- As hedge funds grow and institutionalize, one key challenge is retaining its attractiveness—aligned incentive structure and nimbleness, without the drawbacks—asset gathering and closet indexing.
- The key to success is manager selection and selecting markets that have more opportunities relative to capital. Stick with policy and don’t trade in and out of asset classes. Have long-term focus and be early adopters of new asset classes and strategies.
- Kaplan and Schoar (2003) private equity study: buyout funds net returns underperform the S&P 500; venture funds net returns underperform on an equal-weighted basis. Venture results are skewed by a small number of top funds that are generally closed to new investors.
- Private equity managers exhibit performance persistence. Active manager selection is crucial to success. New managers and private equity FOFs tend to be poor investments.
- Sandy Urie (CEO, Cambridge Associates): the key to success is sticking with a disciplined process, not trading in and out of asset classes.
Laurie Hoagland, CIO, Hewlett Foundation
- Former CIO of Stanford University endowment.
- Long tenure and low turnover of investment staff are keys.
- The word “distressed” tends to be good investments.
- Asset allocation should begin with top-down views of asset classes. However, flexibly allocate to arising bottom-up opportunities. Do not fill a bucket with less desirable manager.
- Try not to invest with big institutions, but with firms that have excelled over time. Diversified firms have less business risk but less focus on core competencies.
- Warren Buffett said the investment business tends to be a binary situation: either it never takes off or it does well.
Dr. Allan Bufferd, Treasurer Emeritus, MIT
- There’s no such thing as investment philosophy—everyone wants to buy cheap, get good value, not put all their eggs in one basket, and sell at the right time.
- Only special knowledge or expertise in an asset class should move you off of the policy portfolio (“null hypothesis” equally–weighted portfolio). A thought experiment including 4 asset classes: X, Y, Z, W. Each of the asset classes, individually and in aggregate, increased the risk-adjusted performance of a portfolio. Expertise in them should dictate whether they should be included in the portfolio. The assets were: fine wine, fine art, antique automobiles, and high-end jewelry.
- Since the dispersion is so great in alternative asset classes, one must be able to identify a priori, the best performers. If not, don’t play. In PE, the median manager underperforms the market.
- Idea generation is the most important aspect of investments. Look for it in any way you can: conferences, conversations, reading. “A turtle does not move forward without sticking its head out.”
- Manager selection: look for intelligence, a sense of humor, honesty, and commitment to success (drive, quality).
Alice Handy, CIO, Investure and former University of Virginia
- Instead of filling buckets, allocate assets based on opportunities and construct portfolios based on risk and return drivers. Normal asset allocation will do ok, but tactical opportunistic allocations will do better.
- Investment committees should be small in size and formed for diversity of opinions. Members should be advisers and strategic thinkers. Look for investors with good constitution, strong conviction, and investment intuition.
- Treat your investment managers and clients like partners an you will become an investor of choice. Be passionate about investing and look for managers who are also. Look for ethical managers you (or someone you trust) know very long and very well.
- Avoid herd mentality and short-term horizon, and understand cyclicality of markets.
- Advice for her daughters: you can be a good businesswoman, a good mother, or a good wife, but it is difficult to be all three at once. Find a mentor early, one you can relate to that is also a good investor.
Scott Malpass, CIO, University of Notre Dame
- Became CIO at age 26.
- Investment ideas come from “intense engagement with smart people all over the world”. Constant dialogue with respected investors and thought leaders, and constantly expand network.
- Manager selection: good fundamentally-driven managers, compelling strategies that are not overly complex, evidence of repeatability, reasonable fees, non-correlation with other assets. Avoid: excessive leverage, difficult to repeat, secretive managers who withhold information, no skill in hedging peripheral exposures, paper portfolios, “me-too” strategies.
- “If I can’t understand it, I won’t do it, because if it does poorly, I can’t explain it.”
- A long horizon gives you a huge advantage. So, think long-term and don’t get pressured into short-term opportunities. Don’t rush or take due diligence shortcuts.
William Spitz, CIO, Vanderbuilt University
- A lot of the returns of non-traditional asset class have already been arbitraged. Early adopters do well, late adopters get killed. There’s nothing out there truly new. Maybe we have to accept the reduced returns of stocks and bonds.
- Have a 5% “Opportunistic” allocation, for thematic, tactical, 2-sigma type of major mis-valuations.
