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Thursday, September 24, 2009

Is This Anyway to Pick A Mutual Fund ?

from the tech ticker website
my comments in italics at the end

Top Ranked Fund Manager Finds Ways to Beat the Market
Posted Sep 23, 2009 11:19am EDT by Peter Gorenstein in Investing

With the S&P 500 rallying sharply off the March lows, the key is not to, "get swept away by some of these momentum stocks and stocks that have been moving because those could turn around and end up burning people," say Bob Auer, portfolio manager of the Auer Growth Fund.

Auer preaches investor discipline and has a keen eye for fundamentals.

Thanks to his stock picking strategy the fund gained 31% in the second quarter and Lipper ranked it the #1 multi-cap growth fund over that same period....

A little bit of research shows that the fund started in December 2007 and lost 53.27% in 2008.The one year performance of -31.79 is 18% worse than the S+P 500. It has assets under management of under $150 million, many registered investment advisors have more assets under management. The management fee is 1.95% (!).

But that didn't stop other hot money chasers like Smart Money and The (Cramer vs Fund Manager video)to feature this manager.

After all this year he is outperforming the S+P 500 by 16% (after underperforming by 18% last year), Isn't that a good reason for investing in this fund ?

It Seems Like Many Not for Profits Were Pretty Creative on The Liability Side of The Balance Sheet as Well...

... and the results weren't too pretty. It seems that in addition to riskier strategies on the asset (investment) side, not for profits of all types were making use of aggressive liability management strategies and were very "good" customers of Wall Street's more creative bankers. Could it be possible that these universities with stars in their eyes and expectations of double digit returns on their assets were confident that those gains would more than offset the 4.5% interest on their new liabilities. And could it be that they were encouraged to adopt that strategy based on presentations from the investment banks ready to underwrite those bonds and sell the interest rate swaps ?

From the NYT today (my bolds and italics)

September 24, 2009
Nonprofits Paying Price for Gamble on Finances

Homeowners and businesses were not alone in taking on piles of debt over the last decade. Nonprofits of all sizes did the same, and now they, too, are paying the price.

Far from being conservative stewards of their assets, many nonprofits engaged in what some experts call risky financial behavior. “They did auction-rate securities, interest-rate arbitrage, complex swaps — which backfired on them the same way it would backfire on any hedge fund or asset manager,” said Clara Miller, chief executive of the Nonprofit Finance Fund, which has experienced a huge increase in organizations turning to it for assistance with soured bonds. “Organizations got to be all fancy-pants with their financial management.”

Those struggling now include the full range of nonprofits, including museums, colleges, orchestras and small local social service providers.

For example, Brandeis University, with $208 million in tax-exempt bonds outstanding, plans to close its art museum and sell off the collection to raise money. The Orange County Performing Arts Center, with $265 million in bonds, has laid off staff members. Copia, a culinary center in Napa, Calif., went bankrupt in December with $78 million in bond-related debt that its lawyer blames for its failure.

Even Harvard, with some $2.5 billion in tax-exempt bonds at the end of fiscal 2007, and Yale, with $1.6 billion, are cutting jobs, freezing salaries and delaying dormitory and lab construction.

While debt is the not primary reason for these institutions’ woes, the need to service it eats into their dwindling financial resources, forcing near Faustian choices. “Debt is the fourth horseman of the nonprofit apocalypse,” Ms. Miller said. “Add it to the failure of governments to fulfill contracts, declining donated revenues and a surge in demand for nonprofit services, and suddenly a lot of nonprofits are faced with some very hard choices.”

Much of the nonprofits’ debt is in the form of tax-exempt bonds. The number of charities issuing such bonds more than doubled from 1993 to 2006, according to figures compiled by the Internal Revenue Service, and the amount of debt linked to those bonds rose to $311 billion from $98 billion (adjusted for inflation to 2006 dollars).

In many cases, charities used the money from bonds to buy real estate and build facilities. Prep schools added golf courses, pools and observatories. Colleges bought entire neighborhoods and put up labs and sports facilities. Museums erected new wings, and symphonies added thousands of seats to their concert halls.

These nonprofits gambled that income from donations and investments would more than cover their debt service. But the recession turned that logic inside out.

Norman I. Silber, a law professor at Hofstra University who has done extensive research on the problem, calls the rising debt of nonprofits a “calamity.”

“If my analysis is correct,” said Professor Silber, who is also a member of several nonprofit boards, “over the next several years nonprofits across the country will have to renegotiate bond covenants, reduce services, cut staff or actually default and face foreclosures, repossessions, and in some cases, even bankruptcy.”

Before 1986, only nonprofit hospitals were allowed to float tax-exempt bonds, which they used to build new facilities. Then Congress amended the tax code to allow all charities access to the credit markets, and now even the tiny Family Service of Greater Boston has tax-exempt bond liabilities.

To be sure, the assets at nonprofits grew faster than bond-related debt. In the dozen years that ended in 2006, the value of assets held by nonprofits grew to $1.37 trillion from $347 billion (adjusted for inflation to 2006 dollars), thanks to more large gifts, increased property values, rising stock prices — and the explosion of tax-exempt debt.

“I think one could make a good argument that the greatest contributor to the enormous growth in university endowments and other endowments is not some wealthy person or persons,” said Robert L. Culver, chief executive of MassDevelopment, a state agency that supports nonprofits’ floating bonds, “but the federal government making available low-cost, tax-exempt debt that allowed endowments to remain invested and earn rates in the market as high as 25 percent.”

Traditionally, projected income determined how much debt an organization could handle, but Professor Silber suspects that as assets grew, lenders began extending credit based on how much money a nonprofit had in its endowment.

“Now, those assets have dropped in value by 20, 30 percent, but the amount of debt hasn’t changed,” he said.

Consider the case of New York Law School, which floated $135 million in auction-rate securities in 2006 in a deal that won an award for the creative use of structured finance.

