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Business Officer Magazine

Heads Up

Take a good look around. Future endowment performance success depends in part on out-there thinking and anticipating opportunities before they knock.

By Karla Hignite

Taking a world view on investing is something more institutions are doing in earnest with their endowments. In fact, increased exposure to international interests was cited as among the key drivers of positive portfolio returns for the six institutions featured in this article—all top performers for the past 10 years with endowments of less than $1 billion. Introducing greater flexibility with regard to asset classes and allocation models has likewise spelled success for some institutions, allowing them to take advantage of opportunities more quickly.

World Wise

For Don Lindsey, chief investment officer at George Washington University (GW), the best investment management approach begins with a review of current asset allocations followed by a top-down scan of major themes. Specifically, he looks for trends that are consistent throughout the world or have the potential to change the world during the next decade. From there, it’s a matter of identifying what Lindsey calls “invest-able” opportunities.

For instance, several years ago Lindsey identified as major themes the growth in India and China and the impact of a global demand for energy and commodities. Even though no clear consensus existed at that time about how dramatic growth in these areas might be, Lindsey made a dedicated exposure to private equity investments and commodities. An underlying theme of those investments was publicly traded companies dedicated to energy and commodity stocks. Those investment decisions became key drivers of double-digit returns for GW during the past three years, says Lindsey. “Starting with a global-themes approach won’t tell you what to invest in, but it can provide directions.”

Flexible Investing

Taking advantage of investment opportunities that arise also requires flexibility with asset allocation models, says Lindsey. “Rather than say we will maintain 5 percent in small caps, we think it makes more sense to add to or cut back on small caps as opportunities change.” Also helpful is looking beyond artificial categories of asset classes. “An institution is best served by developing an investment program based on opportunities, including opportunities that may not neatly fall under a specific class definition,” says Lindsey.

Kenyon College is now better positioned to take advantage of any opportunity. “We used to have a tightly defined asset allocation model with narrow ranges, but we recently widened these ranges so that we can be more tactical,” says Joseph Nelson, Kenyon’s vice president for finance. In addition, Kenyon’s investment committee created an opportunistic asset category that currently accounts for 15 percent of the college’s endowment portfolio and that allows the institution to make investments that don’t fit within its broader allocation model. During the past two years, that’s allowed Kenyon greater exposure to various global markets, says Nelson.

The University of Maryland Foundation has broadened the asset allocation model even further. In recent years, UMF shed asset categories to arrive at four broad classes: public equity/public markets; private capital (venture capital, buyouts, distressed); real assets; and fixed income and cash. “Our strategy for the next 10 years is to invest with managers who have a great deal of flexibility within those four categories. We try to maintain a higher concentration in our best medium- to long-term opportunities, wherever they may be across the globe,” says Michael Barry, UMF’s chief investment officer.

Smart Growth

In hand with carefully researching investment possibilities and incorporating flexibility, several top-performing endowments have achieved added investment success by making necessary sweeping changes to portfolios and internal structures. Since the early 1990s, UMF’s investment strategy had remained fairly constant, with a majority of the portfolio allocated to traditional long-only U.S. equities. In recent years, that changed dramatically with a reallocation of that asset class from its peak of 75 percent in 2000 to 15 percent in 2006. According to Barry, restructuring of the portfolio is the result of a shift in strategy, where 75 percent of UMF’s current portfolio is allocated to alternative investments: 60 percent in a global hedge fund portfolio and 15 percent invested across several private partnerships including real estate, energy, buyouts, and distressed. Says Barry, “Our primary aim is to improve risk-adjusted returns through increased diversification, though another reason for restructuring has been to lower overall portfolio risk.”

Lindsey points out that “historically our endowment has been very real-estate heavy—specifically in terms of investment in the local Washington, D.C., market and university campus properties.”  During the past decade, this sector has been a key driver of returns for GW, and it continues to provide strong performance. Even so, significant restructuring to the portfolio during the past three years has reduced allocation in real estate from 25 percent to 15 percent, says Lindsey. “That makes sense from the standpoint of prudent diversification and reallocating assets to take advantage of a wider range of opportunities.” Included in those opportunities has been an increase in GW’s global exposure—the biggest single performance success factor for the endowment during the past three years, notes Lindsey. GW raised its weighting in international equity from 10 percent to 15 percent between 2003 an 2004, and this category now represents 22 percent of GW’s total portfolio.

For both GW and UMF, portfolio shifts coincided with an overall restructuring of investment operations in response to endowment growth. Before Lindsey was hired in 2003, GW did not have a separate investment office, with endowment management operating as one function within the university’s treasury office. Trustees recognized the growing complexity of the investment environment and the need for dedicated exposure to investment management.

