Sam Gallo is the chief investment officer at University System of Maryland Foundation, where he is responsible for the investment portfolio totaling more than $1.2 billion. Previously, Gallo served as a senior official with PricewaterhouseCoopers and Ennis Knupp & Associates. He holds an MBA from the University of Chicago Booth School of Business and BAS in accounting and finance from the University of Illinois. Gallo is president of the CAIA Washington, D.C., a chapter of CAIA Association. He is also investment committee chairman and a board member of the Bender Jewish Community Center of Greater Washington.
This interview is split into three parts. In today's article, Gallo discusses the value in a background of varied work experiences and why the first step in leading a world-class institutional investment program is developing strong governance. Check back next week for the second installment of Trusted Insight's discussion with Gallo.
He was recently named on Trusted Insight's Top 30 Endowment Chief Investment Officers. He graciously spoke with Trusted Insight on Feb. 13, 2017. The following interview has been edited and condensed.
Trusted Insight: Prior to joining the University System of Maryland Foundation, you developed a consulting practice at PwC assisting institutional investors and investment managers, then you moved into asset management. How has that experience influenced your approach toward endowment investing?
Sam Gallo: Well, I actually started my career in asset management, as I was a trader/portfolio manager at a proprietary trading firm in Chicago. After a successful career managing a large book of capital and being responsible for generating daily and long-term profit, I wanted to get into the business of investing in people like myself, but for institutional programs. I joined an investment consulting firm where I was conducting hedge fund manager research and helping large pensions incorporate alternative investments into their programs. My first assignment was to meet with the top 250 largest hedge fund of funds, to understand their processes and systems, and find the commonalities of amazing programs. I did a lot of other things while being an institutional investment consultant, but the initial research assignment of covering the fund of funds industry was an amazing experience, of which I watched, listened and took careful notes. I was able to see the differences between good and not so good processes, and how a great process translated into better investment performance and risk management.
It was that perspective that then led me to PwC to consult both asset allocators (i.e., pensions and endowments/foundations) and investment managers on how to become more effective and efficient, helping them build an environment of best practices. After advising a number of prominent plans, the opportunity opened up to join the University System of Maryland Foundation as its chief investment officer. It was the perfect job, as it brought everything I previously did in my career together – managing an internal portfolio of risk assets, working strategically and tactically with boards of directors/trustees, and building operational and investment processes for large institutional programs.
It is that well-roundedness and broad perspective that has shaped my approach toward endowment investing. To be a great institutional investor, you must understand markets and investment strategies well, but you also must understand the constraints and the boundaries of an institutional program. After all, one can be an amazing investor, yet horrible CIO if the processes are not built to get ideas executed efficiently within the portfolio. Having a dynamic and systematic process is incredibly beneficial to running an investment office, and being able to take action within the portfolio.
At PwC, I was advising investment offices around the globe on how to become more efficient and effective at their tasks. It was really a fantastic entryway into seeing the challenges of other investment offices and helping them fully optimize and utilize their competitive advantages. I guess you could say, in this role, I was an operational/management consultant, building a business within a larger organization. It seemed the perfect complement to my past roles.
As I reflect on my approach to endowment investing, the first step in leading a world-class institutional investment program is developing strong foundations around governance and defining processes. So how did PwC help? Well, I was guided toward defining the rules of engagement up front, so that day-to-day tasks can transpire fluidly and flexibly.
When I joined the University System of Maryland Foundation, the first thing I worked on with our board, investment committee, back-office business office and staff was further strengthening our already strong governance related to our investment processes. While this involved many steps, the two most notable were: (1) improving the time it took to make decisions and (2) segmenting out the people necessary to make critical specific decisions.
Similar to most institutional programs that maintain a diverse portfolio of investments in externally hired investment managers (a.k.a., a manager of managers program), Maryland is an investment committee/staff model – staff scours the globe for investment opportunities and makes recommendations to our investment committee that approves and/or rejects our suggestions. Should it receive approval to transact, staff then executes and monitors the investments. The exception in our model is that staff is granted bounded discretion in making some strategic and tactical calls within our passive securities. However, for this to work, another set of policies must be firmly established.
