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Exclusive Q&A: Stuart Mason, CIO, University Of Minnesota

by trusted insight posted 3years ago 10852 views
Stuart Mason is the associate vice president and chief investment officer at the University of Minnesota, which has $2.5 billion in assets under management including an endowment totaling $1.3 billion. Mason is also the portfolio manager for the endowment’s venture capital allocation.

Previously, Mason spent 15 years as a senior investment banker or executive officer in several investment banks including Dougherty & Company, EVERERN Securities and Dain Rauscher Corporation. He also served for 10 years as a vice president of Wells Fargo Corporation. Mason holds an MBA from the University of Minnesota and a B.A. in chemistry and biology from St. Olaf College.

Mr. Mason was recently named the #1 chief investment officer on Trusted Insight’s ranked list of the Top 30 Endowment Chief Investment Officers. He graciously spoke with Trusted Insight on March 8, 2016.



Trusted Insight: Your portfolio, and that of many other endowments, to some degree follow the model that David Swenson is often praised for. Does that ubiquity create a herd mentality? If so, how do you differentiate yourself from the crowd?

Stuart Mason: At a very high level, the Yale model, if you will, says “use private investment vehicles to gain more portfolio diversification,” and capture the benefit from the illiquidity premium to produce higher long-term returns. To that extent, the devil is in the details. The details that matter are how large is the allocation to private markets that makes sense for your specific portfolio, and what kind of private investments are you able to professionally execute.

Often our $10 million commitment, for example, to a private fund is meaningful to the fund manager, and if they actually do well, it can be meaningful to us. It “moves the needle.”
For smaller endowments, generally speaking, those with a few hundred million dollars, it's not working very well. Part of the reason is that it's not working is the allocations to private alternatives are relatively modest, and investment offices of those under $1 billion often don't have the depth in their staff to invest directly with managers, or often don't have the ability to gain access to the very best managers. So they resort to using fund-of- funds that are top heavy on fees. No surprise, the results are often disappointing. If one invests 10% or 15% in a fund-of- funds, it’s difficult to see how that becomes a successful strategy.

If the endowment is large enough to support a professional staff with depth and expertise, which typically can happen over $1 billion the game changes. At the University our strategy has been to have nearly 50% in private fund structures, do it all direct and really underwrite very aggressively a variety of private investments where the expectation is high for added value.

Given our size, we can make commitments to smaller funds in almost any asset class. Often our $10 million commitment, for example, to a private fund is meaningful to the fund manager, and if they actually do well, it can be meaningful to us. It “moves the needle.”
 
There's a lot of research that suggests smaller funds do better than larger funds in virtually every asset class. That’s one reason we seek out funds that are $100 million or $250 million, and we generally avoid funds that are $2 billion or $10 billion. We don't do those because it's virtually impossible in our mind to get a three-times-your-money back on a $10 billion fund, like some of the mega private equity funds.

If you're a venture fund raising $100 and you execute the strategy with success, then it only takes one investment to return the fund or return a multiple of the fund. While our strategy differs somewhat for each of the asset classes, across the board, you could say that we seek niche opportunities that are often addressed by smaller fund managers. Our expectation is when we do the underwriting of each of these, that we are underwriting with an expectation of some return that is, almost always, significantly higher than just the mean for that asset class.

Trusted Insight: What do you look for when you're looking to invest a new manager?

Stuart Mason: I've described at least a portion of our strategy as small and niche, which in our minds does not always translate to new managers. While we have done some first time funds that have GPs that we have known for some time and have confidence in or have invested previously with, we would much prefer to invest in a fund that is sized appropriately for the opportunity, and with a manager that has a history and has sponsored funds before.

What do we look for? We basically look for the same thing in every private fund manager: a meaningful enough history of consistently addressing an asset class that we have determined is an attractive market. In venture, for example, a vast majority of our investments are with managers who are addressing big data analytics, enterprise moving to mobile platforms, consumer marketplace solutions, SaaS services and AI or machine learning. If it isn't in these sectors, we probably aren't interested. That narrows the field.

