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Investment Strategy, Asset Allocation and Performance
4. What is the investment strategy?
The GEF's strategy is to invest in a broadly diversified portfolio of equity and fixed income securities in both domestic and international markets using a long-term investment horizon. In order to earn above market returns, UTIMCO has also sharpened its focus on several asset categories characterized by complex, illiquid, and mispriced securities where proprietary information and sophisticated investment strategies offer the opportunity for value added returns. These asset categories have an additional important advantage. Because these assets typically provide returns which have a low correlation with those of the more traditional exchange-traded equities and fixed income securities in the GEF portfolio, they offer the additional advantage of reducing the overall risk level. These asset categories are generally referred to as high potential value-added assets and include non-marketable alternative investments, marketable alternative investments, and various other specialized public market investments.
5. What is the current asset allocation of the GEF?
To properly diversify the GEF assets, UTIMCO invests in a broad variety of asset categories. This allocation policy was developed through a careful asset allocation review with the UTIMCO Board in which potential returns for each asset category were balanced against the contribution to total portfolio risk by each category. While the allocations in Figure A indicate the longer term average strategic weights of each asset category, UTIMCO repositions the allocations to each asset category from time to time in response to changes in the investment outlook.
6. How does the current asset allocation compare to other colleges and universities?
Figure B indicates how the current strategic allocation of the GEF compares with other endowment funds larger than $1 billion as reported by the National Association of College and University Business Officers (NACUBO), an endowment industry trade group. The expected returns and expected risk in Figure B are based on UTIMCO's long term capital market forecasts.
7. Has the asset allocation changed with the dramatic changes in the investment markets over the last two years?
UTIMCO has made both strategic and tactical changes to the GEF and Permanent University Fund (PUF) asset allocations as a result of the dramatic changes in the investment environment after the "internet bubble." Endowment funds enjoyed very favorable investment returns for long periods through the peak of the bubble. But, as it became apparent that those returns were no longer sustainable, the UTIMCO staff and Board recognized the need for lowered expectations regarding future returns, particularly in publicly traded stocks and bonds. The result of that reevaluation is an emphasis on higher potential value-added investments in the portfolio including smaller capitalization domestic and international equities, equity investments in developing countries, specialized debt securities investments including so-called distressed debt, and hedge funds.
UTIMCO has responded tactically to the changing environment as well. While the markets were in freefall following the bursting of the internet bubble, UTIMCO maintained a below risk policy portfolio anchored by a large position in fixed incomes securities. As a result, the UT System endowment portfolios did not suffer large losses like many pension funds and some endowments did. However, as the US military entered Iraq, the endowment portfolios were changed substantially to take advantage of what we expected to be a much more favorable investment climate. An overview of those changes is shown in Figure C which indicates portfolio positions for asset categories prior to the Iraq war and at years ended August 2004 and 2003. The weights shown are relative to the policy portfolio weight for each asset category.
During fiscal 2003 domestic and international equities were increased to weights above the policy portfolio level from below policy levels prior to the war. The funds for the increases in equities were taken from the overweight position in fixed income prior to the war, reducing the bonds position to near policy portfolio weight. Private capital, still struggling from the burst internet bubble, was allowed to drift lower in portfolio weight. The net result of these tactical decisions was to position the endowment portfolios to take full advantage of the much more favorable environment through 2003. The result was significant value-added and very good overall investment results.
However, the spring of 2004 brought a significant shift in financial markets. Although the real economy continued to grow and job growth blossomed, investor focus began to shift to when the monetary brakes would be applied by the Federal Reserve Bank. Compounding this concern was a spike in oil prices that had the effect of a tax hike on corporate earnings growth. We responded to the new situation by reducing the risk exposure of the endowment portfolios as indicated by the August 31, 2004, data in Figure C. Our current objective is to add value through security selection within each asset category rather than through tactical allocation. Our tactics have shifted to match the conditions of the capital markets.
8. What are the significant risks associated with the GEF and how is this risk monitored?
Equity values in the GEF can fluctuate in response to the activities of individual companies as well as to general market conditions. In the short-term, stock prices can fluctuate dramatically in response to these factors. Bond prices in the GEF can also fluctuate based on changes in interest rates and the credit quality of the issuers. Investments in international securities in the GEF can involve political and macroeconomic risk in addition to typical individual company risks as in domestic markets. An additional element of risk in all international investments is the currency risk as the returns on those investments must be converted to US dollars for use here. Some of the longer term investments in the GEF, including venture capital and private equity, also have an element of liquidity risk due to the fact that these investments can not be easily converted to cash at short notice. All these risks are carefully monitored by both the UTIMCO staff and the UTIMCO Board. It is essential that some risk must be assumed in order to earn the levels of real returns necessary to meet the long term goals of the GEF. However, it is particularly important to carefully weigh each element of risk against the reward - expected future returns. The process used at UTIMCO to evaluate risks and rewards is known as risk budgeting and is almost exactly analogous to the normal budgeting process in a business. The UTIMCO staff is charged with carefully budgeting risks so that the risk assumed in the aggregate does not exceed the risk limits set by the UTIMCO Board and the UT Board of Regents. A risk budget also ensures that the rewards - expected future returns - are the best available at a given level of aggregate risk. Risks are monitored daily by UTIMCO staff and monthly by the UTIMCO Board.
9. What does total return mean?
Total return measures how well an investment or group of investments, such as the LTF, has performed over a certain time period. Total return is the sum of: the change in the value (including both realized and unrealized gains and losses) plus income (from dividends or interest for example) measured over a specified period of time. Total return is usually expressed as a percentage calculated by dividing the sum defined in the prior sentence by the beginning value of an investment. Total return is also sometimes referred to as investment return or performance return. If total return is after deduction of investment management fees and expenses, it may also be referred to as total net return.
10. What was the total net return of the LTF over the last year? Over the last five and ten years? How does it compare to the Endowment Policy Portfolio total return?
The table in Figure D summarizes the total return comparison for the one, five and ten year periods ended August 31, 2004.
(1) Policy portfolio returns for the LTF were restated in 2004 to correct errors in benchmark construction and calculation. Results were restated for all periods beginning June, 1993. The complete details of the restatement as well as prior Policy Portfolio returns are available upon request.
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