Timothy Crowe was waiting for the most important call of his life. It was a warm late-January afternoon, and from his window on the 33rd floor of the John S. and James L. Knight Foundation’s headquarters in Miami, he could see pleasure boats and wide-beamed cruise ships plying the bright-blue waters of Biscayne Bay.
In a little while he would hear from Hodding Carter III, the foundation’s CEO, calling to relay the decision of the board of trustees on how it planned to manage its nearly $2 billion investment portfolio. Crowe, the foundation’s chief investment officer, had announced that he was leaving to start his own firm and planning to take with him his nine-member investment team, in expectation that he would win the right to manage the foundation’s money as an independent contractor.
He had every reason to feel confident, to believe that the sun would shine as brightly on his plans as it was shining on Biscayne Bay. During his nearly 15-year tenure, he had compiled an outstanding performance record, easily outdoing the majority of his foundation peers, and the only other finalist in the competition, Boston-based Cambridge Associates, was merely a consultant to the foundation, not a hands-on investment manager.
After the phone call finally came, Crowe strode over to Carter’s office in high spirits. Then the CEO told him the news: The board had decided to give the job to Cambridge, after receiving assurances that the firm’s co-founder, James Bailey, would personally oversee the portfolio.
“You’ve got to be kidding me,” Crowe said. “Hodding, what’s going to happen to our people?”
“They’re all going to be let go,” Carter answered, “as of March 1.”
Crowe, 57, was stunned. Although he had been planning to take early retirement from the foundation to launch the new firm, his staff -- most of them in their early to mid-30s -- depended on their salaries. “They’re all expecting me to go back in there and say, ‘All right, we’re in business,’” Crowe said. “What am I going to tell them?”
“That’s my job,” Carter replied. “I’ll tell them.”
Immediately after meeting with Carter, Crowe gathered the investment team in an empty conference room. The CEO arrived a few minutes later and was so choked up, one staffer recalls, that he had difficulty delivering the bad news.
Two days later the Knight Foundation announced that it would dismantle its highly successful in-house investment team and turn the portfolio over to its outside consulting firm in March. Investment professionals in the close-knit foundation community were astonished. At a time when investment talent is getting harder to find and more expensive than ever to hire, the decision struck many as illogical. Under Crowe’s guidance Knight’s portfolio had delivered an annualized 13.9 percent over the preceding decade, easily outpacing the Standard & Poor’s 500 index’s annualized 12.1 percent return, with about half the volatility: 8.4 percent versus the S&P’s 15.2 percent. Knight also bested its peer group of master trusts (including foundations and endowments) with assets greater than $1 billion, as tracked by Wilshire Associates’ Trust Universe Comparison Service: It reported a median return of 10.7 percent over the past ten years.
“Tim is very well regarded in the foundation community, so the news came as a real surprise,” says Wayne Pierson, CFO of the $530 million Meyer Memorial Trust, who has known Crowe for more than a dozen years. “He’s not only a smart investor, he’s inquisitive and looks hard at things, while keeping an open mind. And he put together an outstanding team at Knight that has served the foundation very well.”
Those returns helped to enhance the clout and prestige of one of the wealthiest foundations in the country, ranked 24th by assets under management. Established in 1950, the Knight Foundation supports programs that promote journalistic excellence and a free press. It also funds community service efforts in cities where John (known to all as Jack) and James Knight owned newspapers, including Akron, Ohio; Charlotte, North Carolina; Detroit; and Miami. The foundation’s academic fellowships are among the most sought-after in the industry and include the Knight-Bagehot Fellowships in economics and business journalism at Columbia University and the Knight Science Journalism Fellowships at the Massachusetts Institute of Technology. The foundation also endows journalism chairs at 18 colleges and universities around the country.
During his long tenure with Knight, Crowe earned a reputation as a thoughtful, skillful CIO who transformed a portfolio laden with Knight Ridder stock into a showcase of alternative investments: When he left, nearly 62 percent of Knight’s assets -- $1.2 billion -- was invested in alternatives. Hedge funds formed the core of the portfolio at 30 percent, but Knight also had sizable allocations to private equity, timber, commodities, energy and real estate. Unlike many of his peers, Crowe did not rely on funds of hedge funds. He made direct investments and developed the staff expertise to perform due diligence in-house.
