John Neff’s knack for finding gold among “woebegone” companies has transformed Penn’s endowment from among the worst performing in higher education to one of the best — at a price you can’t beat.
By John Prendergast | Photo by Michael Ahearn
Attending the open meeting of Penn’s board of trustees can be a bit like watching the performance of a play made up entirely of stage directions. Whatever hashing out of issues has been required has already occurred, and the meetings pass in a blur of motions, seconds, and “ayes.” But there is usually one spark of life in the proceedings, which is the moment when John Neff, Hon’84, who chairs the University’s investment board, delivers the latest investment report.
Partly this is due to Neff himself. A leading proponent of what is variously called the value-oriented, contrarian, or low price/earnings (p/e) ratio school of investing, Neff is a near-legend among investors for his ability to pick winners from among apparently floundering companies and industries. His Windsor Fund outperformed the industry yardstick, the Standard & Poor (S&P) 500, in 21 of the 31 years he managed it. Neff is also possessor of a fine, dry wit and favors down-to-earth language over technical jargon when it comes to describing financial matters. An article in Fortune last year aptly summarized him as “an investor who has a nose for value, a concern for shareholders, and a unique way with words.”
It also helps that, with a few exceptions — the recession years of 1989-1990 comes most vividly to mind — he’s had good news to share. Certainly, that news has been a lot better than it was in the 1970s, the decade before Neff, a non-alumnus whose undergraduate degree is from the University of Toledo and whose MBA is from Case Western Reserve University, was persuaded to take over management of Penn’s endowment by then-chair of the trustees, Paul F. Miller Jr., W’50, Hon’81.
In the 18 years since Neff began managing the equity portion of the Associated Investments Fund (AIF), the fund that represents about 73 percent of the University’s total endowment, the overall endowment has grown from $200 million to more than $2.5 billion. According to the National Association of College and University Business Officers (NACUBO), Penn currently ranks 12th in total endowment — though in terms of endowment per student the University continues to lag behind its peers, coming in at 65th.
According to John Fry, the University’s executive vice president, preliminary statistics from NACUBO put Penn among the top 25 percent of all endowments in terms of its performance over the last 10 years, “and significantly better for other measurement periods.” Under Neff’s leadership, the average annual return for Penn’s equities has been 18 percent since 1980, compared to 17.1 percent for the S&P 500. “John Neff has consistently exhibited skill and thoroughness in his work as chairman of Penn’s investment board and as a University trustee,” says Fry. “As a result of his financial talent and sense of responsibility, he has been an extremely valuable trustee both on the investment board and on other committees.”
Neff’s most recent investment report was on February 20. It’s not clear how many more he will deliver. Though he remains as chair of the investment board, he personally manages only about $85 million these days (down from about $1 billion), and is looking to liquidate that as opportunities arise. Neff retired from his position as manager of the Windsor Fund at Wellington Management at the end of 1995, and since then has been gradually winding down his direct involvement with Penn’s investments while participating in the board’s efforts to replace him. It hasn’t been easy.
Over the past two years Penn has been shifting to a system in which several external firms will manage its equity investments rather than a single investment manager like Neff — a move that brings the University more in line with the practice at comparable institutions. Having multiple managers, including international and emerging markets equity managers, makes for a “significantly more diversified” portfolio, says Fry, adding that, while doing this, the investment board “has continued to maintain a value-orientation.”
“We’ve tried to remain as contrarian as we could,” agrees Miller, a member of the investment board who chaired the ad hoc committee that settled on the plan, “but there’s no other John Neff out there.”
From the Depths
“Dismal” is the word Miller uses to describe the record of Penn’s endowment in the 1970s. The University began the decade by losing millions in the bankruptcy of the Penn Central Railroad. That was followed by an ill-timed foray into growth stocks just as the stock market was going into a decade-long stall. Penn’s 10-year endowment performance on June 30, 1979 ranked in the lowest 97th percentile of all endowments as measured by NACUBO. Average annual returns over that period were 2.25 percent.
Searching for a “dramatic way to improve performance,” Miller, who had become chair of the trustees in 1978, went to then-Penn president Martin Meyerson with the idea of approaching Neff — “the best investor I know,” he said — to become chair of the investment board. Meyerson, whose administration from its start had been constrained by Penn’s persistent financial problems, heartily approved. Today, he says of Neff, “I’ve never known anyone so disciplined” and praises his “infectious enthusiasm.”
Miller and Neff had known each other since 1962. Neff had managed the Gemini Fund, on which Miller was a board member, and both belonged to a group called — “somewhat arrogantly, but not really,” says Neff — the Garden of the Gods group, “big hitters in the investment tribe that got together twice a year at some great resort, with wives, and kicked things around — a forum of people that you respect.”
