Harvard University President Lawrence Bacow

By James Comtois and Rob Kozlowski
Pensions & Investments

Endowments and foundations face some unique and unprecedented challenges as a result of the COVID-19 pandemic.

While most had prepared for some kind of market downturn following a record-long bull market, the closure of universities and the subsequent loss of revenue from room and board, tuition and other sources of revenue such as sporting events have created previously unforeseen pressures.

University endowments, if they are forced to provide more of their funds in light of those revenue losses, may have questions to face on how to manage those endowments. Endowments traditionally are required to distribute around 5% of their assets and no more than that, and the management of endowments reflects that expected level of distribution.

“Revenues (of the universities they support) have been in decline very rapidly, so that’s a big challenge for endowments and foundations,” said Margaret C. Chen, partner and global head of the endowment and foundations practice at Boston-based Cambridge Associates LLC. “They have to respond to this challenge very quickly. And they mostly have been.”

Ms. Chen added: “This is a multifactor crisis because it’s not just health, and it’s not just financial. This crisis has touched every aspect of society.”

Harvard University President Lawrence Bacow wrote in an open letter on April 13 that the effects of the coronavirus have put a strain on the school’s operations and on its $40.9 billion endowment.

“Because of the recent declines in the markets, the endowment, while still large, is not as large as it was previously,” Mr. Bacow wrote. “As it shrinks, it has less capacity to support our existing operations, especially as other shortfalls in revenue sources loom.”

Still, the Cambridge, Mass.-based university “can’t just dip into the endowment” to get through tough times. Harvard’s endowment is “highly restricted” and the “vast majority of it is dedicated to specific purposes by donors,” he wrote.

“We cannot legally take a restricted fund and simply repurpose it for another use to make up for shortfalls elsewhere in our budget,” Mr. Bacow added.

Harvard announced on May 5 that it had implemented salary freezes, a hiring freeze and was deferring or canceling all discretionary spending to combat a projected revenue shortfall due to the coronavirus pandemic. However, Katie Lapp, the university’s executive vice president, announced on June 9 that Harvard is not considering furloughs or layoffs and that it would extend pay and benefits continuation beyond June 28 for directly employed staff and contract workers whose work had been idled due to the pandemic.

Other universities act

Among other universities that have announced emergency measures related to the COVID-19 pandemic is Evanston, Ill.-based Northwestern University, which announced earlier in May it would increase the payout rate from its $10.8 billion endowment in addition to suspending the matching contributions to its retirement plans and temporary furloughs of employees. The university did not provide details of the increase.

Jon Yates, Northwestern spokesman, did not reply to requests for further information.

Managers of endowments and foundations with whom Pensions & Investments spoke, however, feel their asset pools are safe.

Phillip Zecher, chief investment officer for the $3 billion endowment at Michigan State University, East Lansing, said in a phone interview that investment losses in the first quarter of 2020 weren’t a big deal since the endowment gained 19.9% in 2019. He declined to elaborate on investment losses.

“We’ve tended to focus in the last couple of years more on U.S. and global companies, and we’ve been early in pulling out of some of the non-U.S. equity exposure,” Mr. Zecher said. “That didn’t hurt us any during the downturn. It helped us a lot in the last couple of years. We also underweighted real assets. Not because of any ESG particular consideration or policies, but the risks in that asset class were not being properly rewarded, so we were going underweight real assets.”

Brian Neale, vice president of investments at the $1.7 billion University of Nebraska Foundation, Lincoln, said in a phone interview that diversification has been beneficial.

“Obviously as an endowment invested for a perpetual time horizon, we’re pretty broadly diversified across all major asset classes,” Mr. Neale said.

But what has really helped the foundation during this time of extreme market volatility was the decision to raise liquidity months before the impact of the pandemic was clear, he said.

“I would say going back to late 2019 and early 2020—December and January—if you look at equity valuations in particular (and) if you look at where rates were, to use the term ‘frothy’ is an understatement. We started raising liquidity,” Mr. Neale said. “It was really precipitated on the view that we were going to see some sort of correction or drawdown.”

“That’s been a really helpful thing for us,” he said. “I will tell you what one of our biggest challenges in terms of providing stopgap revenue coverage to the university is the fact that 99% of our assets are restricted.

“That has been a challenge for us but we’ve been working very closely with the university to identify whether there are opportunities to work with restricted funds where perhaps we could have conversations with the donors: ‘Can we re-evaluate the fund agreements to determine if there’s some flexibility?'”

Justin Barton, president and CIO of the UCLA Investment Co., Los Angeles, which oversees the investment management of the $2.8 billion UCLA Foundation, said in a phone interview the foundation’s endowment had cash and liquidity balances that enabled smooth management of the portfolio.

“We spent a lot of time just trying to assess what our liquidity needs are likely to be as an institution,” Mr. Barton said. “We’ve got ‘liabilities’ to our stakeholders in terms of payouts.”

As a result of running stress tests in the last few years that modeled instances such as public markets falling 50% or not receiving distributions from its private portfolios, the portfolio had sufficient liquidity in March to rebalance asset classes to their target allocations, he said.

The investment company, launched in late 2011, is still building up its private portfolios, Mr. Barton said.

“Being heavily exposed to marketable securities, the (first) quarter was a challenging quarter,” Mr. Barton said. “What’s really important for us to be aware of—and we are aware of—is what really matters is the quality of the assets you own. One of the things we stress internally as well as to our stakeholders is what we can’t control is market pricing. What we can control is what we own, and I think we feel really good about just the intrinsic quality of our assets that run through our managers.”

What the future holds can be difficult to determine during an unprecedented crisis, but expertise at institutions is helping.

