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Staying Focused

After eight stellar years, University of Michigan CIO Erik Lundberg faces tougher markets.

University of Michigan chief investment officer Erik Lundberg is not a well-known figure on campus. Not like, say, recently retiredfootball coach Lloyd Carr, who, after 13 years, five Big Ten championships and one national title, is a hallowed figure, his name a household word in the state. By contrast, Lundberg, 48, even while posting comparable results in his field in eight years at Michigan, has gone out of his way to avoid publicity. Every time the local newspaper the Ann Arbor News asks him for an interview, Lund­berg declines. Still, says money manager J. Ira Harris, chairman of J.I. Harris & Associates, a Palm Beach, Florida–based financial consulting firm, and a longtime member of Michigan’s investment advisory committee, “He is right up there in importance with the football coach — and maybe even the school president — in what it means over a long period of time to the university.”

How good is Lundberg? Since he arrived at Michigan in October 1999, the endowment has nearly tripled, to $7.1 billion, rising from 17th to eighth place in total assets in the National Association of College and University Business Officers’ (Nacubo) annual survey. For the university’s fiscal year ended June 30, 2007, Lundberg and his ten-member investment team had a return of 25.6 percent. According to the Wilshire Trust Universe Comparison Service, the average endowment or foundation with more than $1 billion in assets returned 17.5 percent for the same period. Investment advisory firm Cambridge Associates says Michigan’s returns have been the best of any U.S. public university over the past one, three and five years and that it is the only public school in the top six of all U.S. schools for those periods. Michigan’s investment numbers last year were better than those of all the Ivy League schools except for Yale University, where CIO David Swensen returned 28 percent.

Part of Lundberg’s success is just hard work. Asked what his hobby is, he says: “This is. I love what I do.” His boss, CFO Timothy Slottow, says: “Erik has tenaciously built a top-notch team that has incredible focus. He balances his role as an investment strategist, a team leader and a fiduciary with great aplomb. He also works extremely effectively with the development professionals all across the university, which has often been crucial to [attracting] important gifts and gift vehicles.”

The other part is the big bet Lundberg has made over the past few years on alternative investments. In 2007, Michigan had 56 percent of its endowment allocated to alternatives — 21 percent in hedge funds and 35 percent in the kind of hard-to-access, illiquid investments the Ivies pack their portfolios with. Michigan’s investments in real estate, venture capital and private equity produced returns ranging from 30 to 47 percent last year.

Finding those kinds of returns is never easy, and these days it’s getting tougher. The world is crowded with pension plans and endowments chasing hedge funds, which in turn are pursuing a limited number of alpha opportunities. The easy credit that fueled private equity is gone. Distinctions between asset categories have blurred. Lundberg shrewdly avoided the highly leveraged credit-related investments that started blowing up last summer, but worries about what time bombs may yet lie in all the new products that came out of Wall Street over the past several years. “There have been many financial innovations, and some of these are coming back to bite us,” he says.

Even as Lundberg’s job gets tougher, its importance to the university is growing. Well before the subprime-triggered slowdown, the state economy was soft, and that has translated into deep cuts to the university. According to the U.S. Department of Labor, last year the state of Michigan had the highest unemployment rate in the country, 7.6 percent. A decade ago the state provided more than 30 percent of the university’s general education budget. In 2007 it supplied $332 million, or only 19 percent of the budget. CFO Slottow expects that figure to remain flat for 2008, meaning the appropriation won’t keep pace with inflation. “Because of the decline in state support, we have to find ways to make the money up,” says Jerry May, vice president for development. Lundberg notes, “We supply 8 percent [$140 million for fiscal 2007] of the operating budget, and we hope to increase that.”

Lundberg is from Stavanger, Norway, the country’s fourth-largest city. It was long a fishing and shipbuilding town, but following the discovery of oil in the late 1960s, things changed. Lundberg spent one summer building oil platforms, pouring concrete and tying steel. By the 1980s the high price of oil had made it feasible for ambitious young people to go abroad to get business degrees and experience, then come home to take white-collar jobs in the oil exploration business. That was the 20-year-old Lundberg’s plan when he left to study at the University of Wisconsin in 1981. A career in finance in the U.S., however, proved more alluring. “I like it here,” he says, adding that meeting his future wife, who was then a premed student at Wisconsin, sealed the deal. After earning a bachelor’s degree in business administration from Wisconsin in 1984, Lundberg got an MBA in finance and international business from Ohio State University in 1986. He has been in the U.S. ever since. He and his physician wife have three children.

