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ENDOWMENTS - Ivy League Education

As the first CIO of Dartmouth College, former University of California treasurer David Russ is learning to deal with the unique pressures of managing the endowment of a small school with big ambitions.

Dartmouth College CIO David Russ has always had a fascination with numbers. Ask him about growing up in Marin County, California, and he will tell you about the 308 steps down to the lighthouse at Point Reyes National Seashore, where he used to bike as a teenager, or the ten Nike missiles that would rise out of the ground at a 10:00 a.m. drill every morning at the U.S. Air Force base next to his school. Later, while Russ was living in Austin, where he helped manage the endowment for the University of Texas, he built the first of his three telescopes -- the largest of which has a 20-inch primary mirror and stands about eight feet high, enabling him to see galaxies billions of light-years away.

Numbers bring the world into focus for Russ, 54. When he arrived in Hanover, New Hampshire, in August 2005 to manage Dartmouth's then­$2.7 billion endowment, he immediately began digging into them. Although the portfolio had performed well in the previous three years -- its annualized return of 11.5 percent was a full two percentage points above that of the Standard & Poor's 500 index -- Russ found the Ivy League school was taking on too much risk for that level of return. After running thousands of scenario analyses on the portfolio using a proprietary asset allocation model he had developed, Russ realized he needed to make some major changes: shifting assets from U.S. equities into international equities and emerging markets; reducing U.S. bonds; and adding Treasury inflation-protected securities, commodities and other real assets, while maintaining the endowment's already sizable allocation to hedge funds and private equity.

Russ presented his new plan to his bosses on the Dartmouth Investment Committee on March 2, 2006, in New York City. In advance of the meeting, he sent the eight members of the committee, who are selected by the board of trustees, a 32-page white paper detailing the asset allocation process, as well as 200 pages of analysis of the portfolio. Still, Russ was nervous that day entering the large glass-and-wood-paneled boardroom at First Republic Bank, where investment committee chairwoman Pamela Joyner, class of 1979, was hosting the meeting. He knew he would have to win over financial heavyweights like John Brennan, chairman of mutual fund giant Vanguard Group; private equity pioneer and founder of Apollo Management, Leon Black; and Charles (Ed) Haldeman Jr., CEO of Putnam Investments.

Russ explained to the committee how the new asset allocation would enable the endowment to produce higher returns with only slightly higher risk, improving its all-important Sharpe ratio (a measure of risk-adjusted returns developed by Nobel Prize­winning economist William Sharpe). As he took them through his findings asset class by asset class, they fired back questions: What was the basis of his conclusions? Why didn't he consider certain securities? Where did he get his numbers?

"It's the toughest and most sophisticated group I have ever worked with," says Russ.

After nearly three hours, the board voted to approve the plan. Satisfied but drained, Russ walked uptown to the Ritz-Carlton hotel, where he was staying, and promptly fell asleep. The next thing he knew, it was 3:30 p.m. "I hadn't taken a nap in 15 years," says Russ, who nearly missed his next meeting. "I was exhausted."

When Dartmouth College came calling in January 2005 looking to hire its first CIO, the job seemed to Russ like the perfect opportunity to escape the public scrutiny he faced in his position as treasurer of the regents for the University of California, his alma mater. In his four years at UC, where he oversaw a $63 billion pool of pension and endowment assets, Russ was forced to walk the gauntlet of angry unions and special-interest groups. He had to lobby for legislation in Sacramento to protect the university's private equity and hedge fund investments.

But at Dartmouth, Russ has learned that there is no escaping the pressure that comes with managing an endowment, regardless of its size. The competition for students, professors and alumni dollars among U.S. colleges and universities is fierce -- and increasing every year. For those charged with shepherding an endowment, all that matters is investment performance, and the pressure to deliver it is unrelenting.

