In this issue:

Going Public: Endowment Performance and Chief Investment Officers at our Great State Universities

Skorina is seeking: a Director of Public Market Investments and a Director of Asset Allocation & Risk Management for the University System of Maryland Foundation investment office

This month: Performance, pay, and the rest of the story: This month we analyze recent investment performance and compensation at top public university endowments; we also comment on the controversial severance package Treasury Secretary Jack Lew got from NYU; and we note the upgrading of the investment office at University of Illinois. There are some common themes here.  Chief investment officers and other senior executives contribute to their organizations in many ways.  They can save millions of dollars on fee reductions and administrative restructuring, help to close key donors, and build consensus around spending plans and investment policies. Some of their performance is measurable, even by outsiders.  Some is not.  The boards and executives who run the organizations operate with information, constraints, and goals which may be invisible to outsiders.  And these subjective measures are not always obvious when setting bonuses and incentives. We track the performance and follow the careers of most of the top investment officers in this country because we want to develop objective criteria for evaluating them.  Then we can present the best among them to the boards who hire us. We disclose some of our research in our newsletter as part of the public conversation about how these large pools of money are being managed.  This process is not always comfortable for the people we scrutinize, but we try to be as transparent as possible about what we’re up to. We think our performance and pay rankings and analyses are useful tools for both outsiders and insiders, but we recognize that it’s never the whole story.  And we hope you do, too.

The University System of Maryland Foundation is staffing up its investment office: Last year I helped the University System of Maryland Foundation find their excellent new Chief Investment Officer, Sam Gallo.  http://www.charlesskorina.com/category/people-in-the-news Now I’m assisting them in filling two new senior positions reporting to Mr. Gallo.  Both will work closely with the Foundation’s new fund of fund strategic partners. They are: (1) a Director of Public Market Investments who will oversee hedge fund and long-only equity investments, working with the strategic partner to identify outperforming strategies and managers. (2) a Director of Asset Allocation & Risk Management who will monitor existing investment risks and identify new investment combinations and risk overlay strategies. A competitive base salary, plus significant bonus opportunity will be offered for both positions. Best of all, you’ll be joining an outstanding team of professionals.  The Foundation Board, Investment Committee, President Leonard Raley, and CIO Sam Gallo are all focused on results-oriented management for their growing Endowment.  They are building a compelling model of endowment investment management. If you or one of your colleagues is interested, please send me a bio and we can discuss detailed specs for these positions. I expect to be starting interviews in New York the week of May 6th.

Skorina: Media Star Mr. Jack Lew, President Obama’s new Secretary of the Treasury, recently ran the gantlet in the U.S. Senate as members of the loyal opposition pummeled him with questions.  A few surprising facts about Mr. Lew’s career emerged, which in turn got your humble headhunter a few minutes on cable TV. It turns out, for instance, that Mr. Lew received a generous golden handshake back in 2006 when he left a job at New York University.  He had been making $840 thousand as executive VP for operations, plus a $1.4 million home loan (much of which was forgiven).  Then, as he went out the door, he collected an additional $685 thousand as a severance bonus. Now, that is a very affectionate handshake, indeed, and it rather astonished some people who aren’t au courant with what top university administrators are making these days. Bloomberg TV asked me if I would comment on this matter, which I was glad to do.  I got a quick haircut and hurried down to Pier 3 here in San Francisco where Bloomberg has their local broadcasting facility.  Everyone was very nice and professional and gave me about thirty seconds to say my piece. My appearance is here, a few minutes in. http://www.bloomberg.com/video/what-are-the-perks-for-a-college-administrator-UdQco5woTIGQIwlVTbJzqQ.html In essence, I tried to convey some of the facts of life about big-time higher-ed in the 21st century.  The public may think of college employees as the earnest, underpaid, chalk-dusted professors of yesteryear.  But most of the payroll now goes to the burgeoning ranks of administrators.  And hiring a marketer, an investment manager, or an operations guy is different from hiring a professor of post-modern whatever.  These professionals have the same skillsets as senior executives anywhere in corporate America, and command the same kind of compensation. If I’d had a little more camera-time, I could have simply quoted NYU’s EVP for Finance, Martin Dorph.  When Mr. Lew’s severance package was disclosed, there was rumbling in the professorial ranks down in Greenwich Village. In a letter to his troops, Mr. Dorph wrote: …[T]he salaries people earn here are often not as much as they want or feel they need …[But] it is important to note the economic truth that the markets for different positions often dictate different levels of compensation… And, when we commit to provide such compensation, we do so only when we are sure that the benefit to the University far exceeds the cost. … When [high-level administrators] have been successful – as was the case with Jack Lew – the benefit to the University can range in the tens of millions of dollars.  In some cases, when such people are hired, there are employment agreements that dictate obligations – such as severance – when they depart.  To be clear:  We do not give gifts – we honor employment agreements. When NYU hired Mr. Lew in 2001 they were getting a guy with degrees from Harvard and Georgetown and years of experience at the highest levels of the federal government.  He had just spent six years in the Clinton White House OMB: three as Deputy Director and then three as Director.  And Mr. Dorph says that NYU came out tens of millions of dollars ahead due to Mr. Lew’s performance. With the Democrats out of the White House in 2001, Mr. Lew no longer had friends in high places, but he was still a formidable operations manager, and that’s what NYU was hiring.  After you’ve spent a few years dealing with Congress, even academic politics holds no terrors.  Hiring that kind of talent takes money, and whether it’s paid upfront or on the backend is up to the lawyers writing the contract. That’s an economic truth, as Mr. Dorph plainly put it. That’s what I would have said if I’d had a little more time.

Comings and goings: Ellison to Illinois Ellen J. Ellison was hired in January as the first full-fledged chief investment officer for the $1.6 billion University of Illinois endowment.  She will be the nucleus of a new, professionally-staffed internal management office at the associated University of Illinois Foundation. She was recruited from the private University of Miami, where she’s been executive director of investments since 2006, handling Miami’s $700 million endowment. We suspect she got a compensation package at UIF in the range of $250 – $300 thousand.  Of course, the move also entailed trading south Florida for the stimulating climate of northern Illinois in the middle of January.  There are always tradeoffs. She will also be reporting to a brand-new foundation CEO, Thomas J. Farrell, a veteran fundraiser recently recruited from University of Chicago. Typically, endowments hire a professional CIO as their assets grow into the $500 million-to-$1 billion range; so UIF, with its $1.6 billion, looked long overdue for a proper CIO before they recruited Ms. Ellison. The move may have been partly driven by their recent not-great returns.  UI is one of the Public Ivys we dissect elsewhere in this newsletter.  Their annualized 5-year return of 0.41 percent is below average among their peers, and well below the 1.7 percent average 5-year return for all large endowments per NACUBO. Ms. Ellison has an impressive resume, featuring a BA from Mount Holyoke, an MBA from Columbia, a year at the Sorbonne, command of four languages, and industry experience stretching back 30 years with name-brand firms. Miami’s endowment performance over the past five years has been even worse than UIF’s: -0.9 percent for the whole endowment, including -0.2 percent in its long-term growth pool.  That’s a significant miss against the 1.2 percent return for medium-sized endowments per NACUBO. Despite Miami’s mediocre investment performance in recent years, Korn/Ferry, who did the search, apparently delivered a candidate who pleased the UIF board. In the circumstances she faced at Miami, it may be that both Ms. Ellison and her employer thought it was time to go. At Illinois she will get a fresh start, and a chance to build a new office, something she has already demonstrated she can do when she set up the JIK family office in Miami in 2004. I’ve had some contact with Ms. Ellison, and she clearly has the professional and intellectual weight to impress the donors, which is always a major consideration for an organization like UIF, which has traditionally focused on fund-raising. We wish her all the best.

Going Public: Endowment performance at our great state universities

In our last letter we took a hard look at recent investment performance among the eight Ivy League endowments.

[See NL44 at http://www.charlesskorina.com/775/]

As a bonus we added four “Alt-Ivys” to round it up to an even dozen.  These are all, of course, privately-funded institutions.

Now, we turn to the cream of our state-supported schools, the twelve Public Ivys.

The traditional Private Ivy endowments, including Harvard and Yale, get lots of scrutiny for obvious reasons.  They control a lot of money; they’re regarded as leaders in the art and science of investing; they have lots of bigfoot alumni; and they’re located in the media-saturated Northeast corridor.

Endowments at the big state schools, many of which are tucked away in flyover country, draw much less media attention.  So, we would like to provide some, welcome or not.

A list of “public ivys” was composed by Richard Moll in 1985, and expanded by Howard and Matthew Greene in 2001.

Dr. Moll was a Princeton man and, as he visited schools around the country thirty years ago, he was especially charmed when he encountered traditional neoclassical architecture on the historic flagship campuses of our older public colleges.  Today, of course, these schools have expanded into multi-campus behemoths, but we will generously apply the Public Ivy tag to the complete university systems.

Admissions offices at these schools, as one might expect, were very receptive to the Public Ivy phrase, and the term stuck.

We ranked these schools by endowment size; then cut the list down to a manageable twelve to correspond to our original dozen Private Ivys.  This omitted some worthy runners-up (with slightly smaller endowments); so, apologies to Michigan State, University of Florida, University of Iowa, and several other good schools which would have been included in a longer list.

These twelve Public Ivys, as one might expect, also ranked among the top one hundred schools on either or both of the U.S. News and Times Higher Education lists, which include both public and private institutions.  Many people mock these rankings as manipulated beauty contests, and many people are probably right to do so.  But, in education as elsewhere, perception is reality, and we are bound to take some notice of it.

In the Great American Pecking Order, a degree from Cornell or Columbia might slightly outrank one from Berkeley or Michigan, but not by much.  And, on a prestige-per-tuition-dollar basis, the ranking almost certainly tips back the other way.

Investment performance, however, is objective, as most boards of trustees would agree; and we shall see how our state schools have done in that sphere.  We’ll also consider the relationship between pay and performance among their respective chief investment officers, and how they stack up against their colleagues at the private colleges.

These are not small pots of money, either, even compared to the Private Ivys.  The University of Texas controls more money than Princeton; Michigan is bigger than Columbia or Penn; and the University of California has an AUM higher than Duke or Cornell.

In terms of endowment assets, our twelve Public Ivys range from about $18 billion for the University of Texas system down to $1.5 billion at University of Minnesota.

Twelve Public Ivy endowments ranked by assets under management:

N.B.: U of California figure includes separate campus endowments as well as UC Regents funds.

There are only about 45 U.S. endowments over $1.5 billion, so our 12 Private Ivys (in our last newsletter) and 12 Public Ivys comprise more than half of them, including the lions’ share of total assets.  Taken together, their performance should give us a pretty good picture of how the country’s big, professionally-managed endowments are doing as of Fiscal Year 2012, ending last June.

What have you done for us lately?  The Public Ivy Endowments in 2012:

We’ll look at longer-term performance further along, but first: who excelled (and who didn’t) in FY 2012.

The stock market did pretty well in this period, with the S&P 500 up 5.4 percent between July 2011 and June 2012.  Domestic bonds did even better, such that a plain-vanilla 60/40 stock/bond portfolio would have returned about 6.2 percent.  But the average large (over $1 billion) endowment earned 1.2 percent in 2012, per NACUBO.  As we shall see, a big allocation to alternative assets didn’t pay off for most of these investors in FY2012.

Twelve largest public university endowments

Investment return ranking – One year returns FY 2012:

The clear winner is University of Virginia, with a very good 5.1 percent return.  This is especially impressive when we note that five of our twelve state schools had negative returns, including the giant University of California system, with a dismal -1.10 percent.  After all, as the media keep telling us, we are now enjoying an economic recovery.

This should be gratifying for Lawrence E. Kochard who took over as head of the University of Virginia Investment Management Company (UVIMCO) in the middle of FY 2011, and reflects well on the UVIMCO board who hired him away from Georgetown University.  FY 2012 performance can properly be credited to Dr. Kochard but, as we shall see below, the UVIMCO team also did well under his predecessor, Christopher Brightman.

Harkening back to our original Private Ivy rankings for 2012, we also see that UV’s performance beat all but three of the privates.  UV topped Harvard, Yale and Princeton, and was surpassed only by MIT (8.0), Chicago (6.8), and Dartmouth (5.8).

The news is not so good for University of California.  With almost $11 billion on the line, their endowment (run by a patchwork of separate campus foundations, plus the central UC Regents Treasurer’s office) managed to lose millions of dollars in a year when the stock market did pretty well.  With the legislature already pinching state support for UC in recent years, this couldn’t have been welcome news in Sacramento.  More about UC further along.

Five-year Returns: The No-excuses Rankings:

Any given portfolio in any given year can take a bad (or good) bounce; ask anyone who runs one.

For our purposes, we think five-year investment return is the Goldilocks number.  Since we’re in the executive search business we want a number which can (usually) be attributed to identifiable individuals.  Most fund managers don’t have the longevity of Warren Buffett.  Our research suggests that average tenure among endowment chief investment officers and senior staff is, coincidentally, about five years.

Here are returns for our twelve Public Ivys over the eventful half-decade FY 2008 through FY 2012:

Twelve largest public university endowments

Investment return ranking: Five-year returns 2008-2012:

Again, team UVIMCO at University of Virginia leads, and by a good margin, with an annualized five-year return of 4.7 percent.  For comparison, the NACUBO number for all large endowments, public and private, was just 1.7 percent; and the weighted average among our twelve Public Ivys was 1.9 percent.

And look at that annualized CPI inflation over this period: 2.3 percent.  Deflate those nominal returns for inflation and there are only a few positive real returns.  This should be worrisome for any endowment investor who, above all, wants to preserve the purchasing power of the corpus.

UVIMCO’s return wasn’t just good for a public college; it was good, period.  Only a hair lower than Columbia University’s 4.9 percent, which led the Private Ivys.  Dr. Kochard’s team out-invested every other traditional Ivy endowment in the period, including much bigger funds at Harvard, Yale and Princeton.  Taking all 24 schools together, Virginia ranked 2^nd out of 24.  Not bad at all.  Thomas Jefferson would be pleased.

For most of this period Christopher Brightman was president and CIO of UVIMCO.  Although he left Charlottesville in 2010, most of that performance was under his aegis, so he and his team deserve recognition for their excellent performance.

In this half-decade, including the calamitous 2008/2009, equity investors faced severe headwinds.  Even including the “recovery” of 2010-2012, the S&P lost 2.5 percent.  On the other hand, the flight to safety and Fed intervention boosted domestic bonds, and the Barclay’s index was up 6.8 percent.  A passive investment in a traditional 60/40 blend would have given investors about a 1.2 percent return.  As we can see, half of the Public Ivys beat that modest benchmark, but half didn’t.  Two of them had essentially zero returns, and two posted small losses.

On a five-year basis, U of California is now in the middle, at 6^th place, but it still managed only a highly mediocre 0.9 percent return.

Someone has to finish last, and here it was Ohio State University, in 12^th place with a negative 1.0 percent five-year return.  However, on a 3-year basis, not shown here, they rise to 6^th place, the middle of the pack.

Notwithstanding our preference for a five-year measurement, we should note that there were some special circumstances in play in Columbus.

Until late 2006, OSU’s endowment was handled by long-time Treasurer James L. Nichols.  Mr. Nichols was pushed out after an audit found that he had misled trustees about the size and performance of the endowment and made some other mistakes (although no criminal acts were alleged).  A former state budget director was hired as interim investment manager and a long eighteen months elapsed as they did a national search for real CIO.  When Jonathan Hook was recruited from Baylor University in June, 2008 (where he’d had an outstanding record as that school’s first CIO).  He had to begin from scratch at OSU with a retro-looking portfolio and no staff, not to mention having to cope with the implosion of world financial markets just as he was setting up shop.

If we look at Mr. Hook’s 3-year return in FY 2010 – 2012, we see that he has recently done pretty well, with an annualized return of 10.5 percent.  But on the same three-year basis, University of Virginia still tops the league with a 14.6 return.

Sharpe ratios: The risk-adjusted rankings:

Arguably, this is best way to measure overall investment performance, even if it isn’t quite as intuitive as raw returns.  High returns are only desirable if they don’t involve excessive risk.

Re-ranking these endowments by Sharpe ratio (where higher is better), we get this:

Twelve largest public university endowments

Five year investment returns 2008-2012 ranked by Sharpe Ratio:

Virginia is still number one with a bullet.  This implies that they’re not ramping up risk to achieve their good earnings.

Interestingly, Texas jumps up three places in the rankings as we move from raw to risk-adjusted performance.  In fact, Mr. Zimmerman’s team achieved by far the lowest standard deviation of returns in this group.

Remember, too, that a negative SR means that an investor would have done better just closing up the office and putting her money into T-bills for five years.

Be warned, not every theoretician thinks that after-the-fact standard deviation of returns is a proper measure of risk, per the Sharpe ratio.  This statistic presumes that investment returns are normally distributed per the traditional Gaussian bell-shaped function.  Some critics, such as the redoubtable Nassan Nicholas Taleb think that real risk is something darker and deeper; it’s where the unknown unknowns and Black Swans lurk.

That’s all way above our pay-grade.  We still think the SR helps to understand how managers are balancing risk and return, which is the essence of their job.

Know your CIO:

If you’re a board member, recruiter, or just dying to know, here’s the good stuff.  Who runs the investment office, and how much are they paid?

Twelve largest public university endowments

Chief Investment Officers and their compensation:

N.B.: Compensation figures are for calendar 2010 unless otherwise noted.

(1)   Brightman left UVIMCO in March 2010. 2010 comp includes final separation payout.

(2)   Kochard joined UVIMCO Jan 2011. Calendar yr 2011 comp per FY2012 unreleased Form 990.

(3)  Zimmerman 2010 comp excludes $1.9 million deferred comp.

(4)   Lundberg comp for calendar 2012.

(5)   King’s 2010 comp excludes $139.3 K deferred comp.

(6)   Ferguson comp is for calendar 2011.

(7)   Krueger comp as of Dec, 2012

(8)   Branigan comp estimate for calendar 2012.

(9)   Ellison joined U of Illinois Fdn in Jan 2013. Comp is estimate for calendar 2013.

(10) Stratten comp excludes $35.3 K cumulative deferred comp and $25.5 K nontaxable benefits.

As executive recruiters, we tend to think that the ability to pay more will attract better talent.  And, we have a meritocratic bias; we like to think that superior performance should be rewarded with superior compensation.

There’s a lot to be said for both those positions but, of course, things don’t always work out that neatly.

The size of the job in terms of AUM is also an important factor.  As we’ve noted, University of California’s endowment performance has been unimpressive.  However, while Marie Berggren handles about $6 billion of the whole UC endowment, she’s also responsible for investing a whopping $70 billion in pension funds.  Her salary is commensurate with running that much money.