Lundberg began his career in corporate finance in 1986 at Wisconsin Bell in Milwaukee before moving to the Chicago headquarters of its parent, regional phone company Ameritech Corp., two years later. There he switched to investor relations, crunched data on Ameritech’s performance and wrote a monthly report for its 150 top executives interpreting Wall Street’s view of the new Baby Bell, one of the seven created by the 1984 antitrust breakup of AT&T. He then decided that the world was bigger than the Midwest and that he wanted to follow more than one company. Lundberg moved to Ameritech’s pension department, starting as an international equity analyst. It gradually dawned on him that investing with a purpose — not just to generate returns but to fund something useful — was his real ambition. “It took me a while to realize what I wanted to do,” he says. By 1996 he was an investment strategist leading Ameritech’s global asset allocation activities and managing its U.S. and international equity programs. About the same time, however, he began to feel restless and saw that he was as high up on the Ameritech corporate ladder as he was likely to get: “I wanted something bigger, and Ameritech had a CIO.” That was Susan Manske, now CIO at the John D. and Catherine T. MacArthur Foundation in Chicago. Lundberg started to look around for new opportunities.

In 1999 he was selected as the top candidate in the University of Michigan’s national search for its first CIO. “Erik’s performance does not really surprise me, because it was obvious he had it all,” says investment advisory committee member Harris, who interviewed him. “I spent two hours with him and was so impressed I told them if they didn’t hire him, I’d recommend him for another major job. I liked his style, his thought process and his philosophy of investing. He mixes conservatism with creativity; he’s always willing to look at new areas to invest in, but he never forgets to look at the downside risk.” When the offer came, Lundberg’s charge was not simply to run the endowment’s investments, it was to build an investment team and strategy.

Michigan’s endowment had not been a priority in the years preceding Lundberg’s arrival. “There was no one giving it their full attention,” he says. CFO Slottow, who arrived six months before the CIO, agrees, pointing out that endowment assets were being managed by an investment team in the treasurer’s office that also handled the university’s risk, debt and cash management portfolios. Although the fund had benefited from the bull market of the late 1990s and a five-year, $1.5 billion capital campaign, growing from $400 million in assets in 1990 to $2.5 billion by June 30, 1999, its investments had underperformed. The annualized return for the five years ended that June was 15.5 percent, below the 16.4 percent median measured by Cambridge Associates.

When Lundberg arrived in Ann Arbor, five staff members from the treasurer’s office signed on to help him build the new investment office. From the beginning, the CIO made staff development and retention a top priority. But while he was learning how to manage his staff, the Internet bubble was preparing to pop. In 2000 the endowment turned in a 44 percent return largely on the strength of its venture capital investments; it then sank to negative single digits in 2001 and 2002. After U.S. equity markets peaked in 2000, Lundberg met with Harris and the seven other members of the endowment’s investment advisory committee and plotted what he called “the postbubble plan.” Following the bubble’s burst there was very little going on in the illiquid world, recalls Lundberg. “We sat down to say, very deliberately, we want to grow our portfolio of illiquid assets.” The committee gave the CIO the green light.

That decision paid off. Michigan’s highest returns last year came from the nonmarketable, or illiquid, side of the portfolio. Lundberg and his team increased this allocation from 21.7 percent in 1999 to 35.1 percent at the end of June 2007. (According to Nacubo, the average endowment of $1 billion or more has 19 percent of its assets in illiquid alternatives.) In fiscal 2007, private equity, 11.5 percent of the portfolio, produced a 47 percent return. Real estate, 10.7 percent of the fund, was up 45 percent; venture capital, 5.6 percent of the total, rose 30 percent; and energy, 7.3 percent, increased 19 percent.

Michigan’s hedge fund portfolio approached a 20 percent return. Housed with equity and fixed income in the marketable securities side of the portfolio, its allocation has doubled, from 10 to 20 percent, under Lundberg’s direction.

Although Lundberg is satisfied with last year’s performance, he wonders whether the hedge fund industry can deliver on its promise of high returns with low risk over the long term. “They can’t all be above average,” he says. “There are so many of them now, and everybody has one, and they can’t all be that good. And how much of this is plain old diversification you can get in other ways, without paying the two and 20? It’s a lot of money, and as an investor, that’s a lot of head wind you have to overcome.”

Like alumni from other top schools, Michigan’s have provided entrée to top venture capital and private equity funds with limited capacity, as well as hedge funds. Sanford Robertson, founder of San Francisco investment bank Robertson Stephens and now a partner at Francisco Partners, a Menlo Park, California, private equity firm, has helped his alma mater invest in technology venture capital firms like Kleiner Perkins Caufield & Byers and Sequoia Capital. “[Lundberg] is the best thing that ever happened to our portfolio,” says Robertson. “He’s very inventive.” Other Michigan alumni have connected the CIO with private equity funds including Chicago-based Madison Dearborn Partners and Boston-based Berkshire Partners, Bain Capital and global buyout firm Advent International’s non-U.S investments. In the absolute-return portfolio, Harris helped the university invest in such hedge fund stalwarts as San Francisco–based Farallon Capital Management, as well as Highfields Capital Management and Brookside Capital Management, both in Boston.

