The Secret of Smaller Endowments and Foundations’ Outperformance

Smaller endowments and foundations may lack the heft of their multi-billion dollar peers, but sometimes that may be their biggest advantage. And the big guys may be wise to take note.

These smaller organizations take less-risky approaches due to the nature of their size, and are less eager to try alternative investments, particularly hedge funds, according to Eric Bailey, principal and financial adviser at Captrust, the wealth management firm.

“In the environment that we’ve been in for some time, smaller allocation to alternatives certainly helped those smaller organizations,” he told CIO. They have been “a little bit more of a drag in terms of overall performance.”

According to HFR, hedge funds are down 4.49% year to date. This is due to 2018’s high volatility and the Federal Reserve’s tightening of monetary policy, which led to losses, closures or layoffs. Rather than invest in the hedge world, the smaller organizations turned to real estate, private investments, and infrastructure.

“This big shift toward real heavy hedging-type strategies [from] so many years ago hasn’t necessarily translated into excess returns or diminished risk,” he said, which is why “so many of the smaller organizations have outperformed.” He added that large-scale asset owners could adopt these policies that their $10 million to $100 million endowment and foundation peers use.

Agile tactical shifts in response to market conditions have been another plus for the more modest-sized players. “It’s possible that smaller organizations are acting more nimble, and that’s something that their larger peers can benefit from,” Bailey said.

Of the respondents, 46% of investors employ tactical asset allocation in their portfolios. That’s where managers shift portfolios to ride upcoming trends.

A trend that mirrors the asset owner community across the smaller endowments and foundations is the growing need for environmental, social, and governance —or ESG— investments. Although the interest in the space has increased, especially for good governance practices, a considerable amount of survey respondents are undecided when it comes to taking the plunge. This is similar to the ESG landscape for heavyweights in the corporate and public pension world, who are split on the space’s legitimacy.

“There’s so many different definitions of socially responsible. That may be what’s being tossed around in a board room on the corporate side,” said Bailey. “One person might think it’s ‘no guns,’ [but] the other person might love guns, so you have some political differences which spawn into social responsibility and different variations of that and it’s hard to generate a consensus on that.” 

Mission-based organizations, such as churches and universities, were found to be more open to ESG investing, according to the Captrust survey.