And, consider Amy Krueger Marsh. Ms. Marsh, the long-time Treasurer and CIO at University of Pittsburgh, has produced a good 5-year return of 2.5 percent, ranking 4^th among our twelve Public Ivys.  For this she’s paid only about $400 thousand.  That’s better 5-year performance than Mr. Zimmerman at UTIMCO (with his $1.3 million comp) or Ms. Mendillo at Harvard (with her $3.6 million).  And, CIO is just one of her hats.  She’s also responsible for the whole Treasurer’s office.  On a performance-for-pay basis she’s a star, and her board should be glad to have her.

What’s wrong with Cal? Part I

Three of the four largest public Ivys are getting pretty good investment returns on a 5-year basis: Virginia, Michigan, and Texas.

The exception is University of California, earning only 0.9 percent over five years.  We should carefully note that this return figure for UC is a composite, averaging together 1.5 percent for the $6.0 billion in the general endowment pool operated by the UC Regents Treasurer’s office in Oakland, with lower returns from the $4.3 billion in the separate campus foundations.  On this basis, UC has a $10.3 billion endowment, the 5^th largest in the country (after Harvard, Yale, Texas, and Princeton), but its investment performance is the lowest among these five mega-endowments:

Top 5 US University Endowments – AUM – 5-year returns

In our report on the Private Ivys we spent some time trying to figure out why mighty Harvard, with all its investment expertise, earned only an annualized 1.2 percent over five years.  So, now let’s see what’s up with UC.

There doesn’t seem to be any obvious reason why a public university can’t build a first-rate investment team.  University of Virginia and University of Texas have shown that it can be done.  But we think there are some institutional constraints which may make it harder for a public endowment to achieve consistently good returns.  There may also be some clues in the UC asset allocations, and we’ll take a look at those, too.

UV vs UC: Allocations and execution:

Endowments report their asset allocations and performance in idiosyncratic ways which make it hard for amateurs like us to make strict comparisons.  But if the UC Regents pool (GEP) earned 1.5 percent, while UVIMCO earned 4.7 percent in the same period, then it should be possible to make some surmises about what caused that gap, and whether they’re due to allocations or execution (excess returns versus benchmarks).

This chart involves some rather crude rounding, classifying, and interpolating, but we think it’s basically correct.

UVIMCO vs UC Regents Pool: Allocations and Execution:

(FY 2012 reported allocations)

As of 2012, UC had a 42 percent allocation to public equities (both U.S. and non-U.S.).  The corresponding number for UVIMCO was just 21 percent.  That’s a fairly striking difference right there.  UC’s allocation was markedly higher than the NACUBO average for all big endowments (27 percent), and UVIMCO’s was significantly lower.

About half of UC’s public equity was non-U.S., and they lost an annualized 5 percent on that portion.  Returns on domestic equity were -0.2 percent, so returns average out to -2.2 percent for all public equity over five years.

UVIMCO doesn’t break out U.S. vs. non-U.S. equity, but their overall 5-year return for public equity was positive: 2.7 percent.

The MSCI All Country World Equity 5-year return was -2.2 percent in this period.  If we take that as a benchmark, then UC hit it on the nose, whereas UVIMCO beat it handily, with an excess return of 4.9 percent.  (UC benchmarks its domestic equity against the Russell 3000, but it missed that, too; by 37 basis points).

Both portfolios are highly diversified and each had some hits and misses, but without getting into all the grittiness, we think that little chart above tells the story.  UVIMCO’s higher allocation to alternatives vs. equities helped somewhat in this period, but it was superior execution of their equity strategies that gave them a real edge.

The SAIMCO gambit:

One way that public school endowments can help level the investment playing field is by creating a semi-autonomous investment management company (SAIMCO?).  This idea began among the old Private Ivys, but was soon aped by their public sisters.  Among our twelve Public Ivys, Virginia, Texas and North Carolina have one each.  The University of California system now actually has two, as we’ll see in a moment.

A SAIMCO has at least two advantages:

First, it provides an additional layer of insulation between the endowment and its ultimate overseers, remembering that, among the publics, the powers-that-be are usually hip-deep in state politics, which can interfere with effective management.  Unfortunate examples abound in the world of public pensions, which face similar governance issues.

Second, an “independent” investment company can usually get away with paying the investment staff more generously when they are, technically, no longer state employees.  As recruiters, we are particularly aware of this problem.

As an added bonus, a SAIMCO makes it easier to dodge each Spring’s new crop of matriculants as they parade around the quad demanding immediate disinvestment in whatever.  The president and trustees can point to their SAIMCO and truthfully say that it’s out of their hands.

At University of Virginia’s UVIMCO, for instance, the president/CIO is normally paid about $1.3 to 1.5 million, including bonus (as of 2010).  And, as we’ve seen, Mr. Brightman — and now Dr. Kochard — have been earning their keep.  Their pay, however, is still not quite comparable to CIOs at the top Private Ivys such as Harvard, Yale, and Columbia. (See: http://www.charlesskorina.com/775/)

Bruce Zimmerman, head of UTIMCO at University of Texas also does well, receiving about $1.3 million in 2010.  Jon King, head of North Carolina’s UNC Management Company, made significantly less, about $711 thousand in 2010, but his endowment is much smaller than UTIMCO’s, and only half the size of Virginia’s.

UC vs the media: The private equity problem:

Another institutional constraint faced by UC is getting into top private equity funds without having to disclose more about them than the general partners would like.

It’s well known that the top-tier of private equity performs a lot better than the rest.  An endowment the size of UC Regents should be able to invest in those top firms; except when it can’t.  According to UC, some top-shelf firms like Sequoia and Kleiner Perkins have blacklisted them from future funds after a court ruling forced the Regents to release details about fund performance in 2003.  As of right now, the matter is still being litigated.

The UC Regents is an organ of the state government and various state laws require that they tell the world what they do with their money.  Harvard and its sisters are private corporations which don’t have to make such disclosures.

How about the private campus foundations and their SAIMCO satellites which run a big chunk of the total UC endowment?  A question for the lawyers, but we suspect not.

A big school in a broke state:

U.S. public universities have been in a financial bind for several years.  This may puzzle any readers who have had to stump up for constantly-rising tuition at one of these fine institutions, but it seems to be true.

In the gravy decade of 1999-2009, state financial support for colleges grew steadily, with spending across the country up almost 50 percent.  It was good times on the campuses, with schools expanding their plants and, especially, their administrative headcount and compensation.

But, after the crunch of 2008/2009, the trend reversed.  Total state spending is now down almost 11 percent in the five years 2008 – 2013.

California, with by far the biggest higher-ed budget, has taken the biggest hit, with annual spending down 24 percent over five years: from $11.6 billion to $8.8 billion.

(All figures per Center for the Study of Education Policy at Illinois State University http://grapevine.illinoisstate.edu/index.shtml).

None of this is supposed to be a direct concern for endowment managers, in California or elsewhere, but it would be naïve to think that it doesn’t affect the context in which they operate.

When campus personnel are being cut and tuition is escalating, it becomes politically more difficult to staff up the investment office and pay the going rate for top talent.  If they aren’t segregated in a separate foundation or investment company (and many aren’t), they become just one more office competing for a shrinking budget.  The fact that they make money, instead of just spending it, should cut some ice, but usually doesn’t.

Historically, public schools have had smaller endowments than private colleges and haven’t relied on them as heavily to fund their annual expenses.  But that may be changing.  In a country full of tapped-out states, Public Ivy leaders may have to learn to rely much more on private donations if they expect to keep their excellent jobs and perks.

Let’s take California, which happens to be both big and broke (1). Its world-class University of California system is Exhibit A for this trend.

(1) That’s not rhetoric.  The California State Auditor has just issued her report for FY2012, which says liabilities exceed assets by $127 billion.  The technical accounting term for that is: “broke.”  That doesn’t include hundreds of millions in unfunded liabilities for pensions and retiree health care.  People running a private business would be imprisoned for such omissions and, indeed, the Governmental Accounting Standards Board and Moody’s have been pushing states to include such items in their balance sheets.  The legislature, understandably, doesn’t agree, and the State  Auditor can only follow the rules she’s given.
See: http://www.sanluisobispo.com/2013/03/28/2448374/capitol-alert-state-auditor-californias.html#storylink=cpyc

The future of UC: From public funding to Dr. Blinder’s database:

The annual NACUBO-Commonfund endowment report says that “University of California” has an endowment of almost $6 billion as of June, 26012.  This is technically correct, but slightly misleading.  The UC Regents (the system’s governing body) invests that $6 billion through its Treasurer’s office in Oakland.  But the total system endowment is much more: about $10.3 billion.  The other $4.3 billion is invested by separate campus foundations.

Most of the $6 billion controlled by the UC Regents is legally earmarked for spending on some specific campus and could therefore be counted as part of that campus endowment.  The $4.3 billion controlled by the separate campus foundations can be invested as their respective boards prefer.  They can use external managers, or even choose to invest some of it internally, using their own staff.

And now, the two biggest campus foundations, UC Berkeley Foundation ($1.1 billion) and UCLA Foundation ($1.3 billion), have recently set up their own investment companies, each with a chief investment officer and professional staff.

So, that 0.9 percent 5-year return we calculated for the UC system is actually generated by a blend of investment managers.  In fact, the Regents General Endowment Pool (GEP) returned 1.5 percent over five years.  Not great, but only a little short of the NACUBO 5-year average of 1.7 percent for all large endowments, and better than Harvard in the same period.

What pulled the system average down was investment performance at the campus foundations, primarily at the two big ones: Berkeley and UCLA.  They handle about $2.4 billion, with the rest of the system’s endowment money scattered among eight smaller campus foundations.

Up in Oakland, Marie Berggren, whose official title is Acting Treasurer and Chief Investment Officer of the Regents, runs an investment staff responsible for about $6 billion of endowment funds.

In Berkeley, John-Austin Saviano, a former consultant with Cambridge Associates, is president and CIO of the Berkeley Endowment Management Company (BEMCO), investing about $1.1 billion.  BEMCO was set up by the UC Berkeley Foundation in 2009.  As of 2010, his total comp is $430,390 including a $134,000 bonus.

Down in Los Angeles, Srinivas “Srini” Pulavarti, formerly CIO at University of Richmond’s Spider Management Company, is president and CIO of UCLA Investment Company, launched in 2012, and managing about $1.3 billion.  Srini, one of the country’s outstanding endowment investors, was recruited by UCLA just last year and is their first “real” CIO.  We think that Mr. Pulavarti’s total compensation package, based on his prior earnings, is at least $900 thousand.

A lot of money was mobilized to launch these operations.  In Berkeley, the William and Flora Hewlett Foundation donated $3 million to set up BEMCO.  In L.A., the UCLA Foundation has committed $1 million per year to support their new management company for the first four years.

Part of the logic here applies to any endowment as the fund gets big enough to justify full-time, professional management.  The hope is always that these pros can reduce fees previously paid to external managers, while also improving returns.  In theory, they can pay for themselves and make the office self-supporting within a few years.

We think there’s also a bigger picture.  As state money shrinks, each campus increasingly has to swim for itself.  There’s a limit to how high tuition can be hiked, and there’s only one remaining source of funds: private donations.  But the big, sophisticated investors they’re targeting want to see proof that their money can be efficiently invested.

Having a qualified CIO on hand, with a real track record, can be a major sales tool for the development officers.  After all, if the average Silicon Valley mogul thinks he can invest the money better himself, then why would he not do so, and then gift it out of his estate thirty or forty years from now?  Obviously, the schools would rather have the money today, and the income it generates.

It’s too early to see how these new CIOs are working out.  BEMCO has only really been up and running for two years, and UCLAIC has just launched.  But UC’s own reports make it possible to see what investment returns are campus by campus in recent years.

The UCLA Foundation earned only 0.3 percent over five years on its self-managed portfolio.  If we count the UCLA-earmarked funds managed by the Regents, we could say that the UCLA endowment earned 1.1 percent overall.  The money they’re plowing into their new investment office is certainly intended to get something more impressive than a 0.3 percent return over the next five years.

Berkeley, the other big campus, did only slightly better, with a 5-year return of 0.8 percent on the $1.1 billion they run through BEMCO.  Averaged together with Berkeley-earmarked money in the Regents pool, they’ve made about 1.3 percent on their endowment overall.  Again, the BEMCO board, looking forward, would like to see better numbers in the years ahead.

In theory, UC is one big happy family, and no one should care whether a donor writes a check to the UC Regents or to a separate campus foundation.  In practice, every campus would prefer to have the closest possible relationship to its benefactors and their money.

David Blinder, Berkeley’s top development exec, told a reporter last year:

“It is our belief that the donors…feel a higher level of confidence knowing that it is the campus controlling the investment.  Right now, in our conversations with donors, we recommend in the strongest way that endowment gifts and checks and stocks go to the Berkeley Foundation.  It gives us that direct link.”

Mr. Blinder was formerly the top fund-raiser at tony Wellesley College in Massachusetts, where he ran a record-breaking development campaign.

In 2011, after four years on the job at Berkeley, Mr. Blinder was handed an out-of-schedule $40 thousand salary boost, from $240 K to $280 K, because he was being aggressively courted by other employers, including Berkeley’s sister UC campus at Irvine.  Although he was also a VP of the Foundation, he was paid as an Associate Vice Chancellor of the University, constrained by the campus pay-scales.

They noted that: “As UC Berkeley comes to rely more on private support, professional development leaders like Mr. Blinder are critical to the campus ability to maximize their philanthropy.”  In plain terms, he’s very good at pulling in the money which the state no longer provides.

Unfortunately, their retention efforts fell short.  Dr. Blinder was just stolen away by the Scripps Institute, where he started as their senior VP for External Affairs on March 1.  We suspect he got a very handsome offer well over the $280 K that Berkeley could afford.

But Dr. Blinder left behind his giant database.  There are a million names in it, and if you’re Berkeley grad, they will find you.

Our focus on the UC situation is not intended to demean anyone over there.  I know several of the UC Regents managers, who labor just across the bay from me, and I can attest that they’re very good at their jobs.  Our question is whether the institutional framework can make optimal use of their talent.

But, UC’s size makes it conspicuous, and we think their situation is, to a considerable extent, similar to other public universities across the country.  They’re competing with other potent interest groups, including the public unions and K-12 schools, for slow-growing, debt-strapped state budgets.  We think they are inevitably going to have to rely more heavily on private financial support.  Spinning off SAIMCOs, as Virginia and Texas did years ago, and UC is doing now, may help.

However they go about it, our big public colleges are going to have to get more serious than ever about building and maintaining top-flight, professionally-staffed investment organizations.

Mr. Martin was previously the Head of Opportunistic Investments and Real Assets at the New Jersey Division of Investments, which runs the assets of Jersey’s public pensions.

The Hamann family office, operating as Spectrum Financial Services, Inc., is headed by Daniel A. Hamann.

Spectrum’s substantial and diversified portfolio resembles a professionally-managed, mid-sized college endowment, including significant allocations to alternatives.

Mr. Hamann, with an extensive background in the financial services industry and an MBA from Wharton, is fully qualified to run the family money, but he also has a day job as CEO of a large insurance company.  He decided it was time to beef up the family office with another professional.  He needed an investment veteran experienced in all asset classes, but especially alternatives and private market assets.  Mr. Martin is all of that, plus he has family ties to Omaha.

Mr. Martin is a young man with a thick resume.  He earned a BS and MBA from the Kelley School of Business at Indiana University, class of 2004.

In the late 90s he worked with private equity firms in northern California before returning to Indiana for his MBA.  From 2006 to 2010 he worked for both of Indiana’s public pension plans: Indiana PERF and Indiana STRS.  By 2010 he held the rank of Director of Investments at STRS, the state teacher’s pension, running an $8 billion portfolio including hedge funds, real estate, real assets, and internally-managed public equities.

In 2010 Mr. Martin’s boss at STRS, chief investment officer Tim Walsh, was recruited to be the new CIO for New Jersey’s Division of Investments, which invests $68 billion for seven state pensions.  A year later, Mr. Walsh reached back to Indianapolis and whisked Mr. Martin away to New Jersey.

At his new post in Trenton, Mr. Martin made some big moves.  He was behind the creation of new strategic relationships with major private equity and real estate firms including Blackstone, TPG, and Och-Ziff.  New Jersey was among the first big institutional investors to broker this kind of deal.

Deryl F. Hamann, father of Daniel Hamann, was a lawyer who acquired a very small bank in southern Iowa back in 1971.  The little bank expanded to a 70-branch regional powerhouse, Great Western Bancorp, with Deryl Hamann as chairman and his son Daniel as president.  In 2008, the family sold Great Western to National Australia Bank for a reported $798 million.

The elder Hamann was born in rural Iowa in 1932.  He was the son of a tenant farmer, growing up in a farmhouse without electricity or indoor plumbing and attending a one-room country school.  But he went on to study law at the University of Nebraska and has been recognized for decades as one of the country’s outstanding corporate attorneys.

The Hamann family today is a force in their hometown of Omaha, participating in that city’s revival through many civic, charitable, and professional organizations.

With Bryan Martin aboard, Mr. Hamann has one more reason to be confident that their resources will be secure to serve their descendants and community far into the future.

A post-season look at performance, pay, and pitfalls: the Ivys and Alt-Ivys

Omaha family office adds new CIO: Bryan Martin joins Spectrum Financial Services, Inc.

Skorina seeks a business-development pro for a growing outsourcer

From Academe: Yale Discovers The Ivy Allocation Arms Race

Skorina announces hire of Bryan Martin by the Hamann family office: I am very pleased to announce that Skorina & Co has assisted in the hire of Bryan Martin by the Hamann family office in Omaha, Nebraska.  Mr. Martin became their new Director of Investments on November 26, 2012. Mr. Martin was previously the Head of Opportunistic Investments and Real Assets at the New Jersey Division of Investments, which runs the assets of Jersey’s public pensions. The Hamann family office, operating as Spectrum Financial Services, Inc., is headed by Daniel A. Hamann. Spectrum’s substantial and diversified portfolio resembles a professionally-managed, mid-sized college endowment, including significant allocations to alternatives. Mr. Hamann, with an extensive background in the financial services industry and an MBA from Wharton, is fully qualified to run the family money, but he also has a day job as CEO of a large insurance company.  He decided it was time to beef up the family office with another professional.  He needed an investment veteran experienced in all asset classes, but especially alternatives and private market assets.  Mr. Martin is all of that, plus he has family ties to Omaha. Mr. Martin is a young man with a thick resume.  He earned a BS and MBA from the Kelley School of Business at Indiana University, class of 2004. In the late 90s he worked with private equity firms in northern California before returning to Indiana for his MBA.  From 2006 to 2010 he worked for both of Indiana’s public pension plans: Indiana PERF and Indiana STRS.  By 2010 he held the rank of Director of Investments at STRS, the state teacher’s pension, running an $8 billion portfolio including hedge funds, real estate, real assets, and internally-managed public equities. In 2010 Mr. Martin’s boss at STRS, chief investment officer Tim Walsh, was recruited to be the new CIO for New Jersey’s Division of Investments, which invests $68 billion for seven state pensions.  A year later, Mr. Walsh reached back to Indianapolis and whisked Mr. Martin away to New Jersey. At his new post in Trenton, Mr. Martin made some big moves.  He was behind the creation of new strategic relationships with major private equity and real estate firms including Blackstone, TPG, and Och-Ziff.  New Jersey was among the first big institutional investors to broker this kind of deal. Deryl F. Hamann, father of Daniel Hamann, was a lawyer who acquired a very small bank in southern Iowa back in 1971.  The little bank expanded to a 70-branch regional powerhouse, Great Western Bancorp, with Deryl Hamann as chairman and his son Daniel as president.  In 2008, the family sold Great Western to National Australia Bank for a reported $798 million. The elder Hamann was born in rural Iowa in 1932.  He was the son of a tenant farmer, growing up in a farmhouse without electricity or indoor plumbing and attending a one-room country school.  But he went on to study law at the University of Nebraska and has been recognized for decades as one of the country’s outstanding corporate attorneys. The Hamann family today is a force in their hometown of Omaha, participating in that city’s revival through many civic, charitable, and professional organizations. With Bryan Martin aboard, Mr. Hamann has one more reason to be confident that their resources will be secure to serve their descendants and community far into the future.

