May 24, 2014

Rice U. and insider trading

Rice U. in Houston has long had a large endowment per student. It didn't charge tuition until the 1960s, and when I attended in the 1970s, tuition was substantially lower than at comparable private universities such as Duke, Northwestern, or Carnegie-Mellon.

It started off with a large endowment from William Marsh Rice, although that took a decade and a lot of spectacular legal effort to collect because the old man was murdered by his butler and doctor and they substituted a forged will making themselves the beneficiaries. (Yes, the butler did it.)

(Rice U. and forged wills seem to go together: the famous first Howard Hughes' will that Melvin Dummar produced just as I was on my way to Rice cut Hughes' old college in for a share. Unfortunately, Dummar's handwritten will, the subject of Jonathan Demme's movie Melvin and Howard, was ruled a forgery in 1978.)

But Rice U. got really rich with the discovery of the East Texas Oil Field in 1930 because Rice U. had just bought a lot of piney woods acreage in the middle of nowhere. Why? Because George R. Brown of the Brown & Root oil services firm (which is sort of a predecessor of Halliburton) was on the Rice board. And Brown had told his fellow trustees that the exploratory drilling that B&R was servicing in East Texas looked very, very promising.

Was this insider trading? Well, until 1933, there wasn't much of a law against insider trading, so it didn't really come up, legally speaking. But it sure saved my parents a lot of tuition, so thanks for the tip, Mr. Brown.

Is it possible that the way Rice U. grew its endowment in 1930 has something to do with how Harvard, Yale, and Princeton generate above-market returns on their endowments in the 21st Century?

No, of course not. As Thomas Piketty explains, HYP beat the market "By economies of scale in portfolio management."
       

41 comments:

wren said...

Reminds me a little of how Jane Stanford was murdered.

Anonymous said...

I seem to recall a lot of Brown & Root references in Robert Caro's series of biographies of Lyndon Johnson.

-meh

Anonymous said...

I think insider trading only applies to publicly traded companies in the US of A. Not land or commodities.

bjdubbs said...

Buffett offered some tips to Grinnell, Stanley Druckenmiller helped to manage the Bowdoin endowment. But I bet Yale and Harvard probably benefit from being long-time investors in prime VC and PE firms managed by alumni. VC is probably the only asset in which "scale" matters.

dearieme said...

'As Thomas Piketty explains, HYP beat the market "By economies of scale in portfolio management."'

That's the most damning criticism of Piketty I've yet seen. Congrats.

leftist conservative said...

i used to live down the road a bit from rice. Used to do a lot of biking on campus. Strange lot, rice alums. Not too much of football fans. My alma mater, Houston, beats up them regularly in football. And the rice fans don't seem to care too much. Too nerdy to care.

Anonymous said...

Schools with mega-endowments actually do benefit from scale. For one, these schools can pay their endowment managers an amount closer to what they would receive in the private sector, so they get better talent. Second, mega-endowments have the resources to make investments directly into hedge funds/private equity rather than going through a fund of funds, which eliminates a layer of fees.

Harvard was a little different in that it did more direct investing rather than going through outside funds, but the Class of 69 got upset about the size of bonuses being paid, so the managers left to form their own hedge funds, seeded with money from the endowment. In the end, Harvard was actually paying these guys more, but now it was off the books.

Of course, I do love a good insider trading conspiracy theory, so I direct you to Cohen, Frazzini, and Malloy (2008), "The Small World of Investing: Board Connections and Mutual Fund Returns"

Abstract: This paper uses social networks to identify information transfer in security markets. We focus on connections between mutual fund managers and corporate board members via shared education networks. We find that portfolio managers place larger bets on firms they are connected to through their network, and perform significantly better on these holdings relative to their non-connected holdings. A replicating portfolio of connected stocks outperforms a replicating portfolio of non-connected stocks by up to 7.8% per year. Returns are concentrated around corporate news announcements, consistent with mutual fund managers gaining an informational advantage through the education networks. Our results suggest that social networks may be an important mechanism for information flow into asset prices.

