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A rainy November Wednesday in North Carolina. Jim Dunn, newly ensconced Chief Investment Officer of the $1.2 billion Wake Forest University endowment, sits at a drab desk in a linoleum-floored classroom of Reynolda Hall, the school’s main administrative building. In front of him, a flurry of papers and a remote to control the room’s projector.
“People remember everything, forever, at an endowment,” he says. “They remember the bad bet—think of Jack Meyer, Larry Summers—for years. The politics of higher education are rivaled only by the military and clergy, and so my job, having come into town relatively recently”—Dunn, formerly of California-based Wilshire Associates, arrived in Winston-Salem in July, 2009—“is to meet with the different constituencies and, above all, ‘protect, perform, provide’. This is how I plan to do it.” With that, he turns on the projector, and the presentation begins.
Wake Forest University is in a forest, but it is not in the Forest of Wake. Instead, it is situated outside the banking and tobacco town of Winston-Salem, lured from its pastoral roots north of Raleigh by a donation of land and capital from the Z. Smith Reynolds Foundation in 1956. The school’s main campus is both secluded and clustered, with its green lawns cloistered by foliage and brown brick buildings. As a tribute to its benefactor, a number of these buildings—including the one Dunn sits in—are named after the family that gave both Winston-Salem and Wake Forest University its lifeblood. North of the Mason-Dixon Line, such nomenclature would likely draw vocal criticism from “social investors,” but the reality is that, 60 years on, the university is no more tied to tobacco than it is to cotton. Change, like elsewhere, has swept through Wake Forest in the last half century, and it continues its unmitigated march at the school’s endowment under Jim Dunn.
“I have a 100-day plan,” Dunn says, the projector’s output supporting his claim. “The first 30 days, I set expectation. The next 55: we plan for growth. In the last 15—which we’re in right now—we execute the plan. We are five days behind.”
An essential part of this Patton-like plan is to reassess the University’s asset allocation. “Our asset allocation has served the university well, but we’re in different times now,” Dunn notes. “We’re starting all over. I don’t care about what other endowments do.” Translation: Returns mean nothing if liquidity isn’t present.
Liquidity, many know, is the latest clarion call of endowment investing. Even the newest students at Wake Forest’s Business School—one of whom, football player Willie Dixon, works in the endowment office in an effort to increase connections between the university and its investment office—has likely heard of the liquidity problems that swept through American endowments in the fall of 2008. Although Wake Forest avoided a Harvard-esque liquidity embarrassment in that year, Dunn is still looking to refocus the endowment’s asset allocation inside a liability-driven investment framework.
“Our allocation strategy is somewhat unique,” Dunn says, referencing the latest image to flash on the wall, where a simple slide indicates that, while it is not the factor-based approach that some institutions are following, it is also not the clear-cut 60/40 allocation of years past. Thirty-six percent of assets are in equities, which include private equity holdings; 16% are in fixed income, both Treasury bills and higher-yielding instruments. More interestingly, 25% are allocated toward absolute return strategies: “This includes hedged strategies, and event-driven and macro-drive strategies,” Dunn says, pointing out that absolute return does not always mean return, absolutely. The remaining 23% are in inflation hedges that incorporate real estate holdings, commodities, and inflation-linked bonds.
It is organized like this with a dual goal in mind: to always have access to liquid capital, and to meet the liabilities of the university instead of simply beating some other institutional portfolio. Recalling Dunn’s alliterated dictum, these are, respectively, the “provide” and “protect” pillars. While they are decidedly less sexy than the outperformance seen at the Endowments of Extraordinary Size in the decade before 2008, these pillars are, Dunn believes, the true measure of a capital pool established to fund the university’s mission.
“Like most endowments our size, we accomplish this by being a manager of managers,” Dunn says, turning to his next slide. On it, a multi-colored pie chart lays out the various funds—some well-known top-decile funds, some relatively anonymous—that Wake Forest taps into to reach its target allocations. In total, 40 external managers handle 60 separate portfolios, a figure that Dunn and his team would like to lower for simplicity and strategy’s sake.