In addition to outsourcing the portfolio to Cambridge Associates, Knight’s board of trustees decided to give the firm complete discretionary power over its investments. The decision sets a precedent. Cambridge, the dominant investment consulting firm in the foundation, family office and university endowment community, with 712 clients and $799 billion in assets under advisement, does do some outsourcing work but rarely assumes legal liability for making decisions on a client’s behalf. Most of what co-founder Bailey calls its “comprehensive relationships” -- contracts where the consulting giant is actively involved in setting overall investment objectives, establishing policy and recommending managers for its clients -- are conducted on a nondiscretionary basis. Cambridge has 60 such whole-portfolio investment oversight contracts, but none of those clients gave the firm the power to call the shots.
The firm’s discretionary business is even smaller. Before winning the Knight contract, Cambridge had just three such accounts, totaling a mere $101 million in assets. All three involve carve-outs of specific asset classes, such as private equity or hedge funds. Knight’s portfolio will be the first for which Cambridge has total investment oversight -- and complete control.
“Why would you give your business over to an organization that is doing both outsourcing and consulting?” asks Albert Hsu, U.S. investment officer of the Atlantic Philanthropies, which has a $3.7 billion endowment, nearly half of it invested in hedge funds. “What about the potential for conflicts of interest? Frankly, giving Cambridge complete discretionary power over this portfolio sets a dangerous precedent, and I think ultimately the fund may suffer for it.”
The switch to Cambridge could spell big changes for Knight’s portfolio. Although Bailey stresses that the transformation in the coming months will be “evolutionary, not revolutionary,” Crowe’s emphasis on hedge funds, which he coupled with active indexing strategies, was never particularly popular with the consulting firm. The allocation to hedge funds is likely to be slashed, the use of tailored indexes will probably disappear, and long-only equity managers will make a comeback.
Bailey, a longtime consultant to Knight, is quick to defend his expanded role. “In this case, the client asked us to take discretion and to have the power to act on their behalf,” he says. “That’s a function of what they want in terms of administrative and investment oversight.” He places the blame for the mass layoff of Knight’s investment team on Crowe himself. “Tim precipitated this,” Bailey says. “He decided to leave. I had nothing to do with causing him to leave or making that decision.”
Crowe is hardly alone in trying to make the leap to the private sector. In the past 18 months, Alice Handy, former CIO of the University of Virginia, and Mark Yusko, ex-CIO of the University of North Carolina at Chapel Hill, have both left their respective institutions to start their own portfolio management firms. And in January, Jack Meyer, legendary CEO of Harvard Management Co., announced that he would leave HMC on June 30 to launch his own fixed-income investment shop, taking key professionals with him.
One difference, perhaps, is that Crowe never wanted to sever his ties with the Knight Foundation entirely. In exchange for Knight’s potentially becoming his first, cornerstone client, Crowe sought to make the foundation a beneficiary of his new business. He intended to combine outsourced portfolio management services for Knight -- and possibly a couple of other key clients -- with the creation of a private equity and hedge fund of funds, capitalizing on the group’s experience with alternatives. In his proposal he offered Knight’s investment committee a stair-stepped rebate on its fees as the new firm’s assets under management grew, an arrangement that could eventually have reduced Knight’s portfolio management costs to zero.
WHY DID THE THE BOARD OF TRUSTEES, WHICH had avowed total confidence in Crowe and his team until that fateful day in January, give the business to Cambridge instead? Partly, the answer lies in the complex relationship between Bailey and Crowe and the way it shifted over 15 years. As Crowe’s confidence as an investor grew, Bailey’s influence as a consultant diminished.
When Knight first retained Cambridge in 1985, Bailey served as the lone investment expert at the foundation, which was then anticipating an influx of more than $400 million following Jack Knight’s death and the settlement of his estate. Knight had a CFO, David Catrow, but he was not an investment expert; he primarily served as the foundation’s comptroller. Once the board retained Cambridge, Bailey effectively took charge of overseeing the portfolio, a role he held unchallenged for more than five years.
When Jim Knight decided to move the foundation to Miami, where he lived, Catrow retired. Crowe, who was hired to replace him as CFO in late 1990, did not have a Wall Street pedigree, but he did have a keen interest in portfolio theory. The soft-spoken Pennsylvania native, a former CFO and treasurer for technology company Black Box Corp., had spent much of his career as a financial officer for software concerns. Mild-mannered and affable, he possessed a sharp, disciplined mind: In addition to having an MBA from Pennsylvania State University and an MA in human behavior from United States International University in San Diego, he was a former U.S. Navy lieutenant and intelligence officer who had served in Vietnam.
When Crowe joined the foundation, Knight had $522 million in assets. A sizable chunk, 23 percent of the portfolio ($120 million), was in Knight Ridder stock. The rest of the portfolio had a fairly traditional structure, with roughly 60 percent in equities and 40 percent in bonds. The equity portion was invested with five long-only equity managers, three large-cap and two small-cap. The fixed-income portion was invested with three active managers in domestic issues, a blend of Treasury and corporate bonds. Knight had two small, unusual investments in the mix: a real estate partnership and a buyout partnership.
