School is out for the summer, but the college endowments never stop working. Many endowments had a successful fiscal year ending in June 2021, but with raging inflation, the outlook for 2022 is more uncertain.
Amy Falls became chief investment officer of Northwestern University’s $15 billion endowment in May 2021, the first woman to hold the position. The portfolio helps fund university operations, including financial aid, faculty salaries, research, and athletics.
Falls, 58, came to Northwestern from Rockefeller University, a biomedical research institution in New York with a $2.5 billion endowment, where she had been CIO since 2011. Her performance was outstanding : The Rockefeller endowment has gained an average of 8.4% per year over five years. years, and 9.5% for the 10 years through June 30, 2020, his last full year at the helm, compared to an average of 5.1% and 7.5%, respectively, for all university funds.
Falls, a former partner at Morgan Stanley, is a member of the board of trustees of the Ford Foundation and of the Harvard Management Company, which manages Harvard University’s endowment. She leads the Northwestern endowment with a staff of 23 in an office located on the edge of the private school’s campus in Evanston, Illinois.
In a recent interview, Ms. Falls discussed her outlook for the market, why it’s important to include private equity and venture capital in the portfolio, and her mission for the endowment. An edited version of the conversation follows.
Barrons: The stock market was skewed this year. What will the second half bring?
Amy falls: It was a predictable correction. Valuations were too high for inflation. I also felt for a long time that interest rates were too low. The policy levers that were pulled appropriately to deal with Covid created a massive rally, but valuations were unsustainable. In some ways, it’s healthy to have this kind of correction.
We are witnessing a normalization of interest rates; 3% to 4% over 10 years [Treasury] is where we should be. The real rate should be positive. You should get something for being a saver. It is destructive for income inequality, because the elderly and low-income people should have a vehicle without capital to accumulate or protect their savings.
Is the economy in recession or heading for it?
A recession is a significant risk. You have a fiscal squeeze in rolling out stimulus. You have monetary tightening and inflation. All three things happen. Inflation means you can’t really stop the monetary correction.
“Everyone has the same advantage of large venture capital investments. I felt we should take some chips off the table.”
There are not as many degrees of freedom as in the era of zero inflation in which we lived. The good news is that there is a strong employment rate. There is wage growth, which is probably acceptable if it doesn’t get out of hand. The risk of recession is quite high, especially in six months.
In the 12 months to June 30, 2021, the Northwest endowment gained 42.2%, beating the average gain of 30.6%. This performance was boosted by the fund’s venture capital investments, up 115%. The performance was mostly that of your predecessor. What are you doing differently, if at all?
Asset allocation is not something I would drastically change. [The largest positions at May 31, were 34.6% in private equity and venture, 21.4% in long public equities, 14% in absolute return, and 14% in real assets]. A 42% return sounds good. But everyone gets the same benefit from big venture capital investments. I felt we should take some chips off the table. So we made a secondary sale of individuals [holdings in nonpublic companies] in the fall, and raised on the theory that when things go up 115%, it’s a good idea to sell.
We have also reduced overall equity exposure on the public side. So we tried to pull the boats ashore a bit in the fall and entered January with about 13% in cash and fixed income, which is high. [It’s 10.1% as of May 31.]
And more recently?
We look carefully at things that are more cyclical, which have held up well. We are reviewing how far we are from a correction? We dribbled. May was the predominant month of addition. We started adding some distressed debt funds in June, on the idea that the cost of capital is rising and credit spreads are starting to widen. It’s early, but by the time we give them the money and deploy it…
We gradually explore opportunities as we see them integrate. More recently, we have turned to troubled credit markets. It’s also a bit early but we’re getting settled.
Was the venture capital portfolio concentrated in a few sectors or broad?
It was quite wide. There was a component in fintech and crypto, but it wasn’t very big. There were a lot of standard stories of change accelerating because of the pandemic. We’re leaning towards early-stage companies, which are doing a bit better than late-stage companies. We don’t have a single name in the venture capital portfolio that has grown more than 1%. You can get one of these huge unicorns and then you have a business that’s 4% or 5% of your assets. It was quite large, with information technology and a bit of biotechnology, and it was global, not just in the United States
Performance for fiscal year 2022 will be below your bar. [School endowments report investment returns in the fall after their private-equity portfolios are valued.] How is Northwestern’s performance trending and are you worried about the returns on your private equity holdings?
