First up is the CALPERS interview. There was a money quote and the fund's allocation.
Global Equities 49%
Fixed Income 20%
Private Equity 14%
Real Estate 10%
Inflation Linked Including Commodities 5%
Cash 2%
CALPERS had to increase the target for private equity because the value of everything else fell so much it raised the weighting to private equity. This is the same concept I talk about with using SDS. If the market falls a lot SDS will grow to a larger weight in the portfolio thus hedging more. As I understand the article, had they not done this they would have been forced to sell some of their PE exposure.
The fund is trying to make it's "assumed rate of return of 7.75%." The brings up an important point. Many people think in terms of the stock market averaging some percent every year. Maybe the number is 10% or 8% or something else but something. Unfortunately reality is much lumpier than 9% per year. Whatever the real number is it includes all the 1997s, 2008s and everything in between.
Pensions and endowments cannot be very flexible with what they payout for their obligations but you can be--maybe. Obviously living below your means helps here. When the market has the occasional really bad year (not talking a 10% decline) you have a better chance of cutting back on certain expenditures than a pension fund does.
The money quote;
To try to capture more growth, we have to look at expanding our allocations in emerging markets. In emerging markets over the past year, we've greatly increased international exposures.
So they need to increase their foreign exposure to get the growth they need. That should sound familiar to long time readers. This has been an ongoing theme and I am convinced it will continue to become ever more important. I would note this does not have to mean 30% in emerging.
The table is from Barron's and shows the allocations of several college endowments. It seems that things were great for a long time and then market declined which coincided with liquidity problems and now the entire endowment theory is being called into question. Well Byron Wien as questions anyway.The article is a good read and I certainly am interested in what happened and what changes there may be as a result of 2008 but I am more interested in what you and I can learn from all of this; benefiting from their mistakes if there were any mistakes.
One of the ideas that emerged from the article was that returns in the future will be less than they were in the past. Perhaps that is correct but I had one encouraging thought for the endowments to the extent they continue to invest with hedge funds. If US interest rates go up as much as some people think there will be some hedge funds that go up several hundred percent shorting the bond market and perhaps the endowments will own such a fund.
In looking at the table you can see how heavy they are in alternative assets (so also illiquid) and how they did. A big focus over the years here has been all things in moderation and I don't think the above weightings in the alternative stuff is moderate, far from it. Anyone, anywhere caught up in some sort illiquid asset implosion had no control over what happened and probably could not have anticipated the totality of what happened but they did have control of how much they allocated to these things.
A little can go a long way. People have a tough time with that one but all I can say is it is true and simple.
8 comments:
One of the myths of endowment investing was that they, unlike us, could afford riskier bets on illiquid assets because their time horizon was forever. As the article makes clear, that's certainly not the case. Like us, the universities have annual cash flow needs and are now in the uncomfortable position of floating bond deals and cutting expenses to weather the storm.
How good has Calpers performance been?
I am heavy in foreign equities, but I think this will be a very wild ride and I can sell everything in an afternoon if I need to.
I could be wrong but I think foreign equities are the current trend and they will eventually crash like housing and tech trends crashed.
I was happier when I was heavy in foreign equities and everyone thought I was crazy to be that heavy. Now that it is becoming accepted I am getting concerned.
Doesn't it depend on what foreign equities you own? Some foreign companies own pretty big pieces of American companies. I can think of multiple examples of Asian companies that own non trivial pieces of North American mining companies.
This brings up something I'm trying to fully grasp: what my exposure is to emerging markets. If I just look at emerging market equities then it is only 4%. It is just not so simple to look at the allocation title.
So then I need to add my shares in FXA (AUD) and DJP (Commodities)? If emerging markets dive, these will too.
Then for individual stocks, I own some global companies like COP, PEP, and JNJ. What is their exposure to EM? COP owns 20% of Lukoil outright. I also own ABB and observe a high correlation as they run on global growth.
So I don't consider my full exposure to be 4%. I sense a sort of systemic risk in a lot of modern portfolios, maybe to political instability abroad.
anon 7:43, I believe what you are describing is a correlation issue. That may not seem like much of a diff to you but it is a different thing.
I think the 5.38 AM ananymous is confusing two issues: illiquidity and too much of it. If the endowments had only bought 1% collectively in those assets instead of 40% to 60% there wouldn't be a liquidity.
What they did was load up on too many illiquid assets and were trying to use current payoff yields to fund future obligations. The payoff yields stopped, but the future obligations didn't. Ouch!
If they would have kept the illiquid assets to much lower levels they probably wouldn't be in this situation. It appears even Yale had to take a loan to cover some cash flow. Compared to Harvard trying to sell private equity when the going rate is 50 cents on the dollar, Yale is doing a lot better.
An article I read in the last few months mentioned David Swensen at Yale ran liquidity drills in 2000-2002 during the tech bear market. In the same article he also mentioned trying to ensure illiquid assets such as real estate through off income so they were at least somewhat compensated for the illiquidity risk they were taking.
Paul
Hedge Funds and Systemic Risk is a paper that I refer to often. It was the singular best source in cultivating my understanding of what was happening early before the crisis became a crisis.
Many of the insurance companies also used hedge funds as part of their investment portfolio. HIG being one that I researched. Once I understood that many of the insurance companies were buying the fixed income crap that was being peddled (in the voracious search for yield in a low interest rate environment), then I realized the enormity of the problem.
I'm just a peon, nobody, and found this is in my research. (Interestingly, it was not something being written about).
In a systemic risk event, you have phase-locking (market-wide cluster f). Which means quite simple that hedging strategies that are non-correlative, suddenly correlate. They correlate in a way that is not good for your money. (There are few places to hide, and even money market became a frightening place).
Most of the important stories were not being written then. I've little time for that type of research anymore. But, I was glad to have had the time to commit to such reading. Though, most of it made my head hurt.
Always interesting when you are "supposed to" rebalance into an illiquid asset. Two thoughts - when it appreciates how do you trim? And is the devaluation in PE just due to the new MTM rules? Yes that would present an opportunity, but it also will create an overweighting in the cost basis. As I mentioned before, it is a shame these well paid money mangers forgot whose money they were running. On a side note, from an earlier post you mentioned Andrew Lo - you can download many of his "people friendly" behavioural finance papers from his MIT site...just google. Thanks for the post Roger.
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