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The Stanford Endowment Experiment | Chief Investment Officer

Of the many unflattering stories that are told about the Stanford University endowment, the one about Jason Zhang may be the worst.

It was 2005. Zhang was fresh out of Stanfords business school and one of those superstars, says a former boss. Zhang had been tasked with creating an emerging Asia investment program for the Stanford Management Company (SMC), buying a $45 million anchor stake in a small local Chinese private equity group. This was Zhangs first allocation. It would make the university nearly half a billion dollars. But Zhang would be long gone before that became apparent.

There was basically a blank sheet of paper, and the senior Stanford people told me, Go figure it out, Zhang recalls. He couldnt look to peers for a model, either. Most international investors were not doing much in China. If they were, it was giving money to the big names with Asia offices: Carlyle, Warburg Pincus, etc. We took a different approach.

Over three years, SMC put itself on the map as a frontrunner in emerging-market Asia. It applied for a license to invest in the domestic Chinese equities market, created new teams of local managers, and deployed upwards of $500 million across the region. Zhang and then-CEO Mike McCaffery had envisioned a long-term goal from the very beginning: SMCs first satellite office, in China, which Zhang would set up after a few years proving his mettle.

Art by Wesley Allsbrook

As he crisscrossed Asiataking up to a dozen meetings a day in search of dealsa brew of market circumstance and personal opportunity gathered above SMC. Zhang had no way of predicting the event that would kick off a decade of turmoil at SMC: On January 9, 2006, the funds leadership quit en masse.

CEO Mike McCaffery, CIO Mike Ross, and private equity chief Dave Burke were leaving Stanford to launch Makena Capitalan outsourced-CIO (OCIO) shopacross from SMC on Sand Hill Road, the artery at the heart of Silicon Valley. The announcement threw SMC into crisis. No McCaffery meant no China office, at least until a new leader approved it. The mass resignation came as a shock to me, Zhang says. To be very honest, it was a disappointment. I was working well with everyone, having a lot of fun, and making great investments. The bottom line was that we were making so much money: It was great for the school. But they saw an opportunity and went for iteveryone has that right. Zhang stayed on through the six-month search for Stanfords new leadership. I was still working pretty hard, he says, but wondering the whole time, Whats going to happen?

Foremost, hot markets. Elite endowments have a reputation for generous compensation (by institutional standards), but no one was getting rich working at SMC. McCaffery and Co. returned 18% for Stanford in the 2004 fiscal year, 19.5% in 2005, and the same in 2006. Yet as they ballooned the universitys capital base, their opportunity cost of doing so rose alongside it. Staffers responsible for $1 billion-plus strategies say they earned about $100,000 a year. Talent retention was a problem. SMC leaders had proposed accepting some outside capital, managing it for a fee, and passing the revenue onto staff, according to two insiders. But the board rejected the idea; Makena was born. In place of those leaders, a man named John Powers would come to lead the Stanford Management Company.

No one interviewed blames McCaffery, Ross, and Burke for their decisioneven those hurt by it. Indeed, many praised the trio for stellar market timing. SMC got an equity stake in the new business and a board seat. Makena, like SMC, would not permit staff to speak on-the-record for this article. CEO Burke sent a statement, saying the team is proud of our association with Stanford Management Companyboth historically and as a current partner in investment endeavorsand we admire their consistent investment execution through cycles and transitions. That first transition, of course, was the exodus of Burke and Co.

There are a lot of wonderful things people enjoy about working at an endowment or foundation, says Nolan Bean, a consultant at Fund Evaluation Group. But for the folks who left to start Makena, they get equity in that business. Youre not getting equity in Stanford. There are economic considerations at hand.

Despite the competitive labor market, SMC had the option to hire a proven endowment leader. Nancy Donohue, a Harvard Management Company star, was one of three top candidates. I did interview for the position and I think so highly of the Stanford community, she confirms. At the time, Donohue was responsible for approximately half of Harvards endowment as vice president for external management, working under then-CEO Mohamed El-Erian. But, the committee decided to go in another direction, she says. Donohue instead co-founded Summit Rock Advisors, an OCIO firm managing $10 billion in endowment, foundation, and family assets.

During the leadership transitiona phase marked by turnoverone departure remains etched in the minds of ex-team members. Managing Director Mark Taborsky had been with SMC for five years when John Powers took over the CEO seat in June 2006. This was Powers first job at an institution, having spent the four years prior as research director at OCIO firm Hall Capital Partners. Upon his arrival, Taborsky was already discussing a position at Harvards endowment with El-Erian. A week or two into Powers tenure, Taborsky told him hed taken the Harvard job and would stay on as long as needed for a smooth transition, according to three people who worked there at the time. His co-workers understood: The Harvard job was a prestigious upward move, and Taborskys managers had left SMC.

