Looking beyond asset allocation to enhance educational endowment returns

Industry expertise

High inflation and a challenging market environment represent a financial one-two punch for many schools and colleges. These conditions not only force institutions to divert endowment funds to cover rising expenses, but they also dampen an endowment’s asset value growth at a time when institutions are wrestling with higher costs.

In 2022, higher education institutions saw operational costs rise in all categories, with the Higher Education Price Index (HEPI) inflation rate topping out at 5.2%—the highest rate since 2001. It’s almost double the 2021 rate, when costs rose 2.7%.Disclosure 1

High interest rates are also affecting operating margins as the cost of debt service rises, causing some institutions to push against or beyond the limits established in their covenants. Expecting higher endowment draws to cover operating margin shortfalls is no longer a viable answer in today’s environment. The stock market’s recent downturn has sent endowment investment returns into negative territory, a marked change from their strong performance in 2021. Returns on endowment portfolios fell on average 8.0% in 2022, with smaller institutions hit especially hard.Disclosure 2

Given higher costs and lower endowment returns, many institutions are looking for ways to operate more efficiently and reduce expenses while rethinking their approach to endowment management.

Looking for improvements to close the financial gap.

Institutions, especially those that provide generous scholarships and financial support to students, are looking for operational cost savings to fulfill their missions in an inflationary environment. Yet operating improvements alone are unlikely to deliver the financial results needed in today’s economic climate, and that has leaders looking for opportunities in donor management as well.

Many institutions still manage planned giving and donor fund accounting with inefficient, manual processes to track donors and their financial information. Using spreadsheets for sub-fund accounting creates a time-consuming administrative burden when institutions are looking to improve staff productivity and introduces the possibility for error in recording donor gifts.

At a time when donors expect greater transparency about the institution’s stewardship of their gifts, outdated donor management processes hinder an institution’s ability to fully apprise donors of the current fund value of their donations and the benefits their gifts are providing. Fund accounting is more than a courtesy that donors appreciate. They’re more likely to give generously now and in the future when they can observe the growing value of their gifts and witness the ongoing benefits for students.

Nonprofit fund accounting solutions can automate the tracking and reporting of donations resulting in increased accountability for financial staff and greater visibility for improved oversight by the investment committee, their trustees, and the board. Some endowment managers, like Truist Foundations and Endowments, can provide comprehensive solutions.

Regular review keeps investment costs in line.

Endowment investment advisory and management expenses are another area where wise stewardship can deliver meaningful cost savings. Regularly reviewing the fees and costs associated with managing an endowment is a prudent move, even if your institution’s charter or board policy don’t require periodic requests for proposals for these services.

Scrutiny of the fee structure can often reveal costly investment vehicles or hidden fees, both of which can erode net endowment returns. A cost review provides an opportunity to consider the value of the service the school is receiving for management costs and fees.

Beyond fees, a strong investment platform is vital in meeting your investment objectives while providing quality advice and service to yield the returns you need. When reviewing investment advisors and managers, consider:

  • Do investment advisors bring substantial experience in the educational endowment space and knowledge of its unique challenges and opportunities?
  • Do investment managers specialize in serving institutions of comparable size?
  • Do they offer open architecture (both in-house and third-party products and services) for endowment investment choices?
  • Are the investment recommendations conflict-free (i.e., not exclusively proprietary)?
  • Do they utilize appropriate benchmarks to evaluate endowment performance and identify best-fit investment vehicles?
  • Are they adept at tailoring guidance to align with institutional values? Do they have an approach to managing investments to fit your institution’s environmental, social, and governance (ESG) objectives?

Addressing considerations like these can reduce costs, ensure that fees paid meaningfully bolster your endowment today, and create an asset that will provide financial support for your institution over the long term.

Optimize your investment strategy to raise endowment performance and growth.

Controlling endowment costs addresses the expense side of the cash flow equation, but what about the income and returns side? During periods of high inflation and market volatility, protecting endowment income is critical for ensuring adequate institutional support and positioning for a strong future.

Begin by evaluating your endowment investment portfolio. Does the investment strategy reflect the specific needs and goals of the institution? Have you rebalanced your investment mix lately to account for changes in the economy, asset class performance, and changes in investment risk? Many institutions are automatically funneled into a common plan, so it's important to make sure you’re not one of them. A “one size fits all” investment strategy doesn’t recognize the nuances of your institution’s endowment and is not likely to maximize its financial potential.

Focus on risk management.

When was your Investment Policy Statement (IPS) last updated? This important financial tool guides overall portfolio management and informs specific investment decisions. An IPS helps leaders recognize the risk associated with their endowment investments and determine the appropriate balance between risk and potential return.

You can use a Monte Carlo simulation to evaluate various investment approaches. By running hundreds of different combinations of market and economic conditions, Monte Carlo simulations determine the probability that a portfolio structure will meet your endowment performance goals. Based on that data, you can construct a portfolio mix that offers a level of risk and potential returns that are appropriate for your institution.

If you don’t have an IPS, then it is in your best interest to create one and review it regularly.

If you have an IPS in place, you’ll probably want to reassess its effectiveness considering current market and economic conditions and adjust as necessary.

As institutions look to boost endowment income, they depend on investment managers and advisors to guide their financial decisions and respond to market events quickly and effectively, without putting the long-term sustainability of your assets at risk.

Investment professionals will work with you under either a discretionary or a non-discretionary model. Under the discretionary or Outsourced Chief Investment Officer (OCIO) model, your investment manager can make investment decisions in line with your investment policy on behalf of your institution. With the non-discretionary model or consultant model, an investment advisor provides advice and guidance to your investment committee and acts on decisions made by that group.

Institutions of all sizes are trending toward the OCIO model since it places clear accountability for investment decisions with professional managers and provides them with the discretion to respond quickly to changing financial conditions. Use of the non-discretionary model hearkens back to a day when endowments were smaller, markets were simpler, and economic conditions were more stable. Sticking with a legacy endowment management approach that lacks strategic sophistication—or the ability to course correct in volatile market conditions—can diminish your endowment’s income and growth. 

Investment advisory service models
Discretionary (OCIO Model)
Investment policy development Yes
Manager research/selection Yes/Yes
Asset allocation – tactical shifts Yes
Portfolio rebalancing within approved ranges Yes
Daily monitoring and trading Yes
OCIO* serving as advisor: fiduciary status Yes*

*Some OCIOs can act as co-fiduciary and trustee

It's during periods of volatility and economic uncertainty that a nimble, tactical approach to asset allocation and investment decisions is necessary to curb negative market turns. If you’re not sure that’s what your current endowment management approach is delivering, explore your options with other managers who can provide the agile investment response you need in changing economic conditions.

Talk to a financial partner who sees the whole endowment picture.

The combination of your Truist relationship manager and the endowment management professionals at Truist Foundations and Endowments Specialty Practice can help you look at all the financial levers to weather the coming years and provide insights about effective endowment management and sustainable growth strategies. Visit Truist.com/Education.