domingo, 28 de junio de 2009

domingo, junio 28, 2009
Monday, June 29, 2009

BARRON'S COVER

The Big Squeeze

By ANDREW BARY

The alternative assets that enriched big Ivy League endowments are now causing outsized headaches for Harvard, Yale, and Princeton. Time to go back to school and get back to stocks?

FOR YEARS, TOP UNIVERSITY ENDOWMENTS at Harvard, Yale and Princeton were the envy of the investment world, thanks to the outsized returns they generated from significant investments in nontraditional assets such as private equity, real estate, hedge funds and commodities, and low exposure to U.S. stocks and bonds.

Now that widely imitated asset- allocation strategy, dubbed the Yale model because of the enormous success of the Yale endowment under the 24-year leadership of David Swensen, is facing its sternest test amid the bear market of the past 12 months. Harvard and Princeton are assuming their endowments fell about 30% for the fiscal year ending June 30, while Yale is projecting a decline of 25%.

The outlook is challenging for the big Ivy League endowments because many of their investments are in illiquid private- equity and real-estate funds or commodity-related assets such as timberland, whose estimated value might not reflect today's steeply discounted market prices. Yale and Princeton, for instance, have invested roughly half their endowment assets in private-equity deals, real estate and commodities, a far cry from the 65%-to-35% blend of stocks and bonds favored by many individuals. If the three Ivies valued such assets at market-clearing prices, their endowment losses for fiscal 2008-09 could approach 35%.

It is tough for outsiders to assess the big university endowments, given limited public disclosure, and endowment directors at Harvard, Yale and Princeton declined to speak with Barron's. The endowments reveal their asset allocations, but not individual investments or outside managers. Most of their assets are farmed out, with endowment pros like Swensen overseeing the selection process while monitoring risk and results.

We have assumed that private-equity, real-estate and commodity investments lost about 50% in the past year, based on market benchmarks. Major commodity indexes are off 50%, as are independent oil and gas stocks. The MSCI index of real-estate investment trusts has lost 45%, and private-equity investments are trading for 50 cents on the dollar, or less. The Standard & Poor's 500 index has fallen 27%.

Timberland, for instance, looks significantly overvalued and could drop sharply as investors "race to the exits," Barron's Roundtable member Oscar Schafer said in our midyear update two weeks ago ("Too Far, Too Fast," June 15).

OTHER MAJOR ENDOWMENTS, including those of Stanford, the University of Michigan and the University of Virginia, also have allocated a significant portion of assets to so-called alternative investments. Stanford has less exposure than the biggest Ivies, however. It is projecting a 30% loss for the current year.

Barron's was among the first to identify university-endowment problems, in a cover story last fall ("Crash Course," Nov. 10, 2008), and the financial pressures on both the endowments and schools have worsened significantly since. We correctly predicted the major endowments could be down 25% or more in the current fiscal year, even as some endowment chiefs were insisting any losses would be much lower.

The endowments may end up trailing the stock market in the coming year because of the lag in marking down illiquid asset classes. As we argued last fall, it is probably time -- and now, past time -- for the big endowments to exit some of their illiquid investments and buy stocks and bonds, both to take advantage of market opportunities and gain greater financial flexibility.

In the near term, however, endowment holdings may become more skewed toward illiquid assets, as they are tapped to ease strained university budgets and fund new investment commitments to private-equity and real-estate managers that were made when the markets were stronger. Endowments normally recycle distributions from existing private-equity and real-estate funds into new investments, but the bear market has slowed such distributions to a trickle. Institutional investors who walk away from private-equity commitments usually pay a steep price, which could include forfeiting existing holdings.

Liquidity problems are affecting Harvard, which ended its 2008 fiscal year with the country's largest university endowment: $36.9 billion. Harvard lost two key internal bond managers last week amid reports the managers were unhappy that the endowment had grown more conservative in its investments, limiting their ability to buy riskier bonds. Such caution isn't surprising, however, because liquidity problems last fall, prompted by market declines and the need to post collateral to offset losses on an interest-rate swap tied to a university bond offering, nearly forced the endowment to sell private-equity interests at distressed prices.

