Tufts' investing strategy places heavy emphasis on hedge funds

    Editor's note: This is the second article in a two-part series exploring the university's investments. The first piece appeared yesterday.
    While the outcome of Tufts' ill-fated $20-million investment in Ascot Partners was an exception, the financial vehicle the university used is increasingly becoming the rule. According to the most recent publicly available numbers, which are from the end of fiscal year 2008, Tufts has well over $1 billion of its $1.8 billion in long-term investments tied up in hedge funds.
    The university began investing in hedge funds in 2000, and until the recent economic downturn clipped the wings of nearly all college endowments, the results had been overwhelmingly positive.
    But recently, hedge funds have plummeted along with the rest of the economy, and their promises of independence from the fluctuations of the market have fallen flat. Colleges, which have funneled billions of dollars over the past several years into the funds, have been among the victims.
    "For a while, it worked out great," Economics Lecturer Christopher McHugh said. "Everybody loved hedge funds until [last] year."
    Over the past five years, the university's investments posted average annual returns of 11.5 percent. During that period of growth, Tufts investors veered increasingly into alternative forms of allocations, substantially expanding the university's real estate holdings and making a recent plunge into timber.
    As the school braces itself for a 25-percent drop in its endowment and $36 million in budget cuts, Chief Investment Officer Sally Dungan does not expect to abandon this trend, and is instead looking to continue diversifying.
    "We generally do not adjust our asset allocation or investment strategy for economic conditions, but only for changes in Tufts' risk tolerance," she said in an e-mail to the Daily. "We expect to continue to pursue a strategy of diversification with appropriate consideration for risk and return."
    While investors once looked to hedge funds as a magic bullet, the funds had their worst-ever year in 2008. Reports indicate that the average fund lost 19 percent, although some economists suspect that the real deficits could be far worse since most funds do not have to publicly release their numbers.
    As investors lose confidence in hedge funds, analysts have started to write off the vehicles as too risky. Meanwhile, regulatory groups are bemoaning the funds' lack of transparency.
    But according to Dungan, Tufts' hedge fund investments are no riskier than other parts of the school's portfolio. And Tufts officials are quick to point out that hedge funds run the gamut of risk and often differ from more traditional forms of allocations only by their legal structure. In many cases, for example, hedge funds simply invest in the stock market.
    "This has not been a good year for most of the investment industry," Trustee Chairman James Stern (E '72) said. "To say that investments in hedge funds are not viable is crazy … If you look historically, I think a lot of the best and brightest have set up their own shops, and those are the people you want to be invested with in the long term."
    Tufts economists agreed that not all hedge funds carry additional risk, but since the university does not publicize the names of the funds in which it invests, they could not comment on the overall safety of the portfolio.
    "Yes, it sounds scary," Economics Lecturer Michael Fenollosa said of the extent to which the university is invested in hedge funds. "But actually … the devil is in the details, and it really depends what they are."
    McHugh, the chief financial officer of the hedge fund New Generation Advisors, agreed. "Hedge funds have a rap as having a lot of leverage and doing crazy things," he said. "That's one out of three or one out of 10. But most hedge funds [are] just souped-up mutual funds, and they're just souped-up in the sense that they might do short selling or they might do distress debt or something.
    "They're not necessarily as bad as they're made out to be," he added. "But it really depends what hedge fund you're in."
    If the 19-percent average loss is accurate, hedge funds are, on the aggregate, actually safer than the rest of the market. The average stock mutual fund lost 37.5 percent in 2008, and the Nasdaq was down 40.5 percent.
    It's possible that this outperformance will continue into the future. "I wouldn't be surprised if at the end of the year, [Tufts investors] report that they had more hedge funds than they had equities and they beat the market by a little," McHugh said.
   
