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Special Report: Foundations

Alternatives spark decade of growth for largest funds

Steven Charlton said alternatives are an easy sell to the sophisticated mindset of foundation executives.

29.3% rise comes at expense of traditional asset classes

Nearly a decade after the financial crisis, foundations with an appetite for alternative investments have enjoyed a steady growth in assets.

Assets of the 49 largest private foundations reached $226.3 billion in tax filing year 2016. That is up 3.5% from $218.6 billion the year before and up 29.3% from $175 billion in 2007.

And "almost all of them want to know what they can do with alternatives," said Steven Charlton, partner and director of consulting services for NEPC LLC in Boston.

Since 2007, foundations have significantly increased their allocations to "other" investments — typically alternatives such as private equity, hedge funds and real estate — according to the tax filing data. In 2007, those investments added up to $70.6 billion, or about 40% of total assets. In 2016, such investments had grown to $136.3 billion, or about 60% of total assets.

By contrast, allocations to corporate stock dipped to $75 billion in 2016, from $84.6 billion in 2007, and bonds had an even steeper dive, to $3.8 billion from $9 billion over the same period.

The $6.7 billion David and Lucille Packard Foundation in Los Altos, Calif., nearly tripled its alternatives portfolio to $6.1 billion over the past seven years, while the $3.9 billion Rockefeller Foundation in New York doubled that asset class in the same period.

Pensions & Investments looked at the 50 largest private foundations, but the $3.3 billion Carnegie Corporation of New York foundation was not included in aggregate totals as it had not yet filed for tax year 2016.

For private foundations interested in being around for a long time, "alternatives are an easy conversation for them," and for their sophisticated trustees, said Mr. Charlton, whose firm is spending more time evaluating the number of alternative investments available. "There is a lot of interest across the board in new (types of alternative strategies) being discovered. It takes a lot of kissing frogs," he said.

"It comes up in every single meeting," agreed Margo Cook, Chicago-based president of Nuveen Advisory Services."People are on the spectrum somewhere."

While more traditional counterparts, such as corporate stocks and government bonds, are basically unchanged or experiencing slight dips as a percentage of foundation portfolios over the past decade, they, too, have enjoyed strong performance in recent years.

That's helped bolster overall returns for foundations.

According to the 2017 Council on Foundations-Commonfund Study of Investment of Endowments for Private and Community Foundations, private and community foundations averaged returns of 15% and 15.1%, respectively, in fiscal year 2017. The study of 143 private foundations and 81 community foundations, with a total of $104.4 billion in assets, represents the strongest performance in the past four years across the board, said Deborah Spalding, Commonfund deputy chief investment officer and managing director.

Among liquid investment strategies, non-U.S. equities had the strongest returns, at 26.4%, for private foundations, according to the study. Among alternative strategies, private equity was the top performer for private foundations, at 10%, followed by 9.2% for private real estate and 7.7% for marketable strategies including hedge funds, absolute return, long/short, event-driven and derivatives.

New money driving growth

Another area of growth for foundations is new money, spurred by lots of new tech billionaires and other wealthy people drawn by the tax advantages.

"Wealthy people are putting in new money, and there's new money in the wings," said NEPC partner Catherine Konicki, who is seeing the creation of new foundations in the $50 million to $100 million range.

For those new trustees, "that's a challenging conversation. What can we afford to do? That's a big conversation in today's markets, and it does require more hands-on work and education," Ms. Konicki said.

All those additional pools of capital also mean competition for foundation investment experts, noted Lawrence Kochard, chief investment officer and a managing director at Makena Capital Management LLC in Menlo Park, Calif. "One of the increasing challenge is the growing pools of capital similar to ours. It doesn't make it easier, and valuations are high."

Some of the largest foundations, including the $39.9 billion Bill & Melinda Gates Foundation in Seattle and the $12 billion Ford Foundation in New York, have seen steady asset growth over the last decade.

Others have experienced massive growth. The Bloomberg Family Foundation Inc. grew from $312 million in assets in 2007 to $7.8 billion in 2016, with sizable infusions in the years in between.

George Soros' Foundation to Promote Open Society grew to $10.1 billion in 2016 from $2.2 billion in 2009, more than doubling in size in the last two years alone. Another Soros organization, the Open Society Institute, went from $572 million in 2012 to its current $3.4 billion.

