Boston University Undergraduate Finance & Investment Club Investment Policy Statement

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1 Boston University Undergraduate Finance & Investment Club Investment Policy Statement [Adapted from Scott D. Stewart s Training Student Equity Analysts and Utilizing their Recommendations in Active Portfolio Management ] Statement of Purpose: The Boston University Small-to-Mid Cap Investment Fund ( the Fund ) is a student-run equity portfolio designed to provide students with hands-on equity analysis and portfolio management experience. The portfolio is an absorbed part of the Boston University Undergraduate Finance & Investment Club ( the Club ) and serves as an experiential and practical application of the Club s curriculum as well as the broader undergraduate finance program at the School of Management. The Fund has been established to achieve several archetypal goals that support both the development of Club members as well as the development of the larger University. The Fund provides an expanded educational opportunity for its students while also enhancing career path & job placement within the investment management and other finance fields. The student managed Fund has also been established to raise the School of Management s overall and finance ranking amongst undergraduate business programs, enhancing admission recruiting and alumni satisfaction. Overall, however, the Fund is intended to generate alpha for its investors and stakeholders while being managed in every way like a professional money management firm. Club members will have the unique opportunity to acquire real-world investment management experience by formulating investment hypothesis, making investment pitches, taking investment action and evaluating the performance of these recommendations in the analysis of the larger portfolio. Management of the Fund is governed by Faculty & Technical Advisors ( the Advisors ), an Alumni Board ( the Board ), and the participating members of the Club. Investment Objectives and Philosophy: The Fund s investment philosophy focuses on the pursuit of investment opportunities in the Small-to-Mid Cap equity market. Since 1979, Small-Cap and Mid-Cap equities have provided returns of 11.23% and 13.09% and standard deviations of 20.12% and 17.34% respectively i. A Fund of this style we consider to provide an appropriate risk to return tradeoff versus large caps which have returned 11.28% and deviation of 15.54% in the same respective period. We define our initial investment universe as domestic equities with market capitalizations not to exceed $5 billion, considering any equity below $2 billion in market capitalization as Small-Cap.

2 The nature of the Fund s investments are growth focused on companies that typically exhibit simple business models. The Club considers companies of few business segments or significant dominance of a specific business line as a simple business model. The goal in this focus is to target companies that are easier to understand and value for students, while also having more limited Wall Street Research coverage to provide students the opportunity to add value with their research while differentiating themselves in potential interviews. The research approach is primarily targeted for bottom-up security selection, although in the individual sectors members are first taught industry analysis before employing the club s focus on fundamental security selection. The Fund employs fundamental trend analysis, trading multiple valuation, discounted cash flow valuation and risk management techniques through beta-targeting to pursue investment opportunities. Return Objective: The Fund s primary long-term objective is capital appreciation with a focus on generating annual alpha. The anticipated holding period for each security selected is twelve months, establishing a focus on long-term investment holdings and a risk neutral portfolio relative to a benchmark. Avoiding speculative, high beta stocks that do not provide an appropriate risk/return tradeoff for the Fund is one way we intend to maintain this focus. The Fund anticipates to closely follow and present findings on its return and risk versus the Russell 2000 Small Cap Index ( the Benchmark ). Risk Tolerance: Serving potentially as an extension of the Boston University Endowment, the Fund intends to limit its risk in relation to the Russell 2000 while also targeting capital appreciation. Measuring beta based on 5-year rolling weekly historical returns, we anticipate a beta within the range of 0.75 and 1.25 to the Benchmark while a beta constraint within the range of 0.5 to 1.5 to the overall market as measured by the S&P 500 Index. To achieve this goal, beta targeting within sectors and in individual security selection will be a focus, while the standard deviation of the fund s returns as well as within the seven established sectors will also be tracked by the Chief Risk Officer ( the CRO ). Using FactSet, the CRO will also track risk & return allocations on a weekly basis whether it be security-specific or sector specific risk. We expect to carry sector specific risk in our allocation of seven sectors versus the Benchmark, but intend to limit risk while driving returns in our fundamental security selection techniques. The Fund intends to use BARRA for forward looking analysis as well as utilizing Value-at-Risk (VaR) analytics. Investment Constraints: In performing fundamental bottom-up security selection, the Club targets a one year target price for its investment recommendations. As of fall 2013, the average holding period for securities has been about eighteen months, with some reinvesting and tapering of investment over the life of the holding based on market fluctuations and changes in price targets. In consideration of the fact that there are no withdrawal requirements for the Fund, liquidity is of limited importance. The Fund does not target a cash balance, although a small buffer at times may be suitable for the Fund to either re-invest or taper investments in specific securities at the outset of particular findings and news events. As long as a specific investment recommendation meets the initial investment criteria, the security will be purchased regardless of the specific business model. As an investment fund that operates using gift donations received, any returns are generated to benefit the reputation of the club and the University. Returns are not generated to benefit any member or office of the Club and further regulations surrounding this topic can be found in the Boston University Undergraduate Finance & Investment Club Code of Ethics and Standards of Professional Management ( the Ethics Policy ).

