The Investor's Consigliere

Singapore Moving Away from the Harvard Model of Endowment Investing

Gillian Tett column in the FT. An excerpt:

. . . After all, the whole point of a sovereign wealth fund (or endowment fund) is that it is supposed to take a long-term perspective, which should enable it to ride out any temporary storms.

However, in the past two years, sovereign funds discovered that the long-term mantra provides far less protection than previously thought. For by investing in private equity and hedge funds, the GIC (and others) ended up being exposed to the vagaries of their co-investors - and some of those had short-term horizons, or mark-to-market triggers. Thus what hurt groups such as the GIC was not just the issue of asset correlation, but a contagion of investor style as well.

That raises some big questions about how the GIC (and others) should conduct themselves. Should they only co-invest with similar investors in the future? Could they now demand detailed lists of their co-investors (even if they hate providing such data themselves)? Could they ask to be paid for assuming illiquidity risk? Or should they dump external managers altogether, and bring that activity "in-house"?

BTW, if someone is moving away from it, it's called the Harvard model. If someone is moving towards it, it's called the Yale model.

Cooper Union's Endowment

The Times (of London) profiles Cooper Union's endowment and its head John Michaelson.

"Men never do anything well except through necessity," wrote Machiavelli, a charter member of the Consigliere Hall of Fame.  The fact that Cooper Union charges no tuition and must rely on its endowment for 70% of its expenditures has concentrated Michaelson's mind on two simple goals: "no material losses" and "a constant cashflow to meet expenses." 

The other endowments mentioned in the article, which rely on endowment income for only about a third of expenditures, all follow the Yale Model of illiquidity-embracing strategies like PE, VC and hedge funds, which promise neither of Michaelson's two guiding principles.  They thought they'd be compensated for this over time in the form of higher returns, in some cases correctly, and consoled themselves that their ancient institutions could handle short-term declines in endowment value with equanimity.  What they did not count on was that during times of crisis, short-term declines in the endowment are correlated with things like the willingness of parents to afford high tuition, the propensity of faculty and staff to resist strongly any layoffs or strict cost control measures, and the propensity of alumni to make up any shortfalls with increased gifts.  It was a political and psychological miscalculation more than an investment miscalculation.  In a sense then, the dynamic faced by the sophisticated endowments of the more famous universities was more similar to Cooper Union's dynamic of discipline enforced by necessity than they realized.

Warren Buffett New York Times Op-Ed

The last one urged people to "buy American" stocks.  This one is a warning about the side effects to be expected from the extraordinary fiscal and monetary measures that have been taken to turn around the economy.

A little background:  Buffett's father Howard was kind of a psychopath about inflation--he thought FDR would turn the US into the Weimar Republic.  His son was never as bad, but throughout his career the specter of inflation has always guided his investment decisions.  In 1977 he wrote an essay for Fortune called "How Inflation Swindles the Equity Investor" which is the best analysis of the effect of inflation on corporations I've ever read.

Buffett almost guarantees that one day the United States will face higher inflation as a result of the actions being taken.  Yet here we sit with the 10-Year Treasury yielding 3.53%.

P.S.  Some might argue that this op-ed conflicts with the last op-ed he wrote, in which he urged Americans to buy equities.  If we're in for inflation, stocks will do poorly, like they did in the 1970s.  But read the first op-ed closely and you'll see that Buffett recommended only that Americans buy equities as an alternative to cash, which is perfectly consistent with his thinking in the second op-ed.  In fact, if you fear inflation your money may be best off in equities (public or private, in the sense of being a business owner), even more so than gold.

Disclosure: Long Berkshire Hathaway

P.P.S.  If you're a member of SumZero, you can see my write-up of a stock I think will do well in an inflationary environment.

Bloomberg Article on Endowment Losses

Read it here.

Because it's a Bloomberg article and not an analysis, the piece didn't ask the two questions I'd most want to know the answer to:

1)  Which universities screwed up the most in terms of the permanent, as opposed to quotational, endowment losses they sustained?  In order for a loss to be quotational rather than permanent, it must satisfy two conditions:

    a)  It must represent a temporary deviation of market value from a relatively unchanged long-term intrinsic value.  Berkshire Hathaway falling 40% to me is a quotational loss.  A highly levered PE fund whose equity is completely wiped out, never to return, is a permanent loss.

    b)  The institution must have the ability to continue to hold the asset until its market value returns to its intrinsic value.

