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The ABC's of hedge funds
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October 2, 1998: 3:03 p.m. ET
University endowments increasingly invest in hedge funds; most are insulated
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NEW YORK (CNNfn) - At least two university endowments have emerged as the latest victims in the hedge fund debacle that began last week with the near-collapse of Long-Term Capital Management.
But those tracking the "hugely misunderstood" industry say foundations and endowments that invest in hedge funds -- an increasingly popular investment venue -- have for the most part yielded large returns on low risk.
"Most of the concern with hedge funds has been generated by the media (rather) than by actual performance," said Hunt Taylor, executive director of the hedge fund tracking firm Tass Management Inc. "So even though this is a difficult year for hedge funds, it's not nearly as difficult as for other asset categories."
Hedge funds are largely unregulated speculative funds, known for their aggressive trading tactics and their highly leveraged market bets. They are typically used as investment tools by wealthy investors and institutions.
Over the last year, and more importantly the last quarter, he added, diversified hedge fund portfolios have "dramatically outperformed stock portfolios."
The Standard & Poor's index was down 14.6 percent in August, Taylor said, while hedge funds have been down around 3 percent, and yet "everyone calls hedge funds exceptionally risky. It's so misunderstood."
University foundations and endowments, which raise money through donations to support research, professorships and other academic advancements, have invested aggressively in hedge funds over the last three to five years, with allocations increasing annually, Taylor said.
Nearly all have created a broadly diversified hedge fund portfolio, which further insulates them from risk. Individuals can be more exposed to hedge fund volatility since they tend to invest in single hedge funds.
"Any statistical measure we can see of the broad market performance it appears that (hedge fund) performance is fairing far better than stock markets in general," he said.
At least 75 universities, through their endowments, invested last year in hedge funds, including Loyola University of Chicago, Amherst College, Colgate University and Tufts University.
Some have been luckier than others.
Cornell University, for example, began putting money into hedge funds about three years ago. The university, which moved a considerable amount of money from domestic equity managers into hedge fund managers in the last year and a half, now invests about 11 percent of its total $2.3 billion endowment in hedge funds.
Although he wouldn't disclose the names of the funds in which Cornell invests, James Clarke, the university's chief investment officer, said hedge funds have been a wise investment so far.
"When we went into these we looked at them as a way to possibly give us a bit of a defensive stance on the market, and it worked," he said. "In other words, all of ours are long-short equity funds without any leverage at all. "
Basically, he said, they're hedge funds "with training wheels," since the lack of leveraged positions leaves less room for risk.
Long-Term Capital Management, the U.S. hedge fund that was rescued from liquidation last week by a consortium of 14 banks and brokerages, fell into the highly leveraged category. Some say it leveraged its risk by a ratio of 100 to 1.
The fund, run by former Salomon Brothers trading legend John Meriwether, had been battered since the end of the summer through bad debts and its arbitrage-trading strategies.
"I don't think that LTCM was hedging anything really," Clarke said. "In general, though, hedge funds make a great deal of sense. The main advantage is that it dampens volatility of the holdings.
Cornell's endowment didn't make money from its hedge fund investments in August, Clarke said, but it "lost a lot less in the hedge funds" than in its other equity investments.
Not all universities were so lucky.
According to reports, endowments headed by Yale and Brown universities suffered undisclosed losses after investing in Everest Capital Ltd.
The Bermuda-based hedge fund operator reportedly lost nearly half of the $2.7 billion it was managing at the beginning of the year, making it the latest victim in the emerging market fallout.
Everest has lost $1.3 billion so far this year in its two large hedge funds, which had invested heavily in Russian bonds and Latin American stocks.
Some following hedge funds speculate that multi-billion dollar endowments run by Ivy league schools can afford to be more risky with their investments, and therefore place their money into riskier hedge funds and stocks.
Harvard University's $13 billion endowment returned a healthy 20.5 percent in fiscal 1998.
Jack R. Meyer, president and chief executive of Harvard Management Co., said the endowment doesn't invest through outside hedge funds, "but we do engage in (in-house investments) similar to what hedge funds do."
A glance at the endowment's portfolio returns reveals a loss of nearly 23 percent in emerging market investments. Every other investment category under the endowment had solid rates of return, most in the double digits.
The hedge funds that have taken the greatest hits in recent weeks invest in emerging market stocks and bonds.
Meyer acknowledged that Harvard's emerging market investment strategy involves a type of arbitrage trading, not unlike hedge funds. And he said the fund has turned over $500 million to a hedge fund manager that formerly worked for the endowment. 
-- by staff writer Shelly K. Schwartz
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