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The undergraduate Student Managed Fund invests using a set of principles first espoused by Benjamin Graham and later modified and propagated by the principals of Berkshire Hathaway, Warren Buffett and Charles Munger. We evaluate our common stock investments in the same way one would evaluate the purchase of an entire business: by looking for understandable, well managed, and competitively advantaged businesses at prices well below their value to a private owner.
Each SMF manager is responsible for, but not limited to, finding suitable investments in two assigned industries. To carry out this investment philosophy, the SMF team focuses on risk in its various forms, including:
- Business Model Risk – the avoidance of unstable or uncompetitive business models.
- Balance Sheet Risk – the avoidance of companies with unsuitable leverage.
- Management Risk – the avoidance of poorly managed companies.
- Valuation Risk – the avoidance of companies selling at an inflated price in relation to a reasonable range of true business value.
- Obsolescence Risk – the avoidance of businesses with a product or service subject to rapid change or obsolescence.
- Aggregation Risk – the avoidance of a common stock portfolio with highly correlated business risks, i.e. a portfolio of companies subject to interest rate risk, similar investment risk, or commodity risk .
The SMF team seeks to build a portfolio of 10-15 businesses that, in addition to avoiding the above risks, possess substantial recurring free cash flow and sustainable competitive advantages over their competitors. Metrics such as free cash flow yield, return on capital, and debt/free cash flow are among the important barometers used to measure an investment’s value and risk profile.
Once a manager identifies an investment candidate, he or she brings that business to the SMF team to discuss its merits. After hearing the case, the managers point out various pros and cons to the investment case and decide whether the company is suitable or unsuitable for purchase. In many cases, the team simply decides that more information is necessary to decide, and the investigating manager is assigned this task. Once the team has substantially agreed that an investment avoids risk of permanent capital loss and has an attractive upside, the investment is made.