A Hands-on Future of Endowments and Foundations

The endowment and foundation sector is at

the forefront of innovation in the investment

industry. Industry players are accelerating their

move into alternatives to drive performance

and diversification in an era of low interest

rates. At the same time, they’re updating their

existing technology to support more sophisticated

investment strategies.

A State Street survey of 170 endowment and

foundation funds, conducted by the Economist

Intelligence Unit, reveals how the industry is evolving.

It shows how industry leaders are taking a more

proactive approach to investing so they can prosper

in an increasingly challenging environment.

Invest to perform

Our research suggests that many endowments and

foundations are now broadening their portfolios and

also pursuing a risk premium. For example, more than

half (52 percent) of funds expect to ramp up their risk

appetite over the next three years, as the search for

returns intensifies.

Investment allocations are shifting accordingly. Three-

fifths of endowments and foundations in the survey

(62 percent) see increased investment opportunities

for their institutions in emerging markets, with

18 percent believing there will be a strong increase

in these opportunities. While some endowments were

early advocates of greater diversification and higher

allocations to some alternative assets, alternatives are

becoming an even more important piece of their future

strategy. Thirty-eight percent expect to increase their

existing allocation to infrastructure, while 26 percent

plan to increase their allocation to private equity, and

another 20 percent plan to invest there for the first time.

This shift into alternatives comes against the backdrop

of preliminary data from the 2014 NACUBO-Commonfund Study of Endowments (NCSE)1. The

NCSE shows that over the last 10 years, US college

endowment funds have seen an average return of

7.1 percent. This is below their average long-term

growth target of 7.4 percent. However, annual returns

Expectations for investment risk appetite

Source: State Street 2014 Asset Owner Survey, conducted by the Economist Intelligence Unit (170 respondents from endowments and foundations)

A Hands-on Future for Endowment and Foundation Funds

Executive Summary

■ Decrease significantly

Over the next year Over the next three years

■ Decrease slightly

■ Stay the same

■ Decrease significantly■ Increase slightly

10%

27%

4%

58%

1%

25%

27%

4%

43%

1%

1 2014 NACUBO-Commonfund Study of Endowments, November 2014. http://www.nacubo.org/Documents/about/pressreleases/2014_NACUBO-Commonfund_%20Study_of_Endowments-Preliminary%20Data.pdf.

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Executive Summary A Hands-on Future for Endowment and Foundation Funds

need to hit about 9 percent for endowments to grow,

once their typical yearly spend is factored in.

The preliminary results of the NCSE also found

that larger, better-diversified endowments have

outperformed their smaller, equity-heavy peers for the

first time since 2012. The large funds, with $1 billion or

more, returned 16.8 percent, outperforming the overall

average of endowments at 15.8 percent. This stronger

performance is largely attributed to a continued shift

from public equities and fixed income into alternatives.

The NCSE also shows allocations into alternative assets

increasing from 53 to 58 percent overall, and schools

with $1 billion or more increasing their alternatives

allocations from 58 to 65 percent.

Diversification brings clear benefits — but this

trend is challenging existing operating models in the

industry. Only 11 percent of our survey respondents

report strong confidence they have the operational

infrastructure in place to accommodate such changes

to their portfolio. “These entities are looking for

technology that can give them a view into all their

alternative asset classes — hedge funds, private equity

and real estate — in a user-friendly portal, but to date

that need hasn’t been fully met,” says Chris Sadler,

State Street vice president, Asset Owner Servicing.

DefInIng a new relatIonshIp wIth asset managers

As endowment and foundation funds seek to take a

more hands-on approach to investment management,

they are looking for asset managers who can deliver

solutions that are aligned with their long-term investment

objectives and can offer a competitive edge.

Our survey shows that improving due diligence

in manager selection remains top of mind for

institutional investors in this sector. Fifty-six percent

say conducting due diligence post-hire to ensure

managers are meeting their expectations is a

challenge, while 51 percent say due diligence is

a challenge when hiring new managers too. “We’re

looking for asset managers who have some kind of

edge, but you need to do the due diligence,” says the

chief operating officer of a US university endowment

fund with more than $2 billion in assets. “It’s not

enough to look at a manager’s track record — how

much of that track record comes down to market

conditions, and how much is attributable to skill?”

Along with other institutional investors such as

pension funds and insurance companies, endowments

and foundations are searching for greater transparency

from external managers around performance and

risk. Almost half (46 percent) of those in our survey

say they struggle to obtain a complete picture of risk-

adjusted performance from their managers.

Funds in the endowment and foundation sector are

increasingly looking at the advantages of in-house

management, partly to provide them with greater

visibility of risk and to reduce costs. Nearly one-third

(32 percent) say they’re planning to increase the

proportion of their assets managed in-house. Sadler

agrees, “Some endowments and foundations are

starting to manage more assets internally, such as

futures, swaps and swaptions.”

a more hanDs-on approach to governance

Endowments and foundations will not only need to

be more proactive in how they manage investment

performance in the future, but also in how they

handle governance.

