Infovest21 Investor Focus:Endowments reassess portfolio construction and objectives

Tom Heck, treasurer of Ball State University, says all institutions, having gone through the past couple of years, are reassessing what portfolio construction will achieve their objective. “Up to a year ago, we were in different stages of following the Yale or Harvard model. Now we all are stepping back and assessing how much volatility we can tolerate in our spending and how that translates back to how much volatility we can tolerate in the portfolio. At the same time, how do we achieve the portfolio return required to achieve our long-term objective?”

Part of the answer is based on their assumptions about each asset class and the managers they can access. Heck points out that Yale can access very top-flight managers in any class which gives them a very different risk/return profile than the average endowment.

Heck says the trick in this environment is how to solve simultaneously multiple equations i.e. the return, risk, and governance equations for a successful portfolio.

Average endowment lost 18.7% in FY 2009
The average endowment lost 18.7% for the year ending June 30, 2009, according to a joint National Association of College And University Business Officers-Commonfund Institute report. The study was based on 842 US endowments, representing $306 billion in assets.

The surveyed endowments allocated 51% to alternatives, 18% to domestic equities, 14% to international equities, 13% to fixed income and 4% to short-term securities/cash/other.

Performance-wise, alternatives lost 17.8%. International equities dropped 27.6% while domestic equities retreated 25.5%. Fixed income returned 3% while short term securities/cash inched up 0.8% - the only two categories with positive results.

Smaller endowments outperformed larger ones for the first time in several years, largely due to their reliance on fixed income investments. The smallest endowments – those with less than $25 million – lost 16.8% in the last fiscal year. They had, on average, 13% in alternatives compared with 9% in 2008.

Those endowments with more than $1 billion had about 61% in alternatives. Of that amount, 40% was in hedge funds, 22% in private equity, 13% in private real estate, 12% in energy and natural resources, 8% in venture capital and 5% in distressed debt funds. The largest endowments lost 20.5% for the year.

Harvard, which lost 29.8%, had the largest drop among the 53 endowments with more than $1 billion. Yale followed closely with a 28.6% setback, resulting in its assets dropping to $16.3 billion.

Sampling of Select Endowment Returns FY 2009 (%)

Harvard -29.8
Yale -28.6
Stanford -26.0
George Washington Univ -21.2
Wellesley -17.0
Virginia Tech -14.0

Endowment Assets under management ($B)
Harvard 26.0
Yale 16.3
Stanford 12.6
George Washington Univ 0.9
Wellesley 1.3
Virginia Tech 0.5

Role in the operating budget
On average, the endowments spent 4.4% of their endowments on operating costs, up slightly from the prior year which was 4.3%. About 43% of the endowments said spending was up while 25% said it decreased and 28% cited no change.

Jonathan Hook, chief investment officer of Ohio State University, observes that people got caught on how much their university relied on the endowment performance. “Each school was a little bit different – some relied on their endowment for a lot of their operating budget and some relied a little. A lot of schools did not take that into account when they planned their asset allocation.”

Hook says their returns were not what they would have liked, but because the university was not reliant on the endowment for a large percentage of their operating budget, it was easier to work through.

Heck points out: “The Yale endowment is responsible for a significant portion of the university’s operating budget, where we at Ball State are not. When you are funding an operating budget, then you are dealing with a constraint in the volatility of spending, and your investments. We are a public institution, and our endowments fund scholarships, lectureships, and other university programs which enhance the university but do not “turn on the lights in the morning.” Our tolerance for volatility and spending is different from what theirs is, and would probably be reflected in a different portfolio construction.”

This situation has led endowments to think more holistically about coordinating their Treasurer/CFO office and endowment office, and how everything works in concert with each other, says Hook.

He believes a higher percentage in alternatives will generate better performance. A one-year time period is not an appropriate barometer in which to measure performance. “Hedge funds held up better than many other asset classes,” he said.

Just released issue of Infovest21Investor Focus: Endowments reassess portfolio construction and objectives
 Interviews with Tom Heck, Ball State University and Jonathan Hook, Ohio State University
 Quarterly Sentiment Survey: Managers
 Updates: Yale University, University of Sydney, University of Toronto Asset Mgt
 TUCS vs Nacubo
 Book Review: Michael Lewis’ The Big Short