2)  Recalling that the word "economics" comes from the Greek words oikos, meaning "household, and nomia, meaning "management":  Which universities screwed up the most in terms of the basic household financial management that is seldom taught in universities, much less business schools: don't set out to spend more than you know you will earn.  Also recall that, GAAP rules notwithstanding, the word "earn" should mean cash generated by an asset itself, not cash generated from selling an asset.  The latter should more properly be looked at as "receiving a lump sum today in exchange for giving up the right to receive future earnings from the asset."  A $37 billion dollar endowment upon which you must rely to meet annual cash operating expenses (unfortunately professors, janitors, utility companies, etc. do not yet accept payment in the form of LP interests in illiquid PE funds) does you little good if its assets do not themselves generate enough income (from dividends, distributions, rents) at a time when you can't sell them either. 

This Vanity Fair article on Harvard is a little more interesting. 

Little Addendum: America's greatness is its freedom of the press, but Graydon Carter's greatness is his menefreghista attitude about hypocrisy (your consigliere is trying to teach you his native language).  At the highest levels, as practiced by masters like Pietro Arentino and Dean Martin, the menefreghista attitude can only be admired.  Here's what I mean:

The owners of Vanity Fair depend for their very livelihood on very conspicuous consumption-no one needs to buy those Chanel dresses advertised on the first pages of the August issue, or the Private Collection Jasmine White Moss perfume from Estee Lauder advertised on the next pages, or the Gucci stilettos+dress+gigantic handbag on the next (although I'm sure whatever reptile that handbag came from needed his skin), or the . . . you get the idea.  The employees of Vanity Fair also depend on consumption, especially when the owners of Vanity Fair are consuming it on them: the nice salaries, the beautiful cafeteria, the town cars home, the $55 macaroni-and-cheese dinners, the . . . you get the idea.  So this particular magazine probably shouldn't run an article scolding Harvard University for its lack of Puritan virtue the handling of its financial affairs.  But it runs it anyway, and it's a good article too.  So learn that new word, readers: M-E-N-E-F-R-E-G-H-I-S-T-A.

Spencer Jakab on Value Investing

In the FT.  A sample:

"You could argue that value investors could have invested with a greater margin of safety," said John Buckingham, who manages the value-oriented Al Frank Fund.

Tantalising opportunities to buy seemingly enduring franchises such as Bear Stearns or Fannie Mae for pennies on the dollar became painful lessons in risk management and diversification.

"The problem that value managers face is that we're closet quants," said Mr Buckingham. "When you're looking at what has worked historically and what valuations were at that time, you want to back up the truck and go in."

The Greenwich Associates 2008 US Investment Management Study

is summarized here--you have to buy the full report.  I'll talk my own book by highlighting the following quote:

But the dramatic variation in performance among individual hedge funds last year reinforced the critical importance of institutional due diligence capabilities.

The level of due diligence required to assess the people, process and philosophies of both traditional and alternative investment managers can only be achieved with adequate resources and staffing, the study says.

However, the typical US institution employs only two professionals to select and supervise external investment managers - a number that was essentially flat from 2007 to 2008 but is down from the 2.5 average across all institutions in 2006.

Only the largest public and corporate pension plans expanded internal staffing for manager selection and supervision last year, with the average staff among corporate plans with more than USD5bn in assets increasing to 3.4 full time equivalents in 2008 from 2.9 in 2007, and average staffing among public plans with at least USD5bn increasing to 5.8 FTEs from 4.5 FTEs.

'It is impossible to identify those managers with the skill and consistent, repeatable processes needed for investment success without sophisticated due diligence capabilities,' says Greenwich Associates consultant Dev Clifford. 'The real lesson of 2008 is that institutions need to either build up these capabilities in-house, or acquire them externally. Doing without is not an option.'

In January I linked to a Barry Ritholtz post about underinvestment in hedge fund due diligence.

Here is a another Greenwich Associates study from January, co-authored with SEI, called "Hedge Funds Under the Microscope."

Jeremy Grantham Article: "Reinvesting When Terrified"

Read it here. 

More on Gold: Some Heavy Hitters Speak

Batting first:  Peter Munk of Barrick Gold, in the FT.

Batting second:  David Einhorn, John Paulson, Kyle Bass et. al., in the WSJ.

And batting third (baseball fans know the best hitters hit third, not cleanup--see Barry Bonds in his prime, Babe Ruth, and the greatest hitter/fly fisherman who ever lived):  Warren Buffett, on CNBC (here too).

Mark Hulbert on the Great Depression

In Barron's. 

Hedge Funds: The Road Back

Eric Jackson of Ironfire Capital makes some interesting points about the future of hedge funds.