On the morning of May 17, nine leading pension, endowment and foundation investors gathered for a roundtable discussion at the Union League Club in New York City. The previous evening each had been recognized for investment excellence at Institutional Investor’s annual U.S. Investment Management Awards dinner. The morning get-together was an opportunity for the nine to share their most challenging investment questions — and to attempt to come up with answers. Uppermost on everyone’s mind: how to manage portfolios in uncertain times.
| As CIO of the California State Teachers’ Retirement System in Sacramento, Christopher Ailman, 53, has fully integrated environmental, social and corporate governance (ESG) into the $153 billion plan’s investment thinking, and he delivered a 12.7 percent return in 2010. |
| Former corporate attorney H. Craig Slaughter, 53, was tapped by the incoming state treasurer in 1989 to shore up what is now called the West Virginia Investment Management Board. He proceeded to move into equities in 1998, followed by alternatives in the spring of 2008 — steering the $9.8 billion fund to a 16 percent return in 2010. |
| In 1988, University of Notre Dame alumnus Scott Malpass was appointed head of his school’s now-$6 billion endowment. A loyal and long-tenured group of mostly fellow alums have helped the 48-year-old CIO post a 10 percent annual return over the past decade. |
| While raising the alternative-investment allocation from 18 to 58 percent between 2003 and 2010, Donna Dean, CIO of the Rockefeller Foundation, instituted an annual liquidity exercise that has helped the $3.5 billion fund produce a five-year annualized return of 6.8 percent. |
| Ralph Egizi, 63, director of benefits finance and investments at Eastman Chemical Co. in Kingsport, Tennessee, built a 30 percent allocation to alternative investments while eschewing hedge funds. That has helped him deliver a 12 percent annualized return since taking over the now-$1.1 billion pension portfolio in 1999. |
| A cautious approach to private equity, a 10 percent cash allocation and a flexible investment strategy by CIO Brian Hiestand, 40, enabled the $600 million College of William & Mary Foundation to survive the financial crisis of 2008–’09 and beat its peers by 220 basis points last year. |
| Wayne Pierson, 60, CIO and CFO of the Meyer Memorial Trust in Portland, Oregon, created an annual investment roundtable and award competition at the now-$640 million foundation to motivate external managers, helping him produce a 10 percent-plus annualized return over the past decade. |
| A previous career in corporate finance was key to the decision by Dennis Duerst, 52, to adopt a liability-driven investment plan for St. Paul, Minnesota-based 3M Co.’s $15 billion pension fund, enabling Duerst, president of 3M Investment Management Corp., to achieve a 14.4 percent return in 2010. |
| Myra Drucker, 63, has held top investment positions with General Motors Asset Management, International Paper Co. and Xerox Corp. Today the pension guru spends much of her time on the boards of GMO, Kresge Foundation and Sarah Lawrence College. |
Ever since the financial crisis hit their funds in late 2007, institutional investors have been dealing with increasing risks from both natural and man-made disasters. Although most funds turned in positive performances in 2010, assets remain below their 2007 highs. “I think our jobs now are harder than they’ve ever been,” observed Christopher Ailman, CIO of California State Teachers’ Retirement System.
Pension fund, foundation and endowment investors face many of the same issues: ensuring that there is enough liquidity in their portfolios while seeking returns, creating the flexibility to move nimbly when investment opportunities arise and negotiating the balance that is tipping from developed to emerging markets. “I’ve been going to China almost every year since 1989,” reported Scott Malpass, CIO of the University of Notre Dame. “They’re going to be the winners for the next century.”
