Friday, April 11, 2008

Overture Center Finances: A Fine Mess

by Tom Bozzo

Quick background: The Overture Center, Madison's $205 million concert hall and arts center, was a gift from local philanthropist Jerry Frautschi (who made his fortune investing in American Girl, founded by his wife and sold for big $$ to Mattel). The gift was structured so that about half was put in a trust fund, intended to pay off construction debt and contribute to the Center's maintenance, assuming it made roughly 9% annual returns off stock market investments. The year was 1999. D'ohh!

After years of 2% annual returns, the trust fund represented insufficient collateral for the bankers, so a refinancing plan was hatched, and approved in late 2005, that required the City of Madison to guarantee a portion of the debt. The plan would work just great as long as it attained an 8.25% annual average return and the trust balance stayed over $104 million. That also hasn't worked out so well, as noted here a week-and-a-half ago.

My question has been, how have the Overture trust fund's managers managed to screw up so badly? Well, other than the obvious reason that 8.25% is well above any sane person's idea of a risk-free return. Courtesy of Isthmus executive editor Marc Eisen, I've seen a spreadsheet with a summary of the Overture trust's investments, and can only conclude that the investment choices never gave them a serious chance. For junkies of mid-sized institutional asset management stories, some gruesome details are after the jump.

I'd divide the trust fund's management into two eras, the Cash Era and the Alternative Investments Era.

The Cash Era ran from late 2005 to late 2006. The trust fund's balance ranged from $106.2 million to $109.3 million over the period, and 46% to 61% of that was held in "cash equivalents." The balance was in "general equities" (which I take to be meant generically, and not the firm General Equities) and Fairfield Sentry Ltd., a hedge fund. The higher cash percentage was sustained for the latter two-thirds of the year, when the trust turned a good portion of its Fairfield Sentry holdings into cash equivalents. My naive calculation from the spreasheet says that the equitites returned 4.6% and the Fairfield Sentry fund returned 8%. In 2006, you could have made right around 5% with a very good money market fund, such as the institutional share class for Vanguard's Prime Money Market fund. The upshot was that their weighted average return was right around 5% for the year. With that asset weighting, the trust had to make 12.7% off the non-cash-equivalent assets to reach the 8.25% target. 2006 actually was a good year for stocks — Vanguard's Total Stock Market index fund returned north of 15%. They chose a bad year not to be 'seeking beta.'

The interesting question is why they stayed in cash for so long post-refinancing. Pardon me for thinking that the financial geniuses behind the refinancing might have had an investment plan ready to roll upon approval. None of the obvious answers — they didn't have a plan, the Cash Era represents an inept plan, and they chose a deliberately defensive position to avoid the political embarrassment of a quick I-told-you-so from refinancing opponents — is confidence-inspiring.

The Cash Era ended in late-2006, as the cash-equivalents gradually moved into a series of other investments. At the end of the series I've seen (3/14/08), only 2% of the Overture trust is held in cash equivalents. I call this the Alternative Investment era as it was kicked off with a roughly $15M investment in "Highbridge Fund," which appears from the value of holdings to be the quasi-hedgey Highbridge Statistical Market Neutral fund (as of 3/14, 21% of the fund's holdings). Stakes in Pimco All Asset fund (a fund of Pimco funds, 16%), principal protected notes (PPNs) from JPMorgan and Barclay's (the latter purchased with the proceeds of the "general equities,"14% and 8%, respectively), additional investment in Fairfield Sentry (18%), and "JPMorgan muni's" (20%) followed.

It's hard to reliably track performance across the board because of apparent asset sales and purchases, but nothing has come especially close to putting in an 8.25% return over the period. The highest-flyers, the Fairfield and Pimco funds, have had 1-year returns around 6%. The Highbridge 1-year return was 1.2% (they've done relatively well YTD), the munis are up 2% over the 7-month period they've been held, and the PPNs down. The upshot is that the trust is showing a weighted average return around 3% for the last year, far below the target. Granted, all I need to do is look at my 401(k) performance to see that it's been a tough year through the end of March — I'm down 3.3%, though then again my five-year average is 9.7%. An irony is that while Madison Cultural Arts District Treasurer told the Cap Times that it would be "a very unfortunate change" if the creditors forced the assets into Treasury securities, which might be true now, had they actually been in Treasurys all along, they'd have ridden the bond market's flight to quality well past their return goal for the past year. Whatever the skills of the MCAD, investment timing ain't it.

The better question, perhaps, is what the prospects would be for this asset mix to earn 8.25% on average in the future. The underlying assets for the PPNs could be anything, so it's hard to say there. The munis won't under foreseeable interest rate environments. Pimco All Asset seems to be tuned to produce single-digit annual returns. Highbridge hasn't exactly been minting 'alpha,' and who knows about Fairfield Sentry. If the PPN investments were selected at least for perceived safety before the fact (actual performance notwithstanding), then I'd have to say it isn't going to happen. If nothing else, the MCAD seems to have done a good job of picking relatively high-cost holdings, which just increases the return that has to be earned from the underlying assets for the trust to net 8.25%.

This brings me back to my main point — the MCAD is undercapitalized, and they should get cracking on raising money. That was something that was supposed to have been facilitated by keeping the facility in the hands of the MCAD instead of under direct city ownership, but a capital campaign seems to have become a priority only now that they're in the soup. If they want to make good on the facility's promises, and shut us critics of their financing misadventures up, they need to raise a lot.

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