When tradition meets modernity
The University of Melbourne in Australia sees itself as a potential world leader and its endowment fund, like many investors in this part of the world, has modelled itself on the great educational institutions of North America.
Chairman of the eight-strong investment committee is Robert Johanson. He explains how the fund's investment approach has developed: "The university changed the way its endowment and investment funds were managed about five years ago. The investment committee used to decide directly where the funds would go and so, reflecting the skills of its members, the fund was invested in Australian equities and fixed interest securities. Liabilities were, I think, more or less taken for granted; that is to say, we were ensuring there was income for the scholarships and the other special purposes for which bequests had been made, and some capital growth for the future."
With the change to an external manager, a number of other things changed too. One was that private funding came to be seen as a critical part in the university's funding base. Institutions, especially ones aspiring to be among the world's best, realised that government funding would in the future be constrained and would not be sufficient. So the US model, where private funding from alumni and community sources is a major and regular contributor to the great universities, was seen as providing good lessons.
Melbourne's investment committee modelled their strategic approach to management on that developed by David Swenson at Yale. Johanson explains: "Once a year we spend a whole day discussing our liability profile and our asset allocations and targets. We have been doing that for three years now and I think we are getting better at it. Then we try to limit our involvement during the year to supervising the strategy's implementation."
In 2003, the university outsourced its long term investment fund to an external manager of managers, the Victorian Funds Management Corporation (VFMC). At the same time, the fund moved to a unitised structure.
"Our fund has a quite different profile to the rest of the funds they manage so we get good advantage out of their scale," says Johanson. "We are heavily weighted to equities and to Australian equities in particular. Over the last five years that has rewarded us, because Australia has been such a strong performer. To a tax-exempt entity like us, the high dividend payouts and the tax refund we get for imputation credits attaching to the dividends received by the fund make it an attractive asset class. It is unreasonable to expect the growth rates in Australian equities of the last few years to continue, but it's not obvious what is likely to do better. So I expect the dominance of our Australian bias will continue for a while as we carefully build our alternative, less liquid portfolio."
In 2005, the reported income from the University of Melbourne Fund was A$82m (€48.9m), $66m of which was distributed to unit-holders. The pay-outs contributed 6-7% of the total revenue of the university. "So while we are still a long way short of the 20-30% of revenue that, say the Yale and Harvard Funds provide to their universities, it is still very significant," says Johanson. "It has supported borrowings for capital purposes and it is a major factor in our financial strength."
Another change was that, freed from the responsibility of the regular investment decisions, the committee spent more time thinking about the real nature of the
fund's liabilities. The best and strongest lesson that Swenson and Jack Meyer, late of the Harvard Fund, have provided is that if you understand your liabilities, an appropriate asset policy will follow. Johanson says, "Our liabilities aren't like a superannuation fund where members will cease contributing and start withdrawing in an actuarially predictable way. The funds are effectively perpetual and the university's enabling legislation gives us a lot of legal discretion on how we deal with a benefactor's directions." The committee has also taken care to balance the inter-generational issues, not ignoring current students and not sacrificing the long term to somebody's next good idea. Johanson explains that "this has given us the framework to think about new asset classes and to seek illiquidity premiums. I am sure that in 10 years, if we continue to grow the fund successfully, there will be a much bigger proportion of assets in private equity style investments with situational managers. We have made a start with investments in private equity, airports and selective hedge funds. But we are feeling our way."
One very important matter they have to manage is the profile and political nature of any development at the university. As the state of Victoria's oldest and most prestigious university, Melbourne has always excited interest and debate, whatever it does. This has only been amplified by the new proposals to reorganise undergraduate education into a few core strands and to conduct all professional schools as post-graduate study. Combined with an explicit aim to be one of the world's great universities, this has excited a lot of debate.
The fund has to be seen to support this strategy. Johanson explains: "The university will become more solicitous of and dependent on non-government support. So the fund needs to be highly professional and managed with the highest standards of governance. There's little advantage in getting too adventurous in chasing the latest fashionable asset class - even if intellectually we think it's attractive - if it runs the risk of having us branded in a politically charged debate as reckless. If you look at the history of investment by the Yale Fund, its shift away from listed liquid securities took a long time and only came after its managers had earned the university's confidence. So we are in the early days of this process and we need to expand the asset classes in which we invest confidently but judiciously." The fund has already invested around A$40m into infrastructure and private equity.
The fund management contract is bound by specific performance criteria and is subject to tender every three years. Johanson says, "Our target return is 4% income, an extra 1% for imputation credits and 4% capital growth. They seem reasonable long-term targets. Of course we have exceeded them over the past few years, so we have questioned whether our targets are right, or just soft. But it is not just a matter of managing expectations. It is striking that delicate balance between the demands of the generations and our strong belief in the critical role if universities in general and in the University of Melbourne as a major world leader in particular."