Institutional Investor's Alpha Magazine - March 2009 - (Page 45) when a J.P. Morgan & Co. campus recruiter made him an offer he couldn’t refuse — a job as a junior bank officer in commercial lending and corporate finance. “I hadn’t taken one course in banking, finance or accounting,” recalls Lawler, but the recruiter called him twice — to wish him good luck before, and congratulations after, an NCAA swim meet. “I said to myself, ‘Any firm that shows this kind of interest in their people is a firm I’m interested in.’” After seven years at J.P. Morgan, Lawler moved to Columbia University as treasurer and assistant vice president of finance, then to Troy, New York, in 1985 to head up the endowment at Rensselaer Polytechnic Institute. In 1997, Richardson, former president of Johns Hopkins University in Baltimore, tapped Lawler to start up a new investment office at the Kellogg Foundation, where Richardson had recently assumed the presidency. Lawler was still a one-man shop when he crafted his makeover in 2003, though he had support from Ziomek and a team from Boston-based consulting firm Cambridge Associates. They divvied up the diversified assets according to three broad functions: asset preservation (20 percent), stable cash flow (17 percent) and capital appreciation (63 percent). Nearly a third of the diversified assets were set up so that positions could be changed quickly, depending on market conditions. Two recent examples: The allocation to private equity was lowered to 3 percent from 5 percent, and commitments to distressed securities were increased to 10 percent from 5 percent. Beneath Lawler and his team’s unassuming, Midwestern façades beat the hearts of iconoclasts. “We chose to create our own models of opportunity, risk and function and do that in full recognition of the textbooks and what academics would purport to be concerns of an institutional investor,” explains Ziomek, who questions the views of mainstream economists, including people like Nobel Prize–winner William Sharpe, who invented the Sharpe ratio, the popular formula that calculates how well the returns on an asset compensate an investor for the risks. “His ideas don’t work here,” Ziomek says. Rather than following the old-school method of doling out allocations by cookie-cutter asset buckets, the foundation’s diversified portfolio allows for rebalancing with functionality in mind. “You fill up buckets whether it’s a good idea or not,” investment director Malcolm Goepfert says of the traditional approach. “It’s kind of perverse because if you’re compensated by the return of your asset class and paid relative to a benchmark, you’re not concerned with absolute returns, but relative returns.” He explains the Kellogg approach this way: “Here you pay attention to what will make money on an absolutereturn basis.” For example, instead of maintaining a static 10 percent allocation to fixed income, Kellogg might put global bonds in its stable-cash-flow portfolio, where they rub shoulders with a real estate allocation. So radical was the portfolio redesign in its rearrange- ment of the taxonomy of investing that Lawler insists he has trouble naming the 17 hedge fund managers the endowment uses because he says he views the portfolio as a single entity — though individuals are assigned to subportfolios that reflect their utility to the overall investment strategy, which, of course, is absolute return. “I couldn’t tell you how much in alternatives we have,” Lawler says with what is no doubt a measure of disingenuousness. “I would argue respectfully that the question isn’t that relevant any more. It’s all embedded, it’s everywhere. STUCK ON CHOCOLATE AND ADDICTED TO COKE T o diversify or not to diversify — is that still in question? The W.K. Kellogg Foundation isn’t the only charitable organization with an addiction to an oversize stake in one stock. The $5.9 billion Pennsylvania-based Hershey Trust Co. and the $2 billion Atlanta-based Robert W. Woodruff Foundation are holding on to their vast holdings in, respectively, Hershey Co. and Coca-Cola Co. shares. Thirty-eight percent of the assets of the Hershey Trust, which supports the Pennsylvania-based Milton Hershey School for underprivileged children, are in the chocolate company’s shares — the rest are in a diversified portfolio that includes a 2 percent allocation to hedge funds. The Woodruff Foundation, which grants money within its home state of Georgia to educational, health, arts and human services programs, has 83 percent of its assets in Coca-Cola; the remaining 17 percent is in fixed income. Trustees of both foundations, like those at Kellogg, are unconstrained by the wishes of their respective founders — chocolate magnate Milton Hershey and Robert Woodruff, the former chairman of Coke — and can invest as they see fi t. Maintaining their company holdings seems governed more by emotion than reason, though defenders note in each case it has been a safe long-term bet. Kellogg, Hershey and Woodruff are part of a dwindling minority. The stock market downturn of 2000–’02 hurt a number of foundations that retained majority positions in one stock, such as the David and Lucile Packard Foundation and the Annie E. Casey Foundation. In 2002, 53 U.S. foundations had donor stock and the average holding was 40 percent; by 2007 only 28 U.S. foundations held donor stock, with an average holding of 17 percent, according to a 2008 Commonfund study of 226 private foundations. “Overly large concentrations in donor stock can constitute the single largest risk factor,” the study concluded. “ W hen you hold donor s tock , you’d bet ter get used to volatility,” says P. Russell Hardin, president of the Woodruff Foundation. Coca-Cola stock soared 30 percent in 2007, only to fall 22 percent in 2008 (better than the overall market, but down nonetheless). Because the foundation’s grants are one-time gifts not used for ongoing programs, the volatility is less troublesome than it might otherwise be. The story at Hershey is a bit stickier. The trust owns 78 percent of Hershey Co. voting shares, which gives it control of the candy company — an advantage some trustees and many Hershey, Pennsylvania, residents don’t want it to relinquish. The trust runs, in addition to the school, several other local enterprises vital to the town’s economy: Hersheypark, the Hershey Museum, Hershey Gardens. In a shot at diversification, trustees in 2000 allowed an initial allocation to hedge funds — a tough sell, recalls Robert Vowler, president and CEO at the time. “Some people hear ‘hedge fund’ and think it’s a four-letter word,” he explains. — F.D. MARCH 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 45
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