As Miller and Neff tell it, what evolved into a relationship of nearly two decades and counting began with a “long shot” telephone call. “He called me and said, ‘This is a long shot, but would you consider running Penn’s endowment and becoming chairman of the investment board?'” Neff recalls. Miller adds that he sweetened the proposal with this offer: “I told him the only compensation he would get would be a parking sticker and a trusteeship.” After talking it over with his wife, Lillian, Neff told Miller he would accept. “I said, well, I’ve never given a whole lot back [to the community], and I was never going to be a big fundraiser or something like that. That’s not my speed.”
The next step was an appearance before the investment board. “I had to give them a song and dance [about] exactly how I managed money and what I hoped to do at Penn,” Neff explains. “There were some pretty tough people on there, including John Eckman, who was an old curmudgeon. They called him the U boat commander — somewhat behind his back — but even he said, ‘Yeah, it sounds pretty good to me.”
After being approved by the full trustees, Neff’s tenure as head of the investment board began December 31, 1979. At the same time, Miller had recruited Richard Worley, a colleague at his investment firm, Miller Anderson & Sherrerd, to handle the University’s fixed income investments. Worley is “one of the smartest guys I know” in that area, Miller says. Since the end of 1979, those investments have also outperformed the standard benchmarks, returning 11.8 percent annually versus 10.7 percent for the Lehman Bros. Government/Corporate Index. High-yield bonds, in which Miller Anderson & Sherrerd began investing on Penn’s behalf in March 1991, have returned 15.9 percent versus 14.9 percent for the Salomon Bros. High Yield Index. “The combination overall did very well for Penn,” says Miller. (Both Worley and Neff have donated their services over the years — at a savings the University estimates at more than $100 million.)
Remaking Penn’s portfolio
When he took on the job, Neff didn’t know much about Penn’s investment portfolio, “except [where] it appeared here and there in the press and didn’t always get a very good notices, for obvious reasons,” he says. “The irony was occasionally, here’s the Wharton School and here’s Penn’s endowment fund that stood in somewhat startling contrast.”
Once he did become familiar with the portfolio, Neff was quick to make changes. “He ripped the endowment from one end to the other,” says Miller. “He changed the whole portfolio.”
Neff’s description is more measured, but comes to about the same thing. “I didn’t just tear it apart right away, but within six months it evolved into pretty much the Windsor Fund portfolio,” he says. “I sold some stuff right away. Those that seemed okay, or maybe even undervalued, I kept around for a while, but eventually I got out of them.” Ironically, in that first year “which was a poor year for my type of stocks,” Neff says, Penn’s portfolio actually did better than the Windsor Fund “simply because it had some stuff around that I hung onto a bit. Both portfolios did poorly, but Penn’s did less poorly.”
Despite that rocky beginning, Neff recalls little resistance from the trustees as he redirected Penn’s investment strategy. “There was one member of the investment board that shall remain anonymous that kind of bellyached a little bit at Martin Meyerson,” Neff says. “I remember one of his remarks was, ‘God, all he buys is shoe stocks.'” Neff calls that “a stretch,” although he allows that he had bought stock in several companies that had started in shoes, but had since diversified dramatically. “But the remark was not totally inappropriate,” he adds. “Because I’ve always said if the portfolio looks good to you, we probably aren’t doing our job. You’ve got to be careful you don’t wear that on your sleeve. On the other hand, we were buying stock that was out of favor, ‘misunderstood,’ I would say — somewhat woebegone and relatively unloved — and that’s not too far from a cogent description of low p/e stocks.”
Meyerson pooh-poohs any talk of serious complaints. “Half of the board were trying to get [stock tips] from him,” he says with a chuckle.
Miller, too, shrugs off the idea. “Things that are cheap are not things people are going to be comfortable with,” he says. In sharp contrast to “the general attitude of Wall Street, which goes to extremes on both ends, overselling and overbuying,” Neff has the rare ability to “keep his head while others are losing theirs. He is very dispassionate and unemotional about stocks,” Miller adds. Neff is not always right, but, “Contrarians are right about two thirds of the time.”
Though he prefers the neutral “low p/e approach” to “contrarian,” Neff embraces the label, along with the adjective “crusty” that usually accompanies it in press accounts. “I’d plead guilty, I think. I wouldn’t want to wear that on my sleeve, but you call them like you see them. You need a pricker of the bubble or someone who’ll take on, in effect, the conventional wisdom. You don’t want to overdo that; it’s only good if it has utility for the shareholders — in this case, the endowment — but that’s been a characteristic [of mine] for better or worse. My mother used to say to me, ‘John Brown, you ought to be a lawyer. You’d argue with a signpost.’ She’s essentially right, but I did the better thing, which was to argue with the stock market.”
Winning the Fair Maiden
It’s an argument that he’s won, much more often than not, with an investment approach that boils down to finding the strengths in companies and industries that the market says are weak — to recognizing Cinderella under the ashes and rags. “I’ve always said the odds are very much with the low p/e player, because the market’s not anticipating anything there and is dishing up companies that, allegedly, by virtue of their valuation are poor companies,” Neff explains. “Well, they aren’t poor, they’re probably above average if you are selective and have some kind of skills to pick them.”
