NFP portfolios must work harder in the new macro environment 

Not-for-profits are looking at their portfolios to see if they are fit for purpose to deal with the new challenging macro environment, according to our recent podcast.

Macro and geopolitical concerns have been at the centre of institutional investors thinking globally, and over the past two years these issues have really come to the fore.

The recent increase in inflation is a double-edged sword for not-for-profits such as endowments and foundations. It is making markets more difficult to navigate, whilst also having a direct impact on their ability to meet portfolio objectives in the short term given many NFP investors have inflation linked targets.

Investors are now looking at their portfolios to see if they are fit for purpose to deal with this new challenging macro environment in the short and medium term.

Speaking on our recent podcast, Conor Power, Regional Leader, Not-for-Profits and Wealth Management, Europe, said rising inflation poses a challenge for not-for-profits given the frequent use of  inflation-linked objectives which can range from CPI +2%-4%.

Given assets have been performing well with inflation at low levels in recent years, meeting their objectives has been relatively easy for investors. However, Power highlighted that with inflation now between 6% and double digits, depending on the region, achieving those targets is very difficult. In 2022 inflation in the UK rose to 10% in July, and the Bank of England predicts this will increase to 13% by October. 

NFPs have a multi-faceted challenge

Against this backdrop, the cost-of-living crisis means that NFPs will be under more pressure to provide services. They are being asked to do more but with less given the effect of inflation.

Market volatility and expected returns were also noted as key concerns in our 2022 global NFP investment survey. Over a third of NFPs were not sure if their portfolio would meet its financial return objective in the coming few years.

As Rebekah Dunn, Mercer’s Head of Endowments and Foundations for Pacific noted on the podcast, NFPs are really feeling the pressure, and that combined with higher inflation adds a lot of uncertainty to markets and to clients.

The majority (80%) of respondents in our survey report they have found it easy to meet their objectives until recently. It will be challenging for these organisations to adjust to working very hard to meet the same targets in the new macro environment. 

The issue becomes even harder given that despite the backdrop of inflation, lower returns, and higher demand for services, NFPs are still committed to supporting underlying causes. In our survey, only 8% say they would decrease their spending in the short to medium term.

Power noted that among UK clients, there is a willingness and commitment to continue spending and funding the mission of NFPs underlying causes was beneficial for society, particularly in light of a cost of living crisis.

Given the macro backdrop, however, NFPs must find ways to ensure they can meet those obligations over the short to medium term, whether it is considering higher return seeking asset classes or using some of the gains they have earned in recent years. 

Diversify into private assets

For Dunn, this means portfolios will have to do a lot more. One opportunity, which has been highlighted for a few years now, is diversification away from traditional assets.

2022 is a good example of why investors should diversify, she said, pointing out that with equities and bonds moving in the same direction, there has been a lot of downside risk.  

At Mercer, we have seen increased interest from NFPs in private assets. Previously, there were concerns about liquidity in private assets and how much investors need, but our 2022 research shows that over 50% of NFPs will increase their allocation to private markets.

Power said as part of this, NFPs are looking to act on climate change, and that in the past 18 months there has been a sea change with NFPs perceiving it as not just a risk but also an opportunity.

He has seen interest from NFPs in private infrastructure and private equity as well as creating portfolios that are specifically linked to the energy transition through those asset classes. This can clearly be a significant driver of positive social impact for the portfolio. Importantly in addition to positive impact itmay potentially be very beneficial in relation to diversification and increased return potential.

Before making any changes to the portfolio, however, both Power and Dunn said NFPs need to check it is fit for purpose, ideally through running some forward looking scenario analysis on their portfolios. This should include analysis on what impact different scenarios in relation to rising rates, inflation and market returns will have on the underlying portfolio.  In addition liquidity testing and stressing is important in advance of considering a private markets allocation

While this will not give investors a crystal ball, it will help them to prepare to take actions as the macro environment evolves.