st. lawrence university endowment asset allocation and

1

St. LawrenceUniversity Endowment

Asset Allocation andSpending Study

Millie ViqueiraSenior Vice President

April 2006

Callan Associates Inc.200 Park Avenue, Suite 230

Florham Park, NJ 07932(973) 593-8050

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49%Broad Domestic Equity

13%Domestic Fixed

12%Absolute Return

19%International Equity

7%TIPS

Executive Summary

What is the appropriate asset allocation for the Fund?

The appropriate allocation depends on the time horizon and variable (spending, market value) deemed most important by the Fund.

Focusing on a five-year planning horizon and balancing the competing objectives of maximizing spending and growing the corpus of the Fund, the analysis points to a mix between Mix 2 (30% fixed) and Mix 3 (20% fixed). Extending the time horizon to ten years points to a more aggressive mix, similar to Mix 4 (10% fixed).

Alternative Mix 3 Alternative Mix 4

Expected Return = 7.95%Standard Deviation = 12.38%

Expected Return = 8.33%Standard Deviation = 13.85%


5%Domestic Fixed

13%Absolute Return


5%TIPS

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Study OverviewModel of spending policy and fund growth

Inflation Projections

SpendingPolicy

Beginning Fund

Balance

Capital MarketProjections

Ending Fund

Balance

Annual Spending

Value of FundValue of Spending(Nominal or Real)

Efficient Frontier(Optimal Asset Mixes)

These variables measure the future health of the Fund.

Real values are determined by discounting nominal values by inflation.Real values show the future expressed in today’s dollar equivalent.

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Callan’s Capital Market Assumptions2006-2010

Correlation Matrix

Asset Class Broad Int'l Eq Dom Fix TIPS NUS Fix Real Est Pvt Equity Abs Ret Cash EquivBroad Domestic Equity 1.00International Equity 0.71 1.00Domestic Fixed 0.25 0.20 1.00TIPS 0.01 -0.09 0.40 1.00Non-US$ Fixed 0.01 0.22 0.32 0.11 1.00Real Estate 0.59 0.47 0.20 0.00 0.03 1.00Private Equity 0.64 0.63 0.20 -0.03 0.10 0.44 1.00Absolute Return 0.60 0.55 0.43 0.00 0.15 0.42 0.46 1.00Cash Equivalents -0.12 -0.25 0.30 0.29 -0.05 -0.06 0.07 0.50 1.00

Asset Class IndexProjected Annual

ReturnProjected Standard

Deviation

EquitiesBroad Domestic Equity Russell 3000 9.00% 16.90International Equity MSCI EAFE 9.20% 20.10

Fixed IncomeDomestic Fixed LB Aggregate 5.00% 4.50TIPS LB TIPS 4.60% 6.00Non-US$ Fixed Citi Non-US Gov't 4.90% 9.60

OtherReal Estate Callan Real Estate 7.60% 16.50Private Equity VE Post Venture Cap 12.00% 34.00Absolute Return Callan Hedge FoF 6.50% 10.20Cash Equivalents 90-Day T-Bill 4.00% 0.80

Inflation CPI-U 2.75% 1.40

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12/31/0561%15%10%14%

100%

8.31%13.80%0.37%

Current Target60%15%10%15%

100%

8.26%13.60%0.37%

Min0%0%0%0%

Max100%100%100%100%

Mix 138%14%40%8%

100%

7.23%9.84%0.40%

Mix 244%17%30%9%

100%

7.61%11.18%0.39%

Mix 350%19%20%11%

100%

7.98%12.55%0.38%

Mix 457%21%10%12%

100%

8.36%13.95%0.37%

Mix 563%24%0%

13%100%

8.73%15.37%0.36%

PortfolioComponentBroad Domestic EquityInternational EquityDomestic FixedAbsolute ReturnTotals

Expected ReturnStandard DeviationSharpe Ratio

Four asset classes - broad domestic equity, international equity, domestic fixed income, and absolute return (hedge funds). Special Situations modeled with domestic equity, TIPS modeled with domestic fixed income.

