Inside the Vault: Manager of Managers

In that way, Princeton resembles Yale, the endowment of which is overseen by PRINCO president Andrew Golden’s old boss, David Swensen. On the other hand, Harvard directly manages 30 percent of its funds, and it selects other firms to manage the rest.

Over the past 10 years, Princeton and Yale’s strategy has outperformed Harvard’s. Yale averaged an 11.8 percent annual return, and Princeton posted returns of 9.7 percent, while Harvard lagged behind with 8.9 percent returns. All three, however, have done better than the average college endowment returns of roughly 5.5 percent annually in the same period.

But the apparent advantage of the “manager of managers” strategy comes into question when markets behave as wildly as they did last year. Because it uses a number of outside managers — in 2008, PRINCO had 43 internationally based managers alone — PRINCO is never sure exactly where its money is at any point in time.

“You cannot control with great precision how much exposure you have,” Golden said. “We sign a contract that allows a manager to ask for cash from us at certain times.”

During last year’s credit crisis, many in the finance industry derided the widespread use of collateral debt obligations (CDOs) and credit default swaps (CDSs), financial instruments that some pejoratively called “Wall Street wizardry.” Though Golden said PRINCO’s investments in financial instruments like these weren’t “anything that caused a problem,” he added that he could not say with “100 percent certainty” that PRINCO was not exposed.

PRINCO’s “manager of managers” strategy might make it harder for the firm to adjust its asset allocation quickly and thus make its response to sudden crises less effective.

PRINCO currently employs 28 people who select and monitor private funds. The company works with more than 100 private funds and pays outside managers roughly $215 million per year, according to a December article in Princeton Alumni Weekly.

Though having an in-house team of investors would give PRINCO greater control over its assets, some say this is not the right way to go.

“If Warren Buffett were the head of PRINCO, I would have it managed internally because it’s going to be less expensive,” said James Clark Jr. ’60, a retired partner at the investment firm Tweedy, Browne. “But you’re not always able to acquire and hold someone of that investment caliber.”

And the sheer size of the endowment almost necessitates hiring a team of outside experts, said Tom Byrne ’76, who is the head of his own asset management company, Byrne Asset Management.

“When you reach some critical mass of assets,” he said, “you have to employ other people because there’s a level of expertise that’s difficult and frankly very expensive to bring in-house.”

Clark said running the endowment with an exceptionally talented in-house team would prove cheaper in the long run, though that team would demand Wall Street salaries.

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For example, Golden’s salary last year totaled $2.2 million, but in the 2005 fiscal year, Harvard paid its top two investment managers salaries totaling almost $35 million.

Harvard argued at the time that it would cost much more to invest with outside managers, according to an article in The Boston Globe. Yet the returns of Princeton and Yale, which take into account the fees paid to outside managers, indicate that the external approach may, in fact, be more cost-effective since Princeton and Yale have posted higher average annual returns than Harvard over the past decade.

Byrne added that the additional control provided by keeping PRINCO’s operations in-house would necessarily accompany an increase in risk for the firm.

“It’s a bigger risk in-house because you’re almost by definition not as diversified,” he said. Working with outside managers allows PRINCO to more easily invest in many different asset classes without requiring in-house experts for each. This kind of diversification also allows for better risk management of the University’s investments since different types of assets can serve as a buffer for each other — if one falls, another might go up and reduce the magnitude of the loss.

Despite the increased control that the in-house approach offers, Golden said, “Partnering with the world’s best specialists is a much more comfortable approach. You want a division of labor.”

This is the fourth article in a five-part series on the University’s endowment and investment practices.