Home Grown

January 18, 2005
When Jonathan Hook returned to work for his alma mater in February 2001, he had one task to accomplish -- and it was a big one: Assume the in-house management of Baylor's endowment and oversee its growth to enable the realization of the Baylor 2012 imperatives.
Judging by the latest numbers, he's doing a commendable job. When he arrived four years ago, the University's endowment was $614 million and had experienced a 10.1 percent growth during the previous five years. At the end of May 2004, the market value of the fund, which had decreased after the September 11 terrorist attacks, was $672 million and had grown 20.6 percent, or about $115.6 million over the previous fiscal year. Of that number, $15.5 million was in gifts, transfers and terminated annuities. To fully appreciate these numbers, consider this growth occurred despite a sustained downturn in the economy. The fund's growth previously had benefited from a historic market upturn.
The foresight that led to these changes began with the Board of Regents, which for several years had considered the possibility of transferring management of the fund from the Baptist Foundation of Texas (BFT), where it had been for nearly 70 years, to an in-house office. "As far back as 1993, when I was a faculty member, I remember Dr. Reynolds voicing his concerns about our endowment performance," says President Robert B. Sloan Jr., referring to former President Herbert H. Reynolds. "He opined on more than one occasion our need to explore better endowment approaches."
The decision to transfer was by no means a criticism of the BFT, say University officials, but an indication of changing needs during changing times. More specifically, it was the University's need to consider investing in ways beyond traditional stocks and bonds, a model many other national universities and colleges already had adopted.
Baylor's portfolio needed a more aggressive strategy, says Hook, a 1981 Baylor MBA who spent 20 years in corporate and investment banking before coming back to his alma mater. According to Sloan, "We were underperforming the market, not even hitting benchmarks. Had we retained the status quo, we would be millions of dollars short of where we are now."
Hook reported numbers to substantiate that claim at the Board of Regents' July 2004 meeting. The portfolio repositioning has begun to hit its stride, he says. The University benefited by an additional $44 million last year as performance was nearly 8 percent higher than its benchmarks and the average endowment and foundation performance for the year ended June 30, 2004. With management of the endowment on campus, the fund had grown to $722 million at the end of November 2004.
The run-up of the stock market in the years leading up to 2001 had created enormous wealth for many institutions-- wealth that Baylor's endowment hadn't fully realized because it lacked diversification into nontraditional investment vehicles, including private equity, venture capital and real assets. Similarly, during the dot-bomb years that followed, that lack of diversity left the University poorly protected from the bear market.
Among BFT's approximately 200 clients, Baylor was the largest, representing about 30 percent of its total assets. University officials recognized that Baylor's investment needs were different from the other institutions whose endowments BFT managed -- mostly smaller colleges, churches and hospitals with a lower tolerance for risk and a greater need for liquidity. "Most of the foundation's clients preferred a traditional investment strategy that maintained investments in equities and fixed income," Hook says.
Baylor was by no means a pioneer in its decision to self-manage. Many well-endowed, big-name schools such as Harvard, Stanford and the University of Texas had brought the function in-house many years earlier, often hiring dozens of market whizzes to grow their funds. In fact, some observers cynically refer to Harvard, whose endowment is a whopping $22 billion, as "one giant hedge fund."
According to a 2002 study by the National Association of College and University Business Officers, the universities that coped best with the nation's economic slump after September 11 were those whose investment pools were well-diversified across asset classes and whose investment managers were intent on preserving capital. The study noted, "Most colleges and universities have already adopted this modus operandi."
Enter David Brooks, who spearheaded the move to bring the management of the endowment on campus. Brooks served as Baylor's vice president for finance and administration from 2000-04. After much research, including talking to higher education investment officers across the country, Brooks concluded that Baylor was one of the few U.S. universities with an endowment of more than $500 million that wasn't managing its own fund.
"I took the initiative to recommend to the Board of Regents that we consider creating the position of chief investment officer and hiring someone," Brooks says. "My rationale to the board was that we had done a great job of raising money over the years, but not a great job of managing it. To go forward under the 2012 plan, to where we wanted to take the University, the progress would be greatly influenced by the performance of the endowment."
Among Baylor's peer group in terms of both endowment size and academic standards is a handful of elite schools: Wake Forest, Boston College, Vanderbilt, Tulane, Georgetown, Duke and Notre Dame. As it turned out, Notre Dame was the school Brooks studied most closely.
"I met with the chief investment officer, who had led the school from a sleepy investment approach and tripled the size of its endowment -- from less than $1 billion to $3.1 billion," he recalls. "It also was a good model as a faith-based school with high academic standards."
Tuition at Baylor at that time was about $12,000, while tuition at Notre Dame was $24,000. Baylor's endowment was roughly $600 million; Notre Dame's about $3.1 billion. "We had one-half the tuition revenue and one-fifth of the endowment," Brooks says. "We had to ask ourselves, 'How are we going to compete for students and faculty with that kind of competition? How do we move to a model that follows best practices for endowment management?'"
Realizing the case for taking control of the endowment fund was compelling, the Board of Regents in late 2000 voted to transfer out of the Baptist Foundation and create a mechanism to manage the funds on campus. In February 2001, Hook came on board to begin the process of assessing the situation and planning the transition to Baylor's own set of institutional money managers and a unique asset allocation that would be endorsed by the regents.
One of his first tasks was to spread the word in the investment community. To generate attention from institutional money managers and "get in their Rolodex" as a prospective customer, Hook spent a lot of time getting the word out that Baylor now was making its own investment decisions.
His next move was to hire an external investment consultant, a company that specializes in college and university endowments. Most universities use independent consulting firms to assist with research and manager selection and to provide a third-party sounding board for decisions, he says. After a lengthy search, Hook turned to Hammond Associates, an investment consulting firm with offices in the St. Louis area. Other schools on its client list include the University of Rochester, Michigan State, Bucknell University, the University of Oregon, Texas Tech and Westminster College.
"Years ago, investment management for institutions consisted of the board sitting around and throwing out names of stocks and bonds, with a low allocation to stocks and a relatively high allocation to bonds," managing partner Dennis Hammond told the St. Louis Business Journal last November. "The new paradigm of investment is one that involves a lot of strategies. Our model portfolio is just 10 percent bonds, 45 percent in traditional stocks and 45 percent in alternative investments."
Hook says about 23 percent of Baylor's funds now are in alternative investments, with a target goal of 30 percent. More important -- and despite the economy's continuing hangover -- the endowment's performance is steady and strong, results that affirm the University's decision to bring its management on campus.
To illustrate, Baylor's peer group encompasses schools with endowments in the $500 million to $1 billion range (regardless of how performance is measured and compared to college endowments in general). Last year, investment returns among all universities ranged between 12 percent and 22 percent. When final numbers are reported this spring, Baylor should be at or near the top of that group with a 25.3 percent return, Hook says. "There may be others out there who have done better, but nobody I've talked to has seen any higher."

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