Challenges experienced in past year with external managers


■ Major challenge ■ Minor challenge

Conducting due diligence post-hire to ensure managers are meeting our expectations

28% 28%

Conducting due diligence when hiring new managers

22% 29%

Gaining a complete picture of risk-adjusted performance

20% 26%

Ensuring their interests are aligned with ours

17% 35%

Justifying the fees

11% 28%

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Regulatory pressure continues to intensify. According to

Rebecca Schechter, State Street senior vice president,

Asset Owner Servicing, “While the endowment and

foundation sector has felt increased regulatory scrutiny,

this is expected to continue apace.”

Internal governance structures are also being

reviewed. More than half (56 percent) of global

respondents believe their increasingly sophisticated

portfolios will require a change in their trustees.

“A board may have one trustee saying, ‘Give me a

synopsis with pie charts that gets to the heart of the

matter,’ and another saying, ‘I need to drill down into

the data that supports the synopsis to form a better

understanding of our situation,” says Martin Sullivan,

State Street head of Asset Owner Solutions.

To get ahead of the market, endowments in particular

are getting far more granular on risk. “Investment

committees and boards are becoming more hands

on, and their level of sophistication is growing,”

says Schechter. “As a result, investment teams are

consuming data daily and pushing harder for daily

updates around risk exposures.”

As they seek to satisfy greater reporting requirements

from regulators and their boards, endowment funds’

IT infrastructure is a vital success factor. In our

survey, 41 percent of endowments and foundations

DarIng to be DIfferent

Endowments and foundations are highly competitive with one another, and they’re often willing to take a different approach to other institutional investors.

The largest university endowments in the US are competitive, and the freedom given to their chief investment officers (CIO) often puts them in a unique position.

“The CIOs of the largest endowments are leaders in the industry. They’re willing to take a different approach,” says Sadler. “Some managers are dramatically increasing their number of separately managed accounts. They’re hiring a lot of different managers, giving each of them small amounts to invest.” This approach, however, creates infrastructure support needs, as some of these managers are effectively very tiny shops.

At the same time, university endowments can tap into vast internal expertise and have the ability to invest for the longer term, both of which bring advantages. “Some of the major universities are willing to work with new technology solutions and software companies to enhance their solution,” notes Sadler. “They’re also willing to do things in-house as they feel they have access to more expertise than may be available externally.”

responsIble choIces

Among foundations in particular, there’s also a growing emphasis on pursuing sustainable and responsible investment approaches in the post-crisis environment. The idea that investment strategies across assets can help to achieve positive societal outcomes and deliver targeted financial returns is gaining greater traction in the sector. As an example of this trend, in 2012, the US SIF Foundation identified 95 foundations in the US that applied some form of environmental, social and corporate governance (ESG) criteria to assets — collectively totaling $60.3 billion2.

2 Unleashing the Potential of US Foundation Endowments, US SIF, January 2014. http://www.ussif.org/files/Publications/unleashing_potential.pdf.

Areas prioritized for improvement over next three years


■ High priority ■ Medium priority ■ Low priority

Regulatory compliance

58% 33% 9%

Overall governance

44% 45% 11%

Data management

41% 36% 24%

Contingency planning

31% 49% 20%

Cybersecurity

25% 30% 45%

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cite better data management as a high priority. They

also recognize that a broader perspective on risk

management is needed, encompassing contingency

planning such as disaster recovery and business

continuity, and emerging cybersecurity threats. One

quarter of our survey respondents say cyber security

is now a high priority.

lookIng to the future

As they respond to changes in both their external

and internal environment, endowments and

foundations will increase the complexity of their

portfolios by deepening their reliance upon

alternatives and moving into new markets. At the

same time, they’re under pressure to deliver

more granular risk and performance reporting to

increasingly knowledgeable and specialist investment

committees and board members.

Many of the larger endowments already possess

the investment know-how to thrive in this hyper-

competitive marketplace. However, they’ll need to

develop specialist talent, advanced technology and

new governance frameworks to help them navigate

the new terrain that lies ahead.

about the research

On behalf of State Street, the Economist Intelligence

Unit conducted a global survey of institutional asset

owners during July and August of 2014. The survey

garnered 170 responses from endowment and

foundation executives globally, spanning public and

private institutions.

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Endowments and foundation respondents by region


Endowments and foundation respondents by investable assets


21%

35%

44%

■ Americas ■ EMEA ■ APAC

13%

22%

65%

■ Less than $100m■ $100m – $499m ■ $500m or more

Economy & Finance

A Hands-on Future of Endowments and Foundations