According to Joyce Marx, UMF’s vice president for finance and chief financial officer, during most of the 1990s UMF endowment operations included herself and a finance committee of about 20 members. By 2000, Marx and her committee chair recognized the increased burden of her daily oversight role and the added complexity involved in diversifying the foundation’s portfolio beyond the traditional equity/fixed income portfolio. The decision to hire Barry, who now heads a three-member investment team, has given Marx the time she needs to address the backend reporting and review required in connection with the endowment’s alternative investments. The move to an in-house chief investment officer brought another structural change: the evolution of the finance committee into a leaner, 12-member investment committee.

The Endowment That Could

When Danny Flanigan arrived at Spelman College in 1971, the institution’s endowment was a tiny $4 million. But like the Little Engine That Could, Spelman’s portfolio has pushed over hills and through valleys to reach its current $300 million. “When we first got started, the endowment income represented only about 1 percent of our operating budget. Today our spending rate reflects almost 19 percent of our operating budget,” says Flanigan, Spelman’s vice president for business and financial affairs and treasurer.

Success has been strenuous. “Throughout the 1970s, the whole college went through a metamorphosis in terms of its financial acumen and to ensure that our trustees had a good understanding about financial and investment policies,” explains Flanigan. “At that point we looked at our little endowment and how highly dependent we were on tuition to meet the operating needs of the institution and determined that we had to grow the endowment big time.”

Since then, the college has engaged in several capital campaigns. The first added $12 million to the endowment; a second campaign in the late 1980s included a $40 million gift from a private foundation. In the 1990s, Bill Cosby donated another $8 million. All these net new dollars added during the past 30 years have lent a tremendous boost, says Flanigan. Yet, even from those early days, college leaders knew they would have to become aggressive with investments and assume significant risk.

Risky Business
Projections for a 5 percent spending rate assumed returns of 10 to 12 percent for 10-year targets, 12 to 15 percent for 15-year targets, and 15 percent and higher for 20-year targets, says Flanigan. “We looked around the table and practically said in unison that there was no way on earth we could be this aggressive while sticking to a traditional 70/30 domestic equity/fixed income allocation model.” Instead, the college looked to replicate the models of several bigger institutions, and investment committee members engaged in scenario planning that included private alternative investments. “We quickly saw that we could potentially earn enough to achieve our spending rate and protect against inflation,” says Flanigan. This decision to decrease domestic equity and fixed income and move some into alternative assets took place back in the 1980s, reminds Flanigan—a rather gutsy move for a little endowment.

“In the mid 1980s, we began to stretch this out further and moved more out of domestic equity to place it into venture capital,” he says. For starters, the college experimented with only $2 million—between 3 to 4 percent of the portfolio at that time. “Within seven years that returned $23 million. Those who initially had reservations saw those returns, and it got their attention,” he continues. “Once we showed we could achieve that kind of return, we understood that we could invest in these other areas with success—and it convinced our board of trustees that we could assume some risk with our investments and make money.”  Spelman started looking at other alternative asset classes such as real estate, distressed obligations, and domestic and international private equity.

Allocation, Allocation, Allocation
Largely due to its endowment success, Spelman has for the past seven years held student tuition to 39 percent of the college’s operating budget. “When I look at the way we’ve grown, I believe our continued success can be traced to our allocation across many lines, including alternatives and, more recently, commodities,” says Flanigan.  Subsequently, Spelman has never stopped reviewing and readjusting its balance of allocations. “We’ve also been on the early edge of some of these investment trends, which I believe is key.”

More recently, Spelman has become more intentional about scanning the global horizon, bringing in investment managers who understand emerging markets and how to better position the portfolio’s current hedge programs. “When you look at growth in the U.S. market, you can maybe count on 5- to 7-percent returns,” says Flanigan. “You can’t sustain an endowment on that. If you want growth today, you have to take a more global approach with your allocations and consider alternative strategies.”

It’s All in Your Approach

As with any strategic effort, clearly defined investment goals can keep top-performing endowments on track. A lasting approach for Kenyon has been to focus on long-term total return. “We’ve done a good job of avoiding behavioral finance—the herd mentality of doing the same thing as everyone else,” notes Nelson. Another constant is a strong value bias that kept the institution from jumping on the growth-stock bandwagon during the 1990s. Above all, says Nelson, an active and capable investment committee has kept Kenyon’s small endowment performing at a high level.

Karen Leach, vice president of administration and finance for Hamilton College, likewise names the role of the institution’s investment committee as perhaps the most important variable in the success of its endowment over many years. “We have 20 extremely dedicated alumni advisors who have wide-ranging expertise in the investment arena and who share a spirit of service to the institution,” says Leach.

