CHEVY CHASE, Md. - The $12.5 billion Howard Hughes Medical Institute endowment has begun dividing its investments broadly into "bets" and "hedges."
The reclassification is the brainchild of Nestor Santiago, chief investment officer, and his staff.
The larger "bets" arena comprises public and private equity portfolios and opportunistic strategies, and the "hedges" section is made up of Treasury inflation-protected securities, nominal U.S. Treasuries and absolute-return strategies, said Mr. Santiago, who took over a year ago as CIO and vice president.
The reclassification accompanies several asset allocation changes. The fund also has:
* slashed fixed income to 18% of assets from its 28% policy target, eliminating corporate bonds and mortgages;
* lowered U.S. equities to 28% from 30% of assets and added a separate emerging-markets equity allocation of 5%; previously emerging markets comprised 3% of assets that were included in a 21% allocation to non-U.S. developed markets;
* focused more on research-driven products in which analysts, not portfolio managers, choose between winners and losers;
* raised private equity to 14% of assets from a 9% policy target;
* increased absolute-return strategies to 10% of assets from 6%; and
* pared real estate to 3% of assets from 6%.
While the new framework is designed to generate enough revenue in a stock market downturn, some of the changes within asset classes are more immediate responses to recent stock market gyrations, Mr. Santiago said in an interview at the Hughes campus in Chevy Chase.
Mr. Santiago and his team developed the new approach themselves, after consulting with their peers at other endowments to learn their assumptions and with consultant Cambridge Associates Inc., Boston. Mr. Santiago said he is fairly confident the new approach will provide the near-term minimum return of 5% to 6% that he seeks.
Around 50% of the U.S. equity portfolio and 90% of the fixed-income portfolio are managed internally entirely in active strategies, the same as before Mr. Santiago's arrival. Hughes does a lot of trading in-house, and can turn on a dime, he said. The investments department employs 30 people, 22 of whom are investment management professionals.
Big bet on value
Mr. Santiago and his investment team made a big bet on value in its U.S. equity portfolios last year, to deal with the bifurcation in the markets, and it paid off. "Since then, we have reduced our bet on value, but we're still overweighting it. Now we're much closer to our benchmark, the Russell 3000 index, than before."
Hughes also underweighted technology significantly in 2000. "We were at 50% of the weighting in the (Russell 3000) index. For 2001, we're still underweighting it, but not as much. Now we're at 75% (of the Russell weighting). Some of the rebalancing into technology is coming from midcap strategies, which are still overweighted but less so than last year. Small cap is also slightly overweighted," Mr. Santiago said.
To cope with current market turmoil, the plan is slightly overweighting small-cap and midcap value stocks, while underweighting growth and large caps. U.S. equities are overweighted now, but will be brought back to the policy target. Emerging markets are overweighted slightly, while non-U.S. developed markets are slightly underweighted.
Mr. Santiago also plans to build up the hedge portion of the portfolio. U.S. Treasuries, now underweighted, will be increased and TIPS will continue to be overweighted. "We could also expand absolute-return to build up the hedge portion using non-correlated strategies, such as long-short and market-neutral. We're also open to ideas such as merger and convertible arbitrage strategies."
The new policy allocation for fixed income calls for 10% of the endowment to be invested in leveraged TIPS and 8% in U.S. Treasuries. The fund's overall portfolio allocations are now close to 75% of policy targets, Mr. Santiago said.
He is making a big push to use more research-driven equity strategies. To do so, the institute has changed some of its managers since Mr. Santiago's arrival. He wouldn't give specifics, but observed that in some cases existing money managers such as Capital Guardian Trust Co., Los Angeles, which managed international equity strategies for Hughes, also received new allocations to U.S. equities to manage in research strategies.
In private equity, Hughes is emphasizing partnerships that are doing recapitalizations in the United States and Europe, and biotech strategies. "We have around one-third of private equity in venture cap, but going forward we will only commit a little, to reserve our spot with top-tier firms." He also is pondering when to move some private equity into distressed debt funds.
The institute is in the process of hiring three currency managers to run overlays on some international equity portfolios. Another ongoing project is redefining and building the risk-management unit.