Mercer outlines top considerations for endowments and foundations for 2016

  • January 19, 2016
  • United States, New York

Mercer, a global consulting leader in advancing health, wealth and careers, and a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC) outlined its top investment considerations for endowment and foundations (E&Fs) for 2016.

“E&Fs have fully recovered from the 2008 financial crisis and have benefitted from strong US equity markets and philanthropic giving,” said Kenneth Shimberg, US Endowment & Foundations Chief Investment Officer, Mercer Investments.  “That said, evolving monetary policy and the expectation of slower growth is anticipated to lead to higher volatility. E&Fs should reevaluate their investment and risk management strategies and consider allocating more assets to active strategies that can generate positive alpha. We have identified key priorities for consideration in the year ahead, encompassing both near-term market-related risks and longer-term governance-focused enhancements.”

Mercer suggests that E&Fs consider the following actions in 2016, including:

Conduct a governance ‘fire drill’

Fire drills help individuals prepare to make decisions and react rationally during a crisis. E&F investment committees should think about creating their own versions of ‘fire drills’ to ensure adequate processes are in place for rebalancing and making opportunistic investments. If the market declines significantly and quickly, committees should decide if they can wait until their next committee meetings or react in real time. Rebalancing is central to the value of diversification — periodically selling those assets that are doing well and reinvesting in assets that have been doing less well are keys to success. In a significant market correction, it can be difficult to step in to invest in assets that are down the most. As such, investment committees should consider which actions will yield the best results and be ready to take advantage of opportunities as they arise.

Determine liquidity needs

Liquidity may be overrated by E&F investors as these organizations typically only draw five  percent or less per year from their investment pool and are generally not overly tactical — suggesting that they have capacity to increase access to illiquidity premiums. For very long-horizon investors such as E&Fs, private equity or private real estate may increase potential long-term returns, much more so than through tactical portfolio adjustments. E&Fs should review what institutional drivers support specific levels of liquidity, and how those are balanced against organizational attitudes or biases toward liquidity. How should a committee consider its liquidity budget, and what steps are necessary to enhance committee and staff views around the liquidity goals of the organization?

Confirm role of enterprise risk

Decisions made for an E&F investment portfolio can have long-ranging impact on the broader organization, but in many cases this impact may not be fully appreciated. How can E&F institutions assess their total enterprise risk, and what value is there in pursuing greater integration between investment portfolio decisions and the bigger financial picture of the institution? E&Fs should consider if the investment committee linked in with the broader priorities of the institution and as such, ask what solutions are available to the portfolio and the institution that can improve the odds of success across the entire organization. Endowments and foundations may want to consider evaluating the potential impact of good and poor results for the investment portfolio relative to the broader financial picture of the organization, including assessment of potential decisions that could impact overall organizational success.

Establish portfolio ‘comfort levels’

How conservative should an E&F investment portfolio be, especially during a time of historically low interest rates? The primary objective of most E&F investment committees is to produce a growing and consistent stream of cash available to support an organization’s mission. This suggests for the average endowment or foundation a nominal return of 7–8 percent. Traditional high-quality fixed income products today offer yields of 2–2.5 percent, well below the targeted need to support intergenerational equity. As such, committees should discuss the impacts of fixed income investments on the ability to generate needed long-term returns, with balance and appreciation for overall portfolio risk control and sufficient liquidity maintenance.

Confirm role of inflation sensitive investments

With inflation at low levels, what role do inflation sensitive investments play for long term E&F investment portfolios? In this low inflation environment, E&F investment committees should consider how to balance potentially negative impacts of inflation-sensitive investments within the portfolio against any inflation surprises that may arise. Committees should stress their assumptions for real return assets and think holistically about the role of real return. With the stresses on the sector today, it’s important that committee members are comfortable with the potential types of inflationary pressure and understand the how their real asset portfolios will react under different inflationary scenarios.  

