Investment Management Company Annual Report 2011–12
CONTENTS From the CEO........................3 UVIMCO Overview...............4 Portfolio at a Glance...............6 Investment Strategy................8 Asset Allocation....................10 Co-Investments.....................14 Risk Management.................16 Portfolio Rebalancing............19 Investment Performance.......21 Organization.........................24
From the CEO To the Rector and Visitors of the University of Virginia, Foundation trustees, and other members of the University community:
O
ver the past year, uncertainty dominated the markets and created a challenging investment environment. Macroeconomic fears overshadowed relatively solid corporate fundamentals, contributing to choppy and negative global equity markets. Investor concerns included the fiscal health of the United States and Europe, the potential collapse of the European Monetary Union, and a slowing economy in China. Conflicting market signals and unrelenting volatility caused many investors to question their investment theses, shorten their holding periods, and attempt to time the markets. Against this backdrop, the University of Virginia Investment Management Company (UVIMCO) employed the same long-term investment strategy that has served us well for decades. Our edge is in partnering with extraordinary investment managers and our ability to be a patient long-term investor. The current macro-oriented market and short investor time horizons create opportunities for our managers to exploit differences between fundamental value and price. UVIMCO’s long-term horizon, patience, and ability to bear liquidity risks allow us to capitalize on such market inefficiencies and give us an edge over investors with shorter time frames. The Long Term Pool managed by UVIMCO returned 5.1% during the twelve-month period ending June 30, 2012. By comparison, our performance benchmark—comprised of 60% equity, 10% real estate, and 30% fixed income—lost 0.4% over the same time period. While we are pleased to report strong relative performance for the year, it is not our goal to outperform the passive benchmark over short time periods. Rather, we seek to generate long-term returns on the Long Term Pool in excess of the University’s spending rate plus inflation. For the twenty-year period ended June 30, 2012, the Long Term Pool recorded an annualized return of 12.1%, comfortably exceeding the 7.5% return earned by our performance benchmark and the University’s spending rate—4% to 6% of the endowment’s market value—plus the 2.5% average rate of inflation. Through effective asset allocation and exemplary manager selection, the Long Term Pool continues to provide the primary source of sustainable private support for the University of Virginia and its related Foundations. This annual report provides an overview of UVIMCO’s investment strategy, asset allocation, risk management process, performance, and organization. I hope you find it useful in understanding the philosophy and principles that guide our efforts to provide exemplary investment returns and service to the University of Virginia community. As always, the Board and staff of UVIMCO are grateful for your continued faith in us. Sincerely,
Lawrence E. Kochard Chief Executive Officer Chief Investment Officer UVIMCO Charlottesville, Virginia June 30, 2012
uvimco annual report 2011–12
3
UVIMCO Overview
T
he University of Virginia Investment Management Company provides investment management services to the Rector and Visitors of the University of Virginia and to the University’s related Foundations. UVIMCO invests the endowment and other long-term funds held by the University and its related Foundations in a Long Term Pool. The University’s endowment consistently ranks among the five largest for public institutions of higher education and among the twenty largest of all colleges and universities in the nation. Equally important, the endowment per student also consistently ranks among the largest in the nation for a public university.
Throughout its history, the University of Virginia has relied on appropriations from the Commonwealth of Virginia for its core funding. However, declining state support means the University must rely on generous donors more than ever before to provide it with a margin of excellence. The following chart illustrates the University’s increasing reliance on endowment spending versus state support to fund academics. In recent years, a historic shift has occurred with endowment spending representing a greater portion of the University’s academic budget than state support.
Historical State Appropriation and Endowment Distribution As a Percentage of Academic Division Operating Budget 35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
State Appropriation*
Endowment Distribution
*State Appropriation represents unrestricted state general funds appropriated for basic educational needs and excludes restricted state general funds to be used for research and financial aid.
