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Business Officer Magazine

Who Calls the Shots?

As institutions strive to maximize endowment performance, determining who makes the decisions about fund management is a topic of debate.

By Mike McNamee

(a) Will the Federal Reserve raise interest rates?
(b) Are stocks overvalued?
(c) Are alternative investments—hedge funds, private equity, and real estate—worth the effort?
(d) Who should be making the decisions for our endowment: an investment committee, the chief financial officer, a consultant, or a chief investment officer?

The answer? Well, the Fed is raising rates at a boringly predictable pace, and stock valuations after the bear market have become more a matter of theology than of evidence (see sidebar, “Mixed Messages”). Alternate investments are now commonplace, even in endowments that fall far short of the mega-range. But the question of how to organize your endowment for the best performance while keeping it aligned with your campus’s culture and goals is driving as much debate and study as the other three issues combined.

The rapid spread of two management models—the on-campus chief investment officer (CIO) and the off-campus “outsourced” investment oversight—has campus business officers examining their own organizations to see whether a different approach could help eke out a crucial one or two percentage points of extra return on their funds. These organizational issues will be featured in the 2005 NACUBO Endowment Study, which has added new survey questions to shed light on who’s calling the shots on campus investments and spending.

Three things are driving this interest:

  • Endowments are bigger than ever and far more vital to their institutions. The bull markets for stocks in the 1980s and 1990s fueled strong growth in endowment assets, while budget cuts and a growing need for financial aid to close the affordability gap made endowments’ budget contributions ever more important. Even at a state institution like the University of Virginia (UVA), “the endowment spending is no longer just the margin of excellence,” says Alice Handy, who left the Charlottesville institution in 2003 to found Investure LLC. “It was an amount of money that the university depended upon.”
  • Markets are tougher to master. The bust of 2001 taught investment committees that any portfolio just holding stocks and bonds—without the ability to hedge against market downturns—was a sitting duck in a downturn. With many investment gurus predicting equity securities will return less than their historic averages for the next decade or longer, campuses increasingly are exploring innovative strategies. When Elizabeth Williams joined Southern Methodist University (SMU) in 1989, the $330 million endowment was entirely invested in domestic U.S. stocks and bonds. “We thought of ‘diversification’ at that point as hiring a couple of small-cap managers,” says Williams, now university treasurer for the independent institution in Dallas. Now, she says, the $1 billion fund “has more than 50 manager relationships,” covering international stocks; hedge funds; and private equity investments, including venture capital, buyouts, real estate, oil and gas, and timberland.
  • Endowments’ growing complexity requires larger and more professional investment staffs to master the strategies, select high-performing managers, and monitor their work. At the 2005 NACUBO Endowment Management Forum, Michael F. Sullivan presented data from the 2004 Commonfund Benchmark Study showing that for $1 billion-plus endowments, which historically enjoy above-benchmark returns, the rising share of funds allocated to hedge funds was accompanied by a rising number of professional staff. Indeed, says Sullivan, CIO of the University of St. Thomas in St. Paul, Minnesota, “Institutions that are moving into hedge funds and alternative strategies with the same number of staff are sitting on a ticking time bomb.” But the higher returns from better oversight more than reward the added investment in staff, Sullivan notes.

In presentations at the 2005 forum and in interviews, top endowment officers described how fund management is evolving.

From CFO to CIO

Mixed Messages

Investment and financial officers at NACUBO’s Endowment Management Forum last January got two very different views of prospects for stocks and asset markets. Months later, a string of events—from China’s currency revaluation to Federal Reserve rate hikes to record prices for oil—has done nothing to close the forecaster gap.

“So far, everything [since January] has been along the lines we expected,” says Abby Joseph Cohen, chief U.S. portfolio strategist for Goldman Sachs and Company and the forum’s chief optimist. “Economic growth remains good, profits [for companies in the Standard & Poor’s 500-Stock Index] are growing at around 8 percent a year, and interest rates are headed upward. That should be a good environment for the stock market.” Indeed, Cohen notes, Wall Street’s trendless drift in the first half of the year means stocks have room to rise, with the S&P 500 hitting 1325 by year-end. “We think the market is underpriced.”

