Endowments and foundations have far outpaced their tax-exempt pension fund counterparts in investing in alternative asset classes.
According to a RogersCasey & Associates survey of 400 tax-exempt investors, of which 27 were endowments and foundations, 33% of the endowments and foundations said they invest in hedge funds; 67% said they invested in private equity; 7% said they invested in private debt; 78% said they invested in real estate; 37% invest in venture capital; 4% invest in managed futures; 7% invest in timberland; and 26% invest in oil and gas.
Defined benefit pension fund investment in many of the sectors within alternatives pale by comparison, according to RogersCasey, a Darien, Conn., consultant
Of the defined benefit fund respondents, 2% invested in hedge funds; 26% invested in venture capital; and 5% invested in oil and gas, substantially below endowment and foundation investment in respective areas.
Within the sectors of private debt, real estate, managed futures and timberland pension funds and endowments and foundations had similar investment experiences, but the latter still equaled or exceeded the former in most of the sectors.
The actual asset allocations to the alternative asset class by the endowments and foundations also out paced defined benefit pension funds.
Endowments and foundations surveyed allocated 12.3% of their assets to hedge funds, private equity, private debt, real estate, venture capital, managed futures, timberland and oil and gas.
Defined benefit pension funds, by comparison, allocated a total of 5.6% to those alternative assets, according to the RogersCasey survey.
"We are not surprised to see that large an allocation to alternative assets by endowments and foundations," said Greg Peeke, associate director with RogersCasey.
"They are more comfortable with it by and large," he said.
William McCarron, principal of Prime Buchholz & Associates Inc., Portsmouth, N.H., said he conducted a survey of endowments and foundations which concluded that most "progressive" institutions had commitments to alternatives that ranged between 15% and 40%.
There is little reliable data on which sector is presently growing faster, though Mr. Peeke suggests that real estate, the largest single alternative asset sector, may be the most popular.
"Tactically, it's a reasonably good time for real estate," said Mr. Peeke. "So you have seen money go into that area."
Nicole Foucher, president of R.V. Kuhns and Associates, a Portland, Ore., consultant, believes that the private equity and venture capital sector were the two most popular alternative asset sectors.
"The history of the returns have been impressive, and the deal flow has been strong," said Ms. Foucher.
The $275 million Claude Worthington Benedum Foundation, Pittsburgh, bumped up its allocation to alternatives by five percentage points in 1997 to 25% of total assets, said Dwight Keating, vice president.
The biggest beneficiaries of that increase will be real estate, venture capital and international private equity, said Mr. Keating. Hedge funds are the largest alternative asset in the Benedum Foundation's asset mix, comprising 13% of total assets, said Mr. Keating.
Trustees of the $500 million endowment for Vassar College, Poughkeepsie, N.Y., raised its alternative asset target to 25% of total assets from 18%, said Jay Yoder, director of investments.
Inflation hedging investments and private equity will be the recipients of much of that increase, said Mr. Yoder.
"We will make two investments in private equity, probably a couple of LBO funds," said Mr. Yoder. A real estate fund and oil and gas fund, both of which provides a hedge against inflation, are also expected to be added to the portfolio, he said.
The $1.3 billion endowment of the California Institute of Technology, Pasadena, also increased its allocation to alternatives to 25% of total assets, earlier this summer.
The sectors that will be considered are absolute return strategies, buy outs, venture capital and real estate, said Philip Halpern, treasurer.
Endowments and foundations are attracted to alternatives because it diversifies their investment risk, said Mr. Peeke.
"It's more for diversification," said Mr. Peeke. "They (endowments and foundations) are trying to get diversification benefits to balance between high-income needs and preservation of capital.
"So they like asset classes with inflation sensitivity," he said.
The long-time horizon of alternative assets matches "nicely" with the liability stream of foundations and endowments, said Mr. McCarron. The trustees of the institutions also have an affinity for these types of investments, Mr. McCarron suggested.
"It (alternatives) fits in stylistically with people on the boards of endowments and foundations," said Mr. McCarron. "Many are successful business people who see the benefit of venture capital and buy outs.
"They are comfortable in the area," he said.
Many of the gifts received by endowments and foundations come on the form of assets that would be considered alternative investments.
"The institutions often get gifts in the form of real estate which contribute to the trustee's familiarity and comfort with alternative assets," said Mr. Peeke.
The interest in alternatives also is a reaction toward concerns about over valuation in the public equities, and the robust returns generated by earlier private equity partnerships, said Mr. McCarron.
The respondents to RogersCasey's survey were the largest and most sophisticated endowments and foundations. But the larger investors often blaze the trail that the small investor will follow, and the proliferation of fund-of-fund partnerships will ensure that there are enough vehicles to allow the smaller institution the opportunity to invest in alternatives.
Russell V. Kuhns, chairman of R.V. Kuhns and Associates, believes that the fund-of-funds approach in private equity will increase smaller investor participation in the sector (July 7, Pensions & Investments).
The endowment for Mount Holyoke College, South Hadley, Mass., is one institution using a fund-of-funds approach for a portion of its alternative asset investing.
The $288 million endowment committed $14.4 million to three of The Common Fund's venture capital partnerships.
The high relative minimums of individual partnerships normally exclude some smaller institutions or might cause them to put more with one partnership than they would like. The funds of funds require less money and spreads around an institution's investment over a greater number of partnerships.
The Investment Fund for Foundations, Charlottesville, Va., recently closed its second multimanager pool, raising $115 million, said David Salem. president.
The first pool raised $85 million, he said. TIFF plans to offer an alternative asset pool each year for its clients, he said.
The proliferation of funds of funds will increase the amount of money pursing private equity deals, which drives up the prices paid for companies and lowers returns.
"It provides excellent return characteristics, but we are cautious at the same time," said Prime Buchholz's Mr. McCarron. "We have some concerns about that."
Fund of fund manager selection is also important and is a growing concern, he said.