To give themselves financial breathing room and forestall asset sales, major universities sold sizable amounts of debt last year. Harvard issued $1.5 billion; Princeton, $1 billion, and Yale, $800 million. Harvard's debt now exceeds $5 billion. Even while borrowing heavily, many big universities have been sellers of stocks, bonds and other liquid assets in the past year.

Despite their investment losses in the past year, major university endowments still have a stellar long-term record. For the 10 years ended June 30, 2008, the Yale endowment gained 16.3% annually, while Harvard rose 13.8% a year and Princeton, 14.9%. The Standard & Poor's 500 logged an average annual increase of just 2.9% in that span.

Yale's endowment grew to $22.9 billion from $6.6 billion in the decade, while Harvard's expanded to $36.9 billion from $13 billion. The Princeton endowment rose to $16.3 billion from $5.6 billion. Harvard's strong performance in the past 10 years relative to that of the average nonprofit investment pool translated into a staggering $23 billion of added value.


EVEN IF THE BIG IVY ENDOWMENTS enter a period of underperformance, their chiefs deserve praise for past achievements, attained while working for far less than they might have elsewhere in the investment business.

Swensen's compensation has been about $2 million annually, while the head of the Princeton endowment, Andy Golden, earned about $1.5 million in 2007. Harvard is more generous with pay, which caused a fuss during the tenure of former endowment chief Jack Meyer. Compensation information for the current chief, Jane Mendillo, isn't available because she started the job a year ago. Her predecessor, Mohamed El-Erian, now chief executive and co-chief investment officer of bond manager Pimco, earned $6.5 million in his final year on the job.

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All the big endowments have a so-called policy portfolio designed to provide optimal returns with relatively low risk (see table above). U.S. stocks and bonds, for instance, have been deemed unattractive in these asset-allocation models relative to private equity, hedge funds and natural resources.

At Yale and Princeton, hedge funds, private-equity and real-estate funds, and commodity-related investments accounted for about 75% of endowment assets as of last June; the total for Harvard was around 55%, above the 35% allocation to alternatives favored by the typical nonprofit endowment.

Yale and Princeton have a 95%-plus exposure to equity and equity-like investments. Yale had a net bond exposure of close to zero last year after factoring in the leverage on its portfolio. This extreme approach to asset allocation may need to be reconsidered.

"The policy-portfolio concept is dead," says Byron Wien, the chief investment strategist at Pequot Capital Management. "The idea used to be that every asset had a predictable rate of return and volatility based on history. History, however, is less useful now. Yale has half its assets in private equity and natural resources. That has provided the bulk of its outperformance. Yale's nonpublic investments could provide lower investment returns going forward."

Wien wrote last year that private-equity returns could be depressed for an extended period because of "sluggish business conditions, a lackluster new-issue environment and an inability to borrow funds to leverage up acquired companies."

In a recent interview on PBS, Swensen acknowledged that "diversification isn't going to help you in the midst of a financial crisis, or at least the type of diversification that you see in institutional portfolios like Yale's." He added, "I'm not sure that the crisis has caused us to conclude that we would do things differently, but it certainly highlighted the importance of liquidity."

Swensen's view has been that universities, as the most long-term of investors, could trade illiquidity for the higher returns of alternative assets. Once markets normalize, the benefits of the Yale approach should materialize once again, the endowment wrote in its 2008 annual.

THE AGGRESSIVE ASSET ALLOCATION favored by endowments is understandable, as they disburse an average of 5% of endowment funds each year for university operating expenses, while also trying to stay ahead of inflation. Princeton, for instance, aims for 10% annual returns, a tough goal over any extended period.

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In the near term, endowment chiefs may be wrestling with how to handle commitments to private-equity and real-estate funds. At Harvard, investment commitments totaled $11 billion on June 30, 2008; at Yale, $8.7 billion, and Princeton, $6.1 billion. These commitments are especially large relative to shrunken endowments. Harvard's endowment could end this month in the $25 billion range; Yale's is about $17 billion, and Princeton's, $11 billion, after investment declines, yearly contributions to university budgets and new gifts from alumni and others.

