THOMAS JEFFERSON, THE third US president, was a powerful advocate of liberty, including freedom of the mind. One of his most enduring projects after leaving office was the University of Virginia, which opened to its first students in 1825. The university, in Charlottesville, is built around Jefferson’s “Academical Village” which is crowned by the library, a building inspired by Rome’s second-century temple, the Pantheon.
In step with Jefferson’s vision, the university’s endowment managers have pursued freedom of the mind and made inspired moves in their efforts to ensure sound and high-yielding investment of the university’s funds which, among other things, provide financial aid for students.
Sustained performance Endowments are among the most cutting edge investors in the US. They were pioneers in investing significantly in hedge funds and remain big players in alternative asset classes. Their strategies are in part shaped by finance professors who want to put their theories into practice.
Under the management of the University of Virginia Investment Management Company (Uvimco),UVa’s endowment has posted top performance at a time when other endowments have been hit by declining returns. However, Uvimco’s long-serving CEO, Alice Handy, left at the beginning of the year and a replacement has not yet been found. There may be big changes in store.
From June 2002 to June 2003, UVa’s fund returned 9.2% compared with a national average of 2.9% for US university endowments, according to the National Association of College and University Business Officers’ (Nacubo) study of endowments for the financial year ending June 2003.
UVa’s endowment had about $1.8 billion in assets at the end of 2003 and even managed to achieve more than double the rates of return of fellow institutions with more than $1 billion in endowment assets. The average return for these larger funds was 4.1%.
Of the 30 largest endowments in the US, the return for the UVa’s in 2003 was second only to Harvard’s. UVa’s endowment is the fifth-largest public university endowment in the US and 23rd when both public and private institutions are included, according to Nacubo. Harvard has the nation’s largest university endowment, with assets of about $18.85 billion at the end of 2003.
Leonard Sandridge, the University of Virginia’s executive vice-president and COO, among whose roles is oversight of Uvimco, says: “[Our endowment] has had good results focusing on the long-term investor.” He adds: “Our objective is to be solidly in the top quartile.”
Much of the fund’s success in 2003 can be attributed to its having been a good year for hedge funds and equities. UVa now has almost 60% of its endowment invested in hedge funds.
Sandridge views the hedge fund allocation as a play on equities, as 80% of the hedge funds in which the endowment is invested are long/short equity funds. The fund benefited from a good year for this strategy and for underlying equity markets. The CSFB/Tremont Hedge Fund Index shows that the average hedge fund investing in this way was up 17.27% for 2003.
A summary of UVa’s board of visitors’ discussion about the performance and market value of the endowment in February 2004 states: “With 60% in hedge funds, a portfolio that is little influenced by the direction of the market, the endowment did not fully participate in the equity market rally. The hedge fund portfolio returned 5.8% [for the six-month period], about in line with the lower end of the 12% to 15% annual return expectation.”
UVa’s fund also has a 6% allocation to domestic equities and a 9% allocation to international equities, as at the end of June 2004. For the six months to the end of 2003, the endowment’s total return was 7.9%. The Russell 3000 Index, which represents around 98% of US domestic equities, was up 16.3% over the same six-month period. The MSCI All Country World Index excluding the US, which measures global developed and emerging-market equities, was up 27% over the same period.
The summary of the board of visitors’ discussion last February states that: “The fund’s more modest allocations to domestic and international equities outpaced their markets with returns of 17.3% and 37.9%, respectively. The oustanding international equity performance is primarily due to the decision to place those assets with emerging markets managers. The allocation to private equity, up 6.6% for the period, also served as a drag on performance.”
Expansion into hedge funds The university made its first foray into hedge funds in 1992. It increased its allocation to about 15% in 1994, an allocation which was maintained until 1998. Despite the endowment’s having much more of its portfolio invested in hedge funds than many of its peers, Sandridge says the fund’s managers do not consider themselves to be big risk takers. “We’re not an organization that’s always looking to be the first into a new field,” he says. “Until 15 to 20 years ago the biggest decision was whether to put 65% to 75% in equity, and the rest into bonds. We grew conservatively and cautiously [into other investments].” He adds: “It’s important not to be greedy. Making money is important but it’s for the university.”
Since 1974, the endowment’s assets have grown from about $60 million to nearly $2 billion. “Most of the growth in the endowment is growth from performance,” says Sandridge. “Gifts and additions are critically important but the real strengths are earnings and appreciation.”
Sandridge says that two courses of action have proved to be outstanding – the fund manager’s decisions in relation to its private-equity and hedge fund investments.
Since the early 1990s the fund has had a small proportion of its assets invested in private equity. In 2000 the allocation reached about 40% after sitting at about 4% for 10 years. This proved to be a highly profitable move for the fund. From June 1999 to June 2000 the endowment returned 43.8%.
