KS: UC is a State public institution with 43,000 students and 16,000 faculty and staff. So, it's a pretty big school and biggest employer in Cincinnati. Our $1.1 billion endowment pool is comprised of about 1,800 underlying individual endowments. Each endowment supports a specific program at UC, so the endowment is very important to all the constituencies on campus and to the local community. It's a very important task managing the endowment and a role that we enjoy and take very seriously in the UC Investment Office.

Strong governance is extremely important to an institutional investor like UC. When I started in 2011, the University's governance was already in good shape, but we've been working to strengthen and clarify policies, procedures, and the governance structure. The University has an investment committee which is a subcommittee of the Board of Trustees, comprised of eight people, six of whom are Bearcats and (obviously with overlap) six of whom are experienced investment professionals. It's a terrific culture on the investment committee. They are very talented people and all very devoted to getting the best outcome for UC without any discernible political aims, self-aggrandizement, or ego. We believe a partnership between the investment office and investment committee leads to the best outcomes and have worked hard to foster that kind of relationship. Committee members do a great job for UC overseeing the investment office, setting risk appetite and strategic target allocations, and helping us with networking and idea generation. It's a very active partnership and I think it's been successful in that regard.

USM: What are your investment strategies across asset classes?

KS: We have 15 percent in core-plus fixed income - pretty traditional, high quality US dollar-denominated bonds that exist to provide us liquidity and value during a downturn. We have a 20 percent allocation to absolute return hedge funds that provide two benefits to the portfolio. Number one is diversification; these are primarily talent-based strategies such as distressed strategies and a variety of arbitrage strategies that aren't driven by the same forces that drive bond markets or equity markets. We funded our absolute return hedge fund portfolio out of the fixed income portfolio three years ago when we adjusted our overall allocation. With low interest rates we felt that the upside potential was greatly improved for the portfolio overall by increasing our allocation to our absolute return portfolio.

KS: That's exactly right. We have 41 percent allocation to global equities with an emphasis on emerging markets which has been a little painful lately needless to say. We have 20 percent in private strategies which include private real assets, private equity, and private real estate. Finally we have a small four percent allocation to public real assets, which is really a placeholder that gives us a tool for increasing our portfolio's inflation-benefited assets if inflation starts to pose a problem for the economy. We don't believe that's a very high returning area today and so it's a small allocation.

KS: We're looking into a whole bunch of different things, and like many other permanent pools of capital, always staying aware of potential new opportunity sets. As a background, in the '80s and '90s, private equity offered a new set of opportunities, then hedge funds became a new area for investment, and then permanent pools of capital began allocating to timber, and so forth. We continue to evaluate opportunities in agricultural land, in direct lending, and other areas but so far none of those have appeared to be compelling additions to our portfolio. Also, within the asset categories that are already very well-known among institutional investors but in which we don't currently invest, we're constantly assessing how long/short equities, global macro, and frontier markets would affect our portfolio's risk profile and return potential. Currently, I think that our portfolio is very well positioned for a wide range of potential outcomes in the next couple of years. I think we're late in this economic cycle and potentially transitioning out of a post-2008 recovery mode into a more "normal" environment characterized more by normal credit cycles and less by significant global meltdown risk.

KS: I've been very pleased with our returns in the past year. We have spent a lot of time since I arrived analyzing managers and making a handful of switches, but also retaining some of the managers that were here when I arrived and I feel very good about our lineup. During the past year, our managers have outperformed their relevant benchmarks on a more widespread basis than we would normally expect. So I think that the portfolio will generate a return of 15% to 16% for the fiscal year, which I'll be very pleased with, given the amount of risk and the types of risks in the portfolio.

KS: Each manager in our portfolio plays a specific role and, depending on the role, our approach to due diligence is pretty flexible. Especially in private equity, though, we are investing in people. We're looking for people with sterling integrity and demonstrated, repeatable, and profitable skills in a structure that provides good governance and strong alignment of interests. There's obviously a substantial amount of quantitative analysis and operational research that we need to do and do well. But it ends up being an art - the judgment of the people is the key element of an institutional investment program like UC's.

USM: What is the typical size of commitment that you make to a fund?