Anonymous said...

Rice U is getting a boost from another oil boom once again in 2014.

Its most famous graduate was Howard Hughes, well known for innovative airplanes and financing movies as well as his eccentric paranoid behavior, actually made most of his money from an oil services company his father started in Houston, which is still around today and called Baker Hughes.

Howard Hughes was also killed by his domestic staff, who starved him to death.

Anthony said...

Warren Buffet has outperformed the market, too, though he's an active manager. CalPERS has achieved a Madoff-like 8% return most years, though they lost a quarter of their value in 2007. There may be some cooking of the books at CalPERS, though, as many of their investments are in real estate, and valuing then is rather subjective.

albert magnus said...

The University of Texas at Austin also had a massive oil field in Texas that provided it with an endowment. I guess this is the way Texas had a sort of Alaska Permanent Fund, but rather that give it to everyone it allowed Texas to build world class universities that everyone could afford.

I went to UT-Austin in the early 90s and paid $800/semester for as a good an education as I could get anywhere. Maybe we should be thinking of doing more stuff like that.

Anonymous said...

Tangentially related to countries that punch above and below their weight in IQ-

I've always thought that Rice U punches below its weight in IQ, assuming SAT scores as a proxy for IQ. Rice has higher SAT scores on average than Duke, Dartmouth, and Northwestern, yet always seems to place behind those three in the USN&WR rankings. Perhaps there is a bias against schools that are more science & engineering oriented, like Rice, and in favor of more liberal arts oriented private universities.

Anonymous said...

So Houston plays Rice not beacause they are hard to beat but easy?

map said...

Yes yes...Harvard makes wise investments in timber, dontcha know?

map said...

Securities markets make their money from index funds. Thanks to the efficient market hypothesis, the general public has been convinced that dollar-cost averaging is the best investing strategy so tens of billions of dollars go into 401(k)'s and IRA's every pay period. This is the massive backstop that makes all Wall Street activities possible.

Anonymous said...

pay their endowment managers an amount closer to what they would receive in the private sector, so they get better talent

All this talk about talent in investing and still not a jot of evidence that it actually exists apart from luck.

Anonymous said...

One of the main reasons the HYP endowments had such high returns is because they over-invested in higher risk investments like VC as well as other equities. That's why they had huge losses in '07-08. Plus they didn't have the cash to cover the cash calls and had to sell illiquid investments at forced-sale prices. Fundamental errors in portfolio construction and management caused by hubris and greed.

Anonymous said...

Warren Buffet has outperformed the market, too

Not really. When apples are compared to apples, he has not. See http://www.marketwatch.com/story/warren-buffett-more-myth-than-legend-2013-07-03?pagenumber=1

Quote: "In those 15 years, an investment of $10,000 would have grown to $21,698 in Berkshire Hathaway stock. The same money would have grown to $24,307 in the three Vanguard value funds or $37,958 in five DFA value funds."

Anonymous said...

Rice has higher SAT scores on average than Duke, Dartmouth, and Northwestern, yet always seems to place behind those three in the USN&WR rankings. Perhaps there is a bias against schools that are more science & engineering oriented, like Rice, and in favor of more liberal arts oriented private universities.

It's true. In, say, biomedical research, Duke and Northwestern are a good notch above Rice. This may change soon because Rice just went through a massive round of expensive recruiting.

Anonymous said...

I had a parent go to "Rice Institute" in the 1950s when it was absolutely free to "white residents of Harris County". It was the only way they could go to school since my grandparents were dirt poor farmers. When the Board overturned the Trust for discrimination in the 1960s, they took out the free tuition while they were at it.

I entered the school in the 1980s and the "huge endowment" did not prevent them from raising the tuition every single year. My family was really struggling at the time and I swore then I would never donate as an alumnus, and I haven't.