The school had sold its library, on prime Manhattan real estate, for $136.5 million, but instead of building a library, it added the money from the sale to its endowment and borrowed for construction. Interest on the securities was just under 4 percent, the dean, Richard A. Matasar, said, compared with the 5.5 percent the school would have paid using ordinary fixed-rate bonds.

The Tax Code bars nonprofits from taking money raised with tax-exempt bonds and investing it in higher-yielding investments, a form of arbitrage. But it does not prohibit the strategy used by New York Law School, which many tax experts regard as a major flaw in the law.

“Congress’s intent in allowing charities to use bonds is to help them achieve their missions — build a health care center or a preschool,” said Dean Zerbe, former tax counsel to the Senate Finance Committee, “not to engage in fast and loose financial games.”

Mr. Matasar said the school did not engage in arbitrage. “The fact that we were fortunate enough to be able to sell a building to raise additional funds was a separate and distinct transaction,” he said.

I am sure the investment bankers and lawyers can back up this opinion but for the layman it is pretty clear that money is fungible. And borrowing at 4.5% and soon after increasing the size of the endowment with far higher anticipated investment income well.....if it looks like a duck, quacks like a duck...

When the credit market began souring last year, interest rates climbed sharply, hitting 12 percent in one week as buyers failed to show up for auctions of the school’s securities.

In December, New York Law School refinanced its debt, converting its securities into variable-rate notes secured by a letter of credit, Mr. Matasar said. Its endowment had fallen 20 percent to $186 million.

But experts predict that many charities, particularly cultural organizations that are seeing declining revenues, will have a harder time.

Soliciting donors to pay off debt “would be like me going to my husband and saying, ‘Give me money because I spent too much at Saks Fifth Avenue,’ ” said Naomi Levine, a former star fund-raiser for New York University who now teaches at the university’s Heyman Center for Philanthropy. “It would be very, very difficult.

and it was a strategy undertaken by smaller endowments as well:

Even the Smallest Nonprofit Groups Tried Their Hands at High Finance

Even the smallest of nonprofits ventured into the world of high finance.

A decade ago, Family Service of Greater Boston, a 174-year-old social services agency with an annual budget of about $6 million, sold its nine-story row house on Beacon Hill. Rather than use the $8.1 million in proceeds to buy a new building, Family Service put the money from the sale into its endowment and floated $8 million in variable-rate tax-exempt bonds tied to a swap contract that protected it from interest rate fluctuations.

The thinking was that dividends and interest on the investments would be at least sufficient to make payments on the notes,” said Randal Rucker, the group’s chief executive.

In fact, investment income never sufficiently covered payments on the bonds, which ended up costing it roughly $800,000 a year — or about 12 percent of its annual budget.

Late last year, with a balloon payment on the bonds looming and its endowment’s value down by more than 20 percent, Family Service had reached what Mr. Rucker called “a very important and undesirable decision point” to lay off staff members and discontinue some programs or reduce all programs across the board.

Then it got lucky. Under a new federal program, the charity was able to refinance its bonds, reducing its debt service costs by more than half.

“I think the strategy was right back then,” Mr. Rucker said. “In hindsight, I might have done some things differently. The assumption was that the market would always give about an 8 percent return, and no one projected we would be in the situation we are now.”

Wednesday, September 23, 2009

Mutual Fund Investors Are Getting The Message...... least I hope so. Based on this wsj article they may be (finally) concluding they are better off with passive (index) instruments rather than actively managed funds. Or they could simply be chasing performance in reaction to last year's results and will be back into to active funds after a year of better returns.

In any case it seems pretty clear that one of the main points used in marketing actively managed funds proved false. Prospective investors were told active managers would protect them in down markets it proved not to be the case.Of course the WSJ can't resist implying that investors ought to be looking to reenter those active funds. My bolds and italics


Fallen Fund Stars Find Fewer Takers
Magellan and Others Rebound, Not Inflows


Some prominent mutual funds have made spectacular comebacks this year, but the investor dollars aren't following.

Fidelity Magellan, Legg Mason Value Trust and Dodge & Cox International Stock are among the funds beating the markets again. But investors haven't forgotten their abysmal showing in 2008 and early 2009, and many funds still are hemorrhaging cash.

After pulling $172 billion from stock funds in 2008, individual investors have begun edging back. Stock-fund inflows, or net buying, are slightly positive in 2009. But the gains are going to index funds; actively managed stock funds continue to experience outflows.

By Morningstar Inc.'s reckoning, $11.6 billion in fresh investments have gone into index funds this year, versus $5.6 billion pulled out of actively managed funds overall. In 2006, when stock funds pulled in $202 billion, just 14% of that went into index funds.

"The managers didn't protect investors on the downside," says Karen Dolan, director of fund analysis at Morningstar. "So some investors have thrown in the towel."

Dodge & Cox International lost 47% in value during 2008, when the Standard & Poor's 500-stock index was down 37%.

This year, the fund has come roaring back, racking up returns of 45% (price appreciation plus dividends) versus the S&P index's 20%. The financial-services and emerging-market investments (yes, but the vanguard emerging markets etf (vwo) is up 65.5%) that hurt it last year have sprung back handily.

Nevertheless, investors have pulled out $790 million out of the Dodge & Cox fund as of mid-year, says Lipper FMI Americas. "People do follow past performance," says Charles Pohl, Dodge & Cox's chief investment officer, who says the fund's recent good renumbers will end up attracting more investments.....

is he right about investor performance or has there been some change ?

Don Rhoades, 43, an insurance agent from Greenwood Village, Colo., also dumped the Dodge & Cox overseas fund portfolio and moved into low-fee exchange-traded funds that track indexes. "Why did I pay so much to lose all that money?" he asks. Although the Dodge & Cox offering charges a not-bad 0.65% in fees, that is still more than Mr. Rhoades pays now.

At the $24 billion Fidelity Magellan, total return has soared this year by 38%. But investors have withdrawn a net $1.5 billion through August.

"We haven't changed our style or anything," says Magellan's manager, Harry Lange. His fund lost 49% last year as bets on tech stocks, among other things, went wrong.

