Investment returns grow for private foundations

Investment returns for private foundations grew to an average of 15.6 percent in 2013, net of fees, marking the second straight year of double-digit average returns, a new study says.

That growth compares to average returns of 12 percent in 2012 and average losses of 0.7 percent in 2011, says the 2013 Council on Foundations-Commonfund Study of Investments for Private Foundations.

The study, based on data from 153 private foundations with combined assets of $94.1 billion,  says foundations with assets over $500 million posted the highest returns net of fees, 16.5 percent, compared to 15.5 percent for foundations with assets from $101 million to $500 million, and 15.2 percent for those with assets under $101 million.

Three-year returns averaged 8.7 percent, up from 7.9 percent in 2012, while five-year returns surged to 12 percent from 1.7 percent, reflecting the fact the the loss of 25.9 percent in 2008 no longer is included in the calculation.

Ten-year returns averaged 6.8 percent, down from 7.9 percent in 2012.

As markets have recovered, foundations are increasing their return targets again, cautiously, as they continue to rebound from the financial pain of the collapse of the economy in 2008, the report says.

“With double-digit returns for the second year in a row, private foundations have regained solid financial footing positioning them well for community investment,” Vikki Spruill, president and CEO of the Council on Foundations, and John S. Griswold, executive director of Commonfund Institute, say in a statement.

Mission-related spending

Fifty-six percent of participating foundations increased mission-related spending, up from 47 percent a year ago, while only 26 percent decreased mission-related spending, down from 32 percent.

Asset classes

Domestic equities yielded the highest average returns, 31.8 percent, compared to 15.9 percent for international equities.

Returns averaged 7.3 for alternative strategies and 0.1 percent for short-term securities/cash/other, and a loss of 0.7 percent for fixed income.

Asset allocation

Asset allocation included 24 percent for domestic securities, down from 26 percent in 2012; 9 percent for fixed income, down from 11 percent; 20 percent for international equities, up from 16 percent; 42 percent for alternative strategies, flat from 2012.

Spending

The “effective spending rate” among participating foundations — the amount spent on mission divided by the foundation’s market value at the start of the year — grew to 5.5 percent in 2013 from 5.4 percent in 2012, returning the effective spending rate to the level reported in 2011.

Among all participating foundations, 36 percent reported an increase in their effective spending rate, 43 percent reported a decrease, and 16 percent reported no change.

Resources, management, governance

Private foundations on average employed the equivalent of 1.3 full-time professional staff devoted to investments, down from 1.4 in 2012 and 1.5 in 2011.

Twenty-five percent of all study participants, and 58 percent of foundations with assets over $500 million, employ a chief investment officer, while 73 percent of all participants use a consultant, down from 80 percent a year ago.

Thirty percent of participants have substantially outsourced their investment function, down from 38 percent last year, marking a return to the level reported in 2011.

Ninety-nine percent of participating foundations reported they have a conflict-of-interest policy.

Todd Cohen

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Board effectiveness tied to ‘cultural forces’ at nonprofits

The success of nonprofit boards, whose role has changed dramatically and become increasingly critical to the success of their organizations, depends on

“cultural forces” on the board and at the nonprofit, a new white paper says.

Those culture forces include capable leadership, a sound organizational structure, attention to fiduciary duties, and a culture that binds board members to one another in a cohesive unit, says the white paper from Commonfund Institute.

“How well a board functions determines, in large measure, the fortunes of the organization it governs,” the paper says. “Mediocre or middling performance may enable an organization to survive, but rarely to thrive, while weak or dysfunctional boards may jeopardize their organization’s very existence.”

Strategy, not tactics

The paper, “Strive for the Best: Building and Maintaining an Excellent Board,” says a board’s role is strategic, not tactical, and that its main task is oversight, or reviewing and assessing management’s success in carrying out its job.

The board should engage in active supervision of management and staff, it says, setting standards that are clear and objective, making sure job descriptions are known and understood, and seeing that senior staff members do a good job supervising the organization’s actual operations.

Because of its fiduciary responsibilities, a board must protect it’s nonprofit’s mission and protect against drifting from that mission in ways its charter does not permit, says the paper, which was written by John S. Griswold, executive director of Commonfund Institute, and William F. Jarvis, managing director.