4
uvimco annual report 2011–12
11–12
10–11
09–10
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
00–01
99–00
98–99
97–98
96–97
95–96
94–95
93–94
92–93
91–92
90–91
89–90
0.0%
62% university endowmen A number of the University’s schools and programs have related Foundations that manage their philanthropic support. This model allows the University and its related Foundations to work together with the schools and programs to ensure that funds are managed prudently and that gifts are used as donors intend. Together they determine how best to use unrestricted contributions to provide student aid, build and maintain library collections, long-term university operating reserves
marketable alternatives support student organizations and publications, and & credit enhance teaching and research. The University’s Board of Visitors has a representative on the board of 62% each of the affiliated Foundations, as does the President of the University. UVIMCO invests long-term funds for the University and numerous related Foundations. As of June 30, 2012, the shareholder composition of the Long Term Pool was as follows:
16%
62% university-related foundations
university of virginia endowment
22%
uvimco annual report 2011–12
5
9.3%
university of virginia endowmen
Portfolio at a Glance
Fiscal Year Ending June 30 Market Value (in millions)
2008 2009 2010 2011 2012 5,100.5
3,959.7
4,454.7
5,346.5
5,430.0
Net Asset Value per Share
5,070
4,006
4,612
5,732
6,025
Return
5.9% -21.0% 15.1% 24.3% 5.1%
Strategic Allocation
6
Public Equity
20.6% 20.7% 20.0% 20.3% 20.5%
Long/Short Equity
34.5% 25.4% 24.8% 23.4% 22.7%
Private Equity
19.6% 16.5% 18.7% 19.5% 19.7%
Real Estate
5.2% 4.0% 4.0% 5.9% 8.6%
Resources
5.0% 5.9% 7.1% 7.3% 7.0%
Marketable Alternatives & Credit
Fixed Income & Cash
uvimco annual report 2011–12
10.7%
15.5%
14.6%
11.9%
9.3%
4.4%
12.1%
10.7%
11.7%
12.3%
E
ndowment gifts benefit the University and its related Foundations in perpetuity. Invested properly, endowments generate a steady stream of income for professorships, scholarships, fellowships, lectureships, book funds, and many other purposes. UVIMCO’s primary investment objective is to maximize the long-term real return of the Long Term Pool, commensurate with the risk tolerance of the University. To achieve this objective, UVIMCO actively manages the Long Term Pool in an
attempt to provide a substantial and growing stream of income to support the programs of the University and its related Foundations, while at the same time preserving the purchasing power of their long-term investment assets. Therefore, we seek to generate a long-term average annual return on the Long Term Pool (after inflation and net of fees) in excess of the spending rate. The following chart shows the growth in the Long Term Pool since 1974.
Long Term Pool Performance 1974–2012 $6,000
5,000
(in millions)
4,000
3,000
2,000
1,000
0 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Long Term Pool Performance (Net of Distributions) Post-1974 Gifts and Transfers* 1974 Endowment* Actual Long Term Pool Value *Adjusted for inflation using the Higher Education Price Index Assuming an inflation rate equal to the Higher Education Price Index (HEPI), an inflation index that tracks the main cost drivers in higher education, the University’s 1974 endowment of nearly $60 million grows to $350 million today. Adding gifts and transfers (including $300 million of University operating funds formerly invested
with the Commonwealth of Virginia), the inflated value of the University’s original endowment plus subsequent inflows grows to $3.1 billion today. The additional $2.3 billion of current value in the Long Term Pool is the result of positive investment returns accumulated over the past several decades. A
uvimco annual report 2011–12
7
Investment Strategy
A
ttractive long-term investment returns are best produced by maintaining a consistent investment philosophy, team, and process over time. Several core principles guide us at UVIMCO as we invest the Long Term Pool. First, we are long-term investors. Our relatively long time horizon allows us to capitalize on market inefficiencies and risk premiums that arise from other investors’ focus on short-term news and market events. While our portfolio may outperform expectations in the short term, this is not our goal. Rather, we seek to outperform our benchmarks over the long term, which means we are willing to underperform passive benchmarks and peer institutions over shorter periods of time. Second, we seek attractive long-term returns through our external investment manager selections, asset allocation decisions, and portfolio tilts that take advantage 8
uvimco annual report 2011–12
of economic themes. Securities are selected for UVIMCO by a team of extraordinary external managers that we have built over time. Whereas the vast majority of money managers fail to beat passive benchmarks, UVIMCO’s disciplined research process and pattern recognition enable us to develop relationships with outstanding investment managers who demonstrate an edge in both security selection and asset allocation. Third, we believe that price matters. Behavioral biases by other investors can cause prices of investments to differ from their fundamental values for long periods of time. Markets tend to overreact to recent events and assume that good or bad news will continue into the future. At UVIMCO, we believe in long-term reversion to fundamental values. Superior long-term returns depend on investing in securities, themes, and asset classes with
current prices below their fundamental values. Mispricings at the security level create opportunities for our external investment managers, while thematic and assetclass inefficiencies may be exploited by both external investment managers and our internal investment team. We seek investments that have fallen out of favor, resulting in a supply/demand mismatch of capital. We recognize that prices can differ from their fundamental values for extended periods, so we must remain patient for this approach to pay off. Fourth, we believe our success is largely dictated by the quality of the people on the UVIMCO team and the longterm partnerships we maintain with external investment managers. We ask all staff members to demonstrate a strong work ethic, passion for investing, effective teamwork skills, and the desire to put the University’s interests above
personal interests. We expect our external investment managers to demonstrate similar values, and believe that hiring talented, high-integrity managers is one of the most important ways in which we control portfolio risk. Finally, we believe in the benefits of diversification. We expect that the quality of our research and manager selection will lead to good results over time, but we understand that certain decisions will be unsuccessful. Therefore, we diversify our investments across asset classes, themes, and managers. We pursue strategies and investments where we have expertise, and decline opportunities where we do not. This approach requires humility in our investment team. We also seek humility in our investment managers, appreciating those who are confident but not overconfident, who employ investment processes we can understand, and A who consider the downside risk of any investment.