Like most schools, Dartmouth relies on its endowment to cover some of its day-to-day operating expenses -- in its case, nearly a third of the $670 million budget for the fiscal year ended June 30, 2007. About 55 percent of Dartmouth's operating budget goes to the undergraduate college, which has 4,100 full-time students. Dartmouth also has three world-class graduate schools -- the Dartmouth Medical School, the Thayer School of Engineering and the Tuck School of Business -- that combined have 1,600 students. According to William Jarvis, managing director at the Commonfund Institute, the research arm of the Wilton, Connecticut­based Commonfund Group, which manages $42 billion for endowments and other institutions, Dartmouth funds a much higher percentage of operations from its endowment than do most colleges and universities. Among schools with endowments greater than $500 million, the average was just 17 percent in 2005, the most recent year for which the Commonfund has data.

For a small school, Dartmouth has large ambitions. Its trustees are undertaking the biggest building spree in the school's 300-year history. The new projects -- which include a life sciences complex; engineering, science and mathematics buildings; eight dormitories; two dining halls; and a broad array of athletic facilities -- carry a price tag of $1.1 billion. To cover the debt service, the trustees voted this spring to increase endowment spending. Beginning in fiscal 2008­'09, the spending ratio, which had been reduced from 5.5 percent to 5 percent of assets in 2004 after the dot-com bubble burst, will be raised to 7 percent. By contrast, the average spending ratio at U.S. colleges and universities is 4 to 6 percent, says Carolyn Pelzel, vice president for development at Dartmouth.

As a candidate without any Dartmouth connections, Russ was in many ways an unlikely choice for CIO to replace director of investments Jonathon King, who left in January 2005. The trustees selected Russ because of his experience, not merely in overseeing two of the biggest U.S. endowment portfolios but also in introducing complex new asset classes, including hedge funds, in each location and turning around bottom-quartile performers.

Now safely ensconced in the Dartmouth investment office on a quiet side street adjacent to campus, Russ likes to sport a Cat in the Hat tie in homage to one of the school's most famous graduates, Theodor Geisel (better known as Dr. Seuss). Russ is considered a hands-on manager who pays scrupulous attention to detail. Within his first month, he conducted a thorough performance review of all 70 public markets managers, drawing upon the proprietary analytic tools he had developed during his years managing endowments. Following the March 2006 approval of his investment plan, he restructured the entire endowment portfolio, recalibrating allocations in nine asset classes, realigning and reorganizing portfolios. In the process he terminated 26 of Dartmouth's 143 managers, including five of the 27 hedge funds Dartmouth was using at the time.

"I like David because he is tough," says former investment committee member Russell Carson. "It doesn't bother him to fire a manager." Carson, co-founder of New York­based private equity firm Welsh, Carson, Anderson & Stowe, is a Dartmouth trustee and graduate of the class of 1965.

The ability to think analytically and take action has served Russ -- and Dartmouth -- well. The endowment has grown by more than $1 billion since his arrival, to $3.8 billion, powered by an annualized investment return of 19.5 percent and $204 million in alumni gifts. Although Dartmouth's endowment is big by most standards, it is just seventh in the eight-school Ivy League (only Brown University's $2.7 billion endowment is smaller) and pales beside the endowments of Harvard University ($34.9 billion) and Yale University ($22.5 billion). That's not lost on the trustees of Dartmouth, who, like many of the school's alumni, are obsessed with beating their bigger rivals, be it at football or investing.

Dartmouth has fought for years to step out of the giant shadows cast by Harvard and Yale. Even when the school's stellar venture capital portfolio helped boost the annual endowment by 46 percent in 2000, the trustees felt self-doubt. "We didn't think of ourselves as being in the big time because Harvard's annual returns in dollars exceeded the size of the entire Dartmouth endowment that year," says Peter Fahey, class of 1968. "We knew we were in a different league." Fahey, a trustee emeritus and former Goldman, Sachs & Co. partner, is co-chairman of the $1.3 billion Campaign for the Dartmouth Experience fundraising drive, to which he has committed $13 million of his own money.

