| Main |
Amy ChenSmithsonian InstitutionIt’s hard to imagine anyone more uniquely suited to run the Smithsonian Institution’s endowment portfolio than Amy Chen . As it happens, she’s the first person ever to manage the endowment’s $1.3 billion portfolio, which helps fund the Washington-based complex of 19 museums and galleries, 20 libraries, nine research centers and a zoo. Helping to advance the work of one of the U.S.’s most important cultural institutions — which draws some 27 million visitors each year — is particularly rewarding for Chen, 59, who started her career in the arts as a documentary filmmaker in the 1980s before switching gears to pursue an MBA and work in finance. After stints at investment banks and a hedge fund, she worked in nonprofit arts management, looking to combine her interests in the arts and investments. She served as director of finance and administration at the New Museum of Contemporary Art, then spent nine years as portfolio manager for the Doris Duke Charitable Foundation, an early and innovative investor in hedge funds. When Chen arrived at the Smithsonian in 2006, she quickly got to work on diversifying the organization’s standard stock and bond portfolio, adding hedge funds and other alternative-investment vehicles to the mix. Lately, Chen has been reducing the portfolio’s allocation to hedge funds to increase its investments in less liquid private vehicles and diversify its asset mix. In any case, she is dedicated to growing the endowment’s assets, which she says are crucial to funding the Smithsonian’s current and future attractions, including the forthcoming National Museum of African American History and Culture, set to open in September.
You are the first chief investment officer the Smithsonian ever hired. What did the portfolio look like when you got there?
Chen: Previously, the Smithsonian portfolio was very simple. It was a stock and bond portfolio, and it was managed by the treasurer. There were a number of people, both on the board of regents as well as on the finance committee, who felt that the institution should have a more diverse portfolio and be able to invest in alternative investments. So in 2005 the board of regents approved the ability for the endowment to invest in alternatives and establish an investment committee that would provide oversight of the endowment. Toward the end of 2006, I was hired to establish an office and to professionally manage the endowment.
How has the strategy changed since then?
Originally, the impetus was to better diversify the portfolio against market risks, since the majority of the portfolio was invested in long-only equity investments. The Smithsonian initially invested with multistrategy hedge funds and long–short funds, then invested in credit and distressed managers in 2007. We always invested directly — I’d always invested directly previously — and we have a very sophisticated investment committee who are very knowledgeable about alternative investments and so have been very supportive of investing directly.
Over the past ten years, we developed a structured approach, by identifying strategies and economic exposures and correlations, to improve diversification of the portfolio. We developed a very large alternatives portfolio. At our peak the marketable alternatives were at 40 percent; currently, we’ve reduced our marketable alternatives down to around 22 percent in favor of increasing our exposures to private investments. That includes private equity, venture capital, real estate and natural resources. Currently, we have approximately 35 percent in privates, so a pretty large allocation to alternatives in general but a smaller allocation to hedge funds than previously.
Why have you reduced your allocation to hedge funds in favor of private investments?
I don’t think there was anything in particular relative to not wanting hedge funds in our portfolio. The shift from public to private investments has been gradual. We have been very disciplined in terms of building out our private portfolios, in terms of maintaining a long time horizon, accessing the best managers and ensuring vintage diversification.
The reason we had such a large hedge fund portfolio originally was because the funds were investing in much more liquid markets, so it was easier to put a lot of money to work. There wasn’t necessarily at that time a trade-off in terms of illiquidity versus liquidity. It was just knowing that we wanted to evolve our portfolio over time. We could have sunk a lot of money into private equity, for example, in 2007, and we would have paid for it for the next three or four years. It was good that we were disciplined.
What are you hoping hedge funds will do for the Smithsonian Institution?
I think we’ve always looked at hedge funds as an ability to add noncorrelated returns on a risk-adjusted basis for the endowment. There’s always going to be some market inefficiencies and anomalies, and I think those are best captured by hedge funds. So ideally, you’re always looking for alpha from your hedge funds in terms of absolute returns.
Why do you think hedge fund returns in aggregate have come down so much in recent years?
It’s complicated. Everybody just points to the extraordinary central bank intervention and how it’s different this time. I think that it’s a combination of certainly having monetary and fiscal policies impacting world economics much more than previously. But I think it’s also due to machine learning, big data — the fact that markets are extremely efficient. And there are so many different types of strategies that have replicated what used to be strategies that were in the hedge fund domain. It’s just very, very difficult for people to make money.
I don’t think you can blame just one party in terms of why that happened. Every single strategy has been hit for different reasons, whether it’s crowded trades or blowups or all sorts of things that are just very different scenarios that have been occurring more recently than in the past. It’s been very hard for everybody. Only recently, the commodity trading advisers have done well and the quants have done well. But everybody’s time will come. There have certainly been lots of cycles for every strategy.
Do you think the glory days of the hedge fund industry will ever return?
I don’t think so. I think it’s very different today. There are still excesses in the market, and there’s so much money on the sidelines today. I think it’s going to take a long time. Hopefully, we’re not going to be like Japan for the next 25 years.
Given that performance is nowhere near what it was in the heyday of the late 1990s and early 2000s, are investors like you able to at least get better terms?
I think it’s based on demand and supply, which has always happened during these cycles. In 2009 there was a short window of probably a year where funds that had been closed for years opened up. I don’t remember if the fees were lowered, but I think the fees were reasonable. Then the pension funds came in and all the consultants felt that it was a good thing for pension funds to invest in alternative investments, so in certain cases, if they were large enough, they were able to negotiate good fees and separate accounts. But all told, because they were new entrants, their negotiating leverage was not necessarily as high. I don’t think the fees ever really went down very much. In fact, funds argued that they needed more in order to be able to pay people and pay for the infrastructure required to become SEC-registered. I don’t think it shifted that much in favor of investors.