Skorina’s seeking a business-development pro for a growing outsourcer: My client is a West Coast-based firm providing asset allocation, manager research and risk-management services to corporate defined-benefit clients.  They act as an outsourced CIO for nearly $10 billion in assets, and are looking to add more clients over the next few years. That’s where you come in.  They need a head of business development to build and maintain strong relationships with big-company CFOs and treasurers.  You will be involved in all aspects of their marketing effort. You will need an educational and professional background which makes you conversant with all aspects of the institutional investment process, including a solid understanding of the corporate pension world. Specifically, we’re looking for at least ten years’ experience in a client-facing, business development role, perhaps as a consultant to institutional investors or with another CIO-outsourcer. Travel will be involved, but re-location may not be necessary.  If you want to join my client at their West Coast location, they’d be glad to have you.  But, if you prefer to operate from another city, that would work, too. If you’re interested, please respond by email to skorina@charlesskorina.com. Please put “business development search” in the subject line so that it gets my attention.  Or just call me, and we’ll talk about it.

The Ivys and Alt-Ivys: A post-season look at performance, pay, and pitfalls: The Ivy League, strictly speaking, is just eight venerable colleges who play football against each other, mostly not very well. But we’re only interested in the Ivys as investors, a game at which they’re world-class players.  More specifically, we’re interested in the people who run the investment process. We look at investment performance through the prism of executive search.  How does the fund’s performance reflect the skills of the chief investment officer and his/her team?  Has the institution hired the right people, and are they doing the right things? Now, with laggard Cornell finally reporting early in November, we can offer a summary and analysis of how all the endowments performed in fiscal year 2012, ending June 30.  For our purposes, a five-year performance window is about right to judge investors, so we’ll also consider their performance over the five years 2008-2012. As we crunched the numbers it occurred to us that we could and should broaden out the field to include some of the other top private-school endowments.  We added four which seemed to us to be roughly equivalent to the official Ivys in terms of prestige, academic standing, and endowment size.  They are: Stanford, University of Chicago, MIT, and Duke.  We hereby dub these four the Alt-Ivys. So, taken together, we now have an even dozen. (Northwestern would have made the cut, but they inconveniently have a later fiscal year, and their results won’t be known until January.) We haven’t forgotten about the public universities.  We’ll have a rundown of their FY2012 performance in our next letter. It would be tedious to poke into the workings of all twelve of these endowments.  In any case, some of them reveal very little about what they’re up to.  But we’ll stop to look at certain points of interest visible to the public. The most obvious and unavoidable question is: what’s happening at mighty Harvard, whose recent performance draws attention in a not-good way? We have, of course, no onus against the excellent people at Harvard Management Company.  Like them, we are committed only to veritas. To infinity, and beyond! Theoreticians may say that an endowment has an infinite investment horizon.  The schools certainly like to emphasize their 10- or 20-year returns (especially if recent performance is disappointing!). That’s all very well, but whom do we hold responsible for 20-year performance?  As Peter Drucker (or was it Spider-man?) used to say: with power comes responsibility. Those who had their hand on the tiller back during the Clinton administration are mostly retired.  But recent performance can generally be attributed to current incumbents.  So, we’ll consider how these CIOs have been doing their jobs.  And, of course, we’ll consider how they are compensated for their performance. On to the stats! Fiscal 2012: the winners and …non-winners: First: the twelve endowments ranked by performance in FY2012, with some benchmarks for reference: FY12 Rtn Rank AUM $ Bil Endowment FY12 Rtn % vs. 60/40 vs. NACUBO 1 9.7 M.I.T. 8.00 1.76 6.80 2 6.6 Chicago 6.80 0.56 5.60 3 3.4 Dartmouth 5.80 -0.44 4.60 4 19.4 Yale 4.70 -1.54 3.50 5 17.1 Princeton 3.10 -3.14 1.90 6 7.8 Columbia 2.30 -3.94 1.10 7 6.6 Penn 1.60 -4.64 0.40 8 5.7 Duke 1.00 -5.24 -0.20 9 16.5 Stanford 1.00 -5.24 -0.20 10 2.5 Brown 1.00 -5.24 -0.20 11 5.1 Cornell 0.14 -6.10 -1.06 12 31.7 Harvard -0.05 -6.29 -1.25 NA NA NACUBO >$1 Bil 1.20 -5.04 0.00 NA NA S&P 500 5.40 -0.84 4.20 NA NA Barclay’s Agg Bnd 7.50 1.26 6.30 NA NA 60/40 6.24 0.00 5.04 It’s just two miles from Harvard to MIT, but measured in investment return, a wide 8.05 percent gap separated first-place MIT from last-place Harvard in 2012. The rivalry between the two schools may be asymmetrical (Harvard affects not to notice it), but MIT’s recent performance should gratify any Beavers in our readership. This win may not quite eclipse that memorable day when aspiring MIT engineers allegedly used thermite to weld shut the gates of Harvard Yard, but an 8.0 percent return is still pretty good.  So, we offer our congratulations to our friend Seth Alexander and his MIT investment crew. We’re also pleased to see my own University of Chicago make a good second-place showing for the year with a 6.8 percent return.  So, congratulations also to Mark Schmid and the Chicago investment office. Does this mean they won’t be asking me for money this year?  Probably not. Big endowments had generally weak returns in 2012. According to preliminary numbers from NACUBO-Commonfund, endowments over $1 billion earned an average of 1.2 percent for the fiscal year ending June.  By comparison, a passive investment in a plain-vanilla domestic 60/40 portfolio, by our calculations, would have earned investors about 6.2 percent in FY2012.  But only MIT and Chicago in our group beat the 60/40 portfolio. Since both domestic stocks and bonds did pretty well, we presume that those low returns must be laid at the door of international and alternative allocations, which have become prominent in all the big endowments. According to NACUBO-Commonfund, the average large endowment currently allocates a whopping 59 percent to alternatives, and only 10 percent to domestic equities.  So a 5.4 percent rise in the U.S. stock market obviously didn’t help them much. Now, what if we take a longer (and much fairer) 5-year perspective?  Presumably those overseas and alternative investments paid off better over this longer stretch. The Half-decade numbers: Alternatives strike back 5-yr Rtn Rank Endowment 5-yr Rtn % vs. 60/40 vs. NACUBO 1 Columbia 4.86 3.67 3.11 2 Chicago 4.17 2.98 2.42 3 M.I.T. 3.72 2.53 1.97 4 Princeton 3.04 1.85 1.29 5 Duke 2.73 1.00 0.98 6 Dartmouth 2.19 1.00 0.44 7 Stanford 2.16 0.97 0.41 8 Penn 1.84 0.65 0.09 9 Yale 1.83 0.64 0.08 10 Brown 1.45 0.26 -0.30 11 Harvard 1.24 0.05 -0.51 12 Cornell 0.54 -0.65 -1.21 NA NACUBO >$1 Bil 1.75 0.56 0.00 NA S&P 500 -2.54 -3.73 -4.29 NA Barclay’s Agg Bnd 6.78 5.59 5.03 NA 60/40 1.19 0.00 -0.56 Here, we see that, indeed, the alternatives seem to be earning their keep.  In this period the S&P lost 2.5 percent and the 60/40 earned just 1.2 percent. For 2008-2012, ten of the twelve beat the 60/40 benchmark.  Harvard tied it, and Cornell missed it by 65 basis points. Despite an off-year in 2012, when it returned “only” 2.3 percent (which is still slightly above median for this group), Columbia had built up such a head of investment steam in 2008-2011, that it still ranked first on a 5-year annualized basis.  Its 4.9 percent return crushed the 60/40 by 367 basis points. But look, there are Chicago and MIT again in second and third place, with 4.2 and 3.7 percent respectively, suggesting that their performance has been consistently good over this half-decade. Harvard’s 5-year annualized return as of June, 2011 had risen to 5.5 percent (up from 4.7 percent as of June, 2010).  But now, with a disappointing 2012 on the books, they’re back down to just 1.2 percent.  So, it appears that their poor 5-year standing is due primarily to a bad 2012, when they were the only school in the pack who posted a negative return (albeit just barely). So, Harvard, alas, now rides near the bottom on a 5-year basis, saved from an ignominious last-place finish only by Cornell’s 0.5 percent return. Next, let’s name some names and consider the role of the CIOs. Naming the names: Eight of the twelve schools have had the same CIO (or president of their investment company) for all five years.  In two cases – Chicago and Harvard – the incumbent has been there for at least three of the five fiscal years: Mark Schmid arrived at Chicago (from the Boeing pension) in August, 2009, and Jane Mendillo came to Harvard Management Company (from Wellesley College) in July, 2008.  Also, recall that Ms. Mendillo had a previous five-year stint at HMC as a senior staffer under then-CIO Jack Meyer. So, we’re going to put these two on the hook for their respective funds’ recent performance.  Mr. Schmid should be pleased by that; Ms. Mendillo perhaps not so much. In two cases – Cornell and Dartmouth – the CIO as of June, 2012 was a newcomer: A. J. Edwards at Cornell, and Pamela Peedin at Dartmouth.  It would be unfair to saddle them with their funds’ five-year performance, and we won’t. Dartmouth sits right in the middle of the pack with a 2.2 percent five-year return, essentially tied with Stanford and Duke.  Even though they had no designated CIO for a year and half between the departure of David Russ in June, 2009 and the arrival of Ms. Peedin (from Boston University) in February, 2010; they seem to have performed quite well. The too-many-CIOs theory: In the case of Cornell, it’s hard to resist attributing some of their less-than-great performance to their having had three CIOs in the period.  That includes the strange appearance and disappearance in Ithaca of Michael Abbot, who lasted just six months.  I’m not privy to all that went on there (although I’ve got a pretty good idea); but, to someone like me who’s been involved in a lot a hiring decisions, the selection of Mr. Abbot had all the earmarks of a classically-bad hire. Having no background as an endowment CIO certainly should not have been a deal-breaker in hiring Mr. Abbott; some outstanding endowment investors have come from other places.  But that fact should have spurred the board to ensure that there was a meeting of the minds on just what his duties would be.  In this case there clearly was not. Allocation vs. execution: There’s at least one datum supporting the too-many-CIOs theory for Cornell’s poor performance.  On the quarterly endowment report for June, 2012, we see that their policy portfolio (which they call the Strategic Investment Policy) earned an annualized 2.2 percent for five years.  But their actual return, of course, was just 0.5 percent. It’s conventional wisdom in portfolio management that a lot of good (or bad) performance is the result of asset allocation.  Cornell’s planned allocation should have given them returns right at the median among this group of twelve.  They came in last because they missed their own policy benchmark by 170 basis points.  The allocation performed pretty well.  The execution fell short. The CIO generally has significant input into the allocation plan, although this varies from school to school. But tracking that policy portfolio, by timely rebalancing and good manager selection/monitoring, is the core of a CIO’s duties. The recent promotion from within of Mr. Edwards from interim to full-bore CIO looks promising for Cornell.  He is, by all accounts, both able and well-respected by his colleagues.  We shall see. Now, let’s ask the allocation-vs.-execution question about Harvard.  Their policy portfolio return for 2008-2012 was about 0.80 percent.  But their actual five-year return was about 1.2 percent.  So, their execution and/or manager selection was fine; good enough to beat their own model by about forty basis points. If Harvard’s five-year return was anemic, it seems to be attributable mainly to their allocation rather than their execution.  It’s the inverse of Cornell. Of course, Ms. Mendillo also sits ex-officio on the 13-member HMC board, and has a strong voice in overall strategy and allocation.  There’s every reason to think that she was in basic agreement with the policy portfolio. Harvard’s 1.2 percent five-year return was less than the 1.4 percent average for all large U.S. endowments (per NACUBO-Commonfund for schools over $1 billion).  And it was only about the same as our passive 60/40 portfolio.  Historically, they have done far better than those modest benchmarks.  That’s why the ladies and gentlemen at HMC have traditionally justified richer compensation than most of their peers. Those treacherous foreigners: So where, exactly, did Harvard fall down versus its peers in 2012? The low granularity of data about private endowment allocations and returns makes it hard to pinpoint.  And Harvard is more transparent than most. But, our best guess is that it was those treacherous foreigners. Harvard earned 3.2 percent this year on its large and growing real assets investments (about which, more below).  They also made 2.5 percent on private equity, 7.9 percent on fixed income, and even eked out 0.8 percent on absolute return.  So what went wrong? Public equities was the only major segment which lost money for HMC in 2012.  The 6.7 loss still beat the benchmark return, which was minus 9.1 percent, but it looks like the driver which pushed the overall return into the red. We already noted that the S&P returned positive 5.4 percent in the period, and Harvard’s U.S. stocks handily beat that, with a positive 9.7 percent return, mostly delivered (we presume) by their internal platform people. The problem was the two-thirds of their public equity which was devoted to foreign and emerging markets.  Those overseas stocks totaled 24 percent of the entire endowment, and they tanked badly in fiscal 2012.  Harvard lost 10.8 percent on foreign equity and 17.4 percent in emerging markets.  The emerging markets loss was even a 150 basis points miss against HMC’s own benchmark. This stung Harvard disproportionately because that 24 percent exposure to foreign and emerging equities is significantly higher than the average among large endowments.  Per NACUBO, the average allocation to “international” equities among big endowments was just 16 percent in FY2011, the latest available. MIT, for instance, at the top of our rankings for the year, was only about $1.6 billion long in foreign equities as of June. (That includes a $76 million short position, which couldn’t have hurt in that market.)  So they had about a 12.5 percent exposure to those treacherous foreigners vs. 24 percent for Harvard.  Big difference. Columbia had a total exposure of about 20 percent to “global equities” – much smaller than Harvard’s 36 percent.  The always-discreet Columbians don’t break out foreign vs. domestic, but it seems unlikely that they had more than 10 or 15 percent in the overseas bucket. And, at Chicago, Mark Schmid’s team had about 15.8 percent in equities (labeled as “primarily international”), again significantly below Harvard. Over the past five years, among this pack of twelve, Harvard has finished first, last, eighth, sixth, and now last again.  But, Harvard’s long-term performance is still good. If 2012 was, indeed, just a bad bounce, it’s quite likely that they will rise in both the 1-year and five-year rankings in 2013. Pay vs. performance: As executive searchers we also have a vulgar and insatiable curiosity about peoples’ salaries.  The latest compensation data for these CIOs, based on IRS filings, is for the calendar year ending December, 2010.  Not quite up to date, but it’s the best available. Note that we have broken out the bonuses from other components.  Incentive pay for these CIOs is typically about half of their total comp, although this varies from school to school.  And, of course, it’s the piece we would expect to have some relationship to performance. We can infer that the bonuses are (probably) based on performance in the period 2008 to 2010, although the specific formulas are confidential. Although the pay does not exactly align with the five-year period 2008-2012, it should still give us a rough idea of who makes more and who makes less. Here’s a chart including all the players and their 2010 comps.  The two blameless rookies are in bold red. CIO/ Pres Total Comp Rank Endowment 5-yr Rtn % CIO or Pres > 3 Yrs ? Base Bonus Total Comp 1 Columbia 4.86 Narvekar YES $812,109 $1,530,269 $4,383,931 2 Harvard 1.24 Mendillo YES $1,012,261 $2,500,000 $3,560,458 3 Yale 1.83 Swensen YES $764,188 $2,028,752 $3,456,305 4 Chicago 4.17 Schmid YES $502,497 $1,382,118 $2,490,271 5 Duke 2.73 Triplett YES $427,591 $1,224,346 $2,305,562 6 Stanford 2.16 Powers YES $761,959 $397,303 $2,109,426 7 Princeton 3.04 Golden YES $689,200 $850,198 $1,985,391 8 Penn 1.84 Gilbertson YES $566,025 $755,598 $1,467,295 9 MIT 3.72 Alexander YES $522,426 $709,001 $1,316,463 10 Brown 1.45 Frost YES $465,723 $346,086 $1,098,265 NA Dartmouth 2.19 Peedin NO NA NA NA NA Cornell 0.54 Edwards NO NA NA NA We can see that the manager with the highest return in this 5-year window – Nirmal Narvekar at Columbia – also had the highest total comp in 2010, and that seems appropriate.  As we’ve noted before, Mr. Narvekar and his team have been producing outstanding results for their school for quite a while. But the second-highest total CIO comp in 2010 went to Ms. Mendillo, whose returns, as discussed above, have been lackluster relative to her peer group in 2008-2012. We should also pause to note that Ms. Mendillo is not the highest-paid employee at HMC; not even close.  And this is unusual.  It’s the only case we know of where subordinate officers pulled down more than the CIO or president of the investment company. Andrew G. Wiltshire, billed as Managing Director and Head of Alternative Assets, pulled down $5.6 million in 2010, versus Ms. Mendillo’s $3.6 million.  Almost all of his comp — $4.99 million — was incentive pay. As far as we know, Mr. Wiltshire is currently the best-paid endowment employee in the country, and probably in the world. Stephen Blyth, HMC’s Managing Director for Public Markets, made $4.5 million, of which $2.2 million was a bonus. Of course, these numbers are paltry compared to some HMC paychecks of yesteryear.  Back in 2003, two of Harvard’s star bond traders each made over $30 million.  But they departed in 2005, along with CIO Jack Meyer and many others.  They made a ton of money for Harvard, but their bonuses were so conspicuous that Harvard caved to political pressure and capped salaries. Mr. Wiltshire and Mr. Blyth are also sometimes referred to as heads of External Platform and Internal Platform, respectively; roles they were assigned in an organizational revamp announced in 2010.  So, all HMC investment managers are now direct reports to either Mr. Inside or Mr. Outside, who in turn report to Ms. Mendillo. Looking at all twelve schools, we see no obvious alignment between 2010 bonuses and 2008-2012 returns, whether we consider them as absolute dollar amounts, or look at them as a percentage of base salary. Neal Triplett at Duke, for instance, got incentive pay of $1.2 million in 2010.  That’s 286 percent of his base, the highest percentage among this group.  But Duke’s return of 2.2 percent was just about at the median among the twelve endowments.  It’s a respectable number, but still behind Columbia, Chicago, MIT, and Princeton. We can’t coax out any consistent correspondence between pay and performance for this group, in this period.  Other factors, such as the size of the endowment, the longevity of the CIO, and just how effectively he or she negotiated their original contract are undoubtedly in the mix. Sharpening the analysis: Another cut on this little dataset might give us a better picture: we can calculate the standard deviations of returns in 2008-2012, then generate Sharpe numbers. Ex-post standard deviations are conventionally treated as a measure of portfolio risk.  If any of these managers produced exceptionally high returns relative to risk, then they should jump to the top in a ranking by Sharpe number. Here goes: Sharpe Rank 5-yr Rtn Rank Endowment CIO/Pres > 3 Yrs ? Std Dev Sharpe Ratio 1 1 Columbia Narvekar YES 15.45 0.25 2 3 M.I.T. Alexander YES 13.80 0.20 3 2 Chicago Schmid YES 16.10 0.20 4 4 Princeton Golden YES 17.61 0.12 5 5 Duke Triplett Yes 18.46 0.10 6 6 Dartmough Peedin NO 15.27 0.08 7 7 Stanford Powers YES 18.26 0.07 8 8 Penn Gilbertson YES 14.17 0.06 9 9 Yale Swensen YES 18.31 0.05 10 10 Brown Frost YES 16.03 0.04 11 11 Harvard Mendillo YES 18.46 0.02 12 12 Cornell Edwards NO 17.47 -0.02 After all that crunching, we see that the rankings aren’t very different. Mr. Narvekar at Columbia produced the highest absolute 5-year return: about 4.9 percent.  And he did it with the third-lowest volatility among his peers: just 15.4 percent standard deviation.  That gave him a nice Sharpe number, but he was already ranked number one and couldn’t go any higher. MIT and Chicago are, again, close behind.  And we note that MIT had the lowest volatility in the group. And the re-ranking doesn’t benefit Harvard, either.  They had the 11th-highest absolute return and the 10th-highest volatility.  On a risk-adjusted basis they’re still sitting in 11th place among the twelve. These aren’t self-reported numbers, by the way, except for annual returns.  We did our own calculations from publicly-available data.  The endowments have access to more precise internal data, but we think our numbers are at least approximately correct.  No doubt we’ll hear about it if we’re wrong. What we can say is that endowments with Sharpe numbers very close to  zero — Brown, Harvard, and Cornell — would, by definition, have gotten just about the same returns with T-bills in this five-year period, on a risk-adjusted basis. Brand management, and a voyage to Brasilia: It’s clear that Harvard had a small public-relations problem this fall.  HMC management must have known by late summer that they were going to report a weak number. Harvard is a brand and a brand has to be managed.  Any PR pro will tell you that it’s imperative to get ahead of bad news, and Harvard did so. Ms. Mendillo made herself available to Bloomberg reporters for a rare, in-depth interview published September 18, in which she talked up their investment program in real assets, especially in timberland, and the reporters suggested that it would be the key to improving Harvard’s performance ranking. Bloomberg’s take was that Ms. Mendillo was going to return Harvard to the top of the performance charts by capping private equity and other U.S. alternatives while buying timberland in places like Brazil, New Zealand, and Romania.  Timberland was already 10 percent of her portfolio, and she was shopping for more.  They even noted that she had personally flown all the way into the Brazilian interior to inspect some of her holdings. Years ago, in her previous run at Harvard under Jack Meyer, she had spearheaded a successful move into U.S. timberland investments, which paid off handsomely.  So we know it’s a strategy she already liked. The natural resources bucket at Harvard (which appears to be mostly timber) has earned about 10 percent annually over the past ten years, slightly better than the 9.5 percent 10-year number for the whole endowment. There’s a good story to tell about timberland as a long-term investment, and Ms. Mendillo tells it convincingly. It takes a long time to produce incremental increases in timber production, while global demand looks to increase dramatically, and she claims that there are still pricing inefficiencies in the market. Most importantly, she thinks she has world-class in-house talent who can find the good deals. Remember Mr. Wiltshire, referenced above as HMC’s highest-paid employee?  While he superintends all the alternatives, his real specialty is timber.  He has a degree in Forestry from Canterbury University in New Zealand, and worked for a while in the N.Z. Forestry Service before taking several top jobs in real-asset management.  And, he has still more arboreal experts working for him in his shop high up in Boston’s Fed building. Mr. Wiltshire came to Harvard from Jeremy Grantham’s GMO group.  HMC has also acquired Mr. Grantham’s son, Oliver Grantham, another timber maven. The elder Grantham, a long-time timber advocate, has pointed out that timber has risen steadily in price for 200 years and has returned an average of 6.5% a year over the past century.  Grantham calculates that stumpage prices – the value of all the wood on the stump – have beaten inflation by 3 percentage points a year over the past century.  That last bit is particularly comforting to institutional investors who must, above all, maintain purchasing power.  Through booms and busts, trees just keep growing.  And, unlike peaches and corn, they don’t have to be harvested in any given year if prices are low. The argument for natural resources as a long-term winner is very plausible.  But it hasn’t always panned out. Does anybody remember Daniel K. Ludwig?  Back in 1982, Forbes listed him as the richest man in America, and he was regarded as one of the world’s most far-sighted investors.  In 1967 he bought 4 million acres in Brazil, planning to use it mainly for tree-farming.  He figured that the long-term demand for paper would be huge.  And trees, like everything else, grow way faster in the tropics than in the temperate zones.  Faster growth equals faster return on investment. But his venture concluded like a tragic Joseph Conrad tale. He spent at least $1 billion back when that was real money, and he lost most of it.  Mr. Ludwig was a very shrewd and determined man, but the Amazon — the combined effects of soil, insects, humidity and tropical disease — defeated him. Ms. Mendillo and Mr. Wiltshire may be smarter than Mr. Ludwig, who may have been right too early, as sometimes happens in investing.  And, besides, Mr. Ludwig was farming trees for pulp, not hardwood, as Harvard seems to be doing. There’s also the Green factor, which Mr. Ludwig didn’t have to grapple with.  Harvard’s constituents mostly love Green, and what could be Greener than trees? Timberland investments sound agreeable to many in the Ivy League.  And, Ms. Mendillo’s Green credentials are good.  Her husband (Ralph Earle III: Deerfield ‘75, Harvard College ‘79, Yale SOM ‘84) coincidentally, is a highly-networked Green guru.  He runs a company that advises on so-called green investing, and was an assistant Massachusetts secretary of environmental affairs. On the other hand, as big investors buy up more and more land in the third world, the activists are getting restive.  As Bloomberg reported, environmentalists and development experts have ramped up criticism of large institutional investors buying huge tracts of land in poor regions of the world. Just last month, protestors at Harvard were demanding that the endowment bail out of all fossil-fuel investments.  It’s always something.  And sometimes the protestors get their way.  Just ask Jack Meyer. The socially-conscious folks may not turn out to be as formidable as the ravenous Amazonian insects which thwarted Daniel Ludwig, but every investment has its pitfalls. We wait with interest to see if real assets really will put Harvard back at the top of its League.

