By Paxton Scott
In the May 9 Faculty Senate meeting, Provost Persis Drell delivered a presentation on the state of Stanford’s budget and endowment. She noted that while the endowment has exceeded the expected 9 percent annual return on average for the last 50 years, in the last three years the average annual return has been only 7.8 percent.
According to Tim Warner, the vice provost of budget and auxiliary management, based off the expected 9 percent return, endowment funds pay out approximately 5.5 percent, while the remaining 3.5 percent is rolled back into the endowment principal, called the corpus, to ensure future sustainability as costs increase. But with recent returns of less than 9 percent in the last three years, on average less than the nominal 3.5 percent has been reinvested back into the corpus.
To learn more about Stanford’s endowment, The Daily interviewed Robert Wallace, chief executive officer of the Stanford Management Company (SMC), which is responsible for managing the $28.7 billion dollar Merged Pool, the principal fund for investing the endowment. Before joining the SMC in 2015, Wallace was the CEO of the London-based private investment firm, Alta Investors, and worked at Yale University’s investment office. Prior to his career in finance, Wallace danced professionally with the American Ballet Theater, the Boston Ballet and the Washington Ballet.
The Stanford Daily (TSD): What do you think accounts for returns dipping below the 9 percent target in recent years?
Robert Wallace (RW): The average annual return for the Merged Pool for the decade ending June 30, 2018 was 6.3 percent, net of all fees and costs. This 10-year period includes the 2008-09 financial crisis, when the endowment lost a quarter of its value in the severe market downturn. Recently, however, returns have been higher. Over the last three and five years, the Merged Pool returned 7.8 percent and 9.4 percent per year, respectively. Last year, the Merged Pool returned 11.3 percent. Across all of these time horizons, the Merged Pool outperformed the average university endowment, as well as typical benchmarks for institutional investors.
TSD: Are lower returns a reflection of the broader market or specific investment decisions?
RW: You can think of the broader market as dictating a material portion of our performance, but not all [of it]. The Merged Pool is fairly diversified by region and asset class, which helps reduce the risk of a problem in any one area of the market. This diversification mitigates market volatility, but doesn’t eliminate it. In addition to reducing volatility, we strive to add value through our specific investment decisions. It requires a disciplined and focused portfolio to drive additional value net of fees and costs. Stanford has achieved this goal over long periods. We realized a few years ago that we had an opportunity to further upgrade our ability to add value, which we have been hard at work to achieve. The early results of this effort have been very strong and have positively contributed to recent performance, though more work remains to be done. Making thoughtful changes to a portfolio as large and illiquid as the Merged Pool takes many years.
TSD: Is the endowment expected to continue growing at lower (less than 9 percent) rates for the next ten years?
RW: While predicting the future with precision is always difficult, we do know that the valuations of financial assets, such as the price-to-earnings ratio of the U.S. stock market, are reasonably good indicators of investment outcomes over the following decade. When valuations are low, subsequent investment returns tend to be high. When valuations are high, subsequent returns tend to be low. Unfortunately, current levels of valuation are above average. For example, at least on several important measures, the U.S. stock market is nearly as highly valued as it has been at any time in the last century. Fixed income and private investment markets are also highly valued. History suggests, therefore, that baseline investment returns over the next decade will be below historical averages, though we don’t know for sure.
TSD: What is the estimated cost, if anyone has tried to do those calculations, of having an ethical bar for investments?
RW: For Stanford, ethical considerations are part and parcel of generating attractive investment returns. While we don’t use the endowment to pursue specific political or ideological agendas, we do consider a close examination of ethical issues to be linked to attractive long-term economic results.
This transcript has been lightly edited and condensed.