Endowments and Foundations Eye Positive Economy, Emerging Markets

On the heels of President Trump’s tax reform, NEPC has released the results of its 2018 Q1 endowments and foundations survey, with positive feelings on the US economy, the S&P 500 performance, and more.

On the subject of tax reform, 38% of respondents are keen on the reforms helping their investment returns. Nearly the same number (36%) see the recent tax reforms having minimal effect on their returns, with a mere 9% fearing the reforms will hurt their performance. The remaining 17% of respondents were unsure.

Endowments and foundations are optimistic about the current state of the US economy. Compared to the same time last year, 55% of respondents consider the economy to be in a better place, while 13% think the US is worse off. Of those surveyed, 32% do not see much of a change in the US economy.

”I think some of the most interesting things [about the results] were not necessarily changes, but the degree of confidence and positive outlook, even in the wake of both a significant run up in markets over the past several years and the return of volatility in February, which was the first time we’ve seen that in a while,” Samuel Pollack, principal and senior consultant at NEPC, told CIO.

As for equities, 91% of respondents are expecting a continued bull run for the S&P 500. While none are expecting the index to perform higher than 20%, 10% are expecting it to perform 11-20% in the black, 47% are safe with 6-10% expectations, and 34% see a 0-5% performance. Only 9% see a negative performance for the S&P 500.

However, institutional investors are not planning to allocate more to domestic equities, but instead to international equities, emerging market equities, and private equity/debt. While 40% of the former are looking to allocate less, 28% and 26% plan to increase international and emerging market allocations, respectively, and 43% will allocate more to the latter. In fact, 45% of respondents selected emerging market equities to be 2018’s strongest performer.

“There’s still some run in the equity markets, where the expectations are still fairly high [and] the majority of respondents expected either high single-digit or even potentially double-digit returns for the S&P 500 in 2018. That to us was interesting coming off the back of a really strong ‘17, [and] even higher valuations as we moved into 2018,” Perry said, noting that China A-Shares are something NEPC has spent a lot of time on with its clients. “That combined with tax reform sets up what we are seeing for some of the potential asset allocation changes that the endowments were thinking about. Those are primarily centered around adding to non-US equities internationally developed as well as emerging markets and typically trimming from domestic equities—and that is in light of fairly high return expectations for the S&P 500.

“Then there’s the continued trend of significantly more capital and commitments going into the private markets,” said Perry. “I think the undertone to that is just endowments being really concerned about meeting their return targets through traditional markets and therefore taking advantage of their illiquidity and their ability to take on illiquidity to continue to allocate to those areas.”

Although cryptocurrency was certainly the hot topic of 2017, endowments and foundations are extremely bearish on the digital asset class. A whopping 96% of respondents do not currently invest in cryptocurrencies, with no plans to ride the crypto train in 2018. An even 4% was split between endowments and foundations that currently do invest in cryptocurrencies as well as those that do not but are considering dipping their toes in the water this year.

The greatest near-term threats to endowments and foundations were slowdown in global growth (21%), rising interest rates (26%), and geopolitics and political uncertainty (36%). Global inflation was an issue for 11% of respondents. Rounding out the list of concerns at 2% each were potential military conflict, concerns in emerging markets, and anonymous “other” concerns.

“One of the other things we also looked at from a risk perspective was geopolitical risk. It feels that our risk factors are heightened. However, the survey and the historical responses have been fairly consistent around  endowment and foundations’ view of geopolitical risk—in fact, it’s actually come down a little bit over the past couple of years,” Perry told CIO. “There’s been a little bit of a transition where investors were probably more worried about global growth, and [now] it’s a little bit more rising inflation and a little more geopolitical risk driving the risk concerns.

“I think the US political environment and the changes with some of the recent announcements around the tariffs in the steel and aluminum industry and the potential that has for triggering a trade war big or small definitely exists. The elections in Italy are still hanging out there. And [so are] relations with Russia and North Korea,” he added.  

As far as the top challenges endowments and foundations face, NEPC is citing resource constraints and spending rates as the issues keeping institutional investors up at night.

“Endowments are grappling with and committees are having that conversation about what’s the right spend rate to not eat into their longer-term corpus. How can they support their current operating needs now without taking from future generations? That’s all built around a view that forward returns, that if they’re muted, coupled with spending rates, could eat into that spending value,” said Perry, noting that spending rates have been decreasing for the past eight to 10 years.