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After the Flood: Endowment Investing for the Next 100 Years

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What reverts and what does not. Supply and demand. Price vs. quantity. Long-Term Trend ... Can a stool stand on one or two legs? Workgroups. Advisors. Staff ... – PowerPoint PPT presentation

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Title: After the Flood: Endowment Investing for the Next 100 Years


1
After the FloodEndowment Investing for the
Next 100 Years
  • UJC Investment Institute
  • February 4, 2009
  • David R. Brief, CFA
  • Chief Investment Officer
  • Jewish Federation of Metropolitan Chicago

2
Floods Foresight and Hindsight
  • And G-d looked upon the earth, and, behold, it
    was corrupt
  • - Genesis 612

Cartoon created for CoolRisk.com by Michael Mittag
3
60-Year Flood
4
Key Issues
  • Economy
  • Risk
  • Allocation
  • Implementation
  • Outsourcing

5
Economics 101
  • Predictions
  • Crisis unfolded in July 2007
  • March, June, September 2008 what inning is it?
  • Mean reversion
  • What reverts and what does not
  • Supply and demand
  • Price vs. quantity

6
Long-Term Trend
7
Growth Rate Comparison
Annualized CPI Increase 4.0
8
Mean Reversion and Corporate Profits
Data obtained from U.S. Department of Commerce
Bureau of Economic Analysis http//www.bea.gov/
9
Mean Reversion and Valuations
10
Return to Long-Term Equity Ownership
11
Bond Market Expectations
12
Price of Credit vs. Price of Stuff
13
Corporate Risk Premium
Mean and standard deviation data calculated from
February 1976 through December 2007
14
Price vs. Quantity(e.g., U.S. Debt, U.S.
Dollars, etc.)
15
Return to Bond Ownership
16
The only risk that mattersEnterprise Mission
to boldly go where no one has gone before
17
Endowment Objectives
  • Generate income to augment organizational
    resources in perpetuity
  • Spending policy and investment policy are key
    mechanisms
  • Balance natural tension between long-term and
    short-term objectives
  • Compounding wealth is a long-term process
  • Managing budgetary needs is a short-term process
  • Defining tradeoff between return and risk
  • Maximize long-term resources
  • subject to limiting short-term cutbacks
    (frequency and magnitude)
  • Feasibility serves as overriding constraint
  • Effective spending policies are complex
  • Liquidity requirements may present challenges
  • Size can limit investment opportunities
  • Incomplete understanding can inhibit prudent risk
    taking/return seeking

18
Want vs. NeedRisk Management Priorities
  • Explain the change, the difference between what
    you want and what you need, theres the key
  • - R.E.M., I Believe, Lifes Rich Pageant, IRS
    Records, 1986
  • You cant always get what you want, but if you
    try sometimes you just might find you get what
    you need
  • - Rolling Stones, You Cant Always Get What You
    Want, Let It Bleed, Decca Records, 1969
  • Distribution policy represents the front line
  • Investment policy should not be driven by
    volatility measures (e.g., standard deviation)

19
Joseph in Egypt revisited Fat years and lean
years
20
What we wanted vs. what we needed
Modestly larger distribution MUCH larger
endowment (3x!)
21
Risk/Return TradeoffUpside Participation
Downside Protection
22
Asset Allocation and MPTMostly Poor Theory
  • Top Ten Critical Assumptions of MPT
  • Returns on all assets follow stationary lognormal
    distributions always
  • Risk equals volatility (standard deviation)
    nothing more, nothing less
  • Zero transaction costs (brokerage or bid/ask
    spreads) or taxes of any kind -gt indifference
    between income, realized gains, and unrealized
    gains
  • No market impact of trading and infinite
    liquidity
  • Complete awareness at all times by all investors
    of all risk entailed in every investment
  • Single universal time horizon for all investors
  • Risk management diversification (via stable
    correlations). Period.
  • Ability to buy and sell all assets at all times
  • Unlimited ability to (a) sell short any asset,
    (b) borrow, and (c) lend at the risk-free rate
  • Zero impact on markets resulting from politics
    and/or investor psychology

