Behavioral Finance Strategy Report (Document)

Legacy Investment Fund

BEHAVIORAL FINANCE – CASE STUDY

LEGACY Investment Fund

Abstract

Founder CEO and family who control large equity in public listed companies act

differently and run their business in a more prudent way which can mitigate the excess

optimism and the risk taking of an employee CEO. Also, Founder CEO and family are

more conservative and have long term horizon view. We have selected a portfolio of

companies that belong to the Global Family Business Index (1) comprises the largest

500 family firms in the world.

Author(s):

Li-Kuan Fang (016008683D)

(With other co-authors)


Behavioral Finance

One Chinese quote says “Walls fall, friends leave. Rely on yourself.” This expression is

the philosophical backbone of our behavioral finance and investment view. Our belief is

that companies run by their founder’s CEO or owned by families with a significant

equity stake could outperform the market. Firms of that type are managed more

cautiously which can mitigate the “excessive optimism” of employee CEO who

destroyed shareholders due to this behavioral theory. Behavioral Finance has shown

that an employee CEO tends to be overoptimistic and this leads to high risk taking in

contrast to the founder’s CEO decisions that are more conservative and as result

founder CEO/ family firm can achieve better results. In fact, they tend to invest more in

R&D which can lead to better products. Furthermore, they are more focus in M&A, they

buy a company which is strategic and enhance the firm’s value. In addition, we strongly

believe that the interests of the shareholders and family businesses are more aligned

when it comes to stock performance because they own a significant equity stake and

therefore in this case the principal-agent problem is mitigated. Our initial assumptions

got validated by several academic papers on of them was written by Rüdiger

Fahlenbrach (2).

Investment Strategy

The investment strategy is to buy and hold worldwide public listed companies that are

managed by their founding CEOs and families who hold a significant equity stake. The

strategy is designed to outperform the MSCI World Index. We have selected a portfolio

of companies that belong to the Global Family Business Index (1) comprising the largest

500 family firms in the world. Global Family Business Index is composed by privately

and publicly held firms. We only chose publicly held firms from the index which are

classified as a family firm in case the family holds at least 32% of the voting rights.

Each stock we selected should be a key player in its region or worldwide and will be

equally weighted in the portfolio. We diversify our portfolio industry-wide and world-

wide, and replace those in which the CEO was not the founder-CEOs at the moment by

a new listed firm.


Historical Analysis

The portfolio is composed by a basket from 35 to 45 stocks through the time, choosing

stocks that match strategy selection criteria. The strategy was back-tested in order to

support the investment proposal, the time frame considered is from the 1st January

2007 to September 2016. During that period, we took in consideration portfolio

management activity to adjust the basket with new stocks: for example, some IPO

aligned with our assumptions have been added and deleted stocks in which

founder/CEO where not more related significantly in the firm or delisted. The decision

to take in consideration that specific period is based on future fund duration (8+2 years)

and on the opportunity to test if the strategy works even in downside market trend.

The empirical result of our strategy fund shows that in the past back-test the fund

performed mainly over the market: during market recession with a reasonable margin

above the market, but with an increasing outperform when world trend market is

positive. Thanks to their strictly connection between founder and management, the


stocks could outperform the benchmark. Indeed, over 9.75 years, the fund registered a

monthly based Beta with the market of 0.94 and an Annualized Alpha of 8,53%% with

significantly significance of 95% confident level. The final return of the fund over the

investment period is 9.74% Gross and 6.82% after fees and costs, whereas the VaR at

95% confidence level is 26.76% annually.

Fund Structure

1. Subscription Policy：Close fund. Accepting subscriptions during IPO only.

2. Duration：8～10 years, we have the right to extend the duration at the end of.

3. Redemption Policy：Redemption is blocked to the end of the duration of this

fund.

4. Management fee: 1,5% (Custodian, management, auditing, and accounting all

in)

5. Performance fee：

- By the high-water-mark approach, at the end of each year during the

duration, we charge 10% performance fee over the hurdle rate of 3,5%.

6. Minimum subscription during issuance：250.000 $

7. Minimum-Maximum amount raised: 5 Million $ - 250 Million $

8. Minimum asset invested：75% of asset under management

Net PTF Gross PTF Index MXWO

Annualised Return over 9,75 Years

6,82% 9,74% 1,45%

VaR 95% - -26,76% -30,64%

C-VaR - -39,77% -40,04%

Average Annual Return - 11,48% 2,91%

Standard Deviation - 17,30% 16,74%

Alpha vs Index - 8,53% -

Beta vs Index - 0,94 -


9. Dividend Policy：No dividend

10. Reinvestment policy：Dividend reinvesting

11. Risk Disclosure：

FX Risk

Macro economy Risk

Political Risk

12. Investment Policy：

Asset allocation：

Cash ：2%, at least.

Equity：98%, at most.

Target markets: Listed stocks worldwide

13. FX hedging: No hedging

Sources

1: http://familybusinessindex.com/

2: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=606527

Founder-CEOs, Investment Decisions, and Stock Market Performance by Rüdiger

Fahlenbrach, Swiss Finance Institute


Appendix


Monthly data PTF IndexAverage Return 0,91% 0,24%Median 1,09% 0,29%Standard Deviation 4,99% 4,83%Kurtosis 1,98 1,74Skewness -0,58 -0,71Minimum -18,7% -19,0%Maximum 15,1% 10,9%Count Obs. 116 116

Coefficient Stat t p-valueAlpha 0,00684 3,55 0,00056Beta 0,94130 23,52 0,00000

R squared 0,8291Annualised Alpha 0,0853

Documents

Behavioral Finance Strategy Report (Document)