Economic uncertainty and policy changes, including the potential increase in endowment taxes and cuts to federal funding, have caused endowments to re-evaluate their investment strategies to maintain both long-term growth and short-term liquidity, says Cerulli Associates.
As concerns about liquidity grow, third-party providers may find new opportunities to support endowments, the firm says.
Liquidity has become a major concern for higher education institutions of all sizes amid the threat of the proposed endowment tax and a federal funding freeze, Cerulli writes.
While an endowment tax places a direct liquidity strain on the portfolio by requiring spending, a reduction in federal funding creates another, indirect strain as sponsoring institutions likely will need to use a larger portion of their endowments to cover the funding shortfall.
“Amidst an evolving landscape, universities may adopt more cautious liquidity management strategies, such as increasing cash reserves, cutting expenses, repositioning their endowment holdings, or participating in the secondary market,” says Agnes Ugoji, analyst. “While large institutions may weather the storm, mid-sized and smaller endowments lacking scale and internal resources could fall behind,” she adds.
Cerulli predicts smaller institutions will increasingly rely on outsourced chief investment officers (OCIOs) to manage complexity and strengthen their investment goals. OCIO use among endowments is highest among small and medium-sized segments (USD100 million to USD500 million in AUM), and the majority of OCIO providers expect endowment clients to drive most of the growth for the OCIO industry over the next two years.
As potential taxes on endowments become an imminent reality, OCIO providers with expertise in complex tax situations could gain a competitive edge. Other services— such as enhancing portfolio access to liquid vehicles, creating more efficient cash flow management systems, enhancing return potential while mitigating risks, and supporting board education—will be increasingly important.
“Firms that are well-equipped to assist with the ongoing challenges of today’s investment and regulatory environment should clearly emphasize and highlight these services to attract new clients,” says Ugoji. “Asset managers looking to tap into the endowment sector should focus on establishing relationships with OCIO providers, particularly during changing financial and regulatory environments,” she concludes.