While Russ has been hard at work, the board of trustees has been having challenges of its own. Unlike most colleges, where alumni have little say over trustee appointments, Dartmouth gave its graduates the ability to nominate and vote on board members more than a century ago.The trustees and alumni each selected eight of the current 18 board members, with the other two being college president James Wright and New Hampshire Governor John Lynch. In the past few years, alumni who have gotten 500 or more signatures have successfully petitioned the Association of Alumni for a place on the ballot. Four petition candidates have won election. As their numbers have grown, the new petition trustees have begun to work toward changing the way Dartmouth is run. They are particularly critical of what they see as the current effort to transform the small college into a world-class research facility.

This September the governance committee of the board of trustees, including Wright, recommended adding eight more trustee-elected positions -- bringing the total to 26 -- to ensure an undisturbed continuation of their agenda. The full board of 16 (minus Governor Lynch and Wright, who recused himself), voted in this proposal. The new board would have 16 trustee-selected members and just eight elected by an open vote. The Association for Alumni, under the guidance of the petition candidates and other alumni seeking change, responded by filing a lawsuit against the Dartmouth administration.

Regardless of which side prevails, the swirl of negative press is affecting fundraising. Alumni donations account for 9 percent of the operating budget, and Fahey, who is overseeing the capital campaign, says many potentially large donors are waiting for the dust to clear before making commitments. Although Russ would like to stay out of the board controversy, he may not be able to avoid it. To keep the money rolling in, the college must convince alumni that it is investing wisely. Russ has traveled from Wall Street to Hawaii to address potential donors.

DAVID HENRY RUSS was born in San Francisco, the eldest of three brothers. He grew up in San Rafael in Marin County, where his father owned a printing company. Instead of joining the Boy Scouts like other kids, Russ became a Sea Scout and learned to navigate a World War II PT boat around San Francisco Bay.

His parents divorced when Russ was 15. Two years later he packed off to UC Berkeley, where he received a BA in genetics. He took the MCAT qualifying exam and paid his first visit to Hanover to see Dartmouth Medical School before a stint as a volunteer in an emergency room prompted a change of heart -- and vocation. Russ tried his hand next at engineering, but that didn't quite fit either. A summer job at Bank of California writing programs for hedging futures and devising simple price-yield tables led to his eureka moment.

"That's when I realized that maybe my path was managing portfolios," says Russ. He went on to earn a master's degree in administration, finance and accounting from the graduate school of management at UC Davis in 1986. That same year he got a job trading bonds for the Bay Area Rapid Transit District.

In 1988, Russ jumped to Stanford University's office of the treasurer. "What did I know about endowments? Nothing," admits Russ. "But I managed bonds, which are harder than stocks -- it's pure math." Russ worked as a portfolio manager at Stanford for six years, during which time the university established the Stanford Management Co. to run its then­$4 billion endowment.

In 1994 Russ took a detour into pensions as director of investment management at Pacific Telesis Group in San Francisco. Russ's reputation for working with complex financial instruments led to an invitation by Thomas Ricks, CEO of the then­newly formed University of Texas Investment Management Co., to help manage the University of Texas endowment in Austin. The relocation meant Russ's wife, Eileen Fehskens, a scientist at Genentech in South San Francisco, would have to put her career on hold, as Austin was not a biotechnology center. Fehskens, who grew up in New Jersey, has a degree in pharmacology from Yale. She and Russ were introduced in 1978 by a friend from his Berkeley genetics study group; they married on January 1, 1982.

At Utimco, Russ oversaw all public markets portfolios -- about 97 percent of the $10.8 billion endowment. (The other 3 percent was in private equity, which Russ and Ricks took over when the private equity team quit in 1999.) While there, Russ helped restructure and modernize the portfolio, using quantitative analytics that included Frank Russell data and Barra risk management tools. He also introduced commodities and hedge funds. "At that time, disclosure was not a big brouhaha, and we were able to hire some of the great hedge fund managers," says Russ, who invested in Farallon Capital Management, Maverick Capital and Perry Capital.