Continue to today and tuition has continued to go up and Rice is no longer a "deal", but yet another university requiring rich parents or massive loans. All this from a place where it allowed the first generation from my family to attend college.

smead jolley said...

Albert:

Steve would have said, "As good OF an education ..."

Anonymous said...

@ 8:21 Anon,

Rice has a lower SAT average than all of the three schools you mentioned (Dartmouth, Duke, and Northwestern).

SFG said...

"i used to live down the road a bit from rice. Used to do a lot of biking on campus. Strange lot, rice alums. Not too much of football fans. My alma mater, Houston, beats up them regularly in football. And the rice fans don't seem to care too much. Too nerdy to care."

See, that's what we call a good college up here in the Northeast. If I get stuck in Texas, I may try to send my (hypothetical) kids there.

Anonymous said...

So Houston plays Rice not beacause they are hard to beat but easy?

Nice.

Anonymous said...

As another commenter has said, the law against insider trading is part of the interpretation of the Securities and Exchange Act of 1934 (and regulations thereunder), and so applies only to sales of "securities," not to land sales.

Anonymous said...

"No, of course not. As Thomas Piketty explains, HYP beat the market "By economies of scale in portfolio management.""

I don't think many people realize how dinky the "HUGE" college endowments are compared to investable funds.

A moderately will known mutual fund .. Fidelity Contra Fund ... has assets of $80 billion. Four times the size of Yale. More than HYP combined.

They have done well not because of scale but because they are small enough to buy smaller assets like timberland.

In the 1970's, Yale's endowment lost 45% of its purchasing power. (http://books.google.com/books?id=DgAv6GaGUjoC&pg=PA128&dq=yale+endowment+nifty+fifty&hl=en&sa=X&ei=8z-CU7C6BcSBqgaMkoHYAg&ved=0CCsQ6AEwAA#v=onepage&q=yale%20endowment%20nifty%20fifty&f=false)

The Ford Foundation was instrumental in pushing endowments into US equities at the peak of the early 70's bull market.

Harvard did better which is one reason it still #1.

Whiskey said...

Piketty is an idiot, economies of scale work exactly backwards. Warren Buffett regularly complains he can't match earlier returns because he's not working with 10 or 100 million, he's working with 10 billion. And its a lot harder to make a fifteen percent return with 10 billion than 10 million.

Example: You do fundamental analysis, figure a stock is undervalued relative to its assets and growth potential. You buy nearly all of the stock, its a small one, not of much interest to many people, hence its undervaluation, for $10 million. You make a 20% return. This was Buffetts play, over and over again, in his early years. Its not that different than say, Baseball scouting. Look for the up and coming prospects.

Now lets say you have $10 billion to invest. Where? What opportunity is big enough? There are a few, but because of their size they get scrutiny that smaller players just on the verge of busting loose don't. So sure, Buffett can buy Burlington Northern, and use his pull with Obama to deep six oil pipelines so Burlington Northern carries nearly all the tar sands and oil shale oil. With predictable derailments. But he still only makes an 11% return because even with growth in rail traffic from the oil business, Burlington Northern has considerable expenses: rolling stock, paying off those derailment accident victims, etc. Its not like buying Dell Stock in the first year of the company.

sunbeam said...

Anonymous wrote:

"Tangentially related to countries that punch above and below their weight in IQ-

I've always thought that Rice U punches below its weight in IQ, assuming SAT scores as a proxy for IQ. Rice has higher SAT scores on average than Duke, Dartmouth, and Northwestern, yet always seems to place behind those three in the USN&WR rankings. Perhaps there is a bias against schools that are more science & engineering oriented, like Rice, and in favor of more liberal arts oriented private universities."

My views IQ and success (financial) in this society are a little murkier than most seem to have here.

There is an old phrase from my college days that was used a lot in some topics "necessary and sufficient condition."

If the school you attend isn't a pipeline into the Northeast FIRE machine, whose most famous example is Wall Street, well there is a limit to how much money you are going to make.