The $2.6 billion Conrad N. Hilton Foundation in Los Angeles is poised for a major growth spurt that will more than double its assets, with 91-year-old William Barron Hilton pledging the bulk of his estate to the foundation. "We have always had growth on the horizon," said Patrick Modugno, vice president and chief financial officer of the foundation.

It is a familiar situation for the foundation, which got its first major funding from Hilton stock, prompting it to create another entity "so we wouldn't have to sell in periods of distress," he said. Another massive cash infusion came when Blackstone Group LP acquired Hilton Hotels Corp. and assets tripled between 2007 and 2008.

By then, when former Yale endowment official Randy Kim joined the Hilton Foundation, "we were extraordinarily liquid," with the freedom to create an endowment-style portfolio right away. "We were in the right place at the right time with the right portfolio to be able to take advantage of the situation," Mr. Modugno said. An alternatives-heavy endowment-style asset allocation model with an investment committee and board "has been very successful," he said.

While its enviable cash-flow position and a five-year cushion on grant-making built up, "we are basically investing along our longer-term model," he said. "We can feel calm and not have to go into panic mode if there is a massive drop in the market.

Cause for concern?

Still, the possibility of another market downturn is not that far from the minds of foundation investors.

"That's what our clients are talking about. The question that seems to come up most often is, 'When is the next downturn?'" said Timothy Yates Jr., Commonfund managing director.

"There's quite a bit of discussion about something we called a crisis playbook. It's good to at least have the conversation now … while things are relatively calm," said Mr. Yates, whose firm has been running optimal portfolios based on the degree and time it would take to recover from a recession.

Makena's Mr. Kochard worries about "the usual macro things," said the former CEO and CIO of the $9.5 billion University of Virginia Investment Management Co. in Charlottesville. "There's more uncertainty in the world recently. Trying to invest means tuning some of that out and stress testing the portfolio," he said.

"The downfall for foundation investors is when they try to get more macro. As a group they have resisted that temptation because that's not what they do well. What we do well is develop good relationships with managers," Mr. Kochard said.

For the $5.4 billion Leona M. and Harry B. Helmsley Charitable Trust in New York, "our chief risk factor is liquidity," said Christopher Rapcewicz, director of risk and operations. Unlike some asset managers looking to get the best returns for their clients, "our purpose is ultimately to help our grantees. We have a good handle on what can happen in the worst scenarios," he said. While no one is ever fully prepared, he said, "you want to be in a position to respond, not react." The Helmsley Trust takes pains to not get near the 20% ownership limit in a single company, which means staying in bigger investment vehicles. "It begins to set limits on the space you can invest in," said Mr. Rapcewicz.

A common mission

Foundations have another distinction, he noted. "It's not a competition. Everybody is out there to do good, to fulfill their mission. People will talk with one another and will want to collaborate." The trust is now sifting through applications for an ambitious collaboration with the Chan Zuckerberg Initiative to develop an atlas of human cell growth.

Acceptance of the outsourced CIO model is also growing, even with increasingly large organizations, the experts say. It is growing faster than NEPC's advisory client base, said Mr. Charlton, with an overall market trend of 10% each year for foundations. "Plenty of trustees or investment committees have made the decision they don't have the knowledge, skills or time. That's why within our client base we're seeing a greater push.

"I don't see that trend slowing down any time soon," he said.

One trend that did not materialize this year was a feared slowdown in donations to foundations after 2017's tax reform. "I think there was an expectation post-crisis and with the tax law changes that donations would decline. I think a lot of foundations are finding that the opposite is true," said Ms. Cook of Nuveen. "It's been a surprisingly good accumulation of assets in foundations."

