Alpha-Beta Test Run Results

We have estimated the alpha-beta values for 51 mutual funds for 1-year (brown), 3-year (green), and 5-year (blue) ending 9/30/2006. Our estimated values are consistent with the published values at Morningstar, Yahoo, and Google. However, there were some values which were not the same as the published values due to different reference indexes other than S&P 500 were used for the published data. In our calculations, we use VFINX returns as the market returns. We believe this is a much better market index than the theoretical S&P 500 index.

We made three observations about this test run. First, our calculation methodology must be consistent with the methodology used by Morningstar since our estimated values for alpha and beta are consistent with the published values at Morningstar web site. We also checked our values with the published values at Google Finance. We have discovered the same consistency. So we believe that our data source and calculation methods are reliable.

Secondly, the 51- funds used in our test run have a wide range of alpha-beta values. The beta values range from 0.25 to 3.00 while alpha values range from -14 to +41. We believe these ranges cover a wide spectrum of data. So the alpha-beta values are not concentrated closely to its origin (alpha = 0 and beta = 1). There is a great possibility for someone to select overly under-valued or over-valued funds among the funds. We believe there is greater potential if all mutual funds are considered for this project.

Thirdly, the values of alpha and beta are not very stable over different time periods. The “best” funds (low beta with high alpha) are changing places among themselves. This may be the reason why some sector rotation funds can outperform the overall market for an extended period of time. This characteristic may be a good treasure place for swing traders to harvest the change tides of sectors or styles.

Our next project is to study the time series characteristics of alpha and beta value for a few selected funds.

David Swensen Asset Allocation Model

David Swensen is the Chief Investment Officer of Yale Endowment. Here are his investment recommendations for himself and others.

For investors unable to compete effectively in active management, Swensen recommended a generally passive approach of indexed funds with the following allocations:

• 30% domestic equities
• 15% foreign equities
• 05% emerging markets
• 20% real estate
• 15% traditional bonds
• 15% Treasury Inflation-Protected Securities (TIPS)

For those investors, investing should be boring—like watching grass growing. If they try to engage in active management on a casual basis, "they are bound to fail," he said. Swensen’s pioneering approach to alternative investing has contributed handsomely to Yale’s 20 years of 16 percent annualized returns. Yale’s current asset allocation is the following:

• 14% domestic equities
• 14% international equities
• 05% fixed income
• 25% absolute return
• 25% real estate
• 17% private equity

The 25% absolute return and the 17% private equity may not be available to average investors. However, the ETF markets are very creative now. New ETF funds are introduced every month. One may be able to find these alternative investment vehicles in the coming years.

Bill Schultheis Asset Allocation Model

PAUL B. FARRELL wrote an article about Bill Schultheis. He quoted Bill: "Wall Street's most common way is to diversify with stocks by industry sector; technology, health care, transportation, financials, energy and so forth. The result is a portfolio of primarily large-cap stocks that will, in the long run, move almost identical to the S&P 500 index."

Bill Schultheis is a strong advocate of modern portfolio theory: "A more prudent way to diversify is to identify the dimensions of the market that move dissimilar to the S&P 500 in the short run, and build a portfolio accordingly." And that means a decidedly different kind of asset allocation. Instead of focusing on industry sectors, the focus is shifted to include all stock categories including small-caps and international. Here's the simple asset allocation from Bill Schultheis using just seven Vanguard index funds:

(40%) Bond Market Index;
(10%) Standard & Poor's 500;
(10%) Large-Cap Value Index;
(10%) Small-Cap Index;
(10%) Small-Cap Value Index;
(10%) International Stock Index;
(10%) REIT Index.

At surface this allocation model looks simple, but it is one of the best asset allocation models out there. Removing or adding one fund to this model would make the portfolio worse off.

This model has one weakness. Without any sector funds in this portfolio would make this model a little bit weak in a sector driven market such as the technology bull market of the 1990s or the recent energy sector bull market in the recent years. However, by adding 10 sector funds to this portfolio would make the number of funds more than doubled. Then this would not be a simple asset allocation model.

