Foundations Struggle With Market Strategies

September 1, 2001       Tom Pope      

Whichever direction the market goes, many institutions are reevaluating investment strategies.

In New York City, the Commonwealth Fund’s endowment grew from $528 million to $557 million between fiscal year 1999 and 2000 with a return of around 11.9 percent. Part of the strength of the return may come from changes put into play by the finance committee in April, 1999. The committee decided to reexamine its overall investment strategy, looking for more concentration in a small group of large capitalization growth stocks. The committee also worried about the severe volatility hitting the technology area.

The fund managers decided that the international bond volatility threatened its desired return, so the U.S. Lehman Aggregate Bond Index replaced the Salomon World Government Bond Index as the fixed income benchmark.

In general, foundations have decided on diversity, using an index that contains certain stocks. Common favorites are in the S&P 500, top companies with brand names.

The Commonwealth committee chose a restructuring plan to focus on the Wilshire 5000 index to replace the S&P 500 index. Roughly 20 percent of the endowment is now slated for the S&P, down from approximately 30 percent.

“We felt the S&P was too narrow for us to have a broad representation,” said John E. Craig, Jr., executive vice president and treasurer at the Commonwealth Fund. “We wanted more weight aimed for the entire nation to reduce risk.”

The use of managers specializing in value stocks was decreased as a new focus on small cap, U.S. growth stock was hiked. Also, the specialized equities area with hedge funds was toned down from 16 percent to 10.

“Some of those growth stocks had higher yields but could not be guaranteed,” he said. “We were too far over-weighted and we needed to rebalance to make sure of a sufficient growth.”

The increase in small cap was selected because some small companies were under used in the portfolio. “Some people believe the large stocks have had their day,” he said.

Commonwealth had two items out of the norm, Craig explained. The fund maintained a portion of private equity in venture capital and some real estate along with exposure in hedge funds.

Commonwealth relied on a single hedge manager that diversified the portion across many kinds of approaches, rather than specializing in a specific area. Hedge areas could include strategies such as merger arbitrage, market neutral, convertible or distressed arbitrage.

However, with $560 million in assets, the committee decided that a better diversification would come with a smaller representation of the portfolio. Presently, the fund allocates 10 percent to such strategies, a figure agreed by many institutions as a reliable number.

“We have to control risks by diversifying,” he said. “When you’re small, it’s important to find a manager who ranges across the spectrum with securities.”

Larger and more sophisticated institutions have been diversifying away from traditional equity and fixed income investment by looking at private equity venture capital alternatives, explained Thomas W. Strauss, managing member of the Ramius Capital Group L.L.C., a financial consulting firm in New York City.

“The traditional 60 percent of stocks with 40 percent in bonds is not a creative portfolio,” he said. “A period of limited equity returns and low interest rates could offer a lot of money coming from alternatives.”

Even with the traditional stock options, different strategies exist. Investment committees start by looking at the asset allocation to figure out how to invest on the size of caps. Asset classes vary between: the large caps of companies with revenue of more than $10 billion sized companies; the mid caps between $2 billion to $10 and the small caps that are less than $2 billion.

While people concentrated on the large caps in the past, the present planners are taking a longer look at mid and small caps.

The Pittsburgh Foundation, one of the largest community foundations in the country, typifies the balance strategy. With assets totaling approximately $548 million, the foundation maintains 762 funds and provided $23.5 million in grants last year, primarily in the Pittsburgh region.

“We had double digit returns for four years so far in the 90s and we’re still hanging in with 10 percent,” said Thomas S. Hay, vice president of finance and administration. “If we’re still facing problems in the market during the next cycle, we may look at our targets.” That means checking which asset classes produce the best returns, he said. Yet, no one is suggesting a pull out of the market in a big way.

The foundation pools assets in such a way that donors are given an option of managers. They have the latitude to invest between 50 to 75 percent in equities and the balance in fixed income. “We set the ranges for various asset classes from large to small cap, or international to those in the U.S.,” Hay said. “Then the managers have the flexibility to determine an allocation within the range.”

Changing times

A trend is forming. Pittsburgh has shifted between five to 10 percent away from stocks to fixed income securities during the past five years. Pittsburgh gains a balance because various managers are selected with special qualities. Manager A may have a stable of mutual funds and deals with large caps or small caps while manager B may not have same products. Others may have an expertise in emerging markets.

Hay seeks different types of stocks without looking at specific industries such as biotech, energy or healthcare. Some managers take sector bets, while others manage the S&P 500. Hay hopes to benefit from the balance. “The benchmark return on a five year to 10 year average is a return equal to our pay-out of roughly 5 percent with inflation and annual growth,” Hay said. “That means we look for 10 percent on average over a long strategy.”

Hay’s finance committee views the allocations each six months to make certain general goals are being met. “We compare our seven managers against each other to see who may be out of line with returns.”

The return is more crucial than the number of negative months or the Sharpe ratio. “But if we see something out of whack, we can make a move,” he said.

One such move occurred with an institution whose foreign fund performed lower than others. “That manager took a bet on Japan and we finally changed that fund,” he said. “But, we haven’t really tried to get too specific with regions or industries.”

Pittsburgh’s allocations allow managers to go up to 10 percent in alternative approaches. With an investment of $450 million, that means $45 million goes to areas of hedge funds and some private equities. “This way you can offset the poor returns if you pick the right hedge area,” he said.

The Parapsychology Foundation, a 50-year-old organization in New York City, has gone further from the norm. This foundation withdrew its portfolio from a 67 percent stocks, 28 percent bonds and five percent cash arrangement. Now approximately 82 percent is in mortgage-backed securities, with 17 percent in preferred securities.

Parapsychology serves as a world wide forum supporting exploration of scientific phenomenon. The move away from the market occurred just before the stocks changed, but Lisette Coly, executive director, said the change did not happen because of a psychic moment.

“You don’t want to loose everything in one swoop,” she said. “We were getting increasingly concerned about the market, realizing the portfolio was shrinking because of expenses. We wanted to stay fairly liquid and decided this was a safe way to go.”

Conservative growth was chosen because the organization needs operating capital for reconstruction, to celebrate an anniversary and is spending more than in the past. A new journal, newsletter, renovation of its office in a Brownstone and funds to maintain a library caused the drain on funds.

The more conservative approach with mortgage-backed securities brought returns of 10.61 percent for the foundation, which has a $3 million budget. However, that figure is close to the 11.1 percent return recorded in March, 1999 that came from the market driven portfolio.

Parapsychology relied on Prudential for the new plan but indicated other options of hedge or private equities weren’t even on the table. “The short fall from the 10 percent is close to what we had before,” Coly said. “However, this is more secure. Slow and steady wins the race.”

Right now, the National Philanthropic Trust (NPT), a Jenkintown, Pa.-based independent public charity is in the midst of establishing an investment policy. NPT helps individuals and families reach philanthropic goals since 1996 making more than 1,244 grants to charities totaling more than $15,106,746.

NPT maintains $300 million in donated assets in more than 187 donor-advised funds. The foundation typically offers the standard money market to its clientele.

Catherine Banat, NPT’s newly-appointed chair of the investment committee, wants to provide choices to a broad menu of options. “We want to take advantage of the changes in the marketplace,” she said. “We are considering options in uncorrelated strategies of items that don’t go up and down with the market.”

That area was around 10 percent because it seemed to allow safe options with 90 percent still tied to the market. NPT probably will not make changes in the 90 percent.

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