When Markets (and Missions) Collide
Verne Sedlacek, President & CEO, Commonfund
In his bestselling book “When Markets Collide,” Mohamed El Erian provides insights to the fundamental changes taking place in today’s markets and financial systems and offers perspectives on how to capitalize on these changes while navigating risks. But even the most prescient market watchers have been shocked by the extreme impacts of the credit crisis, and no asset class or financial firm seems untouched.
The collision of world financial markets has certainly had far reaching effects on the nonprofit community we serve. The value of long term asset pools for most institutions is down substantially which is likely to impact spending for operations and grant giving, and as with any recession and market selloff, gifts for current use and endowments will likely drop. The credit crisis and de-leveraging of the financial sector has put student lending programs at risk and has made borrowing difficult or very expensive for all operating nonprofits. At the same time demands for financial aid will likely rise, and for the educational community in particular, concerns over a protracted recession have led some to worry about matriculation rates this fall and overall levels of enrollment retention.
As a nonprofit, mission-based organization, Commonfund itself is not immune from this same collision of markets and missions that our clients face. And this was certainly made clear by the decision last month by Wachovia Bank in its role as Trustee of the Short Term Fund, to initiate the termination of the Fund, to stop accepting deposits, to establish procedures for an orderly liquidation and distribution of the fund’s assets and to resign as Trustee of the Short Term Fund.
We recognize fully that this decision caused distress for a number of our investors, both immediately as some clients had to scramble for alternative sources of liquidity and in the following days and weeks as investment and treasury staff, caught off guard by this action by Wachovia, sought answers to allay broader fears about Commonfund by their administration and trustees. In response to client needs for information we have provided daily updates on our website on fund liquidity and have also provided full detail of portfolio holdings. We have held three conference calls. We are pleased that the cash flows are ahead of forecast in improving liquidity in the fund, and this remains our top priority. And we will continue to provide our clients with full transparency about the status of the Short Term Fund and the overall state of health of our broader franchise.
Allaying Fears
While we acknowledge that Wachovia’s actions may have adversely impacted how some clients perceive Commonfund, we assure all clients that our franchise is sound, our financial condition is solid and our commitment to the nonprofit community and our mission is unwavering. As we previously disclosed, the impact of the termination of the Short Term Fund on our annual revenues is only about six percent, based on our FY2009 budget. Further, even after accounting for the capital support we provided to the Short Term Fund Reserve Account, Commonfund’s available reserves exceed $80 million and we expect to earn a modest surplus this year, even after accounting for the recent market turmoil. Because of our conservative approach to budgeting, we have substantial flexibility in adjusting our finances to offset this loss of STF revenue and the market impact on fees. Commonfund’s consolidated financial statements will be available on our website on Monday, November 3, 2008. These financial statements reflect the impact of the subsequent events that took place the end of September.
Outside of the Short Term Fund our business continues to grow. In a very difficult quarter we experienced positive net new assets for the period ending September 30th. While redemptions in October are somewhat higher compared to last year in some funds, there is no evidence to suggest that these increased outflows are anything more than some clients seeking alternative sources of liquidity as others dry up. And, importantly, these outflows are well within our ability to meet client needs for liquidity. We continue to attract new clients and today have nearly 1900 investors, by far the most nonprofit investors of any investment firm. We have retained at least 97 percent of our clients each year for the past five years. And, we have achieved our growth, not by aggressive asset gathering strategies, but rather by remaining true to our mission to improve investment management practices and to enhance the financial resources of the nonprofit community.
While the global sell-off of financial assets has been severe and impacted asset classes and strategies broadly, most of our clients have the advantage of managing investment pools that are designed to exist in perpetuity. Certainly good news is hard to find in today’s markets, but the reality is that few nonprofits need to be forced sellers in today’s market, and fewer still need to take any drastic actions in regard to their investment policies, including asset allocation.
Market volatility is at record levels with 4-5+ percent swings in equity, currency and commodity values occurring almost daily. In any environment, market timing is difficult; in this great credit crisis of 2008 anticipating market actions is impossible. The reason we work with institutions and spend so much time on a long-term policy portfolio is exactly for times like these. We often hear the phrase, “this time it is different” when in reality it usually isn’t. That is why we counsel investors not to make major changes to long-term policies in the middle of a crisis, but rather to conduct policy reviews when things settle down. “Staying the course” is almost a trite response to the severity of the market turmoil we have witnessed, but the principles that have served successful nonprofits in the past will continue to serve them well in the future. And while it may be hard to fathom at this point, there are opportunities rising from this sell-off and those able to take advantage of time frame arbitrage, as long term investors and providers of liquidity, will be in the best positions to gain.
What Next?
No one knows where the bottom lies in this massive de-leveraging. The extent of the credit crisis on world economies is just now being understood and we certainly expect a rash of bad economic statistics well into 2009, and perhaps later. But we also know from history that markets anticipate recoveries 12-18 months in advance of renewed growth. We also know that the recent actions of the U.S. government represent the single largest monetary stimulus in our nation’s history and falling oil prices will have the effect of a massive fiscal stimulus in the order of magnitude of $150-200 billion. So while we are cautious about being too early to the market recovery, we also advise our investors not to make decisions that could lead them to be late, and miss opportunities that could have long term impacts on their ability to achieve their missions. And this is the approach we are following not only for our investment programs, but more broadly for Commonfund as well.