In the fall of 2000, the troubled University of California endowment and pension system reached out to Russ. "I got a call, saying, 'The bubble is bursting, the world is falling apart, and we need someone to be treasurer,'" recalls Russ, who was excited at the prospect of serving his alma mater. When Russ left Utimco in June 2001, it had $14.1 billion in assets, including a $1.7 billion hedge fund portfolio.

As treasurer, Russ believed he had found the job that would see him into retirement, ending where he began, in northern California. But the dream job turned out to be a nightmare, requiring an overhaul of both the investment office and its $55 billion in investments. He managed the university's defined contribution and defined benefit plans, as well as the endowment and cash assets. He also helped restructure the $4 billion debt portfolio. After determining that the system's actively managed equity portfolio and its internal managers had underperformed the S&P 500 index for ten years, Russ eliminated the internal management program, resulting in the termination of one portfolio manager and ten analysts. He then moved the $15.8 billion equity portfolio into an index holding pen until he could hire external managers and staff to oversee them. Just as he had done at Utimco, Russ added new asset classes, including hedge funds and direct real estate investments.

As Russ rebuilt the investment office, trouble was brewing in another quarter. A lawsuit was brought against the University of California in 2003 under the California Public Records Act by Berkeley professor emeritus Charles Schwartz, the UC clerical union and the San Jose Mercury News, demanding release of information on the underlying holdings of all venture capital investments, as well as their internal rates of return. In response, most of the venture capital firms -- the source of a ten-year annualized return of 26.5 percent -- shut the tap on new commitments. To counter the attack, Russ helped write and lobby for a state law that successfully shielded private equity firms from having to expose their underlying investments but conceded the release of IRRs. He also wrote in a provision for hedge fund protections.

Continued distractions from the unions, the California public and professor Schwartz, who maintained a Web site called "Russ' Whoppers," finally pushed the treasurer out of the once-coveted job. When an executive recruiter cold-called him in January 2005 with news that Dartmouth was looking to hire a CIO, Russ was more than intrigued.

DARTMOUTH'S ENDOWMENT, Daniel Webster might have said, is a small fund but there are those who love it. For 16 years Jonathon King was one of those people. In late 2004 the Dartmouth community was caught by surprise when its director of investments announced that he was leaving to take over the CIO position at the University of North Carolina vacated by Mark Yusko. A Tuck graduate, King was seen as a lifer. But he had never been granted the CIO designation at Dartmouth nor the salary that comes with it.

When it came time to replace King, Adam Keller, executive vice president for finance and administration, turned to investment committee chairwoman Joyner to help lead the search. She had taken the reins from Fahey several months before King's departure. A member of the fourth class of women to graduate from Dartmouth, Joyner is the founder of Avid Partners, a marketing firm in San Francisco that works with private equity and venture capital funds. Joyner and Keller began by interviewing six headhunters to find someone who fully understood the Dartmouth culture. "Being self-effacing and humble is a core value at Dartmouth," says Joyner. They selected Amy de Rham, who was then working as a senior partner in the San Francisco office of New York­based Rhodes Associates. Part of her job was to deal with the 20-plus Dartmouth alumni clamoring to return to their alma mater for a preretirement job.

"It was a real challenge for me to handle diplomatically," says de Rham, now a senior client partner at Korn/Ferry International in New York. Another concern was finding someone who wanted to live in Hanover. "The position would have been more attractive to many candidates if it had been in Boston," she adds.

Russ did not emerge as the leading candidate until late in the process. As a born and bred Californian working in the high-profile treasurer's role at the enormous state university system, he was not part of the East Coast, Ivy League network. In the final rounds the board narrowed the search to two candidates. The other finalist was the director of a large, aggressively managed corporate pension fund.

"The biggest question I had for David was, 'Why in the world would you pick up and move from California to Hanover, New Hampshire?'" recalls Carson. "It was a huge life change."