While there are sometimes very good reasons for a given company to be out of favor, in other cases it may simply be the victim of a “marketplace that is so much a captive of momentum investing,” he says. “You get some very sharp fluctuations in industries and companies within industries. If you can get the other side of that with a low p/e approach you win [the] fair maiden in the end. But it’s lonely, and you don’t have your hand held by others — because they’re selling — and not everybody can do that.”
Asked to rate his own overall performance at Penn, Neff calls it, “Pretty good, actually. I think it’s about 350 basis points better than the S&P 500 on the straight domestic equity side and that’s a good performance.”
Still, there have been a number of ups and downs over the years. “There always are when you do this kind of stuff, because you could be out of market favor for a while — and you can even be wrong fundamentally,” says Neff. “That’s the key. You’ve got to be right fundamentally, but even if you are it can take time for it to be recognized, or some of your areas can come under attack. There were a couple of dry spells — 1980, as I mentioned, and the other one that was quite bad was 1989 and 1990. That was a period when the banks in particular but financial intermediaries in general, of which we had a considerable portion, came under attack in the marketplace.
“I even got some poison pen letters from shareholders: ‘You idiot, can’t you read the newspapers? All the savings and loans and the banks are all going to go out of business. Why do we own them?’ Sometimes they even used rougher language than that,” Neff recalls. “Of course, that’s the conventional wisdom, and that’s what you’re taking on. That would have been the most treacherous period and the one when we did the worst — although I never really felt on the investment board or even among the trustees a loss of confidence.” Of course, he adds, “I did have 10 years of accomplishment under my belt then,” which might have helped.
Going South on Stocks
Like most other institutions, the University has benefited greatly from the rising stock market of recent years. But Neff, ever the contrarian, remains leery of the market’s apparent unending rise. While the University’s equity percentage “reached 65, even 70 percent stocks when that wasn’t too fashionable, gradually, as the market got very happy, we were going kind of south,” says Neff. “Not to desert equities completely, but [we] recognized — and we haven’t been proven right yet, incidentally — that our market domestically was on the high side.”
As Neff’s management of the portfolio has been cut back in the last couple of years, the University has been buying stock in foreign companies, he notes. While the overall percentage of the AIF invested in stocks has not changed much since 1979, when it was at 58 percent, back then it was all in domestic stocks. Today, those make up a little more than 40 percent of the portfolio, while international and emerging market securities account for the rest of the equity portion. Penn has also started investing in some new areas. Referring to the breakdown of categories of investments, Neff says, “We never had much in ‘other,’ and other was venture capital, real estate, drilling funds, and what now is called alternatives, which includes a lot of high risk stuff,” says Neff. Investments in real estate and high-yield, or “junk,” bonds have performed well — 22 percent for real estate and about 15 percent for bonds, estimates Neff. Unfortunately, “the irony of all this is that equities have done a bit better than either of those areas, so we don’t look quite so good relative to having maintained an aggressive equity position. But you are managing precious money, and you have to have some kind of risk awareness. So, those were not bad decisions under the circumstances. I would not apologize for them.”
Paul Miller says that Neff had proved willing to manage Penn’s endowment for “much longer than I thought he would,” though Neff downplays the time and effort he put in. “It never got to be a pain or excessively time-consuming, because it was essentially an extension of what I was already doing,” he says. He credits the University’s associate treasurer for investments, Lucy Momjian, and colleagues in the investment office with “all the heavy lifting” involved in the execution. “All I did was tell them kind of what to do. I spent more time probably on other Penn responsibilities than I actually did on the investment side.” Besides chairing the investment board, Neff serves on the trustees’ executive and audit committees.
When Neff retired, he said he would handle Penn’s portfolio for a few more years, but clearly another transition was imminent. At the point of his retirement, the decision was made to “change the whole pattern to outside management,” says Miller. One reason was that the endowment had grown so much. “There’s been an immense change. We’ve caught up. There’s still a lot more to do on endowment per student, but we’re much better off than we were.”
Under the new system, the investment board, supported by Penn’s Office of Investments, will still determine in a general way how the University’s investments will be allocated, but specific purchasing decisions will be in the hands of several external firms — who, John Fry notes, are being paid at market rates. Currently, there are five equity managers for domestic stocks, and two each for international and emerging markets.
“This would be the more conventional way that massive endowments and even less-than-massive endowments would be run,” says Neff. “Rarely, if ever, is there the kind of stewardship that we described for those 17-18 years. Typically, what they do is exactly what we’re doing now.”
The transition to external managers is off to a good start. Return on the endowment was 23.2 percent for fiscal year 1997, which ended last June 30, well ahead of the 20.4 percent return among other endowments reported in the 1997 NACUBO survey.
But however effective this new arrangement proves over the long term, “We’ll never be as successful as we were in the first decade of John’s tenure,” says Miller. The reason is that one manager can always take a riskier position than five managers. Given that, the current setup is “more likely to be like the market.” In the early years of Neff’s tenure, Penn did take a risk. Says Miller, it was “a bet that worked.”