First Principles

[A Recent Example of Chasing Returns]

Source: 2001 1Q Commentary

Unintended Consequences

Pardonable Sin

Highlighting the obvious — a sin we're unafraid to commit when circumstances warrant, as they often do in today's data-rich but information-poor world — we'll open this Commentary with two verifiable truths. First, the conspicuous regression to the mean that global stocks have traced over the last year has enabled TIFF to generate more value-added for its members during this interval than ever would have been dreamt possible by those of us whose self-worths as well as net worths are tied closely to TIFF's performance. (Value-added means the aggregate differences between TIFF vehicles' returns and those of their benchmarks, weighted by each vehicle's size. The quantitative bonuses for which some TIFF staffers are eligible are based on this measure of organizational success, as opposed to such competing measures as new business gained.) Second, because the vehicles that TIFF administers have produced such pleasing relative returns since the tech stock mania crested, we can publish this Commentary without fear that its brevity (by TIFF standards) will cause TIFF members to complain that we're hiding something. We've nothing to hide, and much to be proud of, even after taking due note of recent declines in the valuations of certain securities held by TIFF's private investment ("PI") vehicles. Lamentably, securities laws prevent us from reporting such vehicles' performance in this Commentary, which is distributed to many persons in the non-profit community, some of whom do not pass SEC-imposed accreditation tests for PI offerings. Indeed, because TIFF's Commentaries are distributed so widely, they seldom discuss the performance of any of the vehicles that TIFF administers, focusing instead on policy issues germane to all endowed charities. Readers who yearn for such TIFF-specific data should consult our other quarterly reports: Marketable Investments (available to all non-profits) and Alternative Investments (available to non-profits with total assets exceeding $5 million each). Past and current editions of both reports are posted on TIFF's Website (www.tiff.org). A password (which eligible parties can obtain from TIFF) is needed to access the AI reports.

Ya Can't Win

Even if TIFF hadn't generated so much value-added of late, we'd stick to our plan (first disclosed last quarter) to make our Commentaries less prolix. The reason is straightforward: due in part (if not large part) to favorable performance trends, TIFF's assets under management and membership rolls are growing at a rate that compels us to focus ever-increasing hours on our primary task of stewarding members' assets in a prudent manner, leaving decreasing hours to generate Commentaries of practical use to a meaningful portion of the broad audience that such musings reach. Of course, given their prolixity, some of the Commentaries we've published haven't exactly aced the utilitarian test set forth in the prior sentence: some of the fiduciaries whose decisionmaking such writings have sought to enhance have told us they appreciate them but are usually too busy to read such lengthy works in their entirety. Frustratingly, some boards that invest via TIFF have castigated TIFF representatives for the cooperative's apparent failure to furnish detailed reports discussing TIFF's evolving strategies and results, only to find that the staffs of the charities in question have withheld such reports on grounds that they go beyond what volunteer trustees want or need to know. Needless to say, we don't think the TIFF reports that discuss vehicle-specific strategies and results (referenced in the prior paragraph) constitute overload for conscientious trustees, and we have no plans to make these reports — as distinct from our quarterly Commentaries — materially shorter.

Self-Selected Group

Nor do we plan to modify TIFF's mission in a manner that will prevent the recurrence of another unintended consequence of our earnest efforts to enhance the charitable sector's investment returns: complaints that TIFF is insufficiently attentive to smaller charities' needs. By way of review, TIFF's main mission is to assist endowed charities that lack one or more of the three prerequisites for investment success, only one of which (the capacity to gain cost-effective access to a sufficiently diverse array of assets and strategies) correlates reliably with asset size. The other prerequisites — sufficient expertise and sufficient time for informed decisionmaking by fiduciaries — do not correlate reliably with asset size, especially with respect to non-traditional assets and strategies. Although TIFF staffers enjoy assisting organizations whose relatively small endowments preclude them from accessing directly choiceworthy managers and strategies, we derive no less (or more) satisfaction from assisting larger charities whose governance or staffing practices impel them to outsource certain investment functions (e.g., private equity investing) that in theory they could perform internally. Absent some principled basis for discriminating against larger charities, TIFF will continue to eschew such discrimination in favor of a subtler and (by our lights) saner bias — against organizations whose risk tolerances or governance norms make it difficult or inappropriate for them to invest via TIFF, and in favor of those charities whose policies and practices make TIFF a logical vendor of choice for investment services. But this is the only bias that TIFF displays with respect to prospective members: by design, TIFF's staff may not deny admission to any charity seeking to invest in a TIFF vehicle which is still accepting new members, provided the charity meets applicable accreditation tests and minimums. We highlight this fact because our efforts to offer an array of vehicles capable of satisfying eligible charities' "alternative investment" ("AI") needs has spawned a consequence that is as depressing as it is unintended: it has caused some trustees and consultants to infer that TIFF has undertaken these efforts primarily to advance the interests of larger charities.