A mostly consistent strategy
At Tufts, fiscal years begin on July 1 and end on June 30; the most recent numbers available are for fiscal year 2008, which wrapped up in June. At that point, Tufts had $1,054,940,000, or 58.4 percent of its total investments, in hedge funds, up from 37 percent the year before. But according to Dungan, this skyrocketing involvement does not reflect a changing strategy.
    "The apparent ‘jump' in hedge funds from FY 2007 to FY 2008 [speaks to] how our auditors classified certain of our funds, not to any significant changes in our investments," she said. "In this case, our auditors decided that investments in various public index-related funds set up in a common trust fund should be reclassified from equity securities to hedge funds."
    This reshuffling masks an investment strategy that in many ways has stayed consistent. In fiscal years 2007 and 2008, for example, the target allocation across asset classes was identical. In both years, the university placed the plurality of its investments in global equities, the class that Dungan said offers Tufts the best chance for long-term growth.
    But in some cases, actual allocations diverged from projections. This shift is evident in some alternative investments, such as  real estate. Tufts' real estate holdings jumped from 1.1 percent of total investments in 2005 to 4.7 percent in 2008.
    The housing market has suffered substantially in the past year, but Dungan declined to comment on how this has affected the university.
    "The real estate portfolio is managed by external investment managers; we do not discuss specific managers or investments," she said.

The dangers of imitation
    In beefing up its real estate and timber holdings, Tufts is following the example set by the nation's best-performing endowments. Yale, in particular, is noted for its reliance on innovative, pioneering
strategies.
    But some worry that harmful effects can come from following in the footsteps of the endowment giants. "It looks like they're piggybacking on how Harvard and Yale made their money," McHugh said of Tufts. "I think what might have worked for first-comers who have a chance to get in with the better stuff might not work for the ones who come in later."
    Still, it is unclear how much Tufts' investments have in common with those of other institutions. The Daily contacted 12 colleges, and none of the seven spokespersons who responded would comment on hedge fund numbers.
    "We don't discuss that publicly," Colby College spokesperson David Eaton told the Daily. "We just simply don't talk about how the endowment is invested or the strategies we use to invest it."
    Harvard, Yale, Dartmouth and Columbia also stayed away from providing specifics on hedge funds, while Williams and Princeton both gave limited details.
    "We always have been public about the fact that our portfolio includes a range of accounts that include investments in international and domestic securities, fixed income accounts and yes, we do employ hedge strategies," Princeton spokesperson Cass Cliatt told the Daily in
an e-mail.
    While Cliatt acknowledged that Princeton mixes traditional and innovative models in its hedge fund investments, she declined to give precise numbers.
    "As a matter of policy, we do not comment on the specifics of investment strategy, our portfolio or its return drivers," she said. "We do not find it fiscally prudent to do so."
    Meanwhile, a Williams financial report for fiscal year 2007 refers to the school's growing dependence on hedge funds and other alternative investments. "We set our allocation targets for each asset class annually and over the last few years have increased our allocation to hedge funds, real estate and international equities, while reducing our allocation to domestic equities and bonds," the report reads.

Calls for regulation
    Tufts and Williams are hardly alone in turning to hedge funds. As the number of hedge funds has exploded over the last decade, so has the amount of money they collectively handle. The Chicago-based group Hedge Fund Research estimated that hedge funds controlled nearly $2 trillion at the beginning of 2008, as compared to $375 billion in 1998.
    According to McHugh, as hedge funds become less exclusive, their promise to remain independent of the larger market is losing sway.
    "They'll say that they're not correlated, and that was a big selling point of hedge funds," he said. "That's a claim, and it holds up pretty well in the '80s and in the '90s, but what happens is once the hedge funds become so big, they become the market."
    And as hedge funds corner the market, opponents of Reagan-era financial deregulation are growing increasingly concerned.
    "One of the things that I think is really scary about that is that hedge funds haven't been subject to much regulation," Cheyenna Weber, the organizing director for the New York-based Responsible Endowments Coalition, told the Daily.
    President Barack Obama's economic team has indicated support for tightening up restrictions on hedge funds, particularly following the collapse of Bernard Madoff's alleged Ponzi scheme. But Weber said that in the short term, the onus is on individual investors.
    "I think that if investors can't rely on the government to … regulate the economy and make sure the investment vehicles are safe … then it's up to the investors themselves," she said. "[But] you can't do that if you've outsourced all of that to hedge funds and fund managers."
    At Tufts, the $20-million investment in the hedge fund Ascot Partners, which was entirely invested in Madoff, has prompted the university to take a fresh look at its strategies and at how much campus investors are willing to tolerate outside control and unregulated allocations.
    "We will look closely at our experience in this case and fully review our processes and procedures to see if there are ways to strengthen them," Dungan said.
    Still, it is likely that the university will remain heavily invested in hedge funds — just with lower expectations for returns in the ailing economy.
    "[Tufts has been] boasting a great return on their endowment," McHugh said. "That's fine. An economist will tell you, though, ‘Well, you don't get double-digit returns forever.'"