Barcus started his career as an accountant but soon found himself more fascinated by the problem-solving challenges found in finance. Before joining Denison University in 2013, He was the vice president of hedge fund manager selection at Amundi Alternative Investment, Inc, a French asset management firm with offices globally. Barcus received an MBA from DePaul University and a B.S. in accounting from Miami University.
In this interview, you will learn:
Why a medium-size university endowment is in the “sweet spot” of investing.
How Denison’s investment office chooses managers and builds long-term relationships with them.
The biggest challenge facing university endowments in today’s market.
How fintech will affect human jobs at investment offices and change institutional investing as a whole.
The following interview has been condensed and edited for clarity.
Trusted Insight: How did you get involved in institutional investing?
David Barcus: My first job out of college was as a fund accountant for an asset management company. I enjoyed certain aspects of that role, but I quickly decided that I was more interested in the decision-making process that drove the investment performance of the fund. I put my head down, trying to work hard as an accountant during the day and to gain the skills needed to be an effective investment analyst at night. After I completed the CPA exam for my accounting role, I earned an MBA and then completed the Chartered Financial Analyst program. Eventually that hard work was noticed, and I was given the opportunity to move from the back office to the front office.
Trusted Insight: How does managing investments for an asset management firm and for a university endowment differ?
David Barcus: Prior to joining Denison about five years ago, I spent 13 years at Amundi Asset Management. My job was based in Chicago. I worked in the Alternative Investment Group. Our core product offering were fund of hedge funds. After I transitioned from the accounting to the investing side of things, my role was in hedge fund manager selection for North America.
Our client base was almost exclusively institutional investors, primarily insurance companies, pensions and banks. Investor classes that had different return objectives than the norm for a university endowment. Those investors were primarily coming to us for exposure that was less correlated with the broader market and lower volatility in nature.
Another key difference is team. When I first started at Amundi, I was perhaps the fifth or sixth employee in the Chicago office in the alternative business. Over time, the team grew to be in excess of 100 people, with about 40 on the investment team. In the move to Denison, I moved back to a smaller team, which has been very refreshing. You have to wear a lot of hats here, but you also have a lot more influence on the overall portfolio.
Trusted Insight: Tell me about your team at Denison and your decision-making process.
David Barcus: Currently the team has six people -- four, including myself, on the investing side and two focusing on operations. In terms of the decision making process, our board of trustees sets our asset allocation targets, but gives us in the investment office full discretion for manager selection. For the most part, we are taking a team approach to investing the assets, and we operate as generalists with respect to asset class responsibilities. For example, I'm not only looking at credit managers and hedge fund managers, but I am also looking at private equity, real estate, the whole gamut of asset classes. That's the same for all others on the investment team.
This set up allows us to leverage the knowledge that we gain from our general partners, allowing us to compare notes internally, so we can challenge what we hear from one manager to another. Ultimately, final decision-making responsibility for investments lies with our Chief Investment Officer Adele Gorrilla (read our Sept. 2015 interview with Adele Gorrilla here).
Trusted Insight: What’s the makeup of your portfolio? What assets are you investing in?
David Barcus: Right now Denison’s endowment stands at about $750 million. Our target asset allocation is 40 percent to hedge funds, 20 percent to public equities, 20 percent to private equities, 15 percent to real assets and 5 percent to cash and fixed income. We have some tolerance to go above or below those targets, but we are currently pretty close to the policy portfolio. At the margin, we are a little bit overweight in private equity and a little bit underweight in real assets.
In terms of how we invest, we try to take advantage of our size. I believe we are at a sweet spot where we are big enough to be viewed as a meaningful LP to GPs, but at the same time we are small enough to be nimble. For example, our average investment size is typically between $5 - $10 million. Some might get higher, maybe as high as $20 million over the course of a few months. But we are not like a big public pension that has to put $200 million dollars in a fund to have it make sense. We have a very broad manager universe because of that.
