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How do you measure the performance of a blueberry farm? Or a whole portfolio of blueberry farms?

That was the challenge facing one chief investment officer of a major endowment one day this spring as he reviewed an investment opportunity that had been pitched to his fund. The thesis was simple enough: Investing in the farming and production of blueberries in the U.S.’s Pacific Northwest could yield a return on investment of four times capital expenditure, or an annual rate of return of about 20 percent. But how do you benchmark a blueberry?

In the end, the CIO decided not to bring this particular opportunity before his board. The benchmarking quandary wasn’t the only reason for his decision not to go ahead with this investment; the complexity and due diligence involved simply weren’t worth it in comparison with other, more compelling possibilities. But the problem the benchmark issue posed was big and real: how institutional investors can judge the performance of these types of idiosyncratic, special-situation investments, which have become increasingly popular as investors search for higher yields and returns uncorrelated to the broader markets.

Other CIOs confirm the quandary. “We had a situation where a private equity manager owned an organic dairy farm and the market changed,” says Chris Bittman, who runs Agility, Perella Weinberg Partners’ $8.4 billion outsourced CIO business. The investor needed to sell out of the investment, so they had to figure out how much it was worth. Bittman says he and his team were able to find comparisons to give the farm a valuation. But it wasn’t as simple as selling a stock or even a stake in a private equity fund on the secondary market.

Bittman and other investors who spoke to Institutional Investor for this story all agree that they would never pass up an opportunity purely because the asset or fund was hard to measure, but they assert that benchmarking is an increasingly complex problem that is fast becoming as much an art as it is a science.

“I’ve spent an enormous amount of time thinking through this whole benchmarking challenge,” says CIO Scott Pittman, who oversees the Mount Sinai Medical Center’s $1.6 billion endowment. “It is very much an issue that doesn’t get the level of attention that it deserves.”

This used to be much easier. When institutional investors were mostly invested in a 60-40 mixture of stocks and bonds, benchmarking investments and overall portfolio performance was a relatively simple matter. Over time, however, investors have sought to diversify their portfolios, first adding private equity and real estate, then turning to other alternative investments, such as hedge funds and real assets, including farmland and infrastructure. That trend has gained steam in recent years. Particularly since the market meltdown of 2008, institutional investors have sought to do more of their own direct investing in money managers and real assets, while money managers and allocators alike have been seeking more bespoke investment opportunities and esoteric return flows in their search for yield and uncorrelated returns. The upshot: Not only are portfolios more complex, but measuring the performance of those portfolios, both on a deal-by-deal and fund-by-fund basis and at an overall level, is increasingly difficult.

Making matters worse, it turns out that the underlying indicators used to judge and measure economic growth — the consumer price index (CPI), unemployment figures, even GDP — are all more or less faulty. As Zachary Karabell puts it, “We are very good at measuring a mid-20th-century industrial economy, which is not the system we have today.” Karabell — author of the recently published book The Leading Indicators: A Short History of the Numbers That Rule Our World — argues that our system of metrics has failed to catch up with the way the world is changing.

The result is a profound crisis of measurement, all the way from the very micro portfolio level — as with the blueberries — to how investors think about the world at its most macro level. Around the world, investors are getting by with imperfect fixes to measure the performance of various strategies and asset classes, while governments and economists are making do with the data they use to measure and project economic growth and outcomes. This make-do-and-mend approach to investment metrics might not be disastrous; sophisticated investment managers and asset owners have rigorous risk management and performance-­monitoring systems in place in even the most esoteric portfolios. But it nevertheless has significant and sometimes unintended consequences for investment processes. This includes how decisions are made and what kind of investment behavior gets rewarded.

Factors like job security are more often than not at the mercy of benchmarks, for example.

“For a lot of institutions, how an investment committee views whether an investment office has done a good job or not is solely based on meeting a benchmark,” says Mount Sinai’s Pittman. That benchmark can include not just investment performance but, particularly in the case of university endowments, peer-to-peer comparisons. A consequence is that few endowments are willing or able to stray from the herd. That can lead to dangerous groupthink, as was evident in the market sell-off of 2008, when many universities found themselves overly exposed to highly illiquid assets.

Another problem stems from allowing benchmarks, including poorly constructed ones, to drive investment decision making. Investment managers and asset owners alike say some investors will pass on attractive investment opportunities because they don’t fit the return profile needed to meet a certain benchmark. This is a particular problem in private equity. Traditional private equity funds project returns in the high teens or low 20s. But some low-risk long-term strategies, such as infrastructure investing and asset-backed lending, have similar characteristics. Because, however, these strategies typically don’t have such high return projections, many investors will pass on them, afraid of not meeting their private equity benchmark. That sounds logical, but in certain investment environments, and for diversification purposes, these types of lower-risk strategies might be beneficial to investors. As a result, some good ideas are left on the table.

Further complicating matters: The challenges are different for investors of different sizes. The measurement issues for large institutional investors, such as multibillion-dollar pension plans and sovereign wealth funds, that have to hold the overall market are different from those of sub-$25 billion foundations and endowments, which have the relative liberty of being more nimble and opportunistic.

“Most endowments and foundations are absolute-return-­oriented, not relative-return-oriented,” explains Jim Dunn, chief executive officer and CIO of Verger Capital Management, an outsourced CIO firm that was spun out of, and manages the endowment assets for, Wake Forest University in Winston-Salem, North Carolina.

For pension plans and other large investors, which more often than not track the global economy, the past few years have been especially tough. It’s hard for the California Public Employees’ Retirement System to explain to its board and other stakeholders why it has returned only 8 percent for the fiscal year through March 31, 2017, when the S&P 500 was up 13.7 percent over the same period. Sure, CalPERS beat its internal benchmark by 11 basis points. But many external observers, including California taxpayers, are puzzled as to why, during a bull market in equities, their state pension plan isn’t doing better.

To judge overall returns, John Skjervem, CIO of the Oregon State Treasury, says most pension plans default to the Russell 3000 index plus some amount of outperformance. “The Russell 3000 plus 300 basis points 20 years ago was pretty easy to beat; now it’s pretty tough,” he says. Given the nature of the stock markets, the unprecedented low-interest-rate environment, and the way risk assets have performed, “I don’t know anyone in the past couple of years who has beaten the Russell 3000 plus 300,” says Skjervem. He leads the team that manages $94 billion in state assets, including the $71 billion Oregon Public Employees Retirement Fund, which is managed by the state treasury under the direction of the Oregon Investment Council. Most institutions have lowered their expectations to 200 or even 100 basis points of outperformance; others use the CPI plus a certain stipulated amount. But, Skjervem says, it is difficult to know where to draw the line. “Who am I to say that the threshold has got to be 300 or 200 or 100 or even 10” basis points, he asks. “Because 10 basis points, last time I checked, is kind of real money.”

Skjervem is one of many investors disappointed with the benchmarking options available to him, especially when it comes to private equity and other nonpublic market investments. “We have done some work on this issue,” he says. “The work that we have done hasn’t so far revealed a better or even a more satisfactory approach.”

One of Oregon’s biggest challenges with using a standard, off-the-shelf benchmark for its private equity portfolio is its composition. Take the Cambridge Associates private equity index, which is used as a measuring tool by many foundations and endowments. Skjervem notes that the index includes a significant allocation to venture capital, making it a not entirely apples-to-apples comparison for funds like Oregon’s: “For a program of our size, where your council doesn’t want you writing checks under $100 million, VC isn’t really an option.”

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