One closely watched endowment-liquidity barometer is the level of existing limited-partnership investments -- including hedge funds, private equity and real estate -- plus investment commitments as a percentage of the total endowment. Yale and Princeton are thought to have some of the highest -- that is, worst -- ratios. The risk is that these endowments could become even more illiquid in the coming year.

Few outside their own communities will cry for the big Ivies, given their still-enormous endowments. But they ironically are feeling a bigger financial impact from the bear market than less wealthy schools because the big Ivies have garnered as much as half their budgets from their endowments, compared with 5% to 10% at large non-Ivies. The bigger take makes the endowments vulnerable to further market declines.

Even as their endowments shrink, universities are grappling with other problems, such as declining donations and greater demands for student financial aid. Also, state laws often prohibit endowments from spending donated money if endowment assets fall after the gifts have been made.

Precipitously declining values in many asset classes in the past year may mean gifts of more recent vintage effectively are frozen. A donor who funded a professorship at a major university in the past few years says the school recently asked him for a waiver to tap into the gift because state laws otherwise would prohibit it.





Travis Dove/The New York Times/Redux



Because of budget constraints, Harvard has slowed and may pause the construction of a new campus in Allston, Mass., across the river from its Cambridge campus. Last week the university said it would eliminate about 275 jobs.


COLLEGES AND UNIVERSITIES throughout the country are cutting budgets in response to endowment declines and a drop in alumni contributions. The Ivies are freezing salaries, firing administrators and support staff, and not hiring replacements when professors depart. They are also taking lesser steps: Hot breakfasts have been eliminated at certain Harvard dining halls.
Princeton is looking to shave $170 million in two years from its $1.3 billion operating budget, and has put on hold all new construction and renovation projects. In the current fiscal year, the Princeton endowment has contributed more than $600 million to the budget, far more than the university gets from tuition and other student fees. Harvard has slowed and may pause the construction of its Allston, Mass., campus across the river from its main campus in Cambridge, angering Allston residents who have been living with an enormous hole in the ground.

Now that the fat years are over, even the wealthiest universities are taking a hard look at their operations. As some top administrators have observed, universities often are run in the opposite way from for-profit corporations. Until now, schools have taken steps that increase costs, such as reducing faculty-student ratios, raising professors' salaries in excess of inflation, vastly expanding their physical plants with state-of-the-art science labs and dormitories, and hiring an army of administrators.

The richest universities also have offered increasingly generous student financial-aid packages, angering less-wealthy colleges that can't match such offers. Some Ivies were on their way to requiring only modest tuition payments from families with annual income of less than $150,000 to $200,000 a year. Financial aid remains a priority in most places.

Emblematic of the changes forced by the financial crisis and bear market, Princeton President Shirley Tilghman recently wrote a letter in the Princeton Alumni Weekly titled the "New Normal," stating that "the Princeton of tomorrow will be leaner than the one we know today."

Jack Bogle, the former chief executive of the Vanguard mutual-fund complex and now the head of the Bogle Financial Markets Research Center, is sympathetic to the Ivies. "I think the endowment directors will look at the past year as an aberration, rather than a stain on their record, and that's fair," he says.

A Princeton graduate, Bogle says he doubts the endowments will be able to generate 10% annual returns in the years ahead. The big endowments probably erred in keeping their bond allocations so low, he adds, because bonds "have been the most certain way to protect against stock-market declines." That proved true again last year.

WHILE THE BIG IVIES HAVE strong balance sheets, with endowment assets that dwarf their debt, Moody's Investors Service recently downgraded Dartmouth to double-A-1 from triple-A and is concerned about liquidity issues. "The organizations have fared pretty well, but they need to reassess the relative benefit of certain investment strategies," says Moody's analyst Roger Goodman.

University endowments already are leaner than they were just a year ago, and their prospects for recouping investment losses anytime soon look remote. The brutal market of the past year could mark the end of the alternative-investment boom they abetted, as managers of trend-setting university endowments, as well as their followers in the nonprofit world, move back toward the traditional stocks and bonds that once were staples of their investment portfolios.

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