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Which Way to Go for Endowment Expertise?

Outsource investing, or bring a chief investment officer on board? The decision often involves twists and turns.

By Karla Hignite

Clearly, the CIO position is evolving in interesting ways that you might want to follow.

An Incremental Transition

Jay Namyet spent his early career on Wall Street. Twelve years ago, he and his wife decided to step out of the professional rat race. They took a year off, touring the country in search of locations offering a high quality of life. They eventually settled in Eugene, Oregon. Four years later, an investment position opened up in Namyet’s new hometown—at the University of Oregon Foundation.

Namyet describes the mutually beneficial situation: “The institution was looking for a skill set for which it was having difficulty attracting sufficient candidates. And I had been looking for opportunities that provided greater meaning than the sometimes hollow victory of Wall Street investing.”
 
Once Namyet signed on, it wasn’t a pain-free transition for either side. The initial configuration was not for a CIO position but for an investment coordinator. The title didn’t bother Namyet, but the job description did. “I honestly didn’t think this was something that I would want to do. It looked very administrative,” says Namyet. During the interview, he asked the investment committee chair whether the job responsibilities could be adjusted over time to better suit the capabilities of the candidate. The committee seemed to be expecting that question, says Namyet, and the answer was, “Yes.”

It took several years of what Namyet calls “psychological transitioning” for everyone to align with the needs of the current staff-driven model. “I came in,” he says, “knowing this would be a long-term process that would hinge on my ability to convince the trustees I was someone they could trust.” The change also required a learning curve for Namyet and committee members. Because he was well versed on the investment business, Namyet was confident about preparing trustees to embrace new asset categories. He was not experienced in endowment management. “In some ways it was probably beneficial, coming with a blank slate, because I was eager to learn best practices,” says Namyet.

Two years after Namyet was hired, the committee changed his title to director of investments and later to chief investment officer, his current title. He is quick to give credit to trustees, who made the bold move to begin shifting to a staff-driven model at a relatively small level of assets—approximately $200 million when Namyet arrived in 2000. At present, the foundation manages $650 million in total assets. “Although there were clearly some political issues to work through,” says Namyet, “the trustees were completely supportive of the initiative, understanding that the growing complexity of investments required someone’s full-time attention to oversee activities and relationships.”

Addressing Complexity

Other institutions have linked the creation of a CIO position to specific developments within their endowments.

Restructuring the portfolio. Craig Aase eased into his CIO role at Macalester College, St. Paul, Minnesota, in a fashion somewhat similar to Namyet’s. In Aase’s case, however, the new position had a lot to do with Macalester’s particular investment portfolio. “One major driver for our move forward with internal staffing is that we had a concentrated holding of a particular stock,” says Aase, an alumnus of the college. “By 2002, we completed liquidation and were free to restructure our entire portfolio and implement the kind of diverse asset allocation we wanted.”

It was at that point that Macalester created the chief investment officer position. Aase, who has worked for the institution for 30 years, became CIO. His earlier experience positioned him well for the promotion. Previously, he had served as controller and business manager before assuming the responsibilities of vice president of administration and finance in 1995. As vice president, Aase spent 25 percent of his time overseeing the college’s endowment.
 
With Aase in place to spend 100 percent of his time managing the endowment, Macalester made a number of changes. As a result of market corrections in 2001 and 2002, the college wanted to reduce its exposure to equity markets. At that time, Macalester had a target of investing 25 percent of its then $400 million portfolio into alternative assets. It has since increased allocations in that area to 40 percent, says Aase. The current value of the college’s endowment stands at approximately $675 million.

The significant shift into alternatives drove a number of new and more complex relationships with investment managers. “For us,” says Aase, “the decision to develop a CIO position was based more on our recognition that the kinds of activities we desired—for instance, increasing alternative investments through direct investment in partnerships—would require much greater operational attention.”
 
Investment committee members unanimously agreed that Macalester must become more nimble and opportunistic. Further consensus was of a more cautionary nature: In Macalester’s initiatives to replicate what many mega-endowments were doing, the college should be only as aggressive with alternatives as it was competent of executing related plans. “We did not want to overreach,” says Aase, “but to enter this arena incrementally.” Initially, that meant transitioning from a fund-of-funds model to direct exposure to hedge funds.

Aase and the investment committee next focused on real assets. They eventually achieved access to become direct investors in energy and real-estate partnerships, and more recently, buyouts. “We went in an orderly process,” says Aase, “based on where we thought we had the best capabilities at the time.”

