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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.”

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