Access here alternative investment news about Exclusive Q&A: Charles Kennedy, CIO At Carnegie Mellon University’s $1.6B Endowment
Charles Kennedy is the chief investment officer at Carnegie Mellon University. Kennedy earned an MBA from Harvard Business School in 1995. Kennedy was an investment banker and later taught at the University of Pittsburgh before joining Carnegie Mellon’s investment team as a senior investment manager.

Kennedy was recently named to Trusted Insight’s ranked list of the Top 30 CIOs With Ivy League Education. He graciously spoke with Trusted Insight on Oct. 26.

Trusted Insight: You are a Harvard graduate, which comes with a degree of prestige. To what degree did your Harvard education help you achieve your current success?
Charles Kennedy: That’s one of those questions that is impossible to answer. I can tell you a couple things. 

My first job out of school was with a finance company that provided financing for middle-market buyouts. Right from the beginning of my career I gained an appreciation of private equity and what private equity can do. 

That led me to apply to Harvard, which I knew had a a solid reputation for helping people achieve careers in private equity. There is a great private equity ecosystem at Harvard. I applied to business school and went off to Harvard with the game plan that I would be involved somewhere in the realm of private equity or alternative investments. 

We looked at capital markets and various ways of investing on a public or private basis. Harvard was a terrific place to learn about that. I studied under professors Michael Jensen, Josh Lerner, and Rick Ruback. They taught me an awful lot with respect to private equity; the underpinnings of private equity; and the good and the bad of private equity. 

I came out of Harvard, interestingly enough, not pursuing private equity. I went into banking. I was a banker for seven years after Harvard. I joined a smaller boutique investment bank. That investment banking experience -- working with private equity sponsors as my clients, whether on the VC side, the growth or buyout side, and working with investors, whether they be in the capital markets on the public side through an IPO or development officers at a larger corporates -- looking to make transactions happen between the two was a terrific experience. I received great exposure working with companies, seeing how companies developed, seeing how sponsors were able to create value in these companies from the point of time when they acquired the business or put an investment in one of these companies to the point that they were able to create a liquidity event so that they could realize the value that they created. It was a great experience being a banker, being a part of those transactions, either on the going-in side or the coming-out side. 

After banking I became a faculty member at the University of Pittsburgh. I was teaching electives in the MBA program, as well as some electives for the undergrads. I was teaching all finance courses, including private equity, venture capital. 

That combination of the education I received -- in undergrad in finance; the MBA at Harvard; then the experience of working as a banker and trying to make transactions happen; and then teaching students, reading the research and becoming more familiar with the underpinnings of what makes the markets work and what makes private equity work -- provided a great background for going into endowment management at Carnegie Mellon University. 

When a friend connected me to the CIO at Carnegie Mellon, we started having conversations about the portfolio and its long-term strategy. Things moved very quickly with respect to seeing how the world of private equity could offer opportunities to the strategy of the university. The strategy had already kicked off, and we were able to move it forward fairly quickly after I joined. 

Trusted Insight: What is your investment philosophy, and how has that train of thought been informed by your time at Harvard?

Charles Kennedy: It’s tough to encapsulate an investment philosophy in just a couple of sentences. 

A couple key takeaways that I can share: It is very difficult to time markets. It is important to come up with a strategy that is independent of being able to successfully time markets because it’s so challenging. 

It is important to focus on governance of an organization and determine its strengths and weaknesses. Can they be incorporated within that world of governance so as to invest to the strengths and avoid the weaknesses? 

I would argue that one of the great strengths of endowments is the ability to withstand illiquidity. It’s probably the perfect investment vehicle from that perspective. When we are looking at markets and people are clamoring for liquidity, it’s usually the endowments that are in a position to say “We don’t need liquidity. We need long-term returns. We need to maintain the purchasing power of the portfolio over long periods of time.”
Trusted Insight: Tell me about your investment team at Carnegie Melon, and what sets you apart from other endowments.

Charles Kennedy: We are looking to build the team and are in the market for a director of investments. There are four of us on the investment side. We are looking to add a number of people, and we will start with the director of investments. 

The team will grow over the next couple of years under the direction of the investment committee. We are looking forward to bringing that director of investments on.

I think there are a couple of things that set Carnegie Mellon apart. First, there is the CMU culture – a direct, no-pretense, roll-up-your-sleeves attitude to achieve your goals with limited resources. Second, the university has top programs in several areas in technology. Investing in human innovation and entrepreneurship comes naturally, as the university’s name would suggest. Last, Carnegie Mellon is a global institution. Our students and faculty come from around the world. Thinking and investing globally is key to our strategy.      