“I remember going up to Boston to talk to Jim and saying, ‘Gee, this isn’t a very diversified portfolio,’” Crowe recalls. “And Jim said, ‘Well, you’ve never met Jim Knight.’ Apparently, the brothers felt that we really only needed Knight Ridder stock and T-bills.”
Jim Knight’s health was failing when Crowe joined the foundation; he died in February 1991 at age 81. Upon the settlement of his estate, the portfolio received another big block of Knight Ridder stock. Had Crowe and Bailey not already begun to take action by working down the preexisting stake, the Knight Ridder portion of assets would have jumped to 42 percent of the then-$722 million portfolio. After considering various options, from swaps to a secondary private equity offering, they decided to sell the new stock gradually into the market, and with the proceeds they began to undertake even greater diversification.
Crowe and Bailey worked closely together in the early 1990s, Crowe making changes in the portfolio with Bailey’s input and guidance. They focused on international equities, small-cap equities, private equity (including venture capital and buyouts) and real estate. Although Crowe was expected to oversee everything from accounting to human resources, his interest in portfolio management grew, especially after he completed his certification as a chartered financial analyst in 1994.
He began looking to diversify beyond public equities without adding to the portfolio’s bond holdings. In 1995 he came across a glowing report on Lee Ainslie III’s then-Dallas-based hedge fund, Maverick Capital, in a newsletter published by investment firm Lookout Mountain Capital. Back then Ainslie had only about $100 million under management, a far cry from the $10 billion he oversees now. Crowe flew to Texas to meet with him and take a look at his operation. In the fourth quarter of 1995, Maverick became Knight’s first hedge fund investment.
That initial $10 million allocation sparked Crowe’s interest in hedge funds, but it took some time to build up a roster -- not least because he had little investment help. In the mid-1990s, Crowe had just one financial assistant, Maurice Perry, whom he had signed on in 1994. But by 1997, Perry -- who had an undergraduate degree in business administration from the University of Florida and had earned his stripes as a CFA while working at Knight -- had decided that he wanted to get an MBA, at Northwestern University’s Kellogg School of Management. In 1999, Crowe hired Raul Diaz, a former comptroller for Eastern National Bank, in Miami. Diaz, who has a master’s degree in accounting, gradually took over the management of the private equity portfolio.
As the public equities markets grew increasingly frothy in the late 1990s, Crowe began to cast a more critical eye on the long-only managers in Knight’s portfolio. The alpha they were generating relative to the markets struck him as negligible -- and very expensive. Crowe, who was continuing to build up the hedge fund portfolio, began to advocate shifting assets away from long-only active managers to index funds. It was a decision that put him somewhat at odds with Bailey.
“There isn’t a consultant in the world who likes indexing,” Crowe says. “That takes bread and butter off their table. But by that time, I’d built up enough credibility with our investment committee to make a case for it, which I did.”
In 1999, Crowe began to redesign the portfolio’s structure, positioning alpha-generating strategies -- largely hedge funds but also private equity, real estate, and, later, timber and energy -- at the core and surrounding them with less-expensive index funds. But rather than simply invest in plain-vanilla indexes, Crowe gradually implemented what he calls an active indexing strategy. The bond portfolio, for example, used the Lehman Brothers government/credit index as a benchmark but didn’t invest in it directly. Knight had four fixed-income index funds -- short, intermediate and long U.S. Treasury funds and a U.S. investment-grade-credit fund, all provided by Standish Mellon Asset Management Co. -- that allowed Crowe to shift tactical weightings. Through year-end 2004, Knight’s bond indexing returned an annualized 9.2 percent, versus 6.6 percent for the Lehman Brothers benchmark. Crowe also set up active indexing in domestic equities and, separately, international equities.
The development of the active indexing approach forced some administrative changes within the foundation. Knight reached a turning point in 2000 when Crowe decided that he should spend all of his time on the portfolio, which had become increasingly complex. The foundation’s investment committee agreed to make changes: Crowe became chief investment officer and was authorized to hire a staff. Perry returned to Knight in 2001 to oversee marketable securities; he and Diaz were the two most-senior investment managers on the team. Angelique Sellers joined Knight from MSC Networks in 2001and began overseeing hedge funds. Erik Popham was hired in 2002 from Arthur Andersen to help manage real estate partnerships and commodities.
