January 8, 2018

United States, New York

Insights to assist E&F investment committees to keep pace with changing market dynamics

Mercer, a global consulting leader in advancing health, wealth and career, and a wholly-owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), has identified key areas of focus for endowment and foundation (E&F) investment committees in 2018.

“E&F portfolios continue to benefit from strong equity markets, with overseas investments contributing at a greater rate than in most periods since the 2008 financial crisis. Record high equity markets, however, may lull investors into a false sense of comfort. Market dynamics make the persistence of this bull run more fragile,” said Ken Shimberg, US Endowment & Foundations Chief Investment Officer, Mercer. “Concurrently, greater reliance on endowments makes institutions more vulnerable to adverse events. Staff and committees should apply a strategic perspective to governance processes and implementation considerations to ensure they provide the checks and balances necessary to support successful investment execution.”

The following is a summary of areas that Mercer suggests endowments and foundations prioritize for 2018:

  1. Prepare to be opportunistic: To take full advantage of market dislocations, E&F investment committees should review ways that portfolio structure and policy can promote agility in investing to accommodate attractive investment opportunities as they arise.  

  2. Embrace “doing nothing” as strategic: E&F investment committees should weigh the transaction cost of making moves of marginal benefit, assuming that the portfolio is within policy ranges and there aren’t other external factors at play. For some outperforming assets, it may be wiser to maintain them at current weights, waiting to use them as a source of capital when a market event creates a buying opportunity.

  3. Upgrade the governance “Batphone”: Investment committee and staff processes for reacting to an extraordinary event could be rusty, as the credit crisis was nearly a decade ago. Processes should be reviewed to ensure that they are best suited to current committee dynamics and preferred means of communication. Specific and rules-based protocols should help inform timely decision-making during an adverse event and lessen the behavioral impact that inevitably influence decisions in stressed conditions.  Guidelines should reflect the most accurate snapshot of the institution’s risk tolerance.

  4. Undertake a disciplined resource-budgeting process: Increased reliance on endowments and enhanced portfolio complexity has changed the demands on both staff and committee members. E&F investment committees should undertake a rigorous inventory of staff and committee members’ capacity and expertise and evaluate them in the context of strategic priorities to identify potential shortfalls. Once gaps in resources or expertise are identified, determine whether there are tasks that may be better executed by a third party.

  5. Consider the absolute dollars in addition to the spending rate: Anticipating a market correction or an extended low-return environment, many institutions have been successful in reducing their spending rates. For most, however, the continued climb in equities means that a lower spending rate has not yet resulted in fewer absolute spending dollars on a year-over-year basis. At the same time, operating budget dependence on endowments has grown, resulting in the need for greater certainty around expected spending to plan and implement programs. Quantify a spending floor in absolute dollar terms and test the impact of a market decline against the current spending rule. Committees can explore options that reduce variability in spending such as including more periods in the calculation. More complex solutions could include a metric to adjust for inflation to offset future buying-power erosion.

  6. Identify secondary sources of liquidity: According to NACUBO data, in the year ending June 2016, endowments with $500mm or less reduced both equities and fixed income in favor of less-liquid strategies. Committees should identify likely demand for capital in the event of a correction. Institutions may want to establish lines of credit or similar on-demand borrowing, relying on existing banking relationships to negotiate preferential fees and ensure that contracts will be stable through an adverse event.

  7. Re-visit ESG investing: Environmental, social, and governance-driven (ESG) investing continues to take on greater prominence globally. Recent accelerations in technology and scale have allowed certain green-energy businesses to right-size their cost structures, enhancing profitability. Not only are renewable energy opportunities becoming attractive on a standalone basis, but some are expected to become cheaper than fossil fuels in the next decade – paving the way for critical conversion of infrastructure to accommodate new technology.  This catapults certain ESG opportunities from higher-risk, long-horizon initiatives to compelling, medium-term return contributors.

  8. Re-frame the active versus passive debate: For the one-year period through June 2017, active funds regained some performance versus passive funds. Too often, however, investors only observe performance over a full market cycle, which obscures a critical point: E&Fs still need to spend assets through interim down periods. The fundamental nature of active strategies tends to reduce managers’ market sensitivity, and the ability of active managers to preserve capital in periods when other assets decline can be significant. 

  9. Assess litigation vulnerability: Lawsuits against higher education 403(b) plan sponsors surged in 2016 and through November 2017, with 16 prominent private universities the subject of class action suits as of fall 2017. The primary focus of these lawsuits is the amount of the fees paid by plan participants. Another complaint is that there are too many investment options across too many money managers – many poorly performing. Higher education plan sponsors have been sensitive to excessive program fees and complexity. Investment staff, who often provide expertise internally to plan sponsor committees, should expect continued and possibly increased involvement as plans are examined and adjusted. Litigation expense can also add pressure to the operating budget. 

  10. Be aware of tax changes and changing perceptions: The most recent tax reform contemplated generating revenue from E&F’s in many direct and indirect ways, including establishing a taxable threshold for level of endowment per full-time student, creating separate tax treatments for different types of revenue, and eliminating the tax deductibility of certain kinds of revenue. The most concerning feature of the tax bill, however, was not its implementation but the looming precedent of taxing non-profits. Colleges and universities should be sure that their positioning is known and well understood, either to generate additional support in the face of new constraints or to pre-empt future erosion of benefits. Institutions should also be prepared to engage in some education about investing strategies to protect donor comfort and institutional credibility.

The Top Ideas for Endowment and Foundation Investment Committees white paper can be found here.

About Mercer

Mercer delivers advice and technology-driven solutions that help organizations meet the health, wealth and career needs of a changing workforce. Mercer’s more than 22,000 employees are based in 44 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), the leading global professional services firm in the areas of risk, strategy and people. With more than 60,000 colleagues and annual revenue over $13 billion, through its market-leading companies including Marsh, Guy Carpenter and Oliver Wyman, Marsh & McLennan helps clients navigate an increasingly dynamic and complex environment. For more information, visit Follow Mercer on Twitter @Mercer.

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

© 2018 Mercer LLC. All rights reserved.

This contains proprietary information of Mercer. Its content may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Mercer's prior written permission.

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.

This does not constitute an offer to purchase or sell any securities.

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.

This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances. 

Information contained herein may have 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.