Fund Update
Investment gains modest, forecast cautious
Consultants scrutinize markets that might be overextended
The UNT Foundation’s investment portfolio produced modest returns in the second fiscal quarter of 2007, amid a significant downturn in Real Estate Investment Trusts (REITs) and resilient hedge fund growth.
The foundation’s investment consultant, Hammond Associates, advised in its Summer 2007 Research Report that several areas bear scrutiny in the coming months. Despite a rocky quarter on Wall Street, the foundation saw a 4 percent return, slightly lower than its S&P 500 / Lehman Aggregate benchmark of 4.6 percent. Assets reached $77.8 million at the end of June.
| Foundation portfolio (implemented 1/1/06) |
Benchmark 75/25 S&P 500/ Lehman Aggregate |
|
|---|---|---|
| Five years | 12.1% | 9.3% |
| Three years | 10.9% | 9.8% |
| One year | 16.4% | 16.9% |
| Quarter | 4.0% | 4.6% |
Hammond reported a 9.4 percent drop in REITs returns in June, following returns of as much as 13 percent early in the year. The consultant pointed to higher interest rates and unrealistic valuations as likely causes for the downturn. Hammond suggests that the decline has “shaken some of the excesses out of the market,” but is cautious nevertheless, particularly in its assessment of international real estate companies. Hammond indicated that prices are extremely high, relative to potential income.
What is the sub-prime meltdown?
An ongoing global economic condition in which lending institutions grant loans to “sub-prime” borrowers - those with a questionable credit record. Widespread default on these loans has led to financial difficulty for the lenders and their investors.
The consultant also noted a strong second quarter return of 4.6 percent in hedge funds, but again warned that until market conditions bear out, it will be cautious. Hammond reported that although some hedge funds collapsed under the weight of the ongoing “sub-prime meltdown,” a majority have fared well to this point. The concern, Hammond stated, is that “the story hasn’t been fully written. There will be more hedge fund failures to come and the prospect of global risk premiums being re-priced looms large, particularly in the credit markets.”
Hammond recommended minor shifts in the UNT Foundation’s investment portfolio:
- moving 1 percent from U.S. small-cap stock (Luther King Small-Cap, from 5 percent to 4 percent) to U.S. all-cap stocks (Northern Russell 3000, from 7 percent to 8 percent)
- moving 2 percent each from international small-cap stocks (Laudus International Small-Cap, from 5 percent to 3 percent) and emerging market stocks (Vanguard Emerging Markets to 5 percent) to international large-cap stocks (Barclays International Alpha Tilts, from 15 percent to 19 percent)
The foundation’s investment committee agreed to follow these recommendations at its Aug. 16 meeting.
Highlights from Hammond’s executive summary in the Summer 2007 Research Report:
- Global equity markets posted strong returns for the second quarter. Domestically, the S&P 500 rose 6.3 percent and the Russell 2000 gained 5.4 percent. In international markets, the MSCI EAFE index jumped 6.4 percent and emerging markets continued to soar, returning 15 percent.
- Credit spreads have widened over the last few weeks, with the option-adjusted spread on the Lehman High Yield Index moving from a historic low 2.33 percent on June 1 to 2.99 percent as of July 13. The leveraged loan market also has shown signs of tightening. However, credit markets remain very loose by historical standards and emerging market countries continue to amass huge foreign currency reserves, flooding the world with liquidity.
- The carry trade, in which investors borrow in low-yielding currency and lend in high-yielding currencies, continues to grow in popularity. The rush of money into the trade has driven low-yielding currencies such as the Japanese yen well below fair market value and high-yielding currencies, such as the Australian dollar, well above fair value. When risk aversion rises, the carry trade tends to perform poorly. The popularity of the trade is another indicator of the amount of risk being taken on by investors.
- With the housing sector continuing to struggle, consumers will have to rely on wage growth to support their spending habits. While the job market remains healthy, expect consumption growth to be sluggish in future years as households increase their savings.
Committee watching August's market volatility
As this issue goes to press, recent short-term fluctuations in markets have been in the news. The UNT Foundation’s investment consultant, Hammond Associates, reported on this situation at the foundation’s quarterly investment committee meeting, held earlier this month.
The foundation’s portfolio is structured to offer protection from short-term market fluctuations, and those assets performed as expected.
The investment committee reviews past performance quarterly, and focuses most of its attention on the economic road ahead. As needed, slight adjustments to the portfolio are considered, while maintaining its long-term integrity, and the foundation’s goal of stable distributions to UNT.