Trusted Insight: What’s the ultimate end goal for the team in terms of collaboration? What are you looking for in a team member?

Charles Kennedy: Number one: it’s being passionate about the business and having a very high level of curiosity. That’s the one thing about this job: there aren’t a whole lot of titles and promotions in investment management, like there are in some areas of banking or other fields where you can move from title to title on a fairly frequent basis. 

What we do have are lots of opportunities to explore new asset classes, new areas within asset classes, new managers within those asset classes, new geographies, new structures, new ways of thinking about things. At the same time, the markets are constantly changing. If you knew the space pretty well five years ago, it doesn’t mean you know it very well today. Things are changing pretty quickly in a number of areas. 

Exploring, being curious, learning about what are the underpinnings that will create value in a portfolio at this point in time, over the next five years or in a private equity investment, over the next ten years or more, is what really drives people who are very good in this business versus people who aren't as strong.
Trusted Insight: What’s your outlook for both public and private markets headed into 2016 and beyond?

Charles Kennedy: The answer is really rooted in the timing of markets. There’s no way to tell that you’re in a bubble until you’ve gone through the bubble.

Our perspective examines how much cash are we giving up, what are we giving up and what are the expected cash flows we are expecting to receive and what is driving those cash flows? 

If the answer is somebody around the corner is going to offer you a higher price for what you just paid, then that’s a risky strategy. That depends on some extrinsic force. That depends on the timing of the markets, or on somebody saying “Hey, I will pay more for the asset that you just bought.” 

If the answer is there’s a company that is underlying this investment, and they’re generating cash or they have huge market share, or they are being disruptive in the marketplace, and we can see them changing the dynamic of how an industry that currently exists is going to operate going forward, they have high margins and they’re moving at this pace, then that is interesting to us: owning that business. So when somebody applies a price to that business, is it too high? Is it too low? It’s a relationship to those underlying cash flows. 

I would like to think that when we are talking to managers and looking at making a commitment to a potential fund, we are really looking at the world through their lenses, giving a sense of how is the world is going to be different and how they can play a part in that change and create value, as opposed to getting the timing right and calling the bottom of a commodity or calling a top of an asset class. It's pretty difficult being a consistent winner when you have to make those timing guesses.

Trusted Insight: Tell me about the endowment portfolio.

Charles Kennedy: The endowment is now $1.3 billion, and there’s another $300 million in working capital. It’s about $1.6 billion in all that we are managing at the investment office. The strategy is now in its tenth year of allocating to alternatives in a meaningful way. 

Ten years ago there was a new chair on the investment committee, and the investment committee decided that the university should be investing in alternative investments in a meaningful way. In the first couple of years, some commitments were made. 

Then the university decided to staff up. They hired my predecessor and then I was brought onboard in December 2007. So you can imagine not a whole lot of transformation happened in 08-09 as we went through the global financial crisis. 

As we came of out of the global financial crisis, we had made commitments in the prior years that were starting to generate some liquidity events in 2011 and 2012. Since then it’s been a steady state with respect to making consistent commitments. 

We are over-allocated on some asset classes and under-allocated on others. Overall, we are looking to be a pretty steady state with respect to having a significant allocation of around 30% to private equity, defined as venture capital, growth and buyouts.
Trusted Insight: How much of a concern is near-term volatility?

Charles Kennedy: The university is not as dependent on its endowment to support its annual budget compared with peer schools. The endowment supports less than 5% of the university’s budget. Don’t get me wrong, that 5% is extremely important and every gift that comes in is used very efficiently by the university to achieve its goals to provide education and fund research projects that are being pursued. That being said, there’s an opportunity to withstand the volatility because our budget is not so dependent on the endowment. 

We are hoping to change that. Our strategy is to grow the endowment through generous gifts through our donors and through what we do here at the investment office, so that it plays a more meaningful role with the overall university. 

I think you called it exactly right. With respect to short-term volatility, it’s not a big driver. It’s not something that we spend a whole lot of time talking about during investment committee meetings because we are really focused on the long-term aspects of the portfolio.

Trusted Insight: What trends have you identified endowment investing over the years?

Charles Kennedy: The billion-dollar milestone is pretty significant to universities. Once they approach or cross over $1 billion, the investment office starts to get more beefed up and becomes more alternative focused, more direct investing, less fund-of-funds investing. 

