As vice president and CIO of the Carnegie Corporation’s $3.5 Billion endowment, Kim Lew is responsible for its investment management and oversight of the entire portfolio, including the strategy for both marketable and private investments, portfolio construction, and managing liquidity which is particularly important for an organizations with no inflows of capital. She’s known for her ability to select and foster new managers, and help them to grow in a way that develops their mutual goals.
Lew is also known for her comfort with investing in emerging markets. She managed investments in China, South Africa and Brazil while at the Ford Foundation and bought that passion to Carnegie Corporation which has significant exposure to those and other emerging markets.
CIO: Carnegie Corp has been invested in Africa since 2001, and you’ve noted in the past that it was once a beta play, but now it’s an alpha play, and that opportunities there will be greater over time. What opportunities do you think will grow over time? What should CIOs keep their eyes on?
Lew: From our first investment until the crash at the end of September 2008, our composite of African markets was up 21.9% per year. During that time, the S&P 500’s annualized return was about 4%. Conversely over the 10 years ended September 30, 2018, the composite was down 4.3% per year, while the S&P 500 was up more than 11.3% per year. Independent of stock selection, the markets were up sufficiently before the Great Financial Crisis to compensate us for the risk in those markets. However, over the past 10 years, returns have not been sufficient and investing passively for the beta would have been a poor decision. However, there have been pockets of strength, so it was crucial to find a skilled manager who could cherry pick those companies that were capitalizing on the growing middle class rather than the commodities companies, which dominate many of these markets.
CIO: Why have you decided to be benchmark-agnostic in Africa?
Lew: We have benchmarks for our Africa equities managers, but in general, we look at our investments in emerging markets relative to alternate investments. An investment in African equities requires us to believe that the return is higher over the long term than US equities because the risk is higher. Africa has positive investing dynamics: the working-age population is growing as is the middle class and, further, the different countries are trying to find ways to build regional markets. All of this creates an environment where strong companies can develop. Further, the markets remain inefficient, so a good stock picker with patient capital should be able to significantly outperform the market. These traits are strengths of the endowments and foundations community.
CIO: You’re known for being good at manager selections and advising smaller managers. What’s key to evaluating your small managers in this rising rate environment?
Lew: Carnegie Corp. prides itself on its ability to choose managers which we describe as living “on the precipice of greatness.” These are investors who demonstrated that they have the raw talent needed to be a great investor. They have a clear understanding of what drives returns in their markets. They have a process that allows them to develop a differentiated perspective versus the market. They have put together a team with complimentary skills and developed a structure that allows the organization to capitalize on the talents of its members. Often, they have apprenticed under an established great investor or on a great team. Sometimes, they have been at a team that has not been successful but have learned from those mistakes and are now building a stronger, better positioned team.
Often what they have not yet learned is managing an organization. They have not yet thought about the challenges of building a back office. Perhaps they have not had to deal with the challenges of portfolio construction and portfolio management. They have not had to incent and motivate junior talent. Even if they have not yet had to do any of these things, we assess their thought process. We challenge them to think about how they plan to handle these decisions. We encourage them to get support if the experience and talent is not resident in their organization. We help them to think about the implications of how they build their LP base and structure terms. Because of the number of managers that we have collectively seen over the years, we are able to assess and offer guidance. But we understand that each manager has to build the organization, the team, the process that is most appropriate for them, so we are not trying to create a portfolio of cookie cutter new managers. We just hope to prevent them from making the big mistakes that can kill a new manager.
We also know that many of the investing challenges that they will face, they have not had to deal with in the past. They have not had to operate in a rising rate environment. They haven’t had to invest in a world which is swinging away from globalization and towards a more nationalistic posture, to name just two things. But we know that emerging managers will not have experienced everything. It is about how they factor these concepts into their thinking and how they use it in their risk assessment. Obviously, these factors cannot be subjected to the same quantitative analysis as those managers that have a track record, but we can do rigorous analysis and comprehensive due diligence. This is the art of investing. We have made a number of investments in first-time or unproven managers over the past five years and most have proven to be great decisions. We will continue to make these investments. We know that our willingness to take on this risk gives us greater influence with the manager. We can have greater influence over terms and structure. We can negotiate allocation and the speed and pace of how the fund grows, which is important for a fund of our size.
CIO: When investing in China, what are some overlooked things CIOs should be aware of?
