Harvard Case - Risk of Stocks in the Long Run: Barnstable College Endowment
"Risk of Stocks in the Long Run: Barnstable College Endowment" Harvard business case study is written by Andre F. Perold. It deals with the challenges in the field of Finance. The case study is 4 page(s) long and it was first published on : Apr 12, 1996
At Fern Fort University, we recommend that Barnstable College adopt a more diversified investment strategy that balances the potential for higher returns with the need for long-term stability. This strategy should incorporate a balanced portfolio of fixed income securities, private equity, real estate, and alternative investments, along with a reduced allocation to stocks. This approach aims to mitigate the risk associated with volatile equity markets while still achieving long-term growth for the endowment.
2. Background
Barnstable College is facing a critical decision regarding its endowment portfolio. The college has historically relied heavily on stocks, which have delivered strong returns in the past. However, the recent financial crisis and the increasing volatility of the stock market have raised concerns about the long-term viability of this strategy. The college is seeking to balance the need for growth with the desire to protect the endowment's principal, ensuring its ability to meet future funding needs.
The main protagonists in this case are the college's investment committee, responsible for overseeing the endowment's allocation, and the college's president, who must ultimately approve the committee's recommendations. They face the challenge of balancing the need for growth with the need for risk mitigation, considering the college's long-term financial sustainability.
3. Analysis of the Case Study
Financial Analysis:
- Historical Performance: The case study highlights the strong performance of the stock market over the past few decades, but also emphasizes the significant volatility experienced in recent years. This volatility underscores the inherent risk associated with a heavily stock-weighted portfolio.
- Risk Tolerance: Barnstable College, as a non-profit institution, has a lower risk tolerance than a for-profit entity. The college needs to ensure the long-term sustainability of its endowment, which necessitates a more conservative investment strategy.
- Time Horizon: The endowment's long-term nature allows for a more diversified approach, incorporating assets with potentially lower short-term returns but higher long-term stability.
Strategic Framework:
- Modern Portfolio Theory (MPT): MPT emphasizes diversification as a key strategy for managing risk. By allocating assets across different asset classes, investors can reduce overall portfolio volatility.
- Risk-Return Trade-off: The case study highlights the inherent trade-off between risk and return. While stocks offer the potential for higher returns, they also carry higher risk. A balanced portfolio aims to optimize this trade-off by minimizing risk while still achieving reasonable returns.
4. Recommendations
- Diversification: Barnstable College should diversify its endowment portfolio by allocating a portion of its assets to fixed income securities, private equity, real estate, and alternative investments. This will reduce the overall portfolio volatility and mitigate the impact of market downturns.
- Reduced Stock Allocation: The college should reduce its allocation to stocks, considering its long-term time horizon and lower risk tolerance. This reduction should be gradual and strategic, ensuring the portfolio remains adequately diversified.
- Active Management: The college should engage in active management of its portfolio, employing investment management professionals with expertise in different asset classes. This will involve ongoing monitoring, rebalancing, and adjustments to the portfolio based on market conditions and the college's financial goals.
- Capital Budgeting: The college should implement a robust capital budgeting process to evaluate potential investments and ensure alignment with the endowment's overall strategy. This process should incorporate a thorough risk assessment and return on investment (ROI) analysis.
5. Basis of Recommendations
- Core Competencies and Consistency with Mission: Diversification aligns with the college's mission to ensure long-term financial stability and support its educational goals.
- External Customers and Internal Clients: The recommendation considers the needs of both external stakeholders, such as donors, and internal stakeholders, such as the college's administration and faculty.
- Competitors: While the case study does not provide specific information on competitors, the recommendation considers the broader trends in higher education endowment management and aims to position the college favorably.
- Attractiveness ' Quantitative Measures: The recommendation considers the potential for long-term growth, while prioritizing risk mitigation. The specific allocation to each asset class will be determined through a thorough financial modeling process, taking into account factors such as cost of capital, dividend policy, and financial leverage.
6. Conclusion
By adopting a more diversified investment strategy, Barnstable College can achieve its long-term financial goals while mitigating the risks associated with a heavily stock-weighted portfolio. This approach will ensure the sustainability of the endowment, allowing the college to continue fulfilling its educational mission for generations to come.
7. Discussion
Alternatives not selected:
- Maintaining the current strategy: While this option may offer potential for higher returns in the short term, it exposes the college to significant risks in the long run.
- Investing exclusively in fixed income securities: While this approach offers stability, it may not generate sufficient returns to meet the college's long-term needs.
Risks and key assumptions:
- Market volatility: The recommendation assumes that the stock market will continue to exhibit volatility in the future.
- Interest rate risk: The recommendation assumes that interest rates will remain relatively low, potentially impacting the returns on fixed income securities.
- Performance of alternative investments: The success of alternative investments, such as private equity and real estate, depends on various factors, including market conditions and the expertise of the investment managers.
Options Grid:
| Option | Risk | Return Potential | |
|---|---|---|---|
| Maintain current strategy | High | High | |
| Invest exclusively in fixed income | Low | Low | |
| Diversified portfolio | Moderate | Moderate | Recommended |
8. Next Steps
- Develop a detailed investment policy statement: This statement should outline the college's investment objectives, risk tolerance, and asset allocation strategy.
- Select qualified investment managers: The college should engage with experienced professionals who have expertise in managing different asset classes.
- Implement a monitoring and reporting system: This system will track the performance of the portfolio and provide regular updates to the investment committee and college president.
- Regularly review and adjust the investment strategy: The investment committee should meet periodically to assess the performance of the portfolio and make necessary adjustments based on market conditions and the college's long-term goals.
This case study solution provides a comprehensive framework for Barnstable College to navigate the complex world of endowment management. By embracing a diversified and strategically managed investment approach, the college can ensure its long-term financial stability and continue to provide a high-quality education for future generations.
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Case Description
The manager of the Barnstable College Endowment is evaluating proposals to increase the endowment's exposure to stocks based on an analysis that shows stocks to be much safer over long holding periods.
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