The issue that most programs face is that investment decisions are made primarily at their scheduled quarterly meetings. However, markets do not care about when boards/committees meet, as markets will change instantaneously and our external investment managers will need to act irrespective of our meeting date. As will our staff too, if we are to manage risk exposures when working with our passive securities. Basically, we needed a way to move quickly, adapting to markets and not vice versa. Hence, we moved from the traditional governance process of making decisions on a quarterly basis toward a model that brings forward action on a near real-time basis. We still meet with our committee several times a year to discuss performance, investment strategy and assess risk. However, the work related to specific investment action occurs all throughout the quarter via conference calls and electronic communications, allowing for absolute nimbleness.
To accomplish the speed we needed, we reorganized how our investment committee would work with our staff. We built processes with flexible features so that we could transact on any given day and do a number of different things. While quantity does not mean anything in the world of investing, as it is the quality that matters, we can get a lot of things done shifting from timing being against us, to timing being on our side. We have done an astounding job over the last five years. For example, we have executed over 150 investment actions, which have all helped shape the portfolio in one way or another for the better. It has been some long days at the office, but the results are amazingly positive. We are outperforming the vast majority of our nearly 20-plus benchmarks on a short-, intermediate- and long-term basis – all of which started with process enhancements.
Trusted Insight: Can you discuss the “nimble and flexible” features in more detail?
Sam Gallo: Sure. We recognized that specialization is critical in understanding the nuances of our investments. Therefore, we divided our 13-member investment committee into subgroups, each of which is responsible for the oversight of a particular asset class. Two or three people sit on these subgroups. For example, we maintain subgroups in public equity, liquid credit, real asset, private equity and several others. The people who are assigned to that subgroup are industry experts, as this is what they do very successfully in their day job. It becomes very obvious that those that sit on the investment committee at the University System of Maryland Foundation are skillful practitioners.
When our team recommends an investment proposal, we go to the asset class subgroup first. We talk with our subgroup members about the merits and risks of the proposal, making it an extremely collaborative effort. Usually, by the end of the discussion, we have an answer. If it is an approval, the rest of the investment committee is given notice with three days to vocalize thoughts/comments, after which we execute the investment. This cut our execution time from three months at the quarterly investment committee meeting (maybe six months if an agenda item rolls to the next investment committee meeting), to three days. Since we can talk with our subgroup at any point during the year, we do not have to wait for a physical quarterly meeting with the broader 13-member investment committee to take action.
This is just one element (of many) of how we identified the critical decision makers for specific subjects; and thus, were able to enhance our review and execution time.
Another interesting feature we built to add depth and breadth was our incorporation of strategic advisors. I am very careful to call them strategic advisors because they do a lot more than consult. These organizations manage capital themselves and have a lot of “skin in the game.” Our team works with them very effectively so that we are not spending our time interviewing thousands of managers where maybe 99 percent of those interviews are going nowhere. Our strategic partners are asset managers who know the space very well. They cover a lot of external asset managers themselves. They help us really whittle down the investment universe. So, our research is targeted to evaluating the best of the best investment managers and vehicles.
For example, if we want to know the top five distressed debt funds in the market, our strategic partners work with our team to identify those for us. They share their notes, analysts and risk systems with us, and of course we do our own due diligence. At the end of the day, when we walk into a due diligence session with a manager, we are not walking in and asking questions like, "How many people do you have on staff? What is your AUM?" We are saying, "You know what? We have read 10 years of notes on your organization from others who have conducted due diligence on your organization. We know that you traded X, Y and Z four years ago. These were the three PMs that were working on it, and it did not exactly work out all that well. We know that you have the same trade on now, years later with the same PMs running this position. Tell us why this time, the investment is back in the portfolio, and why you believe it has a probability of being successful on the second go around.” As you can imagine, mouths sometimes drop when that is the first question in an onsite diligence session.