Lew: China has grown significantly in size and influence over the past 10 years and we anticipate that this will continue. The size of its middle class is now estimated to be 430 million, growing to 780 million by the mid-2020s. Its middle class is currently larger than the entire population of the United States. This is an economy that will be increasingly hard to ignore because of the combination of size and growth rate. China will eventually be a significant consumer of global goods, so whether you choose to invest in China or global producers, we will need to understand it. But understanding the numbers is the smallest factor in investing. It will be important to do the analysis that you do when making investments in any country, but with China, you will need to take special care in understanding the role of government. You must take the time to understand how the company fits into the long-term plan for the government. Are the competitors state-owned enterprises? Is the company in an industry deemed strategic to the long-term vision for China? How does the government think about foreign investments and allowing flows of capital in and out of the country? It is important to choose a manager in China that has a clear line into the government and will be able to negotiate the ability to move capital. Also, the best managers will understand how investments fit into the government’s plans.
Another factor that is crucial to investing outside of your home market is the cultural norms of that market. What behaviors are rewarded, and which are not tolerated? What motivates the people of that country? What are they trying to accomplish? How are their systems set up to support what needs to happen for those markets to grow? The answers to these types of questions are unique for China because of the challenge of trying to develop a market economy with an entrepreneurial people, but within a communist system.
Another thing that investors need to appreciate is that China, despite being only one time zone, is huge and not a monolith, so it important to understand the differences that exist with the country. There is not one China, but many.
I would also add that investors need to appreciate the growing correlation between China and the rest of the emerging markets. So many other emerging markets are increasing correlated with China and so it is important for investors to appreciate the interdependencies and how and if they will influence investments in China.
CIO: What are some of the recent accomplishments you are most happy to have achieved as CIO?
Lew: I think that everyone thinks that their era is the most challenging investment environment and so I will not be contrarian but will instead agree! This is the most challenging investment environment. There have just been so many unknowns to try and figure out. Given this environment, the things that I am most happy to have achieved are:
- The Carnegie team: We have a built an intellectually curious and talented team that is vested in making great investments. We don’t feel the need to follow the crowd nor do we need to be contrarian for contrarian sake. We have an independent process that leads to great investments.
- The quality of the long-term research that we have done. We have made presentations on demographics, robotics, the future of retails, cryptocurrency, and migrations trends, just to name a few.
- A successful sale of a group of old venture funds at much better pricing than we expected.
- Investments in first-time funds in almost every asset class. Our hit ratio has been extremely high despite the risk inherent in investing in new managers.
CIO: Are there any key goals you are looking forward to in the near future?
Lew: Over the next three years (which I think of as the near future), I expect there to be a dislocation in the markets which I hope will provide me the opportunity to rebalance and reposition the portfolio. I have invested a great deal of team resources looking into long-term trends that could provide investment opportunities in the future and I hope we get a chance to use the knowledge we have obtained.
CIO: What are some of the key challenges the industry faces?
Lew: The industry has a number of challenges that we will need to face over the next few years. There are just too many to list but a few that I think about include:
- The declining return expectations for different asset classes
- The regulatory environment has not kept pace with technology and so there is a mismatch between regulation and how markets will work, which will create some real investment challenges
- The rise of nationalism in the developed economies and the shift away from globalism
- The increasing role of data and artificial intelligence, and the issues we will create if we build bias into the system
- The increased flows of capital into the system with different return expectations and different objectives that might be in conflict with the return expectations and objectives of foundation investors such as Carnegie
- The impact of increasing efficiency and transparency into illiquid assets on the return expectations of these investments
I could go on forever!
CIO: What aspects about the future of the industry do you find most promising and exciting?
Lew: I am most excited about the push towards greater diversity in the industry. The willingness and ability to broadening the opportunity set to include more diverse allocators, more diverse managers, and more diverse investments means that the return potential should increase. I remember reading an article that said that the game of basketball had become a less skilled game as the players have gotten taller. The article argued that the market believed that being tall was an asset to playing basketball and so they started screening for height first and once you narrowed the set of people you can select from to those over 6’5”, the quality will naturally get lower. Not all tall players will be good at dribbling, passing, setting up plays, or three-point shots. The best point guard might in fact be 5’7” but nobody will ever see that player because the first screen is height. This is what currently exist in investing. Someone designed a screen that we could only choose the best white male investors and it led to good investments, but perhaps investing could have been great if you widen the pool to include everyone. Selection from a larger pool means that the performance of the top should rise. Over the next decade (hopefully), we will see this pool expand and then we will really start to see the cream rise to the top. This will be an exciting time in the markets.
Want to join in on the conversation? Put your questions for Lew below in the comments section.