During the lively and collegial discussion, the participants took a hard look at fund governance in addition to sharing their thoughts on a variety of investments, from venture capital and hedge funds to commodities and Japan. In addition to Ailman and Malpass, the group comprised Donna Dean, CIO of the Rockefeller Foundation; Myra Drucker, former CIO of the International Paper Co. and Xerox Corp. pension funds; Dennis Duerst, president of 3M Investment Management Corp.; Ralph Egizi, director of benefits finance and investments at Eastman Chemical Co.; Brian Hiestand, CIO of the College of William & Mary Foundation; Wayne Pierson, CFO and CIO of the Meyer Memorial Trust; and H. Craig Slaughter, executive director of the West Virginia Investment Management Board. Institutional Investor Editor Michael Peltz and Senior Writer Frances Denmark moderated the discussion, excerpts from which follow.
Institutional Investor: It’s been two full years since the market bottomed, yet there still seems to be a lack of certainty about where the world is going economically. As an investor, what do you do?
Ralph Egizi: I think we’re into the recovery. The markets are indicating that. Are there a lot of concerns? I think yes. Obviously, the European issue continues to be a concern — what will happen in Greece and Portugal. Although they are small, relatively speaking, the contagion issue is always a worry for people. As far as the emerging markets are concerned, obviously China is leading the way, and with a country that large and that new in this world of development, you wonder what issues are going to occur. It’s the unknowns that always get to you, right? The knowns you can deal with.
Scott Malpass: I think we’re in a consolidation phase from the excesses of the past cycle, which were so enormous it’s going to take a long time to heal. We’re probably at best halfway through that. For the next couple of years, we’ll still be in a consolidation period where we have healthy balance sheets and income statements in some parts of the world and unhealthy ones in others. I happen to think the healthy elements will ultimately dominate the unhealthy, but we’re in that period where it’s not clear yet. You might say we’re in the last stages of the prior bear market, and we might be starting a more exciting, interesting time two or three years from now. It may be much more positive, and driven by the developing world.
Dennis Duerst: The difficult thing, though, is that the unhealthy balance sheets are now in developed-economy governments, and we have policy responses that we’ve never seen before. So it’s really difficult to anticipate how that might play out. At the same time, you have pretty healthy corporate balance sheets and a lot of favorable fundamentals for equities. The easy trades are gone. In 2009, 2010, there were lots of pockets of clearly undervalued assets, and that’s not the case anymore.
Myra Drucker: I would like to build on that last piece, particularly Dennis’s remark. The world is always full of uncertainty, and if you look back over all of our careers, we’ve seen many periods of uncertainty. What makes this one particularly difficult is that there aren’t any clearly cheap plays today. We’ve been through periods like that before too, but the way to play it is to be extremely diversified because the layup shots are not there.
Donna Dean: Myra, I would also say that in addition to staying diversified, I’m looking at all of my managers and trying to make sure that they can add value. I hope that stock selection is going to come into play in the public sector over the next year or so. It hasn’t been rewarded in several years. And on the private side, I’m expecting whatever alpha return I can get from hard work by the real estate and private equity managers and the value add that they can bring to the equation. I agree there aren’t going to be any layups. It’s going to be tough slogging to generate returns.
Brian Hiestand: I think there’s also a third component of being liquid from a portfolio construction perspective. While I agree there’s probably a lot of very interesting things to do on the private equity side, I think being liquid and being flexible and being able to take advantage of any hiccups that come along in the economy is extremely important. Properly managing liquidity is crucial to the conversation here.
Dean: To give an example of that, I have most of the cash that I’m going to need to fund this year’s grants for the foundation already in cash. We’ve raised it a little bit at a time, as we wanted to make changes in the portfolio, and I keep scratching my head and saying, “Isn’t there anything else I can do with this zero return component of the portfolio?” I’m not comfortable putting it to work, so for better or for worse, I’ve held it as I raised it.
Wayne Pierson: We’re all reacting to what’s happened in the past few years. There were a lot of opportunities a few years ago, and those have gone away. We look at liquidity; our mind-set is just different. The question is, how long will it be before our memories fade on this? It’s still a ways off before we forget the lessons learned.
Drucker: The liquidity question is an interesting one too, because if you’re in a not-for-profit institution that’s being looked at for a credit rating by Moody’s or Fitch or S&P, you are being asked much tougher questions.