KS: Position sizing is a function of asset class and a manager's strategy. In our core fixed income portfolio, we have several positions that are about 7 percent of the overall portfolio. In US equities, we have a couple of 8.5 percent positions in large cap index funds and several smaller positions in mid cap and small cap managers. In our absolute return portfolio, the maximum position size is right around 3 percent and we have a handful that is 1 to 1.5 percent each. Our larger positions in our absolute return portfolio are lower-risk positions, and not just lower volatility, but lower risk overall. Our private equity commitments are usually around one percent of our assets because we want to make sure they're meaningful to the portfolio. Also we think it's easy to fall into the trap of trying to control risk in private equity with smaller position sizes when the only effective way to control risk is through fund selection. Another philosophical point in position sizing across our portfolio is maintaining a fully diversified portfolio while avoiding having too many funds to actively and thoroughly monitor.

KS: Private equity is the place in our portfolio where I'd say the broad top-down outlook may be the least relevant; there are investable themes in every era and investing with the right team drives the outcomes much more than our ability to forecast next year's GDP. Today, if you look at private equity markets, valuations have risen, leverage is up, and debt covenants are weaker than they have been since 2007. But we are finding firms that have the ability and the intestinal fortitude to wait when opportunities are not ripe and to take advantage of opportunities when they present themselves.

KS: If you're looking at our program from a top down perspective, there are a couple activities that are affected by our outlook. Number one obviously is strategic asset allocation. Our Investment Committee sets our strategic targets, ranges, and caps, and our job is to marshal all our programs resources to supply them with the best context and inputs, provide thought-provoking recommendations, and foment a productive debate. For traditional asset categories, we use targets and ranges as most institutions do; but for alternatives, we establish maximums instead as an additional risk control for our Investment Committee. Being under each of those caps creates a small portion of the portfolio that we keep invested in our traditional portfolios. Where we allocate that capital, and the speed with which we rebalance to our target allocations, are the other areas of our program that have sensitivity to our outlook.

USM: What is your outlook on the US economy? What do you expect this year in the housing market?

KS: I think that the US economy is actually in better shape than most folks believe. I expect to see an increasingly stable, if still slow recovery going forward. It's easy to be pessimistic in this kind of environment - as usual. Pessimistic arguments are almost always more intellectually compelling, but I think now is the time to be rationally optimistic. Obviously, investors were rewarded for taking risk last year in equity markets at a time when it would have been easy to take risk off the table. US equity valuations are full to high, depending on which metrics one looks at, and US corporations need to deliver profits to justify those valuations. In US credit markets, spreads are very tight and yields are low; timing is impossible to foresee, but sometime the next few years we're going to see the end of a credit cycle and a jump in defaults. One big wild card in the US is interest rates, but I think people have been too deterministic about interest rates for years and continue to be so. If rates rise due to an improving economy, the housing market will act as a governor on interest rates by slowing in response to higher mortgage rates. The real threat is rates rising due to a policy mistake or macro-change in investor sentiment. Otherwise, the risk of a rise in interest rates is probably overblown.

KS: Some types of distressed strategies will become pretty attractive over the next couple of years. The critical element in generating a good outcome with distressed strategies within your portfolio is going to be making sure your managers don't buy a substantial amount of troubled assets before a credit cycle hits. It's also vitally important that the structure and liquidity of any fund vehicle matches the liquidity of the underlying assets. Those are two ways you can lose when investing in distressed strategies in advance of a period of distress.

KS: One of our newest and largest positions is a fundamental index and I believe that there are two compelling reasons to add fundamental index strategies to the portfolio. Number one, I think that cap-weighted indices have some systematic headwinds in the form of rebalancing into companies as their valuations rise. So, just taking away that headwind is one benefit. The other is mistake avoidance; if you were to see a bubble like the Nifty Fifty stocks of the '70s or the Internet bubble in the late '90s, cap-weighted indices will suffer during those much more than fundamental weighted indices. Fundamental weighted indices can play an important role in portfolios, but one must be careful that the index is weighted in a sensible way and isn't so fancy that it runs afoul of these two basic advantages.

USM: Many investors have talked about managing volatility. Can you tell me a little bit about what you're doing to manage volatility in contrast to investors who are managing stock market volatility with a focus on risk management?