At the end of fiscal year 2008, Harvard University had an investment portfolio of over $36.9 billion. Yet one year later, they were in crisis, with not enough cash flow available for operations. The University had to borrow to continue operating. Why?
Not only had the recession hit and the portfolio lost $11 billion, but Harvard was facing a liquidity crisis of massive proportions. What caused it and how could it have been prevented? By answering these questions, you may gain some insights that will help you prevent your own liquidity challenges.
Here was the picture at the end of the fiscal 2008 year for Harvard:
- They had a leveraged portfolio with an asset allocation model that called for the allocation to cash to be at minus 5%. In other words, they were borrowing against the portfolio and there was no cash readily available.
- They had large allocations to illiquid assets in the portfolio. More than half of their portfolio was in hedge funds, private equity or real assets, with an additional 22% in foreign equity.
- One third of the University’s operating budget was dependent on distributions from their endowments.
- The University had entered into multiple swap agreements to protect against anticipated rising interest rates.
- Harvard had started the construction of a $1.2 billion science complex which was planned to be debt-financed, rather than contribution-financed.
- The debt service commitments as a proportion of their yearly cash flows were growing.
- Faculty hiring was up.
One year later, they had lost 27.3% of the value of their endowments, and they couldn’t sell the private equity or the real estate holdings to make the needed endowment distributions. Capital calls on their alternative investments forced the premature selling of their traditional investments which had already plummeted in value. The swaps were going the opposite direction from what had been anticipated because interest rates had plummeted to historically low levels. They had exposure to collateral calls and losses as well as margin calls. In short, they still had lots of assets, but no cash.
What happened to operations? The University was forced to initiate layoffs, curtail the planned campus expansions, slash operating budgets, and decrease financial aid. In the end, they actually had to borrow in order to get enough cash to continue.
Although your challenges are not nearly as complex, do you know where you stand with regard to liquidity? How can you avoid your own mini-crisis?
The first step is to get a clear picture of your available liquid funds, both those that are on your balance sheet and those that are not. This would include assets that are easily convertible to cash, and those you could borrow from to obtain cash almost immediately. For instance, a line of credit that is not already borrowed to the max would be included in your listing of available liquid funds. You might want to have two categories—those that are available to you within the next 30 days and those that are available within the next year. Your investment portfolio may have a variety of types of investments that will have differing availability criteria which you will need to analyze. You must also consider the donor restrictions associated with your funds. If they are restricted, they may not be available.
The second step is to fully understand your commitments and obligations by expected maturity dates. Again you would want to include the off-balance-sheet amounts that you are committed to. Your commitments and obligations would include debt service obligations, lease payment obligations, other commitments such as severance payments, pension obligations and purchase obligations. You should also look at your swap agreements and see if there are clauses that include posting collateral under certain circumstances. In your portfolio, you should look at your obligations for capital commitments and when they could be called. Look at the maturity of each of these items, again for the immediate term and then also for the longer term.
Once you have those two lists of available funds and of commitments and obligations, you can match them up and evaluate whether you will have sufficient resources to weather a worst-case scenario or not. During the “ups” of the market is the best time to do this evaluation because you may be able to secure additional resources in the form of lines of credit or a different portfolio mix, to ensure that in the “downs” of the economy you will not have to face the tough decisions that Harvard did.