“Perfect Storms” & Long Term Views

Penn’s five-year return on investments places it within the top tier of endowments over $1 billion, but that didn’t stop the editors of The Daily Pennsylvanian from headlining their editorial on the endowment’s FY2005 performance “Endowment Stagflation” and complaining that “Penn’s overly conservative investment strategy is crippling.”

Penn posted a return of 8.5 percent for the year. That was slightly below the 8.7 percent return of its composite benchmark (made up of indices in a variety of asset classes weighted proportionally to Penn’s holdings) and a bit better than the S&P 500 return of 6.2 percent. But it fell short of the average for all higher-education endowments and was well below the performance of most other $1 billion-plus endowments.

According to NACUBO’s annual survey of higher-education endowments, the average change (which includes gifts as well as return on investments) in endowment value for FY2005 was 9.3 percent. For endowments over $1 billion, the figure was 13.8 percent, attributed to their greater diversification and exposure to alternative investments. Penn’s percent change in endowment was put at 8.7 percent. That was last in the Ivy League, with other schools scoring double-digit results ranging from 10.6 percent (Dartmouth) to 19.4 percent (Yale).

None of this came as a surprise to Chief Investment Officer Kristin Gilbertson, who calls last year “a perfect storm” in which “everything that Penn didn’t have did spectacularly well.”

Gilbertson—who had previously managed public equities for Stanford’s management company and before that was a principal investment officer and strategist at the World Bank—was appointed CIO in the summer of 2004, just as the fiscal year was beginning. “Based upon what I knew of Stanford’s portfolios and all the other portfolios and the preliminary returns that I’d seen,” it was clear that Penn would suffer, she says. “We all knew that we were differently positioned than other universities because we did not have private equity. We did not have as much real estate. We had no emerging markets when I arrived here. We had much more U.S. public equity and much more U.S. fixed income than our peers, and we had very little natural resources or commodities.”

The reason for this goes back to decisions made five and 10 years ago, says Gilbertson, which is when many of the investments reaping benefits now were initiated. One prominent example of that would be the money several institutions put into an obscure Internet search engine called Google through venture capital firms back in the late 1990s, which contributed mightily to last year’s gains—especially Stanford’s stunning 23 percent rise in endowment. More generally, investments in assets like real estate and natural resources, typically done through limited partnerships, can take years to mature.

Penn was just then in the midst of setting up its office of investments in its current form, after two decades during which its portfolio had been run—for the most part, with spectacular success—by emeritus trustee John Neff Hon’84 [“An Eye for Value,” March 1998]. Neff stepped in when the University was in real trouble, after a series of missteps had left Penn’s among the worst performing endowments of the 1970s. Under his stewardship, the endowment grew from $200 million at the end of 1979 to $2.5 billion at the end of FY1997. But Neff was leery of the stock market’s apparently unending rise in the late 1990s. The University largely missed out on the tech boom and was slow, compared to its peers, to diversify out of U.S. equities and fixed income into the alternative investment categories that have outperformed in recent years.

“We have been a little bit more conservative than some of our peers,” says Gilbertson. “This office has only been in existence for eight years. David Swenson has been at Yale for more than 20 years now. Jack Meyer was at Harvard for 15 years,” she adds, citing two of the most successful—and controversial—endowment managers of recent years.

Harvard has come under fire for the compensation paid its managers, which contributed to Meyer’s departure to start his own firm last year. Gilbertson, a Harvard alumna, notes that “Harvard runs differently than we—and every other endowment—do, because they are actively investing dollars” rather than hiring outside managers. “To keep people on that level after they’ve learned on your dime is really critical,” she says. “What those guys are earning at Harvard is a lot of money—it’s a lot more than I’m getting paid—but it’s a fraction of what a good hedge-fund manager can make when they’re shooting the lights out.” (For the record, though the University won’t disclose salaries, no one working in the investment office is among Penn’s top five highest-paid employees.)

At Yale, the criticism of Swenson has focused on claims of excessive secrecy regarding the university’s investments, but Gilbertson insists that there is a “strategic need” for secrecy. “We put a lot of time and dollars into finding these ideas. Endowments are in competition, and the last thing you want is to be talking about your World’s Greatest Idea and then have [someone else] go do it,” she says. “I’d hate to give up our trade secrets to other people, because there’s only so much capacity in great ideas, and they tend to go away when they get bid up with other capital going in.”

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Last modified 03/01/06

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FEATURE: Whence the Money
By John Prendergast

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