Four years after the global financial crisis, the road back to healthy economies, markets and growth has been a slow and very hilly one. Endowments are not immune to the difficulties and uncertainties — brought about by political decisions and the coordinated efforts of central banks — that moved markets up and down.
Ups and Downs in Global Markets
The fiscal year ended June 30, 2012 was something of a microcosm of markets since the crisis. The U.S. started the year with the downgrade of its sovereign debt, followed by another round of fear surrounding the Eurozone crisis. This resulted in a significant pullback in equity markets. In the early days of October, the winds changed; and the prevailing view was that central banks would be able to prevent another calamity. Economic growth also showed signs of improvement and all seemed to be on track through March. At this point, there was a renewed fear that the issues in Europe were overwhelming. Coupled with news of slowing growth in China, Brazil, and the U.S., that fear caused markets to pull back again in April and May. The fiscal year ended with renewed optimism led by strong statements from the head of the European Central Bank and a continuation of the Federal Reserve's Operation Twist. The result of all this tumult during the fiscal year was global equity markets falling (6.5)%, global bond markets gaining 2.7%, high yield bond markets rising 6.5%, public real estate gaining 5.3%, and commodities losing (14.3)%. Almost without exception, U.S. markets fared better than the rest of the world.
Protecting Assets in a Volatile Environment
The Foundation’s investments outperformed our benchmarks and posted a slight gain for the fiscal year. It is always difficult to largely end up where you started after enduring so much.
The good news is that the portfolio’s lower risk and sensitivity to equities helped protect assets in this volatile environment. The portfolio was led by investments in Treasury Inflation-Protected Securities, or TIPS, and private capital, each gaining more than 10%. On the flip side, investments in commodities and equity positions based on corporate events gave back more than 10%.
High Debt, Low Interest Rates
It is a bit of a conundrum that most of the developed world has record levels of debt and at the same time enjoys record low interest rates. There is no better example of this seemingly contradictory situation than the reaction of markets to the downgrade of U.S. debt, which in theory means there is an elevated risk as to the ability (or willingness) of the U.S. to service its debt. Basic financial tenets hold that markets should demand higher interest rates to compensate for the increased risk highlighted by the downgrade. Well, the market response is well known; no sooner had the downgrade occurred than interest rates fell. They have continued to fall ever since (with a few minor interruptions). Finance doctrines cannot easily account for the impact of fear on markets. Investors were so fearful of the increased risk signaled by the downgrade that they moved into the safest asset they could find — which just happened to be the very asset that had just been downgraded. Once truly behavioral and other non-financial factors begin to wield an effect on markets, all bets are off. There are simply a number of questions for which there are no definitive answers: about the political or central bank actions that will ultimately be taken, about the impact of these actions on any particular market, and about any contagion to other markets.
A promising start to fiscal year 2011 included a solution to the Greek debt crisis, plugging of the BP oil spill, strong company earnings, and solid economic growth in the U.S. That promise was exemplified by a 24-percent run in global equities. Unfortunately, the promise gave way to reduced economic activity, tepid job growth, the earthquake in Japan, and renewed fears of a European debt crisis. The MSCI All Country World Index of global stocks slowed to 4 percent for the first calendar quarter and returned barely 0.3 percent for the June quarter.
Almost all indicators of economic activity and confidence have flattened, especially in the developed countries, during the spring and summer of 2011. The sharpest downturn has been in the industrial sector. Japan's earthquake seems to be the main problem. Japanese output fell by 15.5 percent in March and this is likely to have had a major effect around the globe, evidenced by the car industry.
Consumer confidence, retail sales and housing prices have all been weaker than expected, especially in America and the UK. The most obvious culprits are the costs of oil and food, which are 30 percent and 40 percent higher, respectively, in dollar terms than they were a year ago. The result is consumers are being squeezed in the developed world. So, there has been plenty for investors to worry about: Japanese disruption, the cost of living, looming austerity and the end of emergency stimulus. There has not been a lot of good news to set against this of late. China is powering ahead; the corporate sector has continued to report good profits (but is still not spending them); and those who sell to the beneficiaries of higher oil and food prices have been quietly smug. The commodity windfall is being spent. Saudi Arabia is embarking on a stimulus program that is said to be worth $166 billion. The emerging economies are still on track to expand by at least 6 percent this year.
Against this backdrop, the Foundation portfolio generated a positive return of 15.5 percent for the fiscal year, driven by public and private equities, real estate, and energy-based investments. While a solid return, the portfolio underperformed its policy benchmark, which has a much greater exposure to public equity markets, and therefore benefited from the aforementioned run of 24 percent during the first half of the fiscal year.