I think he should leave that comment out of the marketing materials given investor fears of another market drop.

The managers console themselves that the current strong performances will bring investors back. "Retail investors tend to be trend followers, and come in after the fact," says Cindy Sweeting, manager of Templeton Growth, up 26% this year after a 43% clobbering in 2008. Investors have withdrawn $1.4 billion this year.

Among the hardest hit since the 2008 crunch has been Legg Mason Value. For 1990 through 2005, it beat the S&P 500 every year. Its manager, Bill Miller, became a financial celebrity and an icon of value investing who cannily snatched up many underappreciated gems.

But in 2008, his heavy holdings in financial stocks like American International Group Inc. and Bear Stearns Cos. produced a 55% loss.

The WSJ recently reported on an article that surely put into question the argument that active managers perform better than indices in down markets. In fact correlations among stocks increase in market selloffs making the purported skills of active managers less important. Although it is true that the correlation among stocks is lower in other types of markets. It does not at all argue for investing with an active manager. And it would not necessarily that the assertion that as the article proclaims "It's a stockpickers market". In fact I think I have never ever heard a single "expert" on CNBC proclaim "it's an indexers market" hmmm...I wonder why.

WSJ on that goldman study. Obviously I agree with the sections I bolded arguing against active funds.


The Return of the Stock Picker’s Market!

A recent research report from Goldman Sachs noted moderating correlation among stocks, calling it a better climate for portfolio managers. “So far, this year is proving to be a much better year for stock-pickers, with 67% of all U.S. equity funds outperforming benchmarks,” Goldman analysts wrote, citing data from S&P.
That’s something for investors to keep in mind, even though there is a long and healthy debate about exactly how much value portfolio managers actually bring to actively managed funds. Still, “if you are one who does believe that they have that ability, this is the time to begin to make allocations towards active management,” Rothman said.

Of course, picking wisely is the trick. Disparate stock performance might free up high quality stocks to rise above the pack. But it also means bad picks are more likely to lag. “You have to be able to pick the right manager,” Rothman said. “And picking the right manager is no easy feat.”

Thursday, September 17, 2009

Morningstar on Harvard and Yale

They come to pretty much he same conclusions I have expressed here before (my bolds my comments in italics)

Are Harvard and Yale Endowments Still Top of the Class?

By Sonya Morris, CFA | 09-17-09 | 06:00 AM

Harvard and Yale recently said that their endowments experienced sizable losses for their most recent fiscal years ended June 2009....
....These results are noteworthy because Harvard's and Yale's endowments have produced results that have been the envy of the investment world. They also have been pioneering practitioners of what are now considered fundamental investment principles, such as diversifying among uncorrelated asset classes and developing a thoughtful long-term asset-allocation plan. Given the sterling reputations of these institutions, many thought that Harvard and Yale would fare much better than the competition amid last year's sell-off. Yet that clearly wasn't the case.
It's important not to make too much of this recent stumble. Last year's extreme market conditions humbled many talented managers, and every investor, even the most skillful ones, occasionally experiences a rough patch. However, the best investors also make a point of learning from their mistakes, and there are lessons to be taken from the endowments' recent underperformance.

Alternatives Aren't a Silver Bullet
Academics theorized that the inclusion of noncorrelated assets in a portfolio would improve diversification and enhance risk-adjusted returns. But the investment managers at Harvard and Yale were among the first to put this theory to practice by including nontraditional assets, such as commodities, real estate, private equity, and hedge funds, in their endowment portfolios. This approach proved very successful for both universities. Indeed, it worked so well that many of their fellow institutions jumped on the alternatives bandwagon. Fund firms also got in on the act by launching a bevy of mutual funds and ETFs that offer exposure to asset classes and hedge fund strategies that were previously unavailable to retail investors, such as commodities, currencies, global real estate, and absolute return strategies.

However, last year confirmed that asset classes tend to correlate during market crises. In other words, when the market implodes, few investments can avoid the downdraft.... .
Does that mean you shouldn't include alternatives in your portfolio? Not necessarily. A modest allocation to a commodity or real estate fund can improve diversification, but don't expect these investments to protect your portfolio from every unexpected turn in the market. Moreover, don't be drawn in by newfangled strategies with fetching back-tested results. The year 2008 proved just how challenging the real world can be.

Liquidity Matters
Many alternative assets held by Harvard and Yale are not readily liquid, and that proved particularly problematic last year. Harvard singled out "aggressive commitments to illiquid asset classes" as one of the factors behind its poor results last year. Private equity proved particularly insidious because not only are these investments difficult to sell, but they can demand additional investments, sometimes at inopportune times. That put private-equity investors in the position of selling their liquid positions at unattractive prices just to meet calls for capital. At the same time, some hedge funds were experiencing problems of their own and consequently limited their shareholders' ability to redeem their investments. This lack of liquidity squeezed many big investors, including university endowments....

Asset Allocation and Time Horizon Must Match

Endowment managers justified including large allocations to nonliquid assets because their time horizons were theoretically infinite. That should enable an endowment to ride out the occasional downturn without having to sell its investments at unfavorable prices....
The ambitious spending demands placed on endowments ultimately caused a mismatch between their asset allocations and their time horizon, which was no longer infinite. Individuals, particularly retirees, can find themselves in similar straits if they don't take realistic account of short- and intermediate-term spending needs in constructing their portfolios. Any money that you plan to spend over the next five years should be set aside in liquid and stable investments such as Treasury bonds, CDs, and bond mutual funds. Also, it's smart to set aside emergency cash reserves to meet unexpected expenses.

I'm not sure I agree with the following conclusion from Morningstar. As I have argued before, if the excess returns at these institutions was largely a premium they for taking more leverage and giving up liquidity, then (to use the flawed but still useful approach of modern portfolio theory) all they did is move along the indifference curve accepting higher risk (and less liquidity) in exchange for higher expected return. Higher risk and higher return perhaps, alpha (especially if you meand both risk and liquidity adjusted return) I'm not so sure.