First-Come, First-Served

In fact, TIFF has always pursued a verifiably inflexible "first-come, first-served" policy with respect to its AI offerings. Regrettably, some organizations eager to participate in such offerings have not found a way to seize such opportunities before applicable limits on asset growth or membership slots have kicked in. The former limits (on assets) are self-imposed, with TIFF capping inflows in order to preserve each vehicle's capacity to achieve its stated return goals. The slot limits are imposed by Uncle Sam. Ironically, these limits (which typically preclude the admission of more than 99 members to any AI vehicle offered by TIFF) would be relaxed materially if TIFF chose to exclude smaller charities from such offerings: the securities cops would permit TIFF's Absolute Return Pool, for example, to admit up to 499 members if all such investors had total assets exceeding $25 million each. Far from discriminating against smaller charities, TIFF's offering rules seek to accommodate as many of them as possible, subject to the constraint that TIFF not offer vehicles whose structure or size prevents them from pursuing "best practices."

Changing Definition

The term just used ("best practices") tends to be a slippery one, of course, as noted in TIFF's Alternative Investments report dated June 30, 2000, which contained a review by TIFF's president (published initially in Barron's and republished with its permission) of Yale endowment chief and TIFF votary David Swensen's fine book on institutional investing. Quoting this review:

Rooted as its success is in the idiosyncratic personality of the man who fashioned it, the unconventional approach to funds management that Swensen extols is no guaranteed path to profit for institutions lacking such talent. Indeed, given the increasing ease with which some of the strategies that Swensen has employed at Yale can be parroted, some fiduciaries are likely to read this book and do the opposite of what Swensen advocates: commit excessive sums to strategies whose strong performance has removed the discomfort associated with superior investment opportunities.

Viewed cosmically rather than from closer distance, "best practices" in endowment management actually change little over time: provided that fiduciaries take "the long view" — a mindset that represents most endowments' best and perhaps only hope of gaining an enduring edge over other investors — endowment stewards can safely assume that strategies which hold intuitive appeal and which seek to exploit (in an ethical manner) behavioral norms in capitalist economies will indeed produce satisfactory risk-adjusted returns over time. The exceptions that prove the rule are strategies whose recent strong performance has eliminated the discomfort that keeps entry prices in reasonable check. Indeed, the reason that "best practices" seem to change materially over time is because asset prices and hence comfort levels themselves vary over time. When your editor gave up his dream of playing for the Red Sox and sank into money management two decades ago, financial assets (i.e., stocks and bonds) were anathema to many trustee groups, "hard" assets (including especially real estate and energy-related holdings) were the rage, and absolute return-oriented hedge funds were the near-exclusive province of wealthy individuals, most of whom did their investing via private banks located within a day's drive of the assumedly penitent Marc Rich's very comfortable home in Switzerland. By the latter half of the 1990s, much had changed, with strategies that fiduciaries found intolerably "risky" two decades earlier having become disturbingly comfortable and with some approaches having generated such strong results that they'd become irresistibly alluring to even the most "conservative" investors. The most conspicuous example: S&P 500 index funds, which clobbered most actively managed US portfolios during the manic phase of the most recent bull market in US stocks.

