Two Harvardians invent an industry

In 1973, two former Harvard roommates and budding entrepreneurs – Jim Bailey and Hunter Lewis – took on an assignment to review the investments held in their school’s endowment.

Things were very different back then.  A treasurer of the Harvard Corporation with the wonderfully Bostonian name of Paul Codman Cabot had managed the endowment from 1948 to 1965 as an account at his own firm, State Street Research & Management; charging the school $20,000 per annum for his services.

Mr. Cabot, one of the inventors of the modern mutual fund, had daringly shifted the Harvard portfolio from ultra-safe bonds into a more balanced stock-and-bond mix, catching the equities boom of the 50s and early 60s.  And in 1973, with the fund having risen to a then-colossal $1 billion, Treasurer George Putnam and President Derek Bok created the Harvard Management Company.

When Messrs. Bailey and Lewis began their consulting relationship with the Harvard endowment in 1973 and formally established Cambridge Associates, Mr. Bailey was still on campus, finishing his joint MBA/JD program, while Mr. Lewis was working at The Boston Company, an old-line merchant banking firm.  Forty-four years later, CA continues to count Harvard as a client.

A decade later, a young woman named Sandra Urie wangled a one-on-one job interview with Jim Bailey.  She was a product of Stanford and Yale (and development office head at Phillips Andover Academy, a CA client).  The scheduled 30-minute interview lasted 3 hours, and Mr. Bailey hired her.

As a divorced single mother, she was not the typical junior consultant of that era.  Yet, fifteen years later she was named CEO of Cambridge Associates, and subsequently chairman, stepping back to become Chairman emeritus in 2016 after thirty-two years with the firm.

Consulting and asset management: the rapidly blurring boundaries

Traditionally, institutional investment consulting – which Cambridge virtually invented – and asset management were distinct businesses run by different kinds of people, and the twain seldom met.

The barrier was as much cultural as institutional.  Consultants were seen (and saw themselves) as operating in a more disinterested, academic, and research-related environment.  Asset managers were closer to the Street: faster-paced, more competitive.  They were increasingly publicly-traded, and therefore relentlessly profit-driven.

An individual consultant who wanted a more hands-on job could always become an institutional CIO (and many CA alumni did just that).  Or, they could move over to a Wall Street asset manager.  CA consultants tend to have good contacts in both worlds.

Our March letter focuses on the venerable foundations of New York City and one of their most accomplished investment pros: Kim Y. Lew, chief investment officer of the Carnegie Corporation.

We have an in-depth conversation with Ms. Lew on her career in foundation investing and the future of women and minorities in her field.  We also look at pay and performance in the NYC foundations, with some illuminating charts for our quant readers.

Our friends at the Foundation Center tell us there are 243 American foundations with over $1 billion in assets and New York City harbors 31 of them, including some of the biggest and most storied.  The money wasn’t all made there, but it tended to flow toward Manhattan because that’s where the money-managers were.

According to David Swensen, “a deep appreciation of history” is essential to an investment professional.  Not just knowledge, mind you; but appreciation.  History may have temporarily put that money in their care, but markets and circumstance are always threatening to take it back.

Goethe’s Faust got it right when he declaimed:

“That which thy fathers have bequeathed to thee, earn and become the possessor of it!”

Mr. Carnegie and Ms. Lew:

When Andrew Carnegie endowed the corporation with $125 million in 1911 – perhaps $3 billion in 2017 dollars – he founded the largest charitable entity of its day.  Along with the creation of the Rockefeller Foundation in 1913, this marked the beginning of the modern era of foundation philanthropy.

The Carnegie Corporation, headed by the eminent Vartan Gregorian, marked its centenary in 2011, the year Kim Lew became co-CIO, and it is still among the twenty-five largest foundations in the U.S. 

Despite continuing to give away at least $150 million every year (5% of net investment assets), the Corporation’s endowment is larger today – in constant dollars – than it was in 1911.  This is due in part to the forbearance of America’s taxpayers via the Internal Revenue Code, but also in large part to the skill of Ms. Lew, her colleagues, and their predecessors in maintaining impressive investment returns over the generations.

What makes a great chief investment officer?

All professional investors want to make money.  The question is, how and for whom?

In the for-profit world of Wall Street asset managers and retail mutual funds, the differences among managers reflect investor appetites, time horizons and risk tolerances.  They must all serve their customers, or the customers will walk.  But they are also profit-seekers, motivated by bonuses and the bottom line.

Most chief investment officers start their careers as traders, analysts, or consultants; working with spreads and price dislocations, capital structures and cash flows, or advising on asset allocations and manager selection.  Ex-traders like Sam Gallo, CIO at the University System of Maryland, are particularly valuable now, because they know how to move large books quickly and cut transaction costs, topics of keen interest these days.

Eventually, some find their way into the family office and non-profit world of multigenerational, multiasset investing, researching opportunities and managers in public and illiquid markets.

Dedicated family office CIOs – between 800 and 1500 in the US – invest in anything and everything; in stocks, bonds, loans, cold storage, tankers, and toll roads.  But tax implications become a priority; and family preferences – rational or not – drive the portfolio.

CIOs work at the pleasure of a complex and opaque authority whose circumstances, mood, location, and needs are subject to change at any time.  In the family office world, one often has no idea how much liquidity is required as family purchases can be large, lumpy and unpredictable. 

