Oaktree's Marks: UPenn Underperformance Due to Defensive Posturing, Attempting to Please University

(March 8, 2012) — The ability to ignore relative performance depends on the circumstances and, in particular, the constituencies the performance has to please, wrote Howard Marks, the chairman of Oaktree Capital who chaired the University of Pennsylvania’s Trustees’ Investment Board from 2000-2010.

In a February memo to the firm clients, Marks delved into this phenomenon, focusing on a case study of the University of Pennsylvania’s endowment, which in fiscal 1995 through fiscal 1999, fell behind substantially when it gained 16% a year while the average of its peers gained about 23%. In fiscal 2000, according to Marks, Penn’s endowment — which completely lacked exposure to growth stocks, tech stocks, buyouts or venture capital — lost 2% while its peers averaged returns in the double-digits. “Penn constituencies such as alumni/donors and the administration with very unhappy in those years, despite the endowments high absolute overall return,” he wrote. 

Marks used the endowment of his alma mater to ask the following questions: What are the non-negotiable requirements for accurately assessing investment performance? Is it more effective to aim for high returns, or is it better to reduce the likelihood of loses?

“Endowments provide an outstanding example of this phenomenon,” Marks wrote in reaction to the ability of endowments to ignore relative performance. “Intellectually, no one could be unhappy with 16% a year for five years. In fact, the trustees of a private foundation probably would have been delighted with such a return in FY1995-99. But it’s harder for an institution with outside constituencies, like a university, to dismiss relative performance.”

According to Marks, in order to survive and have a chance to produce long-term performance, investors must live up to their constituents’ short-term expectations. Ultimately, he said, the manager’s job isn’t to make money, but to deliver client satisfaction, so expectations have to matter. “All of us, on both sides of the process, should be sure we know what pattern of performance is expected. How else can we know how satisfaction can be delivered?” Marks questions. 

He continues: “As a result of holding a highly idiosyncratic portfolio, Penn experienced performance that deviated — unfavorably — from that of its peers to an extent that it became intolerable. This necessitated change.”

Therefore, the requirements for assessing investing performance, Marks asserted, includes:

1) a record spanning a significant number of years,

2) a period that includes both good years and bad, enabling us to assess performance under a variety of circumstances, and

3) a benchmark or peer universe that makes for a relevant comparison. 

Marks’ memo acknowledged that the decision among investors to do what is right in principal or whether to alter behavior to reflect real-world conditions is one of the biggest single issues facing anyone tasked with structuring a portfolio. In other words, he wrote: “If it’s important to track the competition, you should start to make the portfolio less idiosyncratic, regardless of price attractiveness. But if you care more about absolute performance, achieved with risk under control, you should refuse to buy sky-high assets.”

The Oaktree chairman stated that while there is no right answer, absolute performance was his preference, reflected in his decision for Penn to hold off buying tech and growth stocks. “To put it in horribly mixed metaphors, having mixed the boat for six years, I said I wouldn’t jump on the bandwagon just in time to ride it over the cliff,” he concluded. 

At another university endowment, Jim Dunn, the chief investment officer of Wake Forest University, recently voiced a similar theme. Dunn’s philosophy at Wake Forest is to ‘protect, perform, and provide’, a theme described in aiCIO‘s January 2010 issue. Executing that philosophy, he said, takes talent — a quality that is not solely quantified by annual returns, but also by doing things right and avoiding pitfalls. “The biggest risk to our portfolio is another Bernie Madoff scandal — we would not only lose money, but we would lose confidence in everyone who puts money in our fund. So talent is about how much risk you take,” he says, adding that he is the only CIO he knows who gets paid based on a Sharpe ratio. “Talent comes from not taking big bets. Risk-adjusted returns is the real driver here.”