What trends are influencing endowment investing in today’s market?
That was the subject of a recent presentation I gave to an association of private colleges and universities. The trends I identify do not apply exclusively to endowments as investment institutions. Nevertheless, even certain headline issues in the financial press and elsewhere involve this group in unexpected and unusual ways.
1. Consolidation in Higher Ed
Forming the backdrop is how colleges and universities have consolidated in recent years.
Since 2016 alone, 172 institutions have closed, merged, or been acquired. For-profit institutions were the largest cohort affected, making up 42% of the total.
That for-profits have taken a hit may not be a surprise, but private and public universities have not come through unscathed either. A combination of regulatory scrutiny, especially on the for-profits, a strong economy, and demographic headwinds have all fed into this trend.
Closure is the most common form of consolidation, but creative mergers have also been on the rise. This has touched me personally. Arizona State University (ASU) acquired one of my alma maters, Thunderbird School of Global Management, in 2014. To its credit, ASU allowed Thunderbird to remain intact as a distinct program separate from the ASU business school.
What this all means is that schools are aggressively competing for students and donors. Indeed, many are fighting for their very survival. Given such challenges, managing endowments and other school financial resources is central to securing and sustaining fiscal stability and persevering through a challenging era in higher education.
2. Areas of Concern
So what fiscal concerns are these endowments most focused on? The investment consulting firm NEPC updated its annual survey of endowments and foundations at the end of 2018. Two things emerged as high-priority items: meeting/exceeding spending plus inflation and not falling short of return targets. Endowments are clearly looking to optimize their investments right now.
They weren’t overly concerned about the economy in general, however: 85% say that the economy is as good as or better than a year ago. But they also indicated that their expectations for the equity markets have dimmed. While 38% said they expected mid- to high-single-digit returns, 56% thought the market would be flat to slightly negative in 2019.
This is perhaps why, like other institutional investors, many endowments are turning to the private markets in search of higher returns. A majority (51%) were bullish on private equity, with only 4% bearish and the rest neutral.
One intriguing data point revealed by the survey was a de-emphasis around the “time commitment/priorities of Investment Committee members.” This was interesting and contradicted our research into asset owner governance at Marquette University. We found that the quality of governance of the board and investment committee is inextricably linked to the financial performance of the endowment fund.
So if returns and sustaining your spending rate are your top priorities, then by default you must also be concerned about the governance of your organization. Investment committee member engagement is one important element of this. Now, of course, this was only one of the survey’s data points, but it did suggest an area of opportunity that organizations might be missing out on.
4. Socially Responsible Investing (SRI) and Environmental, Social, and Governance (ESG) Investing
Among larger institutions, college endowments have been at the forefront of SRI and ESG investing. The graphic below shows that more than one in four colleges engages in some form of SRI. This could take the form of traditional negative screens or restrictions among faith-based organizations, ESG, shareholder activism, or impact investing.
Parsing the data by assets, we find nearly 60% of these institutions apply some form of ESG criteria. I would hazard a guess that ESG has penetrated most deeply among colleges and universities than any other category of institutional investor. Keep in mind, among such endowments, assets are arranged like a pyramid, with a handful of institutions holding a vast share, Endowments like Yale’s not only lead but also comprise a larger overall percentage. Among the more mainstream institutions I serve and advise, this has also definitely been a topic of conversation.
5. Active vs. Passive
Passive investing has come to dominate the markets. Over 45% of equity investments are now in mutual funds, exchange-traded funds (ETFs), and other passive vehicles. As the late John Bogle’s observed last year, one of the unintended consequences of this general dominance is to concentrate influence in the hands of institutions like Vanguard, BlackRock, and State Street, which collectively control 81% of all indexed assets.
The big question: How are these three organizations exercising their shareholder power from the perspective of corporate governance? For colleges that embrace more activist approaches through such bodies as the Interfaith Center on Corporate Responsibility (ICCR), this question should give them pause.
6. Spending Rates
With the yield on the 10-year Treasury now in the 2.4% range and the yield curve inverted, interest rates seem to be going the wrong way. So the trend among university endowments over the last several years has been to reduce spending rates in proportion to the lower income yield. The one exception has been among the smaller tier of institutions, which have bumped their spending rates up, perhaps to help support their institutions during an era of declining enrollments.
The good news is that the dip in enrollments will likely end, and the shake-out, especially among for-profit institutions, should lay a stronger base that institutions can draw on in the future.
In the meantime, by focusing on better governance, more thoughtful and deliberate investment strategies, and more effective ways to express the values of their organization through SRI programs, endowments can continue to help lead the investment industry. Indeed, both in how it invests and how it engages with the communities it serves, this class of institutional investor is a truly unique and important feature of the investing landscape.
Christopher K. Merker, PhD, CFA, covers these and other topics in Trustee Governance Guide: Five Imperatives for 21st Century Investing, with Sarah Peck, which will be published by Palgrave Macmillan later this year. In September, he will moderate a panel at Marquette University’s Socially Responsible Investing Symposium, which will be headlined by ICCR chair Rev. Séamus Finn.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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Christopher K. Merker, PhD, CFA, is a director with Private Asset Management at Robert W. Baird & Co. He holds a PhD in investment governance and fiduciary effectiveness from Marquette University, where he has taught the course “Sustainable Finance” since 2009. Executive director of Fund Governance Analytics (FGA), an ESG research partnership with Marquette University, he is a member of the CFA Institute ESG Working Group, an international committee currently exploring ESG standards, publishes the blog, Sustainable Finance, which covers current topics around governance and sustainability in investing, and is co-author of the book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing.