Endowments and foundations are set to lead all institutional investors in asset growth, with projections showing they’ll surpass corporate defined benefit plans by 2026. At the same time, pressure to hit ambitious return targets amid declining student enrollment and limited resources is accelerating the migration to OCIOs.
Chris Swansey, an associate director at Cerulli Associates, told attendees at the Investments & Wealth Institute Strategy Forum in New York on Monday that endowments and foundations “are concerned about not meeting return targets,” which is “impacting their investment decision making.”
Cerulli projects nonprofit assets will grow about 7 percent annually, on track to reach $3.9 trillion by 2029. This growth is driven primarily by strong investment performance rather than contributions from donors and other fundraising.
As endowments confront new tax implications and legislative policies impacting their decision-making, student enrollment remains the top concern. With universities expecting a 15 percent drop in the enrollment of college-age students over the next four years, endowments fear this could significantly impact their financial health.
At the forum Institutional Investor attended, Swansey shared data from Cerulli and NACUBO showing that more than a third of endowments and foundations with at least $100 million in assets expect to increase their allocations to alternatives over the next 24 months.
The nonprofits “like the return patterns of alternative investments as a volatility dampener,” he said. Even though it's somewhat artificial because the assets are not marked to market, they like having that stabilization in returns.
“Not only does this help them… improve their investment returns it also helps smooth out volatility,” Swansey said.
While smaller endowments with less than $50 million allocate most of their portfolios to public equities, this cohort of endowments still has a growing appetite for alternatives.
Despite liquidity being a concern for the smaller endowments, “it's not driving investment behavior,” Swansey said, noting that endowments of all sizes are “moving up the risk spectrum in order to meet those return targets.”
Amid this need for higher returns, more nonprofit institutions are handing their portfolios to OCIO providers. As Swansey noted, about a quarter to a third of nonprofit assets are intermediated by an OCIO provider. That's expected to expand on the endowment side up to half, and on the foundation side, up to a third by 2029.
Swansey cited three reasons endowments and foundations are adopting an OCIO provider: They don't have the resources to manage their portfolios internally, they want improved performance, and they want better access to alternatives. And those things “really go hand-in-hand,” he said.
As he explained it, allocators want better access to alternatives to improve their performance. But managing an alternatives portfolio constrains resources for in-house staff, leading them to outsource, even if it’s only a “portion of the investment process.”
OCIO providers can improve access to alternatives through commingled fund-of-fund structures where providers are giving their smaller clients access to high-performing alternative managers. “That's really resonated with endowments of all sizes,” Swansey said.
Nearly all OCIO providers are focused on the endowments and foundations channel for growing their asset base, with the most adoption coming from the $100 million to $500 million cohort. But Cerulli is also starting to see some movement down market as well, where many OCIO providers are now focused on that under $50 million space.
Swansey’s presentation was part of a larger session on the state of endowments and foundations.
