(December 4, 2012) – In the five years since the onset of the financial crisis, the traditional endowment portfolio has gone from a near panacea to a niche mode, according to new research.
“To be a good fit for a pure Yale or endowment model, post-2008, funds need to be very large, less reliant on mark-to-market than average funds, and able to absorb short-term volatility,” State Street Global Advisor (SSgA)’s Dan Farley told aiCIO. “You need to think in a total return framework, and not need a consistent yield.”
Farley serves as senior managing director and CIO for SSgA’s Investment Solutions Group. Farley and, State Street’s Foundations and Endowment Head Rebecca Schechter, collaborated to produce a State Street report combining insights from its asset management and asset servicing business called, “The Asset Owners’ Perspective: Evolving Investment and Operational Models,” to quantify what they all had been hearing in meetings with clients. Namely, that investors are altering their approach to endowment-style investing, in the wake of some hard lessons.”
“Investors are looking to manage liquidity risk while also saying, ‘I have to generate returns,’” Farley said. “We’re spending a lot of time with our clients recognizing that they have dual objectives. At highest level, those objectives can be conflicting.”
State Street connected with Asset International (aiCIO’s publishing company) to survey of 116 asset owners during July and August of 2012, and conducted follow-up interviews with 13 senior investment staff at US endowment, foundation and healthcare organizations.
In total, nearly 84% of respondents found that the crisis had exposed some weakness of the endowment model, and liquidity (or lack thereof) was the number one concern.
“I’m still a big believer in the endowment model,” said one US private endowment manager during the interviews. “I think it works better than everything else…but the two big weaknesses that came out [of the crisis] are the two Ls – leverage and liquidity.”
“It’s a tug-of-war between returns, liquidity, and risk,” Schechter said. So while many endowment-style investors got burned in the crisis—just ask Harvard—the model’s hallmark asset class still appeals as one of the last bastions of alpha.
The survey revealed that 45% of asset owners felt low yields on traditional assets had increased their organization’s appetite for alternatives, particularly for funds under $1 billion. “To broadly generalize, I’m seeing a barbell approach,” Schechter said. “Investors are recognizing there’s a certain amount of liquidity they need, and they’re moving a portion of their assets into very liquid instruments, even cash. There’s liquid alternatives in the middle, like commodities, as well as high yield fixed income.
And on the other side of the barbell? “It’s the idea, ‘If I’m going to bet, I’m going to bet big.’ And then they buy gold bullion, or something.”