The world has largely recovered from the 2008 financial crisis, but the challenges and opportunities it presented are still fresh in the minds of many. Investment is the act of mitigating risk, and to do so amid a market collapse is the learning opportunity of a lifetime.
We have interviewed over 40 institutional investors. In this week's edition of Trusted Answers, we look at lessons learned from the 2008 financial crisis:
There is an increased focus on liquidity management and liability management. That’s the lesson learned in 2008. I don’t think that’s changed. The way people are attacking it is different, and the way people are thinking about it may be different, but in reality I think foundations are stretching for returns, oftentimes taking on more risk. Sometimes it’s real, sometimes it’s perceived, but there is a lot of risk in foundation portfolios.
Foundations are starting to think a lot more about the globe and looking for opportunities around the world. I think there’s a real bifurcation in the market between the really large foundations and the small ones and how they are managed. The outsourced CIO model is an interesting trend. We will see how that develops.
There are a lot of different things happening in the foundation community, but the focus is on returns in a slowing environment, because we do have what is basically an 8% hurdle, no inflows of capital and no security blanket in the way that others can look to their tuition or fundraising as a way to supplement when markets are bad. We don’t have that option. I think people are really aware of that, and it became clear in 2008.
We spend a lot of time focused on portfolio construction and building a diversified portfolio that can withstand downturns while taking advantage of market opportunities. Our mission is to provide consistent, risk-adjusted returns that meet the return requirement of the endowment over the long term. Within the private portfolio, this framework provides us with a roadmap to sourcing investments in sub-categories that present the greatest potential to deliver strong investment returns, which in turn grow the endowment and directly benefits the students of Baylor University.
As it relates to experience, my time at Lee Financial was spent during a bull market. I joined the endowment in May 2008 and saw first-hand the impact the global financial crisis had on the portfolio. Like many with nascent private investment books, we did not have the liquidity to make meaningful tactical allocations. Fast forward to today, and we have a portfolio that is much better positioned to play offense when opportunities arise during market dislocations.
As I mentioned before, cash matters as does having the ability to invest when opportunities present themselves. Within the private investment book, one of the lessons from that time relates to commitment pacing. Large allocations in given years may necessarily restrict allocations in subsequent years when the opportunity may be greater. Cash flow modeling and determining the appropriate commitment pace for the endowment is critical in building out a strong, well-functioning private investment portfolio. We do not seek to time the market with our private investments, but do invest tactically within a commitment range each year.
Post crisis, I would say starting in 2010, we tilted the portfolio more significantly to the U.S. on the thought that the U.S. authorities basically had made the right decision, and therefore there was a higher probability of recovery. We tilted it strongly into the U.S., especially in the public equity portfolio, starting in 2010. Starting in 2011, we took down emerging markets on the theory that if there were enough compelling opportunities in the United States for U.S. investors, then we could just have our money here and not take any currency risk or macro risk.
One trend in endowments is product proliferation. Every year there are new strategies being developed, new ways of going about getting some exposure. People are re-evaluating what a private investment means. The duration of private investments has been extended coming out of the financial crisis and we need to understand if that is temporary or permanent. “Smart Beta” and people pressuring for fees – that’s all true. I don't see one huge trend, just more and more entrances to the investment universe every year.
Cheaper beta and more expensive alpha. Over time our portfolios are becoming more global. This has already happened, but I think will continue to permeate portfolios for years to come.
McCall Cravens, Managing Director of Investments, Southern Methodist University
Read the full interview here.
Trusted Answers is a weekly series that delves into some of the most pertinent issues within institutional investing, and shares some of the insightful responses from the 40+ institutional investors we have interviewed in the past year. Take a look at some of our other Trusted Answers.