Part of this strategy is to use robust liquidity to take advantage of illiquidity issues elsewhere. “Following the crash, you saw a lot of institutions trying to get out of capital commitment to hedge and private equity fund,” Dunn says, mentioning Stanford and Harvard as two prominent examples. “It’s not that they were bad investments; they just were illiquid.” Few would argue that opportunistically taking over these capital commitments at pennies on the dollar would be a solid long-term investment. Dunn, planning to do just that, certainly would not.
However, change, no matter how logical, never comes easily. To alter momentum’s course takes a strong leader. Wake Forest is hoping that Dunn is that leader.
One thing you should know about Jim Dunn is that he has a very nice car. Exceptionally nice, really. Aggressive. It’s a car that says “I once lived in California,” which Dunn in fact did as the CIO of Wilshire’s $52 billion alternative investment portfolio. Although he also has a more practical car now—there is occasionally snow in North Carolina, and Dunn has two young children (family life being one reason for his switch in jobs) —Dunn still likes to ride around in his beautiful European automobile.
The ironic thing is, Dunn is not an aggressive guy. He likes to fly-fish. He can wax eloquent on topics of a surprising range and depth. His pay, differing from many other endowment leaders, is conservative in that it is based on risk adjusted, and not absolute, returns. It’s this dichotomy—a conservative man with a liberal bent—that shines a light on his desire to alter the very tenets of endowment investing, for if changing a university’s entrenched asset allocation ideas is merely difficult, then altering the very structure of the endowment and the way it interacts with the “cost-center” side of the larger institution is almost monumental in its complexity.
In previous discussions, one endowment chief investment officer (unassociated with Wake Forest) had railed openly against “Marxists” in his university’s faculty and administration demanding more capital from the endowment than it could safely afford. Luckily for Dunn, this problem seems nonexistent at his new home. “Wake Forest has had a stable, agreed-upon payout from our endowment to the school,” the school’s President, Dr. Nathan Hatch—formerly of Notre Dame—had said before the presentation from Dunn. “Unlike at many other institutions, the endowment only funds about 10% of our operating budget, and we’re happy with that. We are not making any push to get more money out of the endowment.”
No new capital demands does not mean stasis in the payout structure, of course. “Currently, the spending rate is determined and approved by the Board of Trustees, with the payout for the last couple of years being at approximately 5% calculated over a trailing 3-year period,” Dunn says. “The process going forward will be that a recommendation will be made to the Board with input from development, finance, and investments incorporating spending needs of the university, development fund raising capacity, and a stress/scenario test on the endowment.” In conjunction with this change, Dunn sits on the President’s Cabinet, an elite group of university officials—that include, besides the obvious, the Provost, Athletic Director, and the VPs of departments—that together constitute the school’s administration. He also sits on the University Senate, the Faculty Fringe Benefits Committee, and the Faculty Committee on Athletics. “These roles are invaluable to me in my role as a new member of academia as well as my role as CIO,” Dunn says. “These are all my constituents and their concerns are important factors in our models.”
To accomplish this seemingly seamless transition, Dunn has been proactive in involving different constituencies in the process, as noted with the first step of his 100-day plan. “I went and met with everyone,” Dunn chuckles. “Ev-ery-one.” A major recipient of this outreach was Wake Forest’s Business School, its main building sitting outside the window of Dunn’s presentation room. First and foremost in this effort has been an increased linkage between the school’s faculty and students—football players working in the investment office, for example—and the endowment’s management team.
“If our faculty are not interested in helping, how relevant are they?” Steve Reinemund, the Dean of the Business School and former CEO of PepsiCo, asked later that day. “This is the real world. The market has proved that we need more practical educators and theories. Helping with the endowment, then, is both beneficial and essential.”
While internal change is progressing smoother than expected due to an agreeable university elite, Dunn is also—unpleasantly, at times—attempting to change the dynamics of external relationships as well. One target: custodians. Although he is coy about who he is dealing with, he will say that he is attempting to push custodial fees down by a third after years of what he perceives to be an asymmetric relationship.
