Challenges and Opportunities Facing Endowments and Foundations The Pardoning of Sisyphus Gordon B....

Challenges and Opportunities Facing Endowments and Foundations

The Pardoning of Sisyphus

Gordon B. Fowler, Jr.Chief Investment Officer

[email protected]

Economic and Market Outlook represents a review of issues or topics of possible interest to Glenmede’s clients and friends, and not as personalized investment advice. It contains Glenmede’s opinions, which may change after the date of publication. Information gathered from third-party sources is assumed reliable but is not guaranteed. No outcome, including performance, is guaranteed due to various risks and uncertainties. This document is not a recommendation of any particular investment. Actual investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Clients are encouraged to discuss anything they see here of interest with their Glenmede representative.

February 2013

Key Economic and Market ViewpointsKey Economic and Market Viewpoints

• The world’s largest developed economies continue to experience modest and volatile growth as they work off excess debt accumulated over previous decades.

• Politicians in many nations are addressing these fundamental problems, albeit at the expense of near-term economic performance.

• The global economy is finding some offsetting support from emerging markets, the health of the corporate sector, and modest improvements in housing and employment.

• Long-term return prospects remain compelling for many risk assets, but investors should be selective, giving proper weight to shorter-term concerns.

• Turning the corner of negative debt dynamics will likely be negative for defensive assets that have become extremely expensive over the past few years.

Asset Allocation Recommendations*Asset Allocation Recommendations*

Individual Investor Endowment/FoundationFebruary 2013

* The ability to implement this recommendation depends upon investable assets. The appropriateness of this recommendation to any one portfolio depends upon tax and liquidity objectives as well as other considerations. This is for general educational purposes only

Moderate Risk Portfolio* Moderate Risk Portfolio*

Large Cap 29%

Small Cap 4%

Int'l Equity 16%

Real Estate 2%Private Equity

6%

Absolute Return 11%

Commodities 3%

High Yield 5%

Global Fixed 4%

Core Fixed Income 18%

Cash 2%

Large Cap 25%

Small Cap 4%

Int'l Equity 13%

Real Estate 3%

Private Equity 12%

Absolute Return 21%

Commodities 4%

High Yield 2%

Global Fixed 4%

Core Fixed Income 10%

Cash 2%

Deleveraging efforts have held back growthDeleveraging efforts have held back growthEconomic growth has been moderate since 2000

Questions before the house Questions before the house

1. Do the developed world’s long term financial problems present an insurmountable hurdle to good economic and market growth?

2. Is there a way to protect principal in a low to no yield bond market?

3. Can we generate enough return to meet rising needs?

Sisyphus by Titian, 1548-1549

In Greek mythology, Sisyphus was a wily and arrogant king of Corinth who angered the gods, Zeus in particular, and was punished to an eternity of rolling a boulder up a hill. He originally angered the gods by repeatedly breaking the code of hospitality, murdering guests and travelers, and was sent to be tortured in the underworld. He then successfully escaped the underworld several times through deceit and trickery, exhibiting a belief that he was more clever than the gods. In seemingly just return, Zeus displayed his own cleverness by personally selecting Sisyphus’ punishment and committing him to the unending and useless task of attempting to roll a boulder up a hill and perpetually failing.

Sisyphus’ punishment for trying to outsmart the Sisyphus’ punishment for trying to outsmart the godsgods

Sisyphus’ BoulderSisyphus’ Boulder

1960 1970 1980 1990 2000 2010

5050

100100

150150

200200

250250

300300

350350

Debt

, % o

f GDP

Data through Q1-13Source: Glenmede, FactSet

Household GSEs

Government Non-Financial Business

Financial

Monetary and fiscal efforts seek a pardon of Monetary and fiscal efforts seek a pardon of SisyphusSisyphus

Public Flogging(DeflationaryDeleveraging)

Examples:

US Great Depression (1930-1932)Japan (1990 – Present)US Pre-QE (Jun 2008 – Feb 2009)Spain (2008 – Present)

Pardon(Tolerable

economicand market

outcomes)

Examples:

US Reflation (1933 - 1937)United Kingdom (1947 - 1969)US Post-QE (Mar 2009 - Present)UK Post-QE (Mar 2009 - Present)

Examples:

Weimar Republic (1918-1923)Latin America (1980s)

Printing

Printing

Source: Bridgewater Associates

Depressive/

Deflationary

Stimulative/

Inflationary

Printing

Austerity/

Defaults

Austerity/Defaults

Austerity/Defaults

Private Flogging(Inflationary

Deleveraging)

