Taking the Long-Term Perspective
By Verne O. Sedlacek
President and CEO, Commonfund Group, Wilton, Connecticut
Despite the prevailing doom and gloom, the most experienced and respected thought leaders believe that the economy and financial markets aren't fundamentally broken and will eventually right themselves. The challenge, then, is to make prudent decisions over the short term while remaining true to our missions.
Many institutions face hard decisions as they look for sources of liquidity to support their operating budgets. Still, business officers and trustees have the advantage of being able to take a truly long-term perspective at a time when many individuals and organizations can't get past the short term.
There appears to be massive rethinking in the nonprofit community regarding the concept of liquidity in endowments. Colleges and universities have been buffeted by the perfect storm after a quarter century of mostly calm waters, leading many to run for the cover of more liquidity. For the most part, endowments are perpetual pools of assets. We should not lose sight of the fact that there has been—and, I believe, will continue to be—a return advantage in giving up liquidity. Developing and stress-testing a policy allocation that examines liquidity and illiquidity is now more important than ever.
Asset allocation and rebalancing. Asset allocation is the basis for sound portfolio management. The precept of diversification has been challenged recently, but for long-term investors it remains valid and viable.
Rebalancing, which is challenging even in the best of times, should be approached on multiple time frames: monthly or quarterly for liquid assets, annually for moderately liquid assets, and over three to five years for all assets, including those that are illiquid. As illiquid assets are marked to market, portfolio imbalances may adjust by themselves.
Spending policy. We have long advocated that a spending formula that smoothes over three years is inappropriate, because it creates too much volatility; for a pool of assets that is truly long term, three years is just too short.
Twice in the last decade we have seen periods of significant increases in nominal dollars from endowments (because of short-term market appreciation) only to be followed by cuts in nominal dollars (when markets decline). This "feast or famine" approach is not an effective way to optimize mission.
Some have questioned whether the endowment model is broken: We think not. We continue to believe that equity-based investments should deliver superior long-term returns compared to debt. We believe in diversification over the long term; questions about its value have arisen only under the most extreme conditions of the past 70 years. We believe that alternatives to the endowment model (e.g., tactical asset allocation) do not serve the needs of perpetual pools of capital. And, we continue to believe in time-frame arbitrage, or the inherent advantage that perpetual institutions have because of their ability to take a truly long-term view.
Educational institutions have invested an enormous amount of time in developing investment policy statements. In many ways, these policies were built for times of turbulence such as we have today and, therefore, should not be summarily abandoned. In times of uncertainty, follow your well-thought-through guidelines and adjust them only when more certainty returns.
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