Purpose and direction

In defining the mission and monitoring progress, the paper says, the board must provide purpose and direction to the staff, while in its oversight duties it needs to stay focused on governance and avoid getting involved in operations.

The paper says policies must be in place so that in case of conflicts of interest — with board members’ own interests, or with the interests of another organization with which board members are involved — the conflict will be disclosed and neutralized.

The structure of a board can help or hurt its effectiveness and is key to improving its performance, the paper says, and smaller boards generally are believed to function more effectively.

Picking board chair, executive director

Selection of the board chair is the single most crucial factor in a board’s success, and board orientation is the crucial first step, the paper says. A particularly useful practice, it says, is to assign an existing board member to serve as mentor to an incoming member.

And arguably the most critical task for the board, it says, is to select, hire, support, evaluate and, if needed, replace the president or executive director.

“Only a high level of board performance can create and sustain the energizing, inspiring and motivating environment in which the organization and its constituencies can excel,” the paper says.

The biggest impact on improving a board, it says, may be rooted in “cultural forces inside the board and organization.”

The most important of those forces is “trust among the board members, the chair and the senior staff,” it says.

Beneficial outcomes of that trust, it says, include “elimination of functional silos and narrow mindsets that can result in turf battles or in refusal to become involved outside the well-defined limits of a particular committee function,” it says.

Trust, recruiting, metrics

The “climate of trust must be created from the top,” it says, “with the board chair serving as the role model and this behavior as the template for committee chairs and committee members.”

Recruitment also is critical for creating a board that can excel, the paper says.

“Effective board members need not be heroic leaders or deep visionary thinkers,” it says, “but they must be thoughtful and authentic individuals who can inspire by example and motivate others in a non-threatening way.”

Also essential for successful boards is creating a “measurement system for the board that is comprehensible, relatively simple and not susceptible to manipulation,” the paper says.

Boards need “reasonably objective methods of assessing their own accomplishments, recognizing areas for improvement and development appropriate action plans,” it says.

So a board should try on a regular basis to “obtain a comparatively objective set of measurements by which it can judge its success against the goals it has set for the organization and itself,” it says.

‘Cultural attributes’

“Excellent boards are built on a clear understanding of their duties as fiduciary and governing bodies” of nonprofits, the paper says.

With that foundation, it says, a board “is positioned for maximum effectiveness when it can benefit from strong leadership by the chair, a properly structured committee system, engaged and committed board members and a sound relationship with senior staff members,” particularly the president or executive director.

“Cultural attributes such as leadership, trust, transparency and candor,” the paper says, “are an essential adhesive that binds the board together and constitutes the indispensable ingredient in the formulate for success.”

Todd Cohen

Education endowments rebound

Endowments at U.S. colleges and universities posted investment returns averaging 11.7 percent, net of fees, in the fiscal year ended June 30, 2013, marking a strong recovery from losses averaging 0.3 percent a year earlier, a new study says.

Among 835 U.S. colleges and universities that provided data for the 2013 NACUBO-Commonfund Study of Endowments, with endowment assets totaling $448.6 billion, the portion of their operating budget funded by their endowment averaged 8.8 percent.

That ranged from of a high of 16.2 percent for schools with assets over $1 billion to a low of 2.5 percent for schools with assets under $25 billion.

Domestic equities generated the highest average return in fiscal 2013, at 20.6 percent, net of fees, followed by international equities, at 14.6 percent; alternative strategies, 8.3 percent; fixed income, 1.7 percent; and short term securities, cash and other, 1.2 percent.

Three-year returns for participating schools averaged 10.2 percent, while five-year returns averaged 4 percent, and 10-year returns averaged 7.1 percent.

Endowments with assets under $25 million reported the highest average three-year and five-year returns, at 10.6 percent and 4.9 percent, respectively, while those with assets over $1 billion generated the highest average 10-year return, at 8.3 percent.

“This year’s investment results reflect in large measure the strength in publicly traded equities that has prevailed since early 2009,” John Griswold, executive director at Commonfund Institute, says in a statement.

While larger endowments performed better over a 10-year period, smaller endowments with higher allocations to domestic equities have performed well in the shorter term, he says.

Asset allocations remained stable, with participating schools allocating 53 percent of their portfolios to alternative strategies, compared to 54 percent a year earlier.

