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Investment Policy at the Hewlett Foundation (2005) Case Solution

Solution Id Length Case Author Case Publisher
801 1534 Words (5 Pages) Luis M. Viceira Harvard Business School : 205126
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Hewlett foundation was established in 1966 by William R. Hewlett, the co-founder of HP, and his family. With the assets of worth $6.4 billion in 2004, HF was one of the largest private foundations in United States. The foundation was run with the highly conservative approach as compared to other foundations of comparable size. The main objective of the investment committee had been to ensure the continuity of the grants while increasing the value of assets in real terms. Hoagland, the chief investment officer at HF has presented a new investment plan that will help the foundation to avoid fluctuations in earnings. The assumptions underlying the proposal are highly conservative, to give the proposal a real picture.

Following questions are answered in this case study solution:

  1. What are the financial issues facing the Hewlett Foundation (HF)? In particular, is HF’s newly proposed asset allocation policy adequate to meet the foundation’s long-term spending goal of sustaining a long-term real (or inflation-adjusted) payout ratio of 5%, while preserving capital in real terms? Is it adequate to meet its short-term objective of maintaining consistent spending without sharp fluctuations?

  2. How does HF manage their assets?

  3. Is HF’s donor stock sale program a good idea?

  4. Are a member of HP’s Investment Committee, would you agree with the proposals to

    A. Double to 20% the allocation to absolute return strategies?

    B. Implement the bondization and equitization overlay program?

    C. Make the 5% commitment to Sirius V?

  5. With respect to b), what would be the effect of the bondization and equitization overlay program on the expected return of the absolute return portfolio? Which contracts would be the most effective for HF to utilize?

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Investment Policy at the Hewlett Foundation 2005 Case Analysis

1. What are the financial issues facing the Hewlett Foundation (HF)? In particular, is HF’s newly proposed asset allocation policy adequate to meet the foundation’s long-term spending goal of sustaining a long-term real (or inflation-adjusted) payout ratio of 5%, while preserving capital in real terms? Is it adequate to meet its short-term objective of maintaining consistent spending without sharp fluctuations?

Hewlett foundation is concerned about rapid changes in the market and decreases in returns of almost all classes of investments. The core objective of the foundation is to protect the liquidity of the foundation while increasing the value in real terms of the asset base at the same time. Inflation is also one of the major risks to which asset base of the foundation is exposed. Return from investment is the only source of income for the foundation. Therefore, the investment committee has to choose the appropriate tradeoff level of risk and return. Since the arrival of Hoagland, foundation has chosen more conservative policy by shifting focus to absolute return assets. HF sold Donor Stocks of Agilent and HP worth $4.1 billion in order to reduce the volatility of returns of the complete portfolio. Most of the investments that were chosen by HF were inflation adjusted. Therefore, this new allocation policy has dealt with the inflation risk appropriately. However, if the investment portfolio of the firm is compared with that of other similar foundations in U.S, it can be observed that HF has adopted a policy that is too much conservative. It is true that returns on premium on all assets are expected to remain modest, but still the firm should invest more in aggressive assets in order to maximize the benefits if holding a large asset base of $6.4 billion.

In order to maintain long term payout ratio of 5% in real terms, HF has to invest more in funds that are capable of giving superior returns. In the new allocation policy, most of the funds will be invested in assets that are either risk free or have very low risks. Consequently, return of the portfolio is not very high. With a huge asset base of $6.4 billion, HF has the leverage to invest a small, but significant percentage of funds in assets that are capable of giving superior returns. So, this new allocation policy seems to use the strong fund base inefficiently to some extent. During last three years, even though the FMV of total assets has increased significantly, income has shown a slightly negative trend. Although such a conservative policy helps the foundation significantly reduce the fluctuations in earnings and hence the grants, but the overall return of the portfolio will remain quite low. So, it will be quite challenging to maintain the payout ratio of 5% in the long run.

2. How does HF manage their assets?

The nature of grants and other programs initiated by HF is such that the main focus of the investment committee at HF has always been to avoid cash flow fluctuations. Therefore, stability of returns on investments was ensured even if it had high opportunity costs of return. Normally, investment policy was not changed frequently to maintain stability. The investment committee carefully examined the capital market assumptions and used projections to see the effects of changes in assumptions. Furthermore, new investment opportunities were also considered in order to make the best use of investment funds. For each class of investment, a benchmark was set by the management that signified minimum performance level. The remuneration of management was also tied to the return on investment and growth in real terms of the asset base. Higher allocations were recommended by the investment committee for asset classes in which HF had a comparative advantage due to superior management.

3. Is HF’s donor stock sale program a good idea?

Yes, the sale of donor stock is in line with the strategy of Hoagland. The main objective of any foundation should be to sustain a certain level of return at the cost of minimum risk. Holding stocks in technology companies like, and HP and Agilent is very risky. Although such stocks have the potential of yielding very high returns in the long run, but cash flows associated with them fluctuates very frequently. Therefore, the main objective of the foundations is compromised. For example, when the value of donor stocks dropped from $13 billion to $6 billion during period 2000-2002; grants of HF decreased by 46%.

Furthermore, the return of the donor stocks was not worth taking such huge risk. Domestic equity market was yielding 10.3%, whereas donor stocks were also expected to give the same return in the future. Although the return of donor stocks was much the same as domestic equity, its risk was even more than the private equity. Also, the correlation of donor stocks with the portfolio was 30% and hence. Therefore, not much of the high risk associated with donor stocks could be diversified. The return of the portfolio without the inclusion of donor stocks was 11.1%, whereas standard deviation was 14.6%. If the allocation of donor stocks increases to 20%, the standard deviation of the portfolio rises to 16.5%. On the other hand, increase in return is not enough to compensate for taking such a high risk. Therefore, HF foundation should sell donor stocks and maintain their strategy of avoiding small number of stocks to sustain the returns at minimal risk.

4. As a member of HP’s Investment Committee, would you agree with the proposals to

A. Double to 20% the allocation to absolute return strategies?

In 1995, chief investment officer of HF changed the focus of HF from public equity investments to absolute return investments. Analysis of U.S market has shown that since the market has stabilized, equity premiums are expected to be very low in future. Therefore, it may not be worthwhile for HF to take such a high risk by investing in domestic equities. Experience shows that policy of investing in absolute return market neutral assets has met the targets of the company. Therefore, the decrease in investment in domestic equity and the use of these funds for investment in absolute returns by the investment committee of HF is justified.

B. Implement the bondization and equitization overlay program?

Although effects of “bondization” and “equitization” are difficult to determine, the benefits of this overlay program are worth taking these risks. Implementing this program enables the foundation to extract the maximum return out of the stable returns of absolute return assets. The hedge funds protect the foundation from huge losses while increasing the overall return of the portfolio at the same time. The return of the portfolio increases from 7.32% to 9.6% whereas standard deviation decreases from 15.51% to 13.1%. A comparison of recent equity and bond market data with that of hedge fund shows that hedge funds are doing very well, and it is high time that HF takes advantage of these market conditions.

C. Make the 5% commitment to Sirius V?

Although other foundations of comparable sizes avoid making such commitments, HF should make its commitment for investing 5% in Sirius V. This is because the cash outlays associated with this commitment are not one time. Rather, the foundation had to make payments in installments. Furthermore, since HF had a history of dealing with Sirius, HF could relate to past and understand the risks underlying this commitment. Owing to a good experience and reasonable risk-return profile, HF should commit funds to Sirius. Since investment committee of HF has adopted a highly conservative policy for the overall portfolio, the foundation is in a position to take a modest risk by investing in Sirius V.

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