Academic Endowments Feeling The Effects Of Liquidity Risk

There have been a number of stories over the last few years of academic endowments moving into alternative investments, in particular hedge funds, private equity, real estate, and natural resources, such as timber. While many of these funds have been hurt during the recent downturn, many still found their portfolios falling less than the general market (see previous posts here and here). While losing "only" 20 percent is not as bad as 30-40 percent (although many with budgets getting cut would disagree with losing any money), other consequences of the move into alternative investments are often overlooked, including the valuation of such assets, funding commitments, and issues with liquidity.

A recent WSJ article highlights some of these difficulties. For one, hedge funds often have lock-up periods, keeping endowments in these investments at a time when shrinking budgets and donations are calling out for liquidity (see previous post here). In the case of private equity, the consequences of liquidity risk are even worse since not only is your investment "tied-up," but as a result of previous funding agreements, new capital calls may force you to commit another 50-75 percent of your initial investment, once again at a time when liquidity is tight and budgets are shrinking. While such need for liquidity is challenging for any fund, it is even more difficult for a fund that has decreased equity exposure to the 10-20 percent range, or lower, and has nearly all but eliminated interest bearing fixed income from the portfolio.

As with any shock to the system, strategies will be re-evaluated, and changes will be made. Unfortunately, for many academic institutions this will involve not only changes to the composition of their endowment portfolios, but also an evaluation of their capital improvements, expansion plans, operating budgets, and financial aid for students.