Alternative strategies include marketable alternatives such as hedge funds; private capital; distressed debt; and private equity real estate.

The effective spending rate for the 835 schools averaged 4.4 percent, up from 4.2 percent a year ago.

Schools with assets over $1 billion reported the highest spending rate, 4.8 percent, while schools with assets under $25 million reported a spending rate of 4.1 percent.

Fifty-one percent of schools reported an increase in gifts while 30 percent reported a decrease.

Among those reporting an increase, the median increase was 55.8 percent, and among those reporting a decrease, the median decrease was 33.9 percent.

The median total of new gifts to endowment was $2.3 million, and the the average gift was $9.4 million, up from $8 million a year earlier.

John D. Walda, president and CEO at NACUBO, says in a statement that, despite the improvements in investment returns over the past year, colleges and universities “are in a period of rethinking their budget-setting strategies and priorities.”

The past 10 years of volatile financial markets and deep cuts in government funding for higher education, as well as declines in enrollment and tuition revenue at some schools, he says, provide a context for the strong endowment performance in fiscal 2013 that reflects “continuing stress on tuition, state government appropriations and other revenue sources.”

Among 638 schools that reported they carry debt, average total debt was $204.3 million on June 30, 2013, up from $187.5 million a year earlier, while median debt was $56.3 million, down from $56.7 million a year earlier.

Thirty-one percent of study participants reported their schools increased the level of debt in fiscal 2013, while 62 percent reported a decrease.

Endowments reported they employed the equivalent of 1.6 full-time staff devoted to investment management, unchanged from the previous year.

Fifty percent of participating schools reported they employ risk limits in their portfolios, while 28 percent do not.

And 18 percent of participating schools reported they apply environmental, social or governance criteria, or ESG policy, to portfolio holdings.

Among the 157 schools with some form of ESG policy, 58.6 percent of their portfolio reflects the use of negative screens, 47 percent vote proxies consistent with their ESG criteria, and 70 percent say ESG investing is a formal institutional policy.

Todd Cohen

Responsible investing evolves, raises questions

The market for socially responsible investing is changing, and institutional investors should pay attention to its growing influence and visibility, a new study says.

A recent report estimated that at the end of 2012, the responsible investing market had $3.74 million in assets under management, or 11.2 percent of the $33.3 trillion in total assets under management in the U.S., says the study by Commonfund Institute.

While responsible investing has grown and “is more than a passing trend,” its purpose has moved from a “practice of negative screening and exclusion of certain types of investment to one seeking or encouraging certain characteristics in portfolio companies,” says the study, From SRI to ESG: Changing the World of Responsible Investment.

In the face that evolution, it says, investment professionals continue to debate “whether a portfolio’s long-term performance can be enhanced by including environmental, social and governance (ESG) considerations in the security selection process.”

Long history

While responsible investing dates from the colonial era, when some religious groups refused to invest their endowment funds in the slave trade, the study says, socially responsible investing first took shape as an investment philosophy in the 20th century.

In 1921, Pioneer Group became the first mutual fund to screen out tobacco, alcohol and gambling investments, the study says, and social responsible investing, or SRI, was adopted in the 1960s by civil rights, environmental, social and antiwar protest movements.

As environmental awareness grew in the 1970s, the first funds were introduced that looked at issues beyond traditional “sin” investment screens, the study says, and the movement against apartheid in South Africa led to creation of the first funds that screened out companies doing business in a specific country.

The number of SRI mutual funds grew to nearly 60 by the mid-90s, and SRI assets under management totaled about $640 billion, the study says, with climate change, corporate scandals and humanitarian crises emerging as new concerns in the 21st century.

Changing models

Models for responsible investing also have changed, the study says.

Socially responsible investing, the traditional model, build portfolios that aim to avoid investments in specific stocks or industries through negative screening, it says, while “impact investing” aims to invest in projects or companies with the express goal of bringing about mission-related social or environmental change.

What now has emerged, the study says, is known as “environmental, social and governance investing,” or ESG, which integrates ESG factors into “fundamental investment analysis to the extent that they are material to investment performance,” the study says.

Beyond negative screening

While the negative screening used in SRI “can be a useful tool for institutions desiring to express ethical, religious or moral values through their investment portfolio, the study says, it may prove too restrictive for many because it “limits the range of securities available for investment.”

