From the brick-and-beam boardroom of University of Toronto Asset Management, some of Canada's sharpest financial minds have a bird's eye view of the country's largest campus, a combination of sturdy old stone buildings and gleaming new facilities.
It's a fitting backdrop, since UTAM's work is directly linked to the financial well-being of the campus. The 14-person operation runs $2.8-billion of staff pensions and $1.5-billion of endowments, which traditionally produces tens of millions of dollars annually for student aid and faculty posts.
But this year the money has stopped flowing after investment losses reached $1.5-billion for 2008 and the university was forced to cancel a planned $62-million endowment payout, representing about 5 per cent of its operating budget.
And now, the very existence of one of Canada's most innovative investment funds is in question by the university that is bearing the brunt of its losses.
An examination of its performance shows the vaunted investment fund was clobbered by a sharp reversal in the dollar, an untimely shift away from bonds, and a focus on hedge funds, including $5-million it lost through an indirect investment with Bernard Madoff, the Wall Street financier since jailed for fraud. The currency hedging strategy - essentially counting on the loonie to stay above parity - was one of the hardest hits of all, costing the fund as much as $600-million.
"It's not like the board didn't have a clue what they were doing. It's not like that at all. We are all complicit," says UTAM chairman Ira Gluskin.
Currency hedging is extremely complex, he said, and what may seem clear now - the drop of the dollar - was not clear then.
"After the fact in investment, everything is obvious," says Mr. Gluskin, one of Bay Street's most respected money managers.
While universities across the country are still reeling from the market crash of 2008, perhaps none has struggled more with the financial crisis. UTAM was a pioneer among endowment funds, deliberately importing the investment styles of Yale and Harvard universities to Canada in 2000. And given its location, it was able to draw on Bay Street talent, including its chief executive officer, Bill Moriarty, who joined it last year from Royal Bank of Canada.
But the same complex investing strategies that won praise during the bull years have angered many faculty, and prompted the university administration to consider assigning its pension money to another manager as part of a province-wide proposal to pool the pension funds of many Ontario universities.
"We are considering everything," said university Provost Cheryl Misak.
Settling into a boardroom chair in the restored heritage building of Toronto's MaRS research centre, Mr. Moriarty remains unshaken by the crisis. He stands committed to UTAM's sophisticated investing approach, reciting phrases like "portable alpha" and "risk budgets" to explain portfolio decisions.
"You can't build a portfolio strategy around a single year, and you can't build a portfolio that's there to protect you completely in a financial crisis," Mr. Moriarty argues. "Because if you do that, over the longer term you're going to pay a very significant price."
Indeed, since the beginning of this year, Canada's stock market has rebounded 13 per cent, boosting UTAM's equity holdings.
Mr. Gluskin says he is "well aware" of criticisms from the faculty association and from donors whose funds have eroded sharply in value. "Whenever an investment manager has a major down year, there are always a lot of questions about the strategy. UTAM has done well over the long term and we hope it will do so in the future."
Mr. Gluskin is frank in his assessment of the managers' performance, saying UTAM "did lousy" last year - but not much worse than other U.S. university funds with a similar investment approach.
In retrospect, one of the fund's worst moves was a policy to fully hedge the portfolio's U.S.-dollar exposure against an increase in the Canadian dollar, essentially placing a bet that the Canadian dollar would rise further in 2008 after hitting an all-time high in late 2007. When the 100-per-cent hedging strategy was adopted in 2007, it paid off handsomely as the Canadian dollar soared. But it was kept in place in 2008 even as the currency retreated, and it proved a costly error after the dollar tumbled 25 per cent last fall in the midst of global market turmoil.
By December last year, UTAM was forced to quickly liquidate government bonds to raise money to settle a slew of hedging contracts that had gone dramatically wrong.
Mr. Moriarty could not put a dollar figure on the costs of covering the contracts, but UTAM's annual report notes that the fund's total transaction and rebalancing costs for all elements of its portfolio accounted for about 2.3 percentage points of the fund's 29.5-per-cent loss last year, or about $120-million.
Transaction costs were only part of the pain incurred from the hedging strategy. Mr. Moriarty says the 29.5-per-cent loss last year would have been about 12.5 percentage points better if UTAM had not hedged its U.S. dollar exposure. That means had there been no hedging last year, the university's pension and endowment funds would have saved more than $600-million in losses. The fund has since moved to a 50-per-cent hedging position, a more neutral stance on the movement of the dollar.
