1 / 37

Effective Endowment Management

Effective Endowment Management. CAIS / NYSAIS Business Affairs Conference May 4-6, 2005. Topic 1: Writing a strong, effective investment policy. Why? Fiduciary responsibility demands it Written guidelines protect your endowment from market-driven departures from sound long-term policy

roman
Download Presentation

Effective Endowment Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Effective Endowment Management CAIS / NYSAIS Business Affairs Conference May 4-6, 2005

  2. Topic 1: Writing a strong, effective investment policy • Why? • Fiduciary responsibility demands it • Written guidelines protect your endowment from market-driven departures from sound long-term policy • It serves to educate and inform all parties involved

  3. Characteristics of a well-written policy • Detailed and specific • Includes sound rationales in the form of explicit answers to “Why?” questions • Individual components are logically consistent

  4. Seven necessary components • Return objectives • Relevant risks • Asset allocation guidelines • Asset class rationales • Rebalancing • Benchmarks • Indexing

  5. Return objectives • Financial • The overall financial goal of the endowment is to maintain its inflation-adjusted market value while contributing approximately 5% per year to the college’s operating budget (i.e. CPI + 5%) • Investment • Earn a total return matching or exceeding the portfolio’s composite benchmark • Earn a total return matching or exceeding your peer group

  6. Relevant risks • Volatility • Decline in real value of endowment • Peer risk • Headline risk • Inflation • Deflation • Failing to achieve your policy objectives

  7. Rebalancing • Importance • Failure to do so increases risk and reduces return • Difficult to implement • Counterintuitive • Doesn’t work until trend reverses • Conclusions • An automatic rebalancing rule is extremely important • The method of rebalancing is less important than enshrining the decision in the investment policy and implementing it rigorously

  8. Benchmarks • Definition: The standard or index against which performance is measured • Examples at the portfolio level: • CPI + 5% • Composite benchmark (sum of asset class benchmarks x policy weights) • Peer performance • Extremely important because: • Poor benchmarking leads to poor (i.e. misleading) analysis • Poor analysis leads to poor decision-making

  9. Facts about indexing • Logic dictates that the average manager underperforms • Historical evidence proves that the average manager underperforms • History shows that past performance does not predict future performance • No one benefits from indexing—except the investor!

  10. Past performance is not predictive Where did most top quartile managers come from? Where did most top quartile managers go? 1996-99 2000-03 1996-99 2000-03 Top Quartile Second Quartile Third Quartile Bottom Quartile Source: Frank Russell Company

  11. Views on indexing • How will you beat the odds? • Smart people? • Contrarian decision-making? • A policy on indexing is crucial to avoid jumping back and forth between active management and indexing

  12. Is your investment policy strong and effective? A quick test. • Does your policy meet fiduciary standards by addressing all the issues a prudent expert would address? • Has the policy achieved its goals in the past? If new, is it likely to do so in the future (based on reasonable assumptions)? • Is the policy specific enough and clear enough that a stranger could properly manage your endowment based solely on the policy document?

  13. Topic 2: Good governance and policy implementation • Roles & responsibilities • Board, investment committee, staff, & consultant • Committee structure • Size, tenure, & composition • Policy implementation • Solutions • Conflicts of interest • Frequency of meetings • Reporting

  14. Roles and responsibilities

  15. Committee structure & role Traditional Best Practices

  16. Problems with traditional structure… • Lack of expertise, experience, resources, education and/or time • Diffusion of responsibility • Group decision-making …lead to common mistakes

  17. Common mistakes… • Favoring asset classes, strategies, and managers that have enjoyed recent success • Substituting one’s own (shorter) time horizon for that of the perpetual time horizon of endowment • Overconfidence in the ability to market-time and select managers that will outperform in the future • Selecting managers for all the wrong reasons …lead to poor implementation and value lost

  18. Policy implementation • Two components • Manager selection • Market-timing (all departures from policy) • Determine success of policy implementation by calculating the value-added or lost—in dollar terms over a long period of time. • Present results to the Board and the Committee

  19. XXXXX College endowmentHistorical performance Effect on Market Value • Expected endowment market value: $1.01 billion • Value lost through market timing: $6 million • Value lost through manager selection: $100 million • Actual endowment market value: $907 million

  20. Solutions to poor policy implementation • Revise governance structure • How? If endowment exceeds $100 million: • Institute or revise written guidelines that impose best practices on committee structure (size, tenure, composition) • Hire an experienced CIO and create a strong investment office • Delegate significant authority to the CIO • Employ specialized consultants or advisors