Newer private equity investments include Charterhouse Capital Partners in London and EQT in Stockholm, and specialist managers in the U.S., such as Robertson’s Francisco Partners and Newtown Square, Pennsylvania–based Graham Partners. Among the hedge fund additions are Boston-based credit specialist Sankaty Advisors and New York’s Avenue Capital Group, which invests in distressed debt and special situations.

Lundberg has built the alternatives portfolios almost entirely with single managers, with two notable exceptions. “We have a couple of funds of funds, with the idea that they can operate in areas where we wouldn’t be able to access the managers ourselves,” he explains. To invest with smaller, newer managers, Michigan hired one fund of funds in private equity and the other in hedge funds. Aside from niche access, Lundberg looks to the fund-of-funds managers for their insight into obscure or new markets, such as European private equity.

The real estate program includes such firms as Brookdale Group in Atlanta and Avanti Investment Advisors in Winter Park, Florida. Over the past eight years, Lundberg has expanded the program by adding the likes of Lubert-Adler Partners, based in Philadelphia, and Canyon-Johnson Urban Funds in Beverly Hills (although firm partner Earvin [Magic] Johnson first became a basketball star at rival Michigan State). International real estate investments include London-based Patron Capital Partners and Chicago-based Equity International.

Last year Lundberg’s team added $1.4 billion in investment income to the Michigan endowment, and CFO Slottow is hoping they can do it again in 2008. But the investment landscape is becoming more challenging. “The investment world and the available opportunities are much, much broader,” says Lundberg. “There is more for us to keep track of and understand.” Many new investment vehicles don’t fit into a traditional framework. For example, the CIO has made allocations to an equity manager that invests in emerging-markets debt and an energy manager that makes broader commodity plays. “We find the most representative asset class to put it in, even if it’s not a perfect fit,” he explains.

“One of the things we need to do is be focused and decide what opportunities to go after and what areas to focus on. We’re a small staff, and it’s a big world, and we have to know how to allocate our resources,” Lundberg says. “There are so many things out there and so many ways we could spend our time, but some of them would be distracting and not deliver the returns we’re hoping for.” For the CIO and his team, that means a lot of travel to Eastern and Western Europe and Asia. “That’s the challenge. You have to be out there. We have to be aware of who is there and basically go find them.” On a recent trip to China, Lundberg averaged four to five manager visits a day.

The CIO has given the endowment a global tilt. “Forty percent of the entire portfolio is international by market value, and it’s growing,” he says. That includes the real estate, hedge fund and private equity investments. As international long-only equity investment increased, Lundberg did away with the traditional separation between the U.S. and non-U.S. equity portfolios, combining them into one allocation that comprises about 33 percent of the total fund. (Fixed income has been reduced to 10 percent, from 15.2 percent in 1999.) “The distinction between U.S. and non-U.S. is becoming blurred,” he says, pointing out that 52 percent of the revenues of the companies in the Standard & Poor’s 500 index come from outside the U.S. Lundberg favors a bottom-up approach and does not have a target international allocation as he adds investments to the fund. Calling on international managers used to mean a single trip to London. The rise of local managers has the CIO and his team members hopping planes to China, India, Japan and Russia.

Lundberg uses those trips to groom his staff to be generalists as well as specialists. “It’s better for the institution when people can cover for each other and have a broader view,” he says. “We have to be able to cover all asset classes all over the world.” Professionals who can add value for a significant time period are critical. Lundberg spends a lot of time training his staff and giving them opportunities to learn about more than one asset class. That comes in handy when one or two team members travel abroad to visit managers in multiple asset classes.

“He was always teaching but in a very understated way,” recalls Elizabeth Hokada, a veteran of Lundberg’s team. “He brings together the qualitative and quantitative aspects of investment problems, a balance that is not so easy to find. Working with him was a challenge. He’s always challenging himself, and as a result, the whole staff is challenged.” Says Lundberg, “We want people here who all have the qualifications to be a CIO.” In 2005, Hokada took that mandate seriously, becoming director of the $6.5 billion financial assets division of the Kamehameha Schools charitable trust in Honolulu. “He has been a tremendous resource for me, even after I left Michigan,” she says.

“I say jokingly, I’m an old man now in the business,” Lundberg says. “When I started, there were a lot of people who had worked a long time in one place.” That number is dwindling. “One of the keys to success is the stability of staff and the ability to build programs over time and see ideas work out,” he adds. Lundberg himself has no plans to move on. “The University of Michigan is a great place to work,” he says. “People are allowed to do their work and allowed to excel.”

As for finding strong returns in what has become a very tough environment, he says: “The high returns of recent years are probably gone. We’re going to continue to focus on maximizing the returns within our risk parameters. The credit turmoil is going to present opportunities, and we’re going to try to sort out which ones to pursue. Some of them are going to be more profitable than others.”