From Academe: Yale Discovers The Ivy Allocation Arms Race While we’re talking Ivys, we’d like to alert you to a paper by two professors at Yale which offers a new perspective on how the big endowments decide to invest.  Maybe it isn’t all explained by modern portfolio theory, after all. In September, Sharon Oster and William Goetzmann of the Yale School of Management presented their paper “Competition Among University Endowments” at a National Bureau of Economic Research conference.  NBER is the elite think-tank which, among other things, officially decides when recessions start and end. They’ve explained the big shift into alternatives as a product of institutional competition: it’s an arms race to stay on top of the pecking order with first dibs on the best students. They claim that their data show that when one school makes an investment decision — such as the decision to switch to another school’s investment model — its peers tend to follow suit for fear of losing their position in the hierarchy. If herding behavior is driving allocations harder than actual returns, it seems to imply that late arrivals will find the herd has stripped those lush grasslands clean.  So the leaders have to keep finding new pastures, like Brazilian forests. It’s a lot more complicated than that of course, or we could have written it.  But it’s quite lucid and includes some neat charts. The paper itself is here: http://icfpub.som.yale.edu/system/fileuploads/2705/original/Yale_ICF_WPS_2012_Goetzmann_06-14.pdf?1339624997 (Note: this is a free version on the Yale website, dated June.  We assume it’s substantially the same as the one published by NBER in September.) If you want just a short take, reporter Sophie Gould gives a summary at the Yale Daily News. http://yaledailynews.com/blog/2012/11/29/endowment-alternatives-promote-arms-race/

]]> http://www.charlesskorina.com/775/feed/ 0 http://www.charlesskorina.com/770/ http://www.charlesskorina.com/770/#comments Thu, 18 Oct 2012 20:00:43 +0000 charles http://www.charlesskorina.com/?p=770 One more time, are hedge funds worth it?

Comings and goings.

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And now, on with our newsletter:

Comings and goings: Michael Trotsky: Beantown’s big pension gets a twofer: The top exec at Massachusetts’ MassPRIM pension just got a second big hat and a small pay-raise. Executive Director Michael Trotsky is now also officially chief investment officer of the $50 billion fund. Previous CIO Stanley Mavromates earned $235 thousand base pay in 2011 (plus a $35 thousand performance bonus). Mr. Trotsky will now get a total base of $275 thousand, including a modest $50 thousand boost for his new duties. But wait, there’s more: Mr. Trotsky is also picking up a hefty performance bonus of $98 thousand, bringing his total comp for calendar 2012 to about $364 thousand. Deputy CIO Hannah Gilligan Commoss inconveniently went on maternity leave in June, just as Mr. Mavromates left for a new, more lucrative job with Mercer. She was the obvious candidate for interim CIO, and Mr. Trotsky declined to name anyone else at the time, perhaps because PRIM already has a shortage of senior staff due to recent departures. So, he’s actually been doing both jobs for the last four months. An ED-cum-CIO is not unheard-of at big public pensions. Ash Williams, for instance, fills both roles at Florida State Board of Administration, running a $120 billion pension. But it’s also not very common, since the two jobs tend to have different skill-sets. But Mr. Trotsky, with his Wharton MBA and experience as a hedge-fund manager, clearly has the horsepower to do the CIO’s job. Coming up with enough pay to hold senior talent has been a problem there for years. The previous executive director, Michael Travaglini, drew criticism from Springfield politicians for the bonuses he earned in 2009. As he left (for a job with Grosvenor Capital in Chicago), the exasperated ED told the press that “I have a wife and three children, and I’m going to provide for them…People can vote with their feet, and that’s what I’m doing.” Doing without a separate CIO will free up about $250 thousand in their admin budget, which can be applied to the comp of other hires. They’ve had some gaping holes in their org chart for months. In addition to the empty CIO slot, both of their senior private equity officers have resigned over the past year, as well as the chief operating officer. In a meeting in June the PRIM board’s longest-serving member noted that the only senior investment officer still aboard is running their real estate and timber allocation. He complained that 90 percent of the portfolio currently has no dedicated senior staff running it. The board seems to have decided that a long search for a new CIO would leave management in limbo for too long. Mr. Trotsky told his board in June that “A leading PE candidate just pulled his hat out of the ring” because he didn’t know who his new boss would be. PRIM previously floated an RFP to hire a recruiter for the search, a process which is now obviously suspended, at least for now. Some deserving executive recruiter will miss a payday this winter, but under the circumstances, the board probably did the right thing. ————————————————- David Loglisci: A busted CIO finds a new career in Oklahoma: We ended a piece in our last newsletter with a little rhetorical flourish, noting that, at bottom, running an investment portfolio is just a business: like running a carwash. Then, last week, the real world responded with a strange mash-up of investing and car-washing. In a New York City courtroom, David Loglisci, former chief investment officer at New York State’s $140 billion CRF pension fund, was finally sentenced for his role in a pay-for-play scandal which engulfed him, his boss (former state Comptroller Alan Hevesi), and numerous others. His lawyer told the judge that his client, the disgraced ex-CIO, has recently focused on running a carwash in Oklahoma. Mr. Loglisci, who holds both a law degree and an MBA from University of Notre Dame, was a vice president at Salomon Smith Barney who left investment banking in 2002 to join the state pension in Albany. This involved a 70 percent pay-cut, and was the first in several bad decisions which ultimately led him to that carwash. We won’t recap the whole convoluted story, but a couple of points are worth mentioning as these final shoes drop. Mr. Loglisci told the judge that he had “…entered an environment where political considerations were a customary part of the decision-making process,” which may have been self-serving, but is also obviously true. Hank Morris, who was a political ally of former Comptroller Hevesi, was the kingpin of the scheme, and is said to have collected $19 million in pay-offs for helping to steer some $5 billion of alternative investment mandates to favored parties. Both he and Mr. Hevesi are now serving prison terms. Mr. Loglisci not only sold his office, he seems to have sold it for virtually nothing. His only clear benefit was money which flowed to his brother from investors who helped finance a movie called “Chooch.” Set in Hoboken, New Jersey’s Little Italy, the alleged comedy played in three theaters and earned a total of $30,792. If you navigate to www.choochthemovie.com, you can still enjoy the trailer, buy the DVD, and get Chooch-related merchandise. Mr. Loglisci obtained a conditional discharge from the judge, which means he walks without even a parole period, although he has had to surrender his law license. The light punishment was mostly because he cooperated with the state prosecutors to help nail Mr. Morris and Mr. Hevesi. But, perhaps, also in part because even the hardened Supreme Court judge could hardly credit Mr. Loglisci’s ineptitude for graft. “You sold out and you didn’t get any money for it,” marveled Justice Stone, “which shows how naive you were.” We agree. Mr. Loglisci makes Voltaire’s Candide look like a sophisticate. He clearly wasn’t cut out for politics, and will probably be happier and more productive washing cars in Oklahoma City. ——————————————– Kristen Gilbertson: “Mission accomplished” at Penn: Kristen Gilbertson, chief investment officer at the University of Pennsylvania endowment, issued a “mission accomplished,” announcement this week and has left the campus. That’s a fair assessment of her work and, as far as we know, she didn’t put on a flight-suit to mark the occasion. She will still have an advisory role until the end of the year, but David Harkins, head of the public equities team, is stepping in as interim CIO while a permanent replacement is sought. Ms. Gilbertson took the job in 2004, following the school’s first CIO, Landis Zimmerman (now CIO at the Hughes Medical Institute) who set up the investment office in 1998. In her eight-year tenure the endowment grew from $3.9 billion to $6.8 billion. Ms. Gilbertson, who earned her MBA at Stanford University, had previously headed the public equities team at the Stanford Management Company. Her most notable accomplishment was to lose less money than her Ivy peers in the financial crisis of 2008/2009. Penn was down only 16 percent in fiscal 2009, compared to losses of 27 and 25 percent at Harvard and Yale, respectively. That, plus decent returns since, have let her fund recoup all of its losses, which many schools still haven’t done three years later. Ms. Gilbertson told the Wall Street Journal in 2009 that she had started reducing her public equity allocation in early 2008 – from 53 percent to 43 percent – and put about 15 percent in Treasurys. Market timing isn’t supposed to be the forte of endowment investors, but it certainly worked that year. Those highly liquid Treasurys were one of the few assets to hold their value over the period. And it meant that Penn didn’t face a cash-crunch when their PE partners issued capital calls. In our list of non-profit CIO salaries last year (soon to be updated!), we ranked Ms. Gilbertson number 25, with total comp of about $961 thousand. The CIOs of Harvard, Yale, Columbia, Princeton and Brown were pulling down $4.8, $3.8, $3.5, $1.5, and $1.0 million, respectively according to the latest numbers available back then. In our celebrated Pure Performance study last month, we ranked Penn number 9 out of the ten largest endowments for performance in the five years 2007-2011. Their annualized return was 5.4 percent for that period. Among the Ivys, Columbia, Yale, Princeton, and Harvard all did better, with returns of 8.8, 6.0, 6.0, and 5.6 percent respectively. But, measured by Sharpe ratio, Penn did better, ranking 7th out of the ten biggest endowments. On this risk-adjusted basis, they slightly out-performed Yale, Princeton, and Harvard. For the fiscal year just ended in June, all the Ivys except Cornell and Princeton have reported their returns and so far Penn is in the middle of the pack with 1.6 percent for FY2012. Dartmouth leads with 5.8 percent and Harvard held the bottom spot with a loss of 0.05 percent. Flanking Penn on the up-side were Yale and Columbia, posting 4.7 and 2.3 percent returns. Just below Penn this year, Brown reported 1.0 percent. Ms. Gilbertson is still only forty-ish and has a super resume. She certainly must be regarded as a hot prospect for another high-level institutional job and it will be interesting to see where she turns up next.

The Hedgies strike back: AIMA takes aim at Simon Lack: This spring, a book provocatively called The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to be True was widely reviewed in the financial press. Our own review, which we think was one of the more informative ones, is here: http://www.charlesskorina.com/the-skorina-letter-no-37/ The author, Simon Lack, worked for years at JPMorgan, sussing out hedge fund investments for JPM’s high net-worth private-banking clients. Following Mr. Lack’s critique of the hedge fund industry requires plowing through some statistical arguments. Crudely over-simplified, it amounts to saying that the returns touted for both individual firms and the industry generally are misleading because they are – in math-speak – time-weighted rather than dollar-weighted. The typical investor, he says, has not gotten those headline returns, and is even less likely to get them in the future. He is not down on hedgies across the board; he acknowledges that some of them are amazingly good investors, and that some of the customers have done very well (including those for whom he worked at JPMorgan). But it’s not a fun read for hedge fund marketers who are, in any case, not having a good year. We summarized Mr. Lack’s argument in our review. Or, if you want a short version straight from Mr. Lack, you can look at this article he wrote for AR magazine a couple of years ago, which was the kernel for his book. It was: Hedge Fund IRR Has Been Pathetic …and you can find it here. http://www.institutionalinvestorsalpha.com/Article/2728122/Hedge-fund-IRR-has-been-pathetic-Magazine-Version.html We thought back in April that his argument was credible, and backed by some respectable academic work (including Dichev and Yu’s Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn [2009]). Just this past week for instance, we note that the high-profile financial journalist James B. Stewart cited Mr. Lack favorably in the New York Times, including a marquee quote from the book: “If all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good.” The HF industry, we thought, is going to have to respond directly to this. They can’t afford to let the Lack critique become conventional wisdom. And so it has. While we were taking a break this summer, the London-based industry group AIMA (Alternate Investment Management Association) issued a rebuttal. It’s a 24-page paper entitled “Methodological, mathematical and factual errors in ‘The Hedge Fund Mirage.’” You can check it out here: http://www.aima.org/ Over at Reuters, writer Felix Salmon has given the AIMA paper a careful read and rendered up a pretty devastating response: …the AIMA paper has convinced me of the deep truth of Lack’s book in a way that the book itself never could. Reading a book, it’s often very hard to judge just how reliable the author is, or how cherry-picked the data might be. But if a high-profile hedge-fund industry association spends months putting forward a point-by-point rebuttal, and that rebuttal is utterly underwhelming, then at that point you have to believe that the book has pretty much got things right. http://blogs.reuters.com/felix-salmon/2012/08/08/why-investors-should-avoid-hedge-funds/ You have to feel AIMA’s pain. On the one hand, a full-court rebuttal like this tends to re-publicize Mr. Lack’s argument, perhaps to people who hadn’t even noticed it before. On the other hand, it was getting too much attention to let it pass unchallenged. Readers can go to the sources and draw their own conclusions. But right or wrong, it’s obvious that Mr. Lack drew blood.

