In the third calendar quarter of 2018, the Heritage and Stabilisation Fund (HSF) posted a return of 1.81 per cent compared with a gain of 1.54 per cent for its Strategic Asset Allocation benchmark.
According to the HSF report, while all four mandates (investment strategies) generated positive absolute returns, the main driver of performance was the fund’s exposure to the United States (US) equity markets.
On a relative performance basis, the two fixed income portfolios outperformed their respective benchmarks. However, the two equity mandates underperformed their respective benchmarks over the period.
The total net asset value of the HSF as at the end of September 2018 was US$5,965.8 million, compared with US$5,863.1 million at the end of the previous quarter.
Of this total, the investment portfolio was valued at US$5,965.7 million, while the remaining portion (US$0.18 million) was held in cash to meet the day-to-day expenses that arise from the management of the Fund.
How can T&T maximise the HSF to ensure that the people of this country enjoy the best possible return and also hedge against price shocks in the international energy markets?
We have already discussed the Hacienda Hedge employed by Mexico using their HSF fund.
Mexico has locked in an average export price of $46 per barrel of crude oil for 2018 in its annual oil hedge, which is the largest in the world. The hedge will be supported by a specially set up Oil Revenue Stabilisation Fund, which, along with the central bank’s exchange-rate surplus, will serve to guarantee the price.
The Mexican oil hedge, or the Hacienda Hedge, is considered the biggest hedging bet on Wall Street. It has also earned Mexico billions since it was first made in the 1990s.
The hedge consists of the Mexican government buying large amounts of put options from a selection of investment banks. The average that the government has spent on these put options in the last few years has been US$1 billion.
In 2000, Mexico began locking in prices annually and has since made a profit three times, including a $6.4-billion windfall in 2015 after the price crash from mid-2014. For 2016, the hedge made Mexico $2.7 billion.
What else can we do to improve the returns of funds invested in the HSF fund?
The HSF is structured similar to an endowment fund and several of the Ivy League universities in the United States have endowment funds with Assets Under Management (AUM) larger than the HSF of T&T; at the top of the list are usually Harvard, Yale, Stanford and Princeton.
Harvard, the largest of the four, has an endowment fund of approximately US$37 billion. The fund that regularly outperforms them all and has been hailed for its unique structure is the Yale fund, which is led by Dr David F Swensen.
He has been the chief investment officer at Yale University since 1985.
Swensen is responsible for managing and investing Yale’s endowment assets and investment funds, which total approximately US$27.2 billion as of end of fiscal year 2017. He invented The Yale Model with Dean Takahashi; an application of the modern portfolio theory commonly known in the investing world as the Endowment Model. His investing philosophy is unique in that it stresses allocation of capital in Treasury inflation protection securities, government bonds, real estate funds, emerging market stocks, domestic stocks, and developing world international equities.
Investment heads from universities such as Harvard, MIT, Princeton, Wesleyan, and the University of Pennsylvania have adopted his allocation strategies. Why not T&T?
Under Swensen, the Yale Endowment saw an average annual return of 11.8 per cent from 1999 to 2009.
What’s unique here is that Yale does not manage any of the fund themselves. It is all outsourced to some of the best performing hedge funds and boutique investment firms led by industry insiders.
Rather than keeping a substantial share of its assets in domestic equities and cash, Yale had made significant investments in less efficient equity markets such as private equity (venture capital and buyouts), real assets (real estate, timber, commodities), and absolute-return investments (hedge funds).
Most of the day-to-day activities involved evaluating, selecting, monitoring, and overseeing external investment advisers and not in making investments themselves. They set policy and allowed the best to do what they do.
According to a Harvard case study, this philosophy was built on five principles:
1) strong belief in equities-public or private,
3) seeking opportunity in less efficient markets,
4) use of outside managers and
5) critical focus on explicit and implicit incentives facing outside managers.
Equities are a claim on a real stream of income, as opposed to the contractual sequence of nominal cash flows expected from bonds. For most portfolios to achieve any kind of meaningful returns there must be a heavy investment in equities.
More than 95 per cent of the endowment’s assets were expected to produce equity-like returns.
Diversification was also key, Yale believed that risk could be more effectively reduced by limiting aggregate exposure to any single asset class, rather than attempting to time markets.
Less efficient markets have historically outperformed fixed-income, this gap is even wider for less liquid assets: hedge funds, venture capital and buyout funds and real estate.
Yale believed that they could increase incremental returns by selecting superior managers in non-public markets characterised by incomplete information and illiquidity.
As a result, only 21 per cent of Yale’s endowment was in public stocks and bonds and cash. Swensen strongly believed in outside managers for almost all investments. These external advisers were given considerable autonomy to implement their strategies as they saw fit, with relatively little interference, from Yale.
The managers were chosen carefully after a lengthy and probing analysis of their abilities, comparative advantages, performance records and reputations. It was Jim Collins in his seminal book, Good to Great, that likened business leaders to bus drivers with the crucial responsibility of “getting the right people on the bus.”
Great leaders continuously ask “First who, then what?”
Swensen took the time to do just that.
Finally, after selecting the right people Swensen went on to structure the right incentives.
Swensen believed that much of the industry had a misaligned incentive structure where managers typically prospered if their AUM grew large, and not necessarily if they performed well for their clients.
The Yale fund structured innovative relationships and fee structures with their external managers to align the managers’ interests as closely as possible with those of Yale.
It is time for T&T to get involved in more sophisticated types of fund management. The economic environment and increasing demand for cash flows call for it. Nominal returns are not sufficient if we are to truly take diversification seriously and develop an economy designed to thrive regardless of the price of oil and gas.