Ill-Timed Shift

Talk about unintended consequences: by shifting funds on the margin from seemingly inferior and palpably uncomfortable active strategies into the most "conservative" approach to US equity investment, fiduciaries achieved their true but unspoken goal of reducing reputational risk while unwittingly exposing their institutions to heightened levels of financial risk. That is certainly the conclusion one draws from ex post results: since peaking in early 2000, the S&P 500 has underperformed materially the actively managed diverse US stock portfolio that your editor knows and likes best — the TIFF US Equity Fund (USEF; see TIFF's Marketable Investments report for details). Tooting our own horn a moment longer, we'll note that the USEF is now comfortably ahead of its benchmark since its inception in mid-1994, after having lagged the benchmark for an interval that apparently exceeded the practical as distinct from theoretical time horizons of some organizations that committed capital to the fund during its early years. Other TIFF mutual funds have proven equally effective — if "effective" is the right term — in revealing certain charities' true as distinct from theoretical time horizons, the Multi-Asset Fund (MAF) being the best example. Like the USEF, the MAF underperformed the S&P 500 (as well as its own benchmark) during the manic phase of the bull market — by margins sufficient to induce some organizations to shift money from it into [gulp] ... the S&P 500. To be sure, the MAF (along with virtually all comparably diversified multi-asset portfolios) has produced a negative return since global stock indices peaked in early 2000. That said, during this interval the fund has materially outperformed both the S&P 500 and the Constructed Index that serves as MAF's secondary benchmark. (Its primary aim is to generate satisfactory inflation-adjusted returns over the long term, an aim it has fulfilled since inception.) We ourselves don't fancy comparisons of the MAF's performance with the S&P 500's — the fund is a globally diversified portfolio of stocks, bonds, and other assets, whereas the S&P 500 is a US-centric all-stock vehicle — and we flag the recent superiority of the former over the latter only because some charities decided to shift capital from MAF into the S&P 500 at what in hindsight was a very inopportune time.

Open Question

Rest Assured

The question before the house is whether recent market turmoil will cause certain trustee groups (including perhaps those that have already been whipsawed by the S&P 500) to make similarly ill-timed changes in investment policy in coming months and years. We hope not and will do our utmost to ensure that the governing board with which TIFF staff works most closely (i.e., TIFF's illustrious board) has all of the information needed to fashion sensible investment policies on behalf of TIFF's members. To be sure, there's no assurance that a board armed with even boatloads of relevant data will make the "right" policy choices — emotions trump reason with surprising frequency in most fields of human endeavor — and there's not complete assurance that staff will implement board-approved policies (through manager picks and other means) in a manner befitting the board's considerable eminence and experience. But eligible charities can rest assured that TIFF will continue to apply sensible (meaning: modestly contrarian) principles in all aspects of its work. We emphasize "modestly" because extreme contrarianism can get one into much trouble, as two groups memorably learned in 1964. Echoing a famed remark by the leader of the first group ("Goldwater Republicans"), a devout member of the second group raised the following banner in New York's Shea Stadium: "Extremism in defense of the Mets is no vice." Alas, extremism in pursuit of out-of-favor ideas is indeed a dangerous vice in money management, albeit not as reliably perilous as chasing recent winners. We're proud that we stuck to our contrarian ways during global stock markets' most recent manic phase, despite interim disappointments (more than offset by subsequent triumphs) that caused some folks who didn't appreciate how truly anomalous such conditions were to conclude that TIFF is as skillful in its sphere as the ill-fated '64 Mets were in theirs. (We needn't remind some readers that these same Mets won the World Series not many years thereafter.)

Perverse Comfort

We don't think extreme contrarianism is the proper investment policy for most endowed charities to pursue, and we don't expect the modestly contrarian policies that TIFF favors to continue producing positive relative returns of the magnitude they've produced of late: "bubbles" don't appear (or disappear) very frequently in financial markets. But we do expect to continue our efforts to take the contra side of "crowded trades." And we do take perverse comfort in the knowledge that two new investment programs that TIFF plans to launch in coming months have not excited the same high level of interest among some fiduciaries with whom we've shared our plans as they have among TIFF staffers and board members. (Uniform enthusiasm among prospective investors would tell us that we're perhaps too late with such initiatives.) But even if the self-imposed space constraints cited at the start of this essay didn't prevent us from describing these initiatives here, securities laws would do so. In light of such strictures, all we'll say about such initiatives here is that we're real excited about the assets and properties that the proposed vehicles will target, we're energized by the substantial research we've already performed with respect to the least-conventional of these two vehicles, and we're pleased that we've identified practical means of reducing materially (but legally!) the taxes that certain charities might otherwise be forced to pay when accessing some of the strategies that these new vehicles will employ. Please call or write if these winks and nods pique your interest.

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