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The Short Term Fund
Thirty Years of Making A Difference!

This year brings us to the thirtieth year of The Short Term Fund, a milestone for Commonfund that is extraordinary. From our inception in the early 1970’s, Commonfund has focused on improving higher education’s financial systems and building upon our mission of making a difference in the organizations we serve. The history of the Short Term Fund is an example of how sound investments, unparalleled client service, and an educational focus make a tremendous difference. Over the next months, we will highlight the Short Term Fund’s accomplishments, evolution and history in a series of articles authored by those who played a critical role.

The following article is the second in a series of six retrospectives focused on the Short Term Fund.

The Short Term Fund at 30: Reflections of a founding manager

Q&A with Steve Francis

As Commonfund Treasury continues to commemorate the thirtieth anniversary of the Short Term Fund, we had the opportunity to talk with Steve Francis, one of the four founders of Fischer, Francis, Trees & Watts (FFTW), which became the first manager for the Short Term Fund. Although no longer involved in the firm’s day-to-day activities, Francis remains active at the board level in his role as Vice Chairman. In the following discussion, he reflects on the founding of the Short Term Fund and its contributions to the management of liquid investments held by educational institutions.

How did FFTW come to be the first manager in the Short Term Fund?
The founding purpose of Commonfund was to provide investment management services to educational institutions. With the main focus being on endowment investments. But early on, George Keane, Commonfund’s first President, conducted extensive research and determined that a commingled fund would provide daily liquidity for the investment of operating cash and improve both the returns and the diversification of college and university short-term investments. Additionally, the availability of such a fund would greatly simplify the investment procedures that schools were following in the management of their treasury departments.

The concept of the fund was simple and elegant, although actual operating models for funds of that type were scant in the early 1970s. As it happened, my cofounders and I had some experience with our previous employer that was very relevant to the design, development and management of a commingled short-term fund that would meet Commonfund’s needs.

When we started FFTW in July 1972, we were naturally hungry – indeed, desperate – for business. It was about that time that we first learned that Commonfund was investigating the possibility of a short-term fund for schools’ operating cash. Building on the relevance of our experience and motivated by compelling need, we worked flat-out for two years to prove our worth to George and the founding trustees of the Commonfund. In the end, the decision came down to two organizations, an obscure start-up, FFTW, and the banking giant, BankAmerica. Based on what George and Commonfund trustees saw in us in terms of experience and expertise, they made a truly bold decision and chose us. We’ll never forget that.

You did a lot of work with George Keane, modeling different concepts and structures for the Short Term Fund?
There was a huge amount of work, not only by Commonfund and ourselves, but also by Collin Scarborough and his group at Technology Management Inc. in Cambridge, Massachusetts. More than anything else, the modeling improved everyone’s understanding of the economics of a commingled liquidity fund, and, for the schools that participated in a pilot study, the modeling raised awareness of their real investment needs and requirements.

Even for a fairly large school it’s quite difficult to get adequate diversification in a portfolio and maintain that diversification when standard round-lot transactions in the money market are $5 million and above. And every time there is an outflow, the school’s portfolio manager needs, in theory, to sell a proportionate fraction of each of the investments held in order to keep the portfolio’s strategy constant. A commingled fund is a very good solution to that kind of problem. It also relieves participants of the costly challenge of maintaining appropriate investment controls and reporting systems.

What do you recall thinking when Commonfund first started talking about what would become the Short Term Fund?
The simple answer is pure excitement. The idea of starting something new with the potential of the Short Term Fund in conjunction with the building our own business had immense appeal. That was why we were prepared to commit to the project all that we had to offer. Based on our previous experience, we were confident that the Short Term Fund was feasible and believed it would have significant appeal to schools. Of course, we all had to sweat the details, and that as always is a big challenge. There were hundreds of issues to be addressed and resolved. Although it was going to be a formidable undertaking, we recognized right away how innovative it would be. And we were young enough to think that, despite the hurdles, it was going be a lot of fun. And, indeed, it was.

But right away, you felt the model – once you worked through all the details – was something that was going to work?
Yes, and though there were skeptics of course, a lot of other people did, too. Now, as to the scale of its potential, we thought it could reach a billion dollars, maybe in our dreams $2 billion. Clearly, with the fund now in the $13 billion neighborhood, we undershot on that one, even adjusting for 30 years of inflation.

