Colby and the Economy

Introduction

The fiscal year ended June 30, 2009, was the most difficult period for capital markets in the last 30 years. The credit crisis led to a high degree of correlation among asset classes, and Colby’s equity-oriented asset allocation suffered in this environment. The Investment Committee of the Board of Trustees was actively engaged in managing both the short-term liquidity challenges of the past year and the longer-term implications for asset allocation that the recent market dislocations have created. We expect this process to be an ongoing challenge for several years.

Endowment Growth

During fiscal 2009 the endowment market value contracted by $147 million to $453 million, a 24.5-percent decrease. Figure 1 shows the endowment growth over the past 10 years. The endowment is approximately 1.6 times what it was at the beginning of fiscal 2000, growing at a compound rate of increase of 4.6 percent during the past 10 years, which exceeds the 2.6-percent inflation rate of that period.

Figure 2 summarizes the sources of change in market value for the endowment for fiscal 2009 and for the last 10 years. For fiscal 2009, investment losses and the spending allocation account for the decrease in market value. Over the past 10 years, performance has been offset by spending, with gifts and other additions accounting for the increase in value. This highlights the importance of new additions to the endowment, especially in the form of gifts.

Figure 2 - Colby Sources of Endowment Growth
		Fiscal 2009 ($000)	Cumulative 10-Yr Totals ($000)
Beginning Market Value		600,248	290,420
	Gifts and Matured Annuities	5,673	83,795
	Other Additions	1,218	78,451
	Investment Performance Net of Fees	(130,169)	160,369
	Spending	(23,387)	(154,300)
	Other Deductions	(593)	(5,745)
Ending Market Value		452,990	452,990

Asset Allocation

Figure 3 shows a comparison of the asset allocation of the portfolio at the beginning and end of fiscal 2009.

Figure 3 - Colby Asset Allocation June 30, 2008, and June 30 2009
		Actual Fiscal 2008	Actual Fiscal 2009	Current Target
Equity
	Domestic Equity	11.8%	9.8%	14.5%
	International Equity	19.9%	17.9%	19.0%
	Hedge Funds	27.1%	25.9%	28.0%
	Real Estate	7.8%	5.7%	7.0%
	Private Equity	20.9%	21.1%	19.5%
	Hard Assets	4.8%	2.3%	4.0%
	Subtotal	92.3%	82.7%	92.0%
Bonds, Cash Equivalents, and Receivables
	Domestic Bonds	6.8%	6.9%	7.0%
	Cash Equivalents and Receivables	0.9%	10.4%	1.0%
	Subtotal	7.7%	17.3%	8.0%
	Total	100.0%	100.0%	100.0%

As of June 30, 2009, the portfolio holds an unusually high cash balance and is underweight in marketable equity asset classes. The dramatic fall in market value in the fall of 2008 coupled with a lack of liquidity in the College’s primary working-capital investment forced the College to focus on raising cash to meet spending and partnership commitments. Over the past year the College conducted a detailed review of all external manager relationships and raised needed liquidity through reductions and terminations of relationships. In the fourth quarter of the fiscal year, a group of private equity partnerships were sold to reduce the amount of outstanding partnership commitments to a level more consistent with the lower current market value of the portfolio. While this process cost the portfolio 2 percent in performance for the year, it was necessary to reduce the level of monthly cash draws to support partnership obligations, to control future allocations to nonmarketable asset classes, and to establish a more sustainable level of relationships in these asset classes. The College has addressed its immediate liquidity needs, but asset allocation modeling suggests that controlling the level of allocation to nonmarketable asset classes, while preserving a core set of relationships, is likely to continue to be a challenge for the next four to five years.

Figure 4 shows the changes in June 30 asset allocation over the past 10 years. During that period the College has decreased its bond allocation while adding substantially to the diversification of the equity allocation through a reduction in the allocation to domestic equity and increases in the allocations to international equity, hedge funds, real estate, and hard assets.

Figure 4 - Ten-Year Assett Allocation
		Fiscal Year
		1999	2004	2009
Equity
	Domestic Equity	38.1%	25.2%	9.8%
	International Equity	11.6%	15.5%	17.9%
	Hedge Funds	4.1%	19.6%	25.9%
	Real Estate	5.0%	6.5%	5.7%
	Private Equity	20.8%	15.7%	21.1%
	Hard Assets			2.3%
	Total Equity	79.6%	82.5%	82.7%
Bonds, Cash Equivalents, and Receivables
	Domestic Bonds	19.1%	14.2%	6.9%
	Cash Equivalents and Receivables	1.3%	3.3%	10.4%
	Total Bonds, Cash Equivalents, and Receivables	20.4%	17.5%	17.3%
	Total Investments	100.0%	100.0%	100.0%

At June 30, 2009, the portfolio contained commitments to 152 different investment vehicles, representing 89 investment products and 69 investment managers. These numbers have decreased from June 30, 2008, as a result of partnership sales and the overall manager review. Over the next few years the number of investment relationships is expected to contract further as a number of the older partnership relationships come to the end of their contractual lives.

Performance

The endowment underperformed its composite benchmark for fiscal 2009 by 5.88 percent (-21.79 percent vs. -15.91 percent). While domestic and international equity indexes lost more than the Colby portfolio (the Russell 3000 Index lost 26.57 percent and the MSCI All-Country World ex U.S. Index lost 30.54 percent), this is still a very disappointing result. The underperformance occurred in the hedge fund and nonmarketable equity components of the portfolio, with approximately 2 percent of underperformance related to the asset sales in venture, buyout, and hard assets.

