Investing for Nonprofit Endowments, Foundations and Donor- Advised Funds

Transcription

1 Investing for Nonprofit Endowments, Foundations and Donor- Advised Funds Kathryn A. Hall Chief Executive Officer & Chief Investment Officer Hall Capital Partners LLC Nothing contained herein constitutes investment, legal, tax or other advice, and Hall Capital Partners is not soliciting any action based upon it. The information contained in this material is current as of its date only, and may be based upon certain assumptions. Hall Capital Partners makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. The views of third-party speakers and their materials distributed are their own and do not necessarily represent the views of Charles Schwab & Co., ( Schwab ). Third party speakers are not affiliated with Schwab. Schwab Institutional is a division of Schwab. Charles Schwab & Co., Inc. Member SIPC.

2 Investing for Nonprofit Endowments, Foundations and Donor-Advised Funds I. Current Climate II. Direct Impact on Endowments and Foundations III. Direct Impact on Donor-Advised Funds IV. Implications for Advisors V. Looking Ahead 2

3 3 I. Current Climate

4 Current Climate Amidst the turmoil of the past year, several themes have emerged and remain at the forefront of investor concern including Volatility Liquidity Complexity and Proliferation of Investment Choices Risk and Return Expectations Scandals and Transparency 4

5 Performance of Major Equity Markets Major Indices Comparative Total Returns 60% 40% 20% 0% -20% -40% -60% Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 S&P 500 Index MSCI EAFE Index MSCI EM Index Source: S&P, MSCI 5

6 Dramatic Volatility in Global Markets During the period from January 1979 through June 2008, the S&P 500 only experienced moves of more than 2% (up or down) on 3% of days as compared to 53% of days in 4Q08 100% 80% 60% 40% 20% 0% 3% 12% 85% 20% 19% 61% 53% 14% 33% 36% 16% 48% 8% 19% 73% 1Q79-2Q08 3Q08 4Q08 1Q09 2Q09 6 Source: S&P Greater than 2% up or down Between 1% and 2% up or down Between -1% and +1%

7 VIX Peaked in November VIX Volatility Index Lehman Brothers files bankruptcy Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Source: CBOE Note: The VIX index is an index of implied volatility on S&P 500 index options 7

8 Liquidity or Lack Thereof. 8

9 Liquidity or Lack Thereof Investment Managers Some investment managers found an asset/liability mismatch when faced with large redemptions Those with leverage tended to be impacted more greatly Techniques employed to stem the outflows include Gates Sidepockets Liquidating pools Fee concessions 9

10 Liquidity or Lack Thereof Endowments Endowments have experienced significant drawdowns Denominator effect results in outsized allocations to private investments Pursuit of creative solutions to alleviate liquidity issues Sales of private equity investment portfolios Sales of other assets Accessing capital markets 10

11 Evolving Investment Landscape Proliferation of investment opportunities exists Across asset classes Globally Increasingly difficult to evaluate and distinguish amidst quickly changing and complex investment options Due diligence requires greater expertise and time commitment Global perspective is essential 11

12 Risk and Return Expectations Investment risk and return expectations are being reevaluated and a deeper understanding of underlying drivers of value is required Volatility: Risk vs. return trade-off Appropriate capital base and liquidity to weather significant short-term volatility Duration of opportunity Balance appeal of high short term tactical returns with reinvestment risk Underlying exposure: Greater granularity Impact of leverage Illiquidity premium: Investors must be significantly compensated for illiquid capital 12

13 If it s too good to be true Scandals have rocked the investment world over the past year and have spanned both the corporate world and Wall Street Bernie Madoff Satyam Marc Dreier Investors ranging from small individuals to sophisticated endowments to hedge funds have been impacted by these schemes 13

14 14 II. Direct Impact on Endowments and Foundations

15 Current Climate Impact on Endowments and Foundations Operational challenges Investment policy reevaluation Spending policy Objectives and guidelines Asset allocation Governance Heightened scrutiny of investment decisions 15

16 Operational Challenges Due to Budget Constraints A sizeable percentage of the operating and/or grantmaking budget is often funded by the investment pool With declines in these pools, endowments and foundations are Cutting budgets Establishing hiring freezes or reducing staff Curtailing expenses (e.g., grant-making, financial aid) Reduced donations and more requests for financial aid and grants in difficult markets compound these challenges 16

17 Revisiting the Investment Policy Statement An investment policy statement provides the framework for investing and defines important roles and responsibilities Critical elements are under review Spending policy Objectives and guidelines Asset allocation Governance 17

18 Spending Policy and Intergenerational Equity Spending policies define an institution s choice to balance the needs of past, present and future generations Intergenerational equity requires consideration of short-term needs and long-term asset preservation The current market environment has tested these two competing objectives Flashback two years ago, Congress was arguing that payouts were too low and universities were stockpiling money; now that concern has changed 18

19 Spending Policies Open for Debate PLANNED CHANGES TO SPENDING RATES FOR FY % 45% 40% 35% 30% 25% 20% 15% No Changes Planned Plan to Increase Rate Plan to Decrease Rate Unknown/No Response 10% 5% 0% Source: NACUBO-Commonfund Endowment Study, Follow-Up Survey, Nov