No minimum maximum constraints. The current target mix has a risk and return profile which lies between Mix 3 and Mix 4:

major difference is the current target’s lower allocation to international equity in favor of domestic equity and hedge funds.

Efficient Asset Mix AlternativesUnconstrained

Note: With the exception of hedge funds, the risk and return projections above are exclusive of active management fees and return premiums.

% equity 76% 75% 40% 30% 20% 10% 0%

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12/31/05++61%5%

14%15%5%

100%

8.29%13.74%0.37%

Current Target++60%5%

15%15%5%

100%

8.24%13.53%

0.37%

Min0%0%0%0%0%

Max100%100%100%100%100%

Mix 136%27%9%

15%13%

100%

7.15%9.53%0.41%

Mix 243%20%10%17%10%

100%

7.54%10.94%0.39%

Mix 350%12%12%19%7%

100%

7.94%12.38%0.38%

Mix 456%5%

13%21%5%

100%

8.33%13.85%0.37%

Mix 563%0%

13%24%0%

100%

8.72%15.33%

0.36%

PortfolioComponentBroad Domestic EquityDomestic FixedAbsolute ReturnInternational EquityTIPSTotals

Expected ReturnStandard DeviationSharpe Ratio

TIPS broken out as a separate asset class. The current target mix has a risk and return profile similar to Mix 4. These mixes are used throughout the remainder of the study.

Efficient Asset Mix AlternativesBreak out TIPS

Note: With the exception of hedge funds, the risk and return projections above are exclusive of active management fees and return premiums.

% equity 76% 75% 40% 30% 20% 10% 0%

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Summary of Results

The analysis confirms a tradeoff between growing the corpus and spending.

Focusing on the ultimate real purchasing power of the Fund and a five-year time horizon, the risk/reward analysis points to a mix between Mix 2 (30% fixed) and Mix 3 (20% fixed). Extending the time horizon to ten years points to a more aggressive mix, similar to Mix 4 (10% fixed).

Mixes 2 and 3 are both more conservative than the current target mix, while Mix 4 has a risk and return profile similar to the current target mix. Mix 3 provides the Fund with better protection on the downside relative to the current target mix over all periods, while Mix 4 provides comparable or slightly greater expected results over the ten- and twenty-year periods relative to the target.

All of the alternative mixes grow the real (inflation-protected) value of the Fund over the projection period in the expected-case given the current spending rate and projected contribution levels.

Mix 3 does the best job of bringing the Fund’s asset allocation in line with those of its peers in Callan’s database.

The current target mix is a reasonable investment policy if the Fund does not wish to increase the international equity allocation beyond the current 15% weighting. Ultimately, however, the appropriate allocation depends on the goals, time horizon and variable (spending, market value) deemed most important by the Fund.

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5%Domestic Fixed15%

Absolute Return


5%TIPS

Interpreting the ResultsSelecting an Investment Policy Target Mix

Current Target Mix

Return = 8.25%Risk = 13.5%

Mix 3

Return = 7.95%Risk = 12.9%

Mix 4

Return = 8.33%Risk = 13.9%


13%Domestic Fixed

12%Absolute Return


7%TIPS


5%Domestic Fixed

13%Absolute Return


5%TIPS

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Interpreting the ResultsWhat if Fund Achieves Better Than Median Results?

Return expectations drive the results of the analysis. Callan’s capital market outlook in a nutshell: expect a low inflation, low interest rate, low return environment.

Historic returns for broad asset classes - the market “betas” - will be difficult to match going forward. The Fund’s target is expected to generate a return of approximately 8.25%, enough to maintain the real value of the corpus given the current spending policy, but not enough to generate real growth.

Does the analysis change if the Fund achieves 40th percentile results? 40th percentile return for current target is 9.8%, compared to 8.3% in the median

case. Assuming better than median results (40th percentile), the risk/reward trade-off

suggests a more aggressive mix over both the five- and ten-year time horizons - between Mix 4 (10% fixed income) and Mix 5 (no fixed income).

