Fri 17 Apr 2009
The topic of the endowment has come up several times in recent threads. Below are my thoughts. Summary: Williams is in much better shape than many other schools. But, still, its lack of transparency is troubling. The Trustees are meeting this weekend and will, presumably, get a briefing about recent performance. They should ask some hard questions, especially about the value of the College’s investments in private equity and real estate. Given the (probable) state of the College’s finances, they should reject the proposed avail spending of $79 million for 2009-2010 and force the Administration to produce a more responsible budget.
Here is the allocation of our $1.8 billion endowment as of June 30, 2008.
1) Read my discussion about the 2007 endowment for background. Most of the allocations are identical. (Is it just me, or is relabeling “Private Equity” as “Buyouts” positively juvenile?) US equity is down 3% while Developed International Equity is up 1%. Small changes like this may be due to just rounding issues. Or, instead of an actual change in policy, the movement of various asset classes, or even the timing of manager changes, can have an effect. Or, it could be that the Investment Committee made an active decision to change things. There has been some talk that the College (and/or Collette Chilton) made some genius moves that saved the Williams a bunch of money. This is doubtful, but a full debunking will have to wait for another day. The major change (which is really too small to care much about) is the move from 10% to 12% for Absolute Returns (which probably means hedge funds).
2) The Record reports:
According to the College’s leading financial experts, President Schapiro and Chief Investment Officer Collette Chilton, the endowment has decreased in value since Chilton last estimated it at $1.4 billion on December 31, 2008. By Schapiro’s estimate, the endowment will stand at around $1.1 billion when the fiscal year closes on July 1, with $92 million availed for the current academic year’s spending. However, “with the volatility of markets and the difficulty in pricing illiquid assets … the specific number is hard to nail down,” Schapiro said.
Indeed. I think that those estimates are from the end of February. The market has rallied since then, so things are probably less bleak in the liquid portion of the endowment. It is the illiquid stuff that is the problem.
For those who don’t know, much of the portfolio is invested (either directly or via managers) in things that trade every day. If the College (or its manager) owns a share of IBM, a treasury bill or an oil futures contract, then it knows exactly what that is worth. The College probably gets updates from its managers once a quarter, if not once a month. So, the Trustees will have good information about those components of the portfolio.
The key distinction is not so much between “liquid” and “illiquid” portions of the endowment as it is between “priced” and “estimated” portions. A hedge fund investment is illiquid in the sense that the College may have to wait a year (or more) to get its money out. But that same investment is priced accurately because the hedge fund invests in things like shares of IBM, which are priced publicly each day based on actual trades. It is easy to mark them to market, as opposed to estimating their value. (Other hedge fund investments will be both illiquid and estimated, if the fund invests in things, like obscure fixed income securities, that are not traded and, therefore, priced each day. I suspect that most of the hedge fund investments are priced accurately.)
At some point, I should do a proper calculation of where the endowment is on the basis of other benchmarks. Alas, not today. In the meantime, the main areas of worry are Venture Capital, Real Estate and Buyouts. (Let’s be grown-ups and call this Private Equity.) Most of the rest of the endowment is probably priced correctly. This illiquid portion — 21% of the total — is the real danger.
3) One of the reasons that the College is much better positioned than other schools is that we have been much less aggressive. Yale, and places like it, put much more money into these three categories (and other problematic ones). Indeed, I was positively heartened by Chilton’s talk to the Boston Alumni Society a few months ago. Not only has Williams not been forced (like other schools) to raise taxable debt (a sure sign of desperation), not only has Williams (unlike places like Harvard) not sought to sell off (at 50% losses) portions of its private equity and other illiquid investments, but Williams is actually looking to buy such investments, if we can find them in the right funds at the right prices. Almost no other major endowment (that I know of) has that sort of flexibility today.
Who deserves credit? Tough to say. The asset allocation for Williams is not that different today than it was 2 years ago, so Chilton and other recent Investment Committee members deserve neither blame nor criticism. I have heard an insider praise the long-term influence of Joe Rice ’54 and Dave Coolidge ’65. Kudos to them!