Also, our long-term investment horizon allows us to participate in some interesting opportunities. We try to invest the portfolio on an opportunistic basis within our asset class categories. We will invest in fairly straightforward strategies. For example, we’ll invest in U.S. public large-cap growth equities, but we'll also invest in more niche opportunities. We recently made a commitment to a fund that provides directly negotiated capital to North American energy companies. These investments are mostly credit in nature, but potentially could be across the capital structure. Another example is that we just completed a follow-on investment to a general partner that provides direct, asset-based loans to agricultural businesses. These are floating-rate loans; they are short-term in nature and typically have an average tenure of around 270 days. They help farmers finance their businesses from the planting of their crops all the way through harvest.
I think both of these examples are funds that don't neatly fit into any particular asset class, but our setup has the flexibility to allow us to take advantage of those opportunities. Those are also examples of investors like us, GPs and LPs filling the void left by banks that have pulled back from risky assets.
Trusted Insight: You mentioned the endowment has a 40 percent allocation in hedge funds. That seems aggressively high, given the poor performance of hedge funds in recent years.
David Barcus: Hedge funds have served the Denison endowment well. The investment committee, a subset of the board responsible for the oversight of the endowment, have typically been industry participants in one way or another. Some have worked in hedge funds and some in private equity. They were early adopters in the hedge fund space. The endowment made its first allocation to hedge funds in 1988. So it's a pretty long-lived portfolio. When Adele (the CIO) joined in 2008, the investment office took over the manager selection responsibilities. The allocation to hedge funds have more or less remained constant since then with no near-term plans to change the target.
While there has been some negative press on hedge funds and certain investors have pulled back, I personally remain a believer in hedge funds. I think calling hedge funds an asset class can be a misnomer, as they are often just investment vehicles gaining exposure to more traditional asset classes. That said, within the space manager selection is absolutely crucial.
According to a study by BlackRock from a few years back, manager selection, as opposed to style selection, within hedge funds really drives performance. For example, performance dispersion between top and bottom quartile hedge funds is not reigned in when you focus on a particular strategy. Put another way, the amount of dispersion across all hedge funds in the universe is essentially the same as the amount of dispersion between funds in a particular strategy, like long/short equity or global macro.
However, when you take the same example looking at actively managed equity mutual funds, performance dispersion is essentially halved when you compare the amount of dispersion between all funds versus the amount of dispersion between funds within a particular investment style, like large-cap growth equity funds or small-cap value funds.
I think the message here is that the majority of dispersion in hedge funds return is driven by manager-related risks as opposed to strategy-related risks. It's vital to understand the underlying exposures within the funds and the factor risks the manager is taking. At Denison, we build our hedge fund portfolio from the bottom up, manager by manager. We're not targeting to put X percent in long-short equity managers, or X percent in global macro, or X percent in event-driven. That said, we will occasionally invest in a fund to take advantage of a particularly interesting opportunity. For example, we added a dedicated merger arbitrage manager at the start of the year to try to take advantage of what we viewed as significantly attractive merger arbitrage spreads.
I think another pitfall that some institutional investors have faced in the space is that they are only looking at market-neutral or strategies uncorrelated to equity markets for their hedge fund portfolios. As a result, they might be overlooking fantastic alpha generators. For example, we have a manager who invests primarily in equities -- it's 110 percent long and 10 percent short. That profile might be a non-starter for certain investors, but in this case that particular manager generates exceptional absolute returns and alpha. There's volatility, but even the risk-adjusted returns are fantastic. It's a fund that you want in your portfolio somewhere. Our asset allocation is flexible by design, and if we like the strategy and the manager, we can find a place for it somewhere.
One last point on hedge funds, I think their fee structure is also a big sticking point for some investors. I can appreciate that concern. I would certainly have a hard time stomaching a “3-and-30” fee structure that some funds were able to command in the past. Ultimately I think we are “net of fee investors.” If the net returns are attractive, and the manager is charging “2-and-20,” we won’t rule it out.
Trusted Insight: What is your strategy in finding the best managers? Do you think the endowment’s relatively small size ($750 million) hinders the access to top-tier managers?
