Nov. 18, 2008

Students beat market managing $14 million Cayuga Fund

At Cornell, students can learn to appreciate wine, build robots and even raise livestock in the tropics. But only a select few get to handle $14 million of other people's money.

Between 40 and 50 investors, primarily Cornell alumni, have entrusted a group of second-year Johnson School MBA students with about $14 million to run the 10-year-old Cayuga Fund, the school's student-managed hedge fund. Besides the obvious goal of making money, the Cayuga Fund's educational objective is to train students to become asset managers -- the ultimate exercise of putting theory into practice.

The students work on the fund during a yearlong course called Applied Portfolio Management, taught by Sanjeev Bhojraj, associate professor of accounting. Lakshmi Bhojraj -- who happens to be married to Sanjeev Bhojraj -- is the Cayuga Fund's co-director of operations, helping to manage the fund and directing all investor communications. This year's class of 32 students is the largest yet, and for the first time, the fund is using first-year students as analysts to assist the second-year portfolio managers.

The Cayuga Fund is a market-neutral equity hedge fund, meaning it does not follow the whims of the open market and consistently beats it. In 2007 the fund returned 5.95 percent to investors. While performance was down compared with previous years -- 14.2 percent in 2006 and 10.4 percent in 2005 -- the fund still managed to post a recovery in the fourth quarter, ahead of major market indices, according to the 2007 annual report.

The Cayuga Fund was not always so shielded from market volatility; from 1998 to 2002 it was an index-tracking fund, closely aligning with the S&P 500 stock index. Following the demise of the Internet bubble and then the Sept. 11, 2001, attacks, the school decided to go market neutral and reduce the swings, Bhojraj explained.

"If the market goes up 30 percent, we might be up only 10 or 15 percent," he said. "But if it's down 30 percent, we still want to be up, but maybe only 5 or 10 percent. We want to generate steady returns." The fund's performance is measured against the Hedge Fund Research Equity Hedge and Equity Market Neutral indices.

The students are divided into teams, and each team is responsible for one sector: energy stocks, semiconductor stocks or retail stocks, for example.

The buying and selling of stocks is whittled down through a multistage process. A proprietary quantitative screen takes about 3,000 stocks and runs them through a computer program that determines whether they might be over- or undervalued. This narrows the list down to about 500.

This list is broken down by the students' individual sectors, and each week, the groups must come up with a list of about four stocks that might be interesting to their classmates for buying or selling.

Sasha Kaganas '09 and Filippo Petti '09 are co-portfolio managers of the health care group, consisting of about 15 stocks. They watch their stocks while keeping a finger on the pulse of health care stocks in general.

"Essentially the idea is that you have stocks in the fund, and you buy them and sell them based on what you think is going to happen to the price," Kaganas said.

When class meets every Monday and Wednesday, the students "pitch" stocks to their classmates, and as a group, they vote on whether to buy or sell. A two-thirds majority rules for any move in the fund.

The students spend most of their time determining whether to buy long, i.e., buy stocks anticipating an increase in their value, or to sell short -- borrowing a stock to sell it in expectation of its price to drop.

"Half the battle is communicating well," Sanjeev Bhojraj noted. "They stand up and learn how to present, and how to hone down their idea to key details."

Even if the class decides to take action on a particular stock, it's not a done deal. The potential transaction is then put through a risk management process with a specialized student trader, supervised by Sanjeev Bhojraj.

The students meet in the Boas Trading Room, a classroom equipped with real-time news feeds and stock tickers, giving students access to such major market indices as the S&P 500 and the Dow Jones Industrial Average. The trading room is part of the Parker Center for Investment Research, which comprises the physical facility, the research that takes place there and the Cayuga Fund.