Cash Me If You Can

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Moreover, Harvard's endowment appears to be more leveraged than Yale's. While Yale invests with some firms that use leverage, it largely avoided the mega-buyouts of recent years that are now groaning with debt. Harvard, which manages its endowment internally, uses "a variety of financial instruments with off-balance-sheet risk," including "futures, options, credit default swaps, exchange agreements, interest rate cap and floor agreements, and forward purchase and sale agreements," according to its 2008 financial report. Although Harvard's endowment outperformed Yale's in the fiscal year that ended June 30, before the economy tanked, Swensen is unlikely to suffer that indignity this year: Harvard is said to be anticipating a loss of at least 30 percent, compared with Yale's 25 percent.

The financial crisis continues to test the faith of Swensen's disciples. Most are hanging in-but not the California Institute of Technology. Until 1997, Caltech had a plain-vanilla portfolio, with only 1 percent of its endowment invested in alternatives. Then, after consulting with Swensen and other Ivy League endowment managers, Caltech boosted alternatives to 25 percent. It raised alternatives again in 2002, to 40 percent, and in 2006, to 60 percent, including 25 percent in hedge funds, 13 percent in private equity, 10 percent in real estate, 8 percent in timber, and 2 percent apiece in energy and commodities.

But in August 2007, recognizing that the U.S. economy was shaky, Caltech decided to begin selling domestic stocks and keep 10 percent of the endowment in cash. Now, Caltech is backing away even more and converting 40 percent of its endowment to cash, mainly by selling stocks and redeeming investments in hedge funds that weren't locked up. Chief investment officer Sandra Ell says she considered selling private equity as well but sat tight because the secondary-market prices were too low. "You'd be lucky to get 30 to 50 cents" on the dollar, she says.

"We literally saw there was truly no place to hide," Ell says. "Every single pocket of our portfolio was affected. Our view is truly that this situation could get even worse and it's not going to get better for another year. Our goal is not to make money now. Our goal is to preserve that capital off which the institution funds its operations."

Swensen says Caltech-style market timing is risky: "When you go away from a sensible long-term strategy, you have to be right twice-when you exit and when you get back in."

While Caltech is an extreme example, many universities are reassessing the Yale model. Allan Bufferd, treasurer emeritus at MIT, says endowments and foundations are "reexamining their asset allocation policy" and "more rigorously considering their liquidity risk."

"We were an early mover in all the nontraditional stuff too," says William Spitz, who retired in 2007 as Vanderbilt University's chief investment officer. "We weren't very far behind Yale and Harvard." But now, he explains, "I've heard people say, 'All these different kinds of investments got clobbered. Maybe we don't need such a complex portfolio.'?"

Rice University in Houston faces particularly intense liquidity pressures because it relies on its endowment to contribute almost half of the operating budget, a higher proportion than most other schools. Scott Wise, who in two decades as Rice's chief investment officer has led its Swensen-esque diversification from stocks and bonds into nontraditional investments, says it's carrying more cash in its portfolio and trying to sell some hedge funds: "We're all learning that many of the hedge funds were not as liquid as was expected."

Fortunately, endowment managers seeking counsel in these troubled times can turn to a fully revised and updated edition of Pioneering Portfolio Management, published early this year by Free Press. On January 9, it ranked 1,269 on Amazon?.com, far ahead of High-Resolution CT of the Chest: Comprehensive Atlas, by Eric Stern and Stephen Swensen.

The new edition tempers the original's attitude toward liquidity. For instance, the heading "Illiquidity's Attractions" has been replaced by the more neutral "Illiquidity and Information." And the topic sentence of that section-"Illiquidity accompanies several characteristics prized by serious investors"-has been deleted.

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