America’s university endowments are reporting blistering returns thanks to soaring equity markets and their large venture allocations. Washington University’s managed endowment pool is an outstanding performer, returning a whopping net 65 per cent for the fiscal year 2020-21 and nearly doubling its size to $15.3 billion. CIO Scott Wilson explains how they did it.
When Scott Wilson took the CIO helm at Washington University Investment Management Company (WUIMC) in St Louis, Missouri, in 2017 he set about a radical overhaul of the endowment’s investment partners and underlying holdings. He added capital with high-conviction partners and redeemed capital from others, refrained from investing in certain follow-on funds and sold holdings on the secondary market.
The results of that overhaul were dramatically on show in the fund’s 65 per cent returns, the bulk of which Wilson attributes to performance from investments and capital deployed since 2017.
“We have turned over the vast majority of the portfolio since 2017. Given the huge move in capital markets last year, probably 50 per cent or more of our returns can be attributed to being mostly long risk assets.”
The 2017 overhaul and decision to increase investments with the fund’s most favoured managers was part and parcel of a deliberate strategy to strategically concentrate the portfolio, allowing for exposure to fewer, but more substantial, investment positions in which WUIMC’s managers have the highest levels of conviction.
“Concentrating capital has increased our tracking error significantly but we have not seen a significant increase in volatility. We have more idiosyncratic risk that is driving returns which doesn’t necessarily translate into higher volatility. The primary risk is still choosing who to partner and invest capital with,” says Wilson.
Moreover, Wilson stresses that diversification isn’t lost with a concentrated approach.
“On a look-through basis we still have many hundreds of individual exposures broadly diversified across asset class and geography. You can make a strong argument that we are still overly diversified.”
Diversification is achieved via a bottom-up process, he explains.
“We try to concentrate capital in investments that we think have independent outcomes over our 10+ years investment time horizon – we believe this is real diversification.” He notes, however, that viewing investment in public equity and private equity as “separate asset classes” is irrational. “The primary difference between those two asset classes is how often they are marked to market and they are both still driven by equity factor risk.”
Wilson stresses the fund “rarely adds” new managers – much of the last year was “spent trying to figure out how our current roster of partners were taking advantage of price movements and volatility in certain markets.”
Still, the strategy makes manager selection crucial, and the team search far and wide for the best, including smaller firms, or firms that are newer to the investment industry in the hunt. A recent review of the university’s portfolio revealed more than one-third of the endowment’s assets are managed by diverse-led firms.
“We look for partners who we think are great investors with an attractive opportunity set, definable and repeatable investment process, an appropriately sized capital base and who we can partner with closely,” he says.
Managers also have to agree on the fees in a structure that pays for producing exceptional returns – not by raising and accumulating assets or charging high management fees.
Manager due diligence involves multiple in-person meetings with the senior investment leadership, but also with analysts, traders, and operations professionals at the GP. The team also engages with the senior management team of the underlying portfolio companies.
Alongside concentration and diversification, other key strategy pillars include fundamental orientation that prioritises the characteristics of each individual portfolio holding rather than macroeconomics.
Revisions to the strategic asset allocation are infrequent and gradual – and as of June last year assets were divided between real assets (6 per cent) cash and fixed income (6 per cent) absolute return (11 per cent) global equities (32 per cent) and private capital (45 per cent). Annualised returns for WUIMC’s MEP for three, five and 10 years are 24.9 per cent, 19.2 per cent and 12.2 per cent, respectively.
Impact allocation to grow
Going forward Wilson hopes that impact will grow to account for more than 30 per cent of the endowment. The fund does not screen for impact, but it plays a major role in the investment process.
“We believe that ESG is a significantly long-term investment risk and therefore those companies that are having a positive impact will have more sustainable business models over our investment horizon. We believe this will positively impact both risk and return over time.”
College and university endowments have posted their strongest annual performance in 35 years, according to new data from Wilshire Trust Universe Comparison Service. The median return before fees was 27 per cent in the 2021 fiscal year, which ended on June 30.