The U.S. has moved its boulder another few The U.S. has moved its boulder another few feetfeet

The American Taxpayer Relief Act delayed some of the pain

w/o deal w/ deal Payroll tax cuts $95 (0.4%) (0.4%) Allowed to expire

Tax cuts - wealthy $52 (0.1%) (0.1%) Allowed to expire

Affordable Care Act $18 (0.1%) (0.1%) 3.8% Investment Tax

Budget Control Act 2011 $65 (0.4%) Delayed 2 months

Unemployment benefits $26 (0.1%) Extended 1 year

“Doc fix” $11 (0.1%) Extended 1 year

Tax extenders $65 (0.1%) Extended

AMT $103 (0.3%) Perm. Fix

Tax cuts – middle class $169 (0.6%) Perm. Extension

Total $435 (1.6%) (0.6%)

Comment

Source: Glenmede, Congressional Budget Office, ISI, Ned Davis Research. Economic impact based on output multipliers calculated by the CBO and/or estimated by Glenmede. The “Doc Fix” refers to the funds needed to prevent doctors’ pay from being cut under the Sustainable Growth Rate formula passed in 1997, due to shortfalls in Medicare funding. Tax extenders includes, among other things, accelerated depreciation.

Item Economic Impact (% of GDP)2013 Costs

($ Billion)

The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…

New policy now has the deficit narrowing to historical levels around 2015

2012

The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…

New policy now has the deficit narrowing to historical levels around 2015

Average

2012

……and stabilizes the national debtand stabilizes the national debtUnder the new policy, debt-to-GDP declines to around 73% before increasing

again

2012

Projections always come with caveatsProjections always come with caveatsPotential flaws in Congressional Budget Office projections

• Assumes a return to trend GDP over 5 years

• Does not account for negative impact of unexpected economic shocks

• Longer-term debt levels start rising again due to entitlement spending

Growth 2013 –

2017: 3.3%

Growth 2018 –

2023: 2.7%

Protracted recovery in employmentProtracted recovery in employmentIf current trends hold, unemployment will reach 6.5% in October 2014

6.5% Unemployment

A Housing recovery could stabilize collateral valuesA Housing recovery could stabilize collateral values

01 02 03 04 05 06 07 08 09 10 11 12-60%

-40%

-20%

0%

20%

40%

60%

Data through 1/23/13Source: Glenmede, FactSet

Housing Units Authorized By Building Permits (YoY%)

01 02 03 04 05 06 07 08 09 10 11 12-20%

-15%

-10%

-5%

0%

5%

10%

15%


S&P/Case-Shiller 20 City Price Index (YoY%)

Many housing statistics are showing signs of positive momentum

European Central Bank action has stabilized the European Central Bank action has stabilized the situationsituation

2010 2011 2012

1%

2%

3%

4%

5%

1%

2%

3%

4%

5%

6%


Italy 10-Year Bond Spread Over Germany (Left)Spain 10-Year Bond Spread Over Germany (Right)

ECB action has provided a backstop in financial markets

2010 2011 20121,800

2,000

2,200

2,400

2,600

2,800

3,000

3,200


European Central Bank Assets, € billions

Key long-term imbalances are being addressedKey long-term imbalances are being addressedLabor costs are converging…slowly

Europe has put more fiscal effort into rolling its Europe has put more fiscal effort into rolling its boulderboulder

…and more fiscal adjustments are still needed

Emerging markets never had a boulder to rollEmerging markets never had a boulder to rollEmerging markets generally have lower debts and deficits

Secular trends like the growth of the consumer remainSecular trends like the growth of the consumer remainEM consumption to grow four times faster than developed to 2020

06 07 08 09 10 11 12

30

35

40

45

50

55

60

65

70

ISM M

anuf

actu

ring

Surv

ey

Data through 1/15/13Source: Glenmede, Factset

06 07 08 09 10 11 1280

85

90

95

100

105

110

NFIB

Smal

l Bus

ines

s Opt

imism

Data through 1/15/13Source: Glenmede, Factset

Business confidence surveys show a divergenceBusiness confidence surveys show a divergenceLarge business sentiment steady, but small businesses are having difficulties

Strong Strong

WeakWeak

The gods are crafty and could yet throw up more The gods are crafty and could yet throw up more obstaclesobstacles

03 04 05 06 07 08 09 10 11 12

-2%

-1%

0%

1%

2%

3%

2.19

2.83

Data through 1/23/13Source: Glenmede, FactSet. Derived from TIPS spread data.

