Da Vinci Code

Mutual Fund

Final Report
(November 2007)

Xu (Alex) Da Qi Zhang Yingzhi (Gina) Pan Xing (Cate) Yang Minh Le

Content
I) II) III) IV) V) VI) Introduction Retrospect of the Market Description of Trading Track Specific Stock Analysis Evaluate Portfolio Performance Conclusion

Part 1: Introduction
Da Vinci Code is a simulation mutual fund managed by Xu Da, Qi Zhang, Yingzhi Pan, Xing Yang and Min Leh. The fund seeks to achieve its investment objective by investing in financial instruments that have good liquidity, including common stocks and bonds. The investment consists primarily of common stocks in three parts, financial service, blue chip and high-tech. Our trading date is from September 4th to November 23th. The initial fund is $500,000.

Part 2: Retrospect of the Market

2.1 Macro Economy
The U.S. economy spurted in the third-quarter as new-house prices dropped the most since 1970 and jobless claims rose to a nine-month high. From the earlier period of this year, cheap credit had been fuelling the crazy housing booms. And the credit crunch started in August. The deterioration in collateralized debt obligation (CDO) and credit-default swaps enforced banks to announce big write-downs and caused drops of their stock prices. The collapse in subprime lending and turmoil in financial markets interact as both causes and effects to the continued decline of housing sector.

2.2 Financial Market

The United State Financial Market When the turmoil spread over the Wall Street, Federal Reserve took its actions to withstand the fallout of the market. The Sept. 18 decision by the Federal Open Market Committee to reduce its benchmark interest rate to 4.75 percent from 5.25 percent seemed to be positive news for the equity market. But it didnt successfully support the market and Fed cut its benchmark interest rate by another 25 basis points to 4.5 percent and signaled that its reluctant to lower borrowing costs further.

Chinese Financial Market Fund inflow into Hong Kong market was constantly strong as reflected by the strengthening of the Hong Kong dollars value against the US currency. Institutional investors were keeping chasing H-shares, such as China Mobile (CHL) and China Construction Bank (CCB). They expected that the local market will get a big boost from fund inflows from the mainland after Beijing gives its go signal for the individual investment scheme to start. In the event that Chinese authorities adopt additional tightening measures to rein in inflation, actions, such as a further increase in the reserve rate of banks, could have a mixed impact on mainland banks. China Mobile, PetroChina and China Oilfield Services went up remarkably. Other ADRs with China Concept were also hot in US after all those positive news came in to the market.

Part 3: Description of Trading Track

Our investment period can be divided up into 3 durations.
Graph 1: Historical Portfolio Values

First duration runs from the start of investing to around September 21. In this duration, we built up our position by buying stocks in financial market, real-estate, high-tech and bio-tech segment. We also used $100,000 to buy U.S Treasury Bond. It can be seen from the graph 1 that there was a big jump in return roughly before September 21. The event leading to this increase was that we bought stocks of China Eastern Airline (CEA) based on a rumor that Singapore Airline was going to do a merger with CEA. We bought the stock at $100/share and sold it when it was

$146/share. Although China National Airline committee later denied the truthfulness of this rumor, the huge increase in stock price resulted from the rumor was sufficient for us to make a considerable profit.
Graph 2: China Eastern Airlines (CEA)

The second duration started right after September 21 and lasted till around October 17. In this duration, we started to build up our position in Chinese stocks. We consecutively bought China Telecom, China Mobile and Petrol China. All of those stocks did fairly well in this duration since the policy of Chinese government, Gang Gu Zhi Tong Che, which caused a huge increase in Hong Kong stock market and subsequently led to an increase in Chinese stock market. We also bought a new IPO stock called China Digital Television, and in two days, we gained about 50% in return.
Graph 3: China Digital TV Holding Co., Ltd (STV)