In the end, Dartmouth trustees were won over by Russ's analytical mind, quantitative skills, endowment experience and comparative youth. But with no connection to Dartmouth, Russ was far from a shoo-in. "I had to fight for David," says Tuck finance professor Kent Womack, who served on the search committee alongside Joyner, Keller and Paul Olsen, a 1981 Tuck graduate and head of the Dartmouth real estate office since 1988. "If there hadn't been a little extra effort -- people twisting arms to be okay with outsiders -- it might not have happened."

The move suited Russ's wife. She has found a position as a clinical regulatory and compliance consultant in the clinical trials office at the Dartmouth-Hitchcock Medical Center in nearby Lebanon, New Hampshire.

Dartmouth has a long history of active alumni involvement going back to 1819, when Webster defended the college before the U.S. Supreme Court in a case brought against it by the New Hampshire state legislature to revise the school's charter to turn it into a public institution. When it comes to investing, Dartmouth was one of the first schools in the U.S. to embrace venture capital and private equity.

"One of the reasons we've done so well is because our alumni are so anxious to help Dartmouth that they've let us into funds that other people couldn't get into," says chairman Haldeman, class of 1970, who joined the board three years ago and also sits on the investment committee.

Dartmouth made its initial private equity allocation in 1978 under CFO and treasurer Paul Paganucci. Among the early funds were those offered by Greylock Capital Management, Sequoia Capital, TA Associates, Warburg Pincus and Russ Carson's Welsh Carson. The private equity investments were the jewel in the endowment crown when Lyn Hutton arrived in 1990 to serve as vice president of finance and administration. At that time, the job still encompassed the responsibilities of both treasurer and director of investments at the then­$600 million fund. Almost immediately, Hutton decided to start a hedge fund portfolio.

"When we looked at what managers were doing in the long-short and absolute-return space, it was no longer logical to exclude them from the portfolio," recalls Hutton, who left Dartmouth at the end of 1998 to become CFO of the John D. and Catherine T. MacArthur Foundation. (In December 2002 she left MacArthur to become CIO of the Commonfund.)

Several of the early hedge fund investments have made it into the Russ portfolio, including Farallon and Lone Pine Capital, which has been the college's best-performing hedge fund. Its founder, Stephen Mandel Jr., Dartmouth class of 1978, joined the board of trustees and the investment committee last year. Lone Pine is one of a half dozen of the endowment's investments in funds managed by Dartmouth alumni. Dartmouth has also been a longtime investor in the private equity funds of Apollo Management, headed by Leon Black, class of 1973.

Now dubbed "marketable alternative equity" at Dartmouth, the hedge fund portfolio represents 21 percent of the total, with $760 million in assets. Since Hutton's time it has grown larger than the private equity and venture capital portfolio, which is just under 16 percent of the total, with $585 million in assets. For the ten years ended June 30, 2007, hedge funds provided a 12.15 percent average annual return; private equity and venture capital returned 24.44 percent.

When King took the reins from Hutton in 1998, about 15 percent of the fund was in venture capital, 10 percent in private equity and 5 percent in hedge funds. King brought on David Marcus and Daniel Lynch to ratchet up the hedge fund portfolio. Marcus and Lynch now work for Russ. Marcus, who has a BA in finance from the Wharton School at the University of Pennsylvania and an MBA from the University of Chicago, continues to oversee the hedge fund and LBO fund investments. Lynch, who has a BA and an MA in economics from Boston University, as well as a second master's in liberal studies from Dartmouth, manages the venture capital and natural resources portfolios.

The new CIO has required some getting used to. King had a relaxed management style; Russ is intense. Marcus says Russ is also a more hands-on investment chief than was his predecessor. In the past King met with few of the managers Marcus and Lynch selected before they were hired, but Russ meets with most of them, at the very least by conference call. "I told them I'm responsible for the portfolio, and I'm going to participate in all the decisions," explains Russ. "I'd imagine the staff has had to change gears," adds Fahey.