Some people build businesses and become huge successes, like the guy from Idaho who was a case study in Fast Food Nation.

But by and large the money is this country is in FIRE.

There really isn't any money in tech for the most part. You used to be able to make really good money in this country by going into manufacturing, but that is an oddity now.

I regard the Silicon Valley software concerns as another expression of FIRE, call it Wall Street West in some ways. The stratospheric valuations of these companies come from stock values, not from day to day profits for the most part.

Look let's say you are a kid from Wyoming. Or West Virginia, whatever. You somehow win the luck of the draw, and have the genes to possibly have say a 150 IQ.

If you don't go to the right schools at this point, and have the right kind of major, you aren't going to make what we consider mega money now.

If you stayed in Wyoming, and built a hugely success cattle, or some other kind of business, well your success is kind of a sideliner compared to how Wall Street rolls.

I'd like to see how much below student IQ's Caltech punches. Guess they might be a pipeline for Wall Street quants or something.

Slightly related to this, I think most of the large endowments at Universities were things made in previous versions of America. If your school doesn't produce mega money, which takes Wall Street or something you aren't going to hit the home run 100 million dollar donations and the like.

People have made big contributions in the past to schools like Wisconsin, but that was a time when companies, like GM and the like were a big deal.

And some of the schools made mega money in resource plays like the Texas schools. This just isn't in the cards anymore.

Anonymous said...

Rice has been slipping in the rankings since I graduated in the late 90s. At one point, it was #12 in the US News rankings.

One thing that I've noticed is the rise of Wash U in St. Louis relative to Rice. At Rice, we used to look down on Wash U as a consolation school.

Now Wash U is ranked higher. I wonder if pressure to "look more like Texas" has something to do with it.

DR said...

@sunbeam

"If you stayed in Wyoming, and built a hugely success cattle, or some other kind of business, well your success is kind of a sideliner compared to how Wall Street rolls."

This hypothesis makes sense, except when you consider that Wall Street is filled to the brim with people born in China, India, Iran and Russia. Surely that must be worse than Wyoming.

Anonymous said...

Does Picketois mention the Eskimos and that they are becoming esp rich and powerful?

jody said...

well, here is the big chart on wikipedia. sort by 2013. anybody want to crunch the numbers and do an endowment per undergrad calculation? or is it better to do it for all students combined?

some observations:
texas is going to be number 2 in 2014, passing everybody but harvard. oil and gas are more important than insider trading. texas A&M has all the big players in their sights as well.

princeton and stanford are probably going to pass yale in a few years.

williams has the most for a college, and more than most universities.

how did virginia commonwealth go from 400 million to 1 billion in 1 year? unless it's a typo.

Anonymous said...

well, here is the big chart on wikipedia

Re: the above-mentioned UW Madison. $2B endowment, same as Williams College, which is something like 25 times smaller. Even owning huge-deal patents like ones for warfarin, vitamin D synthesis and stem cells did not seem to make UW particularly rich in comparison with exclusive private colleges.

Anonymous said...

@ Jody

I found a couple of links that do crunch the numbers.

http://leiterreports.typepad.com/blog/2012/07/per-student-value-of-university-endowmentsor-the-rich-are-even-richer-than-you-thought.html

http://www.reachhighscholars.org/college_endowments.html

http://in.princetonreview.com/in/2011/02/the-richest-collegesand-why-you-should-care.html

Other Factoids:

Rice is #7 per student.

The size of the graduate and professional schools makes a big difference. Yale has 12,000 students to Harvards 21, 000.

The entire Harvard endowment is .002 of the US GDP of $17 trillion. And about the same fraction of the S&P 500.

Compared to Harvard's $30 billion, CALPERS has an investment portfolio of about $250 billion. They spend about $1 billion in outside investment expenses.

CALPERS 10 year performance is 7%. Before inflation. The S&P 500 10 year return is a little over 7%.