Adapted from essay by Travis Morien
23
Lognormal vs. Abby Normal?
24
Asset Allocation Liquidity Allocation
25
A New Allocation Matrix
26
Implementation Implications
27
Alternative Investments vs. Alternative Rock
  • The term "alternative" was coined in the 1980s
    to describe punk rock-inspired bands on
    independent record labels that did not fit into
    the mainstream genres of the time.
    Helen Popkin, MSNBC.com
  • Selected Best Alternative Rock Album Grammy
    nominees
  • U2 (170 million albums sold)
  • Paul McCartney (100 gold and platinum records)
  • R.E.M (3 multi-platinum albums)
  • David Bowie (1st gold record in 1974)
  • Alternative Mainstream

27
28
Caveat Emptor
  • Lake Wobegon
  • Fictional place, imagined by Garrison Keillor,
    where "all the women are strong, all the men are
    good looking, and all the children are above
    average."
  • New Jersey
  • Real place in which 68 of drivers (74 of men)
    rate themselves as above average and only 1 as
    below average.
  • Fairleigh Dickinson University's
    PublicMind Institute, June 2007 Survey
  • Alternative Investment World
  • Semi-real place in which all the managers are top
    quartile.

29
Caveat Corollary
  • I sent the club a wire stating, "PLEASE ACCEPT
    MY RESIGNATION. I DON'T WANT TO BELONG TO ANY
    CLUB THAT WILL ACCEPT ME AS A MEMBER".
    Groucho Marx
  • Want vs. need vs. achievable
  • If you've been in the game 30 minutes and you
    don't know who the patsy is, you're the patsy.
  • Unknown
  • Better to not play than to be the patsy.

30
Manager Diversification102 Separate Investments
31
TransparencyToo Much Information?
32
OutsourcingThe Role of Committees
  • A committee is a cul-de-sac down which ideas are
    lured and then quietly strangled."
  • Barnett Cocks
  • A camel is a horse designed by a committee.
  • Sir Alec Issigonis
  • An investment committee should have an odd
    number of members, and three is too many.
  • Warren Buffett

33
iPod by Committee?
34
Prudence
  • Prudent Expert Rule
  • The section directs directors or others
    responsible for managing and investing the funds
    of an institution to act as a prudent investor
    would, using a portfolio approach in making
    investments and considering the risk and return
    objectives of the fund. UNIFORM PRUDENT
    MANAGEMENT OF INSTITUTIONAL FUNDS ACT drafted by
    the NATIONAL CONFERENCE OF COMMISSIONERS ON
    UNIFORM STATE LAWS July 7-14, 2006
  • Prudent Man Rule
  • "All that is required of a trustee to invest is
    that he shall conduct himself faithfully and
    exercise sound discretion. He is to observe how
    men of prudence, discretion and intelligence
    manage their own affairs, not in regard to
    speculation, but in regard to the permanent
    disposition of their funds, considering the
    probable income, as well as the probable safety
    of the capital to be invested." 1830 by a
    Massachusetts Court decision (Harvard College v.
    Amory)

35
Decision Hierarchies and Outsourcing
  • Security Selection
  • Manager Selection
  • Manager of Managers Selection
  • Strategy Selection
  • Asset Allocation
  • Where does the comparative advantage begin
    (and/or end)?

36
Ends Justifying Means?
37
Skill vs. Luck
  • It's better to be lucky than smart, but it's
    easier to be smart twice than lucky twice.
  • - Unknown
  • The man who said "I'd rather be lucky than good"
    saw deeply into life. People are afraid to face
    how great a part of life is dependent on luck.
    It's scary to think so much is out of one's
    control.
  • Woody Allen, Match Point

38
The optimal 3-legged stool
Advisors
Workgroups
COMMITTEE
Staff
Can a stool stand on one or two legs?
39
Food for thought
  • Dont put all of your eggs in one basket
  • Unknown
  • Put all your eggs in the one basket and ---
    WATCH THAT BASKET.
  • Mark Twain
  • How does one define the basket?

40
Top Ten Take Home Lessons
  • Endowment investing must serve the enterprise
    mission
  • Investing is not a casual exercise
  • Driving via the rear-view mirror is dangerous
  • Superficial emulation of others success is
    likely to fail
  • Conventional distribution policies run too hot or
    too cold
  • Modern Portfolio Theory can do more harm than
    good
  • Diversification remains a free lunch
  • Asset class diversification is not enough
  • Risk does not equal standard deviation
  • The question is not whether to outsource, but to
    what degree
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