When Powers heard the news, he canceled the managing directors key card and banned him from the building. Taborskys secretary had to pack and ship his remaining personal effects. There was no, Thanks for your service, says one witness to the scene. I just thought, Wow. That was the first data point of Powers entire tenure.

Taborsky went on to senior positions at Harvard, PIMCO, and, since 2011, at BlackRock as a managing director (MD). Staff members shocked by what they perceived to be a hostile handling of this senior-level exit would get used to it. Over the next nine years, SMC underwent bitter splits with two CIOs (Eric Upin and Ken Frier), one CFO (Mark Lee), several senior managers (Dave Hood, Tyler Edelstein, and John OConnor), the head of portfolio strategy (Mark Hayes), and more.

Like many in the industry, consultant Nolan Bean has noticed the revolving door of employees in and out of SMC. Its very disruptive to have that amount of turnover, he says. Just as with an asset management firm, when you see all of these people leaving, it raises the question: Is there a reason?

Jason Zhang stayed seven months under the new administration. The Asian investing program met with less support under Powers than McCaffery. After all, it was the departed CEOs brainchild, and Zhang his handpicked implementer. The China office plan died (although the notion has resurfaced in recent years).

I think the most honest answer as to why I left is that the leadership team I was working with left, Zhang says. Secondly, I also had a personal reason: I met my future wife and decided to move back to China to be with her. It was not an issue with the people, and besides there were so many interesting opportunities in Asia, he continues. At least, not an issue with my old team. I would say I saw a change in the culture of the office under a new leadership.

Zhang declined to comment further on his experience at post-spinout SMC. However, according to two former staffers, it was not a positive one. Zhang reportedly chose to resign and move back to China when the satellite office project dissolved, offering to stay on for a successful transition. Powers suggested an even better arrangement: If Zhang held on for three months, SMC would give him a substantial bonus and a $100 million anchor investment to launch his own fund in China. Zhang agreed. One person close to the deal called it a gentlemens agreement. Near the end of the third month, Zhang approached Powers to work out the details, and was asked to stay another three months. He did. June arrived, and once again he went to the CEO to discuss next steps for launching his new fund. Powers told Zhang that SMC would not seed the venture after all, nor would he receive a bonus. Zhang asked why. The reply: We dont want to.

Enter 2008. Exit CIO Eric Upin, who had replaced Mike Ross after he left for Makena. Exit two tail-risk hedgesa major credit-default swap and laddered S&P 500 out-of-the-money putsimplemented by Upin and unwound pre-crisis. Exit one-quarter of Stanfords endowment assets. Enter a years-long distraction from SMCs festering internal dysfunction. As one person described the situation, it was a toxic culture, a culture of tyranny, a culture of Washington-Beltway manipulation.

But larger problems existed. Devastating endowment losses pushed Stanford President John Hennessy to cut endowment payouts, lay off staff, and issue bonds to stave off a liquidity crisis. The California school suffered on par with Yale and Harvard in the 2009 fiscal yearthey lost 26%, 25%, and 27%, respectively. Endowments on average lost 19%, with those above $1 billion shedding 21%.

In October 2009, SMC put $6.2 billion of buyout fund, natural resource, and distressed asset stakes on the auction block, seeking to offload up to $1 billion worth. It was either the biggest fire sale in private equity, ever (Dow Jones LBO Wire) or a strategic play to free up cash and take advantage of attractive near-term investment opportunities (Stanford). We are not forced sellers, Powers said at the time. And thats lucky for SMC, since the portfolio received only underwhelming bids. Stanford pulled the sale.

Ironically, Stanford did deliver as an opportunistic buyer: SMC outperformed most of its peers by 300 to 400 basis points in 2010, recovering 14% to Yales 9%. Both Powers (in a 2014 speech) and his former deputy Mark Hayes credit the university leadership and SMCs board with giving them the leash to play tactically. One of the greatest things about the administration was that its willingness to take risk didnt change throughout the financial crisis, says Hayes, who joined in March 2008. We did have clarity from university leadership that it wanted to win, and they werent second-guessing our risk bets.

Powers, reached by email, described this post-crisis recovery as the personal highlight of his Stanford track record. When I arrived at SMC in 2006, I found that I needed to re-staff an investment team, since it had seen a number of departures in the prior period, he wrote. While this reshaping and rebuilding was in process we entered the financial downturn of 2008 and 2009. Personally I am most proud of the strong results delivered by this new team in the recovery period immediately post the stress of the global financial crisis.

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