Chris Ailman: In the ’80s and ’90s, it was all about beta exposure and being fully invested. And now in this decade we’ve all realized we want to be more nimble. We want to have liquidity to be able to handle market fluctuations. I agree with Myra — we want to be diversified — but diversification kind of failed us in the last significant downturn. So it’s interesting trying to keep that cash position, knowing it’s zero and at the same time it’s a drag on your portfolio, trying to diversify your portfolio, meaning you’re exposed to just about everything. I think our jobs are harder now than they’ve ever been. I look back at the ’80s and ’90s almost wishfully thinking, “Wow, that was actually pretty easy, getting paid a high return for exposure and only worrying about tracking error.”
H. Craig Slaughter: I like that our jobs are getting harder. I remember being rather bored. Of course, we were constrained with what we could do, limited to publicly traded stocks and investment-grade bonds on a long basis and so forth for years. It did get kind of boring. With the lifting of constraints, it definitely has gotten much more interesting over the past couple of years. Then throw in 2008. Still, I tend to agree with you, Myra. Our approach has always been that we don’t have any idea what’s going to happen but to just assume that we don’t know what’s going to happen. That means we try to diversify as much as possible. Public plans may have a little more luxury with that because of the structure and nature of the assets and liabilities, but some of my peers are having more trouble than others are.
Dean: I think I’m paraphrasing Peter Bernstein [the original editor of Institutional Investor’s Journal of Portfolio Management] when I say, “If you don’t know what’s going to happen, don’t structure your portfolio as though you do.”
Drucker: One of the things that I have seen some foundations and endowments do that pension funds can’t do legally is use a bit of leverage to deal with the problem of having zero cash and yet needing liquidity. So, for example, to make up for the zero return on cash they’re holding to meet spending needs, they may buy beta through the futures markets, making them 105 percent invested on the books. I don’t think anybody is doing it to a great extent. I saw more of it in 2010. Most people seem to have pulled back on it now.
Ailman: We do operate like that in a way. I view securities lending as a small form of leverage, and we’ve used reverse repos on our cash position, plus the leverage in real estate and private equity. There are a couple of public funds that are starting to venture into 120 percent and 130 percent leverage using futures. It is a very scary risk to try to get right.
Egizi: Our pension fund is very close to looking like an endowment fund, based on the fact that we have a lot of alternatives — “alternatives” defined as everything other than stocks and bonds. Diversification has worked as a process. Not perfectly, because the real estate piece obviously didn’t. But the energy sector and some of the others held up much better in that environment than some of the other ones did. At that time, I was just saying, “Give me some money; I want to invest some money.” Corporations weren’t in a position to use their cash. The same liquidity issues, right, Myra?
Drucker: That’s right. The commercial paper market shut down.
Egizi: And we’re sitting there as investment guys saying, “This is one of the greatest investment opportunities you’ll ever have,” and we didn’t have the money to invest.
Institutional Investor: Turning to investments, where do you look for opportunities in the current environment? Scott mentioned that global growth is going to be driven by emerging markets.
Malpass: We’re in the middle of an extensive special review, visiting 36 emerging markets in six regions and trying to develop a road map for the next ten, 15, 20 years. I do think it will be among the most important decisions we make as CIOs for the rest of our careers.
Institutional Investor: Why do you think that?
Malpass: I buy the emerging-markets opportunity, particularly getting access to the emerging-markets consumer. You have to spend time in these places to see it. It’s not that complicated. If you’re there, you feel it and you see it. Take a place like Brazil, for example. They have all the natural resources you could want, a large population, a young population. Now, if the government would stay out of business, they’d do better, but there are tremendous opportunities in Brazil and Latin America.