With those criteria, we’ve narrowed the field to a relatively modest number of fund managers who are 30 or 40 something years old, who have been doing this long enough to have developed a reference network in an industry segment and an investment record that indicates success. We have selected these industry segments, and we prioritize the kind of manager or teams that we want to invest in because we think there is a persistent longer-term opportunity to big data analytics and AI, etc. This isn’t a new idea, but there's a lot of innovation in this technology sector. If you can pick a couple of funds that do that well, they may have a tailwind for a decade.

We don't feel the same comfort level with our understanding of biotech, so we don't do much biotech, even though some investors have done quite well. For another example, we don't think consumer products -- dating websites, games, grocery shopping and things like that -- are persistent trends with clear market differentiators. Some of them are going to turn out to be just great, but hundreds of them are likely to do poorly. So we’re not interested in those market segments.

We go through a thematic approach to narrow the scope for each of the asset classes. So our approach is the same for value added or opportunistic real estate, commodities investments and distressed credit investments.
 
The fixed income that we do have, is in what we refer to as “return generating fixed income.” It is idiosyncratic, niche-y and often takes advantage of themes such as “going where the banks no longer go.”
In private equity for example, we don't do mega-fund private equity where financial engineering plays a big role in return generation. We have in the past, however, we learned that higher levels of leverage can work against you in periods of stressed market conditions. So we’ve refined our strategy in private equity so that we are presently looking at lower mid-market, with certain market cap limits and certain technology or service-related industry segments. It's made it easier to recognize a manager that fits those criteria when we see it. 

Our normal due diligence process is fairly straight forward, extensive underwriting. We try to look at every deal a manager has done. We talk to many of the CEO’s of deals that have gone well and those that have done poorly. We try to figure out why some deals worked and others didn't. We spend a lot of time, and that's where having a professional staff, who really knows how to dig deeply, is critical to making any private investment and why funds that are much smaller, say $400 or $500 million dollars, with a staff of only one or two individuals, generally can't hope to make private investments other than through a fund-of-funds vehicle.

Trusted Insight: The past decade has been a time of unprecedented government intervention in the global economy -- quantitative easing, ultra-low interest rates, negative interest rates. How do you plan and strategize from a long-term perspective in an environment that is frankly unpredictable?

Stuart Mason: Well I think the QE in whatever form it has taken in various developed economies around the globe has inflated asset prices, generally speaking. Stocks, real estate, lots of different examples you could point to where zero interest rates make those assets more expensive. We have, in general, tried to reduce our exposure to those assets that appear to have inflated value because of cheap money strategies around the globe for the past decade.

We have no traditional fixed income for example. No Barclays Agg portfolio, in part because credit spreads are so tight, yield versus the credit risk is low. The fixed income that we do have, is in what we refer to as “return generating fixed income.” It is idiosyncratic, niche-y and often takes advantage of themes such as “going where the banks no longer go.” All this regulation you referred to means the capital requirements for banks no longer allow them to do this certain kind of subprime lending or certain types of non-investment grade corporate lending. That creates opportunities to create higher yielding portfolios with a managed risk profile. Banks have also largely exited the real estate lending business, which creates other opportunities.
 
Capital being provided to some of these niches has completely evaporated or gone to shadow banking systems in some fashion. Our fixed income book, in total, is half or two-thirds in go-where-banks-don't-go strategies that we underwrite to low-mid teens return targets. This higher yielding portfolio is offset by a smaller slice of TIPS and short-term U.S. Treasuries. This reflects our view that the whole middle section of the fixed income markets is not a productive place to be. As I mentioned, that segment of the market is bearing risks and not getting paid for it. 

Trusted Insight: What sets the University of Minnesota Investment Office apart from your peers?

Stuart Mason: First of all, we view our peers as other major educational institutions and some foundations with portfolios anywhere from $1 billion to $5 or $6 billion dollars and a long-term investment horizon.

What distinguishes us from them is that because we are on the smaller end of that spectrum, we can take advantage of smaller, niche managers. An institution that is $5 billion or $10 billion can't write a check or make a commitment for $5 million to a $50 million private equity or venture fund, for example. That size investment just doesn’t merit their time and effort for the contribution it might make. While that's not our bread and butter, we have a several of those where we committed $5 or $10 million to smaller funds, and, as we have discussed, where our expectation is for potential out-sized returns. 

