Understanding cash flows is an essential element of managing university endowments. When budgeting, institutions not only need to account for rising costs, but also for the college’s spending to achieve strategic goals, such as funding scholarships, improving operations, providing grants or launching new programs. At the same time, the recent political pressures at play are causing endowments to cut spending on investment management talent. Ultimately, these impact an endowment’s value and returns.
While the average endowment achieved an 8.2% return in fiscal year 2018 and 12.2% in 2017, according to the 2018 NACUBO-TIAA Study of Endowments, 10-year average returns across endowments have continued to trail their stated targets.
As a result, many endowments have been steadily shifting from traditional stock and bond portfolios toward greater allocations to private equity, private credit, real estate, and real assets within their multi-asset class portfolios. According to NEPC’s Q1 2019 Endowment and Foundation Survey, 41% of endowments and foundations managing between $100 million and $2 billion plan to increase their allocations to private equity and private credit this year. Nearly a quarter of the respondents plan to increase their allocations to real assets and real estate.
Allocations to these alternative asset classes currently average only about 9% of overall endowment portfolios, according to the NEPC survey. Consequently, internal investment team expertise isn’t immediately available to support growth targets for these newer asset classes. This, along with the previously mentioned pressures on costs associated with retaining in house talent, has many endowments increasingly relying on allocations to external managers. Oversight of outside managers — especially those managing alternative investments – is immensely complicated and involves setting up new processes and systems to monitor performance, risk, liquidity and other metrics on an ongoing basis. As allocations to external managers ramp up, endowment and foundation investment managers will have an increased need for more frequent, professional and heavily data-driven oversight of the investment function to ensure they are continuing to fulfill their obligations.
Going with multiple external managers, by definition, creates a more fragmented infrastructure and added risk that an endowment’s investment management staff is held accountable for from a selection, monitoring and replacement perspective. And while large endowments still have sizeable investment management staffs, many small or mid-sized endowments and foundations rely on their own boards and consultants to evaluate current and prospective managers, assess risks and performance, and make allocation decisions. The increase in the number of roles involved only perpetuates risks and challenges to the investment management process.
Tools to normalize the incoming data and reporting output for this purpose become critical, particularly given the anticipated allocation increases toward more illiquid asset classes. Private equity and private credit, for example, are typically not subject to mark-to-market valuations, and alternative strategies have more limited performance metrics in general.
As they move into new asset classes, many of these smaller funds have strengthened their investment practices by adopting more detailed investment policies that govern the use of leverage and derivatives or adhere to certain allocation targets. They’re also adopting more sophisticated analysis of the portfolio that takes into account capital calls for private equity funds, co-investment capital and performance metrics, which are very different from publicly-traded stocks and bonds.
Enhanced analytics and data that allow funds to stress test their entire portfolios for different scenarios will be critical for endowments and foundations as they move into more alternative asset classes and look to streamline their portfolio management and reporting processes.
To find out more about how comprehensive data aggregation and analysis can inform your asset allocation and management decisions, explore the Solovis platform.
Endowments and foundations looking to investigate tools for better managing portfolio operations and gaining clearer insight across a multi-asset class portfolio should check out Solovis’ Get Lean in 2019 resource center.