• Domestic and international equities outperformed benchmarks by 5.04 percent and 3.18 percent respectively, with the value-oriented managers driving the outperformance.
• Hedge funds underperformed their benchmark by 3.24 percent (-7.72 percent vs. -4.48 percent). Despite the underperformance relative to benchmark, hedge funds did preserve considerably more value than the public market benchmarks. The focus on liquid strategies and limited debt allowed the portfolio to maintain much of its value and allowed the College to tap it as a source of liquidity during the year.
• Venture capital and buyout both underperformed their benchmarks. The underperformance was all related to the losses on the sale of partnerships in those asset classes.
• Real estate underperformed its benchmark by a large margin. The real estate portfolio is levered, while the benchmark is not. In the current environment the presence of leverage increased the losses on the portfolio and explains most of the performance differential.
• Hard assets also underperformed by a large margin. Much of the underperformance was related to losses in a marketable proxy that was terminated in the fall and the sale of partnership assets.

Figure 5 shows the endowment performance for one-, five-, and 10-year periods compared to the composite benchmark and a standard 70-percent/30-percent portfolio. Colby has underperformed its composite benchmark for the one- and five-year period, but outperformed for the 10-year period. It has underperformed the 70-percent/30-percent standard portfolio during the one-year period, but outperformed it for the five- and 10-year periods. While the nonmarketable asset classes have created liquidity and performance issues during fiscal 2009, they have been the drivers of long-term performance over the five- and 10-year periods.

Figure 5 - Endowment Performance
	Colby	Colby Composite Benchmark	Standard 70%/30% Portfolio *
One-Year Return	-21.79%	-15.91%	-16.35%
Five-Year Compound Annual Return	4.50%	5.35%	0.60%
Ten-Year Compound Annual Return	4.58%	2.51%	1.12%
* 70% Russell 3000 Index and 30% Barclays Intermediate Government Bond Index

Spending

The goal of a spending formula is to produce a stable flow of revenue for operations while maintaining, at a minimum, the purchasing power of the principal of endowment. Colby’s spending formula defines spending as a percentage of a five-year moving average of June 30 market values with adjustment for additions received in subsequent years. The use of a five-year moving average in the formula has produced a stable flow of revenue for operations with nominal dollar increases in each of the past 10 years, despite two bear markets in that time span. The smallest year-over-year percentage increase in spending during the past decade was 3.2 percent, and the 10-year compound average rate of increase is 10.9 percent.

Figure 6 shows the comparative 10-year compound average annual growth rates of endowment market value, endowment spending, student charges, and budgeted total operating revenue. The endowment spending has grown at a compound annual rate of 10.9 percent for the past 10 years. This is considerably higher than the rates for student charges (4.8 percent) and budgeted total operating revenue (6.0 percent). In addition, the budgeted endowment income as a percentage of budgeted total operating revenue increased from 11.2 percent to 16.7 percent during the past 10 years.

Figure 6 - Comparative Compound Annual Growth Rates
	Ten-Year CAGR
Endowment Market Value	4.6%
Endowment Spending	10.9%
Budgeted Total Operating Revenue	6.0%
Student Charges	4.8%

The spending rate for fiscal 2009 was 4.42 percent.

Organization and Process

The endowment investment program is the responsibility of the Investment Committee of the Board of Trustees. The Investment Committee comprises 11 trustees plus the president and chair of the Board of Trustees on an ex officio basis. Members of the Investment Committee have deep experience in a broad array of asset classes. The portfolio is divided into five components (cash, marketable securities, private equity, real estate, and hedge funds), with a subcommittee for each component that is composed of Investment Committee members with expertise in the relevant asset classes. Working with the investment staff, these subcommittees have the authority to add and terminate managers and to rebalance investments within the asset classes under their purview.

As a matter of process, all changes to the investment portfolio are approved by either the Investment Committee or one of its five subcommittees, with subcommittee actions ratified at the next regularly scheduled Investment Committee meeting. All endowment assets are managed by outside investment managers.

The Investment Committee and its subcommittees are supported by the Investment Office, which includes three full-time positions. The non-investment-manager operating expenses assigned to the endowment (salaries, travel, office expenses, legal review of partnerships, consulting, custody, UBTI taxes on partnerships, and audit) are monitored by the College’s vice president for administration and treasurer along with all other College budgets. These expenses amounted to approximately 13.4 basis points on average market value for fiscal year 2009.

The investment staff conducts ongoing diligence on existing investment managers as well as potential new managers. Changes are recommended to the Investment Committee or one of its five subcommittees. Investment manager diligence focuses on the following key areas:

• Clear and consistent investment strategy;
• Depth and continuity of the investment professionals;
• Risk management at both the portfolio and operational levels;
• Demonstrated investment performance relative to a predetermined benchmark;
• A level of assets under management that is adequate to support the organization and appropriate to the investment strategy.

Agenda for 2009-10

The actions taken during fiscal 2009 have dealt with the immediate liquidity issues and have left the endowment with a stronger and more streamlined group of investment managers. During fiscal year 2010 the Investment Committee will conduct a review of the asset allocation targets for the portfolio in light of current investment opportunities and an increased focus on liquidity. It will also decide on the appropriate level of cash reserves needed to manage the portfolio through a difficult transition period, during which the College expects to have negative cash flows for the endowment for the next two to three years as spending and net partnership draws are expected to exceed gifts and transfers into the endowment.

 

Douglas E. Reinhardt ’71
Chief Investment Officer

Douglas C. Terp ’84
Vice President for Administration