While risk is a constant, mitigating an institution’s exposure to potential pitfalls is critical to the success of any investment strategy. Identifying and diminishing this exposure is not possible without an in-depth evaluation of current strategies, especially when it comes to institutions with multiple investment portfolios. An educational institution unknowingly facing this type of challenge hired LAMCO to oversee their overall investment portfolio, which was comprised of a long-term endowed portfolio and a short-term portfolio.
Following a thorough evaluation of their current strategies, which, at face, appeared to be conservative, LAMCO noted that the institution was actually underwriting a substantial risk. LAMCO advised that the unspent funds needed to be available on demand and at their full value (Book Value). Because those funds were invested, the market value could be lower than the Book Value at any time, and if this were the case when the funds were demanded, the foundation would have to make up that deficit. Because the foundation had not maintained any reserves for this purpose, nor were they intending on building any reserves, they were taking a substantial and unrecognized risk.
LAMCO worked with the foundation staff to help build various cash flow models. Using these models, we divided the short-term portfolio into two and a liquidity portfolio was established to fund cash flows expected to be required in the next 24 months. The risk level of this portfolio was reduced substantially from the then current short-term pool. The short-term pool maintained the same strategy, which was deemed to be appropriate for cash requirements that would be needed in 24 to 60 months.
Heeding our advice, about 60 percent of the assets remained in the short-term pool while 40 percent transferred to the liquidity pool. The amount of money that was transferred to the liquidity pool underscores the magnitude of the unrecognized risk that was being assumed, helping create a more stable investment strategy for our institutional client.