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Despite the chaotic markets and the pain suffered during the bursting of the stock market bubble, foundations and endowments have maintained a long-term focus and have resisted the urge to do something drastic, until now. Lower expectations for the beta of basic capital market exposure is pushing funds to consider substantial change.

Few new asset classes have been added to the institutional opportunity set. New strategies within asset classes have become institutionally viable and widely adopted by the endowment and foundation universe:

– enhanced indexing - domestic and international equity, fixed income

– domestic mid cap

– international small cap

– emerging market debt

– REITs

– TIPS

– hedge funds

– commodity futures.

Where Do We Go From Here?Is There Something We Should be Doing?

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As plan sponsors confront a low inflation, low interest rate, low return environment, they encounter four broad avenues:

1. Adjust expectations downward

2. Take on more risk to achieve a nominal return goal

a. Seek beta - add more of the risky asset classes

b. Seek alpha - add more active management

3. Seek alternative sources of return

a. Hedge funds

b. Other alternatives not yet explored

c. Market timing and GTAA, the new face of TAA

d. High yield

4. In the belief that the world has changed, restructure all or part of the portfolio

a. TIPS

b. Commodities

c. Real assets and “all weather” portfolios

d. Portable alpha, and the separation of alpha and beta

e. Leverage.

The Cutting Edge in Asset Allocation?Re-examining Implementation

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Bonds?

Yields are finally above 5%, but still not likely to rise much. The “best case” for bonds is a weakening economy, where consumers lose confidence and the Fed has to start reducing interest rates to stave off recession - not exactly fertile ground for strong returns in any part of the capital market.

High Yield?

Yields have compressed and the big gains have already happened. Market composition is changing as big names involuntarily enter the space (GM, Ford). If growth slows and inflation is absent, credit problems may re-emerge. Tight spreads

suggest excess risk-taking on the part of investors.

Asset Class Round-UpSo Where Should We Put Our Money Right Now?

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Real Estate?

Actually got stronger in the last two years, after outperforming all other asset classes following the bursting of the stock market bubble. Despite recent success, industry is in the process of lowering investors’ expectations to 5% real (or lower).

Vulnerable to prolonged economic downturn and rising interest rates. International?

Emerging markets just enjoyed the run of a lifetime - up 165% over the last three years, yet valuations still look attractive. Developed markets did better than the U.S. last year, even with a rising dollar. Valuations are no longer such a bargain, but “everyone” expects the dollar to move back down. Economic growth in Europe and Japan is weak.

Private Equity?

Join the crowd. The new kings of capitalism.


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Hedge Funds/Absolute Return?

Struggling to absorb a lot of money, suffered a couple of highly-publicized blowups, and was the recipient of more than a little gleeful schadenfreude over the past year or two. Yet the industry on average managed to generate returns comparable to those of stocks in 2005. May now be poised to deliver that promised return between stocks and bonds, but with lower volatility. Will interest remain?

So what else is left? How about large cap stocks?

Any hope left for long-only strategies? Any bright ideas?

Active managers in traditional, long-only portfolios. Idiosyncratic managers who don’t care about the benchmark. Expanding the opportunity set beyond the benchmarks. Shorting in ostensibly long strategies.


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Cutting edge strategies are now related to the explosive growth in the use of derivatives and financial engineering to tailor investments.

Portable alpha and the separation of alpha and beta is the positioned as the “next big thing”:

Risk budgeting in long-only space - small cap, international equity. Overlay hedge fund alpha onto the strategic asset allocation. GTAA.

Relaxing the constraints on long-only management to enhance alpha.

“130/30” strategies - 130% long combined with 30% short exposure, resulting in net 100% market exposure with greater opportunity for alpha.

New theme emerging for some endowments and foundations (and for that matter, some pension plans): be more diversified, in both sources of beta and sources of alpha.