Also the article conflates the strategy of using alternative investments with the Yale and Harvard strategy. I don't at all see a problem incorporating commodities through a liquid, transparent, unleveraged instrument through etfs (with the caveat that new rules by the cftc may change that view), But that is not the same as the Yale strategy which included private equity, hedge funds, venturecapia both illiquid and both leveraged.

the conclusion of the morningstar article

Focus on the Long Term
Despite large losses last year, Harvard and Yale both hold enviable long-term track records. Harvard has earned annualized returns of 8.9% over the past decade through June 2009, compared with 4.5% for the average world-allocation fund. While we don't yet know Yale's results for fiscal 2009, its 10-year record as of June 2008 was well ahead of Harvard's and was the best among all university endowments. Its estimated 30% loss for 2009, though painful, isn't large enough to derail its impressive long-term performance.
It would be a mistake to throw out an investment process that has produced these sorts of long-term results just because of one bad year. Still, last year serves as an important reminder of the limits of alternative investments and the value of liquidity

Tuesday, September 15, 2009

Is This Any Way To Improve the Management of A University of Endowment

The FT report on universities improving their risk management includes this convoluted prescription from (surprise) a consulting firm.(my bolds and italics)

US universities still fire-fighting
By Jay Cooper and Whitney Kvasager

Published: September 13 2009 09:44 | Last updated: September 13 2009 09:44

Markets are improving, but many foundations and endowments are still struggling to find the liquidity they need to meet their spending and cash requirements. ...

“It’s absolutely not over,” says Dick Anderson, a principal consultant and director of the endowment and foundations practice at Hammond Associates. “The liquidity issue is still very much front and centre.”

Institutional investors are taking a variety of approaches as they grapple with these lingering liquidity issues.

Redefining private equity to avoid having to sell at low prices is one way forward. The plunging equity markets caused asset allocations to be skewed, with a higher percentage in private equity than desired. But Mr Anderson says endowments can maintain their heavier private equity allocations – and thus avoid selling those positions at deep discounts in the secondary market – if they are willing to reconsider how that asset class fits into the overall portfolio.

Even before the market downturn, Hammond Associates had started combining private equity and public equity as part of a “growth equity” asset class, because the two asset classes share similar market characteristics. Consulting firm Fund Evaluation Group has a similar approach and suggests combining private equity, public equity and other investments into a “global equity” category

If private equity and public equity are viewed as part of the same asset class, a client can keep the higher exposure to private equity and avoid rebalancing the portfolio. “Now that they have overallocated to private equity, it’s useful to understand that public equity and private equity share many characteristics,” Mr Anderson says.

Sorry, but I have absolutely no idea what these folk are talking about. Put illiquid highly leveraged private equity in the same category as liquid unleveraged equity holdings. Then when you need to rebalance and cant sell the illiquid private equity, sell the liquid public equities. But since you have defined private and public equity as part of the same asset class your asset allocation and risk measures on the portfolio haven't changed.

The consultants suggest this makes sense because private and public equity "share some of the same characteristics". I am sure they do but they also differ completely in 2 very important characteristics liquidity and leverage. High Yield bonds and Treasury bonds share many many characteristics and could be included in the same "fixed income category". If one started the year with 75% treasury bonds and 25% high yield and then sold half the treasury bonds and kept all the high yield bonds only a consultant could say that the characteristics of the portfolio haven't changed dramatically.,

Talk about a strategy guaranteed to improperly manage risk !

I am quite sure that the endowment that engages in this "strategy" for asset allocation will wind up cleaning up a big mess should we hit any kind of market selloff.

Call me old fashioned but these managers seem to be following a more logical strategy

Building up cash is another liquidity management technique. Some endowments let their cash holdings grow last year, allowing them to now rebalance areas of the portfolio that are the most out of sync with the investment policy. That is what Michael Sullivan, chief investment officer at Minnesota’s University of St. Thomas, has done.

Mr Sullivan simply held on to cash as it became available last year – through donations, manager terminations and other events, such as a fund of hedge funds manager closing and returning cash. Cash is now about 16 per cent of the $400m (£214m, €274m) portfolio; the investment policy holds cash at zero.

“We weren’t trying to time anything; it was a by-product. We just had cash and we didn’t know what to do so we kept it as cash,” Mr Sullivan says.

“From a strategic point of view, cash should always be minimised. It was just that this was such an abnormal time,” Mr Sullivan says. “We are not changing our strategy to have large amounts of cash.”

Maybe the consultants feel they are not doing their job if they recommend a strategy as commonplace as keeping a large cash reserve.

The consultant seems to be feeding his client a classic bad idea: increase the allocation to risky strategies in an effort to quickly make back lost money:

Some investors are allocating to opportunistic fixed income managers, hoping for higher returns with less risk.

The potentially higher returns can then help meet future capital commitments, and can also help avoid future equity downturns – an appealing prospect given that it was the market crash that helped cause some of the liquidity problems over the past year.

Mr Anderson notes a host of recently launched strategies from managers “who will opportunistically take on risk, but who share the client’s need for protecting the downside”.

These managers invest in a range of credit opportunities including high-yield, structured credit, agencies and senior bank debt.

It seems like the consultees have a better handle on things thant the cosultants:

Last, but not least, foundations and endowments are looking ahead to forestall future liquidity problems. At the $150m Ball State University Foundation, chief investment officer Thomas Heck has created a detailed 12-15-month cash flow projection so he can see when cash will be needed and how much.

“We’re doing an asset allocation kind of approach to liquidity. We’ve gone through and classified our investments based on days, months, quarters, limited partnerships,” he says.

“Within each asset class, I include a liquidity breakdown so we can see where the liquidity problems may be from a rebalancing standpoint.”

Monday, September 14, 2009

A Very Interesting Graph

from the Financial Tines Sept 12/13 edition (click to enlarge)

two Observations

1. The curve here is not "bell shaped". Large magnitude moves are far more common on the downside than on the upside. And of course for most individual investors (who don't engage in shorting) the downside moves are those that they are concerned about.