The portfolio Crowe left behind at Knight last month bore little resemblance to the model he inherited in 1990. Conceptually, he had grouped all the investments into three broad categories: offensive, defensive and real. Offensive strategies were expected to deliver equitylike returns with less volatility than the markets. Of Knight’s total portfolio, 20 percent was invested in hedge funds with what Crowe considered an “offensive edge": largely long-short equity strategies (with a slight long bias) and global macro strategies. Crowe put private equity investments, at 15 percent of the portfolio, under the same heading, along with domestic equity at 13.5 percent and international equity at 10.5 percent.
On the defensive side, where investments were expected to perform better than bonds with equally low volatility, 10 percent of the portfolio was invested in hedge funds pursuing absolute-return strategies, such as event, capital structure, convertible bond and statistical arbitrage. Another 10 percent was in fixed income, 3 percent was in TIPs, and 1.5 percent was in cash. In the last category, real assets, Knight invested 6 percent of its portfolio in real estate, 6 percent in commodities, 2.5 percent in timber and 2 percent in energy.
Though Crowe is increasingly concerned about the amount of money flowing into hedge funds, he is a staunch proponent of certain managers. As of February, Knight had $600 million invested with 22 managers (14 offensive, 8 defensive). In addition to Ainslie, Knight invested with Lee Hobson at Highside Capital Management, Lief Rosenblatt at Satellite Asset Management and Daniel Och at Och-Ziff Capital Management. In the more than nine years that Knight has invested in hedge funds, its managers (as a group) have posted an annualized return of 12.7 percent, compared with the S&P 500’s 10 percent, with half the volatility.
Knight’s second-largest allocation, to private equity, has been one of its most lucrative over time. The foundation has had 45 manager relationships -- and 95 separate partnerships -- with such blue-chip firms as Benchmark Capital (which provided start-up funding for EBay, a huge windfall for Knight), Draper Fisher Jurvetson, North Bridge Capital and Oaktree Capital Management. The internal rate of return since the inception of Knight’s private equity program in 1989 has been a whopping 37.5 percent.
“Tim has done two great things here at Knight,” says private equity analyst Dana Rosenberg, who joined the foundation in July 2004. “He has created an unbelievable portfolio of assets and an unbelievable portfolio of people. And you really can’t have one without the other -- not long term.”
LAST AUGUST, CROWE DECIDED TO SPEAK TO Knight’s management and board of trustees about setting up his own investment firm with his group, and he expressed his interest in continuing to work with the foundation. The board was immediately confronted with a quandary: whether to outsource, and if so, how?
The difficulty of making that assessment was immediately felt by the investment committee’s new chairman, John Rogers Jr., founder and CEO of Chicago-based money management firm Ariel Capital Management, who had taken the committee’s helm in March 2004. Knight’s board chairman, W. Gerald Austen, a professor of surgery at Harvard Medical School, also serves on the committee, as does L.M. (Bud) Baker Jr., a former chairman of Wachovia Corp.; Robert Briggs, chairman emeritus and former CEO of Akron-based law firm Buckingham, Doolittle, & Burroughs; and Beverly Knight Olson, a daughter of James Knight. Jill Ker Conway, a former president of Smith College and the author of five books (including the bestselling memoir The Road from Coorain), was still active on the investment committee at the time, although she was about to rotate off the board.
The committee initially considered trying to replace Crowe but quickly became discouraged by the potential difficulty and expense of finding an equally talented investment officer. According to executive recruiting firm Heidrick & Struggles International, some 20 CIO searches took place nationwide last year, and universities and foundations often ended up paying one and a half to two times what they had planned to spend on total compensation for top candidates. “Given the various ramifications and problems of compensating CIOs, if they’re any good -- and not knowing whether they’re going to be any good for a while -- we came to the conclusion that it was in the best interests of the foundation to outsource,” says Knight board chairman Austen. “You could argue that there is no right answer, but we spent a lot of time thinking about it.”
Once that decision was made, investment committee chairman Rogers called Chicago consultant Richard Ennis of Ennis Knupp + Associates for help conducting a search. The board weighed the pros and cons of outsourcing just its alternative investments but decided to outsource the whole portfolio.
A request for proposals went out to eight firms that Ennis had identified as potential candidates, including Cambridge Associates. Five responded. The investment committee then winnowed the list to three and interviewed each of the principals. There were two finalists: Crowe and Bailey.
Ennis and Mary Bates, a senior investment analyst at Ennis Knupp, compiled a list of criteria. The first item on the list was experience -- not only general experience in investment oversight but also what Richard Ennis calls “bespoke,” or customized, outsourcing for clients such as foundations or university endowments. Second on the list was “breadth and depth” of professional resources; third was the importance of the relationship with Knight to the applicant; fourth was past performance. Last on the list was cost.
