Stanford's endowment is the largest chunk of the Merged Pool, which combines most of the University's investments, expendable funds and capital reserves into one formidable asset. The Merged Pool is the province of the Stanford Management Company, established In 1991 to oversee the University's financial and real estate holdings.
The management company does not directly invest money. For that, says president and CEO John Powers, MBA '83, it hires a coterie of professional money managers. "Our core jobs are manager selection and asset allocation decisions" that determine the portfolio's diversification, he notes, as well as establishing strategies to manage risk. This approach allows Stanford to benefit from the skill and knowledge of "some of the finest money managers in the world, a team that you couldn't afford to assemble and pay in-house."
The downside of outsourcing, Powers says, is that Stanford gives up "granular control" of its assets. "No matter how clearly you've thought through asset allocation issues, you're ultimately somewhat dependent upon the specific decisions that your managers make. You don't necessarily have instantaneous information about what your broadest portfolio looks like."
The results have validated SMC's model, Powers says. "What happened from, let's say, 2002 until 2008, showed the power of the strategy [we employed]. We generated phenomenal returns and the endowment more than doubled in size over that period."
A more conservative approach, perhaps guarding against steep losses, might have avoided some of the heavy damage wrought by the recent recession but would have failed to capitalize on earlier opportunities that had swelled the endowment. "The value of the endowment in 1991 was less than 2 billion dollars. If we had engineered [the investment strategy] to avoid the 80-year flood, it would be a lot smaller today than it is even after the downturn."
The management company did pull back in some categories that proved particularly hard-hit. "Going back to 2007, we saw the emergence of stress in the credit markets, such as corporate debt and commercial and residential real estate," Powers notes. "We made some investments that anticipated some of the difficulties, and the success of those decisions is reflected in the very strong performance we had in 2007 [when the endowment value increased $3.1 billion]. Through 2008, as the credit markets began to fall apart, we then began to position ourselves for the recovery of the credit markets. There was some pain associated with that at the worst period of October-November [2008], but that strategy has been very effective for us in the first half of this year. That having been said, we came nowhere close to fully anticipating the extent of those problems."
The other major issue that emerged in last year's market meltdown was the importance of liquidity as part of an overall investment strategy. Like many other universities with large endowments, Stanford allocated a significant portion of its assets in illiquid investments such as private equities, commodities and real estate. Powers says those lessons have been absorbed into the management company's approach going forward. "We're thinking hard about modifications to our model of running the endowment that will allow us to reap the benefits of diversification and utilization of the best money managers in the world, but doing so in a way that maintains higher ongoing levels of liquidity."
