Asset Manager ‘Size Is The Enemy Of Returns’ | Exclusive Q&A With Scott Wilson, CIO, Grinnell College
Scott Wilson is the chief investment officer for Grinnell College. In this role, Wilson evaluates global investment themes and strategies within equities, fixed income, real assets, private equity, venture capital, and marketable alternatives, including portfolio overlay and hedging options. He also monitors existing investments of the College and recommends new investments, portfolio allocations, and risk metrics.
Prior to joining the College in 2010, Wilson served as the head of rates option trading for Barclays Capital in Tokyo, Japan. Previously, Wilson served in various trading and investment banking roles for Credit Suisse First Boston and Merrill Lynch. Mr. Wilson earned a B.A. in economics and mathematics from Grinnell College. He is also a Chartered Financial Analyst.
In this interview, Wilson discusses how his previous experience working in Tokyo shaped his investment philosophy, Grinnell College’s investment strategy and why the endowment is focussing on niche managers.
Wilson was recently named on Trusted Insight’s Top 30 Endowment Chief Investment Officers. Wilson graciously spoke with Trusted Insight on February 13, 2017. The following interview has been edited and condensed for clarity.
Trusted Insight: You were the head of rates option trading for Barclays in Tokyo prior to joining Grinnell. How has your experience influenced your investment philosophy at Grinnell College?
Scott Wilson: I feel fortunate to have had some real experience in a few asset classes before coming to Grinnell. Having come from an investment banking background, I’m probably more skeptical of different kinds of strategies and funds that I may have known from my previous life. You see some of these funds from an entirely different perspective sitting on the sell-side. Running a derivatives trading desk is a much more fast-paced, high pressure type of environment where there is constant pressure to produce PnL. They both have different challenges, but one is certainly long-term and strategic, while the other is more transactional based where the environment can change minute by minute.
Trusted Insight: Did the experience in Tokyo give you insight on investing in Japan, as an asset allocator? What advice would you give to a young LP looking to make investments within Japan?
Scott Wilson: Having lived in Japan, you realize just how different various markets can behave. One of the lessons that I took away from my experience is that we typically avoid foreign-based teams trying to invest in local markets. We invest in local markets with local people. Japan is probably an extreme example of that because unless you really understand the culture and the market dynamics, it can be a very difficult and frustrating place to invest.
Trusted Insight: You joined Grinnell in 2010. What did the portfolio look like when you joined and how has that evolved over time?
Scott Wilson: When I first joined, we were over-weighted in domestic, large-cap stocks and large-cap buyout. Aside from caring about the College and being a cultural fit, I think they wanted someone with international experience to help diversify the portfolio both in private and public markets. In particular, we have tried to focus on smaller managers in some of the less-followed strategies, asset classes and geographies.
Trusted Insight: The Yale endowment model is fairly ubiquitous. How do you see investment strategy evolving over time?
Scott Wilson: Yale has set the gold standard for endowments with what they have been able to accomplish. Based on what I know of their process, the Yale model is probably much harder to replicate than some people realize. They have not only done an amazing job historically of allocating more capital to higher returning asset classes like private equity, but they have also been extremely skilled at choosing the underlying investments within each asset class, which takes a world class process and investment staff.
Looking forward, the Yale model will have to adapt because so much excess capital is chasing returns in private markets and not just from endowments, but also other large institutional investors like pension funds and insurance companies. If you dig into the underlying economics of where individual deals are actually getting priced today, we don’t think returns looking forward will be anything like what we have seen over the last three decades. We think this is particularly true for larger private deals with $100 million-plus equity checks.
For Grinnell College, we think there is an advantage to being smaller in some asset classes and have shied away from the larger funds. We can make a $25 million allocation to a small private equity fund and if that does well, it will still move the needle for us. For larger institutional investors, it's not worth their time to do all that diligence and only make an investment that’s such a small percentage of the whole portfolio.
Trusted Insight: What is your strategy for private markets given your smaller capital base?
Scott Wilson: We definitely prefer local funds managed by local people. We also have a strong preference for small and middle-market funds as opposed to the larger buyout funds. A lot of that is based on the underlying deal pricing. The world has gotten smaller, and there is a lot of capital chasing deals globally. Even if a deal is based in Africa or South America, if it's a $100 million-plus equity check, that will attract potential investors from Asia, London and New York because there is so much capital that has been raised recently and it needs to be put to work. If you can deploy a lot of capital, we think the pricing becomes less interesting regardless of where that deals located geographically. As a result, we've really focused on smaller funds that targeted a smaller deal size in places that we think still offer good value. We’ve spent a lot of time recently in Eastern Europe, parts of Asia, LATAM, India and Africa.
Trusted Insight: How do you identify and select a good manager that can vet opportunities in Africa?
Scott Wilson: In a place like Africa, the opportunity set is relatively small. Maybe there's a hundred institutional quality partners that you could potentially invest with on the entire continent. It's not that big a universe relative to the U.S. We’ve spent a lot of time there, and I would say that we probably met the vast majority of them at one point or another.
We like to focus our diligence on what we call an institutionalized and repeatable investment process. Everybody wants to invest in a team that has produced a good track record, but we try to focus our diligence on the process to determine if the historical track record is repeatable going forward. We spend a lot of time looking at the underlying investments in a manager’s portfolio so we can truly understand the investment process.