I do think that in aggregate, emerging markets will represent over 50 percent of the world’s economic growth sometime in the next ten or 15 years, and that’s a huge difference from what we saw early in our careers. The only thing that could stop that would be some sort of protectionism, and that could happen, and we’re seeing small signs of that. But it’s hard to stop a rising middle class that wants to buy and advance and enjoy more goods and services and enjoy life. So our weighting in emerging markets is about 16 percent, public and private, across the whole portfolio. Total international is about 40 percent, but I think that number could be almost doubled, potentially, over the next five to seven years.
Drucker: Scott, are you seeing that play out more in the public markets or through private markets?
Malpass: I think it will be about half and half.
Drucker: Because I see a lot of work in emerging markets being done on the private side by some of the groups I’m involved with.
Malpass: I think we have an edge there because we have a staff, a full team that’s used to traveling in these countries, and we’ve developed some institutional knowledge. We have liquidity goals too, so it would probably be closer to half and half. It will be driven by finding the right partners. We don’t force allocations. It’s purely bottom-up in terms of talented potential partners. But I do think it’s going to be one of the most important decisions we make as CIOs over the next decade.
Dean: I agree with you, Scott. Our exposure to emerging markets is over 20 percent across all asset classes in the portfolio. We’re building that out from a combination top down–bottom up approach, as you say — finding partners but also trying to be selective about which asset classes we use in which regions. And you’re right, when you go there, the energy and the entrepreneurship are palpable. I was in Africa a couple of months ago, an early discovery trip there.
Malpass: It’s amazing, isn’t it? Think of Goldman Sachs — when they coined the term “BRIC” [Brazil, Russia, India and China] in ’01, they had projections of what was going to happen. What happened far exceeded it, and it’s pretty hard to imagine an investment bank undershooting. Now they have N-11 [the next 11 countries with the potential to join the world’s biggest economies]. None of those will rival BRIC, but in aggregate they’ll rival the G-7, so that’s pretty powerful.
Institutional Investor: What about China?
Pierson: One of our managers’ comments was, “China is in a bubble, and they’ll be in a bubble for the next 50 years.”
Malpass: The Western press doesn’t understand China, and it never has. I’ve been going to China almost every year since 1989. They’re going to be one of the winners for the next century. I think they’ll have a soft landing in the current cycle, but they’re maturing. The golden era of low inflation and high growth is over, and they’re transitioning to a more cyclical economy, but the inefficiencies are enormous and a lot to take advantage of.
Egizi: We all have designations of domestic versus international. If you look at large U.S.-based companies, a good portion of their revenue is from outside the U.S. Our growth is going to occur outside the U.S. We just built a plant in Korea. We’re looking in China. So when you invest in a company like Eastman Chemical Co., what are you buying? You’re buying, partially, an opportunity for growth in emerging markets.
Whether you think you have exposure in emerging markets or not, you probably have a lot more exposure than you realize. I’ve never tried to think about how to calculate that, but if you did, the 16 percent we’re talking about, people’s exposure is a lot greater than they think.
Duerst: That’s a good point. We’re looking at that right now because emerging markets do hold a lot of interesting opportunities. I think the challenge of assessing public versus private and the valuations of those respective approaches is important. Each country is very different, so it’s like saying you want to be in hedge funds. Every hedge fund is different; every emerging market is different.
Egizi: I agree that that’s the opportunity. There’s the question of benchmark. The roadblocks, the unknowns, are, one, politics, because you don’t know what happens in those countries where you have a dichotomy of the haves and the have-nots. And yes, there’s a development of the middle class, and that will help, but there’s still that uncertainty. You need political stability for these opportunities to continue. We’re talking about the BRICs. So where are Russia and India right now, as far as the equalization of the BRIC countries? I think there are more challenges, obviously, in Russia and India than there are in Brazil and China going forward.
Ailman: Is there another layer of opportunity right below the BRICs, or is it the frontier markets? I’ve been hearing a lot about Africa, but for us that would be very difficult to invest in, given our size.
Malpass: Yes, the frontier markets look really interesting. Look at Turkey and Central Asia and Africa. I think there will be some winners in all those areas. And what asset class to use to execute differs by country.