The last duration ran from October 18 to November 25. A lot of fluctuation of return can be observed during this time period. The overall market performance was unstable in this duration and the effect of credit crunch was still strong and affecting the whole market. We held a number of stocks such as Bear Sterns and

Countrywide in the financial segment, which really gave us a hard time. The other factor contributing to the loss in this duration was Petrol China, which dropped 30% since first we bought it. We did use momentum strategy to hedge away part of the loss created by stocks in financial market and Petrol China. We also bought Microsoft during this period, which turned out to be a very good buy considering it rose by 20% in two days (resulted from the increase in EPS stated on annual report.) Two days before the end of investment period, we used a margin of $60000 to buy Cninsure (CISG). This was the only time we used a margin in our entire trading. This trade was also base on momentum and it gave us more than 20% return.
Graph 4: Cninsure Inc. (CISG)

Part 4: Specific Stock Analysis

4.1 PetroChina (PTR)
PetroChina, China's largest oil producer, won permission for a share sale in Shanghai in Sep. 24. The company planed a sale of 4 billion shares at 16.7 RMB (2.25 per share), which was the world's biggest stock sale this year. The company was also listed in Hong Kong. After that PetroChina became the world's first company to be valued at $1 trillion.
Graph 5: Performance of PetroChina

However, with an open price at 48.60 (191% of issue price), the stock started to fell down from the first day listed. Till Nov.23, the stock price has fallen by 30% to 34.59 RMB per share. When this giant elephant slid off the market expectation, the other China Concept stocks followed.

4.2 Countrywide Financial Corp. (CFC)

As s leading mortgage service provider, Countywide tumbled when the subprime market collapsed. When their price went down, we lowered our position but instead of getting out, we choose to reduce our average cost by following the down turn on an expectation of future rebound.

Graph 6: Performance of Countrywide

4.3 Microsoft Corp. (MSFT)

Microsoft was put into the map because of the popularity of its main products in recent years, say Xbox 360 (released in 2005) and Windows Vista System. Several days before Microsofts earnings release, expectations of a high growth in their earnings spread. In Oct. 25, the company said their first-quarter earnings rose 23 percent, exceeding analysts' estimates, and raised its forecasts for this year on sales of the Vista and the video game. The stock price surged immediately to the highest level since 2002 and thus fuelled our fund solidly.
Graph 7: Performance of Microsoft

4.4 Exxon Mobil Corp.

Exxon Mobil was allocated in the portfolio as blue-chip stock. As the prices of natural resources were climbing, energy segment got strong. Besides that, the stock prices stability in recent year served as a positive control of risk. The company was also sorted as a high-dividend company, which provides expectation of dividend yield other than arbitrage benefits.
Graph 8: Performance of Exxon Mobil

Part 5: Evaluate Portfolio Performance

5.1 Investment Objective and Portfolios Normal Return

A. Objectives: Understanding what objectives we are looking for and assessing whether or not we follow these objectives are the first step in evaluating portfolio performance. After nearly three months, our portfolio performance is consistent with our objectives set up in the prospectus. Our fund seeks to achieve its investment objective by investing in financial instruments that have good liquidity, including common stocks and bonds. Specifically, its main composition is including common stocks (60% to 70%)

ranking from mid to large cap stocks. With these common stocks, we intended to invest about (1) 30% high-tech segments (bio-tech and pharmaceutical companies), (2) 40% of large cap and high quality stocks (from Dow Jones Industrial Average) and (3) 30% undervalued but promising stocks (financial services and real estate). Table 1 shows a snapshot of our portfolios final position, in which proportion of each type of stocks are conforming with our objectives.

