By Kristoffer Jonsson
The search for yield has been an ongoing trend for several years. According to our research, 6% returns are the new 8% for institutional investors.
With the German government issuing five-year debt at a negative yield for the first time in history; and given more than a quarter of European government bonds now hold yields below zero, this story looks set to continue.
While endowments and foundations do not hold the same liability profile as their institutional peers, traditional portfolio construction strategies that rely on equity and fixed income investments no longer enable these not-for-profits to efficiently meet their required distribution streams and administrative costs.
As a result, endowments and foundations – often seen as ‘first movers’ into new assets classes and opportunities as a result of their unique make up – are increasingly looking towards alternatives, and particularly private equity to generate higher returns.
For example, we have found that portfolios tend to have a significant tilt to growth, and in cases where they have a reliable stream of annual fundraising, that part can be viewed as a fixed income source and allow further long term risk taking in the core portfolio. However, we have also learned from the endowment model that with only 3-5% annual distribution rate the portfolio can absorb a high degree of illiquid investment that can drive a greater portion of the alpha generation.
The private equity opportunity set, particularly for the large/skilful operator, has expanded over the past few years. One reason for this is the average age of a company at the point of IPO has doubled over the past 35 years shifting the value creation to a company’s private investors over subsequent public investors.
Our 2015 long term capital market return assumptions forecast an average return of 7.75% returns in private equity. Considering the high dispersion around the averge return, there is compelling case to be made for investors that can consistently invest in first and second quartile managers. Given the current environment this is an opportunity that endowments and foundations are recognising since their long term investment horizon allows them to have a higher allocation to illiquid investments.
Capitalising on these types of opportunities demands a recognition of alpha’s constantly evolving nature and disciplined due diligence that identifies those managers most skilled at capturing it. For example, a recent study found that private equity returns for a given vintage year have ranged from 50% for the top managers down to -30% for those at the bottom.
While the majority of endowments and foundations are highly sophisticated investors, they are increasingly finding strategic partners to assist them to efficiently access these more complex assets that require consistant and patiently applied due diligence to capture these returns.
Whether it’s managing cash, retirement assets or improving the financial, investment and governance practices of endowed institutions of higher learning, there is no ‘one size fits all’ approach to managing the investments of endowments and foundations.
Kristoffer Jonsson is head of the Endowments & Foundations Group at J.P. Morgan Asset Management
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