The largest foundations
Ranked by total investment assets, in millions, as of Dec. 31, 2016, unless otherwise noted. For a printable version of this chart, click here.
RankFoundationInvestment assetsCorporate stocksU.S. and state government obligationsCorporate bondsOther investments
1 Bill & Melinda Gates Foundation$39,910.7$27,647.4$5,325.0$712.5$6,225.9
2 Ford Foundation$11,950.0$214.3$789.2$83.7$10,862.7
3Lilly Endowment$10,241.1$9,236.1$0.0$0.0$1,005.0
4 Foundation to Promote Open Society$10,126.3$0.0$0.0$0.0$10,126.3
5Robert Wood Johnson Foundation$9,644.6$1,741.0$267.1$0.0$7,636.4
6William and Flora Hewlett Foundation$8,857.1$2,916.9$475.5$413.9$5,050.8
7Bloomberg Family Foundation$7,817.7$0.0$0.0$0.0$7,817.7
8W. K. Kellogg Foundation1$7,663.3$4,844.1$170.6$0.9$2,647.6
9 J. Paul Getty Trust2$6,812.7$349.2$0.2$16.6$6,446.7
10David and Lucile Packard Foundation$6,678.1$0.0$533.8$0.0$6,144.3
11Andrew W. Mellon Foundation$6,081.4$332.8$258.3$135.4$5,354.9
12 Gordon and Betty Moore Foundation$6,055.6$237.1$729.9$0.0$5,088.6
13Leona M. and Harry B. Helmsley Charitable Trust3$5,379.8$469.1$0.0$0.0$4,910.7
14John D. and Catherine T. MacArthur Foundation$5,259.9$2,980.5$105.1$33.4$2,140.9
15Rockefeller Foundation$3,856.3$361.1$25.9$0.0$3,469.2
16Walton Family Foundation$3,651.9$0.0$0.0$0.0$3,651.9
17Kresge Foundation$3,524.2$1,174.3$37.4$166.0$2,146.5
18California Endowment3$3,465.0$1,287.1$48.0$203.7$1,926.2
19Open Society Institute$3,411.1$0.0$0.0$0.0$3,411.1
20JPB Foundation$3,393.2$1,982.1$467.3$0.0$943.8
21Carnegie Corp. of New York4$3,327.5$95.6$0.0$367.8$2,864.1
22Duke Endowment$3,301.7$134.8$0.0$0.0$3,167.0
23Robert W. Woodruff Foundation$2,948.9$2,927.9$0.0$0.0$21.0
24John Templeton Foundation$2,898.0$0.0$0.0$0.0$2,898.0
25Margaret A. Cargill Foundation$2,776.9$600.2$99.9$139.7$1,937.0
26Simons Foundation$2,696.5$0.0$0.0$0.0$2,696.5
27 Charles Stewart Mott Foundation$2,625.1$533.0$55.4$96.6$1,940.1
28Susan Thompson Buffett Foundation$2,580.8$2,197.3$383.4$0.0$0.0
29Conrad N. Hilton Foundation$2,569.6$250.0$334.0$0.0$1,985.7
30Annie E. Casey Foundation$2,437.7$1,226.2$115.4$58.8$1,037.2
31Carl Victor Page Memorial Foundation$2,382.5$1,619.6$0.0$0.0$763.0
32William Penn Foundation$2,256.3$989.1$140.4$113.3$1,013.5
33 Richard King Mellon Foundation$2,165.7$1,156.8$17.0$365.0$627.0
34Charles and Lynn Schusterman Family Foundation$2,146.2$0.0$0.0$0.0$2,146.2
35Wyss Foundation$2,102.5$491.1$0.0$0.0$1,611.3
36James Irvine Foundation$2,083.0$299.4$65.4$61.4$1,656.9
37 John S. and James L. Knight Foundation$2,051.3$688.5$64.8$151.2$1,146.8
38 Casey Family Programs$2,038.2$1,296.5$59.1$257.2$425.3
39 Ewing Marion Kauffman Foundation$1,996.0$955.0$27.6$0.0$1,013.4
40Harry and Jeanette Weinberg Foundation5$1,924.0$0.0$0.0$0.0$1,924.0
41Laura and John Arnold Foundation$1,893.1$532.6$0.0$305.1$1,055.4
42McKnight Foundation$1,853.9$997.8$75.4$82.6$698.1
43 Alfred P. Sloan Foundation$1,740.3$152.3$85.0$52.0$1,451.0
44 Doris Duke Charitable Foundation$1,684.7$390.6$0.0$48.9$1,245.2
45Barr Foundation$1,621.5$165.9$0.0$0.0$1,455.6
46Houston Endowment$1,593.0$9.2$45.3$0.0$1,538.5
47 Eli & Edythe Broad Foundation$1,592.8$0.0$0.0$0.0$1,592.8
48Moody Foundation$1,555.4$1,122.0$237.8$194.6$0.9
49Michael and Susan Dell Foundation$1,550.4$78.7$0.0$0.0$1,471.7
50Annenberg Foundation$1,448.2$462.3$48.3$126.7$810.9
Top 50 Total$229,621.4$75,145.4$11,087.6$4,187.2$139,201.2
Notes: 1 Data are as of Aug. 31, 2017;2 Data are as of June 30, 2017;3 Data are as of March 31, 2017;4 Data are as of Sept. 30, 2016;5 Data are as of Feb. 28, 2017. Source: IRS tax filings