Rob Wallace discusses impact of endowment on Stanford’s success
In this Q&A, the chief executive officer of Stanford Management Company explains how the university’s endowment works.
Many discussions of Stanford’s finances and funding end up turning to the university’s endowment, which supports academic programs and financial aid at the university.
In this conversation with Stanford Report, Rob Wallace, the chief executive officer of Stanford Management Company, explains some of the basics of the endowment and shares his perspective on some of the common questions that come up about it.
Wallace joined Stanford in 2015. He previously was chief executive officer of Alta Advisers, a London-based private investment firm, and before that worked at the Yale Investments Office. Little-known fact: Before his career in investment management, Wallace danced professionally for 16 years as a leading dancer with American Ballet Theatre, the Boston Ballet and the Washington Ballet. He is a graduate of Yale University.
How do you describe the purpose of the Stanford endowment?
The endowment is actually a collection of more than 7,000 individual gifts from donors. These generous gifts are meant to support in perpetuity a wide range of university programs, including teaching and research, financial aid, facilities maintenance, athletics and many more. These programs enable the students and faculty of Stanford to weave a rich tapestry of scholarship and achievement. You can view the endowment as one of the most important threads that holds that tapestry together. The stronger the thread, the brighter and more ambitious Stanford’s tapestry can be. Almost all of the endowment gifts have specific, restricted uses that the university is legally obliged to observe.
How is the endowment managed?
The endowment forms the largest part of the $28.7 billion Merged Pool, which is the university’s primary investment portfolio. The Merged Pool is managed by Stanford Management Company. A portion of the endowment is also held in Stanford Lands, expertly managed by the university’s Land, Buildings and Real Estate division.
Because the endowment exists to support programs in perpetuity, we have to be careful to maintain the “purchasing power” of the endowment even as we draw down money to support current programs. It can be tricky to thoughtfully balance these current and long-term goals. Typically, we draw down an annual payout of roughly 5.5 percent of the value of the endowment to support the university’s annual operations, which represents more than a fifth of the operating budget.
To maintain purchasing power over generations, we have to earn back that 5.5 percent plus higher education inflation through our investment work. Altogether, we need to generate roughly 9 percent annual investment returns over long periods of time. If we earn less or spend more, we will impair the endowment’s real value to the detriment of future Stanford students and scholars. As market conditions change, the likelihood of achieving that required return changes as well. The current level of asset valuations and interest rates creates a challenging environment as we consider medium-term prospects.
With a time horizon that is measured in decades, Stanford’s investment program is decidedly focused on the long term. We know that the investment decisions we make today will impact the portfolio five, 10 and 15 years in the future. We invest in multiple asset classes, from public and private equity to real estate and natural resources, and often accept illiquidity in order to optimize performance. Our asset allocation is heavily oriented towards equities, such as common stocks and ownership of private companies, which can generate high returns. However, the portfolio is diversified by asset class, which reduces risk.
In most parts of the portfolio, we strive to add value through active management by working with expert partners that make individual decisions about company-level holdings. These partners are carefully selected for their judgment, discipline, ethics and alignment of interests with the university. We are in the midst of a multi-year-long effort to concentrate the Merged Pool by reducing the number of partners with whom we work so that each can contribute more meaningfully to the portfolio.
How is SMC governed?
We are overseen by a Board of Directors appointed by the university trustees. The directors include the chairman of the Board of Trustees and other trustees, the president and other university officers, and a group of expert investors. This highly engaged group reviews all of SMC’s work and has complete transparency into our investment holdings, decisions and processes. Ultimately, however, the trustees have complete authority over the endowment and its investment program.
People often wonder why the holdings of the Stanford endowment are not publicly available. What is the rationale?
We disclose a substantial amount of information on the investment portfolio. We publish an annual investment report, which details our asset allocation, performance and medium-term priorities. We are not able to disclose individual investments because doing so would erode our ability to add value through active management. Our investment partners are almost always very sensitive to the amount of capital they can accept, and competition from other investors following us into investments would damage results.
We are often asked why we simply do not invest in low-cost passive holdings, which can be disclosed without difficulty. The answer is performance: If we had achieved a result consistent with a passive, transparent approach since SMC’s founding in 1991, the endowment would have been closer to $8 billion in 2017, rather than $24.8 billion. The annual payout from the endowment would have been $400 million, instead of $1.2 billion (see the infographics on our website). Financial aid would be a fraction of its present size and Stanford’s academic programs would be dramatically more modest. The opportunity cost of running a low-cost, fully transparent portfolio would have been far too high to justify the benefits.
Do ethical considerations routinely factor into the investment program?
Yes, they play a very important role. As part of any economic analysis, Stanford Management Company closely considers ethical and social factors. Not only is it the right thing to do, but as a long-term investor, Stanford must be concerned with ethical issues. Businesses that fail to demonstrate an appropriate regard for human and environmental welfare are unlikely to generate attractive investment returns in the long run. We strive to work with external partners that share those same sensibilities.
While we believe we invest within a strong moral framework, we do not use the endowment as a tool to achieve specific political outcomes. Doing so would contravene a core tenet of the university: to avoid taking ideological or partisan positions. It would also conflict with the intentions of our donors, who make gifts to the endowment to advance Stanford’s educational mission, rather than other causes.
Furthermore, ideologically driven investment would fail to respect our duties under the California Uniform Prudent Investor Act, which guides the investment activities of trust fiduciaries. This legislation requires that fiduciaries of trusts put their obligations to their beneficiaries before all others. For this reason, we consider ethical, social and political issues as part of our holistic approach to generate attractive risk-adjusted investment returns, rather than as separate and non-economic goals.
There have been several divestment initiatives in recent years. How do you think about these in Stanford Management Company?
Divestment decisions are made by the Board of Trustees, not SMC, and are governed by the university’s Statement on Investment Responsibility, which considers the appropriateness of certain investments or classes of investments.
We provide input into the economic issues surrounding specific divestment requests, but have no vote in the ultimate outcome. If the trustees elect to divest, we follow the policy with discipline.
The trustees are currently reviewing Stanford’s Statement on Investment Responsibility and the university’s related procedures for addressing investment responsibility issues. Their review should be complete later this autumn.
What do you think are the biggest misimpressions about the Stanford endowment?
One big misconception is that SMC is a for-profit entity that exists outside of university governance. Sometimes I think our fancy name misleads people! In fact, we are simply a division of the university, rather than a separate legal entity. We are governed closely and thoughtfully by a board of directors appointed by the trustees.
Most important, all of us at SMC continuously strive to support Stanford’s academic mission through careful and disciplined investment management. We always have the university’s long-term interests as our top priority. We do not take shortcuts that may be expedient but deleterious in the long run. We consider ourselves very fortunate to be involved with a wonderful educational institution that is performing such important work in the world.
Does your earlier career in dance affect how you approach investment management?
Yes, absolutely. My career in ballet was undoubtedly formative and, at the end of the day, we are all products of our life experiences in one way or another. Dance is very much about creativity, discipline and the day-to-day struggle for improvement. Successful long-term investment management involves many of the same characteristics, including combining quantitative and qualitative factors with discipline and energy in a sustained fashion. Fortunately, investment management tends to involve fewer physical injuries!