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9
Asset Allocation
T
he Long Term Pool is allocated to three broad asset classes: equities, real assets, and fixed income/ marketable alternatives. Based upon the University’s risk tolerance together with capital market risk and return estimates, UVIMCO’s Board of Directors establishes a strategic asset allocation designed to achieve the investment objectives for the Long Term Pool. Our policy allocation to the three broad asset classes is 60% equity, 10% real assets, and 30% fixed income and marketable alternatives. Since the strategic asset allocation is established to reflect the risk tolerance of the University, revisions to the strategic asset allocation are infrequent and gradual, and generally occur only when the risk tolerance of the University changes. Equity investments provide ownership claims on the growth opportunities provided by public and private companies. In a growing global economy with low inflation, equity investments typically provide the highest long-term return opportunities. Real assets provide protection in an inflationary environment, tending to benefit diversified portfolios during periods of rising prices, rising interest rates, and/or a depreciating dollar. Fixed income and
marketable alternatives provide protection in deflationary or weak economic environments. Returns from each asset class depend on the economic environment as well as the assets’ initial purchase price. Each broad asset class includes a number of investment strategies with varying levels of liquidity and risk. However, we do not consider investment strategies as discrete, standalone opportunities. Rather, our decisions in one area may influence our actions elsewhere in the portfolio. For example, when our staff members travel outside the United States, they not only look at stocks and bonds but also consider private equity, real estate, infrastructure, and other investments across the landscape of each country. Thirty years ago, the endowment portfolio that UVIMCO managed was simple—75% domestic equity and 25% fixed income. Over time, UVIMCO developed a more sophisticated portfolio heavily weighted toward nontraditional investment strategies. The following graph displays the trends in the asset allocation of the Long Term Pool over the past decade:
Portfolio Asset Allocation over Time As of June 30, 2012 100% 90%
% of Long Term Pool
80% 70% 60% 50% 40% 30% 20% 10% 0% 2002
2003
2004
2005
2006
2007
2008
Public Equity Private Equity Long/Short Equity Marketable Alternatives & Credit Bonds & Cash
2009
Real Estate
2010
2011
2012
Resources
continued on page 12
uvimco annual report 2011–12
11
continued from page 11 Ten years ago, UVIMCO held a meaningful position in long/short equity, and bonds and cash represented almost 20% of the Long Term Pool. Over the next few years, excess cash was redeployed into public equity, long/short equity and marketable alternatives and credit funds based on an assessment of available opportunities. Long/short equity reached nearly 50% of the Long Term Pool in 2003. From 2004 to 2008, we used new capital flowing into the Long Term Pool to rebalance the portfolio, directing it toward bonds & cash
marketable alternatives & credit
resources
investments in public equity, private equity, and resources, 62% label with long/short equity falling as a percentage of the overall portfolio. During the financial crisis in 2008–09, we label further reduced investments in long/short equity and used 22% the resulting funds to increase our cash and bond portfolio. Since 2009, the asset allocation of the Long Term Pool has remained relatively stable. As of June 30, 2012, the asset allocation of the Long Term Pool was as follows:
12.3%
20.5%
9.3%
7.0%
real estate
22.7%
8.6%
19.7%
Despite the volatility in global equity markets, only small changes to UVIMCO’s asset allocation occurred in the past year, with real estate increasing by 3% and marketable alternatives and credit decreasing by 3%. We continue to rebalance the portfolio, increasing risk assets when markets go down and decreasing risk assets when markets go up to maintain a relatively steady level of market risk in the Long Term Pool.
Equity Public Equity | The objective of our public equity strategy is to achieve capital appreciation through ownership of publicly listed businesses worldwide. We seek capital appreciation by acquiring ownership stakes at attractive prices and sharing in the long-term economic value these businesses create. Because we try to achieve returns in excess of market indices, we pursue opportunities where market 12
public equity
uvimco annual report 2011–12
long/short equity
private equity
inefficiencies are prevalent. UVIMCO typically allocates 15% to 25% of the Long Term Pool to public equity. Long/Short Equity | Our objective when investing in long/short equity is high returns achieved through unconstrained security selection. Long/short equity encompasses a variety of strategies. Certain managers may invest across a wide spectrum of industries, sectors, or regions, whereas others are more specialized. UVIMCO expects long/short equity to generate long-term returns comparable to liquid public equity, but with less short-term return volatility. We typically allocate 15% to 25% of our Pool to long/short equity. Private Equity | Private equity encompasses a broad range of investment activities. It is an illiquid alternative to public equity, and UVIMCO invests in private equity
only when the expected payoff from private investments warrants the assumption of this risk. Our objective is to pursue high, long-term returns through value created by private businesses or other assets. Private equity includes buyout, growth, and venture capital investments. UVIMCO typically allocates 10% to 20% of the Pool to private equity.
