As we’ve noted over the past month, many university endowments are getting hammered–perhaps none more so than the University of Virginia. Thanks to overcommitments to private equity, hedge funds, and other illiquid investments, the endowments are being forced to throw everything else in the portfolio over the side.
This, in turn, is clobbering stocks, which are liquid, and hedge funds, which are more liquid than private equity funds. As of September 30, UVA had $1.8 billion of unfunded private equity commitments and minimal incoming distributions to fund them with. As a result, the endowment plans to keep dumping hedge funds.
In its September letter, UVA explains. First, the bad news:
Extreme volatility of price movements for almost every asset class in the world and a pervasive
sense of fear throughout the global financial system have created a daunting investment
environment. Accurately assessing investment performance and crafting appropriate strategy for
this crisis environment have become increasingly difficult…
In our judgment, the entire global financial system is in distress, and transactions have not beenorderly since Lehman’s failure in mid-September. Brokerage firms fail to honour wire transfer instructions. Treasury bill transactions do not settle. Publically traded short-term debt instruments of high quality companies cannot be sold at any price. Market prices of the stocks of those same companies have been falling in days by more than is normal for entire years as investors sell long-term investments to meet short-term cash needs…
We estimate the value of our pool declined by 11%, or about $600 million, for the quarter ended September. Already in October, our policy benchmark has declined by another 20%.
And now for the future:
We have spent the month of October updating our asset allocation plans. We have more
thoroughly analysed our future cash needs and examined redemption terms of our fund
investments. We have prepared base case plans and considered worst case scenarios.
In liquidity terms, our approximately $4 billion pool, (mid-October pricing), is allocated as
follows: We own $600 million in liquid securities (evenly split between bonds and equities).
We own $1.8 billion in hedge funds (public equity, long/short, absolute return, and credit). We
own $1.6 billion in private funds (private equity, real estate, and resources).
We have uncalled commitments of $1.8 billion to private funds. Under normal circumstances,
we receive regular distributions from private funds and expect these distributions to exceed
capital calls. However, in recent quarters we have received much lower distributions from our
private funds than usual. In conversations with our private managers over the past two weeks,
they tell us that the financial crisis precludes sales of existing investments, and we should not
expect any distributions this quarter and few in 2009. None wish to forecast distribution activity
in 2010 and beyond.
Despite this cessation in distributions, we expect to invest between $600 million and $1 billion in
private funds over the next two years. We expect private investments in distressed markets to
provide exceptional returns. Most of these investments will be through funds to which we have
already made commitments.
In our base case scenario through 2010, we plan to liquidate roughly $400 million from public
equities to fund capital calls from private equity funds, thereby maintaining a constant exposure
to equities throughout the period. We plan to redeem about $400 million from hedge funds to
meet capital calls from real estate and resource managers. We expect about $100 million in
distributions from private funds in 2009 and more in 2010. We have earmarked these funds for
the spending needs of the University and related foundations. We will make whatever additional
hedge fund redemptions are necessary for the balance of the spending needs.
We expect to end 2010 with about $500 million in liquid securities, (cash, government bonds,
and public equities), $1.3 billion in hedge funds, and $2.2 billion in private funds. If markets
continue to fall, we may need to sell more liquid securities and redeem more from hedge funds. If markets recover, we will sell fewer liquid securities and redeem less from hedge funds.
Barring a near-term snap back in prices and resumption of distributions from private managers,
our pool may drift toward a higher allocation to private investments than we intended. For this
reason, we may explore the secondary market for sales of our interests in older private equity
funds. However, because bids for these illiquid investment assets are severely depressed in
today’s period of financial distress, the proceeds from a sale may be far below fair value. We are a price-sensitive seller.
A cash shortage at endowments like this will make the VC and PE funding shortage worse. So here’s hoping we’re near a bottom.
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