We talk about an institutionalized process where everybody, from the junior-level staff to the senior staff, can completely articulate the strategy. We consider how deals are sourced, how diligence is done, how they think about risk-reward, how they think about their opportunity set, how they protect the downside, how they think about deal structuring, how they think about pricing/value, how they think about allocating capital and how they think about portfolio construction. I guess what we are looking for is to avoid is the situation where a manager has a track record driven by just a small number of successful deals.
Trusted Insight: What’s the team structure and culture at Grinnell?
Scott Wilson: We have a small team, and we tend to run a very concentrated portfolio relative to our peers. We are trying to find just a small handful of very attractive investments in any given year. It's a very flat structure. There's four of us on the investment staff that are outwardly looking for new opportunities, and we are all generalists covering all asset classes.
All of our new investments flow through our Director of Investments. His primary responsibility is managing our new investment pipeline. Before taking over as CIO, I was in that position and was fortunate to work for someone that let me focus almost entirely on building out an attractive investment opportunity set. I’ve found that unless someone is almost entirely focused on that role, it’s very easy for the pipeline to get stale. The rest of us are obviously still involved and share diligence responsibilities. We meet weekly to go over the entire pipeline and openly debate the merits of individual investments with the entire team and how it would fit into our portfolio. We also review our pipeline regularly with our Investment Committee to get additional input and solicit feedback. From there we try to focus our efforts on what we think are our highest conviction opportunities.
It's not easy finding new investments. Luckily, we're not trying to change the portfolio significantly on a year-to-year basis. Finding a few great investments every year is a reasonable goal for a small team.
Trusted Insight: Are those handful of opportunities primarily on the private side?
Scott Wilson: That's on the whole portfolio. Last year, we did diligence on over 400 meetings or calls as a team, and added just two new investment partners, that weren't just follow-on investments with existing managers.
Trusted Insight: What is your governance structure and decision making process in proceeding with an investment?
Scott Wilson: We report to the Investment Committee, which is a subset of the College’s Board of Trustees. We have a very strong Committee with significant investment and entrepreneurial backgrounds. The staff is responsible for sourcing and diligence of investment ideas, but the Investment Committee oversees our process and approves everything we put in the portfolio.
We have a standing monthly call with the Committee and typically at least four in-person meetings per year. We are very lucky to have a strong, supportive Committee. They have been a tremendous help.
Trusted Insight: Which trends are shaping how Grinnell invests?
Scott Wilson: We are always trying to deploy capital where it is relatively scarce and avoid markets where we think there is too much capital chasing too few deals or chasing historical returns. Our direct lending investments have been in revenue-based lending strategies in the U.S. as well as smaller direct lending funds in parts of Asia and Europe where capital markets are less developed and the banks are still unlikely to make traditional bank loans to smaller companies or developers. We have also focused our private and public equity strategies on smaller funds making investments in smaller markets or smaller deal sizes. In real assets we are focused on distressed mining situations and non-core, opportunistic real estate funds.
There is a big trend for pensions and other large institutional investors moving into private equity markets and traditional distressed debt funds. Because most of those pensions are so big, they are typically adding capital to the largest funds. We've pulled out of that space and focused on smaller, niche managers because we think the opportunity set is more robust.
I don't think that we're doing anything magical that our peers wouldn't be doing as well. With everything that we do, we try to be slow, cautious and deliberate. We are not making short-term macro calls with the portfolio.
Trusted Insight: It seems to be a trend that institutions are increasingly seeking niche strategies with firms that are earlier in their life cycle versus some of the larger monolithic funds.
Scott Wilson: I think everyone realizes on some level that size is the enemy of returns. If you look at almost every $10 billion-plus fund and measure how much alpha they produced in their first five years versus their most recent five years, you will see a very stark contrast. Smaller managers also tend to be more nimble and provide better diversification benefits.
We spend a lot of time thinking about portfolio construction. Everybody wants a portfolio of uncorrelated investments with a high expected return, but it’s very difficult to put together. Whenever we add something to the portfolio, it has to improve the overall risk-reward characteristics of the portfolio and that typically includes diversification benefits. Truly uncorrelated investments are difficult to find, and it’s harder for managers to be uncorrelated when they are sitting on a very large capital base.
Trusted Insight: What advice would you give to someone looking to enter institutional investment?
Scott Wilson: Having some work experience -- either on the sell side or buy side in a specific asset class, whether that's fixed income, public markets, private investing or even some consulting work -- is good before you get on the allocator side. It brings a good perspective and a healthy sense of skepticism that you need when you're looking at thousands of potential investment opportunities all over the world and trying to narrow that down.
A great database of potential investments doesn’t really exist in this industry. There is no magic funnel that helps you narrow your pipeline down from all of the available investment opportunities to the small handful of things that you'd really like to invest in. So having some outside expertise before you land in one of these roles is a very healthy thing.
Trusted Insight: What else should we know about you, Grinnell College or endowment investing in general?
Scott Wilson: Endowment investing is a fantastic job that I was only marginally aware of until Grinnell reached out to me back in 2010. I’m very fortunate. It’s a great honor and responsibility working for a college endowment where you can do something that is truly interesting and also meaningful for a great cause.
Grinnell has very long, robust history with many great investors and committee members looking after the endowment. These include Joe Rosenfield, who helped manage the endowment from 1941 until he passed away in 2000. During Joe’s time, our endowment grew from just a few million dollars to over $1 billion, while taking in less than $70 million in total endowment gifts. This is truly a remarkable track record.