Meeting with Zhen's Friends

Meeting Agenda

July 21, 2006 At Starbucks

1. Self-introduction (A few minutes each)

2. Zhen Zhao:
Brief introduction of our views of the problem or trend in current financial market

3. Chris Rao:
Brief explanation of our approach of investment (Optimal risk-adjusted return)

4. Exchange of ideas:
Are there any concerns or questions about our approach?
Is it so different from the Target Retirement Funds?
Can it be accepted by the industry?
Can such software solutions be beneficial to investment professionals?
How can this be applied?

5. Learning:
How is professional investment decision made for clients?
What is advisors’ view of the financial advisory market?

6. Discussion:
Is there any potential to adopt our software solutions for advisors’ needs?

7. Conclusions
Please give us other advices.

Self-Introduction of Hu Jizhi

Ladies, Gentlemen, and my respected Professors:

Good afternoon!

My name is Hu Jizhi. I am 18 years old. I come from the No.1 Middle School associated with CCNU (need to spell out the entire name) in Wuhan. I have spent my two great years there to study all the required subjects. I have discovered that I especially like to study Physics.

I believe that it is very important for me to acquire the basic skills of self-learning and independent thinking in my high school years. In junior high school, our learning in large degrees depends on our teacher’s teaching alone. In high school I have discovered that self-learning and independent thinking are becoming equally important compared with the teachings of our teachers. I spend a gradually increasing amount of my time in studying and learning by myself , such as reading books and doing exercises alone.

I have also discovered that discussions with my classmates are complementary to self-learning and learning from the teachers. We try to solve problems by ourselves without asking direct helps from our teachers. In this case, teachers are becoming leaders in learning. At the same time the teachers show us knowledge of learning and problem solving.

I believe that the ability of independent thinking is one of the great gifts for us human beings. It is one of the essential human characters, which differentiate us from other animals. By using this ability of independent thinking, I am learning to understand the world and to form my own understandings of the world.

While studying various subject matters, I have discovered that understanding the inter-relationships between different subjects can help me understand any one subject more easily. This process of understanding the inter-disciplinary knowledge among several subject matters have really helped me greatly in developing my self-learning skills.

For after school hours, I am interested in various sports activities such as basketball and badminton. I believe that playing sports games is necessary for me to keep my physical fitness. At the same time I can make friends and have a lot of fun by playing these sports games.

The above is a self-introduction for myself.

Thank you!

The above is written by Hu Shihua's son. He had a few email communications with me before he went to Fudan University. I received this one around January 2006.

Social Order Control and Deviance

Assignment 12, Chapter 9
Social Order, Social Control, and Social Deviance
By Chris Rao on 5/5/2006

(1) Social order is established through Culture and social structure. Cultural beliefs, values, and norms control people’s action. Culture act as the guiding path for people to act. This kind of guiding force is also called mechanical solidarity. Individuals are linked through families, groups, organizations. They follow the written and unwritten rules in the families, groups, and organizations. This kind of binding force in society is called organic solidarity. (2) Social order depends on working institutions. Institutions are established patterns for people to solve social problems. Education serves as a need for corporations and individuals. In one side, corporations need educated people. On the other side, most individuals need to compete for better jobs in corporations. Education as an institution put the needs of corporations and individuals together. If the education system works well, the society for workers and employers are happy. (3) Social order depends on socialization. Culture, structures, institutions are changing over time. These social patterns can not work by themselves. They can function because individuals are agents for these social patterns. Via individuals, the relationships between institutions can function on a continual basis. (4) Loyalty to organization is the foundation for social orders. Being faithful to family, groups and organization make these patterns stable. If individuals are not loyal to their families, groups, organizations, then these organizations can not function well. (5) Social controls contribute to social order. Parents tell kids what to do is a way of social control. Without this kind of controls, kids would not be able to develop well or survive well.

Social deviance is the behavior not within certain bounds of normal social behaviors. But these bounds can change over time. Gay marriage was a social deviance for a long time. Now, many states are accepted in many states.

Social deviance is created by people think the current social boundaries such as norms are not suited for their happiness. Prostitution is one of the old industries in the world. In most states prostitution is illegal. However, for some people, they may not have other ways to support their happiness such as making enough money to raise their kids. So the prostitution exists for as long as there are people who can not get their means of living in other professions.

Social Power

Assignment 11, Chapter 10, Social Power
By Chris Rao on 5/5/2006

There are three definitions of power. One is the potential power. The second one is actual power. The third one is exerted power.

