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Making Working Capital Work (or Not)

Stupid Investmenta.jpgBuried in the Kim/Folt notes — the ones that frantically attempted to explain the administration’s cost reduction efforts to a skeptical faculty — was a little nugget that sent a shudder through more than a few College insiders:

ï‚· Working capital: Better projected yield on investment of working capital, $2 million

Working capital is the accounting term for the funds that the College holds for its current needs: payroll, ongoing expenses, etc. You can think of working capital as the money in your checking account, whereas the College’s endowment is equivalent to your savings account or stock portfolio. It is a rotating quantity of cash that can grow quite large at times as students pay in their tuition, grant money is received, and so on. The College can invest this float wisely to earn a risk-free return on the funds — or not so wisely, if it chases high returns in risky, illiquid investments.

Let’s go back to the very late 90’s. Former Executive Vice President of Finance & Administration Adam Keller, later aided by his sidekick, former Associate V.P. for Fiscal Affairs Julie Dolan, figured that he’d get creative in trying to earn more investment income from the working capital held in Dartmouth’s cash account. The Wright administration chased after extra returns everywhere as it aggressively ramped up spending in virtually all areas of the College. So the Keller/Dolan team — neither of whom had any background or training as professional investment managers — began investing in hedge funds, especially after the Internet bubble collapsed.

Although the College’s erstwhile Chief Investment Officer, David Russ, raised the alarm in 2005, stating that “hedge funds are not liquid investment vehicles,” his wise counsel was ignored by the Treasurer’s Office, which went so far as to state that the “the risk is reduced” with hedge funds. Wrong.

By 2008, the Treasurer’s Office — its activities unsupervised by and perhaps even unknown to the Board of Trustees and its Investment Committee — had invested over $150 million in six illiquid hedge funds: Farallon Capital Management; Angelo, Gordon & Co.; Prospect Harbor Investors; Och Ziff Capital; and Taconic Capital Advisors’ Overseas and Opportunities funds.

Remember that this is Dartmouth’s bread money — funds used for the College’s working expenses. The strategy worked well, right up until things turned sour. With the advent of the credit meltdown in 2008, the hedge funds performed very badly and, in the case of Prospect Harbor, disastrously. The returns, from June 2008 through March 2009 were as follows: Farallon: -27.7%; Angelo, Gordon: -23.3%; Prospect Harbor: -53%; Och Ziff: -12%. The returns for Taconic Capital’s funds are not available.

As the markets collapsed, the Treasurer’s Office panicked; Keller and Dolan elected to sell what hedge fund holdings they could at firesale prices. The Notes to the College’s 2009 financial statements (page 25) reveal that Dartmouth suffered an immediate $31.978 million loss in doing so.

Working Capital.jpg

However, the damage is not over: in at least one case, almost a third of the College’s invested capital is still locked up in illiquid investments and will not be returned for as long as seven years. The same is true in smaller proportions for other funds.

Today, as faculty members struggle with slow and unreliable photocopiers — so that the College can save all of $500k/year — and other budget cuts amounting to tens of millions of dollars reduce the quality of a Dartmouth education, it is worth noting that nobody on the Board of Trustees bore the blame for letting utterly unqualified staffers throw around hundreds of millions of dollars of the College’s money and lose $31.978 million of it. Our MBA Trustees should have exercised better oversight over students’ tuition money and the funds received from grants.

More importantly, as the Kim/Folt cost-reduction team begins predicting heightened returns from invested working capital, one wonders if the memory of past disasters has already begun to fade.

Note: For accounting purposes, working capital is not part of the funds comprising the endowment; therefore the above losses would not have been incorporated in the calculation of the endowment’s gains or losses for the 2009 fiscal year.


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