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Endowment Investment Strategies Require a “Seasoned Helmsman to Control the Boat.”

It’s been a dreadful year for many colleges due to COVID-19. During the 2020-2021 academic year, enrollment was down, along with room, board, parking, and other revenues. Depending on the state of your endowment, previous negative financial trends may have accelerated into bigger problems. Mergers in educational institutions have been on the rise, such as the Tiny Pine Manor College in Chestnut Hill, Massachusetts. This historic former women’s college was only able to survive by partnering with a larger, well-endowed institution. 

This doesn’t mean private colleges can’t survive an economic disaster. In New Orleans, Tulane University met Hurricane Katrina and, 16 years later, continues to thrive. It seems each year for the past 25 years, some small number of colleges close regardless of unexpected events such as weather, changing political environments, and recessions.

It is vital to prepare for financial realities to avoid a long-term struggle against insolvency. Your endowment can’t operate on an annual deficit, ignoring the urgent need to cut costs.  

During a rough voyage at sea, it’s necessary to use the most experienced helmsman and sail under reefed main and storm jib to maintain control of the boat. For a brief reprieve, we “heave-to” and remain calm while waiting for the storm to pass. Your endowment’s financial outlook depends on finding the correct tools and resources to get through a crisis. Even if your organization is doing relatively well, changes must be made to the actions you take now and in the future. It’s time to trim the budget and reposition your portfolio for new ways to grow.

The good news is that enrollment at some colleges for the 2021-22 academic year show applications are way up, and normal campus life is expected to resume. Get ready to reevaluate the capital necessary to achieve endowment and educational goals. Determine how much funding was held up in light of the pandemic, then assess and begin to correct negative financial patterns. Look at cash flow, make a list of priority needs, and the best way to invest and distribute funds going forward. 

Lessons from Previous Market Disruption

In the last few decades, with more than six major market disruptions, we’ve learned that well-run endowments lightened their equities, leading up to financial downturns and increase holdings in the three years following the start of each crisis. Contrarian behavior is how endowments can continue to take advantage of the pandemic correction. 

Long-term focus is the general rule for growth. However, a well-formulated strategy and resilience to embrace risk in the face of adverse market trends, or hold back spending in the short term when markets appear overly optimistic, is necessary. Intergenerational equity is a back-and-forth effort between supporting the mission and satisfying needs.

Forecasting helps to better understand expected outflows over the long term. Researching options in advance helps determine the asset mix to best support future demands. A target asset mix requires periodic rebalancing and countercyclical investing, such as reinvesting profits from over-target investments into bonds.

Sustainable Investing

Colleges, universities, and their affiliated foundations spent more from their endowments in fiscal year 2020 than ever before to support students, faculty, and mission despite lower average returns. Be sure all future spending actions are disciplined or find other ways to resolve funding gaps.

As you were mission-driven in the past, socially responsible investing was and is required for adverse selection screening for religious and some endowments and foundations. In 2020, you’ll be adding social responsibility to environmental priorities of the past and a focus on diversity and inclusion (D&I).

About 80% of endowments said that Environmental, Social, and Governance (ESG) factors are reflected in their investment policy. But you may be slow to integrate responsible investing into portfolios across asset classes due to performance concerns. Join the 19% currently applying responsible investing into public and global equities to experience “alpha,” based on market evidence and recent data which supports positive alpha can be generated through ESG strategies.

It will be essential to integrate a new checks and balance system for better communication between those involved in core investment processes, including investment teams, committees, and boards. This will ensure improved decision-making under normal or stressful conditions.

recent study evaluated 705 institutions from July 1, 2019, through June 30, 2020 showed the average one-year returns for endowments were at 1.8 percent. Average returns were 5.3 percent for 2019, and it’s sure to be difficult to reach the historical target return of 7.5 percent. Clearbrook believes with proper management, endowments can consistently support institutions with more revenue each year no matter what happens.

Investment-grade fixed income over the next decade may be low, and you’ll need to pay attention to allocation to generate positive returns. Consider risk management by diversifying assets into alternative investments, such as hedge funds, private equity, and venture funds. You may also want to watch the trade war between the US and China and the pandemic’s effects on global trade. Global mandates may impact your portfolio in an uncertain environment.

Changing Asset Allocations

It may be challenging to maintain optimal allocations of fund assets as the market environment remains uncertain. The June 30, 2020 study shows endowment portfolio allocations were 33% domestic and foreign public equities, 23% mixed venture capital and private equity, 20% market alternatives, 12% fixed income, and 11% real assets.

Smaller endowments had significantly greater exposure to fixed income, particularly investment-grade securities, using bonds to hedge against equity market volatility. They may soon re-examine significant bond allocations due to interest rates when realizing fixed income will not offer the same returns as before. Larger endowments can counterweigh public equities and fixed income with greater allocations to alternative investments. 

In the past year, higher education institutions used their endowments to maintain and increase support for their students and missions. Each endowment must have the chance to outlive its benefactors and continue to educate students for centuries. Clearbrook encourages looking at financial and investment strategies with fresh eyes to meet critical targets for a sustainable future.

Institutions will need to be incredibly thoughtful about their endowment’s strategic and tactical positioning as the economy goes through some intermittent rough seas. Make sure you have a “seasoned helmsman to control the boat.” Take the time to formulate a new strategy and “heave-to” until you’ve researched the best options and tools as the storms pass over. 

Sources:

NACUBO.org 2021. In Year Punctured By Pandemic, Higher Education Endowments Provide More Than $23 Billion to Support Students, Mission,

https://www.nacubo.org/Press-Releases/2021/Higher-Education-Endowments-Provide-More-Than-23-Billion-to-Support-Students-Mission

College Financial Grades 2021: Will Your Alma Mater Survive Covid?

https://www.forbes.com/sites/schifrin/2021/02/22/college-financial-grades-2021-will-your-alma-mater-survive-covid/?sh=805d9ad49163

Mercer, Top investment ideas for endowments and foundations 2021, https://www.mercer.us/content/dam/mercer/attachments/north-america/us/us-2020-endowments-and-foundations-in-2021.pdf 

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