The Endowment Model Orkla Finans Thursday June 4th
Trash or Treasure? 2
The Endowment Model = Alternative Investments Why? 3
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Demystifying Alternative Investments What is it? Alternative investment From Wikipedia, the free encyclopedia An alternative investment is an investment product other than traditional investments such as stocks, bonds or cash. This broad definition makes it impossible to list all alternative strategies, but the most important areas are real estate, private equity, venture capital, commodities, and hedged or absolute return strategies. Wine, art and antiques, indeed any business of value, might also be considered as an alternative investment. One common theme to alternative investments is that they are often hoped to have modest correlations with traditional investments and so to increase the diversification of investor's. Highly Subjective! 5
AI is a mixed bag New Asset Classes and/or Risk Premiums Real Estate, Private Equity They differ in that they are not tradable (liquidity) They differ in regards to transparency But also contains active management Hedge funds and Absolute Return = Beta & Alpha 6
Demystifying Alternative Investments What is Alpha & Beta? Inv. Univers Univers (Market) Univers (Market) Inv. Univers 7
Alternative investments, summary β α Traditional Alternatives Total Return Relative Return/abs ret 8
Demystifying Alternative Investments Why? Where did it come from? Financial Theory and evolution of markets New Asset Classes means an improved efficient frontier And.. We want and desperately need return Breakdown of the equity bond correlation Asset liability mismatch LDI Liability driven investment Compressed risk premiums Leverage Can t take downside risk Absolute Return But we lack guidelines to pursue these alternatives 9
Demystifying Alternative Investments Supply side, acting super smart and comes up with the solution that explains partly the extraordinary growth of the financial service sector Let s call it an asset class Let s call it an asset class Too much money chasing too few goods Too much money chasing too few goods 10
11 The breakdown of equity/bond correlation Correlation Equity/Bonds 1,00 0,80 0,60 0,40 0,20 0,00 des.77 des.79 des.81 des.83 des.85 des.87 des.89 des.91 des.93 des.95 des.97 des.99 des.01 des.03 des.05 des.07-0,20-0,40-0,60-0,80 Assets Liabilities Assets Liabilities
Why did the allocation get so big? Asset Classes Equity Return Bonds Emerging * * * * * Asset Classes High Yield Real Estate Private Equity Hedge Funds 1 * Risk Investor forced forced to to chose chose portfolio far far to to the the right right Concentrated portfolios into into alternatives 12
Growth of AUM PE $ bn Source Prequin Hedge Fund Industry $B Source: Barclay Hedge Databas $3 000,00 $2 500,00 $2 500,00 $2 000,00 $1 500,00 $2 000,00 $1 000,00 $1 500,00 $500,00 $1 000,00 $500,00 $0,00 97 98 99 00 01 02 03 04 05 06 07 08 1st Qtr 2009 $0,00 2003 2004 2005 2006 2007 2008 13
Principal-Agent & incentives 14
Principal-Agent & Incentives Citigroup s chief executive, Charles O. O. Prince As As long long as as the the music music is is playing, you ve you ve got got to to get get up up and and dance, he he told told The The Financial Times Times on on Monday (10. (10. July July 2007), adding, We re still still dancing. 15
Hedge fund as an asset class Ex Long/Short Equities It is not an asset class it s Equities! It is not an asset class it s Equities! It is an active investment strategy It is an active investment strategy 16
Investment Guidelines & Constraints How important is it? A study showed that given an ability to forcast you can lose as much as 40% - 70% of estimated excess return. Article: Portfolio Constraints and the Fundamental Law of Active Management by Clarke, de Silva & Thorley, Financial Analyst Journal 2002 17
Trash or Treasure? - Improves the efficient frontier, new asset classes, Beta - Contains active management, Alpha est(@) =0. Two different decisions Should be dealt with separately Risk 18
What about Yale & and other endowments They are down, allocation into alternatives is/was 50-60% Liquidity and funding problems. H & Y support 35-44 % of university s budget To early to question a model that have delivered excellent return over the past 10-20 years Most likely outcome is a reduced allocation Some other constraints/actions are possible 19