Faculty Senate minutes: Feb. 19 meeting
(continuation of minutes)
Report on the Stanford Management Company
Chair Conley introduced Laurie Hoagland, President and CEO of the Stanford Management Company (SMC), who outlined his organization's management of the University's major financial assets. Hoagland opened his remarks by recognizing the contribution of the late Amos Tversky, whose memorial resolution had earlier been presented, to the field of behavioral finance.
Hoagland told the Senate he assumed there were three questions everyone wanted answered. "The first is, why haven't the returns been higher? The second is, why hasn't there been more payout into the budget? And thirdly, how about some hot tips for my mother-in-law?" He promised to address the first two of these questions, commenting that he was "biased enough to think the first question can be revised slightly to: gee, how did we generate such good returns in these years?"
Offering a little historical perspective, Hoagland characterized the portfolio of a typical university or endowed institution in the 1950s as made up mostly of bonds, with stocks gradually creeping into the picture. The rule of thumb was that you could spend income but not principal, he said. Typically, "one or two members of the Board of Trustees who were in the investment business would get together over lunch . . . and decide what stocks to buy for the old alma mater." In the late 1960s, McGeorge Bundy of the Ford Foundation issued a clarion call to the fiduciaries of endowed institutions. To make funds work harder, Bundy recommended two strategies: go for higher returns by investing in equities rather than bonds, and junk the old rule about spending only income. The new rule was: get as much total return as you can (that is, income in the form of dividends and interest, plus capital gains), and then have a spending rule to determine how much you can spend. Although sorely tested by the bear markets of the 1970s, Bundy's theory about the long-term stability of returns on equity-type investments is borne out by recent studies.
Other changes since the 1960s have also reshaped Stanford's assets, Hoagland explained. Institutions have broadened their portfolios from traditional asset classes, defined as U.S. stocks and U.S. bonds, to include nontraditional assets such as venture capital partnerships and international equities. Stanford was one of the innovators in this area. Professionalization of investment management began in the 1970s. SMC now manages some bonds and cash in-house but has placed most of Stanford's equities with external managers. Oversight of SMC rests with a Board of Directors made up of Trustees with investment backgrounds and other investment experts, including Professor William Sharpe (Graduate School of Business), who won the Nobel Prize in Economics for his contributions to investment practice.
Illustrating his talk with slides, Hoagland listed components of Stanford's $6.2 billion portfolio and showed a performance graph for the largest component, the Merged Endowment Pool. Managing this asset involved trade-offs among three conflicting objectives: Maximize the cumulative payout to the University budget, preserve or increase the real value of the endowment, and minimize fluctuations in payout. A key to SMC's success was diversification, "probably one of the few free lunches available in investments," Hoagland declared. Stanford's asset allocation policy sets percentages of the portfolio for the various asset classes. In response to a question from Professor Wexler (Radiology) about SMC's response to recent market fluctuations, Hoagland reiterated that, while the percentage ranges allowed for modest tactical changes, SMC could best serve the University by making a long-term commitment to the asset percentages in each class.
Total target return for the
endowment is 10 percent, which translates to about 6.25 percent in
real (i.e., inflation-adjusted) dollars. "That may sound like a
fairly low number after 15 or 20 years of bull market. But if you
look at a very long-term horizon in the investment business, that's
about the kind of return that's reasonable to expect," he
explained. To maintain the purchasing power of the endowment
against inflation inroads so that, for instance, endowed
professorships can be maintained in perpetuity, the University
reinvests nearly half of the return. The current payout rate is
5.25 percent of market value. To defend against market volatility,
a smoothing formula is applied to the market value. "The formula
puts the most weight on the market value for the most recent year.
It's exponential, so that the impact of each previous year is
gradually smaller until it fades away to almost