Not so fast, says Ben Inker, director of asset allocation at GMO LLC, who’s looking for a good mattress to fill with money. “Cash yields are up—cash is good” after more than 10 hikes in the Fed’s short-term interest rate, Inker says. But in longer-term fixed-income investments or in stocks, “you’re not getting paid very much to take on added risk.” Domestic stocks’ high valuations mean that expected returns will be lower. Shares in emerging markets rose 17 percent in the first half of the year, “so we love those a little less,” Inker says. Even timber, which Inker saw as a winning bet in January, has gotten too much attention, driving prices up. “Nothing is cheap,” Inker laments.

Whatever the forecast, most endowment managers are going to stick with their proven asset allocations. But such stark disagreements between respected market-watchers only underscores the uncertainties and challenges that lie ahead for institutions.

Before 2000, the title “chief investment officer” didn’t even register in data gathered by the College and University Professional Association for Human Resources. Now, says Sullivan, CUPA-HR counts more than 100 CIOs, one for every seven of the roughly 700 endowments in NACUBO’s database. How fast is the concept spreading? In 2004, search firm Heidrick and Struggles conducted a study that found 20 searches that year for endowment CIOs and eight of those were newly created positions, many at funds significantly below the $1 billion mark. “I don’t know if this is the ‘golden age’ of CIOs,” says David A. Morris, founding partner for Heidrick and Struggles’s asset and wealth management practice. “But if it isn’t, it’s awfully close.”

Despite those numbers, many newly minted CIOs are homegrown. SMU’s Williams was vice president for business and finance until, in 1998, she realized that one person couldn’t manage both a rapidly growing endowment and an ambitious campus construction program. She went to her president and suggested spinning off the non-investment portions of her job. “It’s a pretty comfortable way for a mid-size institution to migrate to more professional investment management,” says Williams, who functions as CIO. “You get a person who knows the institution, understands the culture, and who’s used to translating between these two worlds of academe and investing.”

Sullivan made a similar transition from CFO to CIO in 2000 at St. Thomas, which now has $352 million under management. He sees the CIO movement taking hold among endowments far below the $1 billion level: “Democratization is coming to this area.” The reason: “Everyone wants to replicate the two- to four-percentage-point edge that the very large endowments have over the investment benchmarks.”

To get into those benchmark-plus returns, Sullivan says, an institution needs to blend in labor-intensive “inefficient assets” like hedge, venture, and private equity funds. It should also look into “enhancement strategies”—transition management trading to reduce costs when fine-tuning an allocation and use of cash overlays to help it keep its asset mix on track.

Sullivan credits these top-end tactics for half of the two-point edge that St. Thomas has enjoyed over the benchmarks for the past 15 years. External managers still carry out the strategies, but Sullivan’s sole focus on investment gives him the opportunity to master new techniques and monitor them closely. “Before I became CIO, I simply didn’t have time to do those strategies properly,” he says.

Creating a CIO position introduces subtle change in a business office’s relationship with its governing board’s investment committee. “With a small endowment, the committee may end up reviewing all the managers,” says Carole Coleman, vice president for finance and administration at Saint John’s University, Collegeville, Minnesota. “When you add more professional staff, the staff will do the interviewing and screening and make recommendations to the committee.” Her situation falls in the middle ground: As CFO, she oversees Saint John’s $130 million fund with the help of a director of investments.

Sullivan sees another advantage. A CIO has added clout to withstand trustee-level suggestions to “invest” endowment funds in popular but low-return causes like community development or state bonds. “A professional staff can make the case for choosing investments on a pure financial basis,” he points out.

Going Off Campus

In 2003, two colleges approached Handy, then president of UVA’s Investment Management Company, at the same time. One wanted to know how to get big-fund investment returns without the expense of hiring an investment officer; the second wanted to know whether the small institution could simply buy into UVA’s investment pool. “The changed markets have forced boards to realize that they either have to build or buy better investment expertise,” Handy says.