Institutional Investor: What other investments are you looking at now?
Drucker: I hear people talking about natural resources. The long-term projected shortages in the natural-resource area create long-term investment opportunities. I see a lot of people looking at or trying to figure out how to play that appropriately.
Ailman: The Pacific Pension Institute recently had a conference primarily focused on environmental topics, and it very quickly shifted into three things. There’s a simple graph with declining supply and significantly increasing demand for clean water, food and energy over the next decade. Those three will be immense opportunities, but making money in food is for us politically difficult. But clean water will be a major issue, and especially energy, of all types.
Egizi: There’s risk in those, obviously, but when we say there’s a commodity shortage, generally you think about crude oil. Most people believe it’s a limited resource. But most people thought natural gas was going to deplete in the U.S. Prices rose for a long time, then came down. All of a sudden, we’ve found the technology and we found ways to extract natural gas from shale. People who have put a lot of money to work are not going to get the return they expected. It could be the same with crude oil. I think, from my perspective, and it is only my perspective, there’s plenty of that natural resource around. It’s our will to go get it. It’s where to get it, where to drill it. It’s there.
Pierson: Related to commodities, we believe investing in sustainable companies will be a good play. Clean tech is going to be a major factor going forward as well.
Ailman: What happened to nanotechnology and mapping the genome? We haven’t seen huge investment opportunities. It was all 18 months out, 18 months out. That was three years ago. What’s going on?
Institutional Investor: Do you think sustainable investing has become a good long-term investment yet?
Duerst: I’m not convinced you can make money there yet. It takes an enormous amount of capital up front and a long time horizon.
Dean: And right now there’s not the political will to put in place policies that would make it at least a reasonable investment. There was progress in Europe, and we were a little further behind in the U.S. With policy change, those investments might have looked more attractive. But we’re not there yet.
Ailman: Okay, I’ll be the contrarian. We’ve been big on looking for megatrends back to the ’70s and ’80s. To us, it’s about long-term investing and sustainability. It’s not isolated just to clean tech. It’s the idea of the demographic wave of higher demand for clean water, higher demand for energy of all types. We look at it, on one hand, as a risk with climate change. We don’t want to say what’s causing the climate to change, but clearly it is. You brought up natural disasters, so we have to factor climate change as a risk, but then also it presents opportunities.
Institutional Investor: It has been very difficult to make money in clean tech.
Ailman: I would agree it’s very difficult to invest in clean tech and make money. Somebody is going to win, and there are going to be big losers, but to us it’s a long-term trend we can start investing in, play it both as a risk and an opportunity. We do it in real estate, private equity and in global equity as well. We view it as sustainability. It doesn’t help if you make a profit based on exploiting something in the short term. Wall Street is thrilled with improving quarterly earnings, but I want more of a sustainable approach. Craig knows, when I brought up ESG [environmental, social and corporate governance issues] to a bunch of state CIOs, half of them didn’t know what the initials stood for, and the other half laughed at me.
Slaughter: He’s an outlier.
Institutional Investor: What do you think of private equity at this point? Is that a way to play emerging markets or natural resources?
Malpass: It depends on the country. In China, with all the privatization going on and a big discount between public and private valuations, as much as 50 percent or more, that’s a pretty good private equity market. Whereas in India there are so many listed companies, there are really no discounts. In some cases there’s a premium, so that wouldn’t be as attractive. You can find some good private equity in India, but it’s not, in general, as attractive.
Drucker: In fact, there are a number of firms that were set up in India to be private equity firms that are 70 percent public, 30 percent private.
Egizi: It’s just knowing in China who are the right partners to deal with to make sure that you get the right influence, to get through the regulatory processes, to do everything else that you need to do.
Dean: And the landscape keeps changing in China. People move around from one firm to the other, and you think you’re riding the right horse, and all of a sudden he’s gone off somewhere else.
