With equities in the doldrums, some Canadian universities are upping their stake in hedge funds

Date: Sunday, May 4, 2003

Battered in recent years by listless stock market returns, some of Canada's largest universities are picking a new place to invest their endowments: hedge funds. The University of Toronto, McGill University and the University of British Columbia — which control the country's three largest endowments — are among the schools that are paring their exposure to stocks and turning to riskier investments. The schools are exploring hedge funds and even some venture capital investments because even as the stock market has stumbled, they use about 5 per cent of their endowments, huge pools of donated money, to fund scholarships and awards and even pay for faculty positions. In order to maintain the value of the endowments, their investments need to generate at least a 5 per cent return. Among the most aggressive hedge fund investors are Carleton University, which invests $16 million, or 14.5 per cent of its $111 million endowment in hedge funds, and the University of Toronto, which has about $200 million of its $1.1 billion endowment in hedge funds, up from about $140 million four months ago. "It's like the old proverb where you don't want to put all your eggs in one basket," said Felix Chee, vice president of business affairs at U of T. "The party's been over the past couple of years in equities. We just realized the fat cow isn't around any more." While the school's endowment lost 9.6 per cent of its value last year, after a 3.2 per cent drop in 2001, using hedge funds helped narrow endowment losses over the last two years, Chee said. Hedge funds, on average, reported gains of 3.4 per cent a year ago, according to the Credit Suisse First Boston/Tremont Index, used to gauge hedge-fund performance. Over the same period, the Standard & Poor's 500 stock index plummeted 23.4 per cent. Chee oversees eight portfolio managers at the University of Toronto Asset Management Corp., the school's in-house investment unit. He said the school started investing in hedge funds "not so much because there's nothing left to buy, but because they bring some diversification." Similarly, the University of British Columbia first turned to hedge funds last year and now invests about $30 million, or 5 per cent, of its $600 million endowment in hedge funds. The west coast school may soon boost its exposure to hedge funds to 10 per cent, said Roger Polishak, the school's associate treasurer. At the University of Western Ontario, the school's investment committee, which oversees its $152 million endowment, has been reviewing hedge funds and may make a "small allocation" to the category this year, said Stuart Finlayson, the school's treasurer. "We'll probably start with 5 per cent," he said. "This has been something we've been looking at for six months to a year, but you want to understand the process and do your due diligence before getting into it." While hedge funds can generate rich returns, they are typically riskier than investing in broad-based mutual funds. Many hedge funds are often leveraged with borrowed money and, unlike mutual funds, lock in cash and don't have to regularly report results. That means investors typically don't know the performance of the funds for months. One technique typically employed by hedge funds is selling short, in which an investor, anticipating a decline in the price of a stock, borrows its shares and later, at some point, must buy them. For instance, if 100 shares worth $50 apiece are borrowed and the share price falls to $40, the investor can then buy the shares for $4,000. Then he must repay the lending broker, and claim a $1,000 profit. But the results aren't always rosy. In 2001, the Art Institute of Chicago invested 6 per cent of its $667 million (U.S.) endowment with Dallas-based Integral Investment Management LP. The museum lost nearly $50 million when the fund collapsed. Five years ago, Harvard University's endowment — then valued at $13 billion (U.S.) — lost $1.3 billion on hedge funds. In the same year, Brown University in Providence, R.I., suffered a blow when a hedge fund in which it invested lost nearly half of the $2.7 billion (U.S.) it managed after poor investments in Russian bonds and Latin American stocks. Some endowments and foundations, such as New York's Rockefeller Foundation, eschew hedge funds altogether. "They've been known to blow up over the years, but the right manager avoids that by having a broad portfolio," Polishak said. The U of T's Chee concedes hedge funds "have a mystique and an opaqueness that makes them less transparent." The U.S. Securities and Exchange Commission is in the midst of investigating the loosely regulated $600 billion (U.S.) hedge-fund industry and might introduce new rules on how it operates within a year. The SEC is reportedly considering capping the amount of borrowed money hedge funds can use and introducing surprise audits. Losses suffered by schools like Harvard and Brown haven't stopped many U.S. schools from coveting hedge funds. The 556 endowments that responded to a recent survey by Greenwich Associates, a consultant to institutional investors, said an average 7.8 per cent of their money is invested in hedge funds. Yale University's $10.5 billion (U.S.) endowment fund has $2.6 billion in hedge funds. Corporate pension funds, by contrast, have an average 0.4 per cent in hedge funds, the study said. At McGill, hedge funds have been part of the school's endowment, now valued at $700 million, since 1994. McGill now invests about 12 per cent, or $84 million, of its endowment in hedge funds and is allowed under school bylaws to commit as much as 15 per cent, said John Lineburner, McGill's treasurer. To be sure, smaller universities like Ryerson, or Wilfrid Laurier, probably shouldn't even consider hedge funds or venture capital because of the added costs involved. "If we decided to put some money in hedge funds we'd be using a manager, and I guess we're not ready for that," said Hugh Gillis, secretary of the investment committee at St. Francis Xavier University in Antigonish, N.S., which has a $39 million endowment. Instead, the school's investment committee does its own stock picking. (Last year, its rate of return was minus 2.1 per cent.) John Griswald, executive director of Commonfund, a Connecticut financial adviser to 1,400 schools, hospitals and foundations that manages $29 billion (U.S.), said endowments ought to have assets of at least $250 million before they consider hedge funds. "This is not for everybody," Griswald said, "and right now, people aren't taking the risks as seriously as they might." Many schools that hire fund managers to invest in hedge funds aren't doing enough to police them, Griswald said, adding that most hedge funds for schools require initial $25 million investments.