Photo Source: Dartmouth Investment Office
For the fiscal year ending 6/30/2016, Ivy League endowments were all over the place, from Cornell at -3.3% to Yale at 3.4%. How are these large endowments managed, and what makes it so hard to hold onto a good Chief Investment Officer? Dartmouth’s endowment returned -1.9%, and they’re looking for a new CIO for the third time in ten years.
Dartmouth’s endowment is one of the largest in the country. And it plays a crucial role in the College’s financial picture. The endowment is worth about $4.5 billion and contributed over $200 million to College operations during fiscal year 2016 – about 4.5% of the portfolio’s value. Needless to say, the portfolio’s investment return matters a lot.
But this isn’t your parent’s investment portfolio. Less than half of it is invested in liquid, publicly-traded securities. Most of the portfolio is committed to non-public investments. This is the strategy described by Yale CIO David Swensen in his book, Pioneering Portfolio Management (2000). It’s often called the “Endowment Model.” It has four major tenets:
- It is equity-biased and return-seeking. Income is an afterthought. This approach looks to maximize total return, so it favors subordinated claims on cash-flow, as these tend to have the most upside potential. Bond holdings are minimized.
- It is broadly diversified. Diversification is embraced as a way to mitigate risk. That means that the endowments invest globally, in public or private markets, in developing or developed economies. Diversification is applied to asset classes, but also to risk factors – like company size, exposure to commodity prices, geopolitical risk, currency risk, and so on.
- It has a perpetual investment horizon. The portfolio doesn’t restrict itself to public securities. It’s important to keep enough liquidity to meet and needs for cash, both inside and outside the portfolio. But all things being equal, less liquid investments should return more than liquid investments. They have to compensate investors for their illiquidity. Illiquid investments also imply that year-to-year measurements can vary a lot. Private market valuations can be more art than science. Long-term performance matters far more than annual comparisons.
- It relies upon active management, headed up by a strong Chief Investment Officer. The CIO leads a team who oversee a group of highly-qualified external managers. The external managers focus on specialized areas. Discovering, understanding, and evaluating these asset managers is principally what an endowment investment office does. It’s critical that the office establish high-conviction long-term relationships, and structure them so that everyone’s incentives are aligned.
This model divides the portfolio into five or six roughly equal classes, then uses two or three managers within each asset class to select the actual investments. With 15 to 20 external managers, the CIO’s job can be quite demanding. So it’s no wonder that Dartmouth’s CIO wants to take a little time off.
Dartmouth’s portfolio owns public equities, private equities, hedge funds, natural resources (like oil and timber), real estate, and bonds/cash. This is a large portfolio that only provides a modest level of support to the College every year – about 4%.
Source: Dartmouth Endowment Report, 2015
The proof of the pudding is in the eating. Most large endowments work on a fiscal year ending June 30th. It takes a while to determine performance. As mentioned above, private market valuation can be challenging. It’s not just that Uber or Canary Wharf are hard to evaluate. Valuation relies on accounting reports, among other factors, and these may not be ready until August or later. And a fair valuation depends on more than free cash flow and discount rates. You also need to look at management skill, industry structure, competition, economic growth, and other factors.
After the all managers deliver their performance, the College prepares its aggregate performance. A school’s performance can be compared with a 60/40 stock/bond index, as well as with its peers. Everyone talks about performance, though, but hardly anyone mentions risk. But using the variability of returns as a proxy for risk, we can see how Dartmouth’s 10-year return stacks up compared to with its classmates:
Source: University Endowment Offices and Charles A. Skorina Associates
Dartmouth, Penn, and a 60/40 stock/bond index have had middling performance, although the index got there with a lot less downside. Also, an index costs a lot less to administer. Columbia, Princeton, and Yale have had the best performance, but Columbia experienced a much lower drawdown during the financial crisis, so their risk numbers are lower. The back-row kids are Brown, Cornell, and Harvard. Both Cornell and Harvard have both gone through four CIOs in the past 15 years. Their high-risk/low-return results have been a source of heartburn for the schools.
This brings up an interesting issue. Columbia, Princeton, and Yale have had stable management in their Investment Offices. Yale’s David Swenson has there been over 30 years; Andrew Golden worked with Swenson until he went to Princeton in 1995; and Narv Narvekar spent the last 14 years with Columbia. By contrast, management changes seem to be associated with lower returns.
The “Endowment Model” requires talented managers, talented staff, and a strong commitment to long-term returns. This commitment comes from the stability of the parent institution. But strong returns also require strong leadership. Management matters.
Douglas R. Tengdin, CFA
Chief Investment Officer