ENDOWMENT TRUSTEES REPORT TO COUNCIL
Sunday, January 22, 2006
San Antonio, TX
This report provides information regarding the performance of ALA’s Long-Term Investment Fund (LTI) i.e. the Endowment Fund, for the twelve-month period ending 12-31-05. It is provided as a supplement to the oral report given by the Senior Trustee of the ALA Endowment Trustees. This report also provides information on the general condition of the financial markets, the performance of the individual portfolio managers and other issues that impact the LTI fund that are viewed as important to the membership. This report will be placed on the Treasurer’s web page after this Midwinter Meeting at www.ala.org/treasurer.
Attachments
Attached for your review are charts (Exhibits #1-12) detailing the allocation of the Endowment Fund by assets, type and manager. Also included is an annual historical review, manager investment style/benchmark comparisons and historical quarterly comparisons and other pertinent information related to the Long-Term Investment Fund.
Financial Review 2005
Many people in the investing community say that it isn’t where you start but where you end that counts. At a time when investors have come to expect double digit returns, calendar year 2005 can best be described as a below average year. The S&P 500 gained 3.0% to 1248.29 during the year and is still 18.0% short of the record high it hit in March 2000. Along the same lines the Dow Jones Industrial Average declined during the year by -.6%, Note the statistical oddity mention in the last midwinter Meeting report:
Statistical Oddity: It has been determined that since 1885 every year ending in the numeral “5” the DJIA has had a sizeable net gain with an average of 30.7%. Information provided by Merrill Lynch.
Although this is a statistical oddity, it does highlight just how difficult it was to make any significant gains during the year. The NASDAQ Composite index gained only 1.2% in a very volatile year. The only clear winner was the MSCI EFAE index, which gained 10.9% as cash found its way into the more risky investments in areas such as the emerging markets. It is clear that in its totality the markets drifted sideways during much of the year as it digested events such as continually rising interest rates in the US by the Federal Reserve to restrain inflation, the quagmire called the Iraqi conflict, spiking oil prices related to supply concerns or trader anxiety and hurricane Katrina.
Endowment Fund Performance
In view of the above, for the twelve months ended 12-31-05 the value in the ALA Endowment fund increased by approximately $2.4 million from $23.1 million to $25.4 million—see exhibit #2. It should be noted that $1.6 million of the increase in value was due to investing activities resulting from specific asset allocation strategies resulting in a 7.8% return, while $752,000 was from net contributions into the endowment—see Exhibit #12. This exhibit illustrates that active management produced in excess of $701,000 vs. the passive management via a typical endowment 60/40 split between equities and fixed income securities.
The Trustees meet on a monthly basis via telephone, with ALA staff and Merrill Lynch—ALA’s Investment Advisor—to review the LTI’s investment performance, asset allocation and other matters. As a result of this practice and asset allocation decisions made by the Trustees’ during the course of the year, based on prevailing market conditions, the portfolio benefited from an over weighting in small cap stocks, core/blend stocks and international stocks. The weighting in the fixed income portion of the portfolio was increased during the year as interest rates increased and in anticipation of the expected end of rate increases by the Federal Reserve.
Performance on an individual basis resulted in a split decision with four managers beating their indexes, while four were out performed by their indexes—see Exhibit #5. Alliance Bernstein, the core equity manager, returned 10.4% for the year compared to its index of 4.9%. As the year progressed investors moved more investment dollars into large cap blue chip growth stocks. In view of the low performance by the S&P 500 individual stock picks were the key. Although Alliance maintains a balance between growth stocks and value stocks, growth carried the day. Another strong performer during the year for many of the same reasons behind Alliance’s performance was Marsico, the large cap growth manager. Marsico returned the same 10.4% compared to their benchmark of 5.3%. Marsico’s results are definitely due to stock picking as they run a limited portfolio of 25–30 equities. NFJ, the small cap manager, completed a strong year by outperforming its index 14.7% to 4.7%. Their results run counter to the rotation of funds by the market out of small cap stocks. Once again, individual stock picking by the manager was the key.