Crowe and his team, of course, had had no previous experience with customized outsourcing for multiple clients -- they had worked only for Knight. “That was something the investment committee had to recognize,” Ennis says. “They had one firm that had been around for 30 years and had the benefit of being established, and another that would be nascent. So it was a consideration, but it was by no means the dominant one -- if it had been, there wouldn’t have been any consideration of Crowe’s proposal.”
Although Crowe’s small team knew Knight’s portfolio inside and out, Bailey could cite a staff of 84 investment specialists providing “breadth and depth” of professional resources. And Bailey impressed upon the investment committee that he would personally oversee Knight’s portfolio -- specifically, that he would spend 25 percent of his time on it in the first year and 10 to 20 percent of his time thereafter. (Kevin Stephenson, who has been assigned to the Knight account for the past year, will be working closely on day-to-day management of the portfolio, supported by several of Cambridge’s investment specialists.)
Past performance was a draw, Ennis concluded after looking at the ten-year record of a Cambridge client for whom the firm had provided comprehensive oversight. Both candidates, he said, had exceptional performance records. The only area where Crowe might eventually have held an advantage, based on the criteria Ennis listed, was cost. Cambridge will charge a flat asset management fee, and its bid was “materially lower” than what Crowe would have initially charged the foundation, Ennis says. But Crowe planned to reduce fees progressively.
Although no common, industrywide fee structure for outsourced portfolio management yet exists -- the business is still too new -- fees typically exceed those of consulting work, which can range from 10 to 20 basis points and decrease with assets under management. But outsourcing fees are still far less than the 1 percent typically charged by money managers.
The question of potential conflicts of interest arose, but Ennis saw no issue with Cambridge because the firm doesn’t provide investment products to its clients or have business relationships with its managers. Bailey says that the firm solicits investment interest in a potential fund (such as a hedge fund raising capital) from all those clients who have engaged Cambridge to actively seek out new managers; then it submits a list of investor candidates to the fund’s manager and allows him or her to select clients. (Who gets out first if there are problems may be a different question.)
In the end the board’s familiarity with Bailey trumped all concerns. And Bailey traded on his 20 years as a consultant to the Knight foundation relative to Crowe’s 15 years. “On the one hand, we wouldn’t claim all the credit or even the majority of the credit for what has been achieved over there during this period of time,” Bailey says. “But on the other hand, we have had a very active role.” So active, he contends, that “over 90 percent of the managers are ones we’ve recommended to the foundation.”
Crowe just shakes his head. “Does Jim know many of the managers we have? Yes, but just because a manager existed in Cambridge’s database doesn’t mean that he introduced that manager to the Knight Foundation. Some of them, sure, but 90 percent? No way. We’ve done our own sourcing.”
Atlantic Philanthropies’ Hsu, who along with Crowe is part of an informal network of foundation investment managers who often share information about various asset classes and help support each other on hedge fund due diligence, also takes a dim view of Bailey’s assertion. “Tim was driving the investment process,” he says. “But Jim takes no prisoners. If this was a situation where Jim thought he could take the business, then of course he’s going to take credit for it. But if anyone believes that Cambridge was calling the shots at Knight, they’re overstating the firm’s importance.”
Knight’s investment committee ultimately preferred the safety and security that Bailey offered to Crowe’s entrepreneurial acumen. “Jim is an icon in the industry,” says committee chairman Rogers. “If you look at the depth of Cambridge and the quality of the people and the international clientele, I think it was just something that made the board comfortable.”
Only one committee member was apparently less than comfortable: Jill Ker Conway reportedly abstained from voting for Cambridge. (Conway declined to confirm, but did not deny, that she had done so.)
Once the vote by the foundation’s entire board was taken, Knight CEO Carter called Crowe. After Carter broke the news to Crowe and his investment team, the CIO gathered up his shaken staff and took them to a restaurant across the street from Knight’s headquarters. For nearly three hours they sat on a patio in the warm winter sunshine, drinking beer and talking.
“It was shock city,” says former investment director Perry. “We thought we had the inside track, having both the institutional memory and the intimate knowledge of the portfolio. But we underestimated the enemy -- the enemy being Cambridge. Practically speaking, they’ve been irrelevant to us for years, but you would never know it to read the press release.” That release, quoting Knight board chairman Austen, stressed the board’s desire “to ensure both continuity and depth” in the management of Knight’s investments.
Crowe felt equally devastated, but for a different reason than his staff. “I felt as though I’d let them down,” he says. “They were counting on me to bring this home, and I failed them. I don’t know how I’m ever going to forgive myself for that.”