When Cavalla assumed the position of CIO in April 2007, he inherited more than a portfolio. Cambridge has the largest educational endowment in the UK, with university statutes dating back to the Elizabethan period. Until 2007, nearly 86% of the portfolio was run by a single asset manager. UK endowments have historically had an income bias with investments in UK equity and property, two asset classes that offer high dividend yields.

The tilt toward total return started in 2001 with a change in the charity law. In 2003, Allison Richard was appointed vice-chancellor of Cambridge. During her tenure she has helped extend the logic in favour of total return. By comparison, US university endowments such as Yale have significantly higher allocations to alternatives than Cambridge. These holdings have helped them generate strong returns over the past decade. There are reports, however, that they are seeking to reduce reliance on alternatives from very high levels. Harvard University, for example, has more than half of its portfolio invested in alternatives. Some are now trying to unload these investments (among them, private equity and venture capital funds), according to the New York Times.

Active global managers

David Swensen, CIO of Yale’s endowment, is also a member of Cambridge’s Investment Board. Cavalla, was formerly the CIO of Man Global Strategies, one of three multi-manager alternative divisions within Man Investments. At Man, he was responsible for overseeing the teams that research alternative investment managers, their subsequent monitoring and portfolio allocation.

Cavalla’s arrival has ushered a number of important changes: the portfolio has ten new active global equity managers. “There was a strong UK bias in the portfolio which we felt was inappropriate. We have allocated 7% to hedge funds. For the moment, we have stopped those allocations and are moving cautiously. While the single hedge fund mandates are outperforming, we think the hedge fund industry is going through a strategic rather than cyclical set of issues from which it will emerge in different form.”

Following the de-leveraging and expected consolidation among private equity and hedge fund managers, there is likely to be a significant change in asset manager fee models. Cavalla expects a 50bp drop in management fees for hedge funds which have underperformed their benchmarks with high tracking error. “The 2/20 model will likely switch to a 1.5/20 model. The second change will likely involve managers asking for longer lock up periods in exchange for lower fees. The cost of active management will come down across the board, including long-only managers, simply because they have underperformed.” 

The endowment has a long-term return target of UK RPI plus 5.25% (4.25% distribution smoothed). In addition to the central endowment, the university also has 31 separate college endowments with about £2.5bn in assets. In recent years, the university endowment has received the same amount of donations as the individual colleges which has not always been the case. “I went to Kings College. Many graduates have a primary remembrance and attachment to their colleges; however, it is becoming more apparent that the university also has a major funding requirement and so it has been attracting more donations than in the past.” A third of those donations make their way into the endowment. The endowment contributes 5% to the university’s annual budget.

VB