Ten Resolutions for Endowments and Foundations

Consider moral hazard, re-evaluate private equity, and diversify, Mercer has advised E&F investors for the year ahead.

(January 17, 2014) – Investment committees for foundations and endowments have, according to most asset managers, a promising year ahead. 

But, like any year, it is bound to bring crucial decisions and unexpected turns. Asset consultancy/manager Mercer has considered its prognosis for 2014, and identified 10 priorities for foundation and endowment investment committees to tackle in short order.

1) Continue to diversify

“The biggest threat it innovation in investing is a bull equity market,” an asset manager recently told aiCIO. While a portfolio of 100% US equities would have outperformed almost anything in 2013, Mercer stressed the wisdom of continued diversification.

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2) Prepare for the end of quantitative easing

Industry consensus said it is coming, although precisely when is anyone’s guess (or everyone’s). No investment committee should leave this issue unconsidered, Mercer said, and it seems likely that few will.

3) Ask if now the time to play it safe—or dangerously

The firm advised re-examing investment strategy, and being deliberate about moving equity dollars into traditionally defensive securities (large cap, for example) or riskier assets. Which leads into priority 4…

4) Prepare for emerging markets to re-emerge

“Performance has severely lagged developed markets of late, and as a result valuations are relatively attractive,” the advisors wrote. But they declined to make an explicit market call, and recommended committees reach their own position on developing economies. 

5) Evaluate the appetite for tail risk

How much is this committee willing to lose of the foundation or endowment—and at what cost would it be worth preventing? Tail risk insurance is expensive, to be sure, and Mercer advised investors to consider the cost versus benefit of hedging. 

6) Consider if private equity’s payoff timelines fit the group’s patience horizon

The authors called private equity—a stalwart of endowment and foundation portfolios—“the Holy Grail of expected returns.” But with assets locked up for years at a time, how long is the committee willing to wait for that grail to prove its holiness?

7) Assess whether inflation protection is desirable

This issue is especially important for institutions with inflation-sensitive liabilities, Mercer noted. While traditional inflation-hedges, such as natural resource assets, did not perform spectacularly 2013, they may be worth considering for certain highly exposed funds.   

8) Consider the intersection of risk and moral hazard

“Now is the time to review whether the existing definition of risk and risk measurement standards has eroded the true role of risk management in portfolio design,” the list stated. It strongly advised asset owners to avoid basing decisions with major, long-term consequences on relative returns primarily.

 9)Evaluate spending rates

Weaker return forecasts for the coming five years compared to the last five suggest that prudent investment committees with examine their spending plans, according to the report.  

10) Set up a framework to consider ESG issues and opportunities.

Environmental, social, and governance (ESG) discussions can go beyond divestment, the authors noted. These conversations may also reveal investment risks and opportunities, leading Mercer to suggest establishing a policy to periodically review ESG matters.  

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