With respect to endowments overall, I have seen a continuous level of curiosity of finding new sources or return, new managers, new asset classes.  People are exploring new areas and seeing how are things going to be different.

I think most people who work at an endowment think that the world would be a better place if endowments were bigger. Endowments are pretty helpful to one another in terms of getting them up to speed on an asset class or giving some insight about what’s going on with markets. That’s a terrific trend, and I’d like to see that continue. I think the world would be a better place if endowments were bigger.

Trusted Insight: What challenges does your endowment face that are unique to the endowment industry?

Charles Kennedy: It’s an interesting governance structure. You can have turnover at the board level. You can have turnover at the administration level. The strategies that most endowments deploy are very long term in nature. Yet when you drive home from work every day, you hear what happened with the Dow Jones or the S&P that day. 

You are constantly bombarded with short-term results, and often there is a lot of drama around those short-term results that can distract a program that is set up for a long-term return, even a one-year return. There is a lot of focus on one-year results. That is a function of the fact that financial statements are audited on an annual basis and returns are publically announced on an annual basis to coincide with the audited financial statements. It’s a natural milestone in a business, but that doesn’t mean it’s a natural milestone with respect to the investment strategy. It’s an arbitrarily short period of period of time compared to most equity strategies. 

What’s more meaningful is if you make a commitment to a 10-year fund, how much cash did you get back at the end of 10 years? Of course you want updates, you want to see progress along the way, but summing all of that into a single number is over simplifying what’s going on inside a strategy. Especially if you simplify that for a one-year time period, it’s too short a period of time. So I would say the issue with respect to being focused on things that might be too short term versus the long-term strategy that endowments are pursuing.

Trusted Insight: What’s the #1 lesson you’ve learned during your career as an institutional investor?

Charles Kennedy: Some of the folks in the industry have been very kind to me and have shared their insights with me. The one thing that I would point to: when you are under short-term pressure for executing due diligence processes, finding managers and sourcing funds, something that often falls on the backburner is governance, but its importance should be emphasized. 

Pay attention to the investment policy statement and use that as a living document. Get people to agree, not in the heat of the moment, but in the calmness of a calm market, to a sound long-term strategy and to a governance structure that best supports that long-term strategy. 

Memorialize that in your investment policy statement and then pull that out and make it a living document. "Here’s what we agreed to regarding how to run the program, how to make decisions, how to benchmark, how to look at opportunities. This document controls how we think about and process investment ideas. So when you’re in the storms of a choppy market, you’re not tempted to look at things that are going to take you off course. Or in a bullish market, you are not tempted to chase the bright, shiny things that can distract people from pursuing a long-term strategy. 

Trusted Insight: What have I failed to ask that I should know about you in general?

Charles Kennedy: Going from being an investment banker to playing the role of a professor to working at an endowment has been a terrific experience. 

On the one hand, I was in the deal flow and working on transactions as an investment banker on what are the most important transactions of a corporation’s life. 

On the other end of the spectrum, I am working with students who question the basic tenants of fixed income versus equity. You help people build themselves up, and you say here’s how it works. And as a professor I got to work with research-oriented faculty members who don’t take anything for a given. 

Investment bankers are known for being more off-the-cuff and trying to move things quickly to get a deal done. Academics are known for not taking anything as assumed and making sure what they are saying is based in foundation and sound theory and empirical data. 

For me, both platforms provided valuable experiences for applying those diverse skills to the endowment and work with brilliant individuals, including the trustees, the senior administrators, the staff and with the third parties such as the investment managers. I am grateful for the opportunity to work with talented folks who are creating a lot of value in a lot of companies. The students and faculty get the benefit of that.

Trusted Insight: When you encounter a tough investment decision do those two sides -- the empirical professor and the off-the-cuff banker -- battle each other, or is that where the endowment governance comes to play?

Charles Kennedy: I like that question. We live in a practical world with deadlines and issues we are facing on a regular basis, so you you can’t question equity everyday in the office and build a proof of why equity will beat fixed income over long periods of time. You have to get on with your work. 

I think it’s terrific to be exposed to both and understand the positives and negatives of both and to take the best of both worlds to accomplish what you need to accomplish. Whether it’s acting as an investment banker and explaining risks and upside to people, or whether it’s being on the academic side and discussing why there are merits in equity.  The point is the team brings its skills together to hopefully be terrific stewards of the capital for the university today and in the future. 

To learn more about the top-tier institutional investors, check out Trusted Insight's list of Top 30 Ivy League Graduate Chief Investment Officers - Part 1.