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Midsummer Issue (Jul.)


Policies and Current Status of Fund Management at Waseda University

Recently, against the background of the global financial crisis which began last autumn with the subprime loan issue in America, the fund management of universities has become a hot topic in newspapers and other media. Therefore, we would like to take this opportunity to explain regarding the policies and current status of fund management at Waseda University.

1. History and Background of Fund Management at Waseda University

The subject of fund management consists mainly of funds held as various types of reserve assets. These include reserve assets for funds used in the development of facilities, reserve assets for retirement payments, specified purpose reserve assets, and reserve assets for the 3 major funds which are used for scholarships, research grants and international exchange. The return (return on assets) realized through fund management is well used to enhance the educational and research environment of our university, with returns being allocated to areas such as internal university scholarships, research grants and international exchange.

Waseda has a long history of fund management, and we established our "Internal Regulations for Fund Management" in July of 1991. At the time, the interest rate of Japanese government long-term bonds (10 years) was high at approximately 6% and it was possible to conduct simple fund management with a focus on domestic bonds. In such conditions, it was unnecessary to take any greater risk. However, interest rates fell dramatically during the deflation period of the "lost 10 years" the followed the collapse of Japan's economic bubble in 1990. Even now, interest rates for 10 year government bonds continue to be at a historical low with a rate of approximately 1% to 2% (0.435% in June of 2003). Amongst these condition, the high interest long-term national bonds which were purchased around 1991 came to maturity one after the other. However, we had no other option than to reinvest the redeemed funds at a low interest rate. Around this period, Waseda hired highly experienced fund management professionals from financial institutions and began full-scale fund management with the goal of increasing returns through international diversified investment.

2. Changes in Securities Portfolio (Operating Asset Structure)

10 years ago, at the end of March 1999, our securities balance was 28.8 billion yen. This balance was composed of 23.9 billion yen (ratio of 83%) in yen-based bonds and short-term products (MMF, CP, etc.), 1.2 billion yen (4%) in foreign bonds, and 3.7 billion yen (13%) in stock which was mainly composed of donations. This was a very simple portfolio which allowed for easy risk management. In following years, it became different to maintain sufficient returns during the period of historically low interest rates in Japan. Therefore, we focused on the difference in domestic and foreign interest rates and began earnest investment in foreign bonds with a focus on 10 year coupon bonds of the American government, which had 5% to 6% interest rates at the time. We gradually expanded our investment in diversified foreign bonds and mutual funds with a focus on government bonds of advanced nations such as Canada, Australia and England. We worked to achieve a varied and diverse portfolio by considering the balance of risk-return presented by real estate securities products and structured bonds issued by government institutions of advanced nations and by international institutions.

Our securities balance was 61.7 billion yen at the end of March 2009. This balance was composed of 33.2 billion yen (ratio of 54%) in yen-based bonds and short-term products (MMF, MRF, etc.), 16.8 billion yen (27%) in foreign bonds, 4.5 billion yen (7%) in stock, and 7.2 billion yen (12%) in real estate securities products.

3. Management Record and Use of Revenue for the Past 5 Years

The period after the collapse of the economic bubble in 1990 was one in which banks failed and even savings accounts did not offer peace of mind. Finally, in April of 2005, the financial environment had stabilized to the point where the unlimited guarantee of savings account could be terminated. As a result, we shifted our funds from bank savings accounts to investment in securities, and our management revenue grew significantly. Our revenue from the management of securities realized in the last five years (academic year 2004 to 2008) grew to 12.3 billion yen. During this period, we incurred no risk and were able to achieve successful management of funds compared to deposits in bank savings account where practically zero interest is incurred.

Management returns were well used to develop and enhance the education and research environment of our university. 4.5 billion yen of the returns was applied to internal university scholarships, 500 million yen was applied to research grants, 400 million yen was applied to international exchange, and a further 6.9 billion yen was applied to various other university projects. One example of particular note is the 125th Anniversary Scholarship Fund which was newly established in the 2007 academic and used management revenue for a portion of its resources. This was a large-scale fund with a total of 600 million yen in scholarship money, 500 million of which was applied to undergraduate school and 100 million of which was applied to graduate schools. As opposed to conventional scholarships which were uniform across the entire university, this fund offered 31 types of scholarships which consider the unique conditions of each undergraduate school and graduate school.

Additionally, Waseda University has sought to enhance various types of scholarship systems conducted by the university and the Alumni Association. Currently, we possess one of the foremost internal university scholarships systems among all domestic Japanese universities. In the 2008 academic year, at total of 2,247 million yen of scholarship money was issued to approximately 7,200 students. We hope to enhance our scholarships systems even more in the future.

4. Management Policy & Risk Management

Risk is a natural park of fund management, and a return cannot be expected without taking risks. What is important is how the balance between risk and return is considered. Before discussing this balance, I would first like to discuss the subject of risk. Risk can be broadly divided into two kinds of risk: reliability risk and market risk (fluctuation in interest rates, liquidity, movements in exchange rates, etc). Top priority must be placed on avoiding reliability risk. In terms of market risk, management is performed to avoid occurring large risks while working to develop an acceptable range (acceptable level) of risk by analyzing the risk-return balance of various fund management products.