TABLE 1: Snapshot on Our Portfolios Final Position

Final Position
BSC C CFC GS LEH Total Finance Service 18208 30700 17280 20745 17238 104171 15.0% Bond 109650 15.76% CHL GE PTR WMT XOM Total Blue Chip 49560 12185 93037 9006 42840 206628 29.7% Others 265200 (Except Margin) 25.64% INTC GSK MSFT WX GA Total High-Tech 11610 5019 32970 13752 33475 96826 13.9%

B-T169

CISG

B. Portfolios Normal Return: We are the leading group in the portfolio management by return (as at Nov 29 2007). We

started with the amount of capital 500,000 USD in

September 3rd 2007, our portfolio value is 695,627.79 USD as at Nov 29 2007 (actually we ended transaction in Nov 23rd 2007). With nearly 3 months return is 39.13 percent, we come the first ranking (over 30 groups) this year (see Table 1). Factor influencing the portfolios performance is

the enormous and intelligent efforts with total 141 transactions successfully conducted; roughly 3 trading transactions, on average, were made every day (excluding weekends and holidays).
TABLE 2: Snapshot is as of Previous Market Close on November 29, 2007

5.2 Evaluation of portfolio performance:

To assess our portfolio performance, we look at the portfolio performance on a relative basis. To do this, we compare our results to a relevant market index (S&P 500). We think that this index is the best reflection our goals (return and risk). Hence, we use this index as a baseline/benchmark to determine how well we did on a relative basis. A. Cumulated return: Cumulated return is one of the most common used measures to compute ongoing progression for a certain period. This return expresses an image of tendency for a whole period as well as for one point of time to another. In this paper, Figure 1 shows the portfolios daily cumulated return difference relative to the benchmark. At two first week period, our portfolios daily cumulated return was lower than that of the market. After that, our portfolio rose impressively over the market. In general, the markets daily cumulated return tended to be stable (just increasing 0.001 percent for 3 months), whereas that of the portfolio clearly went up to 0.56 percent daily. With this difference, our portfolio created an outstanding cumulated return of 36.56 percent.

Graph 1: Daily Cumulated Return

The above judgment is, to some extent, not fairly because market had different risk (see Table 3). Our portfolios risk was double than that of market (0.48 and 0.22 respectively). However, with the absolutely high of annualized cumulated return, we can conclude that we did derive an average return higher than the market. This achievement can be obtained either through superior timing or superior security selection. We did select high beta securities during a time when we thinks the market will perform well and low (or negative) beta stocks at a time when we thinks the market will perform poorly.
TABLE 3: Annualized Return and Risk

PORTFOLIO Annualized Return Annualized SD 641.25% 0.48

S&P 500 0.274% 0.22

B. Measuring risk-adjusted performance: Due to the fact that some portfolio evaluation techniques measure for one requirement (return or risk separately), we need to look at portfolio performance measures that combine risk and return into ONE single value.

Alternative portfolio return To make an alternative portfolio with the same risk level of the market, we combine our securities and a risk free asset (assumption that Rf equal 5% per year), with the weigh investing in our securities is 45 percent. For the alternative portfolio, its annualized return is 293.17 percent (see Table 4), much higher than that of market (0.274 percent in Table 3).
TABLE 4: Risk Adjusted Measures

RISK ADJUSTED MEASURES Weight Return of Portfolio* M-square Sharpe Ratio Treynor Measure Jens. Alpha Info Ratio 0.45 293.17% 292.90% 13.18 22.43 6.38 254.89

M-squared return M-squared return is a measure to help to compare return that has been adjusted for risk. We do this to put the portfolio and the benchmark (market) on the same risk basis before we compare return. We compare our portfolios M-squared return to the benchmark return. If the M-squared higher than the benchmark, our portfolio has a positive risk-adjusted return. In our portfolio, M-squared is 2.929 (see Table 4). Hence, we can say that our portfolio did better than the market. Treynor Portfolio Performance Measure Treynor ratio measures returns earned in excess of that which could have been earned on a riskless investment per each unit of market risk. In other words, the Treynor ratio is a risk-adjusted measure of return based on systematic risk. It is similar to the Sharpe ratio, with the difference being that the Treynor ratio uses

beta as the measurement of volatility. A larger Treynor ratio indicates a better portfolio. All risk averse investors would want to maximize this value.