2. A gain of the magnitude that has occurred over the past 6 months has occurred only .5% of six month periods . In other words an investor who was out of the market for the past six months missed what was literally a once in a lifetinme opportunity. Such a move has not occurred since the 1932-1933 period.

Friday, September 11, 2009

My Alma Mater Shows Its Numbers

Not pretty but not as bad as the big boys in Cambridge and New Haven. And of course anyone following this story would now the reason why without reading this article from the WSJ. For those new to this story the reason is highlighted in bolds.

Columbia Endowment Falls 21% .


Columbia University, reporting narrower investment losses than some of its Ivy League peers, said its endowment in the past year declined 21% in value to $5.7 billion.

For the year ended June 30, the New York school reported the endowment had an investment loss of 16% -- less than the 18% drop reported in the median return for big endowments, according to Wilshire Associates, an investment-management consultant. The decline also marked an improvement over the negative-22% Columbia had reported for the first nine months of its fiscal year...

The disclosure comes a day after Harvard University and Yale University each said their endowments, higher education's largest, had declined in value by 30%. Harvard, of Cambridge, Mass., reported an investment loss of 27%; Yale, of New Haven, Conn., didn't disclose its investment return.

Columbia declined to release details of its investment strategy. In the past, the school has devoted a smaller percentage of its funds to alternative investments such as private-equity funds than has Harvard and Yale. Those alternative investments, which had led to strong past investment performance, declined sharply in value in the past year.

Columbia said its five-year annualized return was 8%. The median endowment's annualized return over that period was 2.5%, according to Wilshire, and Harvard's was 6.2%.

"Columbia's investment team has successfully positioned the portfolio to take advantage during the bull market and cushion it as markets significantly weakened this year," said Robert Kasdin, a Columbia senior executive vice president.

We Knew This Was Coming

my bolds my comments in italics

nyt today
(graph is from the wsj)

Harvard and Yale Report Losses in Endowments

Harvard and Yale disclosed on Thursday just how many billions their endowments had lost in the last year, signaling yet more belt-tightening at the nation’s wealthiest schools.

Harvard’s endowment tumbled 27.3 percent in its latest fiscal year, largely because of problems with its private equity and hedge fund portfolios, lopping off $10 billion and shrinking its portfolio to $26 billion. Taking into consideration donations and spending, the endowment shrank by nearly 30 percent.

Yale also suffered about a 30 percent loss in its endowment, to about $16 billion, the university’s president disclosed in a letter Thursday, adding that final figures on performance were still being compiled.

We want to alert you to the fact that another round of reductions will be necessary,” Yale’s president, Richard C. Levin, wrote in what he called a budget update to the Yale community praising the cost-cutting that had already occurred.

when the next revised number is released for Yale it will be the second downward revision

the article continued:

Although other endowments at major universities suffered declines, many did better than Harvard and Yale, which have been known over the years for their investing prowess. The University of Pennsylvania, for example, was down 15.7 percent. A survey of foundations and endowments with assets of more than $1 billion by Wilshire Trust Universe Comparison Service found an average decline of 17 percent in fiscal 2009....

While Harvard aims to outperform, it also establishes a policy portfolio with a benchmark index for each asset class. Weighting its assets in each category and using those benchmarks, Harvard underperformed its policy portfolio by 2.1 percent.

Of six investment classes, four failed to meet their benchmarks. In a couple of cases the shortfall was sharp. Harvard’s private equity investments declined by 31.6 percent, compared with a benchmark loss of 23.9 percent. Absolute returns, more generally called hedge funds, fell 18.6 percent, compared with a 13.2 percent decline for the index. Harvard’s public equities did marginally better than the market, as did its real assets.

Yale said that the publicly traded portion of its portfolio did not decline further from December through June, but that the illiquid portions in private equity and real estate continued to sag.

Harvard had a large share of assets in private equity, about 13 percent of its total as recently as February.

The long term performance numbers for the more aggressive Yale and Harvard portfolios:

The Yale endowment is led by David F. Swensen, who has advocated aggressive use of alterative investments like private equity and hedge funds. At the end of fiscal 2008, Yale continued to turn in the best 10-year performance with an average annualized gain of 16.3 percent, which was followed by Harvard with 13.8 percent.

Harvard’s 10-year average annualized return has now fallen to 8.9 percent. That remains well above its policy portfolio of 4.5 percent.

A rough number for the average return for yale should be around 13% at this point.

That crushes the average return of the S+P 500 but interestingly is pretty close to the number for emerging markets index, which arguably have less risk than the yale and harvard portfolios. An emerging markets etf has instant liquidity far different than many parts of the harvard and yale holdings.

But more importantly the growth of wealth for the 10 year period after last year's number is far more devastating on the value of the endowment and I would argue that is the better number to use to evaluate the strategy, after all that is the one that directly affects the university. To give an analogy if you had the Yale portfolio and looked to retire this year the average annualized portfolio return would't mean much to you. But the 30% drop in the value of your nest egg would be quite important ( to say the least)

Which raises the question of whether the Yale or Harvard returns, number adjusted for the lack of liquidity and the volatility and leverage of some of the holdings,really would have beaten a liquid globally diversified portfolio of 100% liquid exchange traded funds.

After all if a hedge fund manager is leveraged 2x (a conservative number) and he beats the s+p index return of say 5% by turning in a 10% performance he really has just met his benchmark on a risk adjusted basis. There was no "alpha" one could have leveraged a position in an s+p 500 2:1 and gotten the same performance with no management fees and no liquidity headaches.

The WSJ writes

Other wealthy schools, including Stanford University, Princeton University and Massachusetts Institute of Technology, have predicted losses similar to Harvard and Yale's. They all follow an investment model that de-emphasizes traditional stocks and bonds and instead loads up on alternatives unavailable to the average investor.

