University endowments are kicking the market's butt

News coverage of an annual report on U.S. university endowments (released this week) has tended to focus on either the gaudy totals, or the related news that Princeton has decided to freeze its tuition for a year. (It turns out that while a few other endowments are larger in total, Princeton has the most endowment dollars per student.)

The Economist wants to know how American universities are managing to invest better than even hot-shot hedge-fund managers? That's not a new or unusual outcome, apparently, and the schools aren't paying successful investment managers the same level of wild salaries and bonuses that for-profit firms do. (Though a few universities do pay their investment chiefs a lot more than their professors or even presidents, which has caused some public controversies that have in turn chased away some managers.)

The Economist thinks that the big university endowments represent "capitol [that] is extremely patient....unlike pension funds, they do not have to fret about matching assets with liabilities. This means endowments can tolerate lots of volatility, which in turn allows them to make, and stick to, contrarian bets....Perhaps they can stay solvent longer than the market can stay irrational." Hence "America's endowments were among the first to look beyond the staid mix of domestic equities, bonds and cash. The idea they helped develop in the 1970s and 1980s—deemed eccentric at the time—was to break the portfolio into a mix of standard and “alternative” assets, as uncorrelated with each other as possible so as to spread risk. This strategy is sometimes referred to as “portable alpha”. Their early moves into hedge funds, venture capital, private equity, property, distressed debt and the like brought outsized profits...."

University investment managers may also have identified a couple of interesting competitive advantages: " “Whereas pension trustees are naturally risk-averse, universities are all about innovating, financially as well as intellectually,” says James Walsh, who runs Cornell's $5 billion endowment. Investment constraints are kept to a minimum. Alumni with Wall Street experience are encouraged not only to donate money but also to sit on investment committees. Many are happy to oblige. “This gives us access to minds we couldn't otherwise afford,” says Mr Walsh." "

One thing I'd like to see some data on, which would help inform the current debate about mission-related investing of foundation endowments, is how university endowment returns have been correlating with divestment decisions. The NACUBO report doesn't address that, unfortunately.

More on foundation investment practices

The Wall Street Journal followed up yesterday with a small article about foundations which clarified for me that there are really three basic choices for foundations, not two as the L.A. Times portrayed it. (You can't read the Journal article unless you're a subscriber but a Chronicle of Philanthropy note on it is here, and Philanthropy 2173 has links to all the foundations mentioned in it.)

(If you're interested in this subject, go take Lucy Bernholz's online poll found on the right at the Philanthropy 2173 link above.)

The L.A. Times articles about the Gates Foundation talked about either letting mission-related issues influence decisions about buying stock, or deciding that getting the highest returns is all that matters. That's basically the same as the debate about whether Western nations should keep China at arm's length until it improves its human-rights practices, or have normal diplomatic relations so as to encourage change. (When I was in college the topical subject of that foreign-policy debate was South Africa.)

Buying stock in a corporation, though, is different: it's ownership. You get to actually vote on the policies of the thing you own part of, and to speak out loud at annual meetings where the management and all the other owners have to listen to you. Indeed if enough other owners feel the same way that you do about an issue like corporate practices, the company must follow your wishes. That's a whole different caliber of influence than any nation, even the U.S., gets by trading with China -- the U.S. State Department obviously does not get to speak, let alone vote, as a member of the Chinese Politburo or even the country's toothless parliament.

Upon reflection that's the path which seems to me to best leverage the latent power for change of big investment portfolios. So that's why I voted for option 4 on the online poll mentioned above. (I notice that the poll stacks the deck in its structure -- it lists three different flavors of the first strategic option and then just one version of the other two -- so there's little chance that anything but a version of "mission imperatives should change investment choices" will win.)

A thoughtful response from Gates

Thanks to reader Greg for a tip that the Gates Foundation has replaced the online announcement that replies to the L.A. Times articles. The new essay, still signed by Chief Operating Officer Cheryl Scott, is quite different from the one that was online for only half a day last week though it does still make the good point that Gates has been completely transparent about its investing.

The new essay makes a point of stating that "Bill and Melinda oversee the investment of the foundation's endowment", so it does look like they were annoyed that the previous posting and Scott's newspaper interview made it sound otherwise. It says that they give "guidance" to professional investment managers, which every non-profit watchdog would agree is the appropriate approach for a foundation board.

Perhaps the most-important substantive message of the new essay is that the Gates Foundation is not in the camp that says a foundation should seek only to maximize returns with its endowment. Rather, their reason for mostly declining to rank companies on moral grounds is the real-life complexity and contradictions inherent in that concept. "There are dozens of factors that could be considered...Many of the companies mentioned in the Los Angeles Times articles do a lot of work that some people like, as well as work some people do not like. Some activities might even be viewed positively by some people and negatively by others." They also note that some of the issues which the newspaper brought up as reasons not to invest in a company, such as lending laws or environmental regulation, are outside the foundation's charitable mission.

On the shareholder activism question they basically vote for reserving proxy voting for issues directly related to a company's carrying out its core mission, i.e. good management of the company itself. And they do note the one specific subject on which Bill and Melinda have thus far decided that the issues are clear-cut enough to decide not to invest at all: tobacco.

I don't personally agree with all of the above decisions but also don't find any of them to be out of the bounds of what reasonable people of good will might conclude. It does sound like the newspaper articles have provoked renewed focus on the subject over there, and that the Gates folks understand that its unique status in philanthropy inherently places some special obligations on them.

