Nov

10

In the UK, Cambridge University's Clare College is standing up to be counted among the optimists. For the first time in its seven hundred year history the college is making a leveraged play on equities. Here's from this week's Economist :

'It has borrowed £15m ($24m) for 40 years at a real (after-inflation) yield of 1.09% and plans to invest the proceeds in equities. In effect, it has turned part of its portfolio into a hedge fund, using borrowed money to speculate on the stockmarket. At an inflation rate of 3%, it will have to repay around £75m in 2048. Will future dons be throwing themselves off the famous Clare bridge?'

It's good to see someone exploiting a few of the extreme pressures in the market:

- Panic selling of equities. No one knows where the bottom is, but I'd rather buy at these prices than at last year's prices.

- Excessive demand from pension funds for long dated inflation-linked bonds in the UK (or insufficient supply) has pushed down the yield to very low levels, resulting in a very cheap financing option for the college.

- Right now, everyone is panicking about where the market is going tomorrow, next week, next month, even a year from now. These guys have a forty year investment horizon. The risk premium can be a fraction of what it was in the past and they will still make a tidy profit. (although I did read an interesting comment that because it would be extremely expensive to insure this forty year trade with options, this suggests that investors who take such long views may not be being rewarded for their patience so much as they are being rewarded for the extra risk they are taking.)

- Relative to the size of the college's total endowment, the investment is apparently quite small. Also, despite press talk of turning in to a hedge fund, there is no mention of investing away from equities or going short. All in all, I congratulate them for taking a measured risk at an opportune time when both ends of the market (financing and investing) appear somewhat stretched.

It's a bet I'd happily take, if only I could get financing at inflation +1.09% for forty years!

A Cantabrigian from the other side of the pond adds:

I heard a few months ago, that Harvard and Stanford were hard hit by the decline. Well they might be, since they had a mish mosh of commodity based investments guaranteed to decline with the simonesque times. They just sent me a disguised fund raiser that implies the decline was much less than feared, a mere 30%.

Riz Din goes back in history:

Keynes seems to have been quite the risk taker, trading currencies on margin before switching to commodities and blowing up his personal account in 1929. His Independent Investment Company (an investment trust), set up in 1924 also failed miserably.

However,  his performance managing the King's College Cambridge's 'Chest' fund is highly impressive, and despite poor performance of the averages, Keynes did succeed in steering the Chest through the turbulent times of the Great Depression. Prof. Dimson has written a nice paper on the Chest's performance.

Keynes investment philosophy was far from static over the course of this period. He realised that his gains came from a handful of stocks and switched from a top-down, asset rotation approach to a concentrated buy and hold philosophy. The lesson is one of continuous learning, but I do wonder if Keynes was deceived by hindsight (i.e. perhaps you have to buy widely to be sure of catching the winners?), and believe the far more important factor in his success lie in his willingness to go against the consensus. At a time when British investment institutions' exposures to equities was extremely low, going from around 3% in 1920 to about 10% in 1937, Keynes went against the prevailing wisdom in no small measure; apart from seeking safety in government assets in the height of the panic, Dimson writes that 'by the mid-1930s he was investing heavily in US common stocks such that the Chest's total equity weighting never dropped below 50%.'

And where are we now? Take a look at this graphic of asset allocation of US university endowments with a minimum size of $1bn, it's taken from a recent research note from ML, although the data is from 2007.

Equity allocation is 47%, with a whopping 34.5% in alternative investments.


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