Real Assets Real Estate | The objective of our real estate strategy is to generate long-term capital appreciation and provide diversification from equity markets. To maximize returns, we invest with managers who buy and improve properties through refurbishing, repositioning, or redeveloping. Because real estate markets possess supply-and-demand characteristics requiring specialized knowledge, skills, and contacts, we invest with small, specialized, private managers. UVIMCO typically allocates 5% to 10% of the Pool to real estate. Resources | Similar to real estate, we expect that our resources strategy will provide an attractive long-term return and provide diversification from equity markets. Our resource managers develop oil and gas properties, mine metals and minerals, and build infrastructure for power production. Resource strategies provide investors with the option of accelerating production when market prices spike
and slowing production when prices decline. UVIMCO typically allocates 5% to 10% of the Pool to resources.
Fixed Income and Marketable Alternatives Marketable Alternatives and Credit | Our marketable alternatives and credit portfolio is designed to exhibit low correlations to public equity markets, providing some protection to the Pool during a deflationary environment (but not as much as bonds and cash). Within this portfolio, certain managers invest in bonds with credit risk, while other managers invest across multiple asset classes and generate returns primarily from manager skill rather than exposure to any single asset class. Our actual allocation to marketable alternatives and credit depends on available opportunities, but over time UVIMCO expects to allocate approximately 10% to 20% of the Pool to these investments. Bonds and Cash | Our bond portfolio is a source of liquidity and a stable, diversifying complement to our large equity allocation. Our bond allocation takes no risk, investing entirely in liquid sovereign debt instruments and related derivatives in developed countries. It provides the most protection during a 2008 type of deflationary environment. UVIMCO maintains approximately 8% to 12% of the Pool in bonds and cash. A
Co-Investments
O
ne of UVIMCO’s current areas of focus is finding co-investment opportunities in private equity, real estate, and resources. A typical private market investment involves a contractual commitment to an external manager’s commingled investment pool, generally referred to as a fund investment. A co-investment is simply an investment with an external manager on a specific transaction (or small group of specific transactions) rather than in a commingled pool. Investment managers seek co-investment partners when they do not have sufficient equity capital to complete a given investment on their own. In the most common example, a prospective investment may simply be too large for a manager’s private fund given established concentration limits. Co-investment opportunities also arise when private managers come across highly attractive investment opportunities between fundraising cycles. Changes in the private fundraising markets since the financial crisis of 2008–09 have improved both the quantity and quality of co-investment opportunities available to investors such as UVIMCO. As many institutional investors have broadly reduced private fund commitments over the last few years, many private managers now raise smaller funds. This increases the likelihood that prospective private deals will exceed fund concentration limits and require coinvestment capital. Furthermore, fundraising timelines have lengthened considerably, and private managers spend more time between funds. Managers are also recognizing that offering co-investment opportunities to institutional investors helps them build strong relationships and goodwill with the institutional community. As a result, more and more private fund managers are actively offering co-investment opportunities to investors. 14
uvimco annual report 2011–12
Co-investments are attractive to UVIMCO for several reasons. First, the fee structure for co-investments is generally lower than that of typical private funds. Whereas private funds typically command 1.5% to 2.0% annual management fees and 20% to 25% performance fees, co-investments are regularly offered with no or low management and incentive fees. In addition, the level of unfunded commitments for co-investments is generally lower than comparable private fund investments, and the duration of co-investments is shorter. Because co-investment opportunities relate to specific transactions, capital is called much more quickly than it is for commingled private funds of equivalent size in which managers spread acquisitions over multi-year investment periods. Therefore, co-investing allows UVIMCO to participate in attractive private market opportunities at lower costs while reducing the liquidity risk, unfunded commitment burden, and resulting cash drag on the Long Term Pool. In addition to these benefits, co-investing enables UVIMCO to extract greater value from our demonstrated ability to find smaller, capitalconstrained managers operating in attractive niches. Finally, co-investments provide UVIMCO with a higher level of insight into a manager’s investment process and portfolio than through investing solely in private funds. UVIMCO evaluates co-investment opportunities against more traditional private fund investments. Co-investing enables us to use our size, brand name, flexibility, relationships, and skill to access relatively lowcost private opportunities that are unavailable to smaller or less nimble institutional investors. As of June 30, 2012, the Long Term Pool included a co-investment portfolio of $99 million (1.8%). A
Risk Management
U
VIMCO strives to assist the University and its related Foundations in their efforts to protect and create value for stakeholders, including students, alumni, employees, and society overall. By identifying and proactively addressing investment risks and opportunities, we provide our shareholder institutions with an important component of their integrated risk management activities. We determine our investment risk tolerance by balancing competing objectives of stable current spending with long-term growth. Investments with low risks and low returns decrease the possibility of significant short-term depreciation, and a corresponding reduction in spending, but also decrease expected long-term growth. Investments with high risks and high returns increase the possibility of a near-term decline in spending, but also increase expected long-term growth. Investors are usually willing to bear short-term risks if they are adequately compensated with long-term returns. Most endowments are long-term pools of capital and hence able to assume certain risks. At UVIMCO, we utilize both quantitative and qualitative risk management tools to understand, measure, and manage the risks in the Long Term Pool over time. We eliminate investments if the risk of losses appears too high, or if we do not earn a sufficient premium for assuming such a risk. Over the past year, the UVIMCO staff and Board of Directors have worked closely together to refine our risk management models and processes. The changes are subtle, but we are making fewer assumptions than before and providing better estimates of risk in the portfolio. UVIMCO measures and controls for three primary risks: market risk, manager risk, and liquidity risk.
