The big idea: For many nonprofit groups, the income generated by their endowment is an essential component of their operating budget. Given the importance of this revenue source, should they consider outsourcing the investment management function?
The scenario: As J. David Maas drove home from his office in downtown Indianapolis, he thought about the presentation he had seen earlier in the day from CornerStone Partners. Maas was chief financial officer of the Lumina Foundation for Education, whose mission was “to expand access to and success in education beyond high school.”
With the resignation of Lumina’s chief investment officer in late 2009, Maas was reviewing the structure the firm had in place to internally manage its $1.1 billion endowment. Although Maas and others at Lumina were temporarily overseeing the endowment, he recognized that many other endowments and foundations outsourced this responsibility. As part of this review, he had invited a number of companies — including CornerStone, a full-service CIO firm based in Charlottesville — to make presentations to the Lumina management team.
The trend toward outsourcing the investment advisory function was largely driven by the increasing complexity of financial markets and the emergence of nontraditional asset classes such as hedge funds and private equity. The outsourced model gave nonprofit groups access to the full range of the advisory firm’s experience and abilities, which would have been costly to replicate internally. Additionally, certain aspects of the investment process, such as vetting and selecting fund managers, were resource-intensive, and the outsourced model could provide economies of scale.
At the same time, income from the endowment was a critical source of funding. With the internal model, the investment approach was customized for the cash-flow needs of the organization, but an outsourced CIO firm might apply a “one-size-fits-all” portfolio approach even though its various clients might have very different endowments and cash-flow needs. Outsourcing might also result in decreased transparency of the investment process, not to mention the added cost of an intermediary.
The resolution: In February 2010, Lumina announced that it had selected CornerStone to manage its endowment. In contrast to other, larger investment management firms, CornerStone kept its client list small and took pride in the individual attention paid to each client. Staying small enabled the firm to create a truly customized portfolio for Lumina. It also worked closely with the investment committee of the Lumina Foundation board to craft an investment policy statement that clarified the performance objectives and risk tolerance of the foundation, acceptable levels of liquidity and the governance structure of the endowment, helping to alleviate concerns about transparency.
The lesson: Lumina recognized that outsourcing the investment advisory function of their endowment could help the foundation better focus on its core mission. Through its careful selection of an investment advisory firm, Lumina was able to achieve the advantages of outsourcing the investment function while avoiding the problems most commonly associated with it. In describing the selection of CornerStone Partners, Jamie Merisotis, Lumina’s president and chief executive, said: “This partnership will provide long -term consistency and expertise with our investment strategy and supports Lumina’s work toward our big goal of increasing the percentage of Americans with high-quality degrees and credentials.”
Evans is assistant professor of business administration at the University of Virginia Darden School of Business.