Saturday, July 28, 2012

Non-Profit Endowments Are Vulnerable To Hyperinflation

I like San Francisco's Exploratorium.  I wrote it into my will because its approach to experiential learning has been breaking new ground in science education for decades.  That's why I get concerned when I look at the breakdown of its investment portfolio (page 14 of their most recent financial statements).  Check out the reported value of their portfolio as of June 30, 2011.  The fixed income portion of $5.1M represents 21.25% of their portfolio, and it's all domestic (i.e., denominated in U.S. dollars).  Forget for a moment the complete lack of exposure to hard assets, non-dollar pegged currencies, and fixed income investments in countries that have low debt and rich resources.  The Exploratorium's equity investments will probably take a big hit of their own if global markets severely correct, but as long-term investments they can survive U.S. hyperinflation.  The U.S. fixed income investments stand no such chance if Helicopter Ben gets his QE3 and the federal government launches capital controls.

Other San Francisco cultural institutions are sitting on a similarly precarious ledge.  The California Academy of Sciences is another institution in my will.  Their portfolio would fare even worse than the Exploratorium's under hyperinflation.  Check out page 11 of the Academy's audited financial statements.  Add up the $48.5M in U.S. government notes, $51M in other government obligations, and $145M in corporate bonds.  That's 58.9% of their total portfolio that is extremely dependent on the U.S. dollar's stability.

The good news for the San Francisco institutions I've named above lies in their brand strength and market position.  The leading cultural attractions in a major tourist city like SF have enormous pricing power as long as they can attract patrons whose spending power isn't impaired by a hyperinflated currency.  I truly believe these institutions can continue to thrive through hyperinflation if they target their marketing to tourists from countries least likely to hyperinflate:  Canada, Australia, New Zealand, Switzerland, and possibly other countries that have the sense not to bury themselves with sovereign debt.  Museums in some American cities charge higher admission prices for out-of-town visitors, so tourists effectively subsidize attractions that are available to locals.  This tiered pricing structure would work wonders for the financial security of cultural attractions in a hyperinflationary environment.

Of course, I could very well be wrong about prospects for serious inflation in the U.S.  The Fed hawks may prevail in the face of macroeconomic deterioration long enough for equities to find their true equilibrium (hint: much lower) without monetary stimulus.  The federal government may elect not to restrict Americans' investment choices.  Panicky policymakers may not force banks to lend newly minted dollars to consumers, forcing a wage-price spiral.  Then again, if even one of these preconditions fails, the U.S. can and will experience serious inflation that will render fixed income investments undesirable.  That is reason enough for non-profits to consider diversification into hard assets and non-dollar currencies.