Foundations and endowments slightly outperformed corporate and public pension funds in 2002, and can boast of significantly better returns over the long run.
The median foundation and endowment fund returned -8.9% last year, while median returns for corporate and public pension funds were -9.2% and -9%, respectively, according to a study by Mercer Investment Consulting, New York. The benchmark for all three universes was -10.1%.
Top quartile foundations and endowments returned -6.8% in 2002, similar to top quartile public funds at -6.7% and ahead of top quartile corporate plans' -7.1%.
Over the longer term, foundations and endowments maintain their performance edge over U.S. public and corporate plans for both median and top quartile returns. The median foundation/endowment fund returned 3.5% for the five-year period, ahead of the corporate and public fund universes, which posted median returns of 3.2% and 3.1%, respectively. Top quartile returns for foundations/ endowments were 4.8%, well ahead of corporate plans (4.1%) and public funds (3.5%). All returns for periods of more than one year are compound annualized.
For the 10-year period ended Dec 31, the median foundation/endowment fund returned 9.1% while corporate and public fund trailed with median returns of 8.6% and 8.1%, respectively. Top quartile foundations/endowments returned 9.9%, while the top quartile corporate and public funds had returns of 9.1% and 8.6%, respectively.
Generally speaking, the lower the exposure to domestic equities, the better the return in 2002, said Ravi Venkataraman, consultant in Mercer's Boston office.
In fact, over the last few years, foundations and endowments have outperformed because they typically have a lower exposure to domestic equities and are more broadly diversified into alternatives, he said. Over the longer term, the higher returns are a function of a lower allocation to fixed income, he said. Despite the fact fixed income has led the way the past few years, over the 10 years fixed-income performance has lagged equities.
The Mercer Pension Asset/Liability Index shows that U.S. pension plans are less than 80% funded. Compared to the peak in January 2000 when U.S. plans were 140% funded, the Mercer Pension Asset Liability Index shows the ratio of assets to liabilities around 79% for January 2003. The index is based on a model portfolio of 50% U.S. equities, 15% international equities, and 35% domestic bonds.
Assets have been dragged down by three years of negative equity markets. Because of the asset drain, an increasing number of plan sponsors revisited their asset allocations in 2002 and into 2003. What they are wrestling with, said Mr. Venkataraman, is how to meet return assumptions of 8% to 9% without taking an inordinate amount of risk. Taking a cue from foundations and endowments, more pension plans are lowering their exposure to domestic equities, maintaining their international equity exposure, and diversifying more broadly into a wider range of asset classes.
"They are taking some of the risk off the table because they can't afford to have the (pension funding) situation get any worse," he said.
Not loading up
At the same time, plan sponsors are not loading up on the hot asset class, fixed income, because the prospects for continued outperformance don't look as good over the next few years. "That's where plan sponsors are feeling the squeeze," he said.
Among money managers, equities, emerging markets and international value portfolios in the Mercer universe were the best performers in 2002, while small-cap growth was the worst. Emerging market equity portfolios posted a median return of -3.7%. Fifth percentile portfolios were up 6.2%. International value portfolios were second, with a median return of -7.8% and a fifth percentile return of 6.1%.
The median domestic small-cap growth portfolio returned -28.2% in 2002, ahead of the Russell 2000 Growth index, which returned -30.3%.
The top performing U.S. asset class, small-cap value equity, had a median return of -9% and for the year ended Dec. 31. The Russell 2000 Value index returned -11.4%.
Domestic value outperformed growth over the long term. Domestic small-cap value returned 5.4% for five years and 12.1% for 10 years. Small-cap growth has been worst, with median returns of -0.8% and 8.5% for the same periods.
It's no surprise that fixed income led the way in 2002, with international and global fixed-income portfolios the top-performing asset classes in 2002.