How We Analyze Risk
The college analyzes risk in the endowment portfolio from the following six perspectives:
1. Geographic Net Exposure (geographic risk)
Geographic risk arises when an investment portfolio is too heavily concentrated within certain geographic areas. The college investment portfolio evaluates its geographic concentration in domestic, international and emerging markets according to approved asset allocation guidelines.
2. Currency Exposure (currency risk)
Currency risk looks at the potential for changes in a currency's value to affect the value of certain investments. The college evaluates its currency concentration in domestic, international and emerging markets, according to approved asset allocation guidelines.
Assets that can be easily bought or sold are known as liquid assets. In other words, liquidity is the ability to convert an asset to cash quickly. The college actively monitors the liquidity of its portfolio to insure that there is adequate cash flow to meet spending needs and respond to investment opportunities when they exist.
Leverage is defined as the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. If an investment manager uses leverage to make an investment and the investment moves against the investment manager, the portfolio's loss will be much greater than it would have been if the investment had not been levered. In other words, leverage magnifies both gains and losses. The college's investment committee monitors leverage on its long and short positions including the gross leverage of the portfolio (long exposure plus short exposure equals gross leverage).
5. Capital Structure
The college monitors the capital structure of the underlying investments of the portfolio to ensure broad diversification. Types of capital structure include equities (stocks) or equity-like derivative instruments, debt (bonds) and cash. Investment managers move funds among these categories of assets as they actively manage the funds under their control.
6. PE NAV and Unfunded Liability Lookthrough
Commitments to private equity (PE) investments are often made long before the transactions take shape and the capital commitments are "called"—that is, that cash is transferred from the investor and put to work. There are, therefore, often extensive "un-called" commitments waiting for action. Private equity investments and un-called commitments are closely monitored as a percent of the total pooled investment portfolio, and the two values are added together and measured against the college's investment policy. The investments committee has established a maximum amount of gross PE exposure, investments plus un-called commitments, and monitors this aggregate exposure on a monthly basis.