<p>I haven't digested it yet, but Moody's has issued a new report on liquidity problems in higher education. Grab it while you can. It's behind the subscriber firewall at Moody's and I don't know how long it will be free for the downloading here:</p>
<p>a) increased need for liquidity with the rising use of variable rate debt and rate swaps that went bad when the credit markets tanked</p>
<p>b) Reduced available cash from a shift towards aggressive and highly illiquid investments combining cash calls with difficulty extracting cash from the portfolio.</p>
<p>Moody's has instituted a mandatory liquidity reporting requirement for rating colleges. They are publishing a new metric: days of cash availability (within one month). Take the available cash (within one month), divide by annual operating expense, divide by 365 days. They show a graph of selected Aa and Aaa rated schools ranging from under 100 days of cash at the low end to 1500 days of cash at the top end. This is a really good comparative measure.</p>
<p>Here's the Inside Higher Eduation summary article:</p>
<p>Actually, I stumbled across a reference to a report issued by Moody’s in 2004 about the increasing risk to colleges of a trend towards variable rate debt (and rate swaps). This is a signficant report for several reasons:</p>
<p>a) It lays out the precise risks of varible rate financing and rate swaps as well as the increasing reliance on debt that colleges used to further leverage their endowment returns. Nothing earthshattering to the regulars in this thread, but a comprehensive look.</p>
<p>b) A number of historical charts showing the rise of debt financing and the shift to variable rate.</p>
<p>c) Establishes a new, formal rating parameter to reflect liquidity. Colleges live and die by their Moody’s rating just as they live and die by “per student endowment”. This new metric now becomes a key indicator of fiscal heath in the “industry”. Colleges will have no choice but to manage to this indicator, shifting the priorities of investment committees a bit away from cowboy returns to ensuring adequate operating cash reserves. The institution of this formal measure will impact behavior.</p>
<p>I thought of you the other day. I was watching the video of President Rebecca Chopp’s Q&A session at the Swarthmore reunion. Asked about whether the College had plans to grow, she attacked the answer from several directions, one of which was an explanation of “per student endowment” as driving all the things that result in perceived quality (including USNEWS rankings) and how diluting per student endowment with growth would weaken the college.</p>
<p>I thought that a) it was refreshing to hear candor from a college president and b) Johnwesely would be rolling his eyes.</p>
<p>Very good, comprehensive report. Thanx very much Idad for posting it. </p>
<p>I have looked at many of the Moody’s reports on recent endowment debt offerings. Hopefully this report suggests Moody’s will be taking a better more honest look at liqudity. </p>
<p>Recent reports on major endowments have, in order to justify triple A ratings, stated that the endowments had many years worth of liquidity. This liquidity assessment, however, excluded the billions of dollars in capital call committments that could be called in at any moment. The Moody’s reports identified the calls but did not include them in their assessment of months of liquidity. In many cases the amount of potential capital calls exceeded the total amount of liquidity.</p>
<p>In addition, much of the liquidity came from potential hedge fund redemptions. But as was learned from 2008 with a hiccup Hedge funds seem to have the ability to decide to put up gates on redemptions. </p>
<p>Net-net I hope Moody’s report suggests that they are going to be taking a more critical look at true liquidity in the future.</p>
<p>That is a very good point. In many cases, the annual cash call commitments equal or exceed the annual operating budgets. Haverford took a 35% endowment whack last year because they had to liquidate essentially all of their stock positions and missed the market rebound. They had no choice. The cash call commitments demanded liquidity and there was nowhere else to get the cash.</p>
<p>basically, they’re only admitting to not having enough short-term cash available when the bottom dropped out from under them; nothing about going overboard in the illiquid investments market. A lot of the big endowment portfolio managers seem to believe sticking to their original strategies is their best way back to overall liquidity.</p>
<p>I’ve got to believe that the Endowments with large outstanding capital calls are very worried about this issue given the strain they are already feeling on their liquidity</p>
<p>There is something wrong with this for the investor…</p>
<p>"Some buyout firms are asking their clients for more time to search for companies to buy. Many more are rushing to invest their cash as quickly as possible, whatever the price.</p>
<p>Many in the industry are getting caught in bidding wars. Firms are assigning surprisingly high valuations to companies they are acquiring, even though the lofty prices will in all likelihood reduce profits for their investors. A big drop in returns would be particularly vexing for pension funds, which are counting on private equity, hedge funds and other so-called alternative investments to help them meet their mounting liabilities."</p>
<p>I believe what is driving the PE firms desire to invest their calls is the 2% management fee which over the past few years has been their primary source of income. Presumably if they don’t invest their calls in the 5 year time frame they forfeit the 2% fee on uninvested capital.
I find it interesting how the structure of the PE deals in so many ways seems to always disadvantage the limited partners like endowments. The GP’s win when they are up and they win when they are down.</p>
<p>“The GP’s win when they are up and they win when they are down.”</p>
<p>Yes they do.</p>
<p>I don’t think investors realize how much these fees are…2 and 20…</p>
<p>If the fund makes a 10% return…the GP is getting about 40% of the return…the investor gets about 60 % of the return which leads to a 6% total return.</p>
<p>2 and 20 sounds so much smaller than 40%…</p>
<p>I wonder how much would be raised if the funds said they would take 40% of the profits…I think a lot less…</p>
<p>If the returns are less than 10%…the GP’s return as a percentage of total returns is so much higher.</p>
<p>If the investments return nothing for 10 years…the investor loses double digits because of the fees…
If the investment returns are negative…as they have been for some of these investments…eccch</p>
<p>Last year, Brown issued $100 million in taxable debt as a “cushion” against future liquidity problems. That’s the functional equivalent of obtaining a credit card to buy groceries: <a href=“Bloomberg - Are you a robot?”>Bloomberg - Are you a robot?;
<p>It lost a third of its endowment between f/y <code>08 and</code>09. Officially, it’s only reporting (-25%); but that’s only in terms of market losses, not the total arrived at after subtracting the amount transferred to support the operating budget. </p>
<p>Also more than one-half of Brown’s endowment is in so-called, Level Three investments, known for their lack of liquidity and cash-call commitments. One upshot of all this is that Brown was forced to issue $100 million in taxable bond debt in 2009, ostensibly to help keep the lights on.</p>
<p>From what I’ve seen at the Ivies you have the “poorer endowment” Ivies Brown, Dartmouth, and Cornell who have the same basic financial issue of spending a good amount more than the income coming in. They are not as dependent on the endowment because it’s small relatively but all the areas they do get income from are suffering.</p>
<p>Then the “rich endowment” schools Harvard, Yale, and Princeton are extremelty dependent on their endowments so however their endowments turn out will have a massive impact. The fact that 80-90% of their endowments are in private, black box tier 3 investments makes it a pretty interesting thing to watch.</p>
<p>Then the "middle endowment’ schools Penn and Columbia seem to be in pretty good shape financially.</p>
<p>Every once in a while you get a peek into Harvard’s private holdings. This is an article about a relatively small purchase of a dairy farm in New Zealand but what caught my eye was their purchase in 2003 of a $1billion forestry preserve in New Zealand. Definately not your father’s endowment.</p>
<p>This really gets at the big question about these private holdings. Is there any reason to feel that firms are conservatively or accurately valuing their private holdings. </p>
<p>Given that Freescale’s bonds are selling at such a discount I don’t really understand how these PE companies can give their investment any value.</p>