3 The Fund is the property of Boston University, and is therefore exempt from local, state and federal taxation. Although the Fund is a corporate brokerage account managed by the Club, by ownership it is subject to the charter and policies of Boston University as well as the Club s own Ethics Policy. Fund Organizational Structure & Hierarchy: The Fund is advised by a number of faculty and alumni while being managed by the student Investment Management Team ( the IM Team ) of the Club. The IM Team is responsible for making investment decisions by a hybrid majority voting system with innate checks & balances; enforcing our tag-line as a completely student managed fund. The IM Team is also responsible for sourcing potential investment decisions while constantly tracking the performance and news related to the current holdings of the Fund. The IM team is comprised of a select number of the Club s executive board ( the E-Board ), sector heads and investment associates. Faculty Advisor: The Club s Faculty Advisor provides supervision and control to the Fund s activities. The Advisor serves to advise and approve the Fund s strategic direction, organizational structure, ethics & regulations, strategic asset allocation while overseeing any tactical changes to the Fund. To assist the Advisor in his supervising role, the IM team provides a written one-page rationale summary whenever an investment action is to take place in order for appropriate record keeping. In addition to these roles, the Advisor is the common contact person for third party vendors and supports the development and training of the Fund s management team. Technical Advisor(s): The Club s Technical Advisor(s) are faculty who leverage their past experiences to provide professional advice on the technicalities associated with portfolio management and equity selection. Technical Advisor(s) are a source of advice regarding risk measurement, analysis and enforcement for the Chief Risk Officer. Advisor(s) may also lend themselves towards the equity security selection of the club by providing critiques on investment hypothesis, investment recommendation, valuation or generally anything related to the professional researching and selection of an equity security for inclusion into an investment fund. Alumni Advisory Board: The Alumni Advisory Board ( the Alumni Board ) is comprised of a handful of Boston University and Club alumni who have established careers in investment management. The primary role held by the Alumni Board is to act as a direct contact for Club E-Board members to reach out to regarding decisions such as strategic asset allocation, tracking of specific portfolio metrics, and identifying any investment strategy recommended that the Fund follow in the constraints of our established policies in this document. The Alumni Board is intended to be contacted as needed by the E-Board although it is the expectation to have semi-annual conference calls to track Fund performance and an annual in-person meeting to be held in late September each year at the Your Future in Finance Conference. President: The President is established to be an acting member on the IM team and is expected to participate actively in the Fund s activities as well as the weekly meetings. The larger responsibility of the President is to set the goals and long term vision of the Finance Club. Responsible for the organization, communication and execution of general meetings on a week to week basis as well as tracking the performance of each other member of the executive board. Handles the primary communication with administration and is responsible for making sure the club remains in good standing

4 with the UPO and SAO. Leads communication with faculty advisors and technical advisors; acting as the face of the club. Vice President Investment Management: The Vice President of Investment Management ( the VP of IM ) acts as one of the three members of the executive board s super majority. The VP of IM primarily oversees and directs the investment management division of the club, which consists of the investment management team and undergraduate investment fund. The VP of IM will also be responsible for assessing and critiquing investment recommendations from the investment research division. The VP of IM is responsible for communicating the performance of the portfolio to the rest of the Club while also having a working perception and knowledge of current markets. Chief Risk Officer: The Chief Risk Officer is responsible for the effective risk management and analysis of the Fund s strategic allocation, risk, returns and overall tracking error to the Benchmark. The CRO maintains a working spreadsheet to track returns on a weekly basis while also drafting the quarterly report to be sent to alumni and shared with all members of the club. The CRO works closest with the Club s faculty technical advisors on effective analysis while acting as the enforcer to ensure the appropriate following of this investment policy statement. Sector Head: The Club has seven sector heads and is a position typically carried by undergraduate seniors or members who have had at least 2-3 years of active club experience. Each sector head is allocated to a respective sector (Consumer, Energy, Healthcare, Industrials, Materials, Real Estate, and Telecommunications, Media & Technology). The primary role of a sector head is to act as a team of portfolio managers in maintaining accurate and complete coverage of existing investments and the market as a whole. Sector heads commonly influence decisions surrounding increasing or decreasing the size of investment positions and may present investment recommendations. In determining our strategic sector allocation, sector head coverage and research is intended to provide top-down sector analysis and overviews in their weekly meetings, to ensure that our exposures are appropriate on a fundamental basis. Investment Associate: Similar to the sector head position, investment associates are allocated across the Club s seven investable sectors (Consumer, Energy, Healthcare, Industrials, Materials, Real Estate, and Telecommunications, Media & Technology). Unlike the sector head position, there is no limit on the number of investment associates a sector can hold, as long as all sectors are represented. The investment associate s position is readily compared to a research associate in an investment management firm. They are responsible for the sourcing of new investment ideas through bottom-up security selection within their respective industries. Although investment associates may commonly work with each other, they are responsible for presenting a full investment recommendation (buy/hold/sell) and related research report on at least one equity security per semester. Investment associates are responsible for leveraging the fundamental analysis learned while participating on the Investment Research ( IR ) side of the club. Investment associates conduct fundamental equity analysis while also providing valid contributions in monitoring the sector and industry trends related to their recommendations and the current holdings of the Fund. Investment Management Security Selection Approval: The IM Team is comprised of a core investment committee ( the CIC ) and the super-majority ( the SM ). The CIC and SM are the only voting members of the IM Team and their interaction reflects the Club s diligence on establishing

