Alternatives: An End Game—see right
Following the lead of more famous investors—Yale’s David
Swensen, most notably—many moved into alternative
investments in the mid-1990s. The result: Institutional assets,
as a whole, became less liquid.
A Shrinking Stock Market Sinks All Ships—p. 25
CLICK HERE >
The liquidity crisis has hit endowments and foundations
harder than others due in part to their reliance on discretionary
contributions, as opposed to the mandatory payments into
many pension funds.
The Cuts—p. 26 CLICK HERE >
Institutions are dealing with a need for cash in different ways.
While some are simply borrowing, others are resorting to layoffs,
salary freezes, and other uncomfortable measures.
The Many Ways To Save Your Skin—p. 27 CLICK HERE >
Another result of the crash: the juggling of portfolios. Pensions
and endowments from across the globe are rethinking their
asset allocation strategies.
“Last Wars”—p. 28 CLICK HERE >
When the current crisis abates, it is unclear whether the
institutional world will see a wholesale change in investment
philosophy. Nevertheless, one thing is clear: Cash is once
Where the Long Term Still Reigns—p. 26 CLICK HERE >
While liquidity is an issue almost everywhere, Australia’s
superannuation system, with its mandatory 9% contribution rate,
is finding the downturn to be a surprisingly mild one.
Sorting Out Alphabet Soup—p. 25 CLICK HERE >
There’s illiquidity, and then there’s illiquidity. For the most frozen
of assets—CDOs, MBSs, SIVs, those three-letter beasts that
have devoured the financial world—new solutions are being
offered by firms looking to cash in on the crisis.
and minus 30%, an unprecedented decline.” The university was
still wealthy, of course, with an endowment of $17 billion, even after
market drops. “Just like any bank, we don’t sit with cash on hand.
We invest it,” he explained, “but we have a large pool of funds—
about $1.5 billion—which is the cash the university can spend at any
The 2009 budget was taken care of, he said, but “the net bottom
line is that, in fiscal year 2010, we expect a $63 million shortfall,
and a total shortfall for 2010 and 2011 of $89 million. If investments
improve in 2010, we’ll have more in the General Fund. If not, there
will be less effect on the downside, because we are already zeroed
out.” He paused and said, again to laughter: “That’s the good news.”
Stanford is not alone: University endowments lost 3% of assets in
the year ended June 2008, and another 22% in the five months
following, for a total of $95 billion, according to annual surveys
by the National Association of College and University Business
Officers (NACUBO) and TIAA-CREF Asset Management. The
problem extends beyond the walls of America’s establishments
of higher learning as well—into pension funds, foundations, and
with institutional investors worldwide—and it is more than just an
issue of shrinking asset bases. Due in part to the broad move
into alternatives, chief investment officers everywhere are finding
themselves short of cash at a time when their sponsoring institutions
need it most. Liquidity, it seems, is no longer considered an old-fogey’s game: Indeed, investors now are finding out that the ability to
access cash is essential to survival.
Alternatives: An End Game
Although prodigious amounts of institutional money shifted out of
equities and into alternatives after the bursting of the technology
bubble, the migration took root earlier, in the bull market of the
After a flattish 1994, U.S. equities started to climb in 1995, and
the risk premium in public equities became increasingly elusive.
Creative investing heads at large institutions came to appreciate
the premium for illiquidity—trading off the ability to sell an asset
quickly for additional return. Because their obligations to retirees or
sponsoring institutions in any single year were relatively small and
their investment horizons were long, pension funds, endowments,
and foundations could afford to lock up a portion of their assets in
illiquid assets such as commercial real estate, hedge funds, and
The leading proponent of alternative investing is David Swensen,
who famously implemented an alternative asset approach for
the Yale University endowment. Swensen’s record and love affair
with esoterica is well-documented but, when he first set the Yale
endowment on its current course, few knew of him or the assets
he seemed to hold so dear. Real estate had long been a favorite of
insurance companies but less so for pension plans, while hedge
funds were primarily a vehicle of high-net-worth investors. Private
equity in the form of venture capital was well-established, but buyout
funds still were fairly novel. Swensen changed this.
His belief went as such: The liquidity premium to private assets is
higher than the volatility premium, or any other premium available
through more rapid public markets, where information flows too
freely to offer high returns. In his 2000 book Pioneering Portfolio
Management, Swensen advised investors to avoid what John
Maynard Keynes derided as “the fetish of liquidity”: “Investors should
pursue success, not liquidity….Accepting illiquidity pays outsize
dividends to the patient, long-term investor,” he wrote.
For years, Swensen was proved correct as the Yale endowment
soared and the liquidity premium embedded in alternative assets
made them big winners in comparison to public equities. A measure of beta for private equity is all but unavailable but, in the case
of the California State Teachers Retirement System (CalSTRS), an
active and successful private equity investor, annualized returns as
of June 2008 were 11.7% for one year, 23.4% for three years, and
24.9% for five years (versus respective returns of - 13.1%, 4.4%, and
7.6% for the Standard & Poor’s 500 Stock Index). As for privately
held real estate, the National Property Index of the National Council
of Real Estate Investment Fiduciaries (NCREIF)—results of which are
calculated before the addition of leverage—posted returns of 9.2%,
15.0%, and 14.7% for the same one-, three-, and five-year intervals.
Hedge funds also beat traditional public market equities, with one-,
three-, and five-year annualized returns of 0.9%, 9.5%, and 9.9% as
of June 2008.
To reinforce alternatives’ success, as institutions amassed their
alternatives portfolios, they performed well over both the short and
long run—thus, the liquidity penalty on alternative asset classes
never materialized between 2000 and 2007. Low interest rates made