]]> http://www.charlesskorina.com/770/feed/ 0 http://www.charlesskorina.com/the-skorina-letter-no-42/ http://www.charlesskorina.com/the-skorina-letter-no-42/#comments Tue, 25 Sep 2012 20:27:06 +0000 charles http://www.charlesskorina.com/?p=757 Comings and goings: John Skjervem, Mark Wiseman, Rob Blandford, Vicki Fuller

Pure Performance: our perspective on corporate and non-profit returns:

John Maynard Keynes: The First Great Endowment Manager:

=======================================

Comings and goings:

John Skjervem:  Portfolio management vs. Portland politics

As we go to press (no actual presses involved, we just like that phrase), still another Chicago MBA has landed still another big job.

John Skjervem, class of ‘91, has been appointed chief investment officer at the Oregon State Treasury’s investment division.  This makes him effectively the CIO of PERF, the state’s $58 billion pension fund. He takes over in November.

The base pay for the position, as of 2010, was $265 thousand, plus a performance bonus opportunity.

Mr. Skjervem was recruited from Northern Trust Corp., where he was senior chief investment officer of their western region, stationed in L.A (apparently, a SCIO outranks a mere CIO!).

Oregon lost their previous CIO, Ron Schmitz, just about a year ago.  Although his team had been generating excellent investment performance (a 6.7 percent return over 2001-2010), he and several senior officers came under fire from Portland’s populist press for alleged extravagance in their travel-and-entertainment accounts.

As far as we could make out, Mr. Schmitz and his people were abiding by the rules then in force and, in the end, the headline-hunting legislative Ethics Committee churlishly conceded that they couldn’t actually charge the officers with any violations due to “extenuating circumstances.”  Those “circumstances” were that they were following Treasury policies and advice from the state Attorney General’s office.  But those guidelines, huffed the ethicists were “flawed.”  Whatever.

The ethicists got their headlines, but also succeeded in losing a good CIO.  Mr. Schmitz exited Oregon and was hired as the new CIO of the Virginia Retirement System in Richmond, shortly afterward.

Mr. Skjervem, age 50, was born in Los Angeles and earned a BA in economics from UC Santa Barbara.  After working a few years in L.A., he headed to Chicago for his MBA (where he also met his wife Jill, a fellow Chicago grad).

He was hired by Northern Trust and spent twenty years working for them in southern California and Chicago, finally becoming the top investment exec for NT’s western region, with broad responsibility for asset allocation and portfolio construction.

Mr. Skjervem appears to be highly-qualified as a portfolio manager, and we congratulate him on his appointment.  We just hope he’s ready to deal with the Portland politics.

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Mark Wiseman: A big job with a big paycheck in Toronto:

A big (and well-compensated) job has just turned over up in Toronto.  The Canadian Pension Plan Investment Board, which is the largest public investor in Canada with US$167 billion AUM, has a new chief.

Mark Wiseman, Exec VP-Investments, moved up to CEO in July.  On the current org chart all the senior investment managers report directly to Mr. Wiseman, so he is now effectively the chief investment officer, as well.  CEO David Denison, after seven years on the job, is retiring.

For FY 2012, Mr. Denison had total compensation of C$3,210,285, including a base salary of C$515,000, bonuses totaling C$2,624,400.

Mr. Wiseman, in his previous position, earned C$ 3,018,083 in the same period.

These are impressive comp numbers compared to even the biggest U.S. public pensions.  Anne Stausboll, the CEO of CalPERS, made around $380,000 in FY 2011, including a $96,638 bonus.  In fact the pay for CPP execs is comparable to the heads of the Harvard and Yale endowments, who have recently pulled down between three and four million annually, including bonuses.

Unlike their U.S. peers, the big Canadian funds tend to run their portfolios internally and invest directly.  Their execs are well-paid, but there is a lot less money flowing out as fees to external managers.

Of the 341 investment professionals at CPP, 112 are working on private investments.  Over the past six years, those private investments have added a net $3.8 billion in value to the total portfolio, while public investments have added only $0.5 billion.

That’s from an allocation of only about 16.4 percent – about $27 billion out of the current $167 billion.

With those numbers in mind, it’s obvious why Mr. Wiseman, who ran the private-market team until a year ago, was a top candidate for CEO.  And, his promotion to VP – Investments last year, putting the whole portfolio under his hand, was obviously the fruit of a longstanding, systematic internal succession plan.  Other boards should take note: this is how succession planning is supposed to work.

Mr. Wiseman got his undergraduate degree from Queens College in Kingston, Ontario, and has practiced law in New York and Paris, but has now settled down as a Torontonian.  He earned his LLB and MBA from University of Toronto, and was head of private equity investments at Ontario Teachers Private Capital, also in Toronto, from 2002 to 2005.

The retiring CEO, Mr. Denison, said he’s looking forward to joining corporate boards, which he was not allowed to do in his current role.  And, since he’s retiring at age 60, he’s still ready to take on some challenges.

“A lot of boards have age limits of 70 years for retirement; to allow for a meaningful period of time to serve on a board, you can’t leave it too long,” he said.  He’s also confident in his successor.  ”He’s someone who is ready.  He doesn’t need any more seasoning or time to develop into a CEO.”

Readers who scroll down to our excellent Pure Performance report below can see how the major Canadian public funds stacked up against their Yankee counterparts.  CPP, for instance, returned 3.8 percent in the five years 2007-2011.  Ontario Teachers did somewhat better, with 4.2 percent in the same period.

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Rob Blandford: Pulavarti’s Understudy is the new Spider-man:

When I interviewed Spider Management Company CIO Srinivas Pulavarti back in July, his departure from Richmond had been announced, but his destination was unknown.  A few weeks later, the UCLA Foundation said that Mr. Pulavarti had been recruited for their open CIO slot.

Then, before that UCLA press release had even cooled, Spider announced that Srini’s second-in-command, Rob Blandford, would step up to the President-and-CIO job in Richmond.  Mr. Blandford had been aboard since 1999 as director of investments.

The most recent available figure for Mr. Pulavarti’s total compensation (two years old) is about $830 thousand, and we expect Mr. Blandford to get a similar package.

I’m given to understand that Mr. Pulavarti highly recommended Mr. Blandford for the job.  And, apparently all the powers that be, including Spider CEO Steve Kneeley, the Spider board, and the investment of committee of Spider’s parent, the University of Richmond, concurred.  No outside search was deemed necessary.

Mr. Pulavarti, who had been both president and CIO at Spider, reported directly to the board until a new CEO slot was created in March.  Steve Kneeley filled that new position and became Mr. Pulavarti’s boss.

Spider is a $3 billion management company which acts as an outsourced CIO for some 20 non-profit entities in addition to the U. Richmond’s $1.8 billion endowment.  The official story is that they needed someone to ride herd on its expanding outsourcing business and tend to all the clients so that Mr. Pulavarti could concentrate on the portfolio.  This may be true, but it’s interesting that Mr. Pulavarti announced his departure shortly after Mr. Kneeley’s arrival, and landed at another fund of almost exactly the same size.

By our calculations, Mr. Pulavarti’s team generated a 7.7 percent return in the five years 2006-2010.  We ranked him second in performance only to Narv Narvekar at the Columbia endowment among highly compensated nonprofit CIOs – a very close second.  And he also stood very near the top of our infamousPerformance for Pay rankings.  In other words, he not only provided great returns, but was a relative bargain for his employers.

With the promotion of Mr. Blandford, both of the senior Spider-men are now University of Richmond alums.

In addition to his BA from University of Richmond, Mr. Blandford earned an MBA from Virginia Commonwealth University, also in Richmond, and previously worked as a senior investment officer atVirginia Retirement System in, of course, Richmond.  As Mr. Kneeley correctly noted in the hiring announcement, “Rob is a true Richmonder.”

His attachment to his town is well established; it only remains to be seen whether he can match the outstanding record of Srini Pulavarti as an investor.

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Vicki Fuller: A Chicago grad to helm third-largest U.S. pension:

On August 30, Vicki Fuller settled into her new office in Albany as chief investment officer of New York State’s Common Retirement Fund.  Like her predecessor Raudline Etienne, she will have the formal title of Deputy Comptroller and make about $300 thousand base pay.  And, I’m pleased to note, she’s a University of Chicago MBA!

State Comptroller Tom DiNapoli, the sole trustee for the CRF, hired Korn/Ferry to do the search, and they found her close to home, working in Manhattan for asset manager AllianceBernstein. As a senior VP and managing director for public funds she had been representing AB’s investment products to public pensions.

After earning her Chicago MBA, Ms. Fuller trained at Morgan Stanley, followed by a stint as a rating officer with Standard & Poor’s. Along the way she also picked up a CPA credential.

She landed a job as a high-yield fixed-income portfolio manager at Equitable Capital Management and continued in that specialty when Equitable was acquired by Alliance Capital in 1993.  Alliance merged into AllianceBernstein in 2000, and Ms. Fuller was promoted to the senior VP/managing director position in 2006.

When the hire was announced in July, Mr. DiNapoli noted that Ms. Fuller “…has an impeccable reputation and understands my commitment to operating the Fund with the utmost ethics and transparency.”

Given the recent history of the CRF, these remarks were more than perfunctory.

Mr. DiNapoli’s immediate predecessor as state Comptroller, Alan Hevesi, is currently serving 1 to 4 years in prison after pleading guilty to corruption charges surrounding a “pay to play” scheme at the CRF.

David Loglisci, who was the fund’s chief investment officer under Mr. Hevesi, has also pled guilty to criminal charges, but is expected to receive a light sentence for cooperating with state prosecutors, possibly avoiding imprisonment.  His sentencing, after several delays, is now scheduled for September 28.

Despite all this recent unpleasantness, the CRF’s investment performance has been reasonably good.  They ended their 2012 fiscal year on March 31 with a return of 5.96 percent and AUM of $150.3 billion.

Marjorie Tsang, who served as interim CIO, deserves some credit for that recent performance.  Although she didn’t get the top job, the results of CRF’s real estate portfolio, which she has run for years, have been outstanding.

As you can see in our illuminating Pure Performance report below, CRF had a not-bad 4.2 percent annualized five-year return through 2011.  They out-earned their larger California peers, CalPERS and CalSTRS, who posted 3.4 and 3.8 percent returns respectively in the same period.

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Pure Performance: our perspective on corporate and non-profit returns:

Why Pure Performance?

We’re retained by the boards of institutional money managers to help them find chief investment officers and other senior people, so we naturally focus on the pay and performance of individuals.  In past newsletters we’ve issued research that attempted to quantify some of those matters, including our infamous Performance-for-Pay study last year.

But this month we want to look solely at the investment performance of the major corporate pensions and non-profit funds.  We call it Pure Performance.  The results are revealing and, in some cases, surprising.

We’ve still attached the names of the CIOs, so praise or blame can be cast on the right individuals, but we’re not including compensation in our analysis.

We wanted to come up with a clear, head-to-head ranking of these big investors, calibrated by both return and risk.  If we had just listed, say, the 50 largest funds by AUM, then the list would be top-heavy with public pensions.  Instead, we’re looking at the ten largest in each group.

For the U.S., we’ve put together investment performance data for the ten biggest public pensions, corporate pensions, endowments, and private foundations.  We’ve also added the five largest public funds in Canada, because we think there are interesting things going on up in the Great White North.

For all 45 funds we calculated a five-year annualized return for 2007-2011.  Then we obtained the standard deviations and Sharpe ratios to get a sense of their risk-adjusted performance.

These funds have different institutional missions, different legal and regulatory settings, and face different political and cultural constraints.  Some of their execs, and even some of our readers, may object that they just aren’t comparable and shouldn’t be lumped together.

We respectfully disagree.

In Roman mythology there was a god called Janus.  Janus had two faces: one facing forward, one back.  Old Janus was a very hard guy to sneak up on.

The managers of these funds are Janus-like.  One set of eyes has to focus inward on the peculiar needs of a specific institution.  But, for all investment managers, the other view is the same: the world market for investable assets.

The investment committee and its executive arm, the chief investment officer, are charged with balancing risk and return.  Whether they succeed, and by how much, can be objectively measured.  And, we will fearlessly assert that higher risk-adjusted returns are always better than lower ones.

Whether those returns are being used to build schools in Africa for Mr. Gates, support retired auto workers for Ford, or keep churning out PhDs in post-modern bafflegab in New Haven, is somebody else’s worry.

A slight hitch:

We hoped that we could offer readers a clean ranking of all these diverse funds, from high to low, based on both absolute and risk-adjusted performance over the past five years.

But, as we worked through the data, we realized that the different fiscal years presented a problem.  Some close their books on June 30 (including most endowments and public pensions).  Others use a December 30 fiscal year (including most corporate pensions).  And there were a handful of odd-men-out using March 31, August 31, or September 30 years.

We think a five-year span is most appropriate for judging investment performance of an individual manager or team.  But, unfortunately, it’s not long enough to wash out all the timing differences.

For a bond investor, it wouldn’t much matter which FY he used.  The Barclay’s Aggregate bond index returned about 6.5 percent whether your five years ended in June or December of 2011.

But, for equity investors, it matters.  An investor holding just the S&P 500 index would have an annualized return of 2.9 percent for the five years ending June 30, 2011.  But he would have had a negative return of -0.2 percent for the five years ending December 31, 2011.

That’s a big difference.  And some of the funds we’re looking at have huge equity exposures.

So, we can’t just blithely pile these apples and oranges together because the late-filers would be unfairly penalized and the early-filers unfairly boosted in the relative rankings.

What to do?

In theory, the returns could be re-calculated on some common-denominator basis by examining quarterly statements.  But that would be a lot of extra work for our research staff: us.  And, some of the funds we want to look at, including most foundations, don’t file quarterly reports at all.

So, we divided our list into two groups.  The first consists of June FYs (plus a few in March).  The second contains all the December FYs (plus a few in September or August).

This isn’t a perfect solution, but it lets us more fairly rank performance over the same (or almost the same) five-year periods.  Sorry for this long excursus, but we wanted readers to understand why we have the “extra” charts.

First, we present the overall ranking by absolute return, with Sharpe ratios also noted.  Fiscal years are cited for each fund.  These rankings, as explained above, are problematic and should be taken with a grain of salt.

Then we have the separate charts for the June and December FYs, with their more defensible rankings.  On each we also include a line representing returns for a 60/40 index fund for that period.  This is a plain-vanilla index based on the S&P 500 and Barclay’s Aggregate bond indexes.

With the index as reference we can see at a glance who was beating the public markets and who wasn’t.  Readers will note that the 60/40 index returned 5.0 percent for the five years ending June 30, but just 3.2 percent for the period ending December 30.

N.B.: These various funds, of course, use their own custom benchmarks, tuned to their specific asset allocations and objectives.  Our simple, one-size-fits-all, 60/40 index is only intended to give a rough notion of how these funds performed relative to the public markets.  Readers can consult the funds’ published reports to see what standards they measure themselves against.

Further below we have some more sub-tables, and some discussion of what it all means.  We found a few surprises.

Now: To the charts!  [Please click on the space if you do not see the chart.  They should appear.]

First: all 45 funds, ranked by annualized return for their respective fiscal years:

Second: the 19 funds with June (or March) fiscal years:

Third: 26 funds with December (or August, or September) fiscal years:

Ford and Boeing: the great investors no one noticed:

One reason we did this study was to salve our own curiosity about the relative performance of the big corporate pensions.

The big endowments like Harvard and Yale announce their annual investment returns with a flurry of press releases.  And, when the big public pensions post bad numbers there are rumbles in the legislatures and letters to the editors.

The corporate pensions, however, rarely publish explicit percentage rates of return.  The information is there implicitly, of course, in the bowels of their annual reports.  But the financial press is usually interested only in how much money will have to be diverted from current earnings to keep the pensions funded, information which moves the markets and affects the stock price.  But required annual contributions are also driven by actuarial and economic factors; investment returns are only a piece of that puzzle.

Besides, when CalPERS stumbles, everyone knows that it’s the taxpayers who are on the hook, sooner or later.  If the GE pension fund is underperforming, and their profits consequently pinched by a few cents per share to make up the difference, the world in general doesn’t take much notice.

So, when we dug out the numbers, we were as surprised as anyone at how the corporate pensions stacked up against other comparable investors.

What we know about Ford Motor Company is that they make cars and that, unlike their Detroit peers, they didn’t quite go bankrupt in 2008.  They hired a guy from Boeing to run the company, and he seems to be doing pretty well.

But they also manage almost $60 billion in pension funds, and, if you judge their recent performance by Sharpe ratio, they’re doing it better than anybody.

Their absolute return for 2007-2011 was a very good 5.6 percent; exactly the same as the Harvard endowment.  That ranks them 11^th overall for return and number 1 among the December FY cohort.

But look at that Sharpe number: it’s 0.45.  Harvard, with the same 5.6 percent return, had a Sharpe number of only 0.18 (and despite the advantage of an earlier fiscal year).  So, the Ford Treasury team matched Harvard on absolute return, and did it with significantly less variance.  Or, as most people are willing to say, they earned the same return with less risk.

By our calculations Ford had the lowest standard deviation of returns among all 45 funds and the Sharpe number is, of course, an inverse function of SD.  Even with the disadvantage of their later fiscal year, Ford’s performance on a risk-adjusted basis was better than any U.S. endowment, foundation, or public pension.  It was also better than the excellent big public investors up in Canada.  And, of course, they beat all their peers among big corporate pensions.

Did you know that?  We didn’t.

Boeing, Canada’s AIMCO, and the Columbia University endowment, were all tied for a close second-place with a Sharpe number of 0.41.

The man responsible at Ford is Neil Schloss, Ford’s VP and Treasurer since 2007 (coinciding almost exactly with our 5-year span).  As with most corporate treasury staffers, Mr. Schloss’ team in Dearborn hasn’t been stove-piped into portfolio management for their whole careers.  They’ve typically rotated through the whole gamut of treasury functions before landing with the asset management group in mid-career.

For reference, here are the top 20 Sharpe rankings, regardless of fiscal year:

Treading right on heels of Ford is not Harvard or Yale, but Boeing.  Again, all we know about Boeing is that they make big airplanes.  And that the guy who probably should have gotten the CEO job there, but didn’t, was hired by Ford.

The Boeing Company had an even higher absolute return than Ford: 6.3 percent, ranking them third overall.  Only two veteran endowment managers – Narv Narvekar at Columbia and Erik Lundberg at University of Michigan – earned better returns: 8.8 and 7.3 percent, respectively.

