Alpha Hunters: A Conversation with Peter Stein

Editor’s Note: We welcome Charles A. Skorina as a new columnist on AllAboutAlpha.com. He is the founder of Charles A. Skorina & Co., which is retained by the boards of institutional investors and asset managers to recruit chief investment officers, portfolio managers, and financial professionals.

Charles Skorina earned an MBA at the University of Chicago and began his professional career at Chemical Bank (now JPMorgan Chase), completing the management training program then working as a credit and risk analyst in New York and Chicago.  After a stint with Ernst & Young in Washington, D.C., he founded his own search firm headquartered in San Francisco, focused on the global financial services industry.

Peter D. A. Stein was chief investment officer for the University of Chicago (2005 to 2009), and previously a managing director at the Princeton University Investment Company (2000-2005). He recently completed an assignment with the Pacific Alternative Asset Management Company (PAAMCO), where he led strategic allocation for a $10 billion fund of hedge funds. Mr. Stein serves on the investment committees of The Annenberg Foundation and the Rhode Island School of Design (RISD). He earned a BS in mathematics from Brown University and is CFA Charterholder.


Skorina:

Peter, as a Chicago grad myself, it’s always good to talk to you.  You’ve gone from Wall Street to the Princeton and Chicago endowments, then to a big southern California fund of funds.  Now here we are just around the corner from each other in downtown San Francisco as you start up a new CIO-outsourcing effort with the Presidio Group.  So, you’re sort of back in the endowment world again.

You’ve really touched all the bases, so let me ask you my favorite easy question: What one big thing have you learned from your investment career so far?

Stein:

Well, more than one thing, I hope!

But, one big thing would be that, back in my endowment days, before the 08/09 crash, we were always talking to the rest of our colleagues in the university about their institutional spending needs and cash requirements, however, in big university systems it takes time to develop consensus and get buy-in.

Endowment and foundation investment offices are there to generate returns, not to set spending requirements; but it’s all related.  Each institution has specific needs and risk characteristics.  Some were looking to the endowment for 20% to 25% of their yearly budget; some needed much less.  But the big ones were all moving towards the same kind of portfolios: complex asset allocations with lots of alternatives to reap the “illiquidity premium”.

And, let’s not forget that universities, in particular, are very competitive.  They compete against each other on many fronts, for many things.  They compete for the best students, the best faculty, and the biggest research grants; and, of course, for winning athletic programs.

Skorina:

That’s right.  People forget that University of Chicago has an actual football team, sort of.  The mighty Maroons, the terror of Division III!

Stein:

Absolutely, Charles.  After all, somebody has to play Carnegie Mellon!

Skorina:

Sad, but true.

Stein:

Every leader wants his institution to move up in the pecking order.  What could be more American?  So, it seemed only natural that an endowment should compete for returns against its peers.

We all worked hard to maximize returns, but many endowments, including mine, were also beginning to reduce risk and build a safety cushion when 2008 came along.

It’s like when one of Ernest Hemingway’s characters asked somebody: “How did you go broke?”  The other guy responded: “Two ways.  First gradually, then suddenly.”  Big institutional portfolios just cannot turn on a dime.

Skorina:

Are you saying, and I hate to use the cliché, but here goes: that the “endowment model” really is broken?

Stein:

No; in fact, quite the opposite.  Significant allocations to non-traditional assets such as absolute return, private equity and real estate are appropriate for most long-term institutional investors.  But that doesn’t mean every one of them should be taking on the same level of liquidity risk as Yale.  Diversification has to be tailored to the needs of each specific investor.

When I talk to institutions and investors, I sum it up this way: an institution may have a long time horizon, but it’s made of people with very short time horizons.

And given what we’ve been through, the virtues of maintaining an extra level of liquidity are now, perhaps, better appreciated.

After all, market crashes and liquidity squeezes like the one we experienced a few years ago have happened many times in history and will surely happen again.  So we need to keep that in mind as we calibrate the investment requirements of each client, whether university or foundation.

For example, Mark Schmid, my successor at the University of Chicago endowment, has done a good job of looking at the entire universe in which the endowment operates and how different scenarios can impact the university and the endowment.

In fact, I believe, Charles, you were the one who pointed me to the excellent paper Mark and his Chicago team wrote about their “total enterprise” approach to managing the investment.  It really explains how all the parts fit together.

[CAS comment:  We’ve posted that paper on our website, front page center, under “People in the News”, and I highly recommend it.

See A Total Enterprise Approach to Endowment Management.  It’s co-authored by Mr. Schmid and Que Nguyen, his Managing Director of Strategy.]

Skorina:

You recently spent some time at PAAMCO, one of the biggest fund of hedge funds managers.  How has that shaped your outlook?

Stein:

My time at PAAMCO has directly affected the way I’m looking at my new business as an outsourcer for mid-sized endowments.

PAAMCO was not offering a one-size-fits-all product.  They focus very strongly on the specific and unique needs of each client and the importance of providing a custom solution.  That’s how the fund of fund industry is evolving, and that’s how the outsourced CIO model must evolve.

It goes back to the lessons I cited above.  Each institution has different cash needs, different debt-service pressures, different levels of dependence on the endowment, different flows of support from donors.  And finally, each board is different; some can live with more risk than others.

And, since each institution tends to operate in its own little bubble, they may not even understand, themselves, how different they are from each other.  An outside firm with a wider perspective can often see things they can’t see themselves.

The only way an outsourced investment office can succeed is by understanding those differences and the implications they have for constructing and managing a portfolio.

I’ve spoken at a lot of development events and listened to many donors and trustees, with the emphasis on “listen”.  They are seldom shy about expressing themselves.

With the help of Presidio Group, we are going to offer a best-of-class outsourced investment office.  We are going to do it step by step, scale it properly, and do it with superior execution.  We will report directly to the client’s board, just as an internal office would do, but offer a level of management excellence that our target institutions could not otherwise afford.

Skorina:

One last thing, Peter:  We’re doing some investment office cost studies (which we’ll be talking about soon in our newsletter), and looking generally at the drivers of investment management costs and the implications for boards and CIOs.  As a former CIO, and now an outsourcer, how do you think about managing those costs?

Stein:

When we evaluated external managers we always thought about whether their fees made sense relative to the specific strategy they were offering.

I always told my people that I would rather have high returns net of high fees, than low returns net of low fees.

Of course, you want low fees as a general proposition.  But it isn’t always smart to squeeze too hard on any specific manager.  You have to understand what he’s doing and how his strategy scales.  Push back too hard on fees and you can force them to make it up by taking on too much capacity; perhaps more than the strategy or staff can handle.

Fees and costs should always be a consideration, but not the determining factor.  Each piece of the portfolio has to be cost-effective in its own way, on its own terms.

As an outsourcer, this concern with return vs. cost translates into an open-architecture approach, meeting the client’s specific needs with maximum transparency.  No black boxes. Institutions should demand nothing less from an outsourcer, and it’s what we intend to deliver.

Charles A. Skorina & Co is retained by the boards of institutional investors and asset managers to recruit chief investment officers, portfolio managers, and financial professionals.

Charles Skorina earned an MBA at the University of Chicago and began his professional career at Chemical Bank (now JPMorgan Chase), completing the management training program then working as a credit and risk analyst in New York and Chicago.  After a stint with Ernst & Young in Washington, D.C., he founded his own search firm headquartered in San Francisco, focused on the global financial services industry. www.charlesskorina.com, skorina@sbcglobal.net

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