Both Alice Ruth and Jason Perlioni jumped to endowment CIO positions this year after long stints at family offices; Ms. Ruth moving to Dartmouth after nine years at Willett Advisors (Michael Bloomberg) and Mr. Perlioni moving to Johns Hopkins after ten years at the Pritzker Group.

Working for a family office can be an attractive and rewarding experience, but all family office CIOs understand Leo Tolstoy’s famous line from Anna Karenina, “All happy families are alike; each unhappy family is unhappy in its own way.”

Managing assets for tax-exempt Institutions differs from all the above.

Some institutions prioritize wealth creation while others prioritize transparency, political accountability, and risk minimization.  Endowments, foundations, hospitals, cultural institutions, corporate and public pension funds can fall into either group. 

In each case, however, the CIO job is what one makes of it; some are delegators, some are micro-managers, and some are just liaisons between a consultant and an investment committee.

Corporate and hospital chief investment officers structure their portfolios primarily to manage risk.  Corporate CIOs are liability driven and have a financial mindset.  They think in terms of payouts, terminal value, and matching durations.  They care less about outperforming peers because absolute return is seldom their top priority or that of their boards.  Bill Hammond, the CIO at AT&T and Jason Klein, CIO at Sloan-Kettering NYC, understand the mission of the institution; their job is to minimized liabilities and forestall surprises.

The “endowment model” of fund management prescribes a highly diversified portfolio of investments across public and private markets.  Most endowment and foundation CIOs strive to earn the best possible risk-adjusted returns and grow the corpus over decades.

Our letter this month focuses on the venerable foundations of New York City and one of their most accomplished investment pros: Kim Y. Lew, chief investment officer of the Carnegie Corporation.  

We have an in-depth conversation with Ms. Lew on her career in foundation investing and the future of women and minorities in her field.  We also look at pay and performance in the NYC foundations, with some illuminating charts for our quant readers.

Our friends at the Foundation Center tell us there are 243 American foundations with over $1 billion in assets and New York City harbors 31 of them, including some of the biggest and most storied.  The money wasn’t all made there, but it tended to flow toward Manhattan because that’s where the money-managers were.

According to David Swensen, “a deep appreciation of history” is essential to an investment professional.  Not just knowledge, mind you; but appreciation.  History may have temporarily put that money in their care, but markets and circumstance are always threatening to take it back.

Goethe’s Faust got it right when he declaimed:

“That which thy fathers have bequeathed to thee, earn and become the possessor of it!”

Mr. Carnegie and Ms. Lew:

When Andrew Carnegie endowed the corporation with $125 million in 1911 — perhaps $3 billion in 2017 dollars — he founded the largest charitable entity of its day.  Along with the creation of the Rockefeller Foundation in 1913, this marked the beginning of the modern era of foundation philanthropy.

The Carnegie Corporation, headed by the eminent Vartan Gregorian, marked its centenary in 2011, the year Kim Lew became co-CIO, and it is still among the twenty-five largest foundations in the U.S. 

Despite continuing to give away at least $150 million every year (5% of net investment assets), the Corporation’s endowment is larger today — in constant dollars — than it was in 1911.  This is due in part to the forbearance of America’s taxpayers via the Internal Revenue Code, but also in large part to the skill of Ms. Lew, her colleagues, and their predecessors in maintaining impressive investment returns over the generations.

A New York story:

Kim Lew was born in Harlem, daughter of a Chinese immigrant father and an African-American mother.  She was admitted to one of New York’s most selective public high schools, the famous Bronx High School of Science, and then became the first in her hard-working family to reach college.

She earned degrees at the University of Pennsylvania and Harvard Business School, came home to launch a financial career in New York, and joined the investment office of the Carnegie Corporation in 2007.

That’s a tall mountain to climb for anyone, but especially challenging for a minority female.

By our own ballpark estimates, only about 25 percent of major educational endowments and about 30 percent of big foundation funds are managed by women, and only a handful are African-Americans.

So, hers is in some ways an unusual story, but New York is a place where unlikely people have always accomplished remarkable things.

Here’s a snapshot of New York City’s top foundation CIOs, where they work, and how much money they manage.

“Persistence of returns” is a phrase we associate with hedge funds.  It seems debatable whether there is any such persistence there.  Hedgies say there is; others are not so sure.

In the case of endowments and chief investment officers, however, it’s a verifiable phenomenon.

The chart below incorporates the latest numbers and lists the top-ten endowment performers (out of our Top 25 cohort) for 1, 5, and 10-year periods as of June, 2016.

What is remarkable is how the same funds tend to show up across the board, even in the more volatile 1-year numbers.

Seven funds – MIT, Princeton, Yale, Columbia, Notre Dame, Rice, and Stanford – show up in each table.  Dartmouth and Virginia both make two out of three (neither of them quite made the cut for 1-year returns).  Notre Dame’s consistency is uncanny: they rank 6th out of 10 on all three.

Rice’s consistent excellence may have been slightly unexpected.  It’s a Southern, non-Ivy school with “only” a $5.3 billion endowment; but it has outperformed Stanford and most of the Ivys in each measurement period.  Good work by Allison Thacker’s Rice Management Company.