Some Endowments and Other Allocators Just Won the Investing Equivalent of the Oscar. Now Comes the Hard Part.

With private market valuations at highs and expected fixed income returns at lows, asset owners are turning to international markets and other new ideas.

Chris J. Ratcliffe/Bloomberg

Chris J. Ratcliffe/Bloomberg

After a year of high-flying performance, asset owners are making plans to manage the inevitable: less favorable market conditions.

While returns are still rolling in, universities, healthcare systems, and other institutions are considering how they will handle high private markets valuations, low fixed income returns, and unexpected changes that could shake the market.

It’s a crucial time for these allocators. Some worry that this year’s returns — in certain cases over 50 percent — could cause investors to get complacent or sloppy.

“Look at the lottery winners,” one ex-allocator, who spoke to Institutional Investor anonymously, said. “When big money is around, it changes people. We’re crossing into a different territory.”

The University System of Maryland Foundation’s chief investment officer, Samuel Gallo, said that rather than piling on risk, the $2.5 billion organization is taking a cautious approach.

“We are rebalancing,” he said. “We have harvested a lot of profits.” The organization has not yet publicly reported its returns, and Gallo declined to disclose them.

According to Gallo, the University System of Maryland Foundation made many of the decisions that led to this year’s best-performing investments five to ten years ago. The changes allocators make now won’t just affect their 2022 performance numbers — they could be consequential a decade from now.

The foundation is leaning into areas where valuations are lower, particularly international markets, where Gallo believes there is still the potential for profits. For example, he noted that while investors have been concerned about tightening regulations in China, there are still opportunities there to invest.

“China still has a strategic plan,” Gallo said. “If you’re in line with the strategic plan of China, which is high-quality manufacturing, history shows that when they say something, they do it.” He added that there are “certainly opportunities” in Europe, and to some degree in Japan and Southeast Asia, as well.

Likewise, Geeta Kapadia, associate treasurer and director of investments at Yale New Haven Health, said the healthcare foundation is open to investing in China and other emerging markets. But the investments hinge on the organization’s ability to get a sense of the risks, particularly regulatory ones, ahead of time. “We’re willing to take that on, but really understanding what it is that we’re getting into is important.”

Washington University CIO Scott Wilson also recently heralded the alpha available in international markets. He told II in September that the endowment has significant exposure to these markets. Wash U’s investments are mostly driven by bottom-up fundamental analysis.

Gallo said he is keeping tabs on private market valuations and whether they will be “sticky.” While venture and private equity returns drove the fiscal year’s high-flying performance, those returns are reported as internal rates of return or multiples of invested capital, meaning that they have yet to be realized.

“These IRRs will probably come down,” Gallo said. He suggested that measuring distribution to paid-in (DPI), or the amount of capital returned to investors divided by a fund’s capital calls at the valuation date, could be made more accurate.

“What I worry about is the capital just stupidly chasing deals,” Gallo said. “People are not doing rigorous due diligence. They’re raising too often, too quickly, too big of funds. They just have the expectation that they’ll be back to market in a quarter or two.”

On the flip side, Yale New Haven Health is considering expanding its relatively young private markets portfolio, which has been underweight. “We are trying to be open-minded about taking meetings about strategies that haven’t historically been our sweet spot,” Kapadia said.

She noted that one of the challenges to investing has been fixed income’s low returns as an asset class. Investors previously relied on the asset class for low risk and stable returns. Low interest rates have decreased fixed income’s yield so that it no longer acts as an offset for rising inflation.

“Fixed income is just an area where you can’t do much of anything,” Kapadia said. She also expects passive investments in broad equity markets to become less attractive.

“We’re going to continue to look for uncorrelated, diversified portfolios that provide sources of alpha outside of true beta,” Kapadia added.

As for what’s next for the market itself?

“There’s just so many things that could hurt the market, but the one thing I’ve learned in my career, it’s never the thing I’ve said,” Gallo noted. “If what you expect happens, that’s rational. Market sell-offs are irrational behavior. It’s based on something that you could not even foresee; therefore you would have never hedged against it.”

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