A Greenwich Associates press release said many U.S. institutions have been frustrated by the fact that the broad diversification strategies they have implemented in recent years failed to protect their portfolios from the market downturn. For now most institutions seem to be committed to diversified investment portfolios including hedge funds and other alternative asset classes, but the dramatic variation in performance among individual hedge funds last year reinforced the critical importance of institutional due diligence capabilities, according to Greenwich.
The level of due diligence required can only be achieved with adequate resources and staffing, but the typical U.S. institution employs only two professionals to select and supervise external investment managers — a number that was essentially flat from 2007 to 2008, Greenwich pointed out. Its research found only the largest public and corporate pension plans expanded internal staffing for manager selection and supervision last year, with the average staff among corporate plans with more than $5 billion in assets increasing to 3.4 full time equivalents (FTEs) in 2008 from 2.9 in 2007, and average staffing among public plans with at least $5 billion increasing to 5.8 FTEs from 4.5 FTEs.
“It is impossible to identify those managers with the skill and consistent, repeatable processes needed for investment success without sophisticated due diligence capabilities,” says Greenwich Associates consultant Dev Clifford, in the press release. “The real lesson of 2008 is that institutions need to either build up these capabilities in-house, or acquire them externally. Doing without is not an option.”
Greenwich found that three-quarters of institutions rebalanced their investment portfolios last year, but noted there is the strategic question in 2009 of whether portfolio managers are willing to take the step when asset values remain at depressed levels. Even if institutions decide to stick with their rebalancing policies, some funds might not have the liquidity needed to fully rebalance, Greenwich pointed out. “One of the important lessons to come out of the current crisis might well be the value of liquidity — or rather, the dangers of undervaluing it,” Greenwich said in the press release.
Prior to the current market collapse, institutions attempted to minimize the proportion of their assets held in cash (averaging in the neighborhood of 0.5% of assets), which was seen as a drag on long-term investment performance. “The rapid plunge in asset values quickly demonstrated the value of liquidity, which provides flexibility needed to prevent institutions from having to sell undervalued assets into falling markets in order to fund operations or other needs,” said Greenwich Associates consultant Rodger Smith, in the press release.
Finally, Greenwich said U.S. endowments and foundations might want to reassess their risk profiles as they had the lowest allocations to fixed income of any U.S. institutions in 2008 (close to 20%), and much lower allocations than those found among not-for-profits in other countries.
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