Examples of these powers are seen in society. College students may have potential power because their education. Higher education is usually associated with higher income. A policeman may have actual power to give or not to give a ticket to a traffic violator. He has actual power because he can use it at his discretionary. United States has no legitimate power over China or Taiwan. But the US often exerts its superpower status in the world in these countries, telling them what to do.

We have learned three theories of Power. The first one is the pluralism. In this theory, power comes from the organization of people. In China Chairman Mao said that the political power comes from the barrel of guns. It has similar meaning. The second theory is the theory of power elite. Political power elites exchange their power with military elites and corporate elites. These elites often appear in the three circles inter-exchangeably. Many corporate executives are former government officials or military officers.

Meaning and Uses of Sociology

Assignment 8, Chapter 14, the Meaning and Uses of Sociology.
By Chris Rao on 5/5/2006

I think the five most important issues of sociology are: inequality, social power, culture, institutions, social deviance, and social change. Inequality is most apparent in society. Inequality is the original source for social power. I think the most critical role for institutions is to address the inequality issue. How institutions address the inequality issue determine whether a society can prosper. Culture is like levees holding the river in its course. Social deviance is like the breach of the levees. Only when the breach is big enough and makes the levees fail, the river can change its course. Gradual acceptance of social deviance makes the social changes.

Since I started learning sociology, I feel that I was rediscovering the world the second time. Two issues I am thinking about the most are inequality and social power. There are theories about inequality such as the just awards, social closure, and exploitation. Each theory gives me a different perspective to the same issue – inequality. I feel that inequality is the source of social balance. Without inequality, the society may not exist. If that society existed, it had to be very boring; nobody in this society would want to live in it. In military, inequality between soldiers and generals are required to have orders executed smoothly. If everyone is equal, then everyone should more or less do the same thing. Then everyone had to be a farmer, an engineer, and doctor, etc, at the same time. If everyone is self-sufficient, then the society would not need to be existed. Social power is like a mirror image of inequality. If every one were equal, there would be no power for any group over another group.

Inequality in Society

Assignment 10, Chapter 5, Inequality in Society.
By Chris Rao on 5/5/2006

Inequality exists in the United States. Inequality in income and wealth are the most observable facts. Most wealth is owned by a small percentage of rich people. Majority of people share a small portion of total wealth of the society. This income inequality makes me thinking there may be a linkage between nature and society. In nature, roughly speaking, 10 units of vegetation can sustain 1 unit of herbivore; 10 units of herbivore can sustain 1 unit of carnivore. In this way, 1 unit of carnivore needs 10 units of herbivore, which further needs 100 units of vegetation. This ratio in nature is similar to the ratio of society between the rich and poor. Inequality may have some unchangeable truth in it.

There are seven elements in social class: (1) class position is determine by income and wealth; (2) power is derived from class position; rich people have better access to resources; (3) class brings prestige; (4) Class brings privileges; (5) Class brings role expectation; (6) Class gives us identities; (7) Class determines our perspectives.

Class, race and gender structures are special social structures. (1) Individual is placed at birth to these structures. Individuals at birth have not choice to select their family. (2) Families are determined with these structures. Individuals inherit them without choices. (3) Family ties are critical for individual development. (4) Family has strong influence in individual’s life. (5) Institutions have vested interests in maintain the status quo for these structures. (6) These structures have long history. A rich family can be rich for many generations, like Fords, Rockefellers.

西安青岛和武汉大型企业

李立华去中国之前，让我给她找有关中国武汉西安和青岛的十大企业。以下是我在网上找到的特大企业名称。

西安市十六大重点企业名单：

1。西安飞机工业集团有限公司
2。陕西重型汽车有限责任公司 http://www.seastar.com.cn/
3。西安海星集团 http://www.seastar.com.cn/
4。 陕西鼓风机集团有限公司
5。西安电力机械制造公司
6。西安比亚迪汽车有限公司
7。陕西东盛集团有限公司
8。金花企业集团
9。中国石化西安分公司
10。陕西法士特齿轮有限公司
11。杨凌秦丰农业科技股份有限公司 http://www.chinaseed.net/
12。彩虹显示器件股份有限公司 http://www.iricoltd.com.cn/
13。西安标准工业股份有限公司 http://www.chinatypical.com/
14。西安旅游股份有限公司 http://www.xiantourismgroup.com/
15。西安民生股份有限公司 http://www.cnminsheng.com/
16。长安信息产业集团 http://www.changxin.com/

