Good returns offer foundations breathing room

Private foundations are enjoying several years of good returns for their investment portfolios, allowing them to focus more on the things that other institutions do, such as diversifying their investments and looking at outsourcing.

Of the 46 largest private foundations filing annual reports with the Securities and Exchange Commission for the year ended Dec. 31, 2013, combined assets of $182.3 billion exceed pre-recession levels for the first time and were 12.5% higher than the end of 2012. Assets totaled $162.6 billion at the end of 2007 before dropping to $122 billion the following year. Some of the increase can be traced to foundations that were not around in 2007, such as the $1.48 billion Laura and John Arnold Foundation in Houston, or ones with marked increases in funding in recent years, like the $5.3 billion Bloomberg Family Foundation Inc., New York, which is up from $975 million in assets at the end of 2008.

What continues to set them apart from other institutional investors — in addition to the fact they are usually very private about their investment decisions — is that they start with a 5% handicap when setting their investment return goals.

To keep their tax-exempt status, private foundations must each year make charitable distributions in prescribed amounts that generally equal 5% of investment assets. When you add in investment fees, administrative costs, excise taxes and inflation, “suddenly you are looking at 8% to 9% a year,” said William F. Jarvis, managing director, Commonfund Institute, Wilton. Conn., the research and educational arm of institutional investment manager Commonfund.

For many of the biggest ones, like the $11.5 billion Ford Foundation, New York, the $6.4 billion David and Lucille Packard Foundation in Los Altos, Calif., and the $5.9 billion Andrew W. Mellon Foundation in New York, the story is more about significant asset reallocations, particularly into less traditional asset classes like private equity, hedge funds and real estate. From 2008 to 2013, The Ford Foundation more than tripled its allocation to those other classes, to $9.78 billion from $3.45 billion, as did the Packard Foundation, increasing to $4.89 billion from $1.48 billion. The Mellon Foundation doubled its alternatives to $4.2 billion from $2.4 billion over the same time period.

“Private foundations clearly made a big jump in alternatives exposure. It's become more reasonable to do,” said Christopher Bittman, partner and chief investment officer of Perella Weinberg Partners' Agility OCIO business in New York, whose largest private foundation client is the $860 million Rockefeller Brothers Fund, New York.

The largest private foundation, the $36.4 billion Bill & Melinda Gates Foundation, Seattle, reported $4.48 billion in alternative assets as of Dec. 31, 2013. Overall, the aggregate asset allocation of the foundations studied by Pensions & Investments shows a steady move away from traditional equity and bond strategies. The aggregate asset allocation as of Dec. 31, 2013, was 37.6% public equity, 7.4% U.S. and corporate bonds and 55% other investments. That compares to Dec. 31, 2007, when the private foundations had an aggregate allocation of 49.1% public equity, 11.9% U.S. and corporate bonds and 39% other investments.

The five-year returns for the period ended Dec. 31, 2013, show that private foundations shook off the recession. With average 2008 returns of -25.9% no longer on the books, five-year returns in 2013 soared to 12% from 1.7% the previous year, according to the Council on Foundations-Commonfund study of investments for private foundations.

While many foundations shifted a lot of assets into cash after the financial crisis, others were able to take advantage the reduced asset prices, looking for opportunities in a distressed market. A lot depended on their degree of liquidity, said Shawn Wischmeier, chief investment officer of the $2.9 billion Margaret A. Cargill Foundation, Eden Prairie, Minn. “If they had that, they were buying everything,” often at a deep discount.

Heather Myers, New York-based managing director for non-profits at Russell Investments, participated in many foundation investment committee meetings in early 2009, where “you saw a huge dichotomy of how committees worked at that time,” she said.

Mary Jane Bobyock, director of non-profit advice at SEI Investments Co., Oaks, Pa., said her firm tried to encourage clients not to do a lot of rebalancing after a crisis, “because you are locking in your losses.” Instead, she said, “we encouraged clients to broaden their policy ranges.” SEI has $6.9 billion in OCIO assets under management for foundations, including community foundations.

Now, as the U.S. and global economies enter a period of slow growth, “you need to have much higher gains to get back to where you were before,” said Mr. Jarvis. “Foundations are constantly cowering behind the parapet, wondering what comes next.”

