What Keeps Endowments and Foundations Up at Night?

More than 80% of E&F investors are worried about not being able to meet long-term goals and critical funding needs 10 years from now, according to NEPC.

Endowments and foundations (E&Fs) are having an identity crisis.

According to consulting firm NEPC, asset owners are deeply concerned about not being about to meet their institutions’ long-term goals and missions.

This worry stems from the difficulty investors face in finding the right balance between institutions’ spending needs and their investment performance, the firm said.

“The vast majority are concerned about the most fundamental reasons why an E&F would have an investment program: meeting their mission and funding needs,” said Kristin Reynolds, partner in NEPC’s endowment and foundation practice.

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Specifically, the firm’s Q2 2015 survey found 42% of E&F investors were troubled by the risk of not meeting the organization’s mission and 40% by the risk of falling short on critical funding needs 10 years from now.

“The vast majority are concerned about the most fundamental reasons why an E&F would have an investment program: meeting their mission and funding needs.” —NEPCNearly half of surveyed investors also identified balancing operations with investment return, risk, and liquidity as their number one current challenge. This was a drastic change from responses in 2012 when the impact of return on the organization was the top concern.

However, NEPC found investors have also made pronounced efforts to bridge the gap between expenses and investment performance within the past two years.

More than half (54%) said they increased interactions between the investment committee and operations, and 46% said they facilitated more meetings with the investment committee and the finance department.

Furthermore, 43% reported they added more liquidity in their portfolios to meet obligations. A quarter said they made efforts to de-emphasize peer comparisons.

And a large majority (80%) told NEPC they now discuss operational issues at investment committee meetings.

Despite these endeavors, 81% still measured their investment success against market benchmarks, NEPC found. More than half continued to compare performance to their peers’.

E&F investors also identified market performance impacting spending needs as the greatest threat to their investments (34%), the report said. Other concerns included expenses rising higher and faster than revenues and slowing gifts and donations.

The $3 billion pension for the Dallas, Texas, police and fire services has been forced to take a 9% hit to its portfolio after overstating returns on its real assets investments.

The Dallas Police & Fire Pension System (DPFPS) could run out of money within 25 years, advisors Buck Consultants told the board on July 9, following write-downs in its real assets portfolio.

“Considering the magnitude of the 2014 and 2013 losses… we may need to re-evaluate how the asset return is determined.” —Buck ConsultantsAccording to documents on the pension’s website, Buck Consultants reported that total actuarial losses for 2014 totalled $460 million. This was significantly more than the $279 million losses reported in May, and came on top of asset value write-downs in 2013.

“Considering the magnitude of the 2014 and 2013 losses, as well as the size of the non-traditional assets, we may need to re-evaluate how the asset return is determined,” Buck Consultants stated in its presentation to the pension’s board.

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The pension currently has 16.9% invested in real estate, 14.8% in private equity, and 6.1% in infrastructure. Buck Consultants said that continued underperformance of these “non-traditional” assets would require a lower rate of assumed return in the future.

On top of the asset write-downs, DPFPS’ actuaries Gabriel Roeder Smith & Company recommended a lower rate of inflation be used in future return assumptions, as Dallas’ 4% assumed inflation rate was much higher than most forecasts.

Buck projected several outcomes for the pension based on future annual rates of return between 7% and 8.5%. While an 8.5% annual return—the current assumption—would see the pension’s assets run out in 2065, a 7% annual return could see it run out of money to pay pensions as soon as 2038.

Buck's projections for Dallas PFPS Source: Dallas Police & Fire Pension System; Buck ConsultantsWith the most optimistic actuarial assumptions, the pension is 71.4% funded, according to Buck’s presentation.

Credit rating agency Moody’s warned that, under new accounting measurements, the DPFPS’ total liability could rise to as much as $5.5 billion.

“By lowering its investment expectations, the board has reduced the risk of unexpected increases in future contribution requirements,” Moody’s analysts Tom Aaron and Adebola Kushimo wrote in the group’s latest credit outlook. “However, the resulting cost increases already challenge the city, particularly because its current contributions are near a state-defined maximum cap.”

The city of Dallas already contributes 27.5% of payroll to its pension funds, but can only increase this to a maximum cap of 28.5% if public employees agree to also increase their contributions, Moody’s said.

The fresh problems for the DPFPS come as it is on the hunt for a CIO to oversee its investments. It is the first time the pension has hired for such a position. The search is being led by new executive director Kelly Gottschalk.