  21. Solutions to poor policy implementation • If endowment is less than $100 million: • Create a strong investment policy • Resist all attempts to improve or tweak this new policy for several years • Institute or revise written guidelines that impose best practices on committee structure (size, tenure, composition) • Delegate policy implementation to an individual • Index large percentage of traditional asset classes

  22. Consultant roles • Proper (because they usually succeed): • Assisting Board, Committee, and CIO in performing their respective tasks • Serving as an independent voice • Functioning as an extension of staff • Improper (because they often fail): • Choosing managers • Substituting for a strong CIO

  23. Conflicts of interest • Disclose • Recuse • Address in formal written policy • Require full disclosure of any conflicts, potential conflicts, or appearance of conflicts • No investing in firms related to committee members • May invest with firms represented by board members, but board members may not promote firm to staff or committee members

  24. Frequency of committee meetings • Four times a year is most typical • Twice a year is enough if the committee is properly focused on major policy issues • Monthly is probably necessary if committee insists on filling CIO role

  25. Reporting • Traditional: 50 pages of detail that provide very little useful or actionable information • Best practices: • Where do we stand? (Asset allocation) • How have we done? (Performance) • vs. financial objective (CPI + 5%) • vs. policy (composite benchmark) • vs. peers

  26. Topic 3:Alternative Investments What are they? • Informal definition: • Any investment or asset class that is unusual, unfamiliar, or causes discomfort among those responsible for investing. • Formal definition: • Investments with unique risk and return properties that are not generally obtainable from traditional asset classes.

  27. Alternative investments —marketable or liquid • Hedge funds • Distressed debt • Long/short • Market neutral • Managed futures • Arbitrage strategies • Convertible • Fixed income • Merger • Capital structure

  28. Alternative investments —non-marketable or illiquid • Real Assets • Energy • Real Estate • Timber • Commodities • Private equity • Venture capital • Buyouts

  29. Rationale for alternatives • Higher returns • Greater diversification • Non-correlated returns • Reduced volatility • Can fulfill certain policy objectives better than traditional investments

  30. Challenges of alternative investments • Require greater expertise • Lack of transparency • Benchmarking • Too much money chasing too few good managers • Expensive

  31. Risks • Low correlation – and stock market soars • Committee panics and retreats at exactly the wrong time • Manager risk • Career or headline risk

  32. Manager risk Ten-year Performance Data Through 2002 Top Bottom Quartile Quartile Difference U.S. Bonds 7.9 % 7.1 % 0.8 % U.S. Stocks 12.5 % 8.8 % 3.7 % Int’l Stocks 7.8 % 4.7 % 3.1 % Hedge Funds 14.3 % 8.5 % 5.8 % Buyouts 38.3 % 12.9 % 25.4 % Venture Cap 39.0 % 10.6 % 28.4 %

  33. Risk mitigators • Ensure that all decisions are driven by sound policy • Perform strong due diligence • Use a fund-of-funds

  34. Key investment policy questions: • Does your investment policy address the seven key components? • What types of risk are most relevant to your endowment? • Are these risks codified and reflected in the policy? • Does rebalancing regularly and automatically take place? • Are all benchmarks appropriate and effective ones? • Has your institution added value by selecting active managers? • Has your institution added value by market timing? • Does your policy pass the three-part test from the prior slide?

  35. Key governance/policy implementation questions: • Has your policy implementation—market timing and manager selection—added to or detracted from endowment returns? • What has been the resulting impact to the market value of your endowment? • Is your investment committee focused largely on broad policy and strategic issues? • Do you have written guidelines governing the structure of your committee? • If your endowment exceeds $100 million, do you have a strong CIO to whom you have delegated significant authority? • If your endowment is less than $100 million, have you considered the five steps to success?

  36. Key questions on alternative investments: • Can your endowment benefit from alternatives? • Why are you interested in alternatives? • Are you willing to make a significant, long-term, policy-driven commitment to alternatives? • Are you willing to incur the challenges and risks of alternative investments? • How will you access the expertise necessary to invest in alternatives?

  37. Helpful Resources for the Business Officer • Pioneering Portfolio Management, by David Swensen • Winning the Loser’s Game, by Charles Ellis • Endowment Management: A Practical Guide, by Jay Yoder (available from www.agb.org)

More Related