Endowments Outperform Up and Down Markets?

I've written before about the interesting financial allocations that Harvard's Endowment and others like it (read Princeton and a few others) have used recently. They include higher than normal investments in private equity (11% of total), timber and agriculture (9%) and real estate (9%). Likewise, they show a mere 12% allotment to domestic stocks, well below normal, while a full 20% was invested in foreign and emerging markets stocks (normal recommendation is around 10%).

In the relatively up markets of recent years (until this year!) these allocations have served the endowments well, with overall performance beating a "normal" portfolio with 65% stocks and 35% fixed income handily, and regularly beating the SandP 500 index (e.g. fiscal 2007 ended June 30 Harvard up 23%, SandP 500 20.6%).

Now with a deep Bear market, Harvard has announced it is down 22% through October, and expects to be down by 30% through fiscal 2009. We'll have to wait and see if this beats the normal allocations, but they are ahead of the SandP 500 performance, down 24% 4 months through October.

If these results hold up Harvard will be able to boast that it beats normal allocations in both up markets and down markets, and we'll start to see more copycat portfolios in the market. Something to watch, and emulate?

Sources, NY Times, Google Finance, www.bloggingstocks.com, and CNN Money.

The Rating Agencies Blow, but We Knew that Already

As Gretchen Morgenson points out in her recent Fair Game column, the overseers are all complicit for the current economic mess. Put in this category the regulators (think SEC, the Fed, etc.), the Boards of these failed financial companies (who didn't understand the products they were pedaling), and the rating agencies. Today lets look at the latter and figure out why anyone cared about their ratings anyway.

Rating agencies rate debt issues. They analyze the risks and assign a grade representing your likelihood of getting your principal and interest back in full. Banks, as lenders and holders of debt make the same calculations when deciding who to lend money. Now, other than the big real estate debacle back in the 80's, lenders to companies have not had the meltdown like now. Why is that? I believe it's because they use more sophisticated devices than the rating agencies. How could this be? It's because they consider the signals from the public equity markets as well as balance sheet analysis.

When I was as banker, we used some type of Z score for our public company relationships. It would measure equity volatility of the target creditor. If the entity's stock was tanking or simply volatile, or low compared to it's competitors, we would stay away from any type of credit exposure, including swaps of any kind. As we have seen with AIG and Lehman Bros, the debt is as exposed as the equity when things go bad.

Lesson, not all is what it seems, only the Gov't is a AAA+ credit because it can tax and print money, so if you want safe try Treasuries, otherwise consider the equity risk of a company who's debt you are investing in, if you want to sleep more soundly.

Liquidity is Still King

When small businesses have cash to hold for awhile, and think about investing it, many bank and corporate based options are available. As the excellent Gretchen Morgenson wrote in the New York Times Fair Game column, an investment that was represented as "near cash", so called auction-rate notes, turned out to be anything but. These notes are a relatively new type of short term investment, offered by closed end funds, with artificially low cap rates. As she notes not all "liquid" investments are truly liquid.

I can think of many short term investments that are truly liquid no matter market conditions, like money market funds and commercial paper, where interest rates float to clear the market. Banks and brokers offer a diverse number of offerings. For the truly risk adverse there are Treasuries.

Any company worth it's salt should have an investment policy that addresses the investment parameters for short term funds. Long term funds should of course be used to pay down debt, make investments in the business using ROI analysis, or repay shareholders if there are not enough good internal or external investment opportunities.

Think long and hard about the risks involved in gaining those extra basis points by putting your money in a closed fund or anything you don't understand. As we've seen recently, even the insured funds are having trouble.