November 2017 IssueLong scroll reading

Fall Frolics

By Edward A. Studzinski

“Maybe this world is another planet’s hell.”

                                 Aldous Huxley

Investment Committees and Performance

We are at that point in time when investment returns trickle in from the endowments of schools and other not-for-profit organizations for their fiscal years ending June 30, 2017. In terms of preliminary numbers, the top ten college/university endowments had total returns ranging from a high of 18.8% (Grinnell) to 14.6% (Dartmouth College). Grinnell of course has had two advantages over time – one, Warren Buffett was originally involved in helping to manage the fund and two, it is relatively small, at only $1.9B in assets. Dartmouth is somewhat larger at $4.96B in assets.

One of the endowment bellwethers, Yale with the second largest university endowment at $27.2B in assets, generated an 11.3% total return. Yale’s endowment of course is managed by David Swensen, who has been a leader in the multi-asset class diversification approach, investing substantial sums in private equity and other hedge-fund investments. While FY2017 looks sub-par, in FY2016 Yale achieved a 3.4% total return when most other school endowments had negative numbers for the same period. Harvard, the largest university endowment, with some $37.1B in assets at the end of FY2017, achieved a total return of 8.1% after struggling in FY2016 with a -2.0% return.

Why do some endowments struggle at producing competitive returns? After all, the motivation should be on earning long-term compounded returns on investment, not on gathering assets. That niggled at me, as a not-for-profit endowment I am familiar with produced a total return for FY2017 in the low single digits. The question is one of identifying the variables that produce such sub-optimal results.

I approached a West Coast-based consultant I know, and asked her about the range of educational institution endowment returns and what they were like. That resulted in the numbers I have related above. I then asked her what she would think of an institution with an endowment roughly the size of Trinity College ($520M) that produced a low single digit return. She was incredulous, not understanding how the return could have been that, given the returns on most global asset classes over the comparable period. That led to my next question, which was, “How large are the investment committees for your best performing endowment clients?” Her answer was that they often were as small as five people, but that the consistently best-performing ones seemed to have eight members, which allowed for one person with experience and knowledge in each asset class in which they were investing. My final question was, “What would you think of a committee with more than twenty-five members on it?” Again her answer was straightforward – too large and unwieldy. The best ideas would be compromised away given the inter-personal dynamics of a committee structure that large.

Deciding to enlarge my sample size, I contacted a friend who runs one of the most successful college endowments in the country, trained by David Swensen at Yale. I asked her, “How large is your investment committee?” Her answer was that it was twenty people when she first took the job as investment officer, but she had been able over time to get it down to eight. I then asked what she would think of a committee composed of twenty-five to thirty members. Her answer was that that has to be solely for entertainment purposes, as it is unworkable for a functioning investment committee.

Neither of those answers surprises me. I have served on four not-for-profit investment committees over the years. The larger the committee, the worse the results were. The other problem was the issue of consultants who always wanted to give money to outperforming managers, and take money away from underperforming managers. This panders to the fears of most non-investment professionals who may be on an investment committee, as well as to those investment professionals who believe that momentum is a one-way street. What you need, if using a consultant, is a consultant bereft of conflicts of interest with an overriding ability to place the interests of the client first over their own job security. I leave you with this thought. Most people instinctively run away from a fire in a burning house. Warren Buffett is the investor (and I can name others) who runs towards the fire and into the burning house.

There are two other potential problems with large investment committees. One is that the larger the committee, the greater the chance that there is someone on there with a real or apparent conflict of interest. Raising the issue of conflicts of interest in the not-profit-setting is equivalent to bringing in your dog to pee on someone’s expensive Oriental rug. People tend to get this pained look on their faces wondering how you could have the temerity to bring up the subject. The assumption of course is always that no one would ever contact the Public Charities Division of the appropriate State Attorney General to file a complaint and ask for an inquiry and audit. The other potential problem is the current development paradigm of using a position on the investment committee (although there are a number of other possible alternatives) as a reward for making suitably large donations to the institution. The failure tends to result from the practice of having people on governing boards with more money than brains, the current fallacy being the assumption that because they have money they must have brains.

Reality Comes to the Buy-Side

Attention has recently turned to Fidelity, based on a recent Wall Street Journal story alleging a hostile work environment, especially for women. Curious, I spoke to a New England-based journalist I know to see what she had heard about the story. She indicated that after the story had broken in the WSJ, one of her sources there had talked to her about the problem, maintaining that the vaunted Fidelity culture was at this point broken. A question that remains to be addressed is how this could happen in a business being run by one of the most senior and powerful woman executives in this country.

What perhaps has been ignored in all of the focus upon what may be the allegedly more racy details, is how much intimidation and subjectivity in personnel evaluation and advancement had become accepted practices in what may best be defined as “nerdy” cultures. Perhaps the best context I can put it in for you is to suggest that one watch about ten or fifteen rerun episodes of a popular television show called “The Big Bang Theory,” which my wife refers to as “The Geeky Boys.” The four male characters, all with genius intellectual abilities, suffer from varying degrees of arrested development. They display a regular inability to have normal social interaction with the rest of the human species. You may think this only happens on television. Well dear readers, it happens in Silicon Valley, it happens in Hollywood, and unlike banking and brokerage firms where many of those practices were rooted out and dealt with, it still happens in today’s investment management firms. It will be interesting to watch the ongoing fallout. My journalist friend indicated that there would be an increasing number of people coming forward to relate how they had been impacted. Look for this to put paid to the culture of the “star” portfolio manager, whose shenanigans had been ignored as long as the assets under management were growing.

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About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. He was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the nearly twelve years that he was in that role, the fund in 2006 won the Lipper Award in the balanced category for "Best Fund Over Five Years." Additionally, in 2011 the fund won the Lipper Award in the mixed-asset allocation moderate funds category as "Best Fund Over Ten Years. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the defense, property-casualty insurance, and real estate industries, having followed and owned companies as diverse as Catellus Development, General Dynamics, Legacy Hotels, L-3, PartnerRe, Progressive Insurance, Renaissance Reinsurance, Rockwell Collins, SAFECO, St. Joe Corporation, Teledyne, and Textron. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing and finance, as well as a Professional Accounting Program Certificate, from Northwestern University. Ed has earned the Chartered Financial Analyst credential. Ed belongs to the Investment Analyst Societies of Boston, Chicago, and New York City. He is admitted to the Bar in the District of Columbia, Illinois, and North Carolina.