In 2006, Macalester hired an analyst, allowing the institution to better monitor its manager structure and meet audit requirements. The additional expertise also allowed Macalester to move faster with sourcing for venture capital and buyouts.

Focusing on market volatility. The need for stronger internal focus on endowment initiatives likewise rang true for neighboring Carleton College in Northfield, Minnesota. “It takes time to stay on top of these more complex investments and relationships, whether you are evaluating what to invest in or monitoring performance and conducting due diligence,” says Frederick Rogers, Carleton’s vice president and treasurer.
 
As did a number of institutions, Carleton experienced significant volatility in endowment holdings during the late 1990s and early 2000s. With a new president in 2002 and consensus among trustees that the endowment required greater attention, the college hired Jason Matz as director of investments, in May 2004. Matz had been director of global equity research at an investment consulting firm as well as an investment analyst at a public pension fund in Minneapolis.
 
Together, they developed a model, since adopted by the investment committee, for staffing an investment office. The office staff includes Matz; a second investment professional; one clerical staff member; and an investment accountant, who was added to the team in 2007. The process included setting up a permanent office in Minneapolis, 40 miles from Carleton’s campus. “We felt it would be more productive,” explains Rogers, “for Jason to be located in a major metropolitan community, where he has greater opportunity for meeting with prospective investment managers and networking with other investment professionals.”
 
To reflect new staff responsibilities and a more strategic role for the investment committee, the college also re-evaluated and changed its consultant and custodian relationships and revamped its trustee investment policy. As a result, consultant and staff are becoming more proactive in suggesting and evaluating investment options. In addition, the role of the committee has been streamlined to enable decisions between meetings and to increase the focus on asset allocation and diversification rather than on selection of individual managers. While the expertise brought by staff has allowed Carleton to enter new investment sectors with greater confidence, the committee still plays a strong role, says Rogers. “We seek to use their expertise and time to help guide the staff and consultants as they develop well-researched options and new relationship opportunities.” Since 2004, the value of Carleton’s endowment has climbed from $511 million to its current $670 million.

Reluctance to Create the Role

The dynamics and structure of the investment committee can set the pace for some institutions when it comes to hiring an in-house investment expert. For example, the University of Kentucky, Lexington, has considered options for establishing a CIO position. But, so far, the formal CIO title and traditional role have not fit well within the university’s governance structure, says Susan Krauss, UK’s assistant treasurer for investments. Several reasons account for this. For one, the university’s five-member investment committee is a subset of the university’s board of trustees and meets only on a periodic basis. In addition, notes Krauss, the state’s governor appoints board members for six-year terms, and these volunteers may or may not have an investment background. Accordingly, says Krauss, committee members are not yet comfortable delegating to a CIO the authority for hiring managers and allocating investments. That comfort level is going to take time, she adds, and will require UK to build its internal capabilities first.
 
That said, Krauss’s transition during her eight years at UK to roles increasingly focused on the university’s endowment demonstrate UK’s incremental shift to more intentional investment management. When she started as manager of treasury services, Krauss was responsible for oversight of the university’s then $300 million endowment. She spent approximately 40 percent of her time on endowment accounting and served as staff liaison to the investment committee, along with the university’s treasurer.

While Krauss retained her existing endowment duties when she became assistant controller several years later, the university recognized the need to establish a separate endowment services department. Krauss then became director of investments and endowment services, spending half her time as investment staff and the other half overseeing endowment accounting, financial reporting, and the state’s matching-fund program. The latter, launched in 1998, matches dollar for dollar any private funds donated to UK for research-related endowments. To date, the university has received about $200 million from the state in matching funds. “Between market growth and matching gifts, the endowment began growing quickly,” says Krauss. UK’s endowment value zoomed from $500 million in 2005 to its current $980 million value.

During this period of rapid growth, UK’s investment staffing model continued with two individuals (Krauss and the treasurer) devoting only part of their time to day-to-day investment functions and working with consultants. “As we recognized how quickly we were approaching the $1 billion mark,” says Krauss, “we decided it would be beneficial to ask what it means to be a large endowment.” Staff selected six public institutions that had reported in the 2005 and 2006 NACUBO endowment studies that they had reached this milestone. UK employees interviewed representatives from each institution, focusing questions on staffing and governance structures (see sidebar, “Milestones May Prompt Reassessment”).

