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Endowments Adopt New Strategies
Jay Cooper, Whitney Kvasager

August, 2009

Foundations and endowments, and their consultants, are taking numerous approaches to help them meet their capital calls and spending commitments. Strategies to preserve liquidity include allocating to opportunistic fixed income managers, who might provide higher returns through less risky assets; reclassifying public and private equity asset classes into the same bucket; and working with private equity general partners to make them sensitive to investors’ situations.

Whatever the approach, consultants warn that preserving liquidity remains one of the most important issues that foundations and endowments face, in spite of the recent improvements in the markets.

“It’s absolutely not over,” says Dick Anderson, a principal consultant and director of the endowment and foundations practice at Hammond Associates. “The liquidity issue is still very much front and center.”

Stories of high-profile universities trying to sell private holdings or issue bonds to meet budget needs once funded by their endowment have caused nearly every endowment and foundation to ask questions about their own liquidity.

For this special report, we spoke to a wide range of consultants and investment officers, asking about their best practices and ideas for handling liquidity concerns. Here’s some of what they had to say.

Rethinking Public and Private Equity

Unless an endowment sells its private equity commitments on the secondary market, it is unlikely to be able to get rid of those commitments. So when public equity markets drop severely, the institution is left with a higher percentage of assets committed to private equity than previously expected or planned. In some cases, though, endowments can maintain that higher exposure, Anderson says.

When designing an asset allocation, Anderson says Hammond Associates typically groups public and private equity together in a category called “growth equity.” As reported, another consultant, Fund Evaluation Group, has made similar changes to its asset allocation, including putting private equity, public equity and some other investments together in a category called “global equity.”

These asset allocation tweaks have been useful in light of the market downfall and the liquidity issues associated with private equity, experts say.

For example, rather than reducing allocations to fixed income or another asset class to bring public equity allocations back to their previous levels, Hammond recommends that some clients simply maintain a “growth equity” allocation that has a higher commitment to private equity. “Now that they have overallocated to private equity, it’s useful to understand that public equity and private equity share certain characteristics,” Anderson says.

Allocating to Opportunistic Fixed Income Managers

Anderson says some of Hammond’s endowment and foundation clients are “opportunistically looking to credit as a hybrid between equity and fixed income.” Those clients are carving out an allocation within fixed income to opportunistic credit managers, who are likely to provide higher returns than normal fixed income managers, but with less risk than equity managers.

The potentially higher returns can then help meet future capital commitments, and can also help avoid future equity downturns – an appealing prospect given that it was the market crash that helped cause some of the liquidity problems over the past year.

Anderson notes a host of recently- launched opportunistic strategies from managers “who will opportunistically take on risk, but who share the client’s need for protecting the downside.”

These managers invest in a range of credit opportunities including high-yield, structured credit, agencies and senior bank debt. “We’re looking for managers that are very concerned about risk and only take risk where they are getting paid to take risk,” he says.

Considering Cash Allocations

Some endowments have maintained a larger cash position, at least for the short term.

“There have been those who have increased their cash,” says Heather Myers, director of endowment and foundation strategy at Russell Investments. “Many are actively changing their cash allocations, but whether that is only for the next 18 months or two years, I don’t know. I don’t suspect you will see, nor are we recommending, that people have large long-term cash allocations.”

Endowment chiefs agree.

Michael Sullivan, CIO at the University of St. Thomas in Minneapolis, Minn., says the $400 million endowment’s cash holdings increased significantly between January 2008 and May 2009 – but that it won’t stay that way. The investment policy holds cash at zero, but the actual cash holdings have gradually grown to about 16%.

Sullivan says the sharp increase was a tactical decision, not a strategic one, resulting from not knowing where to invest cash in last year’s unattractive, roiling market. Sullivan says that when cash slowly became available during those months – through donations, manager terminations and other events, such as a hedge fund of funds manager closing and returning cash – he simply couldn’t decide the best place to reinvest it.