Yale and Harvard pioneered the approach, arguing they could afford to take big risks, because they were investing for decades, even centuries. Many copied the schools, saying they had found a high-return, low-risk strategy. But Eric Bailey, managing principal of CapTrust Financial Advisors LLC, a Tampa, Fla., firm that advises college endowments, says, "If it looks too good to be true, it probably is."

Mr. Bailey says typical colleges outperformed Harvard last year, because they stuck to a plain-vanilla approach, typically allocating 60% of their holdings to stocks and 40% to bonds. That strategy would have generated a loss of roughly 13% in the year ended June 30. Harvard aims to have only 4% of its investments in U.S. bonds, which were one of the few safe havens over the last year. It has cut by more than half its target for investments in U.S. bonds since 2005.

The University of Pennsylvania's endowment, by contrast, loaded up on Treasury securities in 2008 and reported a more moderate 15.7% decline. In New York City, Cooper Union for the Advancement of Science and Art, which charges no tuition, ratcheted down the risk of its investment portfolio three years ago and expects its endowment to hold steady for the year.

Yale and Harvard say their long-term results justify the strategy. Harvard's endowment remains the largest in higher education. In fact, the $10.9 billion it lost last year is bigger than the 2008 value of the endowments of all but six colleges

Thursday, September 10, 2009

Add Brown to The List...A Familiar Story By Now

via bloomberg
Brown’s Endowment Investments Drop 23% in Year, President Says

my bolds my comments in italics

By Janet Frankston Lorin

Sept. 9 (Bloomberg) -- Investments from Brown University’s endowment fell 23 percent in the fiscal year that ended June 30, President Ruth Simmons announced today. The total value of the endowment fell 27 percent to $2.04 billion, Simmons said. The school, in Providence, Rhode Island, paid out $132 million from the endowment for operations and received $44 million in new endowment gifts.

The school previously announced it cut $35 million from the fiscal 2010 budget and needs to cut an additional $30 million from fiscal 2011’s budget. Brown already eliminated 67 administrative and staff jobs in the 2010 fiscal year that began July 1 and 36 workers were fired, according to the school.

“The fiscal year 2009 results tell only part of the story,” Elizabeth Huidekoper, executive vice president for finance and administration, said in a statement. Brown’s endowment fell about 18 percent “over the two full years of the bear market,” about half as much as global equity markets and the Standard & Poors’s 500, she said.

Brown’s endowment is the smallest in the Ivy League, a group of eight schools in the northeast U.S. Harvard University, in Cambridge, Massachusetts, estimated investments in its fund fell 30 percent in fiscal 2009. Yale University, in New Haven, Connecticut, estimated its endowment loss to be 25 percent. The University of Pennsylvania in Philadelphia announced last month investments in its endowment fell 15.7 percent.

Cash Reserves

The university, including its medical school, relies on endowment revenue for 21 percent of its operating budget for fiscal 2010, according to the school. Its budget is $758.7 million.

and as anticipated the asset allocation followed the "Yale Model"On June 30, Brown’s endowment funds were invested 15 percent in public equity; 32 percent in hedged strategies; 17 percent in private equity; 12 percent in real assets; 9 percent in credit, 10 percent in treasuries and 5 percent in cash, according to the school’s statement.

Tuesday, September 8, 2009

Sorry If I Don't Get What Is So New Here

The WSJ today writes about the new innovative way some fund managers are now approaching the downside risk on their portfolios (my bold and my comments in italics)

Some Funds Stop Grading on the Curve


Last year, a typical investment portfolio of 60% stocks and 40% bonds lost roughly a fifth of its value. Standard portfolio-construction tools assume that will happen only once every 111 years.

With once-in-a-century floods seemingly occurring every few years, financial-services firms ranging from J.P. Morgan Chase & Co. to MSCI Inc.'s MSCI Barra are concocting new ways to protect investors from such steep losses. The shift comes from increasing recognition that conventional assumptions about market behavior are off the mark, substantially underestimating risk.

Though mathematicians and many investors have long known market behavior isn't a pretty picture, standard portfolio construction assumes returns fall along a tidy, bell-curve-shaped distribution. With that approach, a 5% or 6% stock-market return would fall toward the fat middle of the curve, indicating it happens fairly often, while a 2008-type decline would fall near the skinny left tail, indicating its rarity.

Recent history would suggest such meltdowns aren't so rare. In a little more than two decades, investors have been buffeted by the 1987 market crash, the implosion of hedge fund Long-Term Capital Management, the bursting of the tech-stock bubble and other crises.

Investors using standard asset-allocation approaches have been hammered. Last year, all their supposedly diversified investments plummeted in unison. In short, the underlying assumptions failed.

"We got blindsided by some developments that weren't accounted for by the models we were using," says Clark McKinley, a spokesman for the giant pension fund California Public Employees' Retirement System, or Calpers. As a result, the fund is looking at incorporating an extreme-events model into its risk-management approach.

Many of Wall Street's new tools assume market returns fall along a "fat-tailed" distribution, where, say, last year's nearly 40% stock-market decline would be more common than previously thought.

Fat-tailed distributions are nothing new. Mathematician Benoit Mandelbrot recognized their relevance to finance in the 1960s. But they were never widely used in portfolio-building tools, partly because the math was so unwieldy blockquote>>

So practitioners have known for years that the model used doesn't reflect reality, a prominent academic and many others have written about this problem for years even options traders in the futures pits acted based on the "fat tail " distribution for decades (by pricing out of the money options higher than would be implied with a standard deviation) but the top fund management and analysis companies are just know updating their approach...pardon me if my head is spinning.

The article goes on to describe seemingly arcane models and techniques to measure and protect downside risk. But at least for many instruments we have long had a mechanism to lmit downside risk: they are called put options. And Mr. Market can tell you everyday what the best estimate of that risk is...the option premium or the cost of buying that protection. And of course that protection comes at a price that will limit upside return. The article does point out that reality (big news: there is no free lunch):

Insulation from extreme market events doesn't come cheap. Allianz SE's Pacific Investment Management Co., or Pimco, which systematically hedges against extreme market events in several mutual funds launched last year, says the hedges may cost investors 0.5% to 1% of fund assets a year. Pimco uses a variety of derivatives and other strategies to hedge the funds.

