Call it the Great Liquidity Squeeze of 2008: Alternatives-heavy endowments found this fall they could access less cash from their portfolios just when they needed the money most.
Universities affected include Harvard, Princeton, Yale and the University of Virginia.
So far, endowment investment executives remain committed to their asset mixes, experts say, but many have been forced to scrimp for cash during this fall's sharp market declines.
“It's a little soon to say for sure, but I don't see people making dramatic changes. They may tweak their allocations, but I'm not seeing a move toward fundamental change in asset allocations,” said Margaret Foley, director of the Boston-based endowment and foundation resource center of BNY Mellon Asset Management.
Endowment chief investment officers have plenty of tweaking room when it comes to alternatives, given the significant allocations many endowments have made to hedge funds, real estate, private equity, real assets and other niche investments. Endowments with $1 billion or more in assets had an average of 39.5% invested in alternatives as of June 30, 2007, the most recent data collected by the National Association of College and University Business Officers, Washington. The smaller the endowment, the smaller the alternatives allocations, the NACUBO survey showed.
As for the liquidity situation, a NACUBO white paper said: “This fall, a number of forces collided almost simultaneously to produce concern on campuses throughout the country about the liquidity of institutional investments.” According to the paper and other sources, those forces included unexpected liquidity constraints, higher financing costs and scarcity of available credit to finance university infrastructure projects.
But some of the investments that universities traditionally have turned to for cash — a number of hedge funds and short-term bond and cash funds — suddenly restricted redemptions. In particular, sources said freezes on withdrawals from two short-term fixed-income funds by endowment specialist Commonfund, Wilton, Conn., tied up the operating cash of a large number of colleges (Pensions & Investments, Oct. 13).
Safety disappeared
“What you always thought of as safe assets that you could turn to for cash were gone in September and October. The failure of short-term funds meant almost everyone, even sophisticated investors, lost access to operating cash. The cash crunch has been very pervasive,” said Heather Myers, director, endowment and foundation strategy, in the New York office of Russell Investments.
In addition, a number of universities that relied on variable-rate bonds to finance campus construction projects were slapped with unexpected and abrupt increases in debt-service payments, according to NACUBO.
As a result, many university chief financial officers are cutting costs. Some are turning to the endowment to provide more cash for operating expenses, scholarships and financial aid and construction projects.
While universities are being squeezed on covering their operating costs, many endowments are being hit with capital calls from their private equity managers trying to take advantage of much cheaper prices for potential acquisitions.
Another problem for endowment CIOs is that the value of their publicly traded equity allocations dropped well below target asset allocations after horrendous stock market returns in September and October. That decline has skewed many endowment portfolio weightings heavily toward alternatives like hedge funds, private equity and real estate, which are near or over target allocations for many endowments, consultants said.
But private investment overweighting is a problem that may take care of itself. While hedge fund and most real asset portfolios are valued monthly, valuations of much less liquid private equity, timber and real estate tend to lag by at least a quarter. Sources said valuations of private equity and real estate portfolios likely will be marked down sharply, eliminating the need for significant and active rebalancing.
“A lot of endowment CIOs have been caught temporarily with far too much invested in private equity, hedge funds and other alternatives,” said a portfolio strategist from a large money manager who asked not to be identified.
“An endowment has a totally different risk profile than the rest of the university. While the college CFO can't borrow cheaply and other sources of financing are drying up, he's looking to the endowment for cash. But because the endowment is supposed to be managing assets in perpetuity, assets tend to be fairly illiquid. There can be some tension between the CIO and the college CFO about whether endowment investments should be more conservative and less illiquid,” the source said.
Still, experts say most endowment officers are not making major allocation shifts. Rather, they are making tactical, short-term moves to shake loose some liquidity while maintaining their long-term strategic asset allocations, said Diane Garnick, the New York-based investment strategist for Invesco Ltd. “The level of endowment officers' conviction about the efficacy of their investment processes remains very high. They know their processes are backed by years of academic research and that supports their conviction,” Ms. Garnick said.
BNY Mellon's Ms. Foley agreed. “The so-called endowment model, one that is reliant on alternatives, has been in place for decades and has worked really well for them. One quarter-plus returns, even though the time period feels much longer because of the severity of the decline, is not going to faze investors whose time frame is into perpetuity,” she added.
Although most university investment officers aren't making wholesale asset allocation changes, the current environment is forcing them to look more deeply at the illiquidity risk of their overall fund as well as hidden land mines within manager portfolios.
Russell's Ms. Myers noted that “everyone is learning about liquidity, when you need it and where you can get it. And the investment policy document is under some scrutiny. If you had a great policy regarding liquidity, great. If not, it's time to have that conversation.”
Consultants at Cambridge Associates LLC, Boston, began to counsel clients about market risk early last year, and many adjusted their long-term liquidity plans accordingly, said Celia Dallas, managing director and head of published research. Even so, “September and October market returns were so unpredictable — it was such an extraordinary market event — that it makes you really question your downside assumptions.”
Ms. Dallas said that while “investors recognize the powerful return potential of alternative investments within their portfolios,” and those with long-term programs remain committed to alternative investments, “this environment has forced them to examine the nitty-gritty details of every manager in their portfolios. Things that you thought were liquid — for instance, commingled funds — in some cases ended up not being so liquid as managers were forced to protect investors by restricting redemptions.”
