Investment Policy and the Hewlett Foundation - Case Study Example

Unit Investment Policy and the Hewlett Foundation Case Study Case Summary Risk allocation entails dividing an investment assortment among different assets like stocks, bonds, and cash. Risk tolerance involves losing some or all of the original investments in exchange for greater possible returns. Often, by investing in more than one asset category, the company will reduce the risk that it will lose money and the portfolio’s overall investment returns will behave in a better way (Pfaff 78). The company is looking for a new asset allocation policy. If the proposal is improved, it will involve a significant reduction in the overall exposure of the domestic public shares. This will also lead to an improvement in the allocation to absolute return strategies. This case study will determine the way forward for the business (Kiger 113). After a well conducted analysis of the financial constraints and challenges facing the business, adoption of the strategies will work towards helping the company realize and achieve its goals. HF investment strategy targeted to provide uninterrupted support for programs that were worth into perpetuity. This was to be done through maintaining and growing current asset size and spending power in real terms. HF believed that it should work towards meeting this objective by holding a diversified portfolio that displayed the most effective and efficient trade-off between portfolio return and risks. HF decided to change its asset allocation policy to respond to the market assumptions and emerging investment opportunities (Kiger 71). Donor Stock Sale HF adopted a policy that encouraged reduction in the donor stock holdings over time. They targeted to reduce the risk usually associated with heavily weighted in small numbers of stock. This had both positive and negative effects to the business. Based on the study, it showed that increasing the donor’s stock in the portfolio improved the overall portfolio risk but had a negligible impact on expected return. This showed little or no impact on the expected returns. Total portfolio standard deviations corresponded with the donor stock accounting for an increasing percentage of total portfolios. This had the impact the risk portfolio increased and this was not what the company needed. In order to compensate for the increased portfolio risk, HF wanted the donor stock to give back a premium over the domestic equity. This was not possible to achieve. Basing on the data analyzed in the previous years, the returns on domestic equity had been lower than the return on HP. This study reveals that the HF should maintain their long-standing policy of avoiding portfolio concentration in a small number of stocks. This shows that the sale of the donor stock negatively impacted HF and the expected returns were not achievable. This action to some tent was beneficial to HF, but according to the study, the long-term goals and objectives were negatively affected since the returns fell. This strategy brought about financial constraints to the business (Smith 201). Financial Issues of Hewlett Foundation Just like any other business, Hewlett Foundation experiences constraints in running of its operations. One of the issues that affect the foundation includes merging and acquisitions. HF announced the acquisition of Compaq. This brought about many complains and adversely tarnished the name of the business because a publicized argument between the management and the HP shareholders. Some of the shareholders delayed the merging process because they did not support it. Another issue that HF faces is the management of funds. Although HF managed the donor stock sale itself, it had to hire outside managers that were responsible for investing its portfolio funds. Misappropriation and embezzlement of funds occurred. This really caused the company to undergo severe losses. In addition, the directors required high compensations and salaries. Their salaries’ were based on a quantitative measure and to a lesser extent a qualitative evaluation. The whole process consumed a lot of money. This entire process was a three-year evaluation of the HF diversified portfolio in relation to the HF composite benchmark (Pfaff 86). Financial bubble is also another factor that affects HF. There were speculations of lower equity premiums in the future. Analysts argued for lower equity premium considering that the current valuation of equities in relation to earnings or dividends was high when compared to the past experiences. This brought about lowering of the expected returns on the absolute-return portfolio leading to inconveniences. There was also a decrease in the expected returns and yields on the long-term bonds. The foundation also faced a decline of 20% in funds available for grants in inflation- adjusted terms from any other past peak. This would make the business strain in achieving the deficiency that will have been caused. The foundation also faces a risk in the increment of the value of the portfolio (Dolezalek 48). Managing Assets The foundation invests heavily in ensuring that it recruits the best people to help in its operations. Being an organization with a significant capital turnover, it has to ensure that its assets are managed in a good way. This prevents the misappropriation of resources and embezzlement of finances. FR example, it hires external managers to manage its finances are well utilized. It hired managers to manage the absolute-return portfolio. Major assets like private equity, real estate, and publicly traded assets and investment research each are assigned a director. It also compares the performance of each investment category with that of its chosen benchmark. This is ensures every asset is well utilized and that the performance of every category meets the required standards (Smith and Hany 195). This also shows the investment team’s effectiveness in selecting managers in relation to its alternative approach of passive investment in index funds. The foundation also measure’s the team’s asset allocation skill by comparison of the performance by an HF benchmark with a blend of other stocks and bonds. HF also evaluates it returns by comparing its return with those of its colleagues. These include other large tax-exempt organizations that faced similar investment parameters (Pfaff 94). These all are measures meant to ensure that the company’s assets and resources are managed in an effective way. Normally, many investment strategies pursued by hedge fund managers involved taking positions in illiquid securities. HF ensured that investors did not pull out of