青岛十大企业集团
http://www.cnqd.net/qybl/

1.。海尔集团公司
2。青岛啤酒集团有限公司
3。海信集团有限公司
4。青岛澳柯玛集团总公司
5。颐中烟草(集团)有限公司
6。青岛钢铁控股集团有限责任公司
7。青岛凯联(集团)有限责任公司
8。青岛黄海橡胶集团有限责任公司
9。青岛双星集团公司
10。中国第一汽车集团青岛汽车厂

武汉大型企业集团

1。 湖北宜化化工股份有限公司 http://www.yihua.cn/
2。 武汉武商集团股份有限公司
3。 中国石化武汉凤凰股份有限公司
4。 猴王股份有限公司
5。 湖北沙隆达股份有限公司
6。 湖北金环股份有限公司
7。 湖北百科药业股份有限公司
8。 武汉塑料工业股份有限公司 http://www.wuhanplas.com.cn/
9。 中国石化武汉石油(集团)股份有限公司
10。 湖北天发股份有限公司
11。 襄阳汽车轴承股份有限公司
12。 湖北双环科技股份有限公司
13。 大冶特殊钢股份有限公司
14。 武汉中百集团股份有限公司
15。 湖北博盈投资股份有限公司
16。 武汉华信高新技术股份有限公司
17。 武汉中商集团股份有限公司
18。 湖北京山轻工机械股份有限公司
19。 国投资源发展股份有限公司
20。 江汉石油钻头股份有限公司
21。 湖北三环股份有限公司
22。 湖北福星科技股份有限公司
23。 武汉凯迪电力股份有限公司
24。 湖北广济药业股份有限公司
25。 湖北长源电力发展股份有限公司
26。 湖北迈亚股份有限公司
27。 华工科技产业股份有限公司
28。 武汉钢铁股份有限公司
29。 东风汽车股份有限公司
30。 葛洲坝股份有限公司
31。 武汉人福高科技产业股份有限公司
32。 湖北多佳股份有限公司
33。 湖北美尔雅股份有限公司
34。 武汉东湖高新集团股份有限公司
35。 武汉道博股份有限公司
36。 湖北省兴发化工集团股份有限公司
37。 武汉三镇实业控股股份有限公司
38。 湖北新华光信息材料股份有限公司
39。 湖北省凯乐新材料科技股份有限公司
40。 湖北武昌鱼股份有限公司
41。 湖北省三峡新型建材股份有限公司
42。 湖北安琪酵母股份有限公司
43。 武汉长江通信产业集团股份有限公司
44。 武汉精伦电子股份有限公司
45。 烽火通信科技股份有限公司
46。 湖北洪城通用机械股份有限公司
47。 湖北潜江制药股份有限公司
48。 万鸿集团股份有限公司
49。 湖北天颐科技股份有限公司
50。 湖北江湖生态农业股份有限公司
51。 湖北幸福实业股份有限公司
52。 湖北天华股份有限公司
53。 武汉祥龙电业股份有限公司
54。 武汉市汉商集团股份有限公司
55。 华新水泥股份有限公司
56。 长征火箭技术股份有限公司
57。 武汉力诺工业股份有限公司
58。 国投华靖电力控股股份有限公司
59。 湖北中航精机科技股份有限公司

On Price Quantity and Value

When I go grocery shopping, I have to deal with two things. One of them is Quantity. Another one of them is price. When economists talk about GDP, they have to deal with quantity and price. When rich people buy or sell gold, they have to know the quantity and price of gold. When investors buy stocks, they have to know the number of shares and the share price. In general, there is a fixed relationship between price, quantity, and value.

V = P * Q

Where V is value, Q is quantity, and P is price per unit of quantity.

The same equation is applicable in the cases of grocery shopping, GDP calculation, gold trading, and stock investing. However, there are some subtle characteristics about the quantity and price. Today I am going to explore this subtlety.