ESG analysis, it says, takes a “broader view” by examining whether environmental, social and governance issues “may be material to a company’s performance, and therefore to the investment performance of a long-term portfolio.”

Inconsistent standards

Preliminary studies suggest that while “integrating ESG issues into fundamental investment analysis procedures can improve investment performance, it still is too early to draw comprehensive conclusions,” the study says.

ESG data reported by companies is of “varying quality,” it says, and the “lack of consistent standards or reporting methods makes it difficult for investors to compare investments with confidence.”

Users of ESG data continue to call for “more standardized reporting mechanisms to improve the quality of data that is at the heart of any analysis of risk and materiality,” it says.

Determining long-term impact

“ESG risk factors affect company performance over the long-term,” it says. “Managers and investors hoping to gain a competitive advantage by adding sustainability practices to an organization’s strategy appear unlikely to obtain short-term outperformance.”

And different analysts have different perspectives “on how long it takes to confirm an impact from ESG risk factors,” it says.

It also says that while ESG investing practices traditionally have applied most broadly to publicly traded equities, the broad category of alternative investments “pose challenges to traditional ESG analytical methods because of the relatively opaque nature of their investment processes.”

Extent of ESG use

The 2012 NACUBO-Commonfund Study of Endowments reported that  among institutions of higher education, 18 percent of the 831 responding institutions used at least one of the ESG criteria in managing their portfolios, the study says.

And the 2012 Commonfund Benchmarks Study of Foundations found the use of ESC criteria more limited, it says, with only nine percent of responding institutions saying they use ESG in their investing process.

Getting started

Boards of institutions considering using ESG might create a working group, in the form of a subcommittee of the board or investment committee, to study the issues and the possible application of ESG processes and principles to the institution’s investment portfolio, the study says.

Institutions also might retain an adviser with expertise in ESG to conduct an initial analysis of the portfolio to determine a “baseline of exposure to defined ESG issues,” it says.

Institutions also may want to put in place procedures for measuring and monitoring their exposure to ESG factors on an ongoing basis, it says.

“Whether or not a particular institution decides to add ESG practices to its investment toolkit,” the study says, “fiduciaries will need to bear in mind its presence and, potentially, its increasing influence and visibility.”

Todd Cohen

Health care groups urged to diversify investments

Health care organizations should adopt a new endowment model that reduces their reliance on fixed income assets such as bonds and cash, and increases allocations to alternative investments and other illiquid assets, a new white paper says.

The new model was developed over three decades by educational institutions and increasingly adopted by other types of nonprofits, and shifting to it and reaping benefits from it could take decades, making that shift “all the more urgent,” says Assessing the State of Healthcare, the white paper from the Commonfund Institute.

“It is in the interest of health care organizations, rating agencies and donors that health care endowments evolve toward becoming more like those of other long-term nonprofit institutions,” the white paper says.

Nonprofit health care organizations typically operate with “razor thin margins, or even at a deficit, the paper says, and they get revenue from reimbursement from government, by far the biggest source, and from income from private insurers and self-pay patients, and through support from donations or transfers from endowments they may have.

Any excess of reimbursements and income from insurers and patients over costs represents the “operating margin” for these organizations.

A 2012 Commonfund study found that, among 86 nonprofit health care organizations surveyed, the median operating margin in fiscal 2011 was 4.1 percent, up from 2.9 percent in fiscal 2008.

The increase reflects cost cutting across the industry, with big health care organizations making the greatest progress but smaller organizations catching up.

Large organizations made early progress “because they realized they would have to reduce operating expenses and took steps to change their cost structures to capture greater economies of  scale.”

Smaller health care organizations followed the lead of those bigger organizations, taking “what actions they could to lift their previously low — and even negative — operating margins.”

But because bigger groups can spread cost reductions over a wider base of patients and constituents and weather reimbursement reductions the paper says, they will reap greater benefit than smaller and mid-sized groups with proportionately higher fixed costs.

Those smaller and mid-sized organizations will rely more heavily on endowments to “enhance surpluses and make up for losses,” the paper says.

Most health systems use bond issues to fund construction projects and improvements, it says, and successful bond offerings depends in large part on the bonds earning a high rating from bond rating agencies.

