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.
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.