Secondly, I think we have exceptional skill in private investment capabilities amongst the six of us on staff here. While we may not have the largest staff, there's a lot of our peers that have fewer people dedicated to the private book, and they struggle to manage a portfolio that's any more than 20% or 30% private, where as we are nearly 50%. Four or five of us spend most of our time dedicated to the private investments, and we leave the publically traded equity portion of the book largely to low maintenance index funds. We just don't have time or bandwidth to try to pick public stock managers, where if we succeed, we earn an extra 50-100 basis points. If we want to underwrite a private equity fund, we may get an extra 500 basis points or 1,000 basis points. I think a focused, exceptional staff, working really hard most of the time on private investments, is a somewhat different model. 

Thirdly, an important factor to success is a governance structure that has within it a very skilled, committed and engaged investment committee. There are eight members on our investment committee. We meet formally on a quarterly basis. We often also have telephonic meetings in between the quarters. All members are professional investors themselves in their day jobs, and they all are really committed to helping us build and manage a pretty complex portfolio. I think their engagement and their commitment really extends our ability to make good asset allocation decisions and keeps the bar high on our underwriting strategies.

Trusted Insight: Tell me about how you structured the investment team.

Stuart Mason: There are five other investment professionals in addition to myself. That would include a range of experience from a three-year analyst level position to a couple of the senior PMs with more than 15 years. 

We each wear several hats. I'll start with myself. I have overall responsibility as the CIO for not only the endowment portfolio, but for the other $1.2 billion in financial assets that the university has in a variety of other reserve pools: a working capital pool, the insurance reserve pool, the long-term capital savings account pool, etc. I have a broad responsibility for all those things, and I am also the portfolio manager for the venture capital sleeve in the endowment. So I have specific managers that I am the primary account person for.

One of my colleagues has the title of Senior Director of Investment Strategy and Research and he also has broad portfolio responsibilities. He oversees the analytical work and the fundamental research that we do. He also serves as the private equity and return-generating fixed income portfolio manager. We have two co-portfolio managers who are part of the real assets team – that being real estate, mining, commodities and infrastructure; and one portfolio manager who is essentially responsible for all other fixed income and hedge funds in the endowment. Because all of the other assets that we have, the additional billion dollars or so are fixed income portfolios, he works part time on the endowment and part time on all other fixed income. In addition, there's an senior analyst, who's a generalist and supports all of the investment activities.

Trusted Insight: What is the key to success for an endowment CIO?  

Stuart Mason: It is my view that we all operate in very dynamic capital markets. They're constantly changing. They're fluid. The opportunity to really add incremental value changes regularly. One of the most important factors is managing risk. It is critical to understand what kinds of risk are imbedded in every investment we make, and how those risks are correlated across the portfolio. Without that understanding, it’s impossible to properly evaluate any new, incremental investment. After that, I think being constantly open to change, being open to new ideas is critically important. History has produced many examples where early adopters have reaped the greatest benefit. Of course new ideas or trends need to be properly vetted, but I can think of examples of timber in the 1990s, technology venture in the past decade, re-insurance and many others.

While we don't all invest in everything, obviously, I think you have to be open to change and aggressively seek new ideas and new platforms because opportunity can often get arbitraged away. If you decide, five years from now, to invest in reinsurance for example, you're likely to be too late. Same as if you decide to invest in discounted mortgage bonds in 2009, you made a killing. If you waited until 2013, the opportunity was not so good.

You also have to have a governance structure that gives you flexibility. You have to have the internal skills to be able to evaluate opportunities, and to determine if it fits in your portfolio and adds incrementally to meeting the objectives that your endowment has established. Every one of us has a different set of objectives. What works for us may work for one of my peers just down the street.

Trusted Insight: What trends have you identified that are shaping endowment investing?

Stuart Mason: Well that's kind of a hard question. Diversification is kind of a fundamental trend that over the last couple of decades has created the engine for the complexity that has emerged in the capital markets. Just repackaging institutional forms of securities or investment opportunities into institutional quality investment opportunities has been a trend.
 