Market Risk Market risk is measured by the volatility of returns or maximum potential drawdown in a portfolio. The Long Term Pool’s largest risk factor is equity market risk. Over the past twenty years, global equity markets have had two peak-to-trough downturns of more than 50%. UVIMCO manages market risk by diversifying across three broad asset classes: equity, fixed income, and real 16
uvimco annual report 2011–12
assets. By investing the Long Term Pool in asset classes that perform differently from each other, we can mitigate the Pool’s exposure to any particular market condition. The Long Term Pool’s actual allocation as of June 30, 2012, is 62.9% to equity managers, 15.6% to real asset managers, and 21.6% to fixed income, marketable alternatives, and cash. Looking through to our managers’ underlying investments, the Long Term Pool has a 50.0% allocation to equities, 16.9% allocation to real assets, and 33.1% allocation to fixed income (including credit) and cash as of June 30, 2012. The Long Term Pool is positioned defensively versus the policy portfolio benchmark, with less market risk. Given the current asset allocation and prevailing market conditions, we expect the return of the Long Term Pool to have an average future volatility of about 11% per year versus the policy portfolio benchmark’s expected annual volatility of 12%. To better understand downside risks, we complement our volatility statistic with a “worst case” scenario estimate. As estimates of negative “tail” events are necessarily imprecise, we are aware of the limitations of such projections.
Manager Risk UVIMCO invests the Long Term Pool with more than 100 external managers. Manager risk includes tracking error or active positions away from the benchmark, operational or business risks, a lack of transparency, and leverage. UVIMCO seeks to construct and maintain a portfolio of managers that generates sufficient returns to compensate the Long Term Pool for bearing both market risk and the additional risk inherent in hiring external investment managers. Over time, Long Term Pool shareholders have been well compensated for assuming manager risk. Attribution analyses suggest that manager selection is the largest contributor to the Long Term Pool’s long-term outperformance versus the policy benchmark and the investment results of peer schools. UVIMCO mitigates manager risk by using a thorough due diligence process. In addition, we reduce manager risk through diversification, by declining certain partnership
structures, and by avoiding certain investment strategies (e.g., highly leveraged hedge funds). Most importantly, we control manager risk by building close relationships with managers who have unquestioned ethics and integrity, and who align their interests with those of the University’s and related Foundations’ shareholders.
Liquidity Risk At UVIMCO, we define liquidity risk as an inability to meet any of the following four primary liquidity requirements: (i) withdrawals by the University and its related Foundations; (ii) an excess of capital calls by private funds over expected capital distributions; (iii) the need to rebalance exposures following a market decline; and (iv) the ability to deploy cash as new investment opportunities arise. We manage this risk by maintaining a portfolio of treasury bills and bonds, maintaining sufficient liquidity with public equity and hedge fund managers, and managing the pace of commitments to private investments. Given our four primary liquidity requirements, we believe that an appropriate target for liquidity is to have 10% of the Long Term Pool invested in assets that are safe and highly liquid. In addition, we believe the Pool should have at least 20% of its assets available for conversion to cash in any three-month period, and 30% available for conversion to cash in any twelve-month period. At any moment, the amount of actual liquidity we have available is a function of the size and nature of our private portfolio, the amount of Pool funds invested in bonds or cash, and the liquidity terms of our public investments. As of June 30, 2012, approximately 12% of the Long Term Pool’s assets were invested in highly liquid, government-issued debt securities and cash. Over time, we expect the sum of the liquid U.S. Treasury bond and cash portfolios to vary between 8% and 12% of the Long Term Pool. In addition, we can access more than 30% of the Pool’s investments within three months, and about 50% within a year. This current level of liquidity exceeds the Long Term Pool’s minimum requirements. Although excess liquidity is a drag on returns in today’s zero interest rate
