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Rebalance?

What is the most important financial decision facing Williams right now? Whether or not to rebalance the portfolio because of market turmoil. Recall our discussion of the College’s asset allocation. Williams has 50% of its endowment in equities, slightly more than half of that in the US, benchmarked (I think) against the Russell 3000. You can check the performance of the Russell 3000 by looking at its exchange traded fund, IWV.

The Russell 3000 is down more than 25% since June 30. International stocks are down, if anything, even more. (I think that the College uses MSCI EAFE (down 38%) as a benchmark for its 18% allocation to non-US developed markets. MSCI EM (down 47%) is probably the benchmark for the 5% in emerging market equities.)

Assume that the College met its asset allocation plan as of June 30th. That would imply an investment of approximately $900 million (50% of the $1.8 billion endowment) in global equities. Given weighted losses of around 31% and ignoring either over or under performance by the College’s investment managers, this means that the College has lost around $300 million in its equity investments in the last 15 weeks.

Ouch!

Yet, today, Chief Investment Officer Collette Chilton is not worried about the money that has been loss. She is focused on what the endowment should look like going forward. Should the College rebalance in response to these dramatic swings? Should it buy more stocks to bring the actual allocation back to the target? Yes. Will it? Depends on if Collette Chilton knows what she is doing.

Yale CIO David Swensen tells the story (page 329 in Pioneering Portfolio Management) of Yale’s response to the stock market crash of 1987. Yale bought stocks and sold bonds in order to bring its asset allocation back in line after stocks had fallen and bonds had risen. Swensen explains how disciplined adherence to a long-term asset allocation plan forces endowment managers to buy low and sell high. He also points out that this is very hard to do. The natural reaction after stocks fall is to sell.

Assume for the moment that other parts of the Williams endowment have stayed constant. (This is almost certainly false.) The 30% fall in equities means that, instead of having 50% in equities overall, Williams now only has 40% — $600 million out of a total endowment now at $1.5 billion. We need to invest another $150 million in equities to get back to 50%. This is what it means to buy low. Williams could do this via futures at relatively low cost, without (temporarily) cutting back on other investments.

Are we doing that? I doubt it.

Now, to be fair, it is also reasonable at this point to stand pat. Other parts of the endowment are probably down significantly as well. Williams may be down $600 million for the fiscal year at this stage. (That’s a terrifying topic for this week-end’s meeting of the Trustees!) If true, then our $600 million exposure to equities is consistent with the asset allocation target of 50%. In that case, there is no need to rebalance.

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#1 Comment By frank uible On October 17, 2008 @ 12:10 pm

If it were my dough, I’d treat it as a buying opportunity and move in a major way from cash, cash equivalents and bonds toward a greater position in value equities – but I tend to be non-anylytical and fairly risk tolerant.

#2 Comment By Ronit On October 17, 2008 @ 2:48 pm

It is certainly far less risky to be 50% in equities now than it was a year ago. On the other hand, you have people like Stevie Cohen going to 50% cash from now until January. I have no idea what Ms. Chilton should do.

#3 Comment By ’10 On October 18, 2008 @ 6:04 pm

From Morton O. Schapiro
to WILLIAMS-STUDENTS@williams.edu
date Sat, Oct 18, 2008 at 5:53 PM
subject The Effects of Economic Uncertainty on Williams

To the Williams Community,

As you would expect, much of our just-ended meeting of the Board of Trustees
focused on current economic uncertainties and how they might affect the
College and its members.

Recent swings in financial markets have been dramatic and no one knows how
long it’ll take them to settle. Some things are clear, though. One is that
well-endowed institutions like Williams are in a relatively strong position.
Among the benefits of a healthy endowment is that it helps us weather
difficult economic times. We’re fortunate that Williams leaders over the
decades have been careful stewards of the endowment‹growing it with
reasonable risk and saving money when economic times were good. We benefit,
too, from having such strong support from alumni, parents, and friends.

It’s also clear, however, that, despite our relatively strong position, our
situation has changed. The College’s three main sources of revenue are
endowment income, gifts, and student charges. When setting the College’s
annual budgets, we project that the endowment will return over the long term
at an annual rate of eight percent. In the last fiscal year, though, its
return was minus one percent and since June 30 all world markets have
dropped precipitously further. While we haven’t yet seen a substantial
effect on giving to the College, it’s reasonable to expect that global
economic uncertainty will dampen it for some time. Finally, as unemployment
rises, some of our families will find it harder to pay student charges.

Also clear are the institutional values we must use in planning how to
weather this storm. Our first priority will be to protect current and future
Williams families. We’ll maintain our financial aid programs and extend
help to those whose changed circumstances reduce their ability to pay.
Second, we’ll remain committed to current faculty and staff. We foresee no
layoffs and we understand the importance to Williams of competitive
standards of compensation. However, spending at current levels in the face
of reduced income would be irresponsible. We need to protect the endowment
so that the students of the future can experience the same quality of
education as the students of today.

With this background and with these principles as guides, here are the steps
the College has decided to take:

1) Postpone for a year the renovation of Weston Field and the remainder of
the Stetson-Sawyer project. This will preserve capital, put off additional
debt interest payments, and provide time to better understand the depth and
breadth of the economic downturn.

2) Reduce spending on other facilities renewal by around $3 million. We
have very little deferred maintenance, so pushing some of this work off to
the future makes sense when times are tight.

3) Not fill newly open positions except those deemed most essential. The
Committee on Appointments and Promotions will review faculty searches that
had previously been authorized. As new faculty openings occur, the CAP will
determine which few, if any, should be filled immediately. Likewise for
staff openings such recommendations will be made to Senior Staff by the
Human Resources Office and Provost’s Office working together. How long
these positions remain open will depend on the time it takes for the
College’s revenue to stabilize. That’s likely to be many months and in the
case of some positions it could be years before we’ll be confident enough to
fill them.

You’ll notice that these steps are less like switches that are either on or
off, and are more like dials that can be adjusted as the economic situation
changes.

In addition, in the weeks to come there will be many discussions among all
parts of the College to focus on other steps we can take. One possible
example would be increasing the size of each entering class by a modest
amount. We’ll also need to find other ways to control spending this year
and going forward and will use current governance and administrative
structures to solicit ideas from faculty, staff, and students.

We’ll need to be creative in devising these plans and thoughtful about how
they affect individuals. In particular, we’ll need to be sensitive to those
among us who may be most directly hit by changes in the economy. I hope
we’ll all be especially aware of how students are affected by changes in
their families’ circumstances and be prepared to offer support.

Given the resources at our disposal and the intelligence and goodwill of the
College community, I am confident that we’ll be able to manage our ride
through this turbulence in a way that’s true to our institutional values and
that will position Williams to emerge from the other side as strong as ever.

Regards,
M. Schapiro
President

#4 Comment By wslack On October 18, 2008 @ 6:57 pm

Thanks ’10; I posted it as a main thread.