What was 1974 like in the fixed income market?
All the financial markets, being interconnected, were pretty much a picture of doom and gloom after the shocks of the first oil embargo and the inflation that it brought with it. There was a lot of anxiety in financial markets. In retrospect, of course, the tense environment that existed then, particularly in the equity markets (the S&P 500 Index fell 48 percent from the end of 1972 through September 1974) was only a prelude to what was to come, when inflation accelerated and the subsequent shifts in monetary policy to correct previous errors led to historic volatility in interest rates. There were some fundamental mistakes in the conduct of monetary policy in the early and mid-1970s. In 1978, Paul Volcker came in as Chairman of the Federal Reserve and began the heroic and prolonged process of wringing inflation out of the system.

People today seek enhanced returns for their operating cash. Was the situation dramatically different 30 years ago? What were most institutions (profit and nonprofit) doing with their operating funds?
Irrespective of the time period, investors universally seek to enhance returns within the constraints they put on acceptable investment risk. That was as true then as it is now. What is obviously different is that the range of investment choices, both in terms of the instruments and the tools available to portfolio managers, has grown enormously.

In addition, in the early 1970s, a preponderance of large institutions followed a buy and hold strategy wherein they would buy an instrument – often a bank CD, commercial paper or Treasury bill – and hold it to maturity, using cash from redemptions to fund any cash outflows. That’s a pretty inefficient way to manage a liquidity portfolio, since, among other considerations, expected cash outflows end up determining the portfolio’s structure. Additionally, the buy and hold strategy fails to utilize the single outstanding feature of money market instruments, their liquidity (their ability to be sold at short notice at low cost). As commonly practiced then, the approach also often led to substantial and potentially risky concentrations of investments, typically in the obligations of local banks.

A related and favorite point of mine is that during the period when the Short Term Fund was being formed, cost-based as opposed to market price-based accounting was the dominant measure of investment results. This meant that calculations of performance for almost all short-term portfolios and a very large proportion of long-term portfolios, as well, were based on the original cost of the investments in the portfolio rather than on their current market value. This practice greatly distorted investment behavior and played, for example, a central role in the massive and hugely costly savings and loan crisis about a decade later. The portion of assets that are being marked-to-market has gradually increased across asset types and institutions, but even today it is not 100 percent. We still see distortions in investment behavior due to the marking of assets to original cost rather than to current market value.

How do you recall the idea of the Reserve Fund being received?
It was and is a novel concept. Essentially, participants in the fund agree to forego a certain amount of return when performance exceeds a benchmark in order to attain a return that – to the extent permitted by the accumulated reserve – matches the benchmark when portfolio returns are lower. It is a mechanism for spreading the volatility of investment returns over time that many find attractive.

What do you believe is the major contribution of the fund’s multi-manager structure?
Multi-manager structures provide manager diversification, which over time should at least lower risk and maybe raise returns. The diversification derives from the investment choices each manager makes. There’s much to commend diversification among managers, which is why the practice is popular in all areas of the investment world.

The fund’s managers can lengthen average maturity of the portfolio. How useful this is to managers in the fund?
There’s more flexibility in managing the average maturity of this portfolio than there is with money market mutual funds. The greater flexibility adds a strategic dimension. But it should be noted that there are other strategic dimensions that are equally, if not more, useful, including the choice of instruments, such as asset-backed securities. These securities didn’t exist when the fund was founded, and have made an enormous difference.

As you recall, looking back over 30 years, what was the most difficult period for you as a manager?
The past 30 years have been an exciting journey. Interest rates have cycled over a range that was unimaginable beforehand and looking backward still seems improbable if not incredible. But to answer the question, I’m inclined to go with an old financial market aphorism that holds, “Now is always the most difficult time to invest.”

In summary, what do you see as the most lasting and far-reaching contribution of the Short Term Fund?
I’d like to believe that all involved in the Short Term Fund, from its origins to the present, have made a valuable contribution to the investment choices available to colleges and universities across the country in terms of how they manage their operating and endowment cash.

Think of a college treasurer or financial officer with broad responsibilities and a great many priorities. Given these responsibilities and priorities, is it practical for that person to make telephone calls to dealers to investigate the best ways to invest the institution’s short-term cash, to oversee the settlement of trades, to put controls in place and monitor them through time, and to produce informative reports? I hardly think so. The Short Term Fund has made all of that obsolete. And, over the years the Commonfund organization has continuously made enhancements that have been made managing cash through the Short Term Fund ever more efficient and less expensive. The technological advancements alone – Treasury Access comes to mind – have made the management of cash very efficient and lowered transaction costs tremendously. But in the end, I think the fund’s most lasting and far-reaching contribution can be gauged best by the schools themselves, as reflected in the number that participate in the fund and in aggregate size of their investments. By these standards, the Short-Term Fund has been a gratifying success for all.

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Inventing the Short Term Fund