the funds by including lockup periods. This makes the company assured of smooth operations of its services. HF also monitors the use of leverage by absolute-return managers. These managers are highly trained and skilled to be conversant with their jobs (Connor 42). The company monitors the program’s liquidity profile to make sure that things work according to the planned objectives. Being a longtime investor with those absolute-return managers, the lock periods for the program’s previous investments had expired and, therefore, the prevailing redemption provisions allowed. Liquidation, however, slows if managers invoke their right to suspend redemption under certain market crisis conditions that do not allow the sale of holdings at considerate prices. This discretion protects the company’s investment from potential bank operated by other investors redeeming for reasons unrelated to the appearance of the fund’s investment strategy (Dolezalek 66). HF made long-term goals of the expected return, return volatility, and return correlation of all the major asset classes in its portfolio. These goals were based on a long run earlier estimates as well as expert analysis of the current market conditions. The created assessed capital market assumptions showed an anticipated environment of lower expected returns because of low interest rates, stable macroeconomic conditions, and high valuations of virtually all investment assets. The reduction in the potential returns on the steady income assets was as a result of lower going-in yields on long-term bonds purchased that time and low inflation expectations. In assessing the expected return on equities, the research team provided a significant weight to the past experiences (Kiger 132). Over the twentieth century, the premium return on stocks over bonds had been about 5.8% per year. This represented a potential return on equities of about 10.0% per annum at prevailing bond yields. Some analysts argued the country’s economy was now more stable and better managed than the twentieth century (Smith and Hany 199). Therefore, one should expect a lower equity premium in the future. The potential return on equities was almost equal to the dividend yield and the expected gain in earnings per share. Assuming that the dividend yield stayed at 2%, that the earnings multiple remained unchanged and that earnings per share gained by 4% per annum in nominal terms, the potential return on equities would be almost 6%. After consultations and research, the team assumed a possible return on equities to be 8% (Dolezalek 55). This return is less than the required return implied by the past equity risk premium and the current yield on long-term bonds. This policy was targeted to return 5.5% per year and maybe beyond. This assumption was justified in the light of current market circumstances and trends in the investment industry. There is an increment in the number of investors who were allocating a significant percentage of their assets to absolute-return strategies. The new asset allocation proposal had been adopted after stimulating the long term performance and risk of different asset allocation policies under the prevailing assessed capital market assumptions. This allocation would be enough to ensure that the company meets its objectives (Smith and Hany 201). HF established its absolute-return investment program to invest in strategies that generated market-neutral returns that can be compared with equity returns, but with substantially lower volatility and little correlation with asset classes in its portfolio. Doubling the allocation would transform the market-neutral risk exposure of the absolute-return portfolio into exposure to equities and bonds using swaps or futures. The net effect of the program would improve the overall expected return in the absolute-return portfolio and, therefore, the overall return of the investment portfolio (Pfaff 96). Therefore, the more the allocation, the more it would help the business. Absolute-return investment will provide consistent absolute returns by taking maximal advantage of fund manager’s investment skills while minimizing the risk exposure to the overall market. On the other hand, because many strategies pursued by hedge fund managers involved taking positions in illiquid securities, investments in the hedge funds often include lockup periods that prevent investors from pulling out of the fund (Dolezalek 58). Summary Recommendations HF should take advantage of this alpha by improving the allocation to the absolute-return portfolio. This process has greater advantages to the business since it exposes the market-neutral risks being transformed into equities and bonds. This increases the organization returns. It creates a potential return on the absolute-return portfolio equal to the return on the beta exposures as return on domestic equity, domestic fixed income, and TIPS. Implementing this proposal will also mean that its risks will not be correlated with the rest of the asset classes in the portfolio (Smith and Hany 211). Investing in Sirius Investing in Sirius is an important decision for the foundation. The primary approach was to invest globally in non- performing loans backed by real estate that resulted from banking crises. Sirius had skills in underwriting real estate. Sirius also had skills in servicing NPLs. The stability of Sirius’s team also gave the green light in implementing in this investment. It was not risk free to invest Sirius due to competition that had intensified in the NPL business. This adversely affected discounts and fees. In addition, Sirius had large investments operating in companies. This refers to hard assets that Sirius had made in recent funds. This increased the overall risk of the portfolio. HF has the ability of excelling and realizing its objectives by implementing the proposals. These proposals encourage the business and create the ways through which this can be achieved. Works Cited Connor, Gregory, Lisa, Goldberg, and Robert, Korajczyk. Portfolio Risk Analysis. Princeton: Princeton University Press, 2010. Internet resource Dolezalek, Holly. The Global Financial Crisis. Edina, Minn: ABDO Pub, 2012. Print Hibbeln, Martin. Risk Management in Credit Portfolios. Heidelberg: Physica, 2010. Print Kiger, Joseph. Philanthropists & Foundation Globalization. New Brunswick: Transaction Publishers, 2008. Internet. Pfaff, Bernhard. Financial Risk Modeling and Portfolio Optimization Chichester. West Sussex: Wiley, 2013. Internet. Smith, David, and Hany, Shawky. Institutional Management: Inside Look at Strategies, Players, and Practices. Hoboken, NJ: Wiley, 2012. Print. Read More