20 Investment Objectives Subject to Constraints The investment objective defines an investment return goal for an organization and is impacted by constraints Key constraints faced by institutions Spending policy Percentage of operating budget funding the institution Predictability of cash flows Time horizon & liquidity As these constraints come under pressure, the ability to fulfill objectives is challenged 20

21 Asset Allocation Transition HISTORICAL ASSET ALLOCATION FOR ENDOWMENTS 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 21 0% 4.4% 4.6% 5.3% 1.9% 11.7% 3.1% 10.7% 64.3% +6.3% +9.8% -12.4% 23.6% 19.2% Source: 2008 NACUBO Endowment Study 12.9% 51.9% 13.6% 22.6% 39.4% 10.8% Endowments >$1B Other Real Assets Private Equity Hedge Funds Equity Fixed Income

22 Key Lessons of Asset Allocation Asset allocation provides the framework to achieve the investment objective Key lessons and considerations Appropriate liquidity is paramount Illiquid investments should generate a sizeable premium True diversification must be an investment goal Leverage should be evaluated carefully Flexibility is valuable Each Investment Committee should follow its own path 22

23 The Decision-Making Challenge Today s complex environment renders governance more challenging than ever before Structures vary from internal CIO and staff oversight to fully outsourced solutions with variants in between Fiduciaries are reevaluating their current governance structure and, in some cases, contemplating changes Ineffective decision-making can lead to paralysis There is no one right solution 23

24 Rethinking Roles Expected Growth of Outsourced Nonprofit Assets 40% 30% Estimated % of Assets Outsourced 20% % 24 0% Source: Casey Quirk < $500MM $500MM - $1B > $1B Endowment Size

25 Why Use an Outsourced Investment Advisor Enhances the ability of the Investment Committee to maintain a long-term strategic orientation when the real time decision-making is thoughtfully delegated Provides collaborative opportunity for the advisor to leverage the insights and specific expertise of the Investment Committee members Allows for proactive, tactical responses to rapidly evolving market dynamics 25

26 The Bar Has Been Raised Heightened scrutiny on all investment decisions Transparency and disclosure Liquidity terms Return expectations and risk Fee structure Higher standards apply to all participants Advisors Investment committees Investment managers 26

27 27 III. Direct Impact on Donor-Advised Funds

28 Appeal of Donor-Advised Fund Increased in Current Market Donor-advised funds offer advantages to private foundations for smaller and mid-sized pools of charitable capital 28 Upfront tax deduction Cost advantaged Administrative ease Privacy No minimum distribution requirements These advantages are more pronounced in today s market environment Demand is growing, especially among larger pools of capital

29 Investment Choice Expansion Recent growth in donor-advised funds has fueled demand for further enhancements to investment options Investment advisors are gaining the ability to manage charitable assets in largest donor-advised funds and desire ability to construct multi-asset class portfolios Key areas of interest and new options include Socially Responsible Investments Asset Allocation Vehicles TIPs 29

30 The Challenge of Implementation High payout rates, recent value declines and heightened scrutiny on investment decisions provide strong tailwinds to drive for greater variety of investment options Challenge that emerges is balancing the goals and responsibilities of multiple audiences Advisors and donors desire expansion of investment options both within existing asset classes and to include a broader range of alternative assets Donor-advised fund administrator as fiduciary must judiciously and carefully expand allowable investments 30

31 31 IV. Implications for Advisors

32 Drivers of Success Today Investment success, experience and conviction continue to be key attributes for advisors Today s focus includes Increased Transparency Greater Accessibility and Accountability Enhanced Risk Management Organizational Stability Customization 32

33 Differentiate through Flexibility As decision-making models evolve, flexibility in working with multiple audiences is essential Proactive engagement and partnership will differentiate top investment advisors Investment Committee Investment Advisor Endowment and Foundation Staff Investment Manager 33

34 Attributes for Outsourced Advisors As the need for an outsourced or partially outsourced investment advisor increases, those who can fulfill this role will benefit Essential elements of the outsourced model Global scale and access Ability to customize Client advocacy Exceptional due diligence Conflict-free business 34

35 35 V. Looking Ahead

36 Evolving Landscape Investment model will continue to evolve as investors recover from the past year Investment policies Asset allocation Liquidity assessment Decision-making process Higher governance standards Regulatory developments will continue to emerge 36

37 Due Diligence Tougher Questions Investment strategy Defined vs. actual: Lower tolerance for drift Liquidity Stated terms vs. characteristics of underlying portfolio Fees Importance of aligning incentives and understanding implications for managers during drawdowns Team Understanding role, impact and potential distractions of each person Risk Management Systems, firm culture, potential conflicts of interest 37

38 Expectations for Asset Managers Remain forward-looking to adapt to evolving policy and regulatory changes Increase transparency and improve communications Develop capabilities to provide appropriate level of information tailored to individual investor needs and interests Review investment terms and update policies to best match strategy of underlying investments 38

39 Be Nimble but Faithful to Key Principles Investment Advisors & Investment Committees Appropriate investment policies and asset allocations Evolving performance evaluation metrics Shift towards absolute return vs. relative performance on benchmarks Fulfillment of intended role and differentiated return pattern within portfolio Effective decision-making for hiring and firing managers Avoid paralysis! Suitable liquidity and flexibility to invest strategically in dynamic markets 39