each stock
1.400 1.200 1.000 0.800 0.600 0.400 0.200 0.000 Beta CalREIT 0.147 Brown 1.163 Beta

The coefficient of the index return for each stock is provided in Figure 5. The higher beta of Brown indicates it has more risk than CalREIT, which is consistent with the conclusion in part b.

D. expression for the excess returns The expression for the excess returns for each unit of the incremental risk of California R.E.I.T. and Brown Group would be as followed: Sharp ratio measures the excess return per incremental risk

And

The sharp ratio depends on the risk and expected return of individual stocks.

V. What we learnt Combining stocks with low correlation with one another can reduce the risk of a portfolio

Risk can be diversified by capital allocation between risky assets and risk free assets.

Potential higher returns can be achieved by combining individual stock to a portfolio by allocating the right amount of capital Following an Index fund is low-risk whilst investing in individual stocks have higher risk