Like Ford, Boeing has a de-risked portfolio with a modest standard deviation.  Their Sharpe number ranks the airplane company right behind the car company.

So, apparently that liability-driven investment stuff, with its tilt away from equities and toward long-duration credit and high-quality bonds, actually works.  At least it worked in this 5-year period, executed by managers who knew what they were doing.

Much of Boeing’s performance can be attributed to Mark Schmid, who ran their pension investments until 2009, when he was recruited to run the University of Chicago endowment.  His impressive returns at Boeing were undoubtedly a factor in that hire.

He turned the Boeing job over to his young second-in-command, Andrew Ward.  I’ve had some exchanges with Andrew, and, since he’s a nice guy and a Chicago MBA, I can almost forgive him for getting that job at age 38.

GE and BofA: the money managers who can’t shoot straight:

After admiring Ford and Boeing’s performance (and noting that AT&T and NorthrupGrumman also did very well), we wondered how the real pros were doing.

After all, Bank of America and General Electric (via GE Capital) are major asset managers in their own right.  They charge other people for financial services, so they must know what they’re doing.

In fact, BofA and GE are way down on the bottom of the Sharpe rankings, ranked 42 and 44, respectively.  Their SRs are actually negative!  Their absolute return numbers were no better: they ranked 42 and 44 on that scale, as well.  GE’s absolute return was a sad 0.4 percent, as compared to Boeing’s robust 6.3 percent.

Now, the mathematicians will tell you that the SR is a “dimensionless” number which is meaningless taken by itself.  But a Sharpe number which is close to zero, or negative, has a very straightforward meaning: it means the investor could have made as much or more money just by laddering 3-month T-bills for five years and saved themselves a lot of trouble.

We don’t profess to understand why the guys who make cars and airplanes are better investors than GE Capital and Bank of America.  We’re sure the explanation is complicated.

We note however, that both GE and BofA are currently freezing their defined-benefit pension plans and pushing everybody into 401Ks as fast as they can.  Whether low investment returns are a cause or effect, we can’t say.

We also note that both Ford and Boeing operate in blue states, facing strong unions.  They are not going to be walking away from their DB plans anytime soon, so they need to make a virtue of necessity and get the best returns they can.

Asset allocation also figures into it, of course.  Even without doing a deep dive into those numbers, some differences stand out.

In 2011, Ford had 47% in fixed income; but GE had only 27%.  In this period, returns on investment-grade bonds have been very good.  Yields are low, of course, but we’re looking at total return.  The Barclay’s 5-10 year credit index had a 5-year return of 6.7% in 2007-2011.  Bonds lost a lot less than stocks in 2008-2009, and they boomed in 2010.

Whatever the reasons, it’s hard to believe that either BofA or GE is devoting their best talent to pension fund investing, based on these numbers.

We couldn’t figure out who was running the BofA pension portfolio, so we just listed CEO Brian Moynihan.  His revenue is down 50 percent, and he’s busy trying to cut 16,000 jobs, so we don’t think he’ll even notice one more problem on his plate.

Jay Ireland was president and CEO of the GE Asset Management unit through most of 2007-2011.  GEAM runs about $120 billion, which includes portfolios for institutional investors around the world in addition to the GE retirement assets.  Whether those outside customers got better returns than the GE pensioners, we can’t say.

Mr. Ireland left last March to take the newly-created post of president and CEO of GE Africa.  We presume this is the regular rotation that upward-bound execs at GE expect every few years, and may have nothing to do with pension returns.

He was succeeded in the GEAM job by Dmitri Stockton in December.

To be continued:

There is much more to be gleaned from these rankings, but we’ve tried our readers’ patience enough for one newsletter.  For now, you all can ponder our charts and discuss among yourselves.

In fact, we’ll give you a few more.  Below are abbreviated lists of the five categories we’re analyzing

We’ll be back soon with Part 2 of our commentary on the Pure Performance funds.

Pure Performance by Fund Type:

01 Top 10 U.S. Corp Pensions: 2007-11 Performance:

02 Top 10 U.S. Pub Pensions: 2007-11 Performance:

03 Top 10 U.S. Endowments: 2007-11 Performance:

04 Top 10 U.S. Priv Foundations: 2007-11 Performance:

05 Top 5 Can. Public Funds: 2007-11 Performance:

Further Pedantic Notes on Methodology:

Some funds publish explicit annual return numbers expressed as percentages, and even five-year returns.  For some others, including a few of the private foundations, and all of the corporate pensions, we had to hand-calculate returns from financial statements.  These are not as precise as the time-weighted numbers which custodian banks produce for their clients, but we doubt we deviate from that canonical (but unpublished) return by more than 50 basis points in any given year.  A little crude, but we’re not doing financial reporting, and it’s good enough for our purposes, since we’re more interested in ranking than in absolute numbers.

Also, Texas A&M University is now, technically, the 10^th-largest endowment, having crept past Universityof Pennsylvania.  But more than half of the TAM endowment is actually managed by UTIMCO, with smaller portions managed by independent foundations or the school’s treasurer.  So, for purposes of measuring investment performance, we’ve let Mr. Zimmerman’s shop represent both institutions, and we’re putting Penn back in the top ten.  No offense to the Aggies.

Also, the Pew group of charitable trusts, taken together should probably be in the top-ten list for private foundations as of 2011.  But they don’t seem to publish a consolidated statement of investment performance, and hand-calculating it defeated us.  No offense to all the excellent work done by the Pew people.  So, we omitted the Pew trusts and bumped the Moore Foundation into our top ten.

Finally, assets for the corporate pensions include all plans clearly labeled “pensions,” wherever they’re domiciled.  Some of these firms have distinct pension schemes for foreign employees in, e.g., the UK.  We’ve taken them all together, as seems proper.  The extent to which investment policy is centralized in the U.S. isn’t always clear, but we assume that it ultimately rests with the board of the U.S. parent and we treat them as one entity.  All assets for non-pension post-retirement plans (e.g., medical plans) are excluded from our calculations.

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John Maynard Keynes: The First Great Endowment Manager:

We heard a lot about the late J. M. Keynes a while back, when Mr. Obama launched his great stimulus. Keynes was cited so often that ordinary folk might have thought he was advising the President.

Lord Keynes, of course, has been dead for sixty-six years, but he probably would have enjoyed the notoriety. It was he who said that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist,” and he has become the best example of his own dictum.

Whether Keynes was ultimately right or wrong about macroeconomics we’ll have to leave to higher authorities; but from our humble perch we can now report that he was, at the very least, a heck of an endowment manager.

Today he would be called a chief investment officer, but back then his title was Bursar of Kings College, University of Cambridge.

Keynes was the son of a Cambridge lecturer, and attended Kings on a scholarship. He earned a BA in mathematics in 1904 (what the Brits call a “first,” which is apparently very good). He had hardly any formal instruction in economics. In 1924, when he was already a very busy and accomplished  man, his old college asked for his help in running their endowment, which was then mostly invested in real estate, as it had been for several hundred years.

It’s long been known that Keynes did very well with the Kings College portfolio from 1924 to 1946, but only recently did anyone take the trouble to dust off those old trading records and closely analyze his performance.

David Chambers of (appropriately) the Cambridge Business School and Elroy Dimson (University of London Business School) have pored through those old records and concluded that he achieved a long-term Sharpe ratio of 0.69, compared to 0.45 on a benchmark balanced portfolio in the same period. That’s a very remarkable performance in any era.

And, for all you readers who think you’ve had some rough sledding, recall that Keynes did this through the Crash of ‘29, the Great Depression, and the cataclysm of World War II. Oh, and he did it as an unpaid part-time job, while he concentrated on writing his revolutionary books, chairing an insurance company, advising presidents and prime ministers, and inventing the post-War economic arrangements of the world.

“Progressive” admirers of Keynes, however, may be chagrinned to learn that he also applied the same strategies to his own personal portfolio, and made himself a tidy fortune along the way.

As the authors point out, Keynes accomplished this by using investment strategies that were just as revolutionary in his day as the so-called Yale model has been in our time.

In the 1920s and 30s, the major institutional investors were insurance companies, and they loaded up on bonds. Respectable fiduciaries, especially after the Crash, shunned stocks. But Keynes, with mathematical intuition which was rare among investors of his generation, recognized and exploited the risk premium available to long-term investors with equities vs. conventional fixed-income assets.

The authors argue that Keynes’s early allocation to equities was at least as radical as the much later move to illiquid assets in the late 20^th century by Yale and Harvard.

His equity weighting in the 1930s was 60 percent, and in the 1940s was 73 percent, unheard-of allocations at the time. His portfolio tilted toward small-cap and mid-cap stocks, which he researched himself, while maintaining an above-average dividend yield.

One of the most striking aspects of this story is the way Keynes was willing to completely scrap and re-invent his investment philosophy in the light of hard experience. He started out as what we would call a strategic macro manager, believing that he understood the credit cycle and could time the market. But, after the Crash, he evolved into a Buffett-style bottom-up stock picker in the early 1930s. From that point his purchases of his long-term holdings began to outperform the market on a consistent basis.

They show that he constructed highly idiosyncratic portfolios with

pronounced size and value tilts, anticipating some of the better performing hedge fund managers of our own time.

The authors point out that, in addition to his pure investment skills, Keynes benefitted from a governance set-up that gave him maximum discretion. The Fellows of his college had complete confidence in Keynes, permitting him to trade whatever asset classes he liked and shift his investment approach when necessary.

Keynes also served on the boards of two insurance companies and co-managed a publicly-traded closed-end trust. But he withdrew from these roles because he couldn’t deal with being cross-examined and second-guessed by his colleagues. He stuck with his Cambridge job primarily, it seems, because it was fun.

Since it’s a proper academic paper, Chambers and Dimson spend some time explaining all their sophisticated methodology and citing other scholars. We understand. They’re professors and they have to make a living. But most of it is quite lucid: a fascinating story about a fascinating man. And if you think it’s only of historical interest, then you’re probably wrong.

It’s a free download, here:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023011

Keynes the Stock Market Investor by David Chambers and Elroy Dimson.

In this issue:

Cornell’s new CIO – A.J. Edwards steps up to the plate

Interview with Curtis M. Loftis – South Carolina treasurer pushes back on fees

New Search — Director of Investments for a family office

New Search: Director of Investments for a family office: I’m looking for a Director of Investments for a professional single-family office in Omaha, Nebraska with AUM in the $500 million to $1 billion range. This is a new position reporting to the family office head/chief investment officer. The director of investments will assist with all aspects of the investment process: asset allocation, investment analysis, due diligence and monitoring of a variety of asset classes. The diversified portfolio includes private equity, real estate, public equity, fixed income and hedge funds. Qualified candidates must have at least 5 – 8 years of relevant experience in an institutional or family office environment, an MBA in Finance, or Bachelor’s degree in Economics, Mathematics, Accounting or Finance, and CFA designation. The position offers a competitive salary and discretionary bonus opportunity. Please respond by e-mail with reference to “family office position” in the subject header.

Comings and goings: Cornell Decides to Buy American: A.J. Edwards steps up to the plate: A.J. Edwards, interim chief investment officer at the $5.3 billion Cornell University endowment for the past year, has now been officially bumped up to permanent CIO. But he’s a native of Connecticut, so his selection is a big departure for the upstate-New York school, which has looked to London for all its CIO needs in recent years. James Walsh, recruited from the giant British Telecom pension, had the job from 2006 to 2010. He was briefly succeeded by another Englishman, Michael Abbot, who had been CEO of fund of hedge funds giant Robeco-Sage; but Mr. Abbot lasted barely six months, leaving last April under rather mysterious circumstances.  (We note that Robeco-Sage evened things out by replacing Mr. Abbot with a Yank: ex- U.S. Army Captain Jill Schurtz, a graduate of West Point and Columbia Law. Robeco-Sage hired Ms. Schurtz as COO in 2008 and moved her up to CEO on Mr. Abbot’s departure. She then presided over the sale of the London firm to Arden Asset Management.) Mr. Walsh’s base salary in calendar 2010 was $421,828 and Mr. Edwards will presumably get at least as much. Following a good year — FY2007 when the endowment returned 25.9% — Mr. Walsh doubled his pay, earning a performance bonus of $420 thousand (paid in calendar 2008). But a return of 2.7% in FY2008 earned him a bonus of only $77 thousand. We’re not privy to the incentive formula, but Mr. Walsh apparently beat his passive benchmark by about the same margin in both years, so other factors must be in the mix. In any case, Mr. Edwards probably has a similar bonus opportunity, if and when the markets cooperate for him. Cornell took a big hit in FY2009, booking a loss of 26%. This wasn’t much different from its peer Ivys – Dr. Swensen’s Yale endowment, for instance, lost 24.6% in the same period – but Mr. Walsh took some harsh criticism. The student reporters at the campus paper served up a story full of progressive politics and bad reporting to the effect that while the endowment plunged, the CIO had profited. An editorial the next day opined that it was “unethical” to pay such a bonus as faculty were being laid off. In fact, Mr. Walsh’s big bonus had been paid back in calendar 2008 for performance in FY2007. A corrected account eventually surfaced, if anyone read it. Faculty and staff were certainly dismayed as the school slashed budgets and froze spending, and Mr. Walsh was probably not the most popular figure on campus that fall. When FY2010 results were announced a year later, it was clear that Cornell had bounced back handsomely, with a 12.6% gain which surpassed both Yale (8.9%) and Harvard (11%). But by then Mr. Walsh had already resigned — just five months after the Cornell Sun’s misleading headlines. He doesn’t seem to have any hard feeling about his time in Ithaca, however, since he chose to name his new London hedge fund, Cayuga Capital Partners, after the scenic lake which adjoins the Cornell campus. In the four-month gap between Brits in early 2010, leadership of the investment office devolved upon its three senior investment officers: Mr. Edwards, David McNiff, and John Regan. According to people close to the school, Mr. Edwards was clearly first among equals, forming a good relationship with the investment committee and its long-time chairman: Paul Gould, managing director and executive VP of the New York investment banking firm Allen & Company. When Michael Abbot abruptly resigned in April of last year, the school issued an opaque press release saying that: “…his style of conducting business is inconsistent with Cornell’s policies and expectations,” and that “the parties concluded that it would be in everyone’s interest to end the relationship.” According to my sources the administration felt that Mr. Abbot had too many personal side projects which were absorbing too much of his time and attention at the expense of his official duties. The two parties simply disagreed about the scale of his extra-curricular activities, and they parted ways. It may be that Mr. Abbot succeeded as a derivatives trader, then a sell-side executive at Goldman-Sachs, then a principal in two hedge funds, in large part because of an entrepreneurial style which didn’t comport with the buttoned-down institutionalism of Cornell. In any case, he’s still in the U.S. and apparently still flourishing. On the West Coast he’s a partner and managing director of Terroir Capital in Santa Barbara, which boasts an impressive portfolio of vineyards and boutique luxury hostelries in several countries. On the East Coast he’s listed as a general partner at hedge fund advisor Helios Advisors LLC. As Mr. Abbot departed, the Cornell higher-ups immediately dubbed Mr. Edwards interim CIO, and they have obviously found no one they liked better during a year-long search. Mr. Edwards was hired in March, 2008 as part of Mr. Walsh’s push to expand and upgrade the investment office. He earned a BA and MBA at the University of Connecticut, then an MS in mathematics from Fairfield University, also in Connecticut. After eight years as an equity analyst with Wright Investors Service, he was hired to manage the $2.5 billion pension of Northeast Utilities in Hartford, giving him a broad base of experience with all asset classes. Mr. Edwards declined to be interviewed for this piece which, given all the drama of the past few years, is entirely understandable. But it appears to us that Cornell has got it right this time, and we wish him well. —————————————- This way to the egress: Stan Mavromates joins the out-migration from MassPRIM: MassPRIM’s long-time chief investment officer, Stanley P. Mavromates, is following his former boss and other senior staff into the private sector. He’s been plucked from the $50 billion Massachusetts state pension fund by Mercer Investments, who will make him their new Boston-based CIO for the Americas on June 25. He earned $270 thousand last year, including a $235 thousand base and a $35 thousand bonus based on his fund’s most recent 3-year performance. Just two years ago PRIM lost Mr. Mavromates’ former boss, executive director Michael Travaglini, who is now a managing director at Chicago-based Grosvenor Capital, marketing funds of hedge funds to public pensions. Then, as now, the legislature was agonizing about performance bonuses for the investment staff. In 2009, despite losing money, the PRIM team beat their 3-year benchmarks, but their bonuses were politically radioactive. One creative solon in Springfield even proposed that no state employee should make more than the governor, who pulls down a princely $177 thousand. The criticism clearly grated on Mr. Travaglini. As he went out the door he told the press: “I have a wife and three children, and I’m going to provide for them…People can vote with their feet, and that’s what I’m doing.” Mr. Mavromates had no such pungent exit lines, but his departure speaks for itself. I’m confident that his take-home will double with Mercer. Mercer Investments, an arm of the giant global consulting company owned by Marsh & McLennan, has been re-vamping its institutional unit under group executive Phil de Cristo and, like everyone else, is trying to move into the outsourcing business. Mr. Mavromates, who will report to global CIO Andrew Kirton, replaces Denis Larose, who is now CIO of the institutional investment group of Guardian Capital in Toronto. Mr. Mavromates’ rather modest bonus was, inevitably, deemed “controversial.” Massachusetts treasurer Steven Grossman, who is ex officio chair of the PRIM board, said last November that he was “awaiting judgment” about whether to keep PRIM’s bonus system until a compensation committee finishes its review. He did cautiously concede that “recruiting and retention of top flight managers is a major issue.” Mr. Mavromates, who certainly qualifies as a top-flight manager, has obviously decided not to stick around to see if the politicians decide to cut his pay. In his twelve years as CIO, the fund has racked up some of the best returns among its peers, maintaining PRIM’s perch in the top ten percent of U.S. public pensions, but the investment staff has had no increase in their base salaries since 2006. Mike Travaglini’s departure in 2010 was followed by three more last year. First, chief financial officer Karen Gershman, who was up for the executive director job herself, turned it down for a more lucrative berth as COO at Health Advances, a Boston-based consultant to medical-device startups. Then, PRIM’s two senior private equity staffers, Wayne Smith and Michael Langdon, were also picked off by headhunters last summer. Mr. Langdon left to join Hermes GPE in September and help establish its Boston office alongside Delaney Brown, their head of Americas. Mr. Smith, head of PRIM’s $6.8 billion PE program preceded him last August, joining fund of funds manager Pathway Capital Management. In January the PRIM board finally authorized hiring a headhunter to fill those still-open PE positions. PRIM under current executive director Michael Trotsky and Mr. Mavromates has been working hard to cut their dependence on fund of funds and reduce fees by shifting to direct hedge fund investments. The plan includes a new senior investment officer for hedge funds to ride herd on those new direct investments. But so far they haven’t filled that job, either. To summarize: no CIO, no senior private equity staff, and no senior hedge fund staff. Oh, and no interim CIO, either, since Mr. Trotsky has decided that the investment staff will report directly to him until a new CIO comes aboard. Mr. Trotsky has the horsepower for that role — he’s a Wharton MBA with ample experience including five years as a senior VP at hedge fund manager PAR Capital — but he’s going to be a busy man. —————————————- Back from Bismarck: John Geissinger’s Second Act: John Geissinger, chief investment officer and executive director of the North Dakota State Investment Board and the ND Retirement and Investment Office, announced his “retirement” last month. That word usually denotes a cessation of labor, but in this case Mr. Geissinger, who is still in his early 50s, will immediately be taking another full-time position in Connecticut. Whatever he calls it, he was definitely gone on May 31st. The SIB manages several state funds totaling about $5.6 billion, including the state’s PERS pension. Mr. Geissinger’s duties have been split between two interim successors. Fortunately, there was a Deputy CIO on hand: Darren Schulz, freshly-hired in January, who has been named interim CIO. The SIB has also appointed deputy executive director Fay Kopp as interim ED. In May, Mr. Geissinger was circumspect about naming his new employer, telling reporter Kevin Olsen at Pensions & Investments only that “My decision is based upon my desire to move closer to family in Connecticut. I will be joining a firm in the private sector, but those details will not be released until I start the position in June.” Now, June has come and Hewitt EnnisKnupp mentioned deep in a press release last week that Mr. Geissinger will be a partner in its Investment Solutions Group. The note also proclaims that HEK has recently added thirty new positions in the investments group. And they are needed to service 100 new clients since the beginning of the year. HEK now claims to have a total of 460 clients for its investment advisory practice and $2 trillion in assets under advisement. Mr. Geissinger has rolled up a solid resume with one major glitch. He earned a BA in math and economics from Wake Forest University and an MBA in statistics from NYU. There followed three years as a bond analyst at Aetna Life and Casualty, seven years as a portfolio manager and senior VP at Putnam Investments, then five years running an $8.5 billion bond portfolio at Chancellor/LGT Asset Management. So far, so good. Then in 1998 he became chief investment officer and senior managing director at Bear Stearns Asset Management — even serving as chair of the Risk Committee — where his career came unstuck. Readers may recall that BSAM contained a couple of hedge funds stuffed full of toxic sub-prime mortgages, managed by Ralph Cioffi and Matthew Tannin. In 2007 both funds collapsed, vaporizing $1.4 billion of customers’ money. One of those fund managers, Mr. Tannin, had unwisely committed some of his thoughts to e-mail at the time, writing in November, 2006: “As I sat in John’s office I had a wave of fear set over me that the fund couldn’t be run the way that I was ‘hoping’…And that it was going to subject investors to ‘blow up risk’.” “John” was Mr. Tannin’s then-boss, John Geissinger. The risks of baring your soul in an e-mail were perhaps less well understood back then. Mr. Tannin may not have realized, for instance, that all G-mail messages are saved on a server somewhere, and that even Google must bow to a federal subpoena. In 2009 the two ex-masters of the universe were defendants in a Brooklyn courtroom; and among the prosecution witnesses was their old boss, Mr. Geissinger. By then Mr. Geissinger’s job had vaporized, too, as Bear Stearns collapsed into the arms of JP Morgan Chase with a little matchmaking help from the federal government. Shortly afterward he found work in Bismarck, North Dakota. Scott Fitzgerald said there are no second acts in American lives; but we wish Mr. Geissinger the best of luck as he takes up his duties in Connecticut.