"You're spending some of your upside to buy the insurance" against catastrophic losses, says Vineer Bhansali, a Pimco managing director.

Any technique other than one that incorporates some put buying will just amount to market timing or relying on an imprecise quantitative model,

And there is nothing new in risk managed funds. The Gateway fund (GATEX) has existed for years. It buys put options on the S+P 500 for downside protection and sells calls (limiting the upside) to finance some of the cost of those options. Not surprisingly it has underpreformed the s+p 500 2.77% vs 14.6 for the vanguad sp 500 fund ytd.<

I do agree with this comment at the end of the article:
Pimco's Mr. Bhansali is unimpressed. Since it is so difficult to forecast extreme events, investors should focus on their potential consequences rather than the probability they will occur, Mr. Bhansali says.

As for comprehensive measures of risk, he says, "they fail you in many cases when you need them the most."

In other words: either buy put options or own a significant amount of treasury bills so that you can ride out the storm. Don't rely on any "extimates of the risk bell shaped or fat curved

Thursday, September 3, 2009

Liquidity Risk In Action

FT Today (my bolds)

Cerberus to bar withdrawals from two funds
By Francesco Guerrera in New York and Sam Jones in London
Published: September 3 2009

Cerberus, the investment group, is barring investors in two new hedge funds from withdrawing money for three years in an effort to avoid a repeat of the large outflows that followed its lossmaking purchases of Chrysler and GMAC, the group's executives said.

The move to introduce a three-year "lock-up" is rare among hedge funds and could pave the way for other managers to follow suit.

Hedge funds typically offer investors the chance to withdraw money every few months - a feature that contrasts with alternative asset classes such as private equity that require multi-year lock-ups.

But after suffering more than $500bn in redemptions in the past year, hedge funds' interest in longer-term investment structures - often accompanied by lower annual fees - is growing. They are keen to avoid fire sales when investors want out, while the latter are clamouring for a better alignment of their long-term goals with hedge fund managers' rewards.

Cerberus executives said the lock-up would apply to two multibillion-dollar funds to be raised later this year specialising in distressed investments.

The funds, Cerberus Partners II and Cerberus International II, are successors to two vehicles that were hit by redemption requests as the financial crisis struck and Cerberus's highprofile investments soure

Wednesday, September 2, 2009

Trading One Risk For Another ?

Today's WSJ Investing in Funds section includes an article entitled

On Second Thought...
Many financial advisers have tweaked their investment policies after big losses last year. Investors should be sure they're comfortable with the changes

my comments in bold italics:

While some of the ideas of the advisors cited seem reasonable,such as adding commodity exposure, others are downright scary. Also none of the strategies mentioned actually reduce risk: that would be done by adding high quality short term bonds, inflation protected bonds or cash. In fact the advisors are just trading one risk: asset class rish which at least can be easily managed by holding low cost transparent index instruments for another risk: the skill of the advisor or fund manager in rotating among asset classes.

From the article:

After turning in a horrific performance in 2008, many financial-planning firms are heading back to the drafting table—and rethinking how they protect their mutual-fund portfolios.

Last year, the traditional safety-net strategy—diversification—failed as a broad range of investments crashed and burned. Now many planners are going further. They're giving themselves more flexibility to move assets around based on market conditions. Others have sworn off certain asset classes or added some they hadn't dabbled in before.

I certainly agree with this comment:

Whatever the change, make sure you understand your planner's new methods and are comfortable with them, says Dr. Katz, who is also a financial planner. "While it's been difficult to bear the movement in the market, be cautious if a planner jumps to things that he or she never looked at before," she says

Here is one example from the article of an advisor's change in strategy:

Now we've moved away from that for 10% of our assets, and we're inviting in different funds with flexibility" in the securities they hold, Mr. Enright says. He adds that these types of funds may lag behind stock indexes in good times, but in market declines the manager may stem losses by pulling out of losing asset classes and moving into more stable ones without any limits....

..or he may utterly fail at doing this. One thing for sure since it is an actively managed mutual fund the investor and advisor likely won't know about the manager's strategy in real time. The manager is only required to report holdings quarterly in arrears. And one has to wonder if a manager with a mandate to move around asset classes won't be inclined to move things around too much just to show he is doing something. And the more he moves things around the greater the potential tax liability.

Mr. Enright says he uses two funds from Allianz SE's Pacific Investment Management Co. that can roam across asset classes and also short securities. One, Pimco All Asset All Authority, largely invests domestically. Over the five years through August, the fund's institutional shares returned an average 6.8% a year, while the Standard & Poor's 500-stock index gained an average 0.5%. The second, Pimco Global Multi-Asset, is similar in strategy but has no geographical limitations. It was launched in November 2008 and is up 13.2% so far in 2009.

In my view the advisors cited in the article (and many individual advisors) have confused diversification with risk control. It is true that many risk assets: domestic and foreign stocks,corporate bonds and reits do not have perfect correlation (i.e.) they do not always move in tandem. But all types of stocks and in fact all of the asset classes listed above have high and positive correlations. Spreading across various types of stocks diversifies market exposure but it does not significantly reduce risk in a portfolio. Furthermore: "the only think that goes up in a down market is correlation" in a sharp market downturn the correlation of risky asset classes increases significantly. Correlations among risk assets are dynamic, therefore the benefits of diversifying among these asset classes in terms of risk control is often overestimated. Past correlations are not predictive of the future.

The only way to reduce the risk of a portfolio with 100% certainty is to increase the holdings of cash and near cash instruments such as short term treasury bills. The characteristics of these asset classes will remain constant: low interest rate risk, no credit risk, and low returns. In fact the founder of Harry Markowitz the founder of Modern Portfolio Theory (MPT) has stated that this is all that his work had argued and extensions of it to other types of diversification was overselling the theory.

