Paste your essay in here…CornerStone Partners Case
Summary
Within the case for CornerStone Partners, J. David Maas, CFO for Lumina, is trying to decide whether or not he should give CornerStone Partners the ability to manage Lumina’s $1.1 billion endowment. This outsourcing decision arises out of the fact that the CIO for Lumina recently resigned. He found that many foundations outsourced the responsibility to oversee their endowments to investment advisory firms, and he wanted to truly know how giving the duty of the CIO function to an outside firm could bring value after deciding what firm to ultimately choose. Nowadays, investment management companies are actually giving advice and executing the recommendations. This can be due to the fact that little endowments aren’t sizable enough to bring about a full-time investment team, the rise of nontraditional asset classes, and more.
CornerStone maintained a small client list because close relationships and responsive service were of great importance to the company. The company believed this was a key differentiating factor between CornerStone and large investment management companies because it provided CornerStone the ability to establish a sincerely customized portfolio for each client. Leading not-for-profit organizations, foundations, and endowments are contained within CornerStone’s client list, which is closely related to the potential addition of Lumina as a client. The firm first has meetings and conversations with the client, and then the company formalized its assessments into the Investment Policy Statement (IPS). The IPS contained a governance structure that clearly states the responsibilities of both parties. If there were any ambiguities, a new IPS would be created for the specific clients.
Asset allocation plays an important role for CornerStone’s investment strategy because clients are often highly concerned with the volatility of their portfolios. CornerStone would generally follow its target asset allocation based upon its investment objectives in the IPS, but the company does have the ability to make tactical asset allocations choices or short-term deviations when the market environments make it crucial. Selecting the right manager afterwards to create solid returns was also important to CornerStone’s beliefs. The alpha, which is the outperformance achieved by the managers compared to the benchmark, is a way that CornerStone would help create wealth for its clients. CornerStone looks at the passion and philosophy that managers have on top of the sustained benchmark outperformance when selecting the ideal manager. Fees would also be lower for client than if they invested directly with the manager because of the scale of assets CornerStone would give to a manager. J. David Mass got to see CornerStone’s actual investment results from 2008 to 2011 compared other methods as well as asset allocation returns to compared to their benchmarks to bring a sense of how beneficial CornerStone’s manager selection process was for Lumina. With all this in mind, Maas needs to evaluate all of his options and decide what is truly best for Lumina going forward.
Case Answers
1) As clearly mentioned within the case, the pros of using an outsourced advisory firm include more complex portfolios that yield superior returns while better enduring challenging periods, lowered opportunity costs that result from acting on investment opportunities swiftly, and access to the complete array of the advisory firm’s skill and capabilities. The cons of using an outsourced advisory firm include the additional cost of an intermediary, handing over control of investment decisions, and reduced transparency.
2) The purpose of an IPS is to outline the client’s investment objective as well as the functions and accountabilities of both the client and firm. It may even include a governance structure that provides clearness between both parties about their responsibilities. Lumina would prefer the revised IPS in Exhibit 3 over the inherited IPS in Exhibit 2. This is because it provides more clarity through numerical statements and better reasoning behind the descriptions, which allows for less ambiguity.
3) I agree with the separation of responsibilities in Exhibit 4. Not one team has too much power over the overall process to make the other teams seem useless. From Lumina’s perspective as the client, they would want to have more control over the execution because they may want to look at the decision investment managers make before a security goes into the portfolio. Lumina may also want more control over the evaluation phase so that if something goes wrong, they can have a quicker and bigger say in the changes made to help improve the performance of the portfolio.
4) CornerStone’s sample client portfolio performs exceptionally well compared to the other investment options. The sample client portfolio returned 2.13% in the four-year period, and it was the only portfolio to earn positive returns besides the 0.44% return for 3-month T-bills. This proves that tactful asset allocation played a role in the returns of the portfolio. The client portfolio outperforms the IPS portfolio by 295 basis points and with a standard deviation that is lower by 198 basis points. The client’s portfolio also beats the S&P 500 by 377 basis points and with a standard deviation that is 904 basis points less than the S&P 500 over the same four-year period. Having an astonishingly less standard deviation than the other options (besides T-bills) indicates that manager selection is an important factor into the risk of the portfolio. These reasons prove that CornerStone’s strategy can provide better returns at a lower risk through both asset allocation and manager selection.
5) To calculate the portfolio performance for both the client portfolio and IPS portfolio, the following formula is used for both: ReturnPortfolio = WeightDomesticEquity*ReturnDomesticEquity + WeightGlobalEquity*ReturnGlobalEquity+…). Using this formula, the return of the client portfolio was 2.128% and the return of the IPS portfolio was -0.819%. Comparing between the two portfolios, the client portfolio outperformed the IPS portfolio by 2.947%. This suggests that the IPS portfolio followed more of the market than the client portfolio did. This is not good for the IPS portfolio since the market did not perform well overall in the 2008-2011 time period. Strategic asset allocation and better portfolio weightings in the client portfolio allowed for losses that were not as severe in the equity asset classes compared to the IPS portfolio overall.
6) Following the tactical asset allocation weights, but keeping the IPS portfolio returns would bring an overall return of -0.107% using the same formula in question 5. Since the return of the original IPS was calculated to be -0.819% through answering question 5, just changing to the tactical asset allocation weights brings an increase in value by around 0.712%. This clearly demonstrates that strategic asset allocation brings more value to the portfolio. It also shows that managers can play a key role in the returns as well since the client portfolio was greater than that number overall.
7) Using CornerStone’s manager selection decisions, but following the target asset allocation would bring an overall return of roughly 1.841% using the same portfolio performance equation in question 5. Because the original IPS return is estimated to be -0.819%, the manager selection decisions for the client portfolio increased the value by 2.660%. This indicates that manager selection decisions did indeed significantly impact the value of the portfolio.
8) The true value added by CornerStone Partners would be a yearly average return of 3.372% through its asset allocation and manager selection decisions based on the facts given in the case and the answers for questions 6 and 7. To explain, this is done by summing together the increase in performance through tactical asset allocation, 0.712%, with the increase in performance of the manager selection decisions, 2.660%. In dollar form, the value added for each year is estimated to be $37.092 million. This is calculated by taking the 3.372% and multiplying it by the $1.1 billion endowment that Lumina would potentially give to CornerStone.
9) I would recommend that Lumina outsources the management of its endowment to CornerStone. This is because CornerStone’s tactical asset allocations and manager selection decisions both clearly make an impact on the value of the client’s portfolio as demonstrated through the answers in questions 6-8. Not only that, but the client’s portfolio displayed that highest returns compared to the other options in Exhibit 5 while having relatively the lowest risk besides the 3-month T-bills. It is important to note that the 2008-2011 time period in the exhibits is significant in that it contained a big recession, which further displays the impressive feat for CornerStone. CornerStone also makes it evident through their entire philosophy and process that the firm emphasizes the exceptional client service and intriguing investment results over the increase in assets under management, and the small size of the firm backs up this strong advantage.