“It wasn’t a brilliant move. We weren’t trying to time anything; it was a byproduct. We just had cash and we didn’t know what to do so we kept it as cash,” Sullivan says. “The rationale was pretty simple. The market was going through such crazy gyrations and I didn’t know what to do. It was a default decision.”

He says the endowment portfolio is slightly underweight across the board, and that he has started redeploying cash to build up holdings in all asset classes. But he says cash will probably stay around 15% for another three to six months, because new cash is becoming available at the same rate the endowment is investing it.

“From a strategic point of view, cash should always be minimized. It was just that this was such an abnormal time,” Sullivan says. “We are not changing our strategy to have large amounts of cash.”

Donald Lindsey, CIO of The George Washington University, agrees with the latter point. He says he’ll continue to closely monitor liquidity, as annual inflows to the $1 billion endowment are typically smaller than outflows. But he does not plan an increase to the 5% allocation to cash.

“We’ve always been very conscious of liquidity management. But I think there are a number of ways of managing liquidity other than simply holding cash,” he says. “We do have cash, but it’s to meet near-term liabilities.”

Working with General Partners on Capital Commitments

Consultants say they are working closely with general partners of private equity funds to explain their client’s liquidity issues and to get a sense of when the general partner may call for more capital. “We’re talking to the client and the general partner both more,” says Norm Nabhan, managing director and institutional consulting director for Graystone Consulting. The goal is to try to get earlier notice on when capital will be called so the endowment can do a better job of budgeting its cash flow around that, Nabhan explains.

“Most general partners are well aware of this and are taking these liquidity constraints into consideration,” adds Hammond’s Anderson.

Changing Policies on Pass-Through Assets

Some community foundations that manage “pass-through” assets for other non-profits have had to develop policies defining how those non-profits would be allowed to pull those assets from the foundation, says Chris Meyer, managing principal and CIO for consultant Fund Evaluation Group.

If the foundation were to give underlying institutions their investments back in the form of cash, they would have to sell their liquid assets to meet those obligations, leaving the community foundation, and the other non-profits that invest through the foundation, holding all of the illiquid assets.

“Either you need to make it irrevocable, or they can give back the assets in-kind” as opposed to cash, Meyer says. “It’s forced them to look at those policies and understand how it would affect everybody.”

More Careful Planning

Another important aspect of preserving liquidity is much more detailed planning on the part of both the endowment and its consultant.

Russell’s Myers says university endowments and foundations are figuring out now how much liquidity they’ll need and when. She says some investors are working to ensure a certain amount of short-term liquidity that they can access over about 18 months, and then forecasting and planning for their liquidity needs for the following years.

“The focus has been on looking at investment policies in terms of how liquid they are,” Myers says. “The pure investment policy statements will be adding liquidity portions to show where they’ll get their liquidity from. They’re looking at it in terms of time buckets.”

She says the length of time endowments and foundations aim to create enough liquidity for differs among institutions and depends on individual funding needs, such as capital improvements, staff salaries and programs.

The $150 million Ball State University Foundation established a $15 million line of credit with local banks in spring 2008 to make sure it could handle its liquidity needs. But to avoid exceeding that credit capacity, CIO Thomas Heck has created a detailed 12- to 15-month cash flow projection so he can see when cash will be needed and how much.

“We’re doing an asset allocation kind of approach to liquidity. We’ve gone through and classified our investments based on days, months, quarters, limited partnerships,” he says. “Within each asset class, I include a liquidity breakdown so we can see where the liquidity problems may be from a rebalancing standpoint.”

Accounting for a Fundraising Decrease

The planning process also includes working closely with the endowment’s fundraising office to get a sense for how much fundraising into the endowment is down, and how the decrease in fundraising could play on liquidity issues.

“Fundraising is down for most of them,” says Graystone’s Nabhan. “There has to be constant dialogue about what fundraising they’re involved in.”

For more articles like this one, go to
FundFire is an information service of Money-Media, a Financial Times company.


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