With industry practitioners uniformly forecasting mediocre public and private market returns for the foreseeable future, institutional investors are left struggling to achieve the sufficient returns necessary to meet their distribution targets.
The largest money managers are projecting U.S. equity returns to be below 6 percent nominally over the next 10 to 20 years. This means allocators will have to be creative in how they navigate markets to meet their minimum hurdle.
Most institutions — particularly endowments and foundations — need to target an annual return of at least 8 percent to meet their 5 percent spending rate.
In recent years, allocators have relied on private markets to boost returns. But ever since rates bottomed out, the multitude of private equity operators that proliferated the market are now sitting on over-levered companies and having a harder time getting exits.
“Now all these asset owners who need their corpus to exceed 8 percent and liquidity are sensing a foreboding future reality,” said Chris Scibelli, managing director at ACR Alpine Capital Research.
Recently updated 10-year capital market assumptions from Verus and Callan suggest a diminished private equity premium, with both projecting public equities to largely return below 7.5 percent and private equity only modestly higher, between 8 percent and 9 percent.
“Liquidity has become a bigger issue,” Jay Kloepfer, director of capital markets research at Callan, told Institutional Investor. “Everybody’s looking under every rock.”
Kloepfer noted that investors can use more exotic private markets, but they have a shrinking premium because everybody’s piled into the space. Another thing they can do is reassess their time horizon. “If it’s short, you do feel more pressure to take on more risk,” he said.
Endowments are among those struggling. Based on recruiter Charles Skorina’s recent annual rankings of the top performing university and college endowments for the past 10 years, only four out of 122 universities with at least $1 billion earned double-digit results. In total, 81 universities delivered a return that exceeded the minimum requisite 8 percent threshold, while 34 percent of them fell below.
Mark Baumgartner, CEO and CIO of the University of Florida Investment Corp., said that no one expects public markets to reach CPI+5. He added that investors have a few options to differentiate themselves and achieve that required 8 percent threshold: They can take on illiquidity risk, they can concentrate on just the winners, they can use leverage, or they can use a combination of a couple or all three.
“There’s risk in being different, but the risk is where you can outperform,” Baumgartner said.
While returns are expected to be anemic, many allocators that II has spoken with aren’t necessarily expecting a downturn. Brian Neale, chief investment officer for the University of Nebraska Foundation, said that while markets could be “one bad Mag7 earnings report away from a massive price correction,” he’s not expecting a downturn.
“I don’t think a recession is imminent,” Neale said. “It’s certainly not on my BINGO card.”
The allocator added: “You have to be creative in how you navigate markets. Now’s not the time to head for the exits.”