Today’s Investment wisdom – he said, she said: It’s hard to get a read on where to invest these days. One public plan CIO I spoke with last week is raising cash as fast as he can because of the “bargains ahead”. Another is going whole hog into equities because he does not want to miss the coming rally. A Swedish fund manager I spoke with last month likes the US housing sector because it’s so “cheap”. But an investor friend of mine at a major foundation says that the best property deals are clearly in Europe, not the States. Huh? Throwing more mud into the waters, last week I listened to an aiCIO conference call with UFG Asset Management, a Moscow based hedge fund/private equity shop run by Harvard-educated American Charlie Ryan and a hard-working Russian/German staff. They have been investing in Russia for sixteen years and politely pointed out that Russia has no sovereign debt, the budget is in the black, the personal income tax rate remains a flat thirteen percent, most Russians own their apartments debt-free thanks to privatizations in the 90’s, and as a result, disposable income is over 75% of pay. The economy is booming and there are few barriers for global investors in consumer products, white goods, autos, and other consumables. In natural resources, well that’s a different matter. There one swims with the oligarchs and government ministers and it’s probably best to avoid these sectors; which means stock picking is key here as opposed to buying the index, of which two-thirds is commodity-related. About China, I hear mixed messages, but the consensus seems to be that as long as investors stick with the “eat, drink, wash, wear” industries, there is still money to be made. Meanwhile, John Burbank at Passport Capital, a major global macro investor, still likes Saudi equities and gold. I hope that clears things up.

Are Institutional Investors getting their money’s worth? In the next few issues I’ll be taking a close look at investments costs, both internal and external, and see how fund measure up. What are you really paying? And are you getting what you pay for? To kick things off, let’s hear from a man who has been relentlessly pursuing answers to those questions, Mr. Curtis M. Loftis, Treasurer of South Carolina —————————————- Investment Fee Pushback in the Palmetto State: A conversation with South Carolina Treasurer Curtis Loftis: I ran into Mr. Curtis M. Loftis, the Treasurer of South Carolina, at an investor conference in New York a few weeks ago and we were able to continue our conversation by phone over the Memorial Day Weekend. Some readers may not appreciate what he has to say, but he doesn’t stand alone. Other public pension leaders are also on record as wanting to push back on management fees, even if they haven’t expressed themselves quite as forthrightly. Mr. Loftis is a small-business owner and real estate investor who decided, at age 51, to enter politics. In his first try at public office he was elected state treasurer, taking office in January, 2011. In South Carolina, the Treasurer is one of five members of the State Budget & Control Board, who are the trustees of the public pension; and he’s also one of five votes on the Retirement System Investment Commission, which functions as the investment committee. Additionally, as Treasurer, he is the statutory custodian of the pension funds. As late as 2007 the state was only permitted to invest in U.S. stocks and bonds and held exactly zero alternative assets. Then a constitutional amendment authorized a more modern, diversified portfolio and a CIO was hired to guide the transition. In just four years the state has jumped into alternative assets with both feet. Today, the system allocates slightly over 50 percent to alternatives [FY2011 CAFR, p. 78]. By contrast, giant CalPERS, which many pensions look to as a model, is only about 23 percent in alternatives, including real estate. But that big push into alternatives came with a big hike in fees. While alternatives went from zero to fifty percent of the portfolio, annual fees to external managers increased tenfold, from $32 million to $340 million. Mr. Loftis has hit the ground running in his campaign to scrutinize mounting investment management costs in his state’s $26 billion public pension fund. He’s been interviewed in the Wall Street Journal, Bloomberg BusinessWeek, and the New York Times. We’re pleased he found time to explain his concerns to our readers. Mr. Loftis is a proud graduate of the University of South Carolina, an avid outdoorsman, and is on record as stating that there is no such thing as an unhappy man on a tractor. Skorina: Mr. Treasurer, thanks for taking my call in the middle of a holiday weekend. I’m sure the voters will be glad to know that you’re at your post on a Sunday afternoon while they’re home firing up their grills. Loftis: Please call me, Curtis, Charles; and I’m glad to speak to you. I should thank you for coaxing my off my tractor on a Sunday afternoon. I’m afraid I get a little obsessive about clearing my land. Skorina: Beating back the wisteria must make a nice break from the office, though, Curtis. From what you’ve told me you spend most of your time trying to decipher all of the investment contracts and legal documents you inherited last year. Loftis: I’m afraid that’s right. I campaigned on the issue of transparency in the state’s revenues and expenses, and I’ve discovered that things are even murkier than I expected. Regarding the state pensions, I’ve concluded that we, like many public plans, have no clear understanding of how much we’re paying our hedge fund and private equity managers. Skorina: Don’t you get bills and statements from the general partners that specify how much you’re being charged? And isn’t it spelled out in your partnership agreements? Loftis: Oh, we get lots of statements, but it’s not that simple, especially with alternatives. Most firms “net” the expenses against earnings in each period. But they usually DO NOT present a bill at the same time, much less one that explains in detail what services we are being billed for. Often there will be several fees in one “net”, and without that information one can never be sure what is being paid. Fees in a “net” might be management fees, incentive fees, organizational fees, back and middle office expenses, partnership expenses, etc. Most public plans in the US, whether they admit it in public or not, have significant deficiencies in their back and middle office operations which make it hard for them to track these expenses and to challenge them when necessary. I believe these deficiencies are important but overlooked drivers in the underperformance of these plans. Only in this bizarre world of public pension plans can a $20 or $30 million bill be presented and paid without explanation. I sometimes wonder what would happen if I sent a Wall Streeter a bill for $30 million, with no explanation! Skorina: Curtis, wait a minute. Are you telling me the South Carolina pension system does not really know what they are paying their alternative managers? I find that hard to believe. Loftis: That’s exactly what I mean Charles. And it is not just us here in South Carolina; it’s a problem that most plans have! SC is like a laboratory to me…I dive deep into the files, reading contracts and PPM’s and side letters and the like. I find all sorts of problems, then I check with my Treasurer and CIO friends around the country…and they all have the same problems to one degree or another, they are just reluctant to admit it in public. My big complaint is that it’s too hard to get accurate information on what the managers are charging. Let’s start with the big picture and then work our way down to some specific contracts. Challenge number one is the system bias against full disclosure. Let me ask you: what treasury or investment office wants news of a bad year for pension fund performance to hit the front page? And they don’t really want details of huge fees to be discussed in the newspapers. Retired pensioners in my state average about $19 thousand a year. It’s hard to explain to someone in that situation how we justify paying hundreds of millions to Wall Street managers. And, just to be clear, sometimes I do think those fees are justified. It’s not fees per se that bother me; it’s the lack of transparency. We can’t compare costs to performance until we get a grip on the costs. Most of those fees and expenses are netted against the pension’s partnership share in a fund. They usually don’t even show up as a separate line-item in the official audited income statement. They’re set out in a foot-note, and sometimes they’re after-the-fact estimates, not audited, real-time numbers. Wall Street is not unhappy about that netting of fees. The headline risk for them fades away. Skorina: So what’s getting in the way of transparency? Loftis: Several things: onerous confidentiality agreements, sloppy and delayed billing and accounting, lack of sufficient back- and middle-office staff, over-lawyered contracts and complex fees schemes, and the lack of political will in many pension funds across the nation to become transparent and accountable to the people they serve. Why do you think I’m in my office seven days a week? It’s not because I have no life, it’s because rigidly enforced confidentiality agreements forbid my senior staff, including, if you can believe it, most state lawyers from reading the documents. Skorina: You’re kidding! Loftis: It’s true. According to many of these agreements, I can’t let others read this stuff without breaching a contract. Now, I wonder who thought that one up. The investment managers can use their lawyers, but according to the agreements, I can’t use mine. These contracts are rigidly enforced by our state investment commission (the RSIC), even more than by Wall Street. My lawyers can’t see these documents. The Governor’s lawyers can’t see them…even the Attorney General himself can’t see these documents! It is a way that state investment authorities across the country escape meaningful, credentialed oversight. It is unacceptable and I am working to remedy the situation. Skorina: So what is it about the contracts themselves that bother you? Loftis: Let me count the ways. First, to put it as kindly as I can, I would say that most of these investment contracts are broadly written but narrowly interpreted. Despite what the contract may say about partnering and sharing, every single cost, fee and charge, down to the last cup of coffee is thrown into one incoherent billing statement or “net” by the manager. That might even include costs which don’t contractually belong to us at all. And it’s catch us if you can. I can tell you plainly that what is told to us orally by some of these money management firms as to cost sharing and all, comes out quite differently in the fine print in the funding agreements and fee agreements. And these fee structures are really complicated. I’m not a CPA, but I’ve run a business for thirty years. I do know how to read a contract and work out billing statements, and I can tell you this stuff is thick and dense. There are setup fees, organizational fees (amortized over years), back and middle office expenses, transaction fees, subcontractor fees, trading fees, and more fees. Let me give you just one big, ugly example. This concerns a certain large alternatives manager, with whom we have placed a considerable amount of money, and whom I shall not name. I noticed that fees, on a rough percentage basis, looked too high. I asked the RSIC, and within a week of my asking, the company restated its fees downward by $18.1. That’s real money, Charles, even on Wall Street! When I pressed for the reason I was told it’s a reporting error! We are also now renegotiating the fee structure with that firm, and this means better net returns for our pensioners. Are we the only public plan in the country where this type of reporting error occurs? No, but by requiring these types of analysis, in fact analysis done by very few plans, we are able to prudentially manage what is becoming a significant drag on our plan. Skorina: So after all this, do you still think there is a role for hedge funds, private equity, and fund of funds? Loftis: Oh, yes; absolutely. Many of these managers are exceptional investors. But I want to know what I am paying and then I can decide if their performance merits the fees. Give me outstanding performance and I can hold still for a higher fee. But transparency has to happen first. And when transparency comes, so does accountability. My complaint is that I can’t tell you with precision what our fees are. And even performance gets tricky. The consultants and money managers have all sorts of ways to measure the performance and, and they have their own biases. Remember: no one wants to say that they recommended a bad manager or that your client is a turkey. There has to be an element of trust when you do business with people. If we can’t even trust a firm to bill us properly, how can we trust them carry out their other duties and to generate the performance they’re promising? Skorina: So Curtis, what’s the big take-away from all this. If you were giving a speech to your peers, what would you say? Loftis: First and foremost: U.S. pension funds are the largest inflows of cash to Wall Street. We are the people who should be driving the bus; we shouldn’t be riding in the back. Second: most plans don’t yet have the ability to really match performance to costs for the reasons I cited above. As an aside, I think the GASB rules on pension accounting are misguided. They basically state that if the fees numbers are not readily accessible we don’t have to report them on a separate line…or in other words in a manner that is discernible to the average reader. I love that. Also, there are these preposterous rate-of-return assumptions that the public plans have in place. They all insist they’re going to earn 7 percent or more going forward. Who believes that? We’ll be lucky to get half that in today’s world. Skorina: I really appreciate your time, Curtis. Any last comments before we wrap up? Loftis: Well, I love my work and I think it makes a difference, Charles. I know that things are not going to change over night. But public pension funds have the money and we can demand change on Wall Street. If we can’t level the playing field then we can go back to liquid markets in stocks and bonds until the pain and reverse flow make the hedge funds and private equity shops rethink their position. If that is what it takes to do the deal, then they will come around. I know a lot of people won’t like hearing what I have to say and the system will eventually chew me up and spit me out. But in the meantime, I can at least begin a national conversation that affects most pension plans and millions of hard-working people. It’s time those of us entrusted with those assets stopped worrying about raising money for the next election and started looking our for the retirees and the taxpayers. Skorina: Thanks, Curtis. Enjoy the rest of your weekend. Loftis: Good talking to you, Charles. Let’s stay in touch.

]]> http://www.charlesskorina.com/730/feed/ 0 http://www.charlesskorina.com/678/ http://www.charlesskorina.com/678/#comments Mon, 28 May 2012 18:20:44 +0000 charles http://www.charlesskorina.com/?p=678 INTRODUCING SAM GALLO, UNIVERSITY SYSTEM OF MARYLAND FOUNDATION’S NEW CIO:

In May I successfully concluded a search for a new chief investment officer for the University System of Maryland Foundation with the appointment of Samuel N. Gallo, CPA, CAIA, BS in finance and BS in accounting from the University of Illinois, 1999.

Leonard Raley, the president of the foundation, and David Saunders, the chairman of the investment committee (and co-founder of K-2, one of the industry’s largest fund of hedge funds) were instrumental in defining and driving the search.

I recruited Mr. Gallo from the New York City office of PricewaterhouseCoopers (PwC), where he was a Managing Director working with leading hedge fund and private equity asset managers as well as institutional investors on industry best practices.

He started as an equity analyst with Arthur Andersen then, in 2002, he jumped into trading fixed income, equity futures and options, using his own money; a gutsy move for a young guy with a family.  There were three more years as a trader for a proprietary trading group in Chicago, and a year at a multi-strat hedge fund before moving into consulting in 2008, first with Ennis Knupp, then with PricewaterhouseCooper.

At Ennis Knupp his biggest client was the U.S. Treasury, where he helped Secretary Henry Paulson with their 2008/2009 financial relief programs.

In a prescient move in January (when Sam was already on our short list), Money Management Intelligence, a publication of Institutional Investor, gave Sam one of its Rising Star awards.  They cited his consulting work for PwC, including testimony at the Department of Labor on the characteristics of hedge funds and private equity investments.

It’s good to be able to find someone like Sam Gallo; what’s less good is disappointing so many other outstanding candidates.  I want to sincerely thank every one of them for the time and energy they spent in helping us through the process.

How to find a CIO:

Our initial screen for the USM position included several hundred sitting CIOs.  Many of them expressed interest in the position, and a number made it into the final rounds.

There are some 200 public pensions, 100 endowments, 60 union plans, and 85 foundations in the U.S. who employ a CIO or equivalent.  Add the various other tax-exempts, not to mention hundreds of corporate plans, and you have over 1,000 people.  Most of them make less than $300 thousand and are interested in moving up.  We didn’t hear from all of them, but it sometimes seemed as if we did.

We also looked at hundreds of senior portfolio managers and traders at pensions, hedge funds, long-only firms, private equity funds, and investment banks.  And we talked to many consultants.

We started with more than 700 queries and resumes and soon winnowed them down to about 50 who met the basic criteria.  Then the hard part commenced, trying, as always, to quantify and rank qualities that are not easily quantifiable or rank-able.

This assignment, like all my work, could only be effectively executed because I thoroughly know the territory.  Over three decades I have assembled a custom database of contacts, compensation figures, resumes and relevant industry information, all tailored to the special needs of boards of trustees and CIOs of endowments, foundations, pension plans, and the heads of hedge funds and large money management firms.  This furnishes the context I need before I ever pick up a phone to speak to a candidate.

I have evolved a recruiting methodology which centers on several rounds of extended, open-ended dialogue with candidates about the specific issues pertinent to the job.  Each round is documented and the next round is re-focused based on feedback from the client.  It’s not the fastest way to do things, but it leads to the best outcome.

The questions I start with don’t have right or wrong answers.  Good answers usually begin with: “It depends on….”  Eventually you get past a candidate’s talking points and start to understand his or her thinking process.

The people I recruit are investment managers, and managers must be decision-makers.  I must be able to tell my client that a candidate can cut through the fog of data and opinion to arrive at a firm, actionable conclusion.  Then I need to know that he or she can communicate that conclusion clearly, and defend it against criticism.

When I can bring candidates like that to my client, I know I’ve done my job well.