S&P returns are pre tax. In spite of hype to the contrary, wealthy individuals still have to pay taxes on dividends and capital gains. If they spend their money. If they don't spend it -- then who cares. Endowments and pension funds don't pay taxes on investment returns.

If outcomes regress to the mean with size and diversification, then the economy of scale argument doesn't hold for capital pools between $30 and $250 billion. And it wouldn't be unlikely that Harvard, Yale and Princeton are outliers and the diseconomy of scale holds for capital over a few hundred thousand.

A lot of the people on the Fortune 400 list made their money in a single company which is non diversified and more risky per financial theory. Especially retail and tech startups like Microsoft,Walmart, and Oracle.


Anonymous said...

texas is going to be number 2 in 2014, passing everybody but harvard. oil and gas are more important than insider trading.
A huge caveat to the Texas endowment is that it's system-wide, spread out over 15 institutions (9 universities and 6 health institutions).

The $21bn endowment is still impressive, especially when compared to the $6bn endowment for the vaunted California system, but as for "Texas," meaning the flagship Austin campus, it has a long way to go before surpassing the likes of Yale, Stanford and Princeton and that's before one even accounts for the under-12,000 students at Yale vs 52,000+ at Texas-Austin.

James B. Shearer said...

All this talk about talent in investing and still not a jot of evidence that it actually exists apart from luck.

Negative talent certainly exists. There are plenty of investments that are likely to underperform because of excessive costs. Just learning to avoid such bad investments is a kind of talent and is worth something.

James B. Shearer said...

Piketty is an idiot, economies of scale work exactly backwards ...

There are many costs involved in investing. Piketty is correct that lots of them are subject to economies of scale. It takes a lot of time and effort to learn enough about investing so that you can plausibly expect to beat the market and the payoff will be insufficient compared to your opportunity costs unless you have quite a bit of money to invest.

James B. Shearer said...

... the diseconomy of scale holds for capital over a few hundred thousand.

This is way too low. Suppose you have $400,000. Every extra 1% of return is worth just $4000 a year and so isn't worth a lot effort. Especially since as Keynes pointed out most people will find the work involved quite tedious and boring.

But with 10 times as much to invest you are looking at an extra $40,000 per year per point of return, with 100 times as much an extra $400,000 per year. Which will justify more effort (but of course rich people will also value their time more highly). Or hiring a manager which involves lots of costs and pitfalls in itself.

Anonymous said...

Unfortunately, some important people on the Rice board of trustees still seems to harbor delusions of being a relevant football power, hence their decision to ignore the McKinsey report they commissioned several years ago which basically told them to drop down to DIII and take that open invitation to the University Athletic Conference (where they would be playing against institutions like Wash U, Chicago, and Carnegie-Mellon) in favor of spending $6000 per student per year to stay in DI.

David Davenport said...

Securities markets make their money from index funds

Then why do many mutual fund managers and hedge fund managers underperform market averages?

Your assertion is the usual "financial advisor" propaganda.

Anonymous said...

This was Buffetts play, over and over again, in his early years. Its not that different than say, Baseball scouting.

Look for value.

Michael Milkin got into the situation that he could because he discovered that non-investment grade bonds paid so much that you could make money even when getting washed out on those that failed.

In the 70s the Stock side of Wall Street was so unfashionable that nobody wanted to be involved in it and in that Bear market 70 cents could buy a $.

Billy Beane's gimmick was to find valuable players among the unwanted.

Steve's homework is to look up Andrew Winslow Jones who discovered you did not have to know which way the market was going to make money so long as you hedged yourself properly.

David Davenport said...

From the 19 May 2014 issue of Barrons pages p24-p25:

Our Top 100 Hedge Funds (based on year 2013 returns ):

by Eric Ulfelder


In the concluding paragraph:

Just remember that all hedge funds aren't created equal. Scores closed their doors last year. And the average hedge fund returned a paltry 11.12% -- roughly a third of the stock market's gain ...