As congressional leaders convene on Capitol Hill in an effort to help Americans on Main Street and Wall Street, it remains unclear what the ongoing financial crisis may mean on Campus Drive.
Returns from the Duke University Management Company for fiscal year 2008, released last week, showed growth of 6.2 percent. That falls far short of last year's 25.6 percent annual growth, but is ahead of the negative 4.4 percent median growth for major institutional investors from Trust Universe Comparison Service.
Fiscal year 2008-from June 30, 2007 to June 30, 2008-was one of the weakest in recent memory for markets worldwide, and a drop is not surprising. But with both domestic and foreign financial markets sputtering, the downward trend is likely not over.
"We did relatively well last year. We got 6.2 [percent]. That wasn't the best in the country, but it is among the best," said Executive Vice President Tallman Trask, a member of DUMAC's nine-person board. "I haven't seen the numbers, but I suspect as of today we've given back 6.2."
It is often difficult to scrutinize DUMAC's performance and holdings. As a matter of competitive advantage, the company protects its strategies and offers very little information about its holdings, including its annual report.
DUMAC does report that only about $2.25 billion of its approximately $7.7 billion in assets is directly in stock and bond markets, with the rest in hedge funds (about 40 percent of the $7.7 billion) as well as private equity, real estate and other areas.
Hedge funds create an intermediate level between stocks and investors, and funds may profit by "shorting" stocks. By doing so, the funds may improve even as the market tanks, said Cam Harvey, a professor of finance at the Fuqua School of Business. As a result, it is difficult to link stock market volatility directly to DUMAC's returns.
"When you watch the numbers on the stock market, we really have relatively little direct exposure to the U.S. stock market," Trask said. "There's a lot of other things to work through. I'm not particularly worried by yesterday nor am I particularly encouraged by today."
But with precipitous drops in the stock market and a $700 billion bailout in doubt, the next few years may be leaner for Duke, as a weak economy translates into lower investment returns, fewer federal dollars and decreased giving to the University.
"Given that the government has to bail out [failing companies] eventually, there will be less money for grants. It is more difficult for students to get loans, it's more difficult for students to get jobs," Harvey said. "Put that all together and it is not good for the University. However, the University is in the enviable position that is has [$7.7] billion of back-up and very few liabilities. And it's got risk-free income from a constant flow of tuition dollars."
In addition, the Duke University Health System, like the rest of the healthcare industry, is reasonably immune to economic downturns.
Bill Brown, a visiting professor of law who previously held leadership posts at Goldman Sachs, American International Group and Morgan Stanley, said Duke may see shrinking donations. Many of the titans of the financial sector-including Morgan Stanley CEO John Mack and Wachovia CEO Robert Steel-are members of the Board of Trustees and major donors.
"To the extent that the University has relied on fundraising from people who have done well in the financial markets, those people will not have free cash to make charitable contributions the way they used to," Brown said.
Another major donor to University efforts is the Duke Endowment, an independent fund based in Charlotte. But since last year, DUMAC has managed the fund's assets, meaning that any slippage for the University's endowment returns would also hurt the Duke Endowment.
But both Brown and Harvey said many investors are being forced into quickly dumping undervalued assets, creating opportunities for long-term investors like DUMAC to buy solid stocks near the market's trough.
"The fact that Duke hasn't done as well over the last year doesn't bother me, because I know there are extraordinary, once-in-a-generation types of opportunities that are available today and over the next few months," Harvey said. "I said to some senior people at Duke that I would be extremely disappointed if in the next three years we didn't have really good returns from DUMAC."
Subprimes and derivatives and bear markets, oh my
The current crisis was caused in large part by lending to borrowers with subpar credit and the bundling of these loans into derivatives-financial tools whose value depends on an underlying asset that an investor does not actually purchase.
Trask said the University has some holdings in financial services, but not much. It is also DUMAC's policy to avoid junk debt, so any junk holdings in the portfolio are assets whose credit rating was downgraded since being acquired.
He added that DUMAC was well prepared for the collapse, partly because of a recent reduction in domestic equities.
"[The portfolio] is well diversified, but if all markets go down, we go down too," Trask said. "No one foresaw this exact series of events, but DUMAC got nervous about where the economy was going a year or 18 months ago and adopted a defensive position."
The estimated value of assets such as private equity and real estate can be misleading. For instance, in some cases, owners may legally choose not to report losses on long-term holdings if they decide that losses may be temporary, putting off write-downs.
Other products are also based on estimated values. In its 2006-2007 Year in Review, Duke stated that DUMAC uses some derivatives with risk that does not appear on the balance sheet. The fair value of these assets might comprise one portion of a larger project, but a collapse in the larger whole would wipe out an investor's holdings. Risky cases like these contributed to some of the high-profile Wall Street collapses.
Although reasonably well-protected from the financial crisis, the University is not without links to some of the companies that have been bailed out by the government or forced to liquidate themselves.
Duke had accounts with Lehman Brothers, the investment bank that filed for bankruptcy Sept. 15. Trask said the transition from Lehman to JP Morgan, though involving copious paperwork and legal consultation, had not caused any financial problems.
Yet another danger is hedge fund secrecy. In order to maintain a competitive edge, many fund managers refuse to divulge their strategies and holdings, but Trask said DUMAC's size allowed it to insist on transparency in most-but not all-cases.
"If [managers] don't tell other people, they probably tell DUMAC," he said.
Back to the future
Despite the drop this year, DUMAC's returns in three other major metrics-three-year, five-year and 10-year growth-are still among the nation's best.
And Trask said in the middle term, a weakened but stabilized market might make it easier for Duke to pursue some projects, such as issuing bonds to cover new construction, such as the massive New Campus plan.
"My guess is when it all settles back down, credit from Duke will in fact become quite attractive in the market," he said.
The University debt-finances because of tax advantages, not because there is no money in the bank, so Duke bonds could become popular with some investors, he explained.
Trask said the shape of the bailout that eventually passes-a deal is expected Thursday-will have wide-ranging results. Either way, the picture for Duke may not be as rosy in the longer term, he said.
"I do worry about going forward whether our options may be somewhat reduced in two or three years," Trask said, with a wistful nod back to the days of double-digit growth. "To me the biggest question-and I think no one knows-is, will we ever be back into a market where those returns are possible?"
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