Is 70% exposure to public markets equity sufficiently diversified? Limit exposure to any one beta. Rethink classification of assets - do real or “hard” assets constitute a separate, viable asset class? Combine diversified beta with portable alpha to engineer a fully custom investment strategy.

Challenge to increasingly intensive exposure to alpha: new set of risks

Wide manager- and strategy-specific risks, many of which are many of which are difficult to quantify and may have yet to be revealed in the market.

In the Absence of Beta, Looking Hard for Reliable Sources of Alpha

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Renewed interest in inflation and its consequences for investing.

Rising inflation clearly hurts financial assets, especially over the short run. Real damage from unanticipated inflation - current prices reflect anticipated inflation. Equities provide a better hedge than fixed income - positive real return even in rising inflation

environments. Real estate should offer protection over the long run, but supply, demand and interest rate conditions can

overwhelm inflation impact. Inflation-linked bonds an excellent hedge to CPI, at the cost of lower real return than that achieved by

equity in past inflationary periods. What about commodities? A hedge or an investment?

No “economic” return to holding a commodity - return solely from price appreciation. In theory, commodities with a finite or restricted supply, like gold, copper or oil, should see prices rise

relative to general price levels. Commodities should therefore provide a reasonable hedge to inflation with the possibility of a positive real return.

In practice, correlation of commodity prices to inflation is low, due to wild swings in commodity prices stemming from global supply, demand and political influences.

Institutional investors are limited to commodity futures as the investment vehicles for gaining exposure to the commodities market. Expectations for commodity futures managed against an index such as the GSCI are LIBOR plus a small premium derived from providing liquidity to the market.

Inflation Protection and Real Assets

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Real asset class concept:

A selection of “hard” investments - commodities, timber, energy, real estate, agricultural land - are managed as a group to protect the portfolio from the ravages of inflation. Some providers also include TIPS. Three key tenets:

The Fed has embarked on a policy of “reflation”, and the greatest risk facing a portfolio today is unanticipated inflation,

Real or hard assets will perform better than financial assets in this environment, and Appropriate exposure to these real assets can be gained by institutional investors.

Concept embodies a tilt or a bet, an expression of belief about future commodity prices relative to overall prices, and their performance relative to capital markets.

Potential benefits to adding a real asset bucket:

Inflation protection potential with the prospect of positive real return. Further portfolio diversification - risk control. Additional sources of absolute return. Potential source of income.


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Callan’s position - real assets are a medium-term tactical approach, an active management bet, and not necessarily an asset class.

Predicated on the ability to correctly anticipate generally unanticipated changes in commodity prices - obviously enables some to make extraordinary profits.

Market timing on commodities has been notoriously difficult - cycles are very long and variable, and where one enters the cycle matters to expectations for return.

TIPS offer a very close match to CPI inflation, at the cost of a modest real return. Other real assets offer enhancements over TIPS, but over the long run, equities are likely to outperform each of the real assets.

Depending on how the real asset concept is funded, the addition of these strategies may slightly reduce expectations for return for the total fund, but at a lower risk.


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Appendix:Comparison of Median and 40th

Percentile Results

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Range of ReturnsMedian vs. 40th Percentile

Meaningful probability that any mix could produce a negative return in any one-year period.

Time diversification means negative returns are less likely over longer investment periods.

12/31/05+ Current Target+ Mix 1 Mix 2 Mix 3 Mix 4 Mix 5(20%)

(10%)

0%

10%

20%

30%

40%

Projection Period: 1 yearsRange of Projected Rates of Return

Ann

ual R

ates

of

Ret

urn

(%)

5th Percentile25th Percentile40th PercentileMedian75th Percentile95th Percentile

32.9%17.7%11.7%8.3%

(0.5%)(11.8%)

32.6%17.6%11.7%8.2%

(0.4%)(11.7%)

23.9%13.7%9.6%7.2%0.9%

(7.3%)

26.9%15.1%10.3%7.5%0.5%

(8.9%)