environment, we believe this liquidity provides insurance against future turbulent markets and will allow us to fund attractive investments that will more than make up for the return drag on the current portfolio. UVIMCO’s private fund investments in private equity, real estate, resources, and credit present multiple challenges to the management of the Long Term Pool’s liquidity risk. The timing and level of capital calls to and distributions from private investments is at the discretion of our external private fund managers, and we must continually recalibrate our models to better predict these cash flows. Investing in an excessive level of private funds could prevent UVIMCO from having the liquidity needed to fund shareholder redemptions or rebalance the portfolio. Moreover, unfunded commitments represent a form of implicit leverage, an even more serious risk. Therefore, our liquidity risk management framework is centered on the level of unfunded commitments to private investment funds. We believe a target for unfunded commitments of 15% of the Long Term Pool is prudent, and enables us to invest consistently through a variety of market cycles. In addition, we also have adopted a maximum unfunded commitment level of 25% of the Long Term Pool. Actual unfunded private investment commitments decreased from $975 million or 18% of the Long Term Pool as of June 30, 2011, to $841 million or 15% of the Long Term Pool as of June 30, 2012. A
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17
Portfolio Rebalancing
T
he Long Term Pool’s asset allocation and risk exposures vary over time due to differing asset class returns, strategic capital allocation decisions, and the collective actions of our external investment managers. Rebalancing is an important risk management tool we use to ensure that the level of market risk in the Long Term Pool does not exceed that of the policy portfolio. Whereas many investors utilize an automatic and formulaic approach to rebalancing, UVIMCO’s rebalancing decisions are based upon both quantitative and qualitative factors, including the considered judgment of the investment team. A portfolio’s strategy mix will affect its rebalancing. Rebalancing liquid traditional investment portfolios is relatively simple, and most institutions with such portfolios have rebalancing policies that are automatically triggered by the passage of time, by movement of a portfolio position or asset class allocation outside an established range, or when overall portfolio risk falls outside a specified risk budget. The advantages of automatic rebalancing approaches are the discipline they impose on the investment process, and the avoidance of behavioral biases in decision making. Rebalancing portfolios with a high allocation to illiquid alternatives is less straightforward. First, alternative investments often involve committing capital to a partnership that is drawn down over a period of three to six years. The uncertainty of the capital calls and distributions creates challenges in managing these asset classes to targets. Second, rebalancing might require the sale of investments or redemption from commingled funds. These actions
are not always possible, due to manager lock-ups, and may not be desirable when an investment fund is closed to new investors. Partial or full redemption from a closed investment fund would likely prevent the institution from being able to reinvest in the future, when the asset class is below its long-term or strategic target. As a result of these challenges, investors often utilize derivative positions such as swaps, forwards, and futures to rebalance portfolios of illiquid investments. Over 70% of the Long Term Pool is currently invested with hedge fund and private investment managers, and UVIMCO does not utilize a mechanical rebalancing policy. Rather, we use a discretionary approach to rebalancing that considers a variety of risk metrics and other factors relevant to illiquid fund investments such as lock-ups, expected costs associated with redemption from closed funds, valuations, and manager returns. We reduce market risk when the risk of the Long Term Pool exceeds that of the policy portfolio, and we look to increase bonds and cash when they fall below 8% of the Long Term Pool. To complement our judgmentbased approach, UVIMCO’s investment policy includes broad asset class and geographic ranges for Long Term Pool exposures, and deviation from these ranges requires prompt notification of and discussion with the Board of Directors on the proposed course of action. As our approach to rebalancing is far from formulaic, frequent and effective communication with the Board is a critical component of our process. A
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19
Investment Performance
T
he Long Term Pool returned 5.1% for the year ended June 30, 2012, handily exceeding the policy benchmark loss of 0.4%. While we are pleased by this relative outperformance, it is not our goal to outperform the passive benchmark over short time periods such as one year. Rather, as long-term investors, we believe the Long Term Pool’s performance is most appropriately evaluated over multi-year periods. Over the ten- and twenty-year periods ending June 30, 2012, UVIMCO’s portfolio
compounded at an annualized rate of 9.8% and 12.1%, respectively. This performance comfortably exceeds both the University’s spending rate (plus inflation) and the 6.7% and 7.5% annualized returns available through ownership of the passive policy portfolio over the same time horizons. The following figure illustrates the difference in return on $1 invested in the Long Term Pool, the policy portfolio benchmark, and Standard & Poor’s 500 stock index over the ten years that ended June 30, 2012.