Enact best practices for due diligence

Due diligence has evolved substantially over the past decade, moving from a simple, straightforward conversation and check-the-box exercise to a comprehensive, multi-day onsite visit. Typically, E&Fs do not have a central depository for operational best practices and instead depend heavily on peer recommendations, conferences, or third-party services, such as investment consultants. Often the operational controls, processes, and trading practices of investment managers are overlooked — until it’s too late. Committees should determine best practices for operational due diligence then review and discuss practices with their consultants to ensure that best practices are being followed.

Assess if benchmarking helps or hurts

The idea of benchmarking your portfolio may initially appear simple. It is not. Too often, benchmarks are used in a simple binary measure of defining success and failure — and that measurement leads to discussions and potential changes in tactical and strategic investment policy — and in certain situations, no changes, which can be equally as concerning. In reality, investment committees should dedicate a significant amount of time to designing a customized policy benchmark that captures not only its return needs but also the quantitative and qualitative risk factors. Since most E&F committees create multiple benchmarks (e.g. return need, custom benchmark, and peer-relative), committees are challenged to prioritize, interpret, communicate, and act on various levels of performance relative to their benchmarks. How can committees create frameworks and monitoring processes to ensure that benchmarking is given the appropriate time and attention it deserves?

Understand factors that affect return objectives

Investors are increasingly re-examining how they identify and manage risk, and climate change is increasingly recognized as an environmental risk, a social risk, and an economic risk. Failure of economies to adapt to climate change is among the top five risks globally, according to a 2015 report from the World Economic Forum. Findings from Mercer’s recent study, Investing in a Time of Climate Change, suggest that climate change will inevitably have an impact on long term investment returns, and the report encourages investors to view it as a key new return variable in the analysis of securities. Consideration of the risk factor is not just at the security level but also at the industry, subindustry, and broader asset class levels. Climate-sensitive industry sectors should be the primary focus, and they will be significantly affected in certain scenarios. Adopting a strategic asset allocation that robustly incorporates both the risks and the opportunities presented by climate change helps to develop climate related investment beliefs alongside other investment beliefs.

Decide if using hedge funds is right for your organization 

E&Fs are among the largest users of hedge funds, embracing a wide variety of strategies in pursuit of stronger returns and managing portfolio risk. Given the strong equity markets in the past seven years, many hedge fund strategies haven’t generated the results that many E&Fs were expecting. E&Fs should take the opportunity to revisit their hedge fund portfolios and confirm the role and expectations for hedge funds.

Consider global portfolios’ asset allocations in a divergent monetary policy environment

Central bank policy has been a significant contributor to the US market recovery. Although the Federal Reserve has begun to tighten, many foreign central banks have adopted more aggressive easing policies. The benefits of those policies may have been largely realized in the US, resulting in all-time highs for corporate profits as a percentage of GDP and above-average valuations. The accompanying strong US equity market returns have led many E&F investors to question their diversified portfolio structure. Committees should gauge where they can look for return opportunities going forward.

Mercer will host a webcast to expand on this topic on Wednesday, February 17, 2016, 2pm-3pm Eastern Standard Time. Register here .

About Mercer

Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in more than 40 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy and people. With 57,000 employees worldwide and annual revenue exceeding $13 billion, Marsh & McLennan Companies is also the parent company of Marsh, a leader in insurance broking and risk management; Guy Carpenter, a leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a leader in management consulting. For more information, visit Follow Mercer on Twitter @Mercer.


This does not contain investment advice relating to your particular circumstances and does not constitute an offer to purchase or sell any securities. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.  The findings, ratings and/or opinions expressed herein are the intellectual property of Mercer and are subject to change without notice. They are not intended to convey any guarantees as to the future performance of the investment products, asset classes or capital markets discussed. Past performance does not guarantee future results. Mercer's ratings do not constitute individualized investment advice.  Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax or legal implications.

Information contained herein has been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential, or incidental damages) for any error, omission or inaccuracy in the data supplied by any third party. 

Mercer Investment Consulting LLC is a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing nondiscretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Mercer’s Form ADV Part 2A & 2B can be obtained by written request directed to:  Compliance Department, Mercer Investments, 701 Market Street, Suite 1100, St. Louis, MO  63011.

References to Mercer shall be construed to include Mercer LLC and/or its associated companies.

© 2016 Mercer LLC. All rights reserved.