In its 2009 Annual Report, Google stated that it had amassed $24.5 billion in cash and marketable securities, only five years after going public in 2004. During the financial crisis of 2008-2009, yields on these cash balances dropped below 1.0% as interest rates plummeted.

The company was faced with a number of critical issues during this time period, including:

• Very low yields on large cash balances.

• Significant fees were being paid to external investment managers.

• The company had an inefficient portfolio strategy in that there was no diversification across their portfolio as all investments were highly correlated and subject to one major risk factor, namely, changes to short-term interest rates.

Tony Altobelli comments, “As we went into safety mode during the global financial crisis, we wisely utilised that time period as an opportunity to make major changes in our portfolio strategy and to actively address the issues noted above.”

Firstly, Google employed traditional mean-variance efficient frontier asset allocation models, borrowing the best practices used in the investment industry, to help establish and design the most efficient portfolio possible; one that generates the highest expected return for a given level of risk acceptable to management. Google then outsourced this analysis to a major investment bank since it required extremely quantitative modelling capabilities and data that Google did not own. The true innovation, however, came about as the company transformed the existing industry standard model into an innovative two-state model that captured the tail risk events that were seen in 2008 when striving for the most optimal portfolio solution.

“The solution was comprehensive, solving various issues simultaneously by insourcing sovereign asset classes to save costs, outsourcing riskier asset classes to achieve higher yields and diversification, and outsourcing the selection and due diligence of external managers to achieve the strategy in an accelerated time period.”

The end result of this innovative work was a new strategic asset allocation that would enable Google to significantly increase their expected yield on the company’s portfolio and at the same time produce a more diversified portfolio with more asset classes. A major component of the solution was a new asset allocation mix across a diversified set of asset classes, including US Treasury and Agency bonds, Agency MBS, investment grade corporate bonds, high yield corporate bonds and emerging market bonds.

This solution involved outsourcing the management of the riskier portfolios having credit risk to professional money managers, who already had deep teams of credit analysts in place and proven track records managing these asset classes. Google’s goal was to roll out all the new portfolios over a nine month time horizon from Q4 2009 to Q2 2010.

The solution was to hire seasoned portfolio managers to join Google from the investment industry and build them a state-of-the-art trading room to manage their sovereign portfolios in-house. Over a six month period the company hired four investment grade corporate bond managers, three high yield managers and one emerging market debt manager and deployed and re-allocated the entire investment portfolio across all these outsourced portfolios as well as the internal portfolios.

As Altobelli elaborates, “The benefits have been quite outstanding. The solution was comprehensive, solving various issues simultaneously by insourcing sovereign asset classes to save costs, outsourcing riskier asset classes to achieve higher yields and diversification, and outsourcing the selection and due diligence of external managers to achieve the strategy in an accelerated time period.”