Next 5 Year Inflation Expectations (Years 1-5) Following 5 Year Inflation Expectations (Years 6-10)

Inflation expectations are tame for now…

Excess reserves have not yet led to loan growthExcess reserves have not yet led to loan growthFederal Reserve assets have

mushroomed… …but money supply and loans have

not

07 08 09 10 11 12

1,000

1,500

2,000

2,500

3,000

Data through 1/15/13Source: Glenmede, FactSet.

Federal Reserve Assets ($ Billions)

07 08 09 10 11 12

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

24,000

Data through 1/15/13

Source: Glenmede, FactSet. Money supply is M2, including but not limited to currency in circulat ion, checking accounts,and savings deposits.

Money Supply ($ Billions) Loans & Leases ($ Billions)

Annualized Growth Rate

Fed Assets: 22%

Annualized Growth Rate

Money Supply: 6% Loans & Leases: 3%

Perhaps the gods have enthralled the politiciansPerhaps the gods have enthralled the politiciansMarket volatility may have fallen, but policy uncertainty remains high

Europe has demonstrated that austerity reduces Europe has demonstrated that austerity reduces growthgrowth

Austerity has been, to the surprise of no one, contractionary

Spain: the show (refinancing) isn’t over yetSpain: the show (refinancing) isn’t over yetSpain has to pay for its maturing debt as well as fund its deficit

2013 Refinancing Needs € Billions % of GDP

Budget Deficit 54 5.7%Maturing Debt 151 16.0%

Total 205 21.7%

Core fixed income has seen huge asset flows…Core fixed income has seen huge asset flows…

2008 2009 2010 2011 2012

-200

-100

0

100

200

300

400

$ Bil

lions


Net New Bond Fund Inflows, Last 12 Months Net New Equity Fund Inflows, Last 12 Months

Fear has driven money into fixed income products for years

……and accordingly offer paltry yields with little and accordingly offer paltry yields with little appealappeal

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 120%1%

2%

3%

4%

5%

6%

7%

8%

9%


10 Year Treasury Yield 3 Month Treasury Yield

Even longer-dated Treasuries have yields below the rate of inflation

Current bond yields suggest poor long-term returnsCurrent bond yields suggest poor long-term returnsStarting yields have a strong relationship with subsequent performance

Current Yield: 2%

Equity prices look more favorableEquity prices look more favorableCurrent multiples suggest good if not great performance

Subdued return projections may entail taking some Subdued return projections may entail taking some riskrisk

Source: Glenmede. Future results cannot be guaranteed, and all investments are subject to loss. Inflation is assumed to be 2.3%. As of 1/21/13.

Projected 10-year returns by asset class

Real returns may require taking some riskReal returns may require taking some risk

Source: Glenmede. Future results cannot be guaranteed, and all investments are subject to loss. Inflation is assumed to be 2.3%. As of 1/21/13.

Projected 10-year real returns by asset class

Expected returns and risks for strategy Expected returns and risks for strategy alternativesalternatives

Portfolio Expected Return RiskNominal Real Risk

Classic Portfolio (60% Equities / 40% High Quality Fixed Income & Cash)

4.8% 2.6% 11.3%

Source: Glenmed.e. S&P 500 is used as a proxy for equities, The Barclays US Aggregate Index is used for high quality fixed income. Expected return is annualized projected over 10 years . Expectations of return and risk are made in good faith, but actual results may vary depending on market conditions. This represents a purely hypothetical portfolio for the purpose of illustration. Hypothetical, expected returns do not include management fees or transaction costs which would lower returns.

Investment allocations for a yield challenged Investment allocations for a yield challenged marketmarket

• Underweight traditional fixed income and cash• Invest in higher return potential fixed income

• Global Fixed Income• Bank Loans & High Yield Debt

• Allocate money to risk-managed equity strategies with similar or better expected return than the market but with 20% to 30% less risk• High quality companies with dividend growth• Secured options/covered calls

• Overweight emerging and developed markets equity• Invest in cheap(-er) inflation protection• Identify lower correlation special strategies

• Private Secondary Opportunities • Catastrophic Reinsurance

• Not all strategies may be available to or suitable for, all investors.