30.0%16.5%11.1%7.9%0.0%

(10.4%)

33.2%17.9%11.8%8.3%

(0.5%)(11.9%)

36.5%19.3%12.6%8.7%

(1.0%)(13.4%)

12/31/05+ Current Target+ Mix 1 Mix 2 Mix 3 Mix 4 Mix 5(20%)

(10%)

0%

10%

20%

30%

40%

Projection Period: 5 yearsRange of Projected Rates of Return

Ann

ual R

ates

of

Ret

urn

(%)

5th Percentile25th Percentile40th PercentileMedian75th Percentile95th Percentile

18.64%12.40%9.80%8.26%4.27%

(1.21%)

18.54%12.35%9.76%8.24%4.28%

(1.17%)

14.35%10.04%8.23%7.15%4.33%0.41%

15.81%10.86%8.77%7.54%4.32%

(0.14%)

17.30%11.68%9.32%7.93%4.30%

(0.70%)

18.81%12.50%

9.87%8.31%4.28%

(1.26%)

20.34%13.33%10.42%8.70%4.26%

(1.82%)

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Risk versus Reward - Median Case Real Ending Market Values

Volatility in market value over the next 5 years suggests a more conservative mix, somewhere between Mix 2 and Mix 3. Extending the time horizon shows that moving to a more aggressive mix results in gains in the expected-case that more than offset losses in the worse-case. This is the benefit of time diversification, where volatility of return declines as the time horizon is extended.

Gain in the expected-caseis greater than the loss in

the worse-case. Real Ending Market Value in 2010

0

1,000

2,000

3,000

4,000

5,000

6,000

Mix 1 to Mix 2 Mix 2 to Mix 3 Mix 3 to Mix 4 Mix 4 to Mix 5

Gai

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Expected Gain Worse-Case LossReal Ending Market Value in 2015

$0

$2,000

$4,000

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$12,000


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Expected Gain Worse-Case Loss

Real Ending Market Value in 2025

$0

$2,000

$4,000

$6,000

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Risk versus Reward - 40th Percentile Real Ending Market Values

Looking at 40th percentile results as the expected case suggests a more aggressive mix over a five-year horizon, somewhere between Mix 3 and Mix 4.

Gain in the expected-caseis greater than the loss in

the worse-case.Real Ending Market Value in 2010

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000


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Expected Gain Worse-Case LossReal Ending Market Value in 2015

$0

$2,000

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Risk versus Reward - Median Case Cumulative Real Spending

In the short run the risk/reward analysis points to a mix between Mix 3 and Mix 4, where gains in the expected-case equal losses in the worse-case. Extending the time horizon, the risk/reward analysis points to a more aggressive mix.

Loss in the worse-caseis greater than the gain in

the expected-case.

Cumulative Real Spending through 2010

$0

$100

$200

$300

$400

$500

$600

$700


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Risk versus Reward - 40th Percentile Cumulative Real Spending

Looking at 40th percentile results as the expected case suggests a similar mix over a five-year horizon as the median results, somewhere between Mix 3 and Mix 4.

Loss in the worse-caseis greater than the gain in

the expected-case.


$0

$100

$200

$300

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$500

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$700


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Ultimate real purchasing power incorporates the competing objectives of growth in assets versus grow in spending. In the short run the risk/reward analysis points to a mix between Mix 2 and Mix 3 where gains in the expected-case equal losses in the worse-case.

Extending the time horizon, the ten-year risk/reward analysis points to a mix with a risk and return profile similar to the current policy mix while the twenty-year analysis points a more aggressive mix.

Risk versus Reward - Median Case Ultimate Real Purchasing Power

Ultimate Real Purchasing Power in 2010

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

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Looking at 40th percentile results as the expected case suggests a more aggressive mix over a five-year time horizon, between Mix 4 and Mix 5.

Risk versus Reward - 40th Percentile Ultimate Real Purchasing Power


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st. lawrence university endowment asset allocation and

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