I expect we will see a slowdown in soldier performance. It was offset to some extent by investments in real estate and commodities. We did an analysis for the board that at the end of May, 70% of the underperformance in public stocks came from 12% of stocks. A small number have been hit very hard. A third of the portfolio is either flat or up double digits, and equity is down. Let’s make it a simple title. The diversification worked.
Can Endowments achieve their typical target return of 7.5%, subject to spending needs, inflation, fees and expenses?
This is what keeps me up the most at night. The problem is that the 5% drawdown [for university spending] is pretty consistent across the board. What is not knowable is inflation or cost growth for universities. Unless you can generate returns that cover this, you are depleting your resources in real terms. You have to be in venture capital and private equity, and you have to take equity risk.
With how many managers are you invested?
The current active range, excluding the tail of private equity managers we don’t invest with yet but have exposure to, is around 107. I would like that to drop. I believe in focusing on high conviction managers and then ensuring that they own a substantial percentage of the portfolio. I would define that as 2-3%. If it is a very limited mandate, less. I try to prevent anyone from becoming too dominant.
What would be your ideal number of managers?
Maybe 90. Where it gets tricky is how much you want to make in sector funds. At Rockefeller, with a $2 billion endowment, I haven’t invested heavily with industry specialists because it can be very difficult to rotate between them. So I’d pick a good generalist, and they’d decide it’s a good time to be in biotech or healthcare or whatever. As you grow, you can add value by choosing a great biotech manager or a great Brazilian manager. My best guess right now is that we’re probably struggling to get below 90.
How do you consider geopolitical risk?
Geopolitical risk must be taken into account. It’s hard to disable. I don’t think we predicted [Russia’s invasion of Ukraine]. We didn’t have a lot of exposure in Russia because it wasn’t an attractive investment climate. If a country is not governed in a predictable way, it is generally not a good place to invest. We had very little discussion about Russia and Ukraine until just before the war. We think a lot about political economy because we have to. But we limit our investments where we believe we are unlikely to succeed.
How are assets distributed geographically?
We’re still fairly US-centric — about 70% US, if we look at the holdings of all our managers. Part of that is because we have funds explicitly in the US, and also, we have funds that have some form of global mandate, but have been overweight in the US
Is the endowment investing in the crypto space?
Only in venture capitalists investing in blockchain infrastructure. Usually they also end up with coins of one form or another. We have investments with some strong players in the global development space.
Why is it important to be in the crypto space?
The feeling was that some of the most talented and thoughtful people in the venture capital funds we invest with, who were usually very good at identifying trends five or six years ago, were putting resources into the field. As someone who has worked in financial systems and business systems, I like the idea of more efficient and less expensive ways to move money around the world. I get the negatives, but there are real positives. It’s not a technology you can ignore, which is different from saying, “This is the new gold, or everyone should have 5% of their portfolio in crypto.” I’m not sure about that. I’m sure it’s an important technology and it’s a different way of storing and transferring value.
What brought you to Northwestern?
I wanted to have the opportunity to teach and work with young people. [Rockefeller has postdoctoral students and no undergraduates.] It was something that I admired so much about David Swensen. [the late endowment manager at Yale], who was an important mentor. He didn’t just do his job. He taught, mentored and developed people. It’s a good way to get people from non-obvious backgrounds to consider the field.
What is your mission for staffing?
The obvious and most important mission is to manage the institution’s assets, which means both downside protection and competitive returns. If you don’t hedge against the downside, in the long run, you won’t generate competitive returns. Risk management is essential. But we also want to generate top quartile returns. Otherwise, we will not be able to compete to attract teachers and students.
Corrections & Amplifications:
Amy Falls is the CIO of Northwestern University Endowment. An earlier version of this article incorrectly spelled his last name as Fells.
Write to Mary Romano at [email protected]