When Harvard first invested in timber in the late 90s, they had an early advantage because they identified an attractive asset class, and they could invest directly. By the mid 2000s, there were timber funds that were of institutional quality that gave everybody a chance, if you wanted to, to invest in timberlands. I think the packaging of various investment opportunities into institutional quality vehicles, gives us all a chance to invest in something new or different, where there might be opportunity. That's clearly a persistent trend. Think of all of the structured finance vehicles that are examples.

The interesting things to migrate toward are found in other geographies, in many cases. Nearly half of our portfolio, for example, is outside the United States.
There are specific industry or specific asset class trends, as I was alluding to earlier, that we incorporate as thematic investment strategies: Go where the banks aren’t, or in technology venture, or perhaps elements of distress credit. 

I think unconstrained fixed-income investing has been a trend that all of us have embraced in some form or another over the last few years. It used to be we all had exposure to the PIMCO or the TCW Total Return Bond Fund, investment grade bonds. Many endowments have broadened their fixed income strategies and moved away from the Barclays Agg benchmark to something much more customized.

I think the trend has been toward niche, segmented investment strategies within asset classes. We've considered that in virtually every asset class. We've narrowed the focus in what we do in real estate for example. We don't have any core real estate anymore; we invest in segments in the value-add or opportunistic sectors.
 
When we go into a different country like China, we have a very narrowly prescribed set of trends that we think are current opportunities in China. We would try to find managers who are investing in those. For example, there are more consumer-service related venture and private equity opportunities that we would purse in China, mostly in the private markets. There are certain niches in real estate in China, or in Asia generally, that we think are currently attractive. In Brazil or India, we'd have a different strategy in those geographies.
 
Maybe the broader answer to your question is: almost everyone has focused more narrowly on the themes that they can execute on, and have conviction in, that they believe will drive acceptable returns. Another example in our portfolio is that we don't have broad EM exposure. We have more focused strategies in each of the larger regions, more focused strategies in India or LatAm or SE Asia, rather than just some mandate for broad emerging markets.

Trusted Insight: What’s the number one rule you have learned in your career as an institutional investor?

Stuart Mason: To be successful in the job, you really need to be open, flexible and aggressively pursue newer opportunities or niche opportunities before the opportunity gets arbitraged or reduced to something that's much less interesting. There’s lots of good data available these days, dig deep and gain conviction, then find appropriate strategies.

I think traveling globally early in one's career to gain perspective beyond the borders of U.S. investing is also important. Spend time in China, India and Brazil. These are booming economies where you are going to encounter really interesting investment opportunities. You need to understand what's going on the ground sooner rather than later if you're going to be able to diversify the portfolio beyond the borders of just a Russell 3,000 Index Fund. 

Russell 3000 70%, Barclay's Agg 30% is the starting point that everybody migrates away from. The interesting things to migrate toward are found in other geographies, in many cases. Nearly half of our portfolio, for example, is outside the United States.

Trusted Insight: What have I failed to ask that I should know about you, about the endowment, about being a CIO, or about the institutional investing, in general?

Stuart Mason: The long-term investment perspective, the intergenerational investment perspective, opens up a lot of opportunities that are different from those appropriate for pension funds and some other pools of capital. It can also be very different from some foundations or family offices. It really gives one the opportunity, if done wisely, to do more in the illiquid investment spaces. It also allows us the opportunity to selectively absorb higher levels of volatility.
 
For me, that translates to very limited use of hedge funds as an example. I think hedge funds dampen volatility, but in doing so, often don’t yield much return. If you're less concerned about some volatility, invest in private equity or distressed debt or things where there are real opportunities to make money over a longer time horizon. While we have a little bit of hedge fund exposure, we have much less hedge funds than many of our peers, because we think we can afford to absorb some volatility. If we have underwritten things well and they fit thematically and everything else, then we should be rewarded over a longer period. Maybe it's by luck or good fortune, but that seems to have played out well for us. The Yales, Stanfords, MITs or Notre Dames of the world that are famous for great long-term returns have all done that. That differentiates endowments from others. Knowing how to use those tools prudently is a critical element of being successful as a CIO of an endowment. There are different requirements for a pension fund, where asset liability is of utmost importance, and liquidity is also at a premium.

To learn more about the the Top 30 Endowment Chief Investment Officers, click here.