In the third cal­en­dar quar­ter of 2018, the Her­itage and Sta­bil­i­sa­tion Fund (HSF) post­ed a re­turn of 1.81 per cent com­pared with a gain of 1.54 per cent for its Strate­gic As­set Al­lo­ca­tion bench­mark.

Ac­cord­ing to the HSF re­port, while all four man­dates (in­vest­ment strate­gies) gen­er­at­ed pos­i­tive ab­solute re­turns, the main dri­ver of per­for­mance was the fund’s ex­po­sure to the Unit­ed States (US) eq­ui­ty mar­kets.

On a rel­a­tive per­for­mance ba­sis, the two fixed in­come port­fo­lios out­per­formed their re­spec­tive bench­marks. How­ev­er, the two eq­ui­ty man­dates un­der­per­formed their re­spec­tive bench­marks over the pe­ri­od.

The to­tal net as­set val­ue of the HSF as at the end of Sep­tem­ber 2018 was US$5,965.8 mil­lion, com­pared with US$5,863.1 mil­lion at the end of the pre­vi­ous quar­ter.

Of this to­tal, the in­vest­ment port­fo­lio was val­ued at US$5,965.7 mil­lion, while the re­main­ing por­tion (US$0.18 mil­lion) was held in cash to meet the day-to-day ex­pens­es that arise from the man­age­ment of the Fund.

(https://www.fi­nance.gov.tt/wp-con­tent/up­loads/2019/01/HSF-Quar­ter­ly-Re­port-Ju­ly-Sep­tem­ber-2018.pdf)

How can T&T max­imise the HSF to en­sure that the peo­ple of this coun­try en­joy the best pos­si­ble re­turn and al­so hedge against price shocks in the in­ter­na­tion­al en­er­gy mar­kets?

We have al­ready dis­cussed the Ha­cien­da Hedge em­ployed by Mex­i­co us­ing their HSF fund.

Mex­i­co has locked in an av­er­age ex­port price of $46 per bar­rel of crude oil for 2018 in its an­nu­al oil hedge, which is the largest in the world. The hedge will be sup­port­ed by a spe­cial­ly set up Oil Rev­enue Sta­bil­i­sa­tion Fund, which, along with the cen­tral bank’s ex­change-rate sur­plus, will serve to guar­an­tee the price.

The Mex­i­can oil hedge, or the Ha­cien­da Hedge, is con­sid­ered the biggest hedg­ing bet on Wall Street. It has al­so earned Mex­i­co bil­lions since it was first made in the 1990s.

The hedge con­sists of the Mex­i­can gov­ern­ment buy­ing large amounts of put op­tions from a se­lec­tion of in­vest­ment banks. The av­er­age that the gov­ern­ment has spent on these put op­tions in the last few years has been US$1 bil­lion.

In 2000, Mex­i­co be­gan lock­ing in prices an­nu­al­ly and has since made a prof­it three times, in­clud­ing a $6.4-bil­lion wind­fall in 2015 af­ter the price crash from mid-2014. For 2016, the hedge made Mex­i­co $2.7 bil­lion.

(https://www.us­ato­day.com/sto­ry/mon­ey/en­er­gy/2017/10/18/mex­i­co-locks-46-per-bar­rel-2018-oil-hedge/774744001/)

What else can we do to im­prove the re­turns of funds in­vest­ed in the HSF fund?

The HSF is struc­tured sim­i­lar to an en­dow­ment fund and sev­er­al of the Ivy League uni­ver­si­ties in the Unit­ed States have en­dow­ment funds with As­sets Un­der Man­age­ment (AUM) larg­er than the HSF of T&T; at the top of the list are usu­al­ly Har­vard, Yale, Stan­ford and Prince­ton.

Har­vard, the largest of the four, has an en­dow­ment fund of ap­prox­i­mate­ly US$37 bil­lion. The fund that reg­u­lar­ly out­per­forms them all and has been hailed for its unique struc­ture is the Yale fund, which is led by Dr David F Swensen.

He has been the chief in­vest­ment of­fi­cer at Yale Uni­ver­si­ty since 1985.

Swensen is re­spon­si­ble for man­ag­ing and in­vest­ing Yale’s en­dow­ment as­sets and in­vest­ment funds, which to­tal ap­prox­i­mate­ly US$27.2 bil­lion as of end of fis­cal year 2017. He in­vent­ed The Yale Mod­el with Dean Taka­hashi; an ap­pli­ca­tion of the mod­ern port­fo­lio the­o­ry com­mon­ly known in the in­vest­ing world as the En­dow­ment Mod­el. His in­vest­ing phi­los­o­phy is unique in that it stress­es al­lo­ca­tion of cap­i­tal in Trea­sury in­fla­tion pro­tec­tion se­cu­ri­ties, gov­ern­ment bonds, re­al es­tate funds, emerg­ing mar­ket stocks, do­mes­tic stocks, and de­vel­op­ing world in­ter­na­tion­al eq­ui­ties.