The Current Fiscal Year
For Commonfund as an enterprise, that means being prudent in all of our spending in the current fiscal year and delaying certain projects without impacting our ability to meet the needs of our clients. Our initial projections for FY2009 were to add significant headcount in support of strategic initiatives. While we will still add to headcount where needed, we have delayed the majority of these staffing additions which provides great financial flexibility without impacting our current business.
Importantly, we have no plans to cut back on programs which we believe are critical to helping our clients navigate through these uncertain times.
We will continue to recruit investment talent during this period even as we slow hiring in other areas of Commonfund. The silver lining to the turmoil within Wall Street firms is that the pool of available investment talent has never been stronger which offers firms like Commonfund the opportunity to add selectively to investment teams. We also know how important client communications are in times of uncertainty and we are committed to providing our clients with full transparency of our operations, strategies and performance. Fundamental to this is meeting face to face with clients, participating in investment committee meetings and being responsive to the information needs of staff and trustees.
Communication also includes our regional seminars and trustee roundtables, Commonfund Forum, as well as our Commonfund Benchmarks Studies. We will be particularly prudent this year in spending on each of these programs; however, we remain committed to one of the founding principles of Commonfund that was established by the Ford Foundation in 1971 – that is to conduct research and disseminate best practices in investment management and governance to the nonprofit community. I firmly believe that our ability to deliver on this part of our mission is more important today than perhaps at any other point in our history.
Our 3 Year Planning Horizon
To ensure that we also balance the needs of today with a vision of future opportunities, we have for the last six years managed Commonfund in the context of a rolling three-year strategic and financial plan. This plan is a road map that helps guide us in our decision making to ensure that we continue to meet the evolving needs of the nonprofit community. From this planning framework we have developed Commonfund Strategic Solutions®, the establishment of Commonfund Institute, simplified fee schedules and, most recently, the ability to manage separate accounts for eligible clients.
From a financial perspective, we use this plan to project asset growth, revenues, client retention and contributions to our reserve. Our budgeting approach is conservative and as a mission-based organization that does not have to answer to the financial demands of shareholders, we follow a growth strategy that reflects the needs of our clients, not the ROE of equity holders. Our current plans, revised based on the realities of today’s markets and the prospects for a protracted period of below average economic growth still forecast a growth in assets. We project that growth will come from our alternative programs which today account for 56 percent of our long term assets under management. It will also continue to come from our Strategic Solutions program, which we believe will only increase in importance for nonprofit organizations as they struggle with the challenge of managing portfolios in such uncertain times. As of the end of September we had 72 clients in this program representing $5.8 billion of assets. For any client that would like to have a more in-depth review of our three-year planning process, I would be pleased to meet with you, as would any member of our senior management group.
The Future of the Short Term Fund
We recognize that even as we reassure investors about Commonfund broadly, there remain many questions about the future of the Short Term Fund. The sudden disappearance of this investment program that has been an integral part of the financial operations of colleges, universities and independent schools since 1974, has left a gap in these operations.
There is no doubt that any replacement program to the Short Term Fund will be dramatically different than its previous structure and investment profile. In fact the entire liquidity management business is likely to be drastically different as 2a-7 money market funds may no longer be viable. Last week’s announcement by the Federal Reserve that they would buy up to $540 billion in commercial paper and certificates of deposit from money market funds was the latest action that spooked the markets as it seemed to indicate a broader contagion that many such funds would break the buck without Fed intervention. Banks are unlikely to use their balance sheets going forward to prop up money funds and for the foreseeable future, no one will have the appetite for seeking incremental yield in short term pools. It is all about safety and liquidity.
As you know we have been seeking a successor trustee to the Short Term Fund. The importance of installing a successor trustee is to remove on-going fiduciary responsibility from Wachovia in light of their announced decision to resign as trustee effective at year-end. However, simply installing a successor trustee will not return us to “business as usual.” Credit markets, while showing some signs of improvement early last week, remain weak and our ability to sell assets in the STF portfolio at levels closer to their intrinsic value will not change with a new trustee. But the installation of a new trustee will enable us to work more effectively in the liquidation of the remaining pool and it will make the transition to a new solution more efficient.
Finding a successor trustee to oversee the liquidation of the current program and implementing a replacement program to the STF has proven thus far to be challenging – not because of any undisclosed risks in the portfolio, but because the financial institution landscape has changed dramatically. Simply put, the willingness of banks to take on any new risk or exposure – however modest – is very limited.
That said, we are currently working actively with a prospective successor trustee. While we must continue to proceed with our due diligence review of this potential successor trustee, we believe that the preliminary discussions have involved structures that should broadly service the interest of investors in the STF – both for the immediate term as we liquidate the fund in an orderly fashion, and longer term for those institutions that need a new liquidity management platform.
In closing, we recognize the importance of providing our clients with full disclosure of our financial condition and strategic outlook, particularly in this period where some of the most storied financial firms have either disappeared or been absorbed by other firms. We also recognize that there is a great deal of misinformation in the market, which is typical in periods of stress. If you have concerns beyond those I have addressed above, please contact me or your Commonfund Relationship Officer.