Hiestand: Due diligence is an issue because you think you’re betting on a general partner for a ten-year fund and they leave three years into it. I think that there are still some very large development issues going on. I agree there are some opportunities there, but there’s got to be company-building skills inside of these private equity firms other than just flipping them into public companies, because that will go away.
Duerst: One of the challenges is, those firms that are good at business-building tend to be the more global firms, but those global firms don’t have the same access to deal flow that the country funds do — that know the entrepreneurs and know the second- and third-tier cities. So this market is early in its development.
Egizi: It really depends on whether they have a presence in China. A lot of these private equity firms have over the past three to five years established offices with a mix of U.S. and locals. I think that’s a good model. You get the experience of the private equity guys that know how to work with businesses and develop businesses, and you get the local presence that you need to identify the opportunities and to get the right context that you need within the country.
Malpass: Particularly in the venture space, that’s worked very well with some of our partners.
Pierson: How do people feel about Japan? Japan has been deemed undervalued and a value play for such a long time.
Hiestand: We’re finding our managers are overweight Japan, so we’re asking them, “Where are you overweight and why, and should we be more overweight?” Maybe we should take a more tactical approach. There might be a window of opportunity there over the next — not 18 months, clearly, but certainly over the next three to five years. We’re taking a harder look at whether or not we should be more overweight Japan in addition to what our managers are already doing.
Pierson: And what about shorting the Japanese government bonds [JGBs]? You’ve got an extremely low interest rate, you have demographics in play, you’ve got an incredible amount of debt. Is there an opportunity?
Drucker: The Japan question is interesting. At one institution I’m familiar with, the institution had been very underweight Japan based on their investment managers’ decisions. And they have, posttsunami, postearthquake, actually put on a beta position in Japan to bring their Japan exposure up closer to market weight. So they’re not overweight, but they felt that at least there was enough reason to want to be in that market again.
Hiestand: There have to be some long and short opportunities in that market. I think it is overlooked. Everyone is focusing on the U.S. and China. Japan is still the third-largest economy in this world.
Malpass: But at the end of the day, it still has to answer to its fundamentals, and those are really bad. I don’t know what’s going to happen short term. It may have a 20 percent option, but long term I’d be very bearish on Japan. And I’d be shorting the yen and the JGBs, particularly if you want to have some fat-tail-risk kind of hedging. That would be a nice way to get some portfolio protection. That would be an area I would look at very carefully.
Institutional Investor: Is there any interest in venture capital these days? The IPO window in the U.S. has opened slightly, but many of the companies going public are backed by private equity, not venture capital.
Egizi: I think you’re seeing a change in that, though. I was just at a meeting and they were talking about 600 venture-capital-registered IPOs that are out there. The expectation of what portion of that will actually get executed is another thing, but you’re starting to see that uptick on that graph. So now you’re getting an opportunity in an up market. And these companies are getting large now, with positive cash flows that you can actually take, so you need $60 million to $100 million of valuation to really make these things work.
Malpass: I do think there will continue to be waves of innovation over time, and we’re actually committing money to some of these smaller seed funds that are $50 million funds. Now, $5 million, $10 million, $15 million isn’t a lot for our size fund, but we want to be part of that innovation and have access to those kinds of people. So, yes, we’re still very committed to it. It was half of our private equity portfolio ten years ago, so it’s probably closer to 20 to 25 percent. It’s come down as a percentage, but our fund is a lot bigger than it was 20 years ago when I started.
Drucker: I think most of the institutional funds that I know have continued a fairly steady commitment to venture capital. There was a period of time when the venture capitalists themselves had pulled back significantly in their attempts to raise funds. At the same time, because of the liquidity crisis that hit many endowment funds, people were unable to make their normal level of commitments. But in general, most of the institutions I know have tried to keep a time-diversified approach to venture on the theory that innovation goes in waves and you can’t market-time innovation.
Pierson: You’ve had some reduction in the number of firms, as a lot of firms went out of business, which overall was good for the venture capital industry.