In view of the amount of volatility experienced during the year and the resulting sideways movement in the equity market, it is not surprising that some of the managers did not beat their benchmarks. Gulf, a long time performer, realized a gain of 5.4% compared to its benchmark of 7.1%. Gulf’s style as a large cap value manager is to identify candidates whose intrinsic value is less than that reflected in its stock price and holds for 3-5 years. Their long-term results on a risk adjusted basis with ALA have been good. Lazard, the international manager, realized a gain of 9.7%, which was less than its benchmark of 13.5%. The international markets have performed quite strongly during the year and 2006 should be no exception. Lazard is more of a defensive manager in that they will capture good upside market results but will limit the downside risk. This manager was chosen for this specific reason i.e. exposure to the international market with downside protection. Additionally it should be noted that they have typically underweighted their Japan holdings as compared to the index. Japanese holdings had a very strong year and are now showing signs of coming out of its decade long malaise. Credit Suisse, the fixed income (bonds) manager, had a return of 2.0% compared to 2.6%. This portion of the portfolio should perform very close to the benchmark. Credit Suisse is currently in the process of positioning the portfolio to benefit from the anticipated end of the Federal Reserves interest rate hikes.
Ariel Capital—the SRI mutual fund—realized a gain of 2.9% compared to its benchmark of 12.7%. Ariel is considered one of the best SRI mutual funds in the industry by Morningstar, Wall Street Journal etc.; they do not typically compare themselves to SRI indexes. Ariel uses the Russell 1000 Mid Cap Value index. This index had the benefit of being supercharged with oil, energy related and utility stocks. The profits of the oil industry have been extraordinary. Ariel avoids these stocks. As a long-term investor Ariel tends to stay away from commodity type businesses ie their product is no different from any other producer and basically compete on price only (supply/demand). Many people believe that we are looking at a classic oil bubble. Since the late 1800’s the country has experienced exactly six energy bubbles, which were characterized by shortages, speculation and high prices. The advents of new technologies, new energy discoveries and rational thinking have brought all these crisis to an end to resume a downward price trend. Although $3 a gallon does not seem cheap, if gas cost today what it cost a family in 1900—relative to income—we would be paying $10 a gallon. With this in mind we have included a new chart (exhibit #9) that compares Ariel’s 1, 3 and 5 year performance against their chosen index and their SRI brethren. We feel that this is more representative of their performance. This includes the KLD Domini 400 and the KLD Social Select indexes. As a result they compare more favorably to their indexes. Remember, Ariel’s motto is “Slow and Steady wins the Race” and their long-term record would suggest that this is the case. ALA’s initial investment of $200,000 is now valued at $236,000 at December 31, 2005. Please feel free to visit the Ariel site at www.arielmutualfunds.com.
Finally, exhibits #10 and #11 have been provided as a review of the audited financial position of the LTI fund’s net assets at 8-31-05 as reported by the ALA’s auditors Ernst and Young in the FY 2005 audit.
Asset Allocation and Rebalancing
See exhibit #8 for details on asset allocation and rebalancing. The practice of rebalancing is based on an assessment of the prevailing risks and opportunities in the market. The Trustees’ continually monitor the portfolio and look for new opportunities to boost performance at appropriate levels of risk.
Future Outlook 2006 and Beyond
Just as the calendar year has seasons (4) so does the investment year ie year-end 4 th quarter rally season, summer doldrums, etc. Right now it’s forecast season. As the Trustees have stated on numerous occasions, no one can accurately predict the future with 100% accuracy, not even our investment advisor. So what’s ahead for 2006?
Right now the general feeling is that economic growth should be moderate compared to 2005 with some expectation of slowing. Corporate earnings are expected to close at about the same above average rate, while a slowdown in the housing sector is expected to take some of the momentum away from consumer spending. Interest rates and inflation will both get considerable attention as each has the potential to cause havoc. Based on the latest FOMC meeting minutes the Fed does not see inflation as a major concern and have hinted at a neutral stance for monetary policy. The minutes suggest at least one more interest rate increase (1/31) is likely and possibly two.
Another important factor potentially affecting results in 2006 is the age of the current bull market. Now entering its fourth year normal bull markets settle down after the early/big gains when coming out of a slowdown. The expectation is that investors should expect only modest gains over the next few years. Many prognosticators believe that stocks are still working off the excess of the 1990’s bull market when business overspent on new capacity.
Acknowledgements
We continue to be well served by Greg Calloway, Keith Brown and Elaine Klimek of the ALA financial staff. They have been very dependable, reliable and thorough in assisting the Trustees in our financial oversight responsibilities.
Respectfully submitted,
Rick Schwieterman—Senior Trustee (2006)
Robert Newlen—Trustee (2008)
Carla Stoffle—Trustee (2007)
Teri Switzer—ALA Treasurer, Ex Officio
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