(November 5, 2012) – In an environment with negative real interest rates, how can foundation investors meet their long-term goals?
Mostly, they can’t-or so says Michael Crook, an executive director and head of the Portfolio Advisory Group at UBS.
Crook, who is also an adjunct economics professor at Marymount Manhattan College, built a sophisticated returns model to test the relative success of different foundation portfolios over the next 20 years, and published the results for three quite divergent portfolios in a paper titled “Investment Policy for Private Foundations: Seeking Compliance and Survival in the New Normal.”
The verdict: Crook’s riskiest portfolio had the likeliest chance of succeeding in the long-term, but the probably was still only 48%. In this scenario, the mock portfolio is 37.7% global fixed income, 10.9% emerging market debt, and just 3.8% US equities. Some 26.6% of these mock assets go to developed markets outside of America. Of the riskiest assets in the model fund, Crook allocates 15.8% to emerging market equities and 5.1%, to commodities.
Twenty years from now, Crook’s model indicates that the most conservative portfolio would have only a 12% chance of meeting its baseline goals, and a moderate portfolio would likely fare slightly better, at a one-in-three chance of 20-year success.
The author defines success using three common foundation investment policy objectives:
1. Distribute 5% of the net fair value of their assets per year.
2. Maintain at least a constant level of real (inflation-adjusted) charitable giving per year.
3. Do so in perpetuity.
So back, then, to the original question: What is a foundation CIO to do?
“It is clear that more-risky allocations have a much better chance of achieving the goals described than more-conservative portfolios. In fact, even a moderate portfolio is unlikely to be sufficient for meeting the general investment objectives of a foundation over the next 10 to 20 years with a high degree of certainty,” says Crook in his paper.
Either risk up, or drop expectations, Crook continues: “To the extent that a foundation’s trustees are uncomfortable targeting a portfolio risk level greater than what is generally considered to be moderate (portfolio #2), the objective of maintaining the inflation adjusted value of the corpus must be relaxed or removed. If trustees are focused on maintaining purchasing power at a 5% distribution level, additional contributions are likely to be necessary to make up the difference.”
Read Michael Crook’s entire paper here.