ANALYSIS

Endowment model endures despite alternatives pain: Cambridge

As Harvard Management Company (HMC) begins shedding 25 per cent of its workforce after incurring a 22 per cent loss since the beginning of the financial year, its investment consult, US firm Cambridge Associates, says the “endowment model” is not impaired.

HMC and other endowment clients of Cambridge Associates, Yale and Stanford, draw much of their alpha from absolute return strategies that sometimes invest in illiquid assets. But Celia Dallas, head of published research with the consultancy, said alternatives were not the essence of an endowment fund portfolio.

Dallas said the perceived “endowment model” was a “relatively complex approach to investing” that could not be simply regarded as any investment portfolio with a high allocation to alternatives.

Among other attributes, such as resourcing and implementation, she said the endowments portfolios reflected a long-term investment timeframe, high allocation to equities to meet near-term spending requirements, hedges against
“fat tail” macroeconomic risks, and an adherence to value investing principles.

She said “even the most exemplary practitioners of the endowment model” suffered in 2008, but that the right alternatives were still capable of generating alpha and providing diversification.

“However, the landscape has changed and so have the skills necessary to succeed,” Dallas warned. “With long-only equities and credit valuations at multi-decade lows, investors should be judicious in determining when to pay higher fees and incur illiquidity associated with alternative assets.”

In November 2008,

Dallas said the consultancy maintained its “long-held belief that alternative investments play an important role in institutional investors’ portfolios”.

“In fact, as previously closed hedge funds open to new money due to redemptions and distressed investing opportunities, investors may have a unique opportunity to invest in top-notch funds,” she said.

Secondary markets also allowed investors to buy “significantly discounted positions” in alternative assets.

After returning 8.6 per cent for the 2007-08 financial year, the $29 billion endowment managed by the HMC began underperforming in the second half of calendar 2008.

The “targeted reductions” now taking place would include manufacturing, backoffice, IT, human resources and legal personnel, HMC said in a statement.

But it is understood that the reduced headcount would not result in a smaller proportion of money managed internally at HMC. The endowment runs a large portion of its assets internally, “in some respects looking more like a long-short hedge fund than a traditional endowment,” Ian Kennedy, global director of research with Cambridge associates, said.

As endowments experienced negative returns, they should remain focused on their core competencies and relative weaknesses, and invest accordingly, he said.

“All endowments should focus on prospective return opportunities and should avoid the classic behavioural risks of chasing yesterday’s great performers in asset classes or managers, chopping and changing course as the investment winds blow.”