Greenwich Associates Reports On US Investment Management, Describing How Institutions Respond To Crisis

Recent research by Greenwich Associates reveals that the typical institutional investment manager experienced a 31% reduction in portfolio asset values in 2008. The suddenness of these losses has left institutional investors stunned, and the magnitude of the declines is raising

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Recent research by Greenwich Associates reveals that the typical institutional investment manager experienced a 31% reduction in portfolio asset values in 2008. The suddenness of these losses has left institutional investors stunned, and the magnitude of the declines is raising questions about asset allocation decisions, risk management practices, manager selection and overall investment policies used by institutions in the run-up to the market events of the fourth quarter of last year. Greenwich Associates’ 2008 U.S. Investment Management Study analyzes many of the most pressing issues facing corporate and public pension funds, endowments and foundations in 2009, including:

Institutions that remain committed to broadly diversified portfolios must ensure that their due diligence practices and capabilities are adequate for the task.

More than 80% of U.S. institutions have a regular rebalancing policy included in their overall plan policy guidelines. But rebalancing brings with it a new and unique set of issues in 2009.

The speed and severity of the market collapse demonstrated the value of liquidity in investment portfolios, and institutions might have to reconsider past attitudes toward cash holdings.

US endowments and foundations were at the vanguard of the move to diversify institutional portfolios with alternative asset classes. Many of these funds will be reassessing risk profiles and overall investment strategies in 2009.

Many US 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 the moment, however, most institutions seem to be working from the premise that it is the global financial system that is broken – not their portfolio management policies – and institutions appear 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.

The level of due diligence required to assess the people, process and philosophies of both traditional and alternative investment managers can only be achieved with adequate resources and staffing. However, the typical US institution employs only two professionals to select and supervise external investment managers – a number that was essentially flat from 2007 to 2008 but is down from the 2.5 average across all institutions in 2006. 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 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.

Three-quarters of institutions rebalanced their investment portfolios last year. But rebalancing in 2009 will pose some unique challenges. First, there is the strategic question of whether portfolio managers are willing to take the step when asset values remain at depressed levels and uncertainty around the shape and pace of an eventual economic recovery remains high. Next, even if institutions do decide to stick with their rebalancing policies, some funds might not have the liquidity needed to fully rebalance.

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. Prior to the current market collapse, institutions overwhelmingly attempted to minimize the proportion of their assets held in cash, which was seen as a drag on long-term investment performance. Historically, money market funds and other “cash” investments have made up only a modest portion of institutional investor portfolios, averaging in the neighborhood of 0.5% of assets.

US endowments and foundations have adopted asset allocations that, in addition to being diversified away from US equities, are also quite aggressive in terms of risk. Endowments and foundations had the lowest allocations to fixed income of any US institutions in 2008, and much lower allocations than those found among not-for-profits in other countries.

D.C.

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