Priceless Artifacts, Extra Pandas, & $1B: Investing the Smithsonian

We met at the Newseum. How fitting. But instead of entering the towering and high-tech altar to journalism, Ryan Dotson—investment officer for the Smithsonian Institution—asks if I’d like to take a walk around the National Mall.

We head east, with the Washington Monument to our backs and Capitol building straight ahead. Even under construction, it beats a midtown Manhattan conference room.

“There’s a really cool exhibit that just opened,” Dotson says, pointing to the American Indian Museum. “Let’s talk there.”

“But is the museum open? It’s 8:30 am…”

Dotson, clearly excited, tells me not to worry. A flash of his Smithsonian ID to the security guard, and we’re off into the atrium where musicians are setting up for a performance later on. Our destination: The 8,500-square-foot exhibition of the Inca Road.

It is staggeringly impressive. Dotson and I walk through a recreation of the 24,000-mile-long Andean roadway, filled with objects and remnants of the Pre-Columbian empire that once stretched across much of South America. (You know, before Amerigo found it.) An interactive game invites children to race Chaski relay supply runners along different routes of the Inca Road. We play at least three rounds.

Art by Lauren Tamaki

“This is probably one of the best perks of my job,” he says. “We get to witness really cool research and projects throughout the Smithsonian”—also, games—“a tangible and rewarding result of what we do at the endowment.”

According to the Smithsonian’s 2014 annual report, the endowment’s objective is to “generate sufficient returns over the long term to provide stable and growing payouts, with an acceptable level of risk.” The institution has $1.28 billion with which to serve 19 museums, galleries, and the National Zoological Park. The endowment initially struck me as small for such a renowned organization. CIO Amy Chen disagrees: The fund is well positioned to meet the Smithsonian’s spending needs, she says, thanks to strong basics.

“It all started in 2006,” Chen begins. “Before then, the Smithsonian’s investments were run out of the treasurer’s office, with limited staff dedicated to managing the endowment’s then-$830 million portfolio.”

Chen joined the endowment in 2006 from Doris Duke Charitable Foundation in New York City. She built the investment office and portfolio from the ground up, initially with the help of just one analyst. The endowment wasn’t in the best shape at the time, still recovering from the dot-com bubble—much of its assets were in the S&P 500. Smithsonian’s board of regents then lobbied to have the endowment invested more in alternatives to dampen that volatility, Chen says. “Our first goal was to develop the right governance. We were creating a blueprint for the endowment to evolve around over time, including defining roles and responsibilities of the investment committee and the staff. We also established appropriate infrastructure, resources, and capabilities to manage a diverse portfolio.”

The investment office began growing rapidly, adding operations staff in 2007 and Dotson in 2008. Its team now numbers nine—five in investments and four for operations and administration. The annual report shows a portfolio vastly more sophisticated than the original 70/30, with allocations to private equity, venture capital, real assets, emerging markets. And diversification has paid off: The endowment surpassed its benchmark for the three, five, and ten-year periods ending September 30, 2014. It reported an annual net return of 7.3% over the decade.

As the endowment continued to diversify, institutionalize, and outperform, the investment office in turn paid out money to the organization. The annual report noted that yearly outflows nearly doubled from $34.9 million 10 years ago to $63.3 million in the 2014 fiscal year. But this rise in spending isn’t a cause for concern, Chen assures, as the payout rate remains conservative relative to endowment and foundation peers. The institution uses a five-year rolling average of the fund’s market value to calculate the rate, which usually lingers around 5%.

Plus, Chen emphasizes, a strong relationship among investment committee members, staff, and the Smithsonian’s broader finance committee ensures payout methodology can withstand different market cycles.

“We were creating a blueprint for the endowment to evolve around over time, including defining roles and responsibilities of the investment committee and the staff.”“Early on, when we were still developing our governance structure, we made sure that the investment committee’s chair sat on the finance committee,” Chen says. “This way, clear and open lines of communication ran between the two groups. It’s important for both budget and investment committees to know what each other is doing.”

The two committees and investment staff hold monthly meetings to discuss everything from short-term operational issues to strategic long-term decisions, Chen says. “The meetings are an opportunity for both groups to provide a status report. It’s a vehicle for communications.”

According to consulting firm NEPC, this is exactly what endowments and foundations (E&Fs) should be doing.

Its survey this spring found more than 80% of E&F investors are worried about not being able to meet long-term goals and critical funding needs 10 years from now. Nearly half of those surveyed identified balancing operations with investment return, risk, and liquidity as their number one challenge—a drastic change from 2012’s prevailing worry about how performance could impact their organization.

“Investors have enjoyed strong returns over the last five to seven years,” NEPC’s Kristin Reynolds says. “But with lower expected returns in the future, E&Fs are worried about the potential mismatch in revenues and expenses.”

A recent report by the Council on Foundations and Commonfund showed these projections had already come true, at least for the short term. Foundations’ returns for fiscal year 2014 were less than half of those for 2013. Private foundations reported an average gain of 6.1% last year, down from 15.6% in 2013. Community foundations also suffered, typically returning 4.8% for 2014, compared with 2013’s 15.2%.

One method for tackling the issue is to follow the Smithsonian model and create a concrete framework for communication between finance and investment committees. In an effort to act proactively, investors have made pronounced efforts to do just that: More than half of surveyed investors told NEPC they had increased interactions between the investment committee and operations, and 46% said they facilitated more meetings with the investment committee and the finance department. Liquidity was also prioritized, with 43% adding more in their portfolios to meet obligations.

For some nonprofits, even these endeavors may not be enough. But failing to meet expected payouts is not an option.

“Depending on the mission, some E&Fs don’t have the flexibility to alter their grant making or spending in down markets,” Reynolds adds. “If a foundation makes grants spread over three years, it can’t simply pull the funding because investment returns are low. Some institutions have policies set in place that investment committees can’t override unless for an extreme circumstance.”

Back at the Smithsonian, Chen admits the endowment she leads is lucky. “We have a little bit more freedom because of the way the Smithsonian is structured. Thanks to congressional appropriations and incredibly­ generous donors, there is a little bit less pressure on the risk of falling short.”