Sarah Clark, managing director of Commonfund's strategic solutions group, said that many conversations now center around “what happens when interest rates really start rising? What are the signals you are looking for?” After that, the next question is what levers you have to make an adjustment if needed, such as short duration/high-yield investments, as well as what Ms. Clark calls “an OMG overnight lever if you need it.”

That uncertainty is prompting foundation investment officers and boards to take a closer look at ways to diversify, with more sophisticated private foundations more likely to adopt the endowment model of higher alternative allocations and lower public market exposure. The country's largest private foundations, such as the Bill & Melinda Gates Foundation and the Ford Foundation, “have a high degree of diversification and a high tolerance of illiquidity,” said Mr. Jarvis.

“It's much more diverse and all over the place,” agreed Ms. Myers. “It's a huge theme but there are many ways to attack it. You also need more help and more expertise. There's depth and there's breadth and you need a whole bunch of experts to help you.”

While the investment strategies are getting more complex, staffing levels are not always keeping up. Foundations with more than $500 million in assets averaged 4.6 full-time employees total in 2013, down from 5.9 the previous year, Commonfund found, and the median number of staffers dropped to two from five in the same time period.

“Post-recession, there has been tremendous turnover of investment personnel, either on committees or in the (investment) office. The turnover is providing an opportunity to look at what's working and what could be working better,” said Margaret Chen, managing director of Cambridge Associates and head of its discretionary outsourced manager business, which has 195 foundations clients representing $219 billion in assets.

“Universities and private foundations tend to be woefully understaffed,” said Mr. Bittman of Perella Weinberg. “It's a given that you have to add resources. You either need to resource or outsource. Endowment management is not a part-time job.”

Attention to risk management often lags behind other institutional investors as well. Ms. Bobyock of SEI was surprised to find that only one-third of foundations her firm surveyed in 2015 conduct a formal risk analysis. “That's important because you should understand what will another 2008 look like. The longer you get away from a bad experience, the less painful the memory, but it's important to get through.” SEI drives home that point by showing private foundation clients how much their spending would drop under negative scenarios. “It's a painful exercise but you should be aware of it as a fiduciary. We are big advocates of it,” she said.

Ms. Myers of Russell sees risk management becoming a more common conversation. “The large guys have embraced it but the whole world is coming along. One reason for the change is that technology has caught up. Now you can model the risk and you have much better tools.” She expects risk management to evolve in the private foundation space as the cost to access risk management technology comes down, or more foundations choose to outsource it.

One advantage foundations often have, regardless of size, is their board members' sophisticated backgrounds and professional and social circles. “They have huge access to all these creative ideas and everyone shares,” said Ms. Myers. “You tend to have very sophisticated investment professionals, and they are focused on long-term results,” said Susan Potter, a managing director and head of member development at The Investment Fund for Foundations in Radnor, Pa., which manages $2.8 billion for private foundations.

At private foundations, personalities can play a big role in investment decisions. “The culture of an investment committee can really change how a pool of capital is managed. Every organization has its own culture. The role of the investment committee is hugely influential,” said Ms. Myers.

An individual chief investment officer can also make a big difference. When Margaret A. Cargill Philanthropies brought on Mr. Wischmeier in 2012 as the foundation's first chief investment officer, they had the benefit of his experience in multiple asset classes from previous stints including CIO of the $88.8 billion North Carolina Retirement Systems, Raleigh, and the Indiana Public Employees' Retirement Fund, which is now part of the $30.2 billion Indiana Public Retirement System, Indianapolis. That enabled him to diversify from Cargill's large stock holdings into more varied liquid assets and attract new managers.

The Cargill foundation's size “allows me to do some smaller, more creative things, like working with smaller funds or picking the top five managers, not the top 20. We can be more focused,” said Mr. Wischmeier.

Despite its $1.8 billion in assets, the Harry and Jeanette Weinberg Foundation in Baltimore did not have a CIO until May 2014, when it brought in Jonathan Hook to build an internal investment team for a foundation growing in both size and complexity. Mr. Hook brought with him 20 years experience in commercial banking and several stints developing investment offices for Baylor University and for Ohio State University, where he oversaw $3.4 billion of long-term assets. n