While UK staff learned that there wasn’t a “best” model, two points became clear, says Krauss. First, the university was at a point where it needed one person devoted 100 percent to investment management, albeit not yet with the title of chief investment officer. Consequently, as of July 2007, UK created Krauss’s current position as assistant treasurer for investments and added a manager of the endowment services department as a way to separate endowment investment and accounting functions. A second realization, based on staff surveying of other institutions, was an overall need to begin redefining the investment committee role to one that would become more policy oriented, says Krauss.

Reformulating Roles

Milestones May Prompt Reassessment

From 2005 to the present, the University of Kentucky, Lexington, has nearly doubled its endowment value—from $500 million to nearly $1 billion. Recognizing their need to understand the implications of reaching this milestone, UK staff interviewed six public institutions that had recently surpassed nine figures. Questions focused on staffing structures; asset-allocation strategies; use of money managers and consultants; and investment-committee composition, roles, and expertise.

“All had different governance structures and staffing models,” says Susan Krauss, UK’s assistant treasurer for investments. “One institution had decided to add a CIO [chief investment officer] when the endowment hit $300 million and another did so at $750 million.” As for the internal-versus-external hire debate, says Krauss, some said that they were not prepared to reward performance or to pay a $2 million salary, yet all recognized the need for someone in charge. Reliance on consultants also varied based on in-house staffing available to conduct due diligence. Interestingly, none of the institutions interviewed were selecting investments in-house, says Krauss. “While no institution said that breaking $1 billion ushered in a specific watershed event, all did use the milestone as an opportunity to review internal capabilities.”

In summary, UK staff reached several conclusions about what the $1 billion endowment mark means for their institution. They said that it’s a time to:

  • Give policies and procedures a thorough review. It might be appropriate to revisit and provide written definitions of the role of the investment committee (policy) and the role of staff (implementation) and to specifically define duties and responsibilities of each. Additionally, it might be appropriate to consider renaming the investment committee the “investment advisory committee” to reflect its policy role in relation to the staff role of policy implementation.
  • Evaluate the structure of the investment committee. Such a review seeks to ensure continuing knowledge on the committee based on term limits of current board members. Incorporating non-board advisory members may be a means to including individuals with hands-on investment expertise. This would strengthen continuity and investment expertise on the committee.
  • Perform an asset-allocation review. During the process, consider increasing the investments in alternative asset classes to improve returns and enhance diversification.
  • Consider establishing a CIO position. In doing so, keep in mind issues with regard to recruitment, retention, and compensation of an externally recruited CIO.
  • Develop a plan for increased staffing. Specifically, think about developing in-house expertise for specific asset classes.

Similar shifts in responsibility are taking place at other institutions. For the University of Oregon Foundation, committee member term limits accelerated the move to staff-driven endowment management. As terms expired, members were strategically replaced by individuals supportive of directional changes, says Namyet. Another breakthrough came from rewriting the foundation’s investment policy statement and its appendix, putting together a roles-and-responsibilities matrix. “All commented on and committed to this,” says Namyet, “including staff and our consultant. These materials identified who could make a recommendation, who could vote on a recommendation, and so forth. In essence, we institutionalized the process.” He says that this transparency of roles has made a world of difference in managing everyone’s expectations.

At Macalester, the investment committee still maintains decision-making oversight, but the day-to-day process is now staff-driven, says Aase. Likewise, Macalester’s reliance on an investment consultant has diminished, as Aase has taken over greater responsibility for setting the agenda, sourcing and evaluating managers, and conducting due diligence. The added tasks have meant some adjustments for Aase. “At first I had to depend heavily on consultants for portfolio design and implementation and had to learn about hiring managers in alternatives—just who is out there in this universe and how you differentiate strong managers.”

As UK moves toward its goal to become more staff-driven, part of Krauss’s role will include staying abreast of newer asset classes so that she can work with UK’s investment consultant to keep committee members informed. “When compared to other institutions of our size,” she says, “our allocations are fairly traditional, with greater emphasis on stocks and bonds. Over the last three years, we have established modest alternative-asset allocations. We will be working with the investment committee to expand our alternative allocations in the future.” In addition to building internal expertise, UK staff are also discussing how they might incorporate community and alumni advisors with expertise in investments.