In­vest­ment heads from uni­ver­si­ties such as Har­vard, MIT, Prince­ton, Wes­leyan, and the Uni­ver­si­ty of Penn­syl­va­nia have adopt­ed his al­lo­ca­tion strate­gies. Why not T&T?

Un­der Swensen, the Yale En­dow­ment saw an av­er­age an­nu­al re­turn of 11.8 per cent from 1999 to 2009.

(https://en.wikipedia.org/wi­ki/David_F_Swensen)

What’s unique here is that Yale does not man­age any of the fund them­selves. It is all out­sourced to some of the best per­form­ing hedge funds and bou­tique in­vest­ment firms led by in­dus­try in­sid­ers.

Rather than keep­ing a sub­stan­tial share of its as­sets in do­mes­tic eq­ui­ties and cash, Yale had made sig­nif­i­cant in­vest­ments in less ef­fi­cient eq­ui­ty mar­kets such as pri­vate eq­ui­ty (ven­ture cap­i­tal and buy­outs), re­al as­sets (re­al es­tate, tim­ber, com­modi­ties), and ab­solute-re­turn in­vest­ments (hedge funds).

Most of the day-to-day ac­tiv­i­ties in­volved eval­u­at­ing, se­lect­ing, mon­i­tor­ing, and over­see­ing ex­ter­nal in­vest­ment ad­vis­ers and not in mak­ing in­vest­ments them­selves. They set pol­i­cy and al­lowed the best to do what they do.

Ac­cord­ing to a Har­vard case study, this phi­los­o­phy was built on five prin­ci­ples:

1) strong be­lief in eq­ui­ties-pub­lic or pri­vate,

2) di­ver­si­fi­ca­tion,

3) seek­ing op­por­tu­ni­ty in less ef­fi­cient mar­kets,

4) use of out­side man­agers and

5) crit­i­cal fo­cus on ex­plic­it and im­plic­it in­cen­tives fac­ing out­side man­agers.

Eq­ui­ties are a claim on a re­al stream of in­come, as op­posed to the con­trac­tu­al se­quence of nom­i­nal cash flows ex­pect­ed from bonds. For most port­fo­lios to achieve any kind of mean­ing­ful re­turns there must be a heavy in­vest­ment in eq­ui­ties.

More than 95 per cent of the en­dow­ment’s as­sets were ex­pect­ed to pro­duce eq­ui­ty-like re­turns.

Di­ver­si­fi­ca­tion was al­so key, Yale be­lieved that risk could be more ef­fec­tive­ly re­duced by lim­it­ing ag­gre­gate ex­po­sure to any sin­gle as­set class, rather than at­tempt­ing to time mar­kets.

Less ef­fi­cient mar­kets have his­tor­i­cal­ly out­per­formed fixed-in­come, this gap is even wider for less liq­uid as­sets: hedge funds, ven­ture cap­i­tal and buy­out funds and re­al es­tate.

Yale be­lieved that they could in­crease in­cre­men­tal re­turns by se­lect­ing su­pe­ri­or man­agers in non-pub­lic mar­kets char­ac­terised by in­com­plete in­for­ma­tion and illiq­uid­i­ty.

As a re­sult, on­ly 21 per cent of Yale’s en­dow­ment was in pub­lic stocks and bonds and cash. Swensen strong­ly be­lieved in out­side man­agers for al­most all in­vest­ments. These ex­ter­nal ad­vis­ers were giv­en con­sid­er­able au­ton­o­my to im­ple­ment their strate­gies as they saw fit, with rel­a­tive­ly lit­tle in­ter­fer­ence, from Yale.

The man­agers were cho­sen care­ful­ly af­ter a lengthy and prob­ing analy­sis of their abil­i­ties, com­par­a­tive ad­van­tages, per­for­mance records and rep­u­ta­tions. It was Jim Collins in his sem­i­nal book, Good to Great, that likened busi­ness lead­ers to bus dri­vers with the cru­cial re­spon­si­bil­i­ty of “get­ting the right peo­ple on the bus.”

Great lead­ers con­tin­u­ous­ly ask “First who, then what?”

Swensen took the time to do just that.

Fi­nal­ly, af­ter se­lect­ing the right peo­ple Swensen went on to struc­ture the right in­cen­tives.

Swensen be­lieved that much of the in­dus­try had a mis­aligned in­cen­tive struc­ture where man­agers typ­i­cal­ly pros­pered if their AUM grew large, and not nec­es­sar­i­ly if they per­formed well for their clients.

The Yale fund struc­tured in­no­v­a­tive re­la­tion­ships and fee struc­tures with their ex­ter­nal man­agers to align the man­agers’ in­ter­ests as close­ly as pos­si­ble with those of Yale.

It is time for T&T to get in­volved in more so­phis­ti­cat­ed types of fund man­age­ment. The eco­nom­ic en­vi­ron­ment and in­creas­ing de­mand for cash flows call for it. Nom­i­nal re­turns are not suf­fi­cient if we are to tru­ly take di­ver­si­fi­ca­tion se­ri­ous­ly and de­vel­op an econ­o­my de­signed to thrive re­gard­less of the price of oil and gas.