Handy established Investure in 2004 to offer another option to “buy” that expertise. Her firm’s four initial clients continue to have their own custodial agents and managers for traditional equity. Investure manages its clients’ fixed-income investments and hedge funds, private equity, venture capital, and real estate. Her goal is to provide top-flight investment ideas and management without losing the personal touch for such clients as Smith College. “I’m sitting in Charlottesville [Virginia], but I try very hard to make Smith’s leadership and the investment committee think I’m in Northampton [Massachusetts].”

Colleges have several options for outsourced investment management, from mutual-fund families to investment pools like Commonfund. Verne O. Sedlacek, president and CEO of Commonfund, believes that outsourcing will take off for funds between $500 million and $1 billion as investing becomes more complex and competition heats up for talented investment chiefs. “The overall construction of endowment funds is not going to get any simpler,” Sedlacek says. “Investment committees realize they need to focus more on policy and don’t have the time, in four meetings a year, to pick and monitor managers.” But finding—and retaining—talented CIOs is almost as tough a job. “Even the biggest endowments have a big challenge keeping people” with Wall Street beckoning, Sedlacek notes.

David Swensen to Speak at Endowment Management Forum

Join David Swensen, chief investment officer at Yale University, and other experts January 26–27, 2006, in New York City at NACUBO’s Endowment Management Forum as they focus on higher education endowment management and contemporary investment management issues and trends. Developed and presented by veterans in college and university finance and endowment management, the program will cover the dynamic effects of the economy and financial markets on institutional endowments; asset allocation and diversification of investments; risk management; and endowment management issues such as working effectively with investment managers, consultants, and investment committees.

Speakers will include campus experts and financial and investment authorities on the major markets. Findings of the 2005 NACUBO Endowment Study will be presented.  Attendees will have the opportunity to meet the experts, ask questions, and network with colleagues. The forum is designed for chief financial officers, senior investment officers, treasurers, trustees, and foundation officers. Last year’s forum sold out, so register early. For more information, visit or call 800.462.4916.

Whatever the model, Handy sees three big advantages: Better access to sophisticated strategies, “a better-compensated, and thus theoretically more professional, staff,” and staff continuity, she says. “The big problem at institutions now is that you train the next layer down from the CIO, then someone else comes after your No. 2.”
The drawbacks? Great ideas that your board might hatch end up being shared with other clients (although your institution can gain from others’ ideas too). And with relatively few firms offering outsourcing, deciding to outsource means making a long-term commitment that can be difficult to unwind.

Paying to Play

Whether internal or outsourced, endowments face the same challenge of retaining talented staff. A university pay scale driven by longevity and job rank can hardly compete with Wall Street on salary, let alone match the financial industry’s rich bonuses. More and more institutions are recognizing that they need incentive compensation to harness the animal spirit of their CIOs.

In 2003, only 24 percent of campus CIOs were eligible for bonuses versus 64 percent of their counterparts at corporate funds, according to the 2003 Greenwich Associates Market Characteristics Report. Bonuses are a sensitive subject but one that more campuses are going to have to confront. First-generation CIOs—business-office converts like Williams and Sullivan—are accustomed to campus pay practices. But “for the next generation,” says Coleman, “we’re likely to be looking at financial-industry people who are accustomed to setting goals, meeting goals, and getting paid according to goals.”

The change is already under way, says headhunter Morris: Most of the colleges for which his firm conducted searches in 2004 paid bonuses. Indeed, Morris sees a growing sophistication in pay schemes. “The institutions that are taking their first steps away from base-only compensation will offer a 25 percent kind of bonus, more discretionary, and not directly tied to performance,” he explains. “Those that have had bonus systems in place are offering more—40 or 50 percent—but with a lot of very specific performance measures, all designed around the question, ‘How well did you do against your peers?’”

Paying for performance will require an attitude adjustment in academe, even if the average CIO’s salary never approaches the multimillion range of, say, the Harvard Management Company. But with the mounting challenges that endowments face—and colleges’ and universities’ spiraling need for funds that only stellar performance can provide—the emphasis on organizing for results is only going to grow.

Author Bio  Mike McNamee, Washington, D.C., covers higher education business issues for Business Officer.