- Too many asset classes. Wants to eventually simply to three: 1) return generators, 2) inflation hedges, and 3) deflation hedges.
- Core-satellite approach; whenever they deviated from that, returns suffered. The core is made up passive, or semi-passive (low tracking error) managers. A core of 40% of global equity is passive. Satellite managers are concentrated, highly convicted, high alpha-generating approaches. An all passive approach will beat most peers, so that should be the starting point.
- Selecting managers: what is their edge, why is it sustainable, why is it systematic? What about their firm gives them a proprietary advantage? Also look for risk management, systems, potential conflicts, and large manager co-investment.
- Firms that are good investors in many asset classes can be a source of good ideas (ex. GMO, Commonfund, Cambridge Associates).
- Spitz believes in mean reversion and cyclicality of asset classes. Have courage to invest in the worst part of the cycle and avoid the other end.
Ellen Shuman, CIO, Carnegie Corporation
- Worked under David Swensen at Yale, Director of Investments.
- Many investment styles work, but you need to stick with your own and not flip-flop.
- Bias to focused managers. Superior managers don’t try to be good at everything. In real estate and country funds, find the knowledgeable locals.
- Foundations face more taxation but have less fixed costs than endowments. They do not have contributions and are generally under-managed and evolve behind endowments.
- Looks for managers that own their own firm, act as principals not agents, run focused portfolios, and has a hungry but stable team. Never fire for performance, but for organizational or strategy instability.
- Beware of over-diversification by hiring too many managers. Beware of principal-agent issues, structures that benefit the manager and not the investor. Favors lock-ups because it weeds out short-term investors.
Bruce Madding, CIO, Henry Kaiser Family Foundation
- If you can’t explain the investment to someone else clearly and concisely, you don’t understand the risks you are taking. This applies to investments you make, and investments pitched to you by marketing people.
- Prefer small teams to solo managers, infrastructure that allows team decision-making to trump that of a strong individual. Investment debate breeds positive outcomes and avoids arrogance and myopia.
Bob Boldt, CIO, Agility Funds
- Engineer, CFA, former CIO of UTIMCO, served as senior officer at CalPERS, and now is an endowment/ foundation consultant.
- “You find out about people in two situations: great stress and great success. If you haven’t seen that, you don’t know the person yet.”
- Boldt favors smaller, emerging managers—ones that are young and hungry. Don’t focus on the track record—look at the people and how they make decisions. It is important to have managed money yourself to better evaluate money managers.
- Examine the decision-making process and use the scientific method (decision factor analysis). People use different methods to make decisions—not everyone uses rationality.
- Be agile and willing to pursue new innovative ideas quicker. Invest in the best opportunities, not in prescribed narrow asset classes.
- Find “spaceship markets”: un-explored markets. There, alpha doesn’t have to be a zero-sum game, because the market is always expanding. First-mover advantage is important. In contrast, in developed markets, skill is more important than speed.
Donald Lindsey, CIO, George Washington University
- Began his career at the University of Virginia Investment Management Company and established the University of Toronto Asset Management Company.
- Volatility can be a good thing. You can take advantage of others acting out of fear. Usually when there is volatility, there is opportunity, because things are mispriced.
- Focus on thematic investing and under-emphasize asset allocation (beta, alpha, etc.). Study economics, demographics, politics, and key trends. Simply seek globally the best sources of future growing cash flows and allocate heavily to the best ideas.
- Manager selection: focus less on performance (style can be out of favor) and more on the culture of the firm. Seek managers who are humble, passionate, responsible (fiduciary), and honest, above all else.
Jonathan Hook, CIO, Baylor University
- Former investment banker, first time CIO at Baptist Baylor University.
- Tilt the portfolio heavily towards value: “over any 10-year period the value side always ends up winning.” Diversification may be the only free lunch.
- Prefers niche-y managers, ones that have found a space without much capital chasing it (rare) or ones that have found a different way to play in the space.
- Separates portfolio asset classes by roles:
- Market Exposures (beta, long-biased, long-short): ~40%
- Risk Reducers (fixed income, low volatility):~20%
- Return Enhancers (private equity, emerging markets): ~20%
- Inflation Hedges (TIPS, infrastructure, commodities: ~20%
- For manager selection, honesty and integrity (principled) are two of the most important attributes.
