Investment Policy at the Hewlett Foundation

Purpose of the case

To provide students with the opportunity to discuss the design of asset allocation policies
for long-term investors, the design and implementation of return overlay (or alpha
transport) strategies, evaluation of performance and risk exposure of hedge fund
strategies, portfolio diversification, and investments in non-liquid assets.

Objectives
After completing this case students will understand:
1. Asset allocation design
2. Design of overlay portfolios, also known as alpha transport or portable alpha
strategies, to separate search from alpha from risk exposure.
3. The role of hedge funds in investors portfolios
4. Portfolio undiversification
5. The benefits of specialization versus the benefits of portfolio diversification.
6. The use of geometric mean returns and arithmetic means returns as forecasts of
expected returns al long horizons.

Case Synopsis
This case examines the asset allocation decisions that the William and Flora Hewlett
Foundation (HP) is considering in early 2005. After careful analysis of the financial
challenges and investment opportunities the foundation is currently facing, the chief
investment officer and his team are about to make three asset allocations proposals to the
foundation committee which, if approved will substantially change the foundations
investment portfolio.

First Proposal
Adopt a new allocation policy to reduce considerably the foundations portfolio of
domestic equities and instead increase the allocation to absolute return (or hedge
fund) strategies and US TIPS (Treasury Inflation Protected Securities). This
recommendation is based on a detailed asset allocation study that includes a revaluation of HFs long-term projections of capital market conditions.
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Second Proposal.
Implement
a return overlay program for the absolute return portfolio. This recommendation
is based on a study of the historical performance and risk exposure of the

foundations long-standing absolute return portfolio. This study has concluded

that returns on this portfolio have consistently exceeded the returns on a passive
investment in Treasury bills, with a risk exposure that is largely market neutral
with respect to the equity market and the fixed income market. The investment
team at HF is asking the investment committee to consider enhancing the
expected return on the foundations portfolio by transforming this exposure into
equities, nominal bonds, and TIPS using return overlay strategies. These
strategies will allow HF to capture the excess return, or alpha, in the absolute
return portfolio and superimpose it on the expected return on a balanced portfolio
of equities and long-term bonds.

Third Proposal.
To
commit up to 5% of assets to a global distressed real state investment fund with
which the foundation has invested in the past. This represents an unusually large
commitment to single investment manager for a non-profit institutional investor.

Study Questions for the Oral and Written Presentations

1. Provide a brief summary of the case
2. Was HFs donor stock sale program a good idea? In your discussion you need to
provide arguments in favor and arguments against the program
3. What are the financial issues facing the Hewlett Foundation (HF)?
4. Describe how HF manages its assets.
5. Is the proposed allocation adequate to meet the HFs long term spending pay out
of 5% (inflation adjusted) while preserving capital in real terms and avoiding
short term fluctuations in spending?
6. As a member of HFs Investment Committee, would you agree with the proposal
to double to 20% the allocation to absolute return strategies? To support your
decision, in your discussion you must provide arguments in favor and arguments
against the proposal .
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7. As a member of HFs Investment Committee would you agree with the proposal
to implement the bondization and equitization overlay program (alpha transport)?
You need to discuss the effect of these programs on the expected return of the
absolute return portfolio and what contracts will be most effective for HF to
utilize. To support your decision you must provide arguments in favor and against
the proposal.

8. As a member of the HFs Investment Committee would you make the 5%

commitment to Sirius V? You must provide arguments in favor and arguments
against the proposal to support your decision
9. Give a summary of your recommendation for the three proposals

Team Meetings
Meeting of March 18 2014: Issues to be discussed by the teams
1. What are HFs objectives as a foundation (Exhibits 1a and Exhibit 2)? What is the
role of HFs Laurie Hoagland and his investment team?
2. How HFs philanthropic objectives translate into specific objectives for the
endowment (Exhibit 3a)?
3. What investment policy could HF adopt to achieve simultaneously its two
objectives of maintaining its asset based in real terms and avoid fluctuations in
spending (Exhibits 3a and 4?
4. Is the volatility of the proposed portfolio too high or too low? What alternatives
can you offer?
5. Should HF adopt highly levered mean-variance portfolios instead of the proposed
portfolio?
6. Review of HFs capital market assumptions. Does HF think that returns are
predictable?
7. Given HFs views on capital markets, is 5% real spending rate compatible with
the proposed investment policy?
8. If you were a member of HFs investment committee would you approve the
proposal to double the allocation to absolute return strategies (hedge funds) from
10% of assets (or about $600 million) to 20% of assets (or about $1.2 billion
(Exhibits 6, 8a, 8b, 9a and 9c)?
9. What additional questions would you ask Laurie Hoagland before approving (or
rejecting) the absolute return strategy?
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Meeting of March 25, 2014: Issues to be discussed by the teams

1. How a return overlay strategy (also known as alpha transport or portable
alpha strategy) works in a simple setting, for example, one in which HF
transports the expected alpha in the absolute return portfolio into the S&P 500?

2.

What is the impact on the expected return on the absolute portfolio of the
proposed overlay portfolio, which involves exposure not only to domestic equities
but also to bonds and inflation indexed-bonds? What are the risks?
3. How can HF implement the return overlay program (bondize and equitize its
absolute return portfolio)? Should HF bondize and equitize the absolute return
portfolio?
4. What are the advantages and disadvantages of investing in Sirius V, the global
distressed investment fund (Exhibits 10, 11, 12a and 12b)?
Should HF pledge
up to 5% of the endowment to Sirius V?

Meeting of April 1, 2014: Teams Oral Presentations; Written

Presentations are due