Hiestand: One of our former investment committee chairs was very vocal about saying that the traditional venture capital model is broken and needs new funding innovation. I think that to Scott’s point about these superangel funds, entrepreneurs, it doesn’t take as much capital. You can do a traditional start-up and they’re either funding it themselves or they’re passing the hat around the Valley. It doesn’t take an organized, big-name venture capital firm anymore to do that and get a venture capital type of outcome.
We’re seeing a lot of interest in these superangel funds, these $100 million to $150 million funds. We think that’s where you might get some venture-capital-type returns for the risk that you take, not growth capital, which is where the evolution of these larger funds has gone at $700 million, $800 million, a billion dollars. That’s a different outcome. That’s a different return profile.
Ailman: I think that’s a really important point. The life cycle of a company has shortened so dramatically. They go from angel seed money, first round, second round and, boom, IPO in no time. So there isn’t the ability to be a growth equity investor, at least on the cloud and the Internet side, which is where people like us can put a larger amount of money to work. And there’s a handful of brand-name funds, like Kleiner Perkins, and they dominate the Valley. If you’re not in or willing to take the terms, you’re not coming in.
Egizi: The M&A world continues to be alive and well. The majority of these exits tend to be merger-and-acquisition type because they’re small companies and they can easily, if they have the right technology, be merged into a larger organization. Large organizations aren’t doing as much bottom-up seed-type research anymore. So they’re looking for seed-stage entrepreneurial companies that do the work, take the risk up front, develop it and get to a point where it’s a viable type of technology. Larger companies jump on that every day. They’re willing to pay that extra value to get those type companies because of the difference between doing a dozen successful research projects but only one becomes successful versus going out and buying one at a higher price. I think that works as a model for them.
Institutional Investor: :What about hedge funds? We haven’t really talked about those at all. Is that because they’ve become so much a part of what everybody does that they don’t really separate them from traditional asset managers anymore?
Malpass: That’s a vehicle, right? [Laughter.] There are a lot of exposures we’re getting through a hedge fund format, but I don’t look at it as investing in hedge funds. I’m investing in certain strategies that have some risk-control aspects to them and which can take advantage of some anomalies in the market. Our total allocation is 30 percent, and we’re not lowering that.
Drucker: That’s consistent with what I’m seeing at a number of the organizations that I’m involved with as well. They don’t talk about a hedge fund allocation anymore. In fact, I don’t even know what the total hedge fund allocation is at the Kresge Foundation [in Troy, Michigan, where Drucker is an investment committee member]. There are hedge fund investments in many different asset-class buckets.
Duerst: We’ve recently added long-short equity in our equity allocation. And for a pension plan with more of an asset-liability orientation, we like it because we believe that these kinds of managers have more skill and more ability to protect on the downside, and it’s that drawdown that really hurts the pension plan. So if we’re getting two thirds of the upside but one third of the downside, that’s a nice profile that we would prefer to have over just long public equity.
Malpass: I know some people are souring a little bit on long-short because the performance has been more muted. That is almost entirely due to artificial stimulus brought on by QE2, which is really distorted. Real stock pickers aren’t being rewarded. I wouldn’t let that deter you, because I do think those folks will do well over time if they’re good stock pickers. They’ll be rewarded for that.
Institutional Investor: How quickly are you and your organization able to jump on a good investment opportunity that requires fast action?
Egizi: It’s very hard. We all wish we ruled the world because then we could do whatever we think is the right thing to do. But we all have committees; we all have somebody we report to that has oversight.
Drucker: That’s an interesting governance question, because in all of my years in the business, I have seen and known many astute investors, but when you put those astute investors together into a decision-making committee structure, they can almost never make a contrarian decision. And that’s a problem for fiduciary portfolio management, which is one of the reasons I was always an advocate of a structure where there was a reasonable amount of latitude for staff to be able to make decisions within certain risk parameters without requiring committee consent.
Egizi: Committees work on a consensus basis. One dissenter who voices worry can shut down the process.