In the case of grocery shopping, the total quantity of food one family can consume over a specific period, say during a year, can be fairly stable. However, the total cost of the food consumption can vary widely depending one the price of food. The rate of change for the total quantity of food can be much smaller than the rate of change of price over the same period of time.

In the case of GDP estimation, since the total quantity of domestic products is impossible to determine accurately. So the Gross Domestic Product is usually just a total value number. Price change is determined independently. The change of quantity of domestic products is smaller than the change of price. So the economists call this extra-change in price as inflation.

In the case of gold trading, the total quantity of gold in the world changes less than 2% on an annual basis while the change of gold price can be as high as 100% per year. Gold price gyration over the past several years is an excellent example of the price change.

In trading stocks, the total outstanding shares of a company changes very little every year while the price movements of many stocks usually over 100% every year. One can almost find some stocks with daily price change over 50%.

From the above example, I can easily conclude that the price change over time is much faster than the quantity change over the same time. If this assumption is indeed true, then one can make some further conclusions.

Since the real values of grocery, gross domestic products, gold, and stocks are associated with quantity only, any extra-change in price will never last a very long time. The extra-change will reverse toward it real value. Investment gurus such as Warren Buffett call this real value as intrinsic value for stocks. Since the intrinsic value for any company would not change as rapidly as its stock price, so the over-price or under-price of stocks will reverse to its intrinsic value eventually.

Since the real value or intrinsic value is much less volatile than the price movements, one can win continuously if he can spot the differentials between the price and value. This is why investors always stress that one has to buy low and sell high.

Playing Golf

Recently, I get involved with golf. I have played twice already at Chase Oaks Golf Club with Zhen. Steve told me about Los Rios Country Club at a party. He paid about $20,000 for a lifetime membership for himself and his family. J told me that the City of Plano has its own golf course at Pecan Hollow Golf Course. Guangyan and Zhen both mentioned about Ridgeview Ranch Golf Club. The club membership fee at Ridgeview is $30 per month.

In order for practicing playing golf, J and I went to Wal-Mart to buy one golf club for practice. I was going to buy one #5 club. But I could not find the right one at Wal-Mart. J told me that Costco was selling a full set of club for less than $200. I thought that it was better to buy the full set. But when we arrived at Costco, we found out that the club set cost almost $300. We bought it anyway. It is a Nicklaus club set. Later I found out from Zhen that the club set was fine for beginners. Actually, there are golf classes at the community college. I am going to take these classes to get some formal training starting around January 18, 2007. Now I guess I am going to play golf.

I googled the golf clubs they mentioned to me, I found the following the golf club information.

Chase Oaks Golf Club (Municipal)
7201 Chase Oaks Boulevard, Plano, TX 75025
Phone: 972-517-7777
http://www.chaseoaks.com/

Hank Haney Golf Ranch (School)
4101 Custer Road
McKinney, TX 75070
Tel: 1-972-542-8800
Dallas: (972)-529-2221

Los Rios Country Club (Semi-Private)
1700 Country Club Drive, Plano, TX 75074
Phone: 972.422.8068, Tee Time Reservations: 972.424.8913
http://www.losrioscountryclub.com/

Pecan Hollow Golf Course (Municipal)
4501 East 14th Street, Plano, TX 75074
Phone: 972-941-7600
http://www.pecanhollowgc.com/

Ridgeview Ranch Golf Club (Public)
2701 Ridgeview Drive,Plano, TX 75025
Phone: 972-390-1039

WestRidge Golf Course (added in April 2007)
9055 Cotton Ridge Road North, McKinney, TX 75070
Phone: (972) 346 - 2212
http://www.westridgegolfcourse.com/
I like Westridge Golf Course very much. I played at this course with Brian, his son, and Professor Li. This is the best course I have played so far. The course is very wide (compared with Ridgeview Ranch or Chase Oaks). I just had one out-of-bound golf ball for the entire game. I achieved 98 strokes at my first play in this course.

Sample Funds to Study Alpha-Beta Matrix

By today, Zhen has completed the first part of data preparation calculations. Now we need to test some real mutual fund data in order to derive our understandings of the scope of Alpha-Beta Matrix. First, let’s study the equity style funds and sector funds first. Stlyle and Sector funds are used often to construct diversified portfolios.