Growth of $1.00: UVIMCO vs. Benchmarks $3.00
2.50
2.00
1.50
1.00
0.50
0 FY 02
FY 03
FY 04
FY 05
Long Term Pool
FY 06
FY 07
FY 08
FY 09
Policy Portfolio Benchmark
FY 10
FY 11
FY 12
S&P 500 continued on page 22
uvimco annual report 2011–12
21
continued from page 21 The following table summarizes the performance of the Long Term Pool and its component strategies over time:
UVIMCO Strategy Allocation and Investment Returns June 2012 Allocation(1)
Annual Return FY 08
FY 09
FY 10
FY 11
Annualized FY 12
5 yr
10 yr
20 yr
0.0
2.7
12.9 11.7
Equity Public
20.5%
(8.3) (31.1) 27.8 41.1
Long/Short
22.7%
18.8 (17.4) 2.8 16.2 6.8 4.6 8.7 10.7
Private
19.7%
13.8 (35.5) 19.7 35.5 8.9 5.4 11.1 20.4
Total Equity
62.9%
8.9 (25.7) 15.5 29.8
MSCI All Country World Equity
5.3
5.0
10.6 14.1
(8.8) (28.9) 12.3 30.8 (6.0) (2.2) 6.3
7.1
Real Assets Real Estate
8.6%
Resources
7.0%
28.6 (23.5) 40.9 62.2 4.7 18.7 25.5 —
15.6%
3.7 (34.9) 9.0
Total Real Assets
MSCI Real Estate (2)
(11.9) (45.4) (28.1) 3.8
13.0 (16.5) (1.9) —
35.6
8.5
1.6
12.4
—
(18.8) (39.2) 31.7 34.8
7.6
(1.2) 9.1
9.1
(5.0) (1.5) 22.7
3.4
Fixed Income, Cash & MAC Marketable Alternatives & Credit
9.3%
Government Bonds
10.0%
Cash & Currency
2.3%
(1.5) 26.8
0.5
0.3
(0.1) 4.7
—
—
21.6%
(2.9) 9.5
16.1
5.6
1.9
6.4
7.4
Total Fixed Income, Cash & MAC
9.2
5.3
7.7
—
6.8 17.8 6.4 0.7 0.1 6.2 6.3 7.2 5.9
Barclays Aggregate Bond
6.0 6.6 8.6 3.0 7.1 6.2 5.3 6.4
Long Term Pool
5.9 (21.0) 15.1 24.3
(3)
100.0%
Policy Benchmark (4)
5.1
4.7
9.8
12.1
(5.3) (19.6) 13.3 22.4 (0.4) 1.0
6.7
7.5
(1) % of Net Asset Value (2) 50% MSCI U.S. Real Estate and 50% MSCI All Country World Real Estate (prior to 1995, 100% FTSE NAREIT) (3) 50% Barclays U.S. Aggregate Bond and 50% Barclays Global Aggregate Bond hedged in USD (prior to 1990, 100% Barclays U.S. Aggregate Bond) (4) Geometrically linked monthly average of 60% MSCI All Country World Equity, 10% MSCI Real Estate, and 30% Barclays Aggregate Bond
As the table indicates, different investment strategies make positive contributions to the portfolio’s overall performance over different periods of time. During the year ending June 30, 2012, our long/short equity, private equity, and real estate portfolios contributed to the Long Term Pool’s relatively strong return. Over the past five years, our mix of active equity strategies delivered an annualized return of 5%, producing more than 7% of excess return per year relative to the 2.2% loss of the benchmark MSCI All Country World Index. Within those five years, the annual returns from certain equity strategies 22
uvimco annual report 2011–12
surpassed those of other strategies. Long/short equity provided the highest return in fiscal year 2008 and then declined by far less than other equities in fiscal year 2009. In fiscal years 2010 and 2011, returns from our public and private equity strategies far surpassed those of long/short equity. In fiscal year 2012, outsized returns from our venture capital investments drove the overall private equity performance beyond those of long/short and public equity. The combined performance of our three equity strategies exceeded our global equity benchmark in four of the past five years, during both rising and falling equity market environments.
Our real asset strategies have produced a five-year annualized return of 1.6%, almost 3% above the 1.2% loss of the MSCI blended real estate benchmark. Within this long-term composite real asset return, our returns from real estate and resources vary widely from each other and from year to year. Over the past five- and ten-year periods, UVIMCO’s resources portfolio has outperformed all other strategies in which we invest. In fiscal year 2012, the real estate portfolio outperformed our resource investments by more than 8%, reflecting the rebound in domestic real estate prices. While the real estate portfolio now represents almost 9% of the Pool, our historical allocation to real estate was much smaller, limiting the negative impact of the strategy’s decline on long-term returns. Our allocation to the diversifying collection of fixed income and marketable alternative strategies produced a five-year annualized return of 5.9%, slightly underperforming the 6.2% annualized return of the
benchmark Barclays Aggregate Bond Index by 0.3%. By design, these investments provide some protection to the Pool through low correlations to the public equity markets. Our bonds and cash returns of nearly zero for fiscal year 2012 reflect the extremely low domestic interest rate environment. Marketable alternatives and credit returned 3.4% for the year, with idiosyncratic manager returns within the portfolio generated primarily from manager skill rather than exposure to any single asset class. To evaluate the Long Term Pool performance, we also compare our returns to those of peer institutions. Universities with large endowments typically report their returns in the fall after completing their fiscal year-end audits, so official comparisons for the 2012 fiscal year were not available at the time of this report’s distribution. However, we can compare the Long Term Pool’s performance to that of the TUCS All Master Trust Universe Median, a widely accepted benchmark for the performance of institutional assets.