Dan O’Leary, who retired from Hamilton as chief financial officer in 2005 after 25 years with the college, was centrally involved in the early days of Hamilton’s endowment when the investment committee chair picked endowment equities and O’Leary handled fixed income. By FY1986-87, the endowment had reached $100 million and they decided they needed help. That’s when the first alumni were selected, and they’ve been relied on for their investment expertise ever since, says O’Leary. During his final years at Hamilton, O’Leary was responsible for setting up a separate investment office for the current phase of Hamilton’s endowment management operations.  He hired Peter Blanchfield as the institution’s first chief investment officer to work directly with investment committee members and to allow Leach to concentrate on campus operations rather than investment concerns.

At Michigan State University, investment basics include a forward-looking asset allocation, diversification, manager selection, and attention to risk-adjusted returns. These will remain the focus of the institution’s long-term investment strategy, says Glen Klein, MSU director of investments and financial management. Other key elements that have bolstered success in the past decade are a high equity allocation (82 percent) that includes a significant allocation to absolute return strategies in the mid-1990s, over-weighting of undervalued asset allocations within market cycles, and disciplined rebalancing among and within asset allocations. Not to be forgotten is the role of endowment governance in investment performance. “Even the best investment strategies will not be successful without timely implementation and evaluation,” says Klein. MSU’s board and executive management are committed to providing an expedited approval process for compelling investment opportunities with short windows of opportunity.

Hits and Misses

Something that hasn’t been so quick to transpire for MSU has been the slow pace in reaching the portfolio’s nonmarketable investment allocation for venture capital and private equity. According to Klein, that’s been MSU’s biggest missed opportunity. “Currently we’re at 50 percent of our overall target allocation of 12 percent,” says Klein. “In recent years, the problem has been an inability to invest with quality managers of our choosing.”

Don’t Miss the Endowment Management Forum

Learn more about investment management issues and trends in higher education endowment management at NACUBO’s Endowment Management Forum, January 24-26, in New York City.  The event features keynote speaker Jeremy Grantham, chairman of the board of GMO. Developed and presented by veterans in college and university finance and endowment management, the program addresses portfolio structure and risk management and the dynamic effects of the economy and financial markets on institutional endowments.

Forum speakers include campus experts and financial and investment authorities on the major markets. Findings of the 2006 NACUBO Endowment Study will be presented. Attendees will have the opportunity to meet the experts, ask questions, discuss operational and governance issues, and network with colleagues. The forum is designed for chief financial officers, treasurers, senior investment officers, trustees, foundation officers, and professional endowment fund managers. To register or for more information on this and other programs, contact or call 800.462.4916.

The near-term solution has been to overweight the shortfall with other equity allocations, including inflation hedge and international equities. “We still have a goal of 12 percent, with annual commitment targets to get us there,” says Klein. He and investment committee members are also more intentional these days with visiting managers outside of fundraising cycles to provide exposure to MSU. Unfortunately, others are doing that, too, notes Klein. “It’s a supply-and-demand issue regarding top-quality venture capital and private equity managers—and right now it’s extremely difficult to get in.”

Kenyon’s “hit” with overall endowment performance during the past decade, says Nelson, has been the significant position in international securities that it assumed in the early 1990s—at 20 percent weight overall, which was high for a smaller endowment like Kenyon’s. On the flip side: “We missed the run in real assets and only recently added these to our allocation model.”

UMF’s continued performance strength is attributable in large part to a high allocation to global equity markets. That has also been the endowment’s biggest miss, says Barry. “Our 30-percent allocation to global long/short equity managers drove a significant portion of our returns for the past three years. In hindsight, we could have allocated a larger percentage, but it took time to find the right managers.”

According to Blanchfield, the biggest positive gain for Hamilton’s portfolio in terms of total value and performance has been its private equity program—venture capital/buyouts, distressed debt, energy, and real estate. “The program has produced a 21 percent internal rate of return during the past 14 years.” During that period, Hamilton invested $170 million, had $200 million returned, and has $95 million in remaining value, says Blanchfield. “We shifted our focus in private equity from venture capital firms to energy beginning in 1998, an early move in that direction. And as we allocated $50 million to energy from 1998 to 2001, we reduced our venture capital and buyout investments as well.”

The Next Big Thing

In hindsight, Nelson wishes that Kenyon had spent more time thinking about its payout policy strategy. Like many institutions, Kenyon had thought that using a specified percent (in Kenyon’s case, 4 percent) of a three-year average market value would protect the institution from having to make any material budget adjustments. “The 2000 correction proved us wrong about that,” says Nelson. Kenyon has since adopted a revised payout formula that combines a constant annual growth component (70 percent) and a market value component (30 percent), still using a three-year average. “This combined weighting formula helps mitigate overall volatility so that we can ride out a big market correction,” says Nelson. He acknowledges that such a strategy can also take steam out of an upswing. Even so, Nelson is convinced that the new formula provides a much better long-range planning tool for the institution’s operating budget.