- Always look for and learn from investment mistakes—do a post mortem. Is there buyer’s remorse? Is there something we missed?
Daniel Kingston, Managing Director, Vulcan Capital
- Internal investments at Stanford Management Company, CIO at Kauffman Foundation.
- Stanford managed 25% of endowment assets internally (those it could manage cheaply)—fixed income, private equity, commodities, and derivatives.
- Manager selection is not about performance analysis—it is about analyzing process.
- Risk taking shouldn’t depend necessarily on the market or opportunity; it should be focused on the capacity to take risk.
- Always ask yourself (and those you hire): what is your edge?; what do you see that thousands of other intelligent investors have missed? Be intellectually skeptical.
- Bottom-up analysis tends to work better in the short-term; top-down processes tend to do better over the long-term. Kingston incorporates both and waits for the best opportunities (“not every wave is worth riding”).
- Investment return is measure by change per unit of time—therefore ignoring market timing is ignoring an important part of the equation. Asset allocation should be flexible, based on market opportunities, not static.
- Asset allocation framework:
- Growth: growth equity, activist, private equity
- Relative value: arbitrage, hedge funds
- Subordinated cash flows: high yield bonds, value equity
- Priority cash flows: bonds, real estate
- Find situations where the investment opportunity exceeds the available capital. Get appropriately compensated for taking the risk.
- Re-evaluate an investment thesis after conditions change. When facts change, you change. Avoid falling into metal inertia.
Mark Yusko, CIO, Morgan Creek Capital
- Former CIO University of North Carolina. Promotes the “outsourced CIO” model.
- Great investors invest with conviction.
- “Asset allocation drives returns. Full stop.” Implement a “hard-coded” strategy: strategic asset allocation with tactical ranges that allow for over- and under-weights. Set upper and lower limits to the ranges and rebalance with discipline and non-emotion. The biggest and easiest mistake is spending too much time on security (or manager) selection and not enough on asset allocation. All activity beyond asset allocation should be focused on managing and reducing risk.
- Invest with skilled managers that don’t need your money. Yusko tends to invest early with “spin-out” managers, who are interested more in managing money than in managing an asset management business.
- You can’t buy historical returns—only prospective returns.
- Yusko does not like fixed income, it is only a deflationary/ disaster hedge.
- Increase illiquid investments. Illiquidity is a return premium. But people generally overestimate their liquidity needs. Private has historically beaten public by about 430 bps/ year compounded. Diversify in illiquid private partnerships to generate higher risk-adjusted returns.
- “Rebalancing is getting back to a target, speculation is getting away from a target.”
- Manager selection: Beer Test, life balance, instinctively competitive, honest (in life), with integrity, intelligent, passion, and pedigree (screened by schools and “Big Dog” companies).
- Yusko believes Boards should be multi-generational, with a strong, long-tenured leader. Given limited time, they should focus only on high-level issues, like asset allocation. Delegate and trust lower-level activities, like manager selection and portfolio construction to the investment staff. “The only thing a board could do in 15 minutes with manager selection is make a mistake.”
- Most investors are wrong most of the time. Legends (e.g. Soros, Robertson) are right about 58%. Most are right only 35-40%. Historically the market averages 11% return, mutual funds 9%, investors only 2%.
- Focus on value. Learn how returns are derived.
- “The quality of the leader is measured by the quality of the followers.” “Look around at the four people you spend the most time with, that’s which you will become.”
Lessons for Investors
- Have a strong asset allocation policy. Add value tactically. Have value-orientation.
- Volatility presents opportunity when asset classes fall out of favor (e.g. high yield bonds in 2003).
- Passive strategies are typically not attractive in alternative asset classes. Do not invest if you can’t find a good manager (e.g. venture capital). Allocate where there is opportunity.
- Manager selection: favor focused strategies, concentrated portfolios, good pedigree, and stable teams. Look for managers who act as partners, are trustworthy, transparent, passionate, and hungry. Strategy must have identifiable and sustainable “edge”.
- Resist the urge to chase performance.
- Align principal-agent interests—look for co-investment and be wary of asset gathering.
- Future investment success may rest upon finding new unexploited asset classes.
- Investment committees should be small, agile, stable and experienced in investments. The investment process should be disciplined yet flexible, allowing for quick decision-making.
- Traveling and meeting people is essential to developing and researching investment ideas.
Finished: 28-Dec-2010