And bond agencies “look not only to the ability of the health care provider to generate cash flow but also to the liquidity of its endowment’s financial assets as a potential backstop source of repayment,” the paper says.

As a result, it says, assets allocations of health care endowments tend, on average, to be weighted more heavily toward cash and fixed income investments than those of other types of nonprofits.

And that bias away from traditional equity investments generally have returned less per year than other nonprofits, the paper says.

“This practice seems increasingly to resemble a luxury that will eventually become unsustainable as other sources of revenue for health care organizations continue to diminish,” it says.

While allocations to fixed income investments and cash total nearly 40 percent of the portfolio of the average nonprofit health care organization, the paper says, health care organizations are better off with more highly diversified portfolios, managed “with prudent regard to liquidity,” to support bond repayment.

For small and mid-sized health care organizations that “lack the ability to spread costs over a wider patient base,” the paper says, “a greater degree of reliance on endowment income appears inevitable, and there is little time to lose.”

— Todd Cohen

Investment returns plunge for higher-ed endowments

Investments on endowments for U.S. colleges and universities lost 0.3 percent on average, net of fees, in the fiscal year ended June 30, 2012, a deep plunge from the average return of 19.2 percent a year earlier, a new report says.

Ten-year returns for fiscal 2012 totaled 6.2 percent, compared to 5.6 percent a year earlier, “suggesting that long-term performance for many institutions continues to improve, says the 2012 NACUBO-Commonfund Study of Endowments.

The biggest endowments, or those with assets over $1 billion, produced the highest return in fiscal 2012, or 0.8 percent, while the smallest, or those with assets under $25 million, produced the smallest return, 0.3 percent, says the study, which is based on data from 831 colleges and universities with $406.1 billion total endowment assets.

Three-year returns averaged 10.2 percent, while five-year returns averaged 1.1 percent, both net of fees, with endowments with assets over $1 billion generating the highest average returns over three, five and 10 years.

Among asset classes, fixed-income investments generated the highest return, 6.8 percent on average, while international equities produced the lowest return, a loss of 11.8 percent.

Domestic equities returned 2 percent, alternative strategies as a group returned 0.5 percent, and short-term equities, cash and other assets returned 0.2 percent.

“With the exception of periods such as the recent economic crisis, institutions with the largest endowments have reported the highest one-year returns,” says a joint statement by John D. Walda, president and CEO at NACUBO, and John S. Griswold, executive director at Commonfund Institute.

That trend was reflected in the data for fiscal 2012, as well as for the “trailing” periods that showed results for three, five and 10 years, they say.

They attribute that outperformance to “well diversified portfolio with an equity bias, the ability to make long-term commitments to less liquid strategies, access to top-tier investment managers, and greater resources, including larger staffs, leading-edge technology and experienced investment committees.”

The effective spending rate at participating institutions in fiscal 2012 was 4.2 percent, down from 4.6 percent a year earlier, with the largest institutions, or those with assets over $501 million, posting the highest effective spending rate, an average of 4.7  percent, and the smallest, or those with assets under $51 million posting average rates under 4 percent.

In fiscal 2012, 39 percent of institutions reported they received less in gifts than a year earlier, while 41 percent reported an increase.

The median total of new gifts was $2.2 million in fiscal 2012 and the average total of new gifts was $8 million, with institutions with assets over $1 billion posting the highest median and average gifts by far.

Among the 616 institutions that reported they carry debt, average total debt was $187.5 million on  June 30, 2012, down from $189 million a year earlier, while media debt grew to $56.7 million from $56.2 million.

Debt service as a share of the operating budget averaged 5.4 percent, essentially unchanged from a year earlier.

Institutions employed the equivalent of 1.6 full-time employees to manage their endowments, unchanged from a year earlier, with the largest endowments employing an average of 10.9 full-time employees and the smallest employing an average of 0.3 employees.

Eighty-two percent of institutions reported using an outside consultant, up 1 percentage point from a year earlier.

Seventy-one percent of institutions said they do not apply environmental, social and governance criteria to portfolio holdings, the same as a year earlier.

Of the 149 institutions that do use some of those investment criteria, 60.1 percent of their portfolio reflects the use of negative screens, with percent of those 149 institutions voting proxies consistent with their screening criteria and 72 percent reporting that screening is a formal institutional policy.

Todd Cohen