| Cornell backs up innovation with 26% returns and massive commitment to alternatives |
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| 24/02/2008 | |
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Founded in 1865, Cornell University was funded by an initial $500,000 endowment. Ezra Cornell made his fortune on Western Union Telegraph Company stock. Today, the endowment has grown to $6bn, the 12th largest in the US, and while it is comparatively small relative to its Ivy League peers such as Harvard ($35bn), the endowment's 26% return last year is the envy of most pension fund CIOs. Long-term and illiquid investments have been important contributors to the endowment's 18% average return since 2005. The portfolio's market value is up from $4.3bn in the fiscal year ending June 30, 2006, following a combination of strong fundraising and returns. "Our liabilities are quite clear," says CIO James Walsh. "We are a university that has been around some 140 years. The intention is that the university will be around for at least another 100. The aim is to get returns over a very long time." This focus on long-term returns has resulted in a portfolio with only a 30% allocation to equities, significantly lower than its 55% exposure to alternatives, including real estate. Hedge funds alone account for 25%, private equity 12%, real estate 11%, natural resources 7% with the balance in bonds (7%) and cash. Private equity The returns are far above Cornell's long-term benchmark for alpha which is CPI plus 5%. Since the university's wages often exceed the rate of inflation, Walsh needs to perform above this stated long-term benchmark. It has done so thanks to five to six years of good decision making, says Walsh, who became CIO a year ago. Paul Gould, head of the board of trustees' investment committee, is largely responsible for shifting the portfolio's allocation mix from traditional assets in favour of alternatives. The current asset mix has a particularly high exposure to private equity, making mark-to-market reporting particularly challenging. Walsh, however, questions whether mark-to-market reporting is essential given the endowment's long-term investment horizon and an absence of liquidity constraints. "We report private equity on a quarterly basis. It does not really matter as long as you know what is going on in the portfolio on a quarter to quarter basis." The portfolio's construction may raise eyebrows with investors who closely monitor balance sheet volatility. "If it was my scheme what would I prefer?" asks Walsh. "All of my money invested largely in bonds and passive equities backed by a single corporate sponsor or assets that are distributed broadly in private equity and real estate where there is a premium being earned for locking up your money long-term. Yes, in a traditional sense the portfolio is risky. There are no two ways about it. It will be volatile; however, I do not care what my pension looks like six weeks from now. I do really worry about what it will look like 20 years from now." This is not to imply that the endowment does not move opportunistically. The investment staff of 20 started to add distressed debt managers to its portfolio more than a year ago before credit conditions began to deteriorate. Walsh is also considering investments in mezzanine lending and opportunities on the long-side of sub-prime debt. He has been trimming emerging market managers who have performed well. "We look for clear opportunities where skill exists. We look for managers who can exploit market inefficiencies. We think about matching liabilities in terms of performance. We are not into LDI." Unlike Harvard, Cornell out-sources its asset management, similar to other US university endowments. Consultants are only used for benchmarking. That means the team must be especially adept at vetting asset managers and pursuing innovative strategies. Before joining the endowment, Walsh was executive director of strategy and alternatives at Hermes Pensions Investment Management, the UK's largest pension fund, which manages assets for British Telecom. VB |
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