Krauss knows this evolution of staff and committee member roles may take more time for UK than for other institutions. As a public university without a separate foundation for managing endowment assets, UK must issue requests for proposal for investment managers and consultants. Currently these come before the investment committee for review and approval, says Krauss. “We’re now in the midst of a search for an investment consultant, as we are in the final contract year with our current consultant. Once a new contract is in place, we will perform a formal review of our asset allocation, which will likely result in a recommendation to increase the alternatives exposure,” says Krauss. “And, as our investments continue to grow and become more complex,” she adds, “we will again need to consider our staffing model.” UK’s current endowment investment staff of less than two full-time equivalents is well below the average of five FTEs for endowments greater than $1 billion, as reported by the 2006 NACUBO Endowment Study, notes Krauss.

The Staffing to Match

Once the CIO is in place and additional oversight begins to pay off, more staff support is often in order. During the past six years, Namyet has added an operations person and an analyst to his staff. The job description for a second analyst is in the works, in part to assist with increased due diligence demands, says Namyet. “We project that, within three years, it won’t be out of the realm for us to reach $1 billion, so we’re continuing to enhance our internal capabilities.”

To Namyet, the economics of hiring staff are overwhelmingly compelling. “I don’t think there is a magical milestone at which an institution should hire a CIO,” says Namyet. Nevertheless, he says, there should be recognition that the investment business as a whole is much more complex than ever before and that institutions would do well to have someone paying attention to the endowment on a daily basis. “While you always have to be concerned about your overhead, wages don’t grow linearly. By developing a strong internal bench, you will come out far ahead as assets grow,” argues Namyet. “This is not a job to be taken lightly, regardless of whether you represent a $10 million endowment or a $1 billion endowment. If you want to do well, you have to be resourced for success.”

Aase concurs. “These days, unless an institution is entirely dependent on a fund-of-funds model, I think the threshold for when to consider significant exposure to more complex asset classes and to hire someone to oversee those investments is probably well below the $1 billion mark.” He concedes that a host of on-the-job training requirements await institutions that grow the CIO position from within. Yet, even for seasoned investment professionals, maintaining oversight of an institution’s endowment requires ongoing education. “This is not something for which you can pull out a solution you developed five years ago and apply it,” says Aase. “It requires continued new thinking and analysis.”

In retrospect, Namyet doesn’t think his hiring experience would likely be duplicated today. “Eight years ago, there was not all this talk of hiring CIOs. Now there is. If the University of Oregon Foundation had made no move eight years ago and was now deciding to hire someone, they would likely start by looking for a CIO,” says Namyet. The difference: a greater sophistication by institution leadership in recognizing the increasingly complex investment arena. “Because of the timing of my situation, I was able to contribute my much-needed investment skills while learning the endowment world. But most institutions today would probably desire someone who already had some understanding of institutional investment—if not an endowment, then perhaps a pension plan,” suggests Namyet.

Yet, for some institutions, the process of pulling in ready-made, top talent poses real challenges—not the least of which is the issue of compensation. Krauss attests that it would be unrealistic for UK to consider paying a CIO salary above that earned by the university’s president. Other difficulties cited include attracting qualified candidates to non-urban locations and retaining the long-term loyalty of those who may make the move.

Careful Consideration

Capturing such loyalty from the CIO can be less challenging if an institution adopts a grow-from-within staffing model, notes Aase. Namyet agrees that institution affinity should be present in the mix, but he offers a few words of caution for institutions looking to develop internal expertise: “In this business, certain things are learnable, but certain core personality traits are also necessary. The investment world requires strong independent thinking that doesn’t always coincide with the consensus orientation valued in many professional jobs.” Questions any institution must ask, says Namyet, include whether current staff have the characteristics to lead investment initiatives that have grown incredibly complicated and whether the institution has the luxury of time for a steep learning curve. “The ability to preserve donors’ hard-earned gifts sends a strong message of stewardship,” says Namyet. “A critical mistake made by someone learning on the job can be costly in terms of reputation as well as financial implications.”

At the same time, Namyet acknowledges that chief investment officer salaries within the private sector have gone through the roof. To attract loyalty as well as expertise—and not break your budget in the
process—Namyet suggests that institutions consider their pool of alumni who have made their marks and who may now long for the geography of their alma maters.

Regardless of whether an institution looks internally or externally for its CIO hire, leaders must be clear about roles and responsibilities, warns Namyet. He has witnessed from afar the hiring process for other CIO positions. “When an institution does not have consensus about what it’s looking for, the hiring process can take forever,” says Namyet. “You can’t move forward until all are in agreement about the structure you want and until trustees are willing to forego some control.”

KARLA HIGNITE, Kaiserslautern, Germany, is a contributing editor for Business Officer.