Gates Fnd: she maybe shouldn't have said that out loud

It may be that Gates Foundation COO Cheryl Scott is in hot water today, and the reason can be read between the lines of today's news coverage.

The L.A. Times today has a followup article which is obviously based on that press release that appeared and then disappeared from the foundation website yesterday. The newspaper is spinning that announcement as being about the foundation newly reconsidering its investment practices in reaction to their articles. I didn't get that from what they had posted, particularly, but since I still can't find a copy I'm not sure. They secondhand-quote Scott saying that such internal discussion was already underway long before the recent articles, which is completely plausible to anyone working in major foundations because it's not at all a new subject in that world.

Nobody at Gates is talking to the L.A. Times but Scott on Tuesday did talk to their hometown paper, the Seattle Times. To them she said on the record that the foundation's current method of investing its assets is "not 100 percent effective," and she did apparently say to that paper that the foundation will now newly review its investment practices. She had also in that press release written that the foundation would "formalize the process by which Bill and Melinda Gates analyze and review these issues."

That last part may be what ticked off one or more people named Gates. In effect Scott told the world that Bill and Melinda, personally, have not been paying much attention to or thought about the issue of where the foundation invests its huge endowment. Whether that is or isn't a fair characterization I dunno, but I can hazard a guess as to how well it was received by a guy who quit college at age 20 and built from scratch a huge global business and fortune.

Gates learns that being a poster child cuts both ways

The Bill and Melinda Gates Foundation has just been placed squarely in the bulls-eye of what has been a quietly-growing debate in the foundations world about mission-related investing of those big endowments. It's the same set of choices that hit home a while back for universities: is the highest investment duty to maximize returns and hence resources for the non-profit mission, or to accept lower returns (or higher risk) in exchange for the investing itself advancing the mission? Or at least not actively violating it?

The two long articles linked above appeared on the front page of the L.A. Times yesterday and today and are being picked up far and wide by newspapers owned by their parent Tribune Company. Many readers will be appalled to learn how many examples there are of Gates money going into stock of companies which are helping cause the very problems that the foundation is attempting to ameliorate with grants.

I have little doubt that most of the specific facts as presented are correct, and I'm not one of those who thinks that trying to balance investment success and mission purity has to mean "doing neither of them well." However the lead human-interest example of the second story is oddly unconvincing (a middle-class couple who got ripped off by a fast-talking mortgage salesman because they couldn't be bothered to read the loan documents they signed). And the newspaper committed several fairness and logic violations.

For example it is obviously just sensationalism to repeatedly list the Gates Foundation's asset value as $67 billion with a footnote that this figure includes the future expected Warren Buffett contributions (whereas the other endowments they compare Gates to are listed at present value). They mix and match examples which are obviously not comparable on merit. Also when rattling off horrible-sounding corporate behavior that Gates money has helped enable they seem to have completely lost track of that pesky distinction between being charged and being convicted (which some musty historical document or other mentions in passing right before some silliness about freedom of the press).

But for all that the core issue is real and foundations need to deal with it. And being by far the biggest such venture in world history, whatever its correct endowment total right now, means that Gates can't just ignore this kind of question. Hopefully someone who has their ear is explaining that right now to Bill, Melinda and Warren.

Microfinance: for profit or not for profit?

The awarding of the 2006 Nobel Peace Prize to Muhammed Yunus put the microcredit/microfinance concept onto the front pages. Those of us who see global poverty as humanity's most-fundamental issue were thrilled to see the issue get such media attention, and you can count me among those who have long been excited by microcredit. Then the October 30 issue of The New Yorker made public a hot theoretical debate about whether microcredit works best in a non-profit or a for-profit form.

Grameen Bank, Yunus' organization, is a non-profit which initially used grants and soft loans for its work; now it is almost self-sustaining. (It's an example of an institution that is openly and unapologetically biased in favor of women, on the grounds that as Yunus says, women are more responsible about re-paying the loans and poor families benefit more when the women control the money; whether that practice would be legally sustainable in the western world is debatable.) Now a group of socially-minded entrepeneurs, who see Yunus as a well-meaning example of founder's syndrome, think that microfinance can reach truly global scale plausibly only as a for-profit sector.

They seem to think that more contributions could be pried loose from the western world's newly-wealthy entrepeneurs to for-profit microfinance funds than to non-profits, an idea which reflects an outdated view of the non-profit sector and which isn't supported by the current flood of huge contributions being made towards this movement. Perhaps more relevantly, they think that commercial enterprises can tap the capital markets for investment funds at a scale that dwarfs even the stunning scale of philanthropy in today's world.

Yunus and his supporters recoil from that in part on philosophical grounds, feeling that profit as a required payoff for helping the poor is vaguely immoral. More tangibly, they worry about mission drift: that commercial competitive pressure inevitably would mean that only the less-poor or the working poor would be considered reasonable risks for loans. One response is that adding working-class customers is simply a way to stay afloat so as to keep lending to the really poor, but that flies in the face of Yunus' core argument that the poor can be reliable borrowers even at high rates of interest.

Hmm, all good questions...is it necessarily an either/or choice? We have both non-profit and for-profit hospitals, ditto theaters, also some other important sectors -- is that diversity of structures and motivations not positive in some important ways?

Another thought is that this seems like a perfect fit for non-profits to leverage the foundation sector's increasing interest in mission-related investment, where part of a foundation's endowment can be invested at higher-than-normal risk or lower-than-normal return provided the investments have a mission purpose. Hopefully somebody is talking seriously about this with some of the multi-billion foundations like Gates, Ford, et al.