More recently, people are trying to provide more-alternative fee structures, depending on whether you want a leveraged or a nonleveraged approach or whether you want to invest in their long-only or their long–short product or some replicating strategy that they might have. So there might be a little bit more in terms of options, but I don’t think investors have had a lot of leverage. A smaller-size investor — and at $1.3 billion we’re considered a fairly small investor — might have more favorable terms with emerging managers, investing in the founding shares or being able to access highly sought-after funds that might have a meaningful impact on your portfolio due to your size.
How do you determine what is a fair price to pay for alpha?
I don’t think you can decompose the returns and try to correlate that to an appropriate price — say, what percentage of their return can be attributed to beta versus alpha — because the industry hasn’t really worked that way. Hopefully, that is something that people are starting to think about in terms of thinking about the pricing, but there hasn’t been a big shift to that. So you either have the 1-and-a-half-and-20 or the 2-and-20. There hasn’t been a lot of adjustment from that. I don’t want to blame the pension funds per se. It’s just a very different world out there.
Have you ever walked away from a manager because they wouldn’t budge on fees?
I think that every investment we’ve ever made has always had an analysis of whether or not you’re getting paid for what you’re buying. I don’t think that we’ve ever made an investment with any manager where we thought that we have to invest with that manager at 2-and-20 because they walk on water.
We always look at whether or not there is a passive or a long-only or a cheaper, more efficient way to implement a strategy, whether it should be a hedge fund, whether it should be a private equity fund — whatever instrument one should use in order to capture that market inefficiency. From that perspective, I think we’re cognizant of the fee. If it makes more sense that you can use an ETF or a mutual fund to get a particular exposure, we would do that. We would never say, “Oh, we can only use a hedge fund to gain certain exposures.” So that’s never been part of our analysis.
But if a hedge fund is charging much more than any of its peers, certainly that will raise eyebrows and we would have to really think, Is there some barrier or competitive advantage that that manager possesses that we would be willing to pay in excess of what others are charging? We look at our managers’ returns relative to their fees.
Is there any area where investors have been able to press for better terms?
I think that transparency has actually increased a great deal. The fact that registration has been enforced by the SEC has provided greater transparency throughout the industry. And I think virtually all the hedge funds have been much, much better at providing better reports on exposures. So from that perspective, that’s possibly one positive benefit of the Dodd–Frank [Wall Street Reform and Consumer Protection Act] and some of the regulatory changes. But I think, unfortunately, because of Dodd–Frank and the SEC registration, it’s pretty difficult for your start-up hedge fund to make it unless they have sufficient working capital and seed capital to begin with.
Once managers amass a certain amount of capital, does the pendulum swing in their favor in terms of their ability to dictate the terms?
I don’t even think it’s an issue in terms of the balance of power; I think it’s an issue in terms of their business model. I think that once they get to a certain size and if certain strategies are not making money, that’s a catalyst for them to either hire teams from other hedge funds or other banks and start new funds and new strategies or acquire other firms. I think that causes them to become different. It really has made them become a business as opposed to a stock picker. And then it becomes a situation where they’re just trying to hold on to their business or to pay for all of their expenses and reduce the risk, whether it’s because they are one of the biggest investors in their fund and therefore they don’t want a lot of volatility in terms of their returns or that they are thinking about their business differently. So the alignment of interests shifts as a result.
How do you think institutional investors have changed the way they view managers since you started at the Smithsonian?
Ten years ago you would say that you would never invest in a manager that exhibited what you would call style drift. So on the one hand, I would excoriate managers for picking up new strategies just to be able to manage more assets. On the other hand, I could say that some managers have been thoughtful in terms of looking at new opportunities and sometimes creating new funds or special-purpose vehicles or whatever structure in order to take advantage of certain opportunities in the market. I guess that’s an area where you have to really think about, Is the manager guilty of style drift, or is the manager a good manager because they’re able to see new opportunities and take advantage of them? You want to make sure that it’s not just a momentum play; you want to make sure that they might not just go into a particular position and get out before they actually see that strategy play out because they might get nervous and not quite know when that cycle is going to turn.
So I think that’s one of those gray areas where there are a lot of talented managers who are able to be very opportunistic and succeed. You have to really look at the managers and their motivations and intentions, and the alignment of interest, where are they putting their money.
How do you determine whether a manager’s interests are aligned with yours?
Well, usually, if all their net worth is in their strategy. That’s definitely helpful. We have one manager we tend to visit quite often just to see if they’re in the office all the time. You have to just watch how well they’re balancing their lives — once they get to a certain level of wealth, how much of their time is being spent on philanthropic causes or hobbies or whatever versus their own business. That’s a really hard thing to judge, how driven a manager is.
Is this another area where manager size comes into play?
I guess I still think that the hedge fund industry to some degree, although it’s not as much of a cottage industry as it was before, is still built on relationships. Today we probably are more supportive of emerging managers than in the past because it’s a really good way of developing relationships and seeing how people grow their business and develop. So I think that’s certainly the best way that we found to understand the managers’ principles and commitment to their business. But I think the main thing is that relationship and whether your relationship is purely with the investor relations people or does the manager still feel that their investors are important to them.
On balance, do you think hedge funds still have a place in institutional portfolios?
I think that hedge funds still have been able to attract some of the best investors and best talent in the world. We’re definitely not going to give up on hedge funds. We still believe that there are talented investors out there and that they still provide a great deal of, in some cases, uncorrelated or lowly correlated diversification to our portfolio. So we definitely think that there’s always going to be a role for hedge funds in our portfolio.•