We are going to select 27 style funds, 18 sectors funds, and 5 real estate funds in our first test. Three funds are selected for each style and two funds are chosen for each sector. We use five real estate funds in this test. So we have a total of 50 sample funds, or about 1% of the mutual fund universe.

Some of the factors considered in selecting funds are fund size versus fund family, index versus actively managed fund, and management fees. Based on these factors, we selected the following 27 style funds in nine styles.

(1) Large cap growth
a. FCNTX – Fidelity Contra fund
b. JANSX – Janus Fund
c. VIGRX –Vanguard Growth Index
(2) Large cap blend
a. VFINX –Vanguard 500 Index
b. FMAGX – Fidelity Magellan Fund
c. JSVAX – Janus Contrarian Fund
(3) Large cap value
a. DODGX – Dodge & Cox Stock
b. FEQIX – Fidelity Equity Income Fund
c. VWNDX – Vanguard Winsor
(4) Mid-cap growth
a. RPMGX – T. Rowe Price Mid-cap Growth
b. FDEGX – Fidelity Aggressive Growth
c. JAENX – Janus Enterprise
(5) Mid-cap blend
a. FLPSX – Fidelity Low Price Stock Fund
b. VSEQX – Vanguard Strategic Equity
c. VIMSX – Vanguard Mid-cap Index
(6) Mid-cap value
a. FDVLX – Fidelity Value Fund
b. JMCVX – Janus Mid-cap Value
c. VASVX – Vanguard Selected Value
(7) Small cap growth
a. BGRFX – Baron Growth
b. JAVTX – Janus Venture
c. VISGX – Vanguard Small Growth Index
(8) Small cap blend
a. NAESX – Vanguard Small Cap Index
b. FSLCX – Fidelity Small Cap Stock
c. DISSX – Dreyfus Small Cap Index
(9) Small cap value
a. RYTRX – Royce Total Return
b. VISVX – Vanguard Small Cap Value
c. JSCVX – Janus Small Cap Value

We have selected 18 sector funds in nine sectors.

(1) Consumer goods
a. FDFAX – Fidelity Select Consumer Staples
b. ICLEX – Icon Leisure & Consumer Staples
(2) Consumer Services
a. FSCPX – Fidelity Select Consumer Discretionary
b. ICCCX – Icon Consumer Discretionary
(3) Energy
a. FSENX – Fidelity Select Energy
b. VGENX – Vanguard Energy
(4) Financial
a. FIDSX – Fidelity Select Financials
b. FSFSX – AIM Financials
(5) Health care
a. FSPHX – Fidelity Select Health Care
b. VGHCX – Vanguard Health Care
(6) Industrial
a. FCYIX – Fidelity Select Industrials
b. ICTRX – Icon Industrials
(7) Materials
a. FSAGX – Fidelity Select Gold
b. VGPMX – Vanguard Precious Metals
(8) Technology
a. FSPTX – Fidelity Select Technology
b. JAGTX – Janus Global Technology
(9) Utilities
a. FIUIX – Fidelity Utilities
b. BULIX – American Century Utilities

The Five Real Estate Funds selected are listed below.

(1) FRESX – Fidelity Real Estate Fund
(2) VGSIX – Vanguard REIT Index
(3) CSRSX – Cohen & Steers Realty Shares
(4) REACX – American Century Real Estate
(5) AIGYX – Alpine Realty Income & Growth

Base Periods for Calculating Returns

Daily Data is usually available for stocks or mutual funds. Stock data is available in five columns: Open, High, Low, Close, and Adjusted Close at Yahoo Finance. Mutual fund data is available for daily close and adjusted daily close.

Weekly data is available on the first trading date of the week. Monthly Data is available on the first trading date of each month.

Daily Return is calculated based on the daily data.

Weekly Return has two ways. One is based on consecutive 5 trading days. This is used to calculate long-term time series (several years). Another one is based on the calendar week from Monday through Friday. This is used to calculate short-term time series (usually less than one year).

Monthly Return is calculated for each Calendar month, such as January, February, etc.

Quarterly Return is calculated for each Calendar quarter, such as 1st Quarter, 2nd Quarter, etc.

Annual Return is based on the Calendar year, such as 2001, 2002, 2003, etc.

YTD (year-to-date) return is calculated as the total return up to the current date of concern. The rate is not annualized usually.