UVIMCO Long Term Pool Relative Performance Annualized through June 30, 2012
1 YEAR
3 YEARS
5 YEARS
10 YEARS
UVIMCO Long Term Pool
5.1%
14.6%
4.7%
9.8%
UVIMCO Policy Portfolio Benchmark
-0.4%
11.4%
1.0%
6.7%
TUCS All Master Trust Universe Median
1.5%
11.6%
1.8%
6.4%
As this table shows, the Long Term Pool has consistently outperformed other institutional investors.
uvimco annual report 2011–12
A 23
Organization Board of Directors
Staff
UVIMCO is a separate 501(c)(3) Virginia non-stock corporation. It is governed by a Board of Directors that includes three individuals appointed by the University of Virginia’s Board of Visitors and one appointed by the University President. Our Board meets four times a year to discuss investment strategy, set investment policy, and monitor performance. As of September 7, 2012, UVIMCO’s Board of Directors was as follows:
The Board delegates day-to-day investment management activities to UVIMCO’s full-time, experienced staff. Our team of twenty-nine professionals works closely with the Board to implement UVIMCO’s investment strategy through selection of external managers, tactical asset allocation, and internal trading. We are pleased to report the 2012 addition of Sherri King to the senior investment team as Managing Director of Fixed Income and Risk. We believe our team’s combination of long-tenured director experience and newer team members provides a fertile environment for investment ideas and productive research. In coming years, we expect to continue to refine and improve our idea generation, due diligence process, and collaborative efforts to source and manage exemplary investment opportunities across the globe.
John G. Macfarlane, III (Darden ’79), Chair Appointed by the UVIMCO Board Jerry B. Bias (College ’90) Appointed by the UVIMCO Board Harry Burn, III (College ’66, Darden ’75) Appointed by the UVIMCO Board A. Macdonald Caputo (College ’63, Law ’66) Appointed by the Board of Visitors Anton J. Levy (McIntire ’96) Appointed by the UVIMCO Board W. Austin Ligon Appointed by the UVIMCO Board David B. MacFarlane (McIntire ’84) Appointed by the UVIMCO Board Richard A. Mayo (College ’64, Darden ’68) Appointed by the UVIMCO Board Edward D. Miller Appointed by the Board of Visitors Timothy B. Robertson (College ’77) Appointed by the Board of Visitors Nina F. Scherago (Darden ’86) Appointed by the UVIMCO Board Owen D. Thomas (Engineering ’83) Appointed by the UVIMCO Board Biographical sketches of UVIMCO’s Board members are available on our website: www.virginia.edu/uvimco.
Lawrence E. Kochard (Graduate School of Arts & Sciences ’96, ’99) Chief Executive Officer/Chief Investment Officer Kristina M. Alimard (Darden ’03) Chief Operating Officer Rob Walker Freer Managing Director Sherri J. King Managing Director Edward H. Klees General Counsel Elizabeth M. Snyder (College ’86) Managing Director Sharon C. Argo Executive Assistant Mary B. Barrick Records Manager Matthew G. Bernstein Information Technology Specialist Diana L. Clark Investment Accountant Bac T. Cuong Associate
24
uvimco annual report 2011–12
UVIMCO senior staff members (from left) Kristina Alimard, Sherri King, Rob Freer, Ed Klees, Larry Kochard, and Beth Snyder Brendan P. Dawson (McIntire ’09) Associate
Anh Q. Luu Senior Investment Accountant
Brenda S. Dierolf Corporate Accountant
Shane H. Miller (College ’11) Investment Analyst
Dubie Dubendorfer (College ’08, McIntire ’09) Information Technology Manager
Chellie V. Morris Administrative Assistant
Allison P. Gillam (McIntire ’06, ’07) Senior Investment Accountant
Laura E. Roller (McIntire ’09) Investment Analyst
David L. Haas (McIntire ’98) Associate
Tina B. Shifflett Administrative Assistant
Leah M. Hall (McIntire ’09) Investment Accountant
Long D. Trinh Performance Analyst
Angela Hartman Administrative Assistant
Dawn C. Wilson Manager of Investment Accounting and Reporting
Sharon F. Herbert Manager of Corporate Accounting and Human Resources
Biographical sketches of UVIMCO’s staff members are available on our website: www.virginia.edu/uvimco.
Martin Hohoff (McIntire ’10) Investment Accountant Mike Husseini (McIntire ’11) Investment Analyst Mary M. Lane Office Manager
Copyright © 2012 by the University of Virginia Investment Management Company Photography by Tom Cogill and Dan Addison (pages 2, 25)
uvimco annual report 2011–12
25
www.virginia.edu/uvimco