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October 1, 2007

Over the hedge | Maine's colleges look beyond stocks and bonds to manage their endowments. Is the risk worth the reward?

By Taylor Smith
In July, Sowood Capital Management experienced a flameout of epic proportions. The high-flying Boston hedge fund crashed to earth because of trouble in the bond markets, losing an estimated $1.5 billion of investors' money in the process. The fund's collapse was front page news, causing millions in losses for loads of clients, from nonprofit groups to the Massachusetts state pension system. Among the most high-profile casualties was Harvard University, which lost a reported $350 million of its endowment.

The loss probably wasn't too hard for Harvard to absorb ˆ— after all, its total endowment is a staggering $34.9 billion. But what if a few holdings went sour at the University of Maine Foundation, which manages $150 million of the University of Maine's $240 million endowment? In short, the results could be catastrophic.

So what are Maine's colleges and universities doing to protect themselves from the scourge of the dropping Dow and other investment vagaries? With billions of Maine educational institutions' money under management, what's keeping those dollars from sliding into the loss column?

The answer is many schools are finding solace in the same high-powered investments that chewed a $350 million hunk off of Harvard's endowment. While they acknowledge that hedge funds can be risky, they also see such investments as a way to diversify and shelter their endowments from the ups and downs of an increasingly volatile stock market. And despite a few blips of bad news, more and more American colleges and universities are turning to sophisticated investments like hedge funds to supercharge endowment returns.

Take the University of Maine Foundation, which manages the bulk of UMaine's $240 million endowment. The makeup of the foundation's fund has changed considerably over the last five years to roll with what the market dishes out, according to Amos Orcutt, president and CEO of the foundation. These days, eight percent of the endowment is invested in bonds, down from 25% five years ago, because, Orcutt explains, while there's safety in the fixed-income markets, there's also not much to gain ˆ— at least not enough to generate the 17.4% return the foundation reported for its 2007 fiscal year that ended in June. "There's no return in bonds," Orcutt says. "We want better than a five-percent return. The question is, what's the mix and where do we go? You have to find something that's going to give you a higher return with hopefully not a greater risk."

Moving money

Orcutt and the University of Maine Foundation's investment committee found the higher returns they were looking for in a part of the market Orcutt calls "alternatives" ˆ— investments like hedge funds, private equity funds and venture capital. They're investments closed to everyday Joes with a 401(k), but wide open to a foundation with hundreds of millions of dollars.

These alternative investments are a strategy that's caught on with educational institutions across the country. In 1997, colleges and universities invested an average of 2.2% of their endowments in hedge funds, according to the National Association of College and University Business Officers (NACUBO), which commissions an annual endowment study. By 2006, that figure had jumped to 9.6%.

The University of Maine Foundation has nearly 20% of UMaine's endowment socked away in alternative investments like hedge funds and private equity. Despite this year's shakedown, Orcutt says the strategy has paid off. "It took some thinking and in-depth study," he says. "But we've done it, and so far we've had good success."

Among Maine institutions, Orcutt's not alone when it comes to looking outside of the traditional equity and bond markets for investment inspiration. Colby College in Waterville invests more than 20% of its $487 million endowment in hedge funds. And while Bates College Assistant Treasurer Ned Carr won't give exact figures, he says hedge funds and other alternative investments in recent years have become a bigger part of the Lewiston college's strategy for managing its $250 million endowment.

Both Colby and Bates are tallying their fiscal year results and were unable to provide annual return numbers for their endowments. Stephen Heacock, Colby's director of communications, says the college's endowment posted a 0.5% loss in July and August, when the stock market and hedge funds were taking the worst beatings. "Considering what's happened in the market, that's not too bad," he says.

One reason colleges and universities have looked beyond traditional investments is asset allocation. The hope is that when the stock market zigs, hedge funds will zag, offering some protection when the Dow drops 250 points between breakfast and dinner. "That increased diversification outweighs any risk that a single investment will underperform," says Matt Hamill, senior vice president of NACUBO. "You take a little more risk in any single investment, but overall, that diversified investment portfolio should give you a better return."

That kind of investment thinking, according to Albert Brenner, editor of the Asset Allocation Advisor, a journal published in West Hartford, Conn., may seem counterintuitive, but it's actually a sound strategy. "Adding high risk into a portfolio can actually lower risk" because of the benefits of diversification, he says. "It takes some sophistication to see that."

In Maine, colleges and universities have taken pains to protect their endowments with a dose of Yankee conservatism. From Colby to the University of Maine Foundation, armies of alumni with investment savvy keep tabs on how professional managers are running the fund. And while that's no guarantee a school won't shed millions in an ill-timed hedge fund collapse, people like Ed Hennessey, president and CEO of Machias Savings Bank and a member of the University of Maine's investment committee, say constant vigilance is among the most important tools they employ. "The best thing we can say is that we've got our eyes wide open," he says.

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