October 19, 2015
Interviewed by: Tom Franco
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Endowment Culture Post-Financial Crisis

Since the start of the global financial crisis in 2008, the culture at endowments has changed slightly. Experts from Abbott Capital and Washington University Investment Management Company say some are looking for more cash flow from investments, while a small number continue to think in the long term.

Since the start of the global financial crisis in 2008, the culture at endowments has changed slightly. Experts from Abbott Capital and Washington University Investment Management Company say some are looking for more cash flow from investments, while a small number continue to think in the long term.

Endowment Culture Post-Financial Crisis
With Jonathan Roth of Abbott Capital

Daniel Feder, Washington University Investment Management Co.: Hello, we’re here with Jonathan Roth of Abbott Capital Management. Welcome.

Tom Franco, Clayton, Dubilier & Rice: Talk about endowments. Dan, you know something about endowments. How is the endowment model shifting in terms of its posture, vis-à-vis private capital?

Feder: For us, what we’re trying to do [is] pull everything back. We’re trying to invest in an area or set of exposures that will enhance return for the endowment, plain and simple. For us, that means we have to seek out—this all sounds pretty simplistic, it’s motherhood and apple pie—the very best managers, especially in areas like venture capital. It’s really the super elite that account for, in some cases, really the benchmark, pretty much all of the profitability of the industry is the top 10% of funds account for—

Jonathan Roth, Abbott Capital:

90% of the gains.

Feder: All of them. Everything else is a waste of time.

Roth: 120% of the gains.

Feder: Now, it’s in an early stage of venture capital over a 15 or 20year period—10% of the funds by number of funds raised account for 100% of the profit. Everything else is a wash. It requires us to figure out ways to use our advantages as a university—the networks we have, the brand we have, and so forth—to get access to those kinds of opportunities. How’s it changed in endowment land? I think one thing that’s changed in endowment practice that is similar to what’s gone on in the fund practice is this maturation. Now, you have career paths for people and when you have career paths, you have short-termism, and different sorts of agency issues start creeping in to the system, and those kinds of things eat away at your ability to do that thing that is long horizon and requires nonlinear or idiosyncratic thinking.

What has changed is, I think, endowments and foundations look more and more like everyone else as a group. There are some, and we hope we’re one of that small group, that are still tethered to this idea that you have to be very long-horizoned in your approach, you have to be willing to do things that aren’t obvious at the time when you’re doing them. You can take advantage of the alignments within an institution to do that that are not unique, but are nearly unique for endowments or universities. It’s as much an organizational issue as it is an investment issue.

Franco: I hear, when I talk to LPs, that they are adopting an endowment-type model more and more. I’m not sure what they mean by that. Do you find that?

Roth: I suspect what they mean is a greater propensity of illiquidity, a willingness to not be so compartmentalized in terms of certain allocation to a certain strategy—equities, fixed income, real estate alternatives—but maybe more for return-orientated profiles, and again, having more of what I might consider an unconstrained investment mindset as opposed to a constrained or predetermined allocation mindset.

We have endowments in foundations as clients who have outsourced essentially all, or part, of their high-risk bucket either to our core portfolios or to some of our specialized portfolios. I serve as an advisor to a large endowment that’s been active in private equity probably since 1992 or ‘93, but accelerating their presence in the ’97 to ’98 to ‘99 timeframe. I would just say that what’s been interesting is I think the experience that some endowments had in the global financial crisis has helped them think about pacing of commitments, exposures, and cash-flow modeling a bit more than they might have before that. Where that’s come back as a firm at Abbott has been that we have seen general partners, who may have at one point thought that endowments and foundations were the best and only types of LPs to have in their GP base, discover that customer diversification for GPs is not unimportant.

We’ve benefited from the fact that…in that global financial crisis, we didn’t have a single client have to sell in 2008 or 2009, and we were buying interest from endowments. I think it sent a message to GPs that we carefully manage our clients’ understanding of what’s realistic and how to measure your commitment pace over different cycles to avoid having that situation. I think that’s paid off in some new relationships that we’ve been able to develop over the last six or seven years.

Franco: What other lessons did you learn from the financial crisis, the Great Recession?

Roth: Even before that, I would say a lesson that we applied going into the GFC that we learned coming out of the ‘99 to 2001 rise and fall of the tech bubble was the notion of, can the private equity business and the venture capital business scale? We saw fund sizes expand significantly in that two-year period between ‘98 and 2000. When we were looking at the same thing happening in the 2004, ‘05, ’06 to ‘07 timeframe, we remembered back and said, “Can someone really go from managing a $6billion fund to a $22billion fund? Or $3½ [billion] to $10 [billion]?” and all the other questions associated with scaling the business, alignments associated with the economic model, with larger fund sizes. I think it prevented us from just going with a lot of momentum. That’s what I would say has been a big lesson we’ve applied over the years.

Franco: In terms of the GPs who navigated through that period loss-free, [it] becomes an easier exercise in analyzing their performance. We’re in a period now where it’s been a pretty benign environment. So, how are you thinking about performance today?

Roth: Yes, you’re absolutely correct in that the policies of the Fed over the last number of years has, in many cases, created an enormous opportunity for funds to do extremely well in a benign environment and, in many cases, saved some firms handsomely.

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