David Barcus: I don't think our size hurts us. I don't think we would necessarily be better-off being above one billion. I think many fund managers view a university endowment such as ours as an attractive LP. We aren’t a fund of funds, so we don't have to deal with the challenges of underlying investors who could pull their capital. We also aren't a big public pension plan, and we don’t have to face the same level of reporting requirements that they have to deal with. We have a very long-lived liability base, so we can invest with a manager for a really long time. When I made the example of the endowment making its first hedge fund investment in 1988, that investment is still in our portfolio today, which is amazing. I think we are considered an attractive investor because we have those qualities.
In terms of what we are looking for in fund managers, I always look for managers who can demonstrate their edge in the strategy. For some, this can be driven by their investment process: do they have a very process-oriented approach? Does this process create a repeatable strategy? Other times this could come from their background: where did they learn the ropes? For example, if they're investing in healthcare, were they previously medical doctors? Do they have that expertise? Or if they are investing in distress, do they have a legal background?
It's also important to be mindful of the managers’ lifecycle. In certain cases, it's great to be with a growing manager, one who is eager to create wealth. In other cases, it's not so bad to have an investment with a very established manager especially in a strategy where capital preservation is the focus. A proper alignment of interest is key. But ultimately, I think the most important quality in a fund manager is their integrity and the relationship and trust that we can develop with them. Are we treated like a partner? Or are we treated like a client, another revenue stream? We're really looking to be a partner with these investors, hopefully for a very long time.
Trusted Insight: Some investors predict that robo-advisors will replace human jobs in the future. What are your thoughts on the changes technology will bring to finance?
David Barcus: I think incorporating technology into the investment process is something that we should all be doing. Ultimately our job is to make informed decisions. We are trying to incorporate technology to allow us to gather more and more information and distill it to help us make our investment decisions. For example, we are beta-testing an information management system that will use email and news filters to help us focus on what is most important. However, I think ultimately some qualitative judgment is necessary, like judging the character of a manager. I think this is especially true for a complex portfolio like ours.
In my opinion, there are certain areas of investing that I think are going take a long time before technology can replace humans. Distressed investing is an example, because you have to interpret legal documents and participate in creditor committees. I would imagine we're a long way from artificial intelligence being competent in these functions. Venture capital is a tricky one as well.
That said, technology in finance makes sense for certain investors, particularly retail and certain fee-sensitive investors. I think there's something to be said for taking a very logical approach to investing and removing emotion from the decision-making process. Through that I think investors can get a well diversified portfolio at a reasonable price.
Trusted Insight: Overall, what do you think are the most challenging aspects of managing a university endowment?
David Barcus: It's really tough hitting our target rate of return in this low-interest rate environment. But we aren't alone in this regard. All investors are facing these same challenges.
Our current spending policy warrants that we distribute about five percent annually to the operating budget of the university. This distribution is a meaningful percentage of the university's annual budget, so that's something we don't take lightly. Ideally we're aiming to replace this percent percent plus match the inflation rate, and hopefully beyond that add 1 percent to the total endowment over time. All of that results in a target rate of return in the very high single digits. This is extremely daunting in an environment of 10-year treasury yields below 1.5 percent. We are also at an era of negative yields. I read in the newspaper a couple of days ago that there are $10 trillion dollars of debt trading at negative yields, and only $35 trillion trading at positive yields. That's staggering.
Trusted Insight: What would you do if you weren't working in your current job?
David Barcus: I am very grateful for how much I enjoy my job. It's always great to wake up in the morning and look forward to going to work. Maybe another thing that I have the same level of passion for is cooking. I enjoy cooking and preparing meals for my family and friends. In another life, I could see myself running a small restaurant.
Trusted Insight: That sounds awesome. Back to investment. What career advice would you give to aspiring institutional investors out there?
David Barcus: Be curious and never stop learning. Read the news every day and travel as much as possible. See the world and use that as context for your career and your decisions going forward.
To learn more about credit investing, view the full list of Top 30 LPs Investing In Credit.