"My Foundation was Invested in What???"

The NY Giants Superbowl victory was a surprise. Let me prepare you for another upset, there's a strong possiblilty your foundation has mortgage backed bonds in it's portfolio and you may be about to take a loss. So many family foundations rely on their brokers and asset managers to manage their foundation's assets. Because it's not "their money", they do not scrutinize the holdings like they would if it was "their money" and many times the brokers know this. They place higher margin securities in this portfolio for many reasons; they get paid more to, there is more internal pressure to sell these assets, and since the assets are higher yielding, it may enhance the performance of the portfolio. The problem is, they are probably AAA rated and look good, the kicker is, many times your broker or asset manager does not really even know how they work.

The rearranged cash flows from mortgage backs enables the structurer to make many different types of securities, some of which are appropriate investments for a foundation, some of which are not. If your asset manager or broker does not understand the complexities of these new securities, you may be invested in inappropriate pieces and none of you are aware. Not until there are significant defaults or interest rate shifts, both of which we are experiencing now, will you know, and by then it is probably too late.

1. What exactly do you own? Is it collateral or is it structure? What types of mortgages?
2. How will it perform in a volatile interest rate environment? (Prepayments/Defaults)
3. At what price do you own it? (Extent of Premium or Discount)

Collateral is pooled mortgages, structure is taking those pools and rearranging the cashflows to create "tranches" in a deal. Find out specifically what your collateral (what types of mortgages) is or where in a structured deal your bond is. Interest rate volatility will determine what extension or shortening risk your security has. As the speeds or prepayments on your collateral change, so will the life cashflow characteristics. The price will determine your yield. If you purchased your security at a significant premium and the security speeds up, your yield will go down. Conversely, if you purchsed your security at a steep discount and the prepayments sped up, your yield would be enhanced. Knowing what types of mortgages you own, the structure they have (if any) and at what price will enable you to understand your true mortgage exposure. The bottom line is, does your broker or asset manager understand mortgages enough and are you comfortable enough investing your foundation's money in them??