Every morning at around 7.30am the investment team at the Stanford Management Company, SMC, managers of Stanford University’s $40 billion endowment, receive a flash estimate of the value of the portfolio. If market movements have taken assets in the portfolio away from their policy weights impacting its risk return and liquidity characteristics, the team will sell what has gone up and buy what has gone down to bring assets back to target.
Rebalancing can happen daily in times of volatility and is a central tenet to success of the endowment that supports research at the university in the heart of Silicon Valley.
Speaking at Norges Bank Investment Management’s 2024 investment conference, SMC’s CEO Robert Wallace outlined three essential pillars to successful investment: strategy, execution – under which rebalancing falls – and governance.
Wallace joined SMC in 2015, and his prior experience included a five-year stint in the early 2000s at Yale Investment Office where he started as an intern and rose to a senior associate role under celebrated investor David Swensen. He attributed SMC’s robust long-term returns to these central tenets.
“If you had taken $100 in 1991, when SMC was established, and invested in the endowment portfolio you would have made 32 times your money by mid-last year. That’s double the amount you’d have achieved in a typical endowment, and four times the result if you’d taken the same $100 and invested it in a 70:30 portfolio divided between equity and bonds. If you form the right strategy, have the ability to execute, and good governance that protects you from outside interference, you can get attractive long-term results.”
Execution at SMC also involves rotating capital inside the asset classes. When SMC’s carefully picked cohort of external managers flag that the opportunity set has evolved, Stanford’s investment team act.
“If the opportunity set gets more attractive, we give them more money and if it gets less attractive, we take money back” he said. “Rebalancing between asset classes and rotating capital within an asset class can take up to 30-50 per cent of the value of the endowment in a single year. We are very active in managing the portfolio.”
Manager selection is also essential to successful execution. Witness the dispersion among leverage buyout firms in the US between 2001 and 2020. Investors in the top 5 per cent of this universe outperformed the medium by 20 points a year while the bottom 5 per cent underperformed the medium by 20 points.
“If you have a complex strategy like Stanford, you have to be in the top distribution in this asset class, and it’s the same for private real estate and venture. You need to execute well.”
Accessing and selecting specialist, niche investment firms rests on key principles, he continued, warning the audience they “probably wouldn’t know the names of most of them.” SMC selects managers according to their grasp of the difference between investment and speculation, and only works with managers that have a strong and repeatable process that the team can see and touch. Next, managers must be able to apply superior investment judgment to data so the SMC team can understand how they assess the risk and return and what kind of weights to attach.
“When we make a mistake about a partner, it’s mostly because we get their investment judgement wrong,” he reflected.
Wallace added that he doesn’t like managers sitting on too much capital either. When this happens, they should return capital to investors so “size doesn’t become the enemy of performance in our portfolio.”
Execution also rests with Stanford’s own team, working on an open floor plan to engender collaboration, minimize hierarchy, and make it fun. Wallace described an investment team characterised by intellectual curiosity; an ability to accept personal accountability for investment decisions and with a strong sense of mission.
“We try to grow our own talent; hire out of Stanford and train our own,” he said.
SMC’s renown strategy (the first pillar of investment success) has a 70 per cent exposure to equity in a reflection of the endowment’s high compound real return target of 7.1 per cent. SMC must ensure 5 per cent of the endowment goes to support the academic life of the students present and future annually, and that returns also take into account the rising price of education year on year. “Higher education price inflation runs higher than CPI,” said Wallace.
The equity bias in the portfolio brings worrying volatility, and price volatility, he warned, erodes long term compound returns. SMC counters this by diversification across every flavour of equity from public to private, international and asset-backed. Although domestic public equity (8 per cent) international public equity (16 per cent) private equity (38 per cent) real assets (10 per cent) are correlated, these allocations do react differently to macro events.
SMC then adds fixed income/cash (9 per cent) and hedge funds (19 per cent), designed to give high expected returns but with reasonable levels of volatility.
Wallace said governance is the final pillar and crucial in supporting the disciplined execution of the right strategy. Governance comes into play when a particular asset class is outperforming everything else. Bad governance would encourage chasing the sector. Alternatively it would allow panic selling risky assets to raise cash in a falling market, when the right thing to do is rebalance to the desired risk return.
“Governance shelters the management team from external influences,” he concluded.