Source: Glenmede

Asset Class

Fixed IncomeCashTraditional High QualityHigh Yield / Bank LoansGlobal Fixed Income

EquityUS Large CapUS Small CapRisk-ManagedInternational

DevelopedEmerging

AlternativesCommoditiesPrivate EquityReal EstateAbsolute Return 15%

9% 12%

3%3%

14%10%4%

22%4%-

21%

21%2%11%2%6%

57%27%4%

13%9%4%

40%4%12%

2%4%

42%16%4%

% w/ partnerships% w/o partnershipsStrategy Portfolio Suggested Weights

18%2%10%


Portfolio Expected Return RiskNominal Real Risk

Classic Portfolio (60% Equities / 40% High Quality Fixed Income & Cash)

4.8% 2.6% 11.3%

Strategy Portfolio 6.9% 4.7% 11.0%Strategy Portfolio (No P.E. or H.F. Partnerships) 6.5% 4.2% 10.7%

Source: Glenmede Expected return is annualized projected over 10 years . Expectations of return and risk are made in good faith, but actual results may vary depending on market conditions. This represents a purely hypothetical portfolio for the purpose of illustration. Hypothetical, expected returns do not include management fees or transaction costs which would lower returns.

Source: Glenmede

High yield bonds may be more volatile, risky, and less liquid than other securities of similar duration. Future results cannot be guaranteed and all investments are subject to loss.

Substitute some credit risk for equity risk by using high Substitute some credit risk for equity risk by using high yield debtyield debt

Expected returns are competitive High yield exhibits protection in downturns

High YieldBB

S&P 500

Yield 5.9% 2.1%

Earnings Growth -- 5.3%

Loss Rate -0.8% --

Valuation Change -0.3% -0.4%

Expected 10-year Return

4.8% 7.0%

Bank loans minimize duration risk with attractive Bank loans minimize duration risk with attractive yieldyield

Yields comparable to high yield, with less interest rate risk

Emerging market bonds offer more substantial yields…Emerging market bonds offer more substantial yields……even at shorter durations

International bonds may be more volatile, risky, and less liquid than other securities of similar duration. International bond investment involves additional risks including but not limited to currency, political instability, and accounting differences.

Seeking to control risk while still aiming for Seeking to control risk while still aiming for attractive returnsattractive returns

High quality has provided greater stability and absolute return over time

Secured options provide an opportunity to both Secured options provide an opportunity to both participate in and protect from market performance*participate in and protect from market performance*

Selling options against an equity portfolio provides protection

*Secured option strategies include covered calls and cash-secured puts. Protection cannot be guaranteed. Volatility can cause results to differ from expectations.

Secured Option (Covered Call) Strategies Secured Option (Covered Call) Strategies offer attractive risk/return characteristicsoffer attractive risk/return characteristics

0 5 10 15 20Annualized Standard Deviation

0

1

2

3

4

5

6

7

8

9

10

Annu

alize

d Re

turn

CBOE BuyWrite (Covered

Call )

Citigroup 3-M Treasury Bill

Barclays Aggregate

S&P 500 Index

Source: Glenmede, FactSet

01/1989 to 12/2012

Emerging markets are becoming more developedEmerging markets are becoming more developedLots of room to grow as their GDP per capita converges to developed world

levels

Real assets can provide a hedge against inflationReal assets can provide a hedge against inflation

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 121

1.5

2

2.5

3


Gold ($/ozt) / Reuters CRB Continuous Commodity Index Median

A broad basket of commodities looks less expensive than gold alone

Special strategies can improve Special strategies can improve a portfolio’s risk and rewarda portfolio’s risk and reward

• Private Asset Secondaries

• Catastrophic Reinsurance

• Risk Parity

• Exotic Beta

Investment Strategy ThemesInvestment Strategy Themes

• Position portfolios to benefit from moderate economic growth• Favor a constructive but not aggressive asset mix given ongoing risk of

policy errors

• Maintain the middle: Investors should maintain a long-term focus on the middle of the investment risk spectrum, where the most attractive risk-reward opportunities lie.• Favor high quality and/or dividend growth within equities• Take credit risk: high yield bonds, bank loans, and emerging market bonds• Utilize alternative risk control: secured options and absolute return strategies

• Position to benefit from long-term growth opportunities• Emerging market consumer growth

• Maintain some protection against unexpected future inflation and currency devaluation• Global fixed income and broad/active commodity basket

Challenges and Opportunities Facing Endowments and Foundations The Pardoning of Sisyphus Gordon B....

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