Sam Gallo is that kind of candidate, and I congratulate him on his appointment.

Farouki Majeed – a CalPERS vet heads back to Ohio

Interview with Peter Stein: an endowment CIO reinvents himself

Risk management: strategic or tactical?

———————————————

By Mark A. Schmid, VP & CIO and Que Nguyen, MD of Strategy – The University of Chicago

Introduction

The crisis of 2008 and the ensuing losses in risky portfolios, including endowment portfolios, continue to affect the financials of universities, despite the rebound in asset prices over the past two years. Although the smoothing inherent in most payout formulas dampened the immediate impact of investment losses, it also spread out the pain over a longer time period. Endowments have always been and continue to be institutions with a long term outlook for investments, but universities do have immediate financial obligations in their day to day operations.

Hence, the singular focus on long term investing had the unintentional impact of shifting much of the burden of bearing short term volatility onto the operational side of the university. In order to balance these risks more equally between operations and investments, the University of Chicago set out to examine our long term investment strategy from a total enterprise perspective.

The first step of a total enterprise approach was a deeper integration and communication between the Investment Office of the University and Finance and Administration.

This included Investment Office involvement in budget planning and review, liquidity and capital resource planning, and coordination with the administration on operating plans. As the University was embarking on an ambitious long term growth plan, including the development of new programs, involving increasing faculty and capital expenditure, the coordination efforts underscored the need for the different parts of the University to have realistic, long term plans in place.

In support of these efforts, the Investment Office launched a project to develop a well structured framework for our investment strategy, which takes into account the particulars of our University, such as growth, debt, and wealth.

While many have likened the Total Enterprise approach to the asset-liability framework often used by pension plans, we found that the problem was far more complex. Pension plans have a well defined liability imposed by regulatory and accounting practices. Universities are largely free from such regulation, and as such our liabilities are much less defined. A university’s risk is both much different as well as more varied than that of a mature pension fund, where the liability risk is dominated by interest rates. Furthermore, the variety of investments in endowment portfolios creates challenges in assessing high level economic risk, as well as translating that high level risk budget into an implementable portfolio strategy. We now turn to a discussion of how we approached this project.

TEAM Discussion

In the beginning of 2010 we launched an initiative to evaluate the overarching investment strategy and risk taking of the endowment in the context of the overall University. This project, called Total Enterprise Asset Management (TEAM), sought to frame the investment strategy of the endowment in the context of the long term operating goals and risks of the University, rather than as a stand-alone, total return fund.

In marrying the asset (the endowment) and the liability (the University’s operating goals) sides, we found that the problem was large and complex, and needed to be reduced to a set of well understood, common economic drivers that could be evaluated. For example, if we believe that GDP growth influences both investment returns and growth in Grants, how can we measure that? In this context, the TEAM approach had several sub-components to achieve project goals. These included developing a fundamental economic model of risk expected returns, economic analysis of the University’s operating exposures, and then marrying both in an internally consistent Monte Carlo simulation to determine the trade-off between risk taking and wealth accumulation for the University.

Risk and Liquidity Modeling

The “endowment model” of investing emphasized capturing illiquidity premia with the belief that illiquid categories added diversification benefits to a portfolio. However, in tail events such as 2008, much of these diversification benefits evaporated at a time when liquidity was challenged.

To monitor and develop a deeper understanding of risks in the endowment portfolio, we use a Factor Risk Model. We extensively map detailed portfolio holdings to 90 public market proxies, and the model then calculates factor exposures and a volatility estimate for each fund and the portfolio in aggregate.

Currently, Staff monitors exposures to U.S. equities, emerging markets, credit, real estate, commodities, interest rates, and inflation factors, in addition to the global equity factor. The Global Equity Factor (GEF) has become our primary risk governance target, as equity factor risk accounts for over 90% of the volatility the portfolio experiences. The table on this page summarizes our factor exposures as of October 28, 2011.  (See Figure 1 below)

Fig. 1

Factor Risk Model

Footnotes

1. Multiple-regression beta. Answers the question: “If there is a 1% move in a

factor and that move is uncorrelated with the moves in the other factors then

what will the percent move be in TRIP?”

2. Single-regression beta. Answers the question: “If there is a 1% move in a

factor and all the other factors move by their usual amount in conjunction

with the event that caused the factor move by 1%, then what will be the percent

move be in TRIP?”

We update this information weekly and distribute to the Investment Committee and senior members of the University Administration. This weekly report provides valuable look-through information that more precisely describes our risk exposures based on true economic risk drivers, as compared to a more traditional assessment of risk based on asset class classifications. We continuously review this model and enhance it as the market and portfolio evolves.

In the past year, we have built several improvements into the model, including: integration of the GEF beta; expansion of the mapped index population; improvements in the mapping process; incorporation of fund-level debt into levered betas; movement to more robust data & regression methodologies; introduction of a new data warehouse; development of a new robust risk architecture to support complete rewrite of the model/ risk engine as an automated modular solution with error handling and a suite of risk diagnostic tools, to replace the initial brittle spreadsheet model; ability to produce new or ‘alternate-view’ risk measures in production; new suite of derivatives’ analytics and risk metrics; and created a full-revaluation ‘fat-tailed’ VaR engine.

In addition to market risk, we have also developed an integrated liquidity model for the total endowment pool. Using this model, we project ten years of monthly flows by incorporating the most up-to-date information available for cash flows, market valuations, and redemption terms.

The asset-level liquidity model consists of an illiquid drawdown model for private investments and a redemption model for hedge fund and liquid investments. Return assumptions are examined via scenario analysis, providing to a deep understanding of the potential range of future asset allocations and liquidity, as well as expected returns.

Expected Returns Framework

In the same way that we sought to understand the economic drivers our risk position, we sought to understand the fundamental drivers of investment returns. Long term expected returns had always been based on looking at long histories of asset class returns and projecting them forward.

While this approach is probably sound for an economy and capital market experiencing little dislocation, it can lead to very misleading results if we are starting from a point of extreme dislocation in the economy and markets. For example, over the past 30 years, bonds have returned 11.5% per year. However, with yields on 10-year Treasury’s now hovering near 2%, such an expectation would seem ridiculous.

Comparatively, stocks have returned 10.8% over the past 30 years. However, 30 years ago, the trailing P/E multiple on the S&P 500 was 8x, compared to the 15x it currently represents, and contributed an annualized gain of more than 2% per year to returns. Unless we expect P/E multiples to close to double in the future, this 2% component of past returns is not repeatable.

Our proprietary expected returns model is designed to evaluate the underlying economic drivers of long term returns for a variety of asset types. Here, we show the important drivers for equities and bonds.  (Figure 2)

Fig. 2

Expected Returns Framework

As can be seen from the graphics above, fundamental drivers of returns include GDP growth, inflation, and risk premia. At this stage of the project, we chose to focus on two major asset categories, Equities and Bonds in order to simplify the problem of integration with the University financials. Our risk analysis of the endowment portfolio had found that the dominant risk factor in endowment was an equity factor, with a secondary factor being a “safe assets” or bonds exposure.

This had become more pronounced in the financial crisis, as the correlations of a variety of risk assets moved closer to 1, and even post crisis, remained elevated. A realistic assessment of the benefit to equity risk taking is crucial in properly evaluating how much risk taking is warranted. For example, if equities are expected to outperform bonds by 4% per year, much more risk taking is warranted than if equities are only expected to outperform bonds by 2% per year.

As our strategy of investing in private structures and hedge funds had added significant alpha to returns over time, we also modeled in the returns and “alpha” that was aimed to capture the benefits of manager selection, liquidity premia, and other endowment-style advantages.

Economic Modeling of University Financials

The next step entailed modeling University financials with respect to economic drivers consistent with our expected returns. In using the University financials, we focused on examining figures from FY 1992 to 2009, as we believe the accounting practices since then as well as the operating of the University since that time is closer to current practices than pre-1992 periods. In some cases, such as evaluating compensation, we extended the dataset further back, to the 1970s to better capture the effects of inflation.

In modeling the University financials, we simplified the problem by focusing on the broad categories of income and expenditure sources as follows:  (Figures 3 & 4)

Examples of relationships we had found include a positive relationship between Gifts and Equity market returns, Grants and GDP Growth and Deficit Growth.  We also found strong absolute growth trends in Net Tuition and Compensation, without much inflation impact.

Integration of Investments and University Fundamental Drivers in Monte Carlo Framework

While the main economic drivers of Investments and University financials can be identified, they are by no means deterministic. For example, we know that there is a strong relationship between GDP growth and Grant growth, any given year can underperform or outperform the central relationship if the University has interesting project ideas or successes. Thus, in marrying the asset and liability side, a significant amount of uncertainty must also be incorporated in the evaluation process in order to properly trade off risk taking and wealth accumulation at the University. In doing so, we turned to Monte Carlo methods.

Our approach to Monte Carlo for TEAM incorporated two important features. The first feature is that the Monte Carlo incorporates some mean reverting features not always considered in financial modeling, but is more reflective of economic reality. Secondly we sought to create internally consistent scenarios for the economy, the University and the investment markets, rather than model them separately. The graphic on the following page illustrates this integrated approach within our Monte Carlo: (Figure 5)

Fig. 5

Drivers in Monte Carlo Framework

To this end, we started with central scenarios for the economy and incorporated the long term capital and growth plans for the University. Some of the key underlying variables include the following:

Key Economic Variables

◆ Inflation

◆ Real GDP Growth

◆ Profitability relative to GDP

◆ P/E Multiples

◆ Real Bond Yields

Key University Variables

◆ Net Tuition Growth

◆ Gifts

◆ Grants

◆ Auxiliary Income

◆ Compensation

◆ Supplies & Other

In generating economic scenarios, we used a bootstrap of historical experience since the 1950s to create realistic scenarios of the evolution of the economy. We also added random noise to simulate the uncertainty of the relationship between the University, investment markets, and the economy. Our simulation involved 1000 scenarios over 20 years. Depending on the amount of equity risk in the endowment portfolio, the University wealth outcome at the end of 20 years varies widely. At the end of the 20 years, we evaluated several financial metrics and related them to the amount of equity risk taking in the endowment portfolio.

Any number of financial metrics can be examined, either on the low or high end. We chose to examine the metrics characterizing the risk of an undesirable financial outcome to the University. The higher the probability of such outcomes, the more likely our operating goals would need significant adjustment (called “off-ramps”). These included the probability that:

◆ Endowment falls below Restricted Endowment adjusted by inflation

◆ Endowment falls below Restricted Endowment adjusted by GDP growth

◆ Ratio of Real Endowment (i.e. inflation adjusted) to Faculty falls more than an acceptable level

◆ Ratio of Expendable Endowment to Debt falls below an acceptable level

Additionally, we examined the expected accumulated wealth of the University vs. the one year drawdown of the endowment portfolio. A greater likelihood of a significant one-year drawdown represents a greater level of operational risk to the University.

The graphs below illustrate this exercise.  (Figures 6 & 7)

Fig 6

Probability of Significant Off-Ramps vs. Equity Exposure

Fig. 7

Range of Endowment Balance and Probability of Drawdown: Year 20

The top graph clearly shows that, given the University’s growth liabilities, there is a benefit to owning growth oriented assets (i.e. equities). However, beyond a beta of 0.6-0.7, the downside risks no longer decrease as the volatility of equities begin to offset their growth benefit to the University. Read differently, this graph seems to say that the University does not “need” more equities than a 0.7 beta would imply.

The red line in the second graph shows that the University can benefit from owning more equities because of the long term wealth accumulation benefits. The blue line shows the risk of a significant wealth drawdown over the course of one year, and includes the impact of the payout in addition to the market returns. The blue line is higher for an all fixed income portfolio, because bonds currently yield so much less than a typical payout. Adding equities decreases this risk through growth benefit up to a point.

At higher and higher levels of equities, drawdown risk increases more quickly, while incremental wealth accumulation shrinks. Beyond a 0.7 to 0.8 beta, the incremental wealth accumulation is small relative to the increase in short term drawdown risk for the endowment.

Qualitative Risk Assessment

To complement our quantitative framework, we also engaged in a qualitative assessment of University risk profile. While the quantitative approach of the Enterprise Model provides the foundation for strategy, a qualitative approach supplements the model by allowing the incorporation of non-quantified considerations.

During a strategy status update in the November 2010 Investment Committee meeting, it was suggested that the Investment Office consider the risk profile of another well-defined institutional investor to allow for a robust assessment of risk. It was concluded that a large pension fund could be a relevant comparison since endowments used to be managed at a 60/40 risk profile. Many mature large pension plans today target 55-60% global equity risk (GEF); whereas, large endowments have migrated to an 85-90% global equity level over the past 10-20 years.

An example of a reason universities can take more equity risk is that we have the ability to reduce costs and capex, whereas defined benefit plans have little leeway in reducing promised benefits. An example of a reason universities should take less risk than a pension plan is that Universities can’t issue equity to fund shortfalls, similar to corporations.

Selection of Investment Risk Profile and Illiquidity Budget

After a thorough discussion of the quantitative analysis, the qualitative assessment, and a review of peers, the Investment Committee decided to have a long run, central tendency global equity beta of 0.75, with authority to vary between 0.7 and 0.8. Additionally, we chose a long-term illiquidity target of 35%, including private investments and sidepockets. We viewed this as being a sensible position which balances the desire of wealth accumulation with appropriate levels of institutional risk taking.

Strategic Asset Allocation

Having chosen our high level risk posture of global equity exposure and illiquidity budget, we then set out to form a sensible portfolio. For example, how much of our global equity exposure should come from private equity as opposed to real estate? In this task, we first expanded our expected return model to cover more asset classes, including Global Equity, Private Equity, Real Estate, Distressed Debt, Absolute Return, Natural Resources, Fixed Income, and Credit. We also added a new investment category, called Portfolio Protection, encompassing tail hedging strategies that seek to benefit disproportionately when markets are volatile to the downside, and budget for small, contained losses when markets are more stable and rising.

While many institutions embed such strategies within a hedge fund portfolio, we chose to make the category an explicit capital allocation commitment for the sake of transparency and clarity from a governance standpoint.

Given a set of expected returns and a risk model, it is tempting to simply construct a mean-variance efficient frontier. However, efficient frontiers are most meaningful when the curvature is steep enough to distinguish between the risks and returns of portfolios on the frontier. As constraints are imposed, the available efficient frontier shortens and flattens. The graphic (figure 8) illustrates this principle.

Fig. 8

Efficient Frontier: Normal Economic Scenario

After imposing all our constraints, the available efficient frontier in green has a minimum risk point of 13.5%, and maximum risk point of 15.5%, and the difference in expected returns is 0.7% per year. The differences in portfolio composition can be significant, but the expected outcomes are not meaningfully different. Hence, in choosing a portfolio, we should consider alternative economic scenarios which may occur over next decade.

For example, our risk model, liquidity model, and expected returns model were all based on assumptions that the economy return to a “normal” state of growth and inflation over the next decade. However, in studying history, the last 10 years was a period of below normal growth accompanied by high volatility, while the 1990s were a period of above normal growth accompanied by low volatility. We simplified potential economic scenarios into four categories:

◆ Normal growth a period of moderate inflation and real growth exceeding debt growth

◆ Stagflation a period of high inflation and real growth less than debt growth

◆ Deep Recession/Debt Deflation a period of zero to negative inflation with debt exceeding real growth

◆ Innovation a period of low to zero inflation with real growth far exceeding debt growth

In studying the history of financial markets, we can understand the impact each scenario will have on asset price fundamentals, and hence investment returns. For example, in an Innovation environment, we would likely witness strong GDP and EPS growth along with elevated P/E multiples for equities. We also looked at the risks and challenges each environment might pose to the University: (Figure 9)

Fig. 9

Economic Scenarios

We developed return and risk expectations for each economic scenario. Within each economic scenario, we formed maximum return portfolios with 0.75 beta to GEF and 35% illiquidity constraint. We found the following to be true of the portfolio in the four scenarios:

◆ Inflation Real assets will be preferred

◆ Growth Private Equity will be preferred

◆ Deflation/Recession Long bonds and Portfolio Protection will be preferred

◆ Balanced/Normal Absolute Return will be preferred

Each portfolio will have similar outcomes in a normal environment, but they have more differentiated outcomes in other scenarios. No single portfolio will be the “best” for all environments. Thus, the appropriate portfolio should take into account both the likelihood of economic regimes as well as the vulnerability of the University in each regime.

In our analysis of the types and magnitudes of risk to the University in each scenario, we were interested to find that the University is much more vulnerable in a lingering deflation environment than in a stagflation environment.

In a deflationary environment, higher economic and political uncertainty creates challenges in maintaining gifts and grants growth. The need for financial aid grows as tuition growth becomes more constrained.

Although the nominal cost of debt decreases, the real cost of debt rises when growth in all sources of income become more difficult. By contrast, in a stagflation environment, universities have been able to raise tuition above the rate of inflation while constraining compensation growth below the rate of inflation due to a poor labor market environment. At the same time, the real cost of debt declines particularly for universities with long dated fixed rate debt. A stagflation environment may not be enjoyable, but by no means will it do as much harm to a university as a deflationary bout. Thus, in assigning probabilities to each economic scenario, we overemphasized the deflationary risks, as we felt the pain in such an outcome would be more severe than in a stagflation outcome. Based on this analysis, we were able to form a portfolio that integrated total enterprise and factor risk budgeting within a traditional asset class framework.

Summary and Implications

The TEAM project was completed over the better part of 18 months and has changed the governance of our investment process. Here we discuss three important implications of our chosen path:

◆ Focus on factor based risk management

Endowments have traditionally de-emphasized risk management in the belief that risk matters less in the long term. The TEAM approach puts risk monitoring and budgeting at the center of our governance structure. While we continue to pursue strong returns, we must do so without taking on excessive risk to the University.

◆ Dynamic Adaptive Expected Returns

Our expected returns model is fundamentally based, and thus evolves with market fundamentals.

For example, if interest rates were to suddenly rise to 7%, this would lead to higher expected return for fixed income. Likewise if P/E multiples increase significantly, this would lead to lower expected returns for equities. This dynamic, adaptive framework works to center long term financial planning on a more sustainable growth path. As the past 2 years have seen very strong returns to risk assets in our portfolio, our expected returns model has led us to decrease expected returns going forward. In this way, the University does not make plans based on unsustainable market dislocations.

◆ De-emphasis of Peer Comparisons

Our decision to have a lower equity and illiquidity risk posture than many large endowments creates an incomparability between our returns and those of our peers. A more appropriate comparison would require a risk adjustment of returns to similar risk levels. In adopting the TEAM approach the Board of Trustees and the University have accepted that peer comparisons are less important to the long run health of the University than tailored risk management.

The TEAM project has been a time consuming exercise for the Investment Office, and has involved the University Administration and the Investment Committee of the Board of Trustees. However, now that the framework has been built, we have the ability to revisit the analysis as conditions at the University change.

While our goal remains to generate strong investment returns, we now explicitly recognize that this has to be done in a risk posture appropriate to the goals and needs of the University.