5 strong internal controls in order to uphold a fiduciary duty to Boston University and the future stakeholders of the Club. Core Investment Committee & Super Majority: The CIC is comprised of seven sector heads; each allocated to a respective industry (Consumer, Energy, Healthcare, Industrials, Materials, Real Estate, and Telecommunications, Media & Technology). As the member of the club responsible for understanding the sector as well as the conditions currently affecting that sector. These members not only provide seniority in decision-making but also a level of understanding and complexion. The SM is comprised of three leading members of the Club s E-Board: President, Vice President of Investment Management and Chief Risk Officer. Weekly Investment Management Meeting Voting Process: The Fund holds weekly meetings of the IM team where investments are pitched and critiqued in a team setting. After a member of the club has made an official investment pitch (to the qualifications outlined in Finance Club Analyst Guide Book ) the team then holds an official vote on whether action should be taken. For a vote to be binding (and therefore an investment action taken as a result) at least five members of the CIC and two members of the SM must be in attendance ( Quorum ). Once a Quorum is achieved, the VP of IM facilitates the democratic voting process amongst the CIC first. If the investment recommendation reaches a simple majority in the CIC, the decision to take action on the pitch is then passed to a democratic voting process in the SM. Again, for the investment decision to be upheld a simple majority must also be made in the SM. Voting Criteria Recommended: Members of the CIC and SM are encouraged to vote to commit the investment action if the recommendation meets the following criteria: 1. That the voting member has a firm understanding of the potential investment s fundamentals and the dynamics of the industry to which they are exposed, 2. That the recommendation provides an in-depth look at the risks the company will be subjected to over the life of the investment holding period; 3. That the recommendation includes convincing evidence that the potential investment will outperform its peers and provide an alpha generating opportunity for the Fund; 4. That there is clear reason and believability to the projections and valuation presented of the equity; 5. That there is no reason to question the integrity of the potential investment s management team; AND 6. That the recommendation presents an advantageous risk / reward proposition for the portfolio in its ability to follow the guide lines outlined in this document while also potentially generating alpha contra the Russell 2000 Small Cap Index Implementation of Investment Decision: If a quorum majority has been reached on both accounts, the CIC and SM then engage in debate surrounding the amount to invest in the particular security and also the timing of actually purchasing the investment. The final decision on the size of the investment and timing is the responsibility of the Chief Risk Officer. Once the debate has transpired into a selected amount and timing for the investment, the VP of IM and Club member who made the investment pitch are then responsible for drafting a one-page summary to be forwarded to the Faculty Advisor along with the official buy/sell instructions.