This type of preparedness really drives a lot of industry respect for the Maryland program, because we do our homework and it shows. People see that we know quite a bit about their programs before we even walk in the door. So, having these strategic relationships gives us a thousand times more effective data points toward targeted organizations that are of interest.
This approach makes our program that much more intellectually stimulating and challenging for our staff, when evaluating investment opportunities. Meaning, when you are dealing with the best of the best, and you are not spending your time on second-, third-, and fourth- quartile ideas, managers and/or securities, any one of what we are looking at could do what we need it to do. You really have to dig into the nuances of each one of the opportunities that we are evaluating, and it forces our team to better understand the things we own and the things we are rejecting.
Lastly, this approach allowed me to build an army of skillful professionals around our program. Between our brilliant investment committee members, fantastic staff and skillful strategic advisors, more than 300-plus people can be touching aspects of the Maryland portfolio on any given day. This is in contrast to my first day on the job five years ago, when there were a lot less resources. Today, we are a well-oiled machine, with a robust architecture in how we operate. Maryland has redefined how to extract rich data from many sources.
This all starts with governance and process. Having a very efficient process is a lifesaver, in a world where you are operating as a small team, and you are resource constrained to some degree. By having flexibility to get approvals done quickly, having strategic partners that assist your team and as unofficial members of your staff, you can cover a lot of ground. This makes it very cost effective, efficient and really shapes the portfolio in a very productive way.
Trusted Insight: How you go about selecting those subgroup members?
Sam Gallo: We prefer that they have some connection to our schools. Remember, we are a system foundation with 22 schools. This includes the University of Maryland College Park, University of Maryland Baltimore, as well as other organizations like Frostburg State University, Towson University and many other wonderful higher education universities, colleges, community colleges and scholarship-providing clubs within the State of Maryland.
There are a handful of these system foundations in our country, and one of the benefits is an amazing pool of bright, wonderful and successful alumni who are practitioners in asset management. We do not just get to choose from one, we can pull people from several different sources. That is really a unique advantage of an institution like ours. We like to see that people are coming from one of our schools, showing representation and commitment to the organization that helped give them their start in the industry. The vast majority of them are alumni of one of the 22 schools. They have done something extraordinary in the world of asset management, and bringing that skill and expertise to our program is an amazing benefit. It is a wonderful way to source talented people, when you have a large opportunity set to pull from.
Trusted Insight: What are the constraints for the University System of Maryland Foundation?
Sam Gallo: A constraint of any program, of similar size and scale to us, is having enough talented people to source, conduct due diligence and monitor investments. We address that issue by having built an army of resources around our investment team. Basically, everything I said prior.
Trusted Insight: What makes USMF unique in comparison to your peers?
Sam Gallo: There are many differentiating features of our program. Central to everything, we are a system, whose governance structure of being able to pull wonderful alums from many different places is a unique advantage. In similar respect, in pooling assets across a broader system of schools, this gives us greater size, scale and relevance within the marketplace.
Also, I think our investment committee is excellent. Some CIOs may fear their investment committee or see them as advisories, which is unfortunate. I see the members of my investment committee as my partners, as they are a great group of super smart people. They are extremely experienced and genuinely have the best interest of the program at heart. I think that is a very unique thing, that they want the best for higher education in the State of Maryland. They are volunteers. We ask a lot of their time, and they provide it because they love the schools.
Additionally, I think the uniqueness of our program is our ability to be flexible and nimble and put risk management at the heart of everything we do. I know we have not even touched the surface on my thoughts related to risk management, and maybe can do so at another point, but that intense focus on controlling downside risk is a big differentiator of our program. Of course we love to see great returns, but we are not return chasers, rather great risk managers.
Also, we have well-aligned strategic partners and outside advisors who give us excellent advice and research. That is a big competitive advantage. We are not living in a vacuum, as we have really great data that comes into our office daily. We do not have a lot of noise to sift through to understand that data. That is a huge advantage.
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