4) But even if Williams is better off than most schools, we might still be in serious trouble. The key to finding out the truth is to dive into the details of the College’s investments in those three categories. Fortunately, we are not talking about that many different funds. The problem is not so much that Chilton is lying to the Trustees or that the managers are lying to Chilton or that the people behind the specific companies/deals that the managers have invested in are lying to them. The issue is that we have no clear pricing and no easy way to ensure that the estimates are flowing up correctly. No one in the entire chain has an incentive to underestimate the value of investment X. Instead, everyone has an incentive to overestimate that value, to look on the bright side, to (honestly or not) expect things to get better. Indeed, the entire industry attracts people who are naturally optimistic and whose optimism has been richly rewarded over the last 20 years.
5) What should a trustee look for? The single biggest key is the dates associated with various deals. What is their “vintage?” If most of the 9% in private equity was invested in 2002, then the College is OK. A lot of those deals will work out fine. If most of that money was put to work in 2006, then the College is in huge trouble. It is not unreasonable to think that this money could be a total loss. (Scary example here.) The same applies to real estate. If the College bought a bunch of buildings (or shares of buildings) in 1998, then all is OK. (Assuming that we kept the buildings on our books at those 1998 prices.) But, that is almost certainly not what happened. Instead, the College invested in various real estate partnerships, which then borrowed a bunch of money and bought properties. (Scary example here.) If most of the College’s real estate investments occurred in 2007, then that 6% of the endowment could be worth zero.
6) But, of course, the truth lies somewhere between. The College has had 20% or so in these sorts of investments for years, if not decades. There is a natural flow of money in and out. As one partnership completes its 10 year life, the money is returned to Williams so that the school can invest in the next partnership. So, some of the real estate and private equity investments were made in 2002 (they may be OK) and some were made in 2007 (they could be toast). The average is somewhere in the middle.
Unfortunately, for the market as a whole (meaning for all large institutions considered together) this is not true. Because many more dollars were invested in 2007 then in 2002. It is impossible for everyone to be in the middle, since the market as a whole was much more heavily weighted to the later (now often worthless) investments. I have heard estimates that the dollar-weighted average in private equity is some date in 2005 to 2006. So, all the dollars invested in this category (and real estate) might be worth much less than 50 cents on the dollar.
So, any trustee who wants to know the truth should ask for a listing of the College’s investments in this area (I doubt that there are as many as a dozen in each), the year that this money went in, and an estimated loss (or gain) for each investment to date. If that data looks as expected (horrible losses in recent years and much lower losses if not gains) in earlier vintages, that would be a good sign. Anything else would make me very nervous.
7) Does all this matter? Well, in one sense, it doesn’t. The College made those investments. We are no stuck with them. Maybe they will work out. Maybe they won’t. But there is nothing that the Trustees can do now to change any of that. They might consider changing the investment policy going forward, but I would not want them to be hasty on that score.
The key issue is that this exercise brings to the fore just how much trouble the College is in. We have not just loss money on the endowment. We continue to spend money like crazy from the endowment. That’s the $92 million in spending for 2008-2009 that Morty is talking about above. Given that the endowment is only worth $1.1 billion (and that might be an overestimate given any mismarks in private equity and venture capital), and given that we have $260 million in debt, the net financial assets of Williams as of July 1, 2009 might be somewhere around $850 million. If you spend $92 million of that each ear for 8 years, then you are bankrupt.
The Trustees need to stand up and force the College to cut spending significantly more than we already have. They should put pressure on Morty to announce and implement significant lay-offs (and early retirements) before he leaves. (Morty is in the perfect position to know where the fat is and to have the trust of the College community in making the necessary hard choices.) It would be highly irresponsible to spend “$78 to $80 million” from the endowment next year. That’s almost 10% of the College’s net financial worth!
Someone needs to start acting in the best interest of, not just the Williams of today, but the Williams of 50 years from now.
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