Foundations have a difficult balancing act when it comes to managing their endowments.
Play it too safe and you risk a return that won’t replace the minimum 5 percent of net assets that foundations are required to pay out annually. On the other hand, many an endowment was licking its wounds years after the financial crisis because their portfolios were overly aggressive.
So, how can endowments maintain a steady course when there are choppy headwinds in the markets? From Mark Yusko’s vantage point, the key is diversification in a portfolio that lets it at once take advantage of the markets’ volatility and limit its exposure in uncertain times.
“You don’t have to do anything smarter, you don’t have to do anything really outstanding,” said Yusko, founder and CEO of Morgan Creek Capital Management in Chapel Hill, N.C. “It’s really about having that lower volatility that leads you to greater wealth. Then you have more money for spending.”
Yusko, who previously oversaw investments for the endowments at the University of North Carolina and Notre Dame, spoke Sept. 11 during a webinar sponsored by JFN and the Jewish Federations of North America. JFNA will hold its 2015 Investment Institute in February, where funders and investment professionals will discuss best practices to nurture and grow the $65 billion in Jewish philanthropic assets.
For Yusko, diversification is about a lot more than simply having a broad array of stocks in different sectors, which have enough investment strategies in common and lack a shield during down markets. Instead, he advocates for endowments more alternative investments—a term he admits is less than apt—that are not generally available to retail investors. These include hedge funds, private equity, and illiquid investments such as real estate and energy production.
It may be a more expensive, esoteric and sometimes riskier way to invest, but Yusko said it’s worth it for the end result.
“People still believe if you minimize your costs you will maximize your returns,” Yusko said. “It’s just not true. There’s actually a high correlation between fees and returns … You have to have an alignment of interests where, when you make more money, the manager makes more money.”
Large endowments—those with $1 billion or more—tend to have an “overweight” bias, toward these alternative investments, according to Yusko, in stark contrast to what had been a more traditional investment model a few decades ago. For example, Harvard University’s endowment—at $32.7 billion the nation’s largest—was almost all domestic stocks and bonds in 1980. Today, they comprise just 16 percent of the portfolio, which is projecting a 15 percent return for the fiscal year that ended June 30. Instead, the endowment is now dominated by alternative investments.
Over the last 20 years, Yusko said, traditional portfolios owned by institutional investors with a 60/40 mix of stocks and bonds made 8 percent annually, while the top-performing endowments that embraced alternative investments made 10 percent, resulting in almost twice as much wealth on a compounded basis during that period.
Yusko agrees with forecasts for a coming correction in traditional equity markets that will knock down share prices. In the meantime, he said, it’s a good time for endowments to buy alternative investments that have a lower demand because other portfolio managers shy away from investments they can’t quickly sell when there’s a market downturn.
“You want to buy when volatility is very high and things are cheap and you want to sell when volatility is contracting and everybody is complacent,” Yusko said. “When nobody thinks anything bad can happen that’s usually when bad things happen.”Share