While Kenyon’s leaders understand that the institution’s top-performing endowment has done well compared to others of its size, they’re now setting their sites on the performance returns of endowments that are $1 billion or greater. “Our focus now is to gain access to the top-tier managers in all asset classes,” says Nelson.
As part of Lindsey’s ongoing focus on global themes, he is lately mulling investment opportunities in infrastructure—roads, bridges, and wastewater and freshwater delivery systems to residents. “In the United States and throughout the developed world, all these systems are very old, and we don’t have a clear solution at present in terms of the tremendous capital that will have to go into upgrades and where those sources of funding will come from,” says Lindsey. He sees a possible trend toward privatization of assets or public-private partnerships between municipalities and private companies.

While infrastructure-related investment opportunities have been active in Canada, Australia, and parts of Europe, these haven’t gained popularity in the United States, explains Lindsey. He believes that’s probably because of related political issues. Not much of an appetite exists for increasing taxes or issuing debt to pay for such upgrades, says Lindsey. Yet, as infrastructure needs become greater and fewer opportunities exist for raising capital, our nation’s collective thinking is going to have to respond to the reality of these needs, says Lindsey. “The good news is this should mean more opportunities for nonprofits to invest in an infrastructure sector through funds designed to build partnerships between public and private sectors.”

Emerging Concerns

Outside the realm of any traditional investment management process, an institution must be aware of political issues that are likely to have significant impact on investments in the coming years, says Lindsey. “Global geopolitical tensions are much higher today than 10 years ago and are much more complex.” Take Latin America, for instance: At the same time that Brazil is positioned to become part of the global community and is developing policies that are pro-economic, certain other Latin American countries are more nationalistic, which tends to conflict with the philosophy of building global partnerships, explains Lindsey. “It’s difficult now to assess how these differences will affect the investment landscape, so we need to constantly remain aware of potential problems and changes.”

Klein notes that the emergence of the BRIC countries—Brazil, Russia, India, and China—not only as economic powers, but also as political and military forces, may carry significant implications for the allocation, control, and cost of global resources. Portfolio performance could also be impacted by social, political, or environmental wild cards, including the possible destabilization of global economies by extremist factions of society or of a bird flu pandemic or other worldwide epidemic. “Fear and uncertainty can have a significant negative impact on markets,” says Klein. “Yet, with a diverse asset allocation, if one asset class goes up or down, this does not present a huge dilemma. The whole idea is not what you’re going to do when something happens, but before it may happen,” says Klein. That includes positioning your institution’s endowment to withstand the lingering impacts of any number of potential negative situations.

Even as investment opportunities become more complex and global in scope, institutions must also consider the broader impacts of national trends such as the changing demographics of the college-bound population, says Blanchfield. The demographic backdrop for colleges and universities has been largely favorable for the admission cycle, and most institutions have done well financially as a result in recent years. Fundraising has also been relatively strong throughout the past 10 years, notes Blanchfield. “While historically, colleges and universities have had some price inelasticity, a recession would greatly impact the ability of families to pay for tuition.” Such an event could certainly hurt Hamilton’s admissions and its ability to operate the college at the level of quality to which it is committed, admits Blanchfield. He adds that a long-term bear market could also erode the ability for colleges and universities to finance building projects at a time when most campuses must continue to invest in updating an aging infrastructure.

While many pressures may tempt colleges to spend more from their endowments, preserving the long-term purchasing power of an institution’s endowment remains key to supporting subsequent generations of students, says Blanchfield. That’s certainly been the case and the commitment at Hamilton—and a big part of its endowment success over the years.

Conversation Starter
What has been the biggest performance hit or miss for your institution’s endowment during the past decade, and how has that refocused investment strategies for the next 10 years? E-mail

Far and Wide

Expectations to preserve endowment purchasing power and ensure healthy spending rates will no doubt place continued pressure on investment staff and committees to make their institution portfolios perform. At the same time that institutions must keep an ever-watchful eye for opportunities that emerge at home and on distant shores, they are well served to maintain a long-term horizon, advises Blanchfield. Looking out 30 years or more can guide investment decisions that allow an institution’s endowment to weather the many mini and mega cycles to follow.

That said, perhaps the best stance to assume for investment success in the coming decade is this: feet planted, heads up.

KARLA HIGNITE, principal of KH Communication, Tacoma, Washington, is senior editor of Business Officer.