(1) Risk elements

[1] Reliability risk (principal risk)

In terms of bonds, reliability risk can be defined as whether or not the issuing body has the ability to repay the principal. Even if a bond has an appealingly high rate of interest, if in the worst case scenario the issuer should go bankrupt, the principal will be lost. Therefore, top priority must be placed on avoiding this type of risk. In particular, it is difficult to use the Waseda University system to accurately assess information regarding foreign corporations when investing in foreign bonds. Therefore, as a general rule, we restrict the issuer to the governments and government institutions of advanced nations such as America, England, Germany, France, Norway, Sweden and Australia, as well as to international institutions such as the World Bank and the European Investment Bank. These restrictions enable us to suppress as much as possible the risk of losing principal investments.

[2] Market risk (fluctuation in interest rates, liquidity, movements in exchange rates, etc)

Regarding the types of market risk known as interest risk (in terms of bonds, the rising of interest rates or the falling of prices) and liquidity, the security management policy of Waseda University establishes a prerequisite of acquiring bonds for holding until maturity without sale before the maturity date. This allows us to avoid market risk and liquidity issues by redeeming the bond at 100% of face value at the time of maturity or at the time of early redemption. Therefore, our university seeks to increase returns by assuming the risk of movements in exchange rates.

The graph given above shows the movement in the markets for U.S. dollars and Australian dollars for approximately 20 years from 1988 to 2009. A broad overview of the graph shows that (1) the yen depreciated in the first 2 years, (2) the yen appreciated in the following 5 years, (3) the yen depreciated in the following 3 years, (4) the yen appreciated in the following 2 years, (5) the yen depreciated in the following 2 years, (6) the yen appreciated in the following 3 years, (7) the yen depreciated in the following 3 years, and (8) the yen has been appreciating since the middle of 2007. However, the yen has been depreciating since February of this year. As shown by this graph, exchange rates repeat a cycle of depreciation and appreciation of the yen. During this period, there is a high rate of exchange fluctuation for the U.S. dollar (20% to 70%) and the Australian dollar (30% to 90%). Furthermore, since the market for Australian dollars is relatively small compared to the market for U.S. dollars, the rate of fluctuation is greater for Australian dollars. Therefore, even if appraisal loss occurs temporarily due to an appreciating yen, there is a high possibility of recovering the loss or achieving an appraisal gain with the passage of time. When viewed from a long-term perspective of 5 to 10 years, exchange rate risk can be suppressed a great deal. In the world of management, long-term investment without rushing to execute cash conversion is the greatest hedge against risk. (The figures used in this article correspond with applicable areas of the graph.)

(2) Management Policy

When managing securities, it is impossible to avoid all risks related to market fluctuations. The essence of risk management is 1) "How to achieve a balance between risk and return?", and 2) "What are the attributes of the managed funds?"

If high risk is taken with a long-term perspective of 5 to 10 years, even if prices fall midway, there is a high possibility of ultimately achieving a high return due to market recovery. One example of this is the high-risk, high-return fund management strategy of America's Harvard University. According to the homepage of the university, Harvard possesses approximately, 3.5 trillion yen of fund reserves from donations mainly by private individuals. The management portfolio for these funds uses international diversified investment with quite rich variety. Included in the portfolio are products such as crude oil, mineral resources and grains, hedge funds, private equity (venture investment, etc.), stocks, real estate (including mountain forests), and bonds. The average annual investment yield for the 5 financial years from 2004 to 2008 was 17.6% (approximately 2 times the principal in 5 years). In this way, a fixed amount of management returns accumulated in the funds is steadily transferred into the university account every year, regardless of market fluctuations. It may be assumed that Harvard University suffered a large amount of appraisal loss due to the current financial crisis, but the loss is actually projected to be within the range of past management revenue. In the future, much attention is being given as to whether there will be a revision in the long-term investment management strategy while waiting for the market to recover. However, since Harvard University appropriates current revenues such as tuition fee to cover annual current expenses, the university performs management using safe assets such as low risk savings accounts and short-term government bonds (3 month treasury bills). In this way, it is important to have a management policy which considers the attributes of funds. On the other hand, low return is the unavoidable consequence of low risk management.

Since market interest rates have decreased due to the current financial crisis, a severe management environment in predicted for the time being. The fundamental management policy at Waseda University is for middle-risk, middle-return fund management that strives for management of approximately 3% to 4% with a focus on bonds. A fixed income is required every year for expenses such as scholarships. Therefore, it is inevitable that our main investment is management focused on income gain (interest income) through bonds, rather than seeking to achieve capital gains through stock. Furthermore, the majority of income for Japanese universities comes from tuition fees. Based on the attributes of these funds, a high-risk, high-return style of fund management can be considered as inappropriate. In summary, the type of management policy used by a university differs according to the management policy of that university, the history and know-how of management, the level of acceptable risk, and the level of understanding and recognition given to operating factors such as fund attributes. There is no one management strategy that is best for all universities, and there is no meaning in simply comparing returns on investment.