Drucker: Usually, it’s happening at a crisis point in the market, so it isn’t so clear. There’s something scary out there, which is why the market is down so much. While many people may say that’s a buying opportunity, there’s somebody saying, “But suppose we really are falling off the cliff?” And that voice in the room becomes very powerful when you’re trying to build consensus. It’s always easier to do nothing than to do something.
Slaughter: To me, the investment organization is just like any other organization. The right structure makes all the difference in the world. And you hit the nail on the head, especially in investments. Proper board governance involves delegating the investment decisions to the people that are doing it day-to-day. Give people responsibility, and let them do their jobs. It may not be true in every case, but my experience has been that the organizations with good governance structures are the ones that end up excelling.
Duerst: We’ve taken a little different approach in our governance structure where we have a small board, three people. They’re well informed, and we can be reasonably nimble, get together when we need to. We also have a fair amount of delegation to the staff to make decisions. The other thing I would say, which is important, is that I don’t think our governance structure is bound by market convention at all. There’s not a feeling that you have to fill up style boxes and that sort of thing. So the board has been willing to act with conviction, and it’s worked fairly well. We have not always had this kind of structure. I think it’s fairly typical in corporate pension plans that you have operating executives that are part of the investment committee, and many times they’re influenced by the things that they’re seeing in their own businesses and are paralyzed by that or by what they hear in the media.
Malpass: Myra and Dennis and Craig have hit on the right issues. You have to have stability in the committee and the chairman, some continuity and philosophy. I’ve had only two chairmen in 23 years, and that stability and consistency has been hugely important to us, as well as the proper delegation of authority. I’m sure a lot of us are getting called in now to help other charities look at their governance structures and give them advice. It’s usually the first thing you notice, that they’re not properly set up. They don’t have the proper delegation of authority, they don’t have a strong chairman, they play to the least common denominator sometimes, and that’s a recipe for disaster in managing money.
Hiestand: We think that despite being a $600 million endowment, we’ve got the right governance structure and the right committee composition. It’s an 11-member group. It’s CIOs at other university endowments, general partners at venture capital firms, general partners at buyout firms, hedge fund executives; most of our investment committee members manage money on a fiduciary basis, with very little ego. We’ve hand-selected them. They’re all William & Mary alumni, and we think that that is really our secret sauce. We do rely on them. We’re two or three degrees of separation away from every manager that we want to talk to. I think that’s a very important asset, and we leverage that.
Pierson: Because our foundation has lifetime trustee appointments, we have many, many years’ experience being together. As such, when we have discussions, we take a very long-term view of things. When we talk about the different situations, we’re asking, “Do you remember when we did such and such?” And by doing this, we’re able to bring a consensus to our decisions. We have a very collegial methodology.
Egizi: It is an interesting dynamic. In a corporation like ours, I have discussions with our committee all the time about risk tolerance. The risk tolerance of the committee versus an investment officer’s risk tolerance can be totally different. If you’re an investment guy, you live with risk. You manage risk, but you live with it every day. You take it because that’s how you make money and that’s how you’re successful, by taking and managing risk. In a corporation it’s about risk avoidance. If you have a CFO on your committee or a treasurer or a controller, for example, accounting people, their whole idea is to avoid risk. They don’t like volatility. They like everything to be very steady, straightforward and predictable. It’s that dichotomy? you have to try and manage in these types of committees, and it’s a real challenge.
Dean: I’ve had just the opposite at times. I think the committee wanted to take more risk than I thought was appropriate for the foundation. After the loss in 2008, there’s been less push on that. They realized what I had been telling them all along, that we really could lose 25 percent of the fund.
Slaughter: This amazes me. There’s a phrase my mother used to use all the time: “There’s always another way to skin a cat.” It’s just amazing how this model works and yours does too. Ours is totally different, and I’m sure everybody around here has a little bit different governance model. But given what I’ve heard here today, probably a sense of humility on the part of the trustees, an understanding of their proper role, I would think, may be an element of commonality. • •