After a good year for those investing in private equity generally, the fund began to take profit and reduce its allocation. So more by luck than design the fund got out at an opportune moment. Sandridge says: “When it appreciated so rapidly, 35% to 45% [allocation] was more than we wanted.” According to the National Venture Capital Association and Thomson Venture Economics, US private-equity investment returns fell to –4% in 2000 and to –18.5% in 2001. Sandridge says: “We hedged our portfolio in early 2000 and ended up with a good portion of the $600 million rise attributed to private-equity funds.”
At the end of June 2004, UVa had just under 13% allocated to private equity. US private-equity investments were up 18.3% for 2003, according to NVCA and Thomson Venture Economics. Sandridge says: “We wouldn’t mind having a bit more there.” The fund’s target allocation is 19.5%.
When the fund lowered its allocation to private equity, it simultaneously increased its investment in hedge funds to just over 30%. “We took many of the proceeds of the private-equity and venture capital portion of the portfolio and put them into hedge funds,” Sandridge says. In 2002 the fund’s managers continued to raise the allocation to hedge funds to just over 47% and to almost 60% in 2003. It is currently about 57%.
Unlike many institutional and retail investors, the managers at Uvimco invest in hedge funds directly, rather than through funds of hedge funds. “There’s an insignificant portion [of the endowment] in funds of funds,” says Sandridge.
Sandridge says there are two reasons why the managers invest directly in hedge funds. “We like being able to research single funds and managers,” he says. “The other reason is that there have not been a substantial number of funds of funds available to us that we’ve found compelling.”
The larger endowments in the US tend to have the highest allocations to alternative assets such as hedge funds and private equity. However, a 60% allocation is more aggressive than most.
The average percentage of portfolios invested in hedge funds for university endowments with more than $1 billion in assets under management was 19.9% at the end of 2003, according to Nacubo. Sandridge says: “Right now we have around 57% in hedge funds. We’re comfortable with that asset allocation now. We look at it regularly because it’s an outlier.”
Like most public universities, UVa has only recently become dependent on its endowment to meet its funding requirements. Last year was the first time that private gifts and income from the endowment were greater than state funding for the university. State contribution to the university’s budget was only 8.1% this year, compared with 27% a decade ago.
The search for a new CEO In1974 the endowment moved from an arrangement where it was managed by a bank to being managed in-house, initially by Alice Handy, a bond trader. When she first joined the university her ‘office’ was in a conference room. This meant that whenever there was a meeting she had to leave. Sandridge points to the fund’s small beginnings when he says: “We used to joke in the early days that Alice would take over the issuance of licence plate numbers from me.”
Initially, Handy’s primary role was to manage the endowment’s relationship with the bond rating agencies. “At a point in time Alice oversaw the insurance programme,” adds Sandridge.
Handy left at the beginning of this year. Since then the university endowment has been run without a CEO. “We’re searching for her successor,” says Sandridge, who is managing the operation in the interim. He adds: “We’re looking for people nationally. We started out thinking we would probably get someone from another endowment but that has broadened. We’re looking at endowments, pension funds, Wall Street and international funds.”
There are currently four directors at Uvimco who are responsible for various asset classes. In addition, there are five analysts and three support staff. “We have held a couple of vacancies so the new leader can bring in new staff quickly,” adds Sandridge.
This could mean drastic changes for the fund’s investment strategy and its large allocation to hedge funds might be reduced. “We fully expect the new CEO to make suggestions,” says Sandridge. “The board is not so set on this allocation that it wouldn’t consider changes. We would envision changes to the portfolio with new leadership but not sudden, wholesale changes. I don’t envision that a year from now you would see a completely revamped portfolio,” he adds.
In July this year, treasury management, including overseeing debt management, was split from the investment management of the endowment. Treasury functions are now managed by the vice-president of finance, and investments are managed by Uvimco.
In July this year, Uvimco – which was established in 1998 as a subcommittee of UVa’s board of visitors – became a foundation to act as the investment management arm of the university. That is, it became more like a company rather than part of a public institution. “Most public universities operate their endowment through a foundation,” says Sandridge.
The rationale for creating a separate company to manage the endowment fund is that it is more likely to attract top managers. Sandridge says: “We’re preparing for a time when the endowment will be more than $2 billion and we will need a lot more staff and expertise.” He adds: “The biggest change is to be able to assemble a top-rate investment professional team, appropriately compensated, and equipped with tools that other investment companies have. This institution will not be able to compensate like some of the large ones you read about, but we need to be competitive.”
Uvimco’s role as a manager of fund managers will not change. Sandridge says: “Even with the new company it is not our expectation to run money internally.” He adds: “Harvard has done it very successfully. They’re much larger than us.” The only exception is that the passive bond funds for deflation protection will continue to be managed by the vice-president of finance.
Sandridge does hope that Uvimco’s being more independent from the endowment will mean that it will be able to attract other university assets. These include funds such as those of the university law school, and the athletics and alumni association foundations. This would add between $2.6 billion and $2.8 billion to Uvimco’s assets under management. “Uvimco wants to make itself available to manage all that money,” says Sandridge.
