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Bfinance endowment and foundation investment survey reveals new pressures

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A new survey conducted by the independent global investment consultancy, bfinance, on the topic of endowment and foundation investment has revealed a challenging investment climate, asset allocation intentions, and the importance of ESG. The Endowment & Foundation survey, dated November 2023, features data from 61 asset owners from 16 countries.

Significant investment challenges

The surge in developed market inflation has had serious implications for endowments and foundations whose return targets are either directly or indirectly tied to domestic CPI and similar metrics. More than 40 per cent of investors say their investment returns have been below target over the past three years (or below expectation, in the cases where no formal target exists but the entity has an expected long-term return).

The ‘average’ respondent invests 41 per cent of their portfolio in private equities and 18 per cent in bonds, with 35 per cent in ‘alternative’ asset classes. Even more interesting, perhaps, bfinance writes, is the data on current skews versus long-term strategic asset allocation. Some 52 per cent of investors are underweight private equity while 37 per cent are overweight cash. These figures indicate that temporary over-exposures to illiquid assets seen in late-2022 (the result of public market volatility) are no longer in effect.

Looking ahead, 62 per cent of respondents expect to increase exposure to private markets over the next 18 months, followed by fixed income (31 per cent), and equities (22 per cent).

Outsourced operating models are popular but costs cause concern

The endowments, foundations and non-profits in this study tend to have highly outsourced investment models: 23 per cent have a ‘fully delegated’ or ‘outsourced CIO’ (OCIO) approach, while a further 48 per cent describe their investment activities as ‘strongly outsourced’ though not fully delegated. There is no notable trend towards insourcing or outsourcing at present.

The asset classes where respondents most commonly invest entirely via external managers are liquid alternatives/hedge funds (85 per cent), private debt (85 per cent), and equities (83 per cent). Meanwhile, significant minorities use internal teams for most or all investments in currency overlay (28 per cent), real estate (18 per cent) and fixed income (17 per cent).

On average, respondents are paying 0.6-0.7 per cent of assets each year in investment-related costs (median 0.5-0.6 per cent). External asset manager fees heavily dominate the overall picture and, for more than a third of respondents, represent over 90 per cent of all costs.

Responses indicate a widespread desire to reduce cost. The vast majority of respondents agree (28 per cent ‘strongly’, 62 per cent ‘somewhat’) that they ‘should be paying less’ in investment-related fees than they do at present. While 49 per cent “strongly agree” that monitoring and benchmarking costs is a high priority, only 10 per cent express high satisfaction with their current approach to benchmarking asset manager costs/fees.

With regard to investor satisfaction with manager performance, some 63 per cent of investors in externally managed ‘multi asset’ strategies are dissatisfied with performance in 2023 (though, interestingly, feedback on OCIO managers— who also have a multi asset remit—is more positive). Over 40 per cent of investors in externally managed equity strategies are also dissatisfied. Conversely, feedback is more positive for managers in (typically high-fee) illiquid asset classes including private debt (88 per cent satisfied) and infrastructure (83 per cent satisfied).

Endowments and foundations drive ESG and impact investment innovation

Given that endowments and foundations have stakeholders that are orientated towards ethical responsibility and investor in these groups also enjoy fewer specific regulatory constraints, they have been driving some of the most innovative impact, ESG and climate-related investment programmes.

Some 80 per cent of respondents say ESG considerations are ‘very’ or ‘moderately’ important to their investment strategy and implementation. A more granular and informative picture can be gained through examination of specific ESG-related practices across asset classes.

Notably, while equities remain the dominant asset class for most of these practices, ‘impact investing’ shows a strong private market focus. 97 per cent of equity investors integrate ESG into the investment process in this asset class, followed by fixed income (79 per cent), private markets ex. real estate (58 per cent), private real estate (48 per cent), and hedge funds (15 per cent).

It is instructive to contrast the data on practices with expectations that investors have for external asset managers in these asset classes. For example, 84 per cent indicated that they have some sort of carbon-related objective in equities, but only 50 per cent would be “unlikely to hire” an equity manager who cannot report on carbon or greenhouse gas emissions/intensity for the portfolio. Similarly, 92 per cent indicated above that they do “active engagement/stewardship” in equities, but only 47 per cent would be “unlikely to hire” an equity manager who cannot demonstrate specific outcomes for engagement.

A significant proportion of this community invest in explicitly impactful strategies, particularly in private markets. Within this cohort, 38 per cent are willing to accept a somewhat lower financial return for an impact investment. These investors are generally seeking both social and environmental impact (55 per cent indicate that they’re equally interested in both), though a minority of respondents primarily look for one or the other.

Kathryn Saklatvala, Head of Investment Content at bfinance and lead author, says:

“It’s a privilege to be able to examine the challenges and trends within the endowment, foundation and charity investor community at this interesting time. Inflationary conditions and higher interest rates affect different groups of investors in different ways and there is evidently still a strong relationship between inflation metrics and return targets for many of these entities, which has contributed to a significant degree of under-performance.

This investor community has long been recognised for its ability to foster innovation and creativity, thanks in part to liability profiles and lighter regulatory constraints than we often find in the pension and insurance sectors. US endowments’ historic activity in illiquid investments is one often-noted example of this effect. More recently, we have seen this group developing some of the most interesting and forward-thinking impact and climate-oriented investment programmes that we’ve yet seen. As such, the third section of this three-part study focuses on ESG and impact investing.”

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