Therefore, what the advisors describe as their new strategy to manage risk is not managing risk at all. By adding strategies that incorporate active trading and switching among asset classes they are actually increasing risk by adding a new risk: manager risk to their portfolios. There is no reason to think that the timers will be particularly successful. The advisors have not limited the downside risk of their portfolios, they have simply increased the likelihood that their portfolios will underperform on both the upside and the downside.

It seems to me either the managers don't realize this fact themselves or they don't want to tell the clients the truth of risk management. If you want to reduce the risk of their portfolio with certainty they need to give up potential gains as well, not simply switch among risky assets.

Tuesday, September 1, 2009

Style Purity Redux : Why Those Morningstar Catergories Don't Mean Much

An article on the Morningstar website illustrates the perils of owning an actively managed mutual funds. It makes clear that the categories for mutual funds are basically meaningless. In this example of the Morningstar category "international value" it is virtually impossible to know what exactly is held in the fund category. Of course that makes asset allocation difficult (to say the least). As can be seen below the international value fund could hold large allocations of cash, gold, emerging markets, or even a bet that international stocks will fall in value.

From the Morningstar Website (my bolds, my comments in bold italics)

Fund Spy

Why International Value Funds Are All Over the Map
By Gregg Wolper

International value funds aren't keeping up. Or are they? If you own one of these funds, or simply watch them as an informed investor, evaluating their performance in 2009 offers more than the usual challenge.....

Not this year. The performance gap between value and growth for foreign funds is minimal. The explanations for performance are more complicated--and therefore more interesting. (I would say frustrating...the category is obviously meaningless)

On the Upside
One reason why the Dodge & Cox fund has rebounded so strongly this year after a poor 2008 is that the managers traditionally have invested much more of the fund's assets in emerging markets than their peers. That has had a huge impact, because even though the major markets have performed quite well in the rally this year, emerging markets have soared even higher. Check out the Russia funds topping the Europe-stock category. Even after a lousy couple of months opening the year, they now boast year-to-date gains ranging from 60% to 100% through Aug. 27. Or look at the emerging-Asia category, with its own fireworks prompting similar gains. (If you wanted to keep track of your holdings in emerging markets, wouldn't you be better off just buying an emerging markets etf than trying to figure out what the fund manager "traditionally" owns)

That helps explain why Templeton Foreign
(TEMFX) is close to the top spot in the foreign large-value chart with a year-to-date return of 39.9%. Its managers have long been partial to Asia's emerging markets, in particular. As of June 30 the fund had about 20% of assets in those countries (not including Singapore and Hong Kong, typically classified as developed markets), plus another 5% spread among other emerging markets. The average emerging-markets weighting for foreign large-cap funds is only about 10% of assets. (Once again showing that the foreign large cap value cab mean just about anything)

But emerging-markets exposure is just part of the story for the outperformers. In general, small stocks have also topped bigger ones by substantial margins during this rally. That's helped Quant Foreign Value (QFVOx)which after two painful years is zooming in 2009. (So a top performing fund in the morningstar international large value category did do by....holding alot of small cap stocks)...

Then there are the international value funds that holds over 20% of their asets outside of the international stock markets:

On the Other Hand
However, many other international value funds have not enjoyed such a bounty. That group even includes a few that like to own some smaller stocks. For First Eagle Overseas (SGOVX) rose 13.6% year-to-date gain lags more than 90% of the foreign small/mid-value category, the explanation lies in caution. Riskier stocks have outperformed, and this fund didn't achieve its stellar long-term record by delving into dicey companies, preferring those with a substantial margin of safety. Moreover, it doesn't have a big stake in emerging-markets companies. And with capital preservation a key goal, it devotes more money to cash (more than 8% at the end of July) and gold-related holdings (12%) than most peers. All of these traits have held it back, in relative terms, after the first two months of 2009--just as they helped the fund stay ahead of nearly all competitors during the bear marke

The same combination of factors explains the laggard showing of IVA International (IVIOX) That's not surprising, for this fund is managed by First Eagle alumni. IVA International, too, has money socked away in gold; had an even bigger cash stake at the end of July (20% of assets) than the First Eagle fund; and had an even smaller emerging-markets position. So it's not shocking that its 13.5% year-to-date gain also sits near the bottom of the foreign small/mid-value group.

Then there is the international stock fund that took a bet against international stocks and adding another undertianty (whether or not these funds hedge the currency exporure) the same fund bet against the currencies of the countries where it invested:

Another value laggard, Mutual European (MEURX )was also held back early in the rally by a cash position, as well as a put option on a European index (that is, a bet that the index would fall). Those positions didn't last too long, though, so other reasons must be found to explain why that fund's year-to-date return lands in the Europe-stock category's bottom decile and trails the MSCI Europe Index by a wide margin. Here, as with some of the others, specific stock selection bears some blame: Its preference for conservative plays on sound financial footing was out of step with broader trends in this rally. And there's another factor here: Mutual European hedges most of its foreign-currency exposure into the U.S. dollar. With the greenback having given up ground in 2009, that hasn't helped returns versus category rivals, most of which don't follow that policy. And the index is unhedged.

The morningstar article ends with a strange conclusion:

Long-Term Outlook
The bright side for shareholders of the underperformers is that all are following the policies you'd expect them to follow. They aren't faltering because of abrupt switches of approach. If you liked their strategies before, you can rest assured that they are still adhering to them.

The same goes for this year's foreign-value winners. They haven't soared because they decided to chase hot areas that they've never before noticed. Rather, parts of their time-tested strategies have happened to be strongly in favor for about half a year now.

In fact, it's worth noting that all of these funds share that admirable trait. These offerings have long-term approaches that actually stay in place for the long term

The above doesn't seem logical to me at all. The funds share an admirable trait that they might hold 21% cash/gold, and might (or might not) bet against foreign stocks or foreign currencies ? It seems clear to me that if one wanted to structure the foreign stock allocation in a portfolio etfs and index funds are the better choice.