6 If a majority for both votes has not been reached, the investment recommendation is rejected. If it is the first time presenting the investment recommendation to a quorum of the IM team, the Club member is allowed to field feedback and make edits to the recommendation to be presented a second time (in brief) in the following week s meeting. After this pitch is made for a second time, the investment recommendation is then put into a second round of voting with the same process as outlined before. The actual members between the two recommendations are allowed to be different as long as a quorum is still reached. If the investment recommendation is again unable to reach the conditions of majority and super majority then the investment recommendation is rejected and will not be revisited unless significant, material events have occurred to the security that would prompt a revised valuation or recommendation. Once the Faculty Advisor receives the one-page summary from the VP of IM as well as the recommendation for number of shares and timing, he or she will execute the trade for the portfolio. The Faculty Advisor can veto any investment recommendation without recourse. In the meantime, the Vice President of Operations will upload all relative materials and files to the Club s web site so that the recommendation and its performance can be publicly followed by any stakeholder in the Fund. Portfolio Composition: The Undergraduate Finance & Investment Club is organized into seven functional sectors: Consumer (both durable and discretionary), Energy, Healthcare, Industrials, Materials, Real Estate and TMT. As a small to mid-cap growth fund, we intend to allocate our investments across these sectors, focusing on fundamental analysis of given industries within each sector to provide top-tier security selection leading to an alpha generating proposal. Strategic Industry Allocation: As a Club that derives its skill in focusing on specific sectors, the fund intends to be equally weighted (~14-15% per each sector, of seven). The fund targets to hold twenty-five to thirty total separate equity securities across these industries with no maximum number of total securities held. No initial individual equity investment shall constitute more than 4% of the total portfolio. Portfolio Rebalancing: Portfolio rebalancing will be targeted on two different bases, the first being for individual equity securities and the second for strategic sector allocation. The Fund will also take an active role on managing the amount of cash or market index held on a similar basis. Rebalancing is intended to be considered at the end of each academic semester as well as at the end of the summer. The reason for this is because at the end of the semester(s) as well as the summer the club has a significant backlog of investment recommendations to be made. Also, the Fund intends to rebalance individual securities, followed then by sectors and followed up by cash rebalancing. Individual Security Rebalancing: An individual security will be allowed to appreciate and exceed a portfolio weight above 4%. If the security exceeds or reaches 6% of total Fund value, half of the investment will then be sold, pushing the security s weight down to 3% and the process restarts. With that said, we do intend for Sector Heads and Investment Associates to maintain coverage on securities and will make investment decisions based on fundamental changes in opinion. Additionally securities will be checked on a market capitalization basis at the end of each academic semester as well as at the end of the summer period. Should an equity be in excess of $5 billion in market cap, the Fund will then sell off the entire position in order to follow its guide line as a small-to-mid-cap equity Fund. Sector Rebalancing:

7 Individual sectors will also be regularly checked at the end of each academic semester as well as at the end of the summer period to ensure that each sector is within the 5% variance range of 15% total Fund holdings. Should an individual sector be allocated above 20% (>+5% target) that sector s holdings will need to be sold off down to 15%. This can be accomplished by either selling off an even amount of each security within that sector or by selecting the least attractive investments and overweighting the sell-off amongst these securities. This decision is to be made amongst the Super Majority (President, Vice President of Investment Management, and Chief Risk Officer) via a unanimous vote. At any time, a sector may be allowed to be significantly below the 15% exposure, as it is intended to hold an even amount yet that allocation may not be possible by fluctuations in expectations of sectors or an inability of the club to find an effective fundamentally attractive security. Cash Rebalancing: As an alpha-seeking investment vehicle, the Fund does not intend to hold a cash balance although acknowledges that naturally the levels of cash in the Fund may fluctuate in times of rapid investment decisions (commonly at the end of each semester). We recognize and believe that a cash balance is not optimal for the Fund, and as such we intend to invest excess cash balances passively into the Benchmark Russell 2000 index. Should the cash balance for the Fund exceed 5% of total portfolio holdings at a point of rebalancing (end of semester or summer), the Fund will passively invest the entire amount into the benchmark. This passive investment will be sold to accommodate for investment transactions once any cash balances accumulated have been exhausted. Additionally, any dividends received from a security will effectively be reinvested to protect from perpetually increasing cash balances. Risk Metrics & Portfolio Benchmarking: As established earlier in the Risk Tolerance section the Fund primarily manages risk through beta targeting and benchmarking against a comparable small to mid-cap equity index. The responsibilities of managing the risks is primarily led by the Chief Risk Officer although supported by the faculty technical advisors as well as the rest of the executive board. Beta Targeting: Fund beta is intended to be calculated using a 5-year rolling weekly historical returns. In addition, the Club intends to use BARRA to calculate projected beta. The Fund anticipates to hold a portfolio beta within the range of.75 to 1.25 to the Benchmark while a beta within the range of.5 to 1.5 to the overall market as measured by the S&P 500 Index. To accomplish this task, each investment recommendation when voted upon is intended to not only be considered on an isolated investment basis but also in consideration of how the investment affects the larger portfolio. Return & Risk Metrics: The Chief Risk Officer is responsible for tracking annualized total return, annualized return standard deviation, Sharpe ratio, tracking error and the Black-Treynor ratio. Also by leveraging FactSet s automatic portfolio tracking platform the CRO will run weekly allocation & distribution reports which will show which sectors and specific investments are driving returns as well as which sectors are fundamentally affecting the performance of the portfolio. Other fundamental metrics that will be tracked include Weighted Average Market Capitalization, Median Market Capitalization, Dividend Yield, P/E and active share. The Russell 2000 Index Benchmark: The Fund intends to target the Russell 2000 Index as the portfolio benchmark ( the Benchmark ). The Russell 2000 is classified as a small-cap equity market index with an average weighted market capitalization of $1.6 billion and no

8 holdings with market capitalizations above $5 billion. At a market capitalization of 10% of the Russell 3000 the Benchmark holds approximately 2000 of the smallest securities based on a combination of market capitalization and current index membership. The Index is reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. i