The Foundation has continued to be focused on risk reduction through diversification and understanding what market factors the portfolio is exposed to. The goal has been to provide real value and purchasing power in support of the University's mission, while taking prudent levels of risk and maximizing the return for the level of risk taken. What this means is that in periods exhibiting sharp upward stock market movements as was the case in the first half of the fiscal year, the Foundation performance will lag the benchmark. However, in sharply down markets as seen this summer, the portfolio will outperform. To that end, the Foundation is estimated to be down 2.5 percent for July and August compared to negative 9 percent for equity markets. Another way to measure this approach is risk-adjusted return (Sharpe ratio). The Foundation had a risk-adjusted return statistic of 3.3 compared to 2.1 for the policy benchmark for the fiscal year.
It continues to be a challenging period for investing the endowment, as well as for the global economy and many individuals. Yet, the Foundation is confident that we will continue as we have done before to strengthen the portfolio and produce results that enhance the ability of the University to meet its objectives. The final item presented for consideration is the actual experience of endowments managed by the Foundation since fiscal year 1996, including growth in value and spending allocations made in support of the underlying purposes of those endowments. The market value of a hypothetical $100,000 endowment grew over 18 percent and provided over $83,000 in spending to support the donor's purpose during the past 15 years.
Coming off of a year that included the worst financial crisis since the Great Depression, one might expect anything to be better. Indeed, for the first half of the fiscal year ending June 30, 2010, that was the case as evidenced by very robust global equities markets. The second half of the year told a much different tale, symbolized by the sovereign debt crisis that swept up several European economies.
Even with a critical eye, it may be difficult to pin down the precise start date of the second chapter in the global financial drama. With that said, however, there is no denying that the United States is greatly impacted by events in the rest of the world, and the global economy continues to be precarious.
It seems the first clue that all was not well was the failure of the state-owned Dubai World to meet its interest payments in November 2009. Then came problems faced by the Irish and Icelandic governments along with a couple of the Baltic states. As with the Dubai fiasco, the economic woes faced by these western and central European nations were viewed as minor anomalies.
The first rumblings of Greece’s debt issues during the spring led ultimately to a global fear of contagion in Europe and then the rest of the world. Significant political commitment from the European Union decision-makers produced a bailout plan in April. Despite a further Greek bailout package in the form of a 750-billion euro safety net to bolster European bourses, the market’s judgment was harsh in demanding the slashing of government deficits and spending, or facing the prospect of being shunned by the debt market altogether. By the end of June, Spain, Portugal, Italy, France, Great Britain and Germany had all trumpeted their plans to bring public finances under control. Stock markets across the globe recognized the impact of such reductions on a fragile economy and came to a screeching halt.
Against this backdrop, the Foundation’s endowment investments generated a positive 9.04 percent return for the fiscal year ended June 30, 2010. Public equities posted positive results for the year as well (Wilshire 5000 earned 15.67 percent and the MSCI AC World ex US earned 10.11 percent). Fixed income-type strategies, as captured by the Barclay Global Aggregate Bond Index, generated a positive return of 5.01 percent over the same time period. Yet, while the Foundation portfolio exhibited much lower risk than benchmarks, it underperformed relative to the policy fund benchmark (publicly cited indices including the DJ Wilshire 5000 US Equities Index, Barclay’s Aggregate Bond Index, and MSCI All World ex-US, amongst others), which earned 12.42 percent over the same time period.
The underperformance of the Foundation portfolio came primarily from private real estate, foreign equities and natural resources investments. Natural resources were the only part of the portfolio to actually incur losses. Investment grade bonds, private capital and opportunistic investments provided the greatest benefit to the portfolio.
The pooled portfolio provided $11.4 million in spending allocations in support of endowment purposes. Additionally, $3.9 million in fees were provided for Foundation operations.
Coming into the financial crisis and during this past fiscal year, the Foundation’s focus has been to reduce risk through diversification and enact measures to provide a greater understanding of what market factors the portfolio is most exposed to. The goal has been – and continues to be – to provide real value and purchasing power in support of the University’s mission while taking prudent levels of risk. It has been a challenging period for investing the endowment, as well as for the global economy and many individuals. Yet the Foundation is confident that we will continue as we have done before to strengthen the portfolio and produce results that enhance the ability of the University to meet its objectives.
The final item presented for consideration is the actual experience of endowments managed by the Foundation since fiscal year 1996, including growth in value and spending allocations made in support of the underlying purposes of those endowments. The market value of a hypothetical $100,000 endowment grew over 8 percent and provided over $79,000 in spending to support the donor’s purpose during the past 14 years.
Clearly, this financial crisis has taken a toll on endowment value. However, endowments are the longest term investments and, while the short term pain is high, the long term goals are still achievable and University support continues. It is this last point that is the most important.
Open the original version of this page.