There have been reports of major losses at other universities through derivatives trading such as currency swapping. These are instances of derivatives trading using leverage which seeks to expand revenue and expands the notional principal to many times the original amount. This kind of investment cannot be called fund management which considers a balance of risk and return. Rather, it can only be called speculation. Waseda University does not engage in these kinds of derivatives trading, CDS (credit default swap) or CDO (collateralized debt obligations).

Derivatives trading is extremely effective if used as a hedge against risks. Consider the examples of being able to select a fixed rate mortgage or a variable rate mortgage for a home loan, and being able to use a credit card overseas. These kinds of transactions can be performed because it is possible for banks and credit card companies to hedge risks by using interest rate swaps and participating in the exchange futures market. However, as discussed previously, derivatives trading becomes a high risk proposition when used as a leveraged strategy to increase income. In other words, derivatives trading is not intrinsically dangerous; rather, a problem exists in the way that it is used.

5. Securities Management Record for the 2008 Academic Year
(1) Management Revenue & Appraisal Profit and Loss at the End of the Term

As of the end of March 2009, there are 62.6 billion yen in various reserve assets which are subject to management. Adding 26.3 billion yen in cash equivalents results in total financial assets of 88.9 billion yen. Each type of reserve asset has its own unique reserve objective, and the 26.3 billion yen in cash equivalents is, in reality, working capital.

We have 61.7 billion yen in securities balance held as various types of reserve assets. In the 2008 academic year we had management revenue of 2.8 billion yen and investment yield of 4.3%. Due to the rapidly rising yen and falling stock prices which accompanied the "once in 100 years" global economic crisis that began in autumn of last year, we have endured a total of 2.8 billion yen in appraisal loss for listed securities as of a March 31, 2009. 600 million yen of these losses are in stock and the remaining 2.2 billion yen are in bonds (exchange). However, these securities are being managed for the purpose of long-term holding and not for short-term sale. Therefore, there is a sufficient possibility of recovering the relevant appraisal losses and it can be said that there is almost no danger of the situation leading to actual losses. Furthermore, the appraisal losses were limited to the relatively small ratio of 4.5% when compared to our securities balance.

Beginning from the financial closing for the 2008 financial year, a note indicating "Balance Sheet Note 7(1): Securities Market Value Information" has been made in the margin for real estate securities products and compound securities products. All of the relevant items are non-listed securities and there is nothing that can be called "market value", but the information is provided for reference.

(2) Real Estate Securities Products

Real estate securities products are preferred securities of Special Purpose Companies (hereafter referred to as SPCs) that perform leasing of real estate. The revenue gained by SPCs through the leasing of real estate is received by Waseda University as dividends that accompany expenditures. The amount of investment in these types of products is 7.2 billion yen. There is no market value for these products because they are non-listed. However, as of December 1st, 2008, according to an appraisal of real estate performed by the bank (management) which provides financing for these products, the appraisal value for relevant products is 19.5 billion yen.

(3) Composite financial products (structured bonds)

Within our 61.7 billion yen of securities balance, there is 21.9 billion yen of composite financial products (otherwise known as structured bonds). Although the broad label of structured bonds is applied, these products are made-to-order with the issuing body. Therefore, there is an infinite variety of conditions and all of these products cannot be categorized as having high risk. On example from Waseda University is "power reverse dual currency bonds which are callable before maturity (principal at the time of early redemption is received in Japanese yen, interest is received in yen". Almost all of these bonds have a period of 30 years. Also, if a specified standard for exchange rates is satisfied on the day that interest is paid, then the bonds are redeemed in advance in 100% yen (assuming an early redemption over 2 to 3 years). In order to hedge against exchange risk and interest risk, a swap contract is contained within these bonds. However, this contract is conducted between the issuing body and the financial institution. Since the issuing bodies of these bonds are government institutions of advanced nations and international institutions, and since there is little possibility of such issuers defaulting on their debt, there is no effect on our university.

The total value for these composite financial products is 13.8 billion yen when trial calculations are performed using the "reference prices" provided by securities companies. However, these "reference prices" can be judged as inappropriate for use as "rationally calculated prices" when assuming cases in which products are held until maturity. Therefore, the balance for these composite financial products is shown as being included in "securities without market value".

The "reference prices" provided by securities companies refer to the liquidation price (dumping price) for cases in which the products must be sold immediately. However, the fund status of Waseda University does not require fund conversion to the point where dumping of products is performed. The risk of losing principal for these bonds can be thought of as extremely small because 1) the relevant financial products were acquired for the purpose of holding until maturity, 2) the products contain a condition for advanced redemption in 100% Japanese yen if a specific exchange standard is satisfied on the day of interest payments every year, and 3) there is almost no reliability risk associated with issuing bodies such as government institutions of advanced nations and international institutions.

In the future, in order to further develop and enhance the educational and research environment of our university, we shall perform thorough risk management and shall continue to perform careful fund management based on the policy of middle-risk, middle-return. (Financial Department)