Dunn has a hard act to follow. The Wake Forest endowment, like Yale or Harvard, has, until this point, largely been the dominion of one man. This man is Lou Morrell.
“I tried to retire, but they said, ‘You know, what will you do?’ and I said I was going to Wilmington, and they said ‘Why not continue to manage money for Wake Forest?’” Morrell’s voice had boomed from the speaker a few hours earlier, piped via telephone into the Wake Forest office from his home on the Atlantic shore. It is he who runs the endowment’s only internally active investment silo: The Tactical Fund, as it is known, is a $96 million pool that Morrell exerts almost complete control over, using mutual funds to act (as the name suggests) on a tactical level. At 71, he has spent his life in the endowment space, having recently handed the endowment’s overall reins to Dunn in an effort, he says, to “slow down”—although few around the Wake Forest endowment think he will do anything of the sort.
He is a colorful man. His conversation is interspersed with journalistic gems—“75% of investment committees in higher education are dysfunctional!”… “The government will screw this up!”…”Private equity is dead!”—opinionated and edgy to the point that Dunn and others are both laughing and nervous when he speaks. Currently, Morrell—a vocal conservative worried about the Keynesian tilt of the Obama Administration and the potential for rampant inflation—is heavy into commodities, first and foremost of which is gold.
“I see gold going to $1400, and it could well go to $2000,” he says. Why? “They will never raise taxes so, to get out of this hole, they will intentionally inflate their way out. Inflation will be slow in coming because the economy is so weak, but you need to protect against inflation by buying commodities and buying gold.” Morrell also believes that gold is a currency play—“I wouldn’t get out of gold until the dollar strengthens”—and that foreign economies (he likes Canada) are a good bet. He is nothing if not confident: “Seventh grade economics says you shouldn’t get out of gold,” he says, and the debate is over.
Morrell is treated with reverence around the Wake Forest endowment, a deserved nod to his years of service and robust returns. Although he has relinquished the larger strategic and executive role to Dunn, his $96 million domain still is undoubtedly all his own. The transition from overall chief to solely investing, which in many cases would be rife with tension, was seemingly a smooth one. “Lou is a driver and, given the opportunity, he always will be, ” says Vicki West—the Director of Trusts who works closely with Morrell—in a soft southern twang straight out of a movie. “That said, he has transitioned into his new role nicely.”
This arrangement—with Morrell removed from the endowment’s quotidian calendar but still controlling a sizeable portion of its capital—highlights the necessity for robust internal risk management structures that are increasingly in vogue. While existing risk controls didn’t exactly make them endowment Luddites, Wake Forest and Dunn are setting up a system that will effectively allow Morrell to focus on alpha creation—“Lou has proved over the years that he provides a great deal of alpha in bull markets,” Dunn says—while beta is controlled elsewhere. Dunn is planning on accomplishing this by the creation of three separate options accounts that will put simple put/call “collar” strategies in place. “Overall, I would prefer that Lou make the most of his risk budget and leave the downside protection to me,” Dunn says.
There is no silver bullet to endowment investing,” Dunn says as the slide projector’s hum fades along with its lights. Educational politics and policy portfolios mingle with the nuts-and-bolts of funding a school’s liabilities, he says, and a true course will chart its way through a forest of all these factors. The biggest threats to his success, he believes, are the external marketplace and the generic internal politics that occupy all halls of higher education (Hatch, the school president, echoed this theme earlier, remarking “by their nature, CIOs, in a university environment, have a bullseye on their backs.”)
But this story is not really about Jim Dunn. What is happening at the Wake Forest endowment also is happening in Boston, in New Haven, in Palo Alto and Philadelphia and Ithaca. The age of the outsized and leveraged endowment return is over. Instead, Dunn’s ethos will be echoed around the endowment space: protect, perform, provide. Ignoring the raison d’être of university capital—to, in times both good and bad, provide enough money to build the school’s hard and soft assets—will no longer be acceptable. Building walls between endowment investment professionals and university faculty will no longer suffice. What will suffice—be required, even—is a return to basics, to sort the confusion of the forest from the trees. Jim Dunn surely is. Others would be well advised to follow.