For our portfolio, its Treynor ratio is 22.42. This number is very huge. To prove how big this ratio is, in this section, we compute the markets Treynor ratio by subtracting Rf from S&P 500s annualized return then dividing by beta of the market (which is equal to 1). Then, we have markets Treynor ratio is - 0.0471. This result shows that the S&P 500 did not even beat-the-bond and that our portfolio defeated the market. Sharpe ratio Sharpe ratio is a measure of the excess return (or Risk Premium) per unit of risk. It is used to characterize how well the return of an asset compensates the investor for the risk taken. When comparing two assets each with the expected return against the same benchmark with return Rf, the asset with the higher Sharpe ratio gives more return for the same risk. Investors are often advised to pick investments with high Sharpe ratios. Our portfolios Sharpe ratio over the holding period was 13.18 (see Table 4) while that of S&P 500 was -.222. This result shows that our portfolio made a bigger risk premium per unit of risk than the market did. Jensens alpha Jensens alpha quantifies the extent to which an investment has added value relative to a benchmark. This alpha is equal to the Investments average return in excess of the risk free rate minus the Beta times the Benchmarks average return in excess of the risk free rate. The basic idea is that to analyze the performance of an investment manager we must look not only at the overall return of a portfolio, but also at the risk of that portfolio. Using Jensens Alpha, we find out evidence of our portfolio superior performance. Its alpha is 6.38, this means that our portfolio is earning excess return. In other words, we have beat the market with our stock picking skills.

Markets Treynor ratio = (0.274% - 5%)/1 = - 0.047

2 Markets Sharpe ratio =

(0.274%-5%)/21.87% = -.22

Information Ratio The Information Ratio measures the excess return divided by the amount of risk. Excess return is the amount of performance over or under a given benchmark index. Thus, excess return can be positive or negative (comparing the annualized returns of the Fund/Portfolio in question with those of a selected benchmark). Our portfolios information ratio is 254.89 (see Table 4). This number means that our portfolios risk-adjusted excess return over the market is 254.89 times. Based on above analysis, we are proud to confirm that we have beat the market due to: 1) Our ability to derive above average returns for a given risk class (large risk-adjusted returns). This ability can be achieved either through superior timing or superior security selection. We can select high beta securities during a time when we think the market will perform well and low (or negative) beta stocks at a time when we think the market will perform poorly. 2) Our ability to completely diversify the portfolio to eliminate all unsystematic risk. A completely diversified portfolio correlated perfectly with the completely diversified market portfolio because both include only systematic risk.

Part 6: Conclusion
Our investments are primarily done according to what we planned in our prospectus. We did decrease the total position invested in stocks in financial service and high-tech segment since both segments performed poorly during the investment period. Our profits mainly come from two parts. First of all, during early investing period, the portfolio made a sound return due to the remarkable performance by high-tech stocks and Chinese stocks. We used momentum investing strategy and bought IPOs (mainly IPOs of Chinese stocks) using circulating fund we reserved. We bought those stocks on their first or second day of trading and were able to gain about 50% return in just two days. We also followed a strategy that is to buy stocks on the day when there is good news coming out and prices are increasing due to the good news. Momentum investing is certainly not a guarantee to winning. What we did that can be considered successful was that we used diversification and risk control. Catching opportunities when the market was good and controlling losses when market did not deliver gave us correspondent return to the risk we bore.

We also learned some tough lessons from investments we made. One is that we undermined the subprime mortgage crises. We thought that this storm should be gone by end of September. We bought a large number of shares in that segment and our underestimation of the severity of the crises made us lose a lot of money. In the end we had to reduce our position by selling. Secondly, we did not fully prepare for the fast change occurred in Chinese Stock Market. Our misjudgment on PetroChina (PTR) cost us almost 30% loss in return in the stock.