Mr. Gluskin, who like other directors is a volunteer, says a change in leadership at UTAM last year led to "some execution problems," including transaction fees that were "higher than they might have been."
UTAM's high exposure to hedge funds and its use of baskets of hedge funds - so called funds of funds - also has come under attack as a costly strategy. Hedge funds accounted for almost one-third of UTAM's investments by the end of 2008 and its reliance on funds of funds exposed the university to about 400 different hedge funds, including those of Mr. Madoff. The exposure to Madoff funds cost about $5-million to the pension fund alone.
Over all, UTAM's hedge fund portfolio lost almost 20 per cent last year, although UTAM notes that publicly traded stocks did even worse, losing more than 30 per cent in Canada last year and even more in the U.S. and overseas. At a time when there is growing unease among public pension funds about the cost and secrecy associated with many hedge funds, Mr. Moriarty says UTAM will not significantly lower its exposure to them, but is moving away from funds of funds in favour of direct hedge fund investments. "The majority of [funds of funds]have not done a particularly good job in terms of managing the risk," he says.
Hedge funds now account for the largest portion of UTAM's investments in "alternative assets," which also include holdings such as private equity, infrastructure, commodities and real estate. The university's pension fund had 46 per cent of its assets in this "alternative" category at the end of last year - up from just 18 per cent the year before - while equities accounted for 39 per cent of the holdings and bonds 15 per cent.
That mix is significantly more aggressive that the average fund of UTAM's size. Data show an average Canadian pension fund with more than $1-billion in assets held 46 per cent equities, 29 per cent bonds and 25 per cent alternative assets in 2008.
UTAM paid a price last year for its decision to hold just 15 per cent of its assets in bonds, which is far less than the 40-per-cent bond weighting seen at a smaller, more passive pension fund. In its annual report, UTAM discloses it would have improved its losses by 5.1 percentage points last year if it had had a 40-per-cent bond weighting - a savings of $260-million.
Whatever the concerns about investment choices or returns, former university president Robert Prichard believes dismantling the independent asset manager he helped to create is not the answer.
The University of Toronto began looking for better ways to manage its growing pension and endowment funds more than a decade ago, about the same time it became the first Canadian university to crack the $1-billion mark in a fundraising campaign. Its growing pension assets also set it apart among its peers in Canada.
Mr. Prichard recalls that staff visited schools such as Harvard, Yale and Princeton before recommending the creation of a separate entity responsible for investing the university's endowment and pension funds, run by full-time professional staff and supervised by an expert volunteer board and accountable to the university. "The stakes were simply becoming too large to leave the responsibility to part-time management," he explains.
Retired Toronto-Dominion Bank chairman Robert Korthals, UTAM's first chairman, says that before UTAM, funds were managed by university finance staff and outside managers and performance trailed similar plans. "The feeling was that if we could increase the performance of the university's funds, people would give more as well - it would go hand-in-hand," he says.
UTAM had a rough start, launched in 2000 just as tech stocks crashed and terrorist attacks further weakened markets in 2001 and 2002. Over the next five years, UTAM had big gains as markets rebounded, and it increasingly shifted its strategy into hedge funds and less-traditional investment areas. Then markets collapsed in 2008, and the risks involved in such a strategy became apparent. George Luste, head of the university's faculty association and UTAM's most constant critic, says it is time for the university to get out of what he calls "a losing game."
"The evidence of the past nine years, not just the catastrophic losses in 2008, suggest that it is time to admit, for the good of the pension plan and our institution, that the UTAM experiment has been an expensive mistake," he wrote in a recent report, one of many number-filled critiques he has issued in recent years.
Prof. Luste calculates that UTAM has a compound annual return of just 1.8 per cent since 2000, compared with 5.3 per cent for a more passive portfolio that he designed - a difference of about $665-million. Mr. Moriarty says he has not put his own dollar figure on the value UTAM's management has brought.
In the face of faculty concerns, the university is pledging to review its approach. In a letter sent to staff earlier this month, U of T president David Naylor said the university is obligated "to ask some hard questions about broader structures and strategies for managing our investments" in light of the poor returns last year.
Janet McFarland