The investment committee has had to switch gears too. King provided a few pages summarizing the endowment's quarterly and long-term performance; the new CIO has turned the quarterly committee meetings into something of an extreme sport. "We tease him about the thickness of the book," says Joyner. "We'll say, 'Thank you for paring it down to 140 pages.'"

Russ's asset allocation changes affected every corner of the Dartmouth portfolio. When he first presented it at the March 2006 meeting, he says, "I didn't know which way it was going to go because I hadn't gone out and presold what I was thinking." Before the meeting he had asked the committee to send him their expectations for future returns in each asset class.

Having received the green light to restructure the endowment portfolio, Russ moved quickly. He reduced the bond and U.S. equity portfolios and increased -- and reorganized -- the international and emerging-markets investments. Chief operating officer Ellen Brownell, whose husband is a research assistant professor of physics at Dartmouth, oversees all of these portfolios, now 50 percent of the total.

Commodities and real estate were placed in separate portfolios. In September Russ hired a fourth investment professional -- Megan Hammond, a 1990 Dartmouth grad with an MBA from Yale and eight years as a consultant at Cambridge Associates -- to manage the real estate investment portfolio.

Russ whittled the number of hedge funds down to 23 from 27 while keeping the allocation at 21 percent to reflect his belief that a more concentrated portfolio yields better returns. In addition to Farallon and Lone Pine, Dartmouth invests with Blackstone Distressed Securities Advisors, Convexity Capital, Maverick and Och-Ziff Capital Management. In all, Russ has ended investment relationships with 26 managers and started new ones with 28, across the entire portfolio, not including "re-ups" with existing private general partners. "There's no blueprint for how to manage the portfolio," says Russ of the changes. "No textbook out there says 'Here's how you should build a portfolio.' It's a matter of cumulative knowledge."

ON A HOT SUMMER DAY in early August, David Russ is sitting in his office awaiting the results of his labors. When he reads the final 2006­'07 fiscal year performance numbers for the Dartmouth College endowment, which Mellon Bank sends by e-mail, Russ leaps out of his chair and punches the air with excitement. "We're up 24.3 percent," cheers the exuberant CIO. "And every asset class that we invested in is in the green."

Although Russ admits it would have been near impossible to beat David Swensen's astounding 28 percent return at Yale this year, he is clearly proud of besting the 22.4 percent return that Mohamed El-Erian is leaving as his swan song at Harvard before returning in January 2008 to his former employer, Pacific Investment Management Co. "We need the kind of performance David is giving us," says Joyner. "We have to compete for resources and students."

The finance faculty and students have been taking full advantage of the quant whiz in their midst. In his two years at Dartmouth, Russ has had more opportunity to work with students than he had in his previous positions. He collaborated with a Tuck student, Amy Kaminski, class of 2006, on a difficult quantitative project that proved of real benefit to the investment office. With Russ's help, Kaminski combined the asset allocation portfolio-optimization model with the school's liabilities -- the spending ratio -- to create an asset-liability model to track future changes to the endowment portfolio.

In September, Russ gave his third annual, six-hour lecture on asset allocation at the Tuck Center for Private Equity, run by Colin Blaydon, professor and former dean. Russ, who sits on the center's board, began the lecture as he does all presentations -- with lots of numbers. "We trot David out whenever we need a speaker," Blaydon says.

Russ has also begun inviting guest speakers to investment committee meetings to continue the education process. Jack Meyer, the former Harvard endowment chief, spoke at the September 10 gathering, which was held in Boston. When Meyer's Convexity produced disappointing earnings earlier this year, Russ took some heat from the board for having invested in the fund. But Convexity's options-based strategy benefited from the market turmoil this summer -- it was up 6 percent a month in June, July and August. Those are numbers that everyone in the Dartmouth community -- Russ, the investment committee, the board of trustees and its 68,795 alumni -- ought to appreciate.