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Small Endowments and Foundations Fall Behind in the Pandemic

Bigger allocations to alternative assets may be benefiting their larger peers — for now.

Large endowments and foundations in the U.S. beat smaller ones in the first quarter, reversing last year’s performance trend as a result of having different investment strategies heading into the pandemic, according to a study by Bank of New York Mellon Corp. 

Endowments and foundations managing more than $1 billion are significantly more exposed to alternatives assets, while smaller ones have higher allocations to equity and fixed income, BNY Mellon said in a report on its findings. As the industry lost an average 10.46 percent in the first three months of this year, large endowments and foundations outperformed their smaller peers by 1.93 percentage points.

Larger allocations to alternative assets such as private equity appear to have provided a cushion during the stock market crash in the first quarter, according to the report. But further declines may be coming as private equity-owned companies aren’t shielded from a downturn — they’re just valued infrequently compared to the daily swings in stock prices.

“You might get estimates on a quarterly basis,” Frances Barney, head of global risk solutions at BNY Mellon Asset Servicing, said in a phone interview Tuesday. “You really are not going to see the same kind of volatility with private investments, in most cases, as you would with publicly-traded stocks.” 

Before the Covid-19 pandemic ended the longest ever bull market, smaller endowments and foundations had been slightly ahead of their larger peers, benefiting from their larger exposure to stocks, according to the study. They returned 15.11 percent in 2019, beating large endowments and foundations by 19 basis points, the report shows. 

“The difference for 2019 really was the relative overweight to equities,” Barney said. “When equities are performing really well, it’s hard to justify the benefits of alternative investments,” she said, partly because of their higher management fees.

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Over longer periods, though, large endowments and foundations have outperformed. 

They posted a 9.61 percent gain in the three years through 2019, compared to 8.33 percent for small funds, according to the report. Their five-year gains were 7.38 percent, exceeding the 6.02 percent returns posted by their smaller peers over the same period through 2019. 

Larger endowments and foundations have kept “relatively high” allocations to alternative assets over the past five years, BNY Mellon said. Their exposure to “high-performing” private equity assets and sub-sectors of the hedge fund industry increased significantly over that period, while their allocations to real estate and other real assets fell.

By contrast, smaller endowments and foundations “greatly reduced” allocations to alternative assets, with the exception of real estate, according to the study. The stock market, meanwhile, had been delivering big returns.

“If you think you can have fabulous returns just by investing in cheaper strategies, that sounds like the best approach,” Barney said, before pointing to the benefits of diversification. Of course, stocks don’t always go up.

The Covid-19 downturn has created significant financial hardship for endowments and foundations, “institutions that the world looks to for help,” said Barney. “They’re struggling to manage the impact of not just the downturn, but the volatility.”

This group of institutional investors manages money for universities, philanthropies, and cultural institutions with long-term asset allocation strategies. With the global pandemic still unfolding, it remains to be seen whether larger endowments and foundations will continue to see a less severe impact on their total portfolios, according to the report.

“It is possible that lagged performance might be obscuring more dramatic dips to come in some alternative asset classes,” BNY Mellon said.

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