Cambridge Associates’ Ms. Chen pointed out that although it’s unclear how long this crisis will last, there’s new information about the coronavirus every week, which helps institutions make decisions based on the future.

Plus, colleges and universities “are very good at adapting.”

“They’re places of learning and they have scientists on their faculties,” Ms. Chen said. “They have many disciplines that help them decide how to respond to change.”

Extra challenge

One challenge that foundations are facing in this crisis that university endowments aren’t is that foundations are being asked to step up and support societal needs more than they otherwise would.

“Foundations are very important today in a crisis like this because they are a source of funding for other non-profits,” Ms. Chen noted.

In response to the coronavirus, the New York-based Rockefeller Foundation has committed $50 million to fund global and domestic programs addressing the COVID-19 pandemic.

“The foundation’s mission is to help the well-being of mankind and trying to address issues that target the most vulnerable,” said Chun Lai, CIO of the $4.4 billion foundation. “And during this COVID-19 global crisis, we want to help.”

During this crisis, the foundation has stuck to its investment strategy and not cut its spending rate of 5.5%. And it has also made sure to have enough liquidity to both rebalance when markets move dramatically and to target new investment opportunities as they arise.

“Now is the time you need a lot of dry powder, (because) now’s the time to shine and make an impact,” Mr. Lai said. “We’re looking forward to different opportunities that the markets offer, but if you don’t have the liquidity, you’re out.”

Like many institutional investors, Rockefeller Foundation has done some rebalancing during the crisis. After being underweight public equities for over a year, the foundation took the opportunity to actively rebalance into public equities in mid-March when the stock market dropped. Now that markets have rebounded, the foundation is looking to rebalance back down.

“The goal is to stay within the long-term range and rebalance to the target,” Mr. Lai said. He declined to disclose Rockefeller Foundation’s target allocation.

During this crisis, the Indianapolis-based Lumina Foundation reallocated certain operational funds (including those reserved for travel expenses) to make investments tied to its mission to support programs and initiatives that make it easier for adults seeking educational opportunities beyond high school.

This includes direct investments connected to both education and education technology companies.

Stronger than before

“We believe that the majority of companies in this space will emerge from this situation stronger than when they entered,” said Brad Kelsheimer, vice president for finance and investments and chief financial officer at the $1.2 billion foundation.

Because of this reallocation of funds, Lumina has also been able to maintain its spending levels.

Lumina has several guiding principles getting the foundation through this pandemic. One of these principles has been to avoid permanent capital loss by not selling assets at depressed prices and having a disciplined approach to managing liquidity. The foundation also has a $100 million line of credit to maintain operations without selling assets.

“We also have a seasoned and exceptional investment committee, which is key in times like this,” Mr. Kelsheimer added. “Now is not the time to panic. We still maintain a long-term horizon view, which has been very helpful during this disruptive time.”

Mr. Kelsheimer explained that Lumina’s portfolio “is highly diversified and remains appropriately liquid during robust return environments” to “have reasonable upside capture during strong markets but outsized protection during downtowns.”

“We do this because Lumina has no revenue sources other than its investment portfolio,” he said, adding that this tactic has served Lumina “extremely well.”

The foundation also cautiously rebalanced in March by moving roughly 5% of its liquidity and diversified allocation to its growth pool. It also has the capacity to move another 10% over time, enabling the portfolio to be “well-positioned for another dip if that comes again this year.”

The impact of the COVID-19 pandemic has been an undeniable strain on the financial health of universities and other organizations with pools of donated assets around the country, and many are asking where markets are going.

Samuel J. Pollack, principal and senior consultant at NEPC LLC, said that tension is growing between the short-term financial needs of universities and the long-term missions of their endowments.

From endowment and foundation clients, “we’ve been hearing a diverse array of things,” Mr. Pollack said. “We’ve been hearing that both endowments and foundations in many cases, they’re looking for sources of funds, period. It’s not more complicated than that, but what does that mean?

“That can mean a lot of them are revisiting the restrictions on restricted gifts, engaging donors in dialogue about the organization’s needs today and potentially loosening the restrictions to some degree that requires that kind of full court press from the organization’s leadership, or if relevant, alumni or board members of whatever,” Mr. Pollack said.

2 shortfall options

According to Dimitri Stathopoulos, senior managing director and head of U.S. institutional sales at Nuveen, a unit of TIAA-CREF, university endowments can manage their revenue shortfalls in two ways. They can either increase their spending policy, which is easier for larger institutions, or, if they’re a small organization, they will probably be faced with deciding where to allocate monies.

“A lot of this all depends on how schools move forward in the fall,” Mr. Stathopoulos said. “If students aren’t comfortable coming onto campus, there’s a lot that’s unknown.”

Some endowments should think about different asset allocations depending on the restriction levels of donated funds in their asset pools, said Andy Daly, managing director, alternative investments at SEI Investments.

“In the financial crisis (of 2008), sure there were some issues, but nobody’s been prepared for something like this,” he said.

It is making people question the endowment model a little more, if they are forced to draw down more than the 5% of assets that the portfolio is modeled to distribute, he said.

“It’s really hard to achieve that return objective without taking a lot of risk and having a really illiquid portfolio,” Mr. Daly said.

On having separate asset allocation, “Nobody’s really thought about it before, so I think people are going to possibly rethink how they’re investing these assets,” Mr. Daly said. “I think organizationally for a lot of folks whether it’s an OCIO or investment adviser it’s going to be a headache. You have to document everything differently you have to have the infrastructure to be able to report it differently.”

This article was originally published June 15, 2020 by Pensions & Investments

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