In their latest report, the school emphasizes that they invest for the long-term.
Prior to commencing any discussion of investment performance, it bears repeating that a single year is a woefully insufficient increment to evaluate the success of an investment program with the time horizon of the Brown endowment. It is common for the endowment to make investments with anticipated lives of a decade or longer. While a decade might be a more appropriate term to evaluate, there remains the accompanying challenge of holding the executors of such an investment program accountable for the achievement of the endowment’s goals. A decade may be too short to determine success, but is also too long to pursue the wrong path. The Investment Office evaluates the performance annually, therefore, but with the caveat that any single year holds the possibility of being an outlier.
Private equity once again outperformed.
Private Equity: Investments with managers that buy private companies make up the third broad category of Brown’s asset allocation. This allocation comprises 27% of the endowment and is approximately equally weighted between venture investments, which are generally early-stage growth companies, and buyouts, which tend to be more mature businesses. The overall economic environment for private companies is precisely the same as that for public companies, so the correlation between the public equities asset class and the private equity asset class tends to be high. Evidence suggests, however, that the market for private companies is markedly less efficient than the public markets. This makes it an attractive asset class for Brown, as it has the potential for high returns, requires a long time horizon, and offers the possibility of outperformance – net of fees and expenses – by managers that meet Brown’s core criteria of ability, integrity and alignment.
Both of the buyout and venture sub-asset classes generated strong returns during FY 2019, and in each case, Brown’s portfolio outperformed the respective benchmarks, returning 18.2% in aggregate. Because of the aforementioned attributes of the private equity asset class, the endowment has increased its exposure in recent years. More critically, however, the endowment has simultaneously increased the quality of investment management partners in the portfolio. Indeed, the former increase would not have taken place in the absence of access to the latter. While a single year is an insufficient time period to measure returns in private equity in particular, the asset class contributed substantively to the portfolio return in FY 2019.
By the way, what kind of mindset do you need to manage risk?
The formula for achieving this result is not complex. It relies on the careful evaluation and application of traditional risk mitigation techniques. The primary concern is diversification, which is balanced against the benefits of concentrating the endowment’s capital in the most attractive investment opportunities. The second is careful attention to correlation; the benefits of diversification are achieved only when the investments that comprise a portfolio complement each other. The third is prudence and meticulousness in manager selection.
This is far from an exhaustive list. Rather these are a sampling of essential ingredients that all capital allocators apply in fundamental endowment management. Where Brown may be somewhat unique, however, is in the degree to which the leadership of the investment office has intentionally instilled a culture best characterized as an “investor mindset.” The office is predominantly staffed by former practitioners of direct investing. As a result, the investment team approaches risk management as investors do: through diligence in underwriting, margins of safety in valuation, and appropriate levels of skepticism in the face of conventional wisdom.
What type of fund manager does the school look for?
Many of Brown’s investment managers no longer fit into a single asset class. This results not simply from the evolution of the investment business, but also from the qualities that the endowment emphasizes in the selection of investment partners. Brown seeks managers that combine a competitive advantage with a market that is less than perfectly efficient. Brown emphasizes qualities in people and organizations such as integrity and durability that may not appear to have much to do with returns but are, in fact, prerequisites. Finally the returns required to provide resources to the University and inoculate those resources from inflation necessitate investing for high returns, which results in a bias towards equity, whether public or private.
Finally, how does the school manage their asset allocation?
In summary, the Brown endowment portfolio is constructed to be a collection of complementary investments that have a high probability of achieving the financial needs of the University, rather than an allocation of asset classes. It may seem too subtle a distinction, but the difference is this: It is the people, opportunity, risks, duration, liquidity and valuation that matter in an investment, the asset class to which it is allocated is ultimately just a label.
Post by Marcelino Pantoja