Endowments & Foundations Part 1: A Basic Overview

Mod Note (Andy) - as the year comes to an end we're reposting the top discussions from 2015, this one ranks #31 and was originally posted 6/28/2015.

Endowments & Foundations Part 1: A Basic Overview

I think the most useful threads I’ve read on this site were threads from people like @BlackHat" who explained a specific industry in finance and what they do. They always helped while I was in undergrad and was trying to figure out what I wanted to do so I thought this might help some people potentially looking into the industry.

Endowments & Foundations (E&Fs) are an industry that doesn’t come up too much on this site and when I was evaluating my job offer there weren’t a lot of resources out there to help my decision. Over the next few months I’m going to post a few threads like this one that go into detail on various aspects of E&Fs and answer any questions people may have about the industry. To give you my background, I currently work as a Jr. Analyst at one of the largest E&Fs in the US. Let’s get started with a basic overview of the industry, how it works, and what a typical day is like.

What is an E&F?

E&Fs are large pools of money that benefit a specific charitable cause. Endowments benefit academic institutions and Foundations typically write grants (though some continually fund something specific like an endowment) that can benefit a wide range of causes. E&Fs will typically pay out in the range of 4-5% of AUM to each year. Payout rate varies between E&Fs but this is about the average from my experiences. So if a university has a $1B endowment, each year the university is receiving approximately $45MM from the endowment.

As I’m sure many of you know, David Swenson of Yale is considered the godfather of the industry and has a very popular book called Pioneering portfolio management that explains the endowment style of investing. Today, almost all E&Fs use some form of Swenson’s ideology. One of the most interesting things about E&Fs is that they have a perpetual life – meaning that they invest with the idea that they should last forever. No one has a longer time horizon than E&Fs and as a result they are able to invest in some really interesting ways.

Many pensions, sovereign wealth funds, and FoF try to use the E&F model of investing, but it doesn’t typically work as well for them for a few reasons. These types of funds have shorter time horizons (especially FoF because investors can pull money from them and move elsewhere) and managers like to take money from E&Fs because of the cause. My biggest surprise about working in the industry is how much managers would rather have your money over other LPs because it’s typically stickier and benefits a good cause. This is most notable in the VC space where there are certain managers that everyone wants to give money to, but they will only take so much.

The Nature of the Work

E&Fs do fund investments and co-investments. The work is divided into two main areas: alpha due diligence and beta due diligence. E&Fs are required to understand the global investment environment and give the money to the managers who are going to generate the most alpha. Understanding this is important because you can give money to the world’s greatest small cap manager who generates an alpha of 500bps, but if the S&P outperforms the Russell by 1000bps you’re in no better position than if you bought into an S&P500 index ETF. This is why both alpha and beta are important.

Our beta due diligence ranges from Private Equity vs. Public Equity vs. Fixed Income to US vs. Internationals to Brazil vs. Mexico and so on. This is obviously never 100% obtainable, but we try to understand every market in every region of the world as best as possible. I’m constantly being sent articles, books, research reports, etc. about something different that I need to read and summarize for my boss (I’ve gotten 4 since I started writing this). I sit in on a lot of fund’s investor calls just to hear what they are saying about their respective markets. Ultimately, we aggregate all the information we can from varying sources and use this to generate our own research and investment theses. At least at my shop, we don’t rely on any external parties (like consultants) to give us ideas – we come up with everything in house.

Alpha due diligence is simply manager selection. This is the part where we try to find the best investors in the world. If we think Brazilian Private Equity is the best place in the world right now (we don’t in case you’re wondering) we will then try to find the best PE manager in Brazil. The due diligence process is pretty long and can take more than a year in some cases. It involves multiple meetings with the managers and a lot of research on our part. While we do look at past performance, this isn’t always the best indicator of how we chose who to invest with. We look for trends and sound reasoning more than anything.

One of the more interesting parts of the job are manager pitches. I like these because you get to meet a lot of really interesting people and hear about some cool (and really strange) investment ideas. At the junior levels, the job is a lot of analyzing and summarizing for senior guys and as you work your way up it becomes more big picture and relationship oriented. As you get higher up there’s a lot of travel involved which can be a really interesting way to see different parts of the world.

Day in the Life

One of the things I like about this job is that I get to do a lot of different things. The work I do varies every day, but I’d consider the following to be as close to “typical” as possible.

7-715: Arrive in the office, grab a coffee, and read all the major new for the day.
830: Put together my to-do list for the day and figure out what I need to accomplish; run some things by boss before I get started.
900: Update some of our models that track market indicators. I’m responsible for distributing internal research reports to the team so it’s better to get these out earlier in the day.
1000: The guy who runs our Hedge Fund book has a conference call with our biggest HF relationship at 1030, he comes by to invite me to the call.
1030: Sit in on the manager call. There’s no need for me to be here, but I go to these just to get information. You learn a lot from listening to good managers.
1115: Back at my desk. My boss sent me a few readings he wants me to analyze and summarize. I’ll put together a high level overview and send the important information out to the team.
1200: Lunch; split 50/50 between going out of the office and eating while I work. I know a lot of people in the area so I try to get out of the office for a bit every day.
100: Work on due diligence for a manager we’re looking into. Typically involves modeling out some risk/reward scenarios and finding patterns or trends in the manager’s return or risk profile.
230: Real Estate fund we invest in is having an investor call on RE in Australia. They’re considering starting a new fund dedicated to that region so they want to educate there investors on what’s going on in the region. No one else is able to make the meeting so I’m sitting in and taking notes. After the call is over I’ll send out a summary to the team.
400: Start working on an ad hoc exposure project. My boss is interested in diving deeper on our PE portfolio and has asked me to create a model we can use for that.
530: Read through the headlines again and see if anything major occurred today.
630: Typically when I leave

Prestige, Comp, & Exit Ops

It wouldn’t be a good WSO post if I didn’t talk about prestige now would it? As you can tell from the typical day above, hours are typically in the 55-60 hour range with occasional work on the weekends. Not a 9 to 5 corporate finance gig, but definitely not IB either. Comp is surprisingly good. I think it’s pretty standard across the industry regardless of location. I’m in a pretty low CoL place and my base is almost the same as an IB Analyst.

Exit opportunities are more up-in-the-air. I constantly see people posting that FoF -> PE is almost impossible, but I don’t believe the same is true for E&Fs. We obviously don’t do the same fundamental modeling that someone in IB does, but you learn a lot about being an investor when working for an E&F and funds value that. I’ve spoken with 2 local MM PE firms, both of which said they would consider me for PE Associate roles if I wanted to go that route. At this point I’m happy working in the E&F space, but it’s good to know that there is exit potential. If I end up making this jump, I’ll let you guys know.

Conclusion

Hopefully this was a helpful introduction to the E&F industry. If you have any questions about E&Fs or suggestions for Part 2 just let me know.