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Endowments & Foundations

Meeting the challenge of the new regime in endowment portfolios

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A new market era

We’re in a new market regime: previously benign inflation, double-digit equity returns, and muted risk has given way to higher volatility, consistently rising prices, and growth uncertainty. To help endowments and foundations (E&Fs) navigate this environment, we’re pleased to present a new publication that builds on the principles laid out in our 2022 paper, which advocated for a modern approach to the traditional endowment model. Today, we underscore these conclusions and highlight additional tools that E&Fs can use to meet the challenges of the new regime, specifically encouraging institutions to:

1. Reconsider diversifying assets
2. Apply a dynamic approach to the whole portfolio;
3. Selectively increase exposure to active managers alongside an index portfolio
4. Be more opportunistic in the alternatives portfolios

 

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Refining diversification

Fixed income in the new regime

We think the new regime calls for a dynamic approach to fixed income investing, rather than a “set-it-and-forget-it" mentality. That approach starts with recognizing the dynamics of the leading bond market indices, which can be driven in large part by interest rate risk, even when they appear to be more diversified.

Fixed income markets may remain more volatile than they were in the post-Global Financial Crisis period. With the mix of higher yields and volatility, we look more to active fixed income to capitalize on the changing dynamics. Skilled active managers should be able to take advantage of the rapid changes in bond yields, the changing shape of the yield curve, and have the ability to find and select mispriced credits and credit sectors to seek excess returns.

Chart showing the Bloomberg Global Aggregate Bond (Hedged USD) Index and its contribution to total risk by factor, measured in basis points (bps)

Source: BlackRock and Aladdin as of 30 June 2024 using a one-year time horizon and 84% confidence level.

Bloomberg Global Aggregate Bond (Hedged USD) Index: Contribution to total risk by factor (bps)

Honing hedge funds

We believe a dynamically managed and rigorously sourced hedge fund portfolio, built with a focus on minimizing correlations to equities and fixed income, can provide meaningful return and potential diversification benefits.

But good outcomes are predicated upon identifying and accessing the most skilled managers with the ability to evaluate a wide range of data, leverage deeply established professional networks, and experience investing across strategies and through multiple market cycles.

The importance of being dynamic

Chart illustrating the ongoing macroeconomic volatility overtime.

Source: Refinitiv Datastream, MSCI, and BlackRock calculations. As of March 31, 2024. Global GDP Volatility measures how individual developed countries’ quarterly GDP changes deviate from the average GDP change of all developed countries, using a 3-yr rolling average. U.S. Core CPI Volatility measures the standard deviation of year-over-year U.S. Core CPI using a 3-yr rolling window. GDP: Gross Domestic Product. CPI: Consumer Price Index. Neither asset allocation nor diversification can guarantee profit or prevent loss.

Some E&Fs use a dynamic approach, which incorporates top-down views of the macroeconomic environment, while others remain focused on bottom-up manager selection. In the new regime, we believe that just employing static asset allocation and manager selection is too limited of an approach. Instead, we recommend that E&Fs take advantage of what is an increasingly thematic and macroeconomic-driven market.

Selectively increasing active in the new regime

While index strategies performed well in the era from the GFC through COVID (2009 – 2023), in the post-pandemic era we see greater dispersion in earnings estimates, valuations, and stock returns, suggesting greater opportunity for skilled managers to generate alpha.

We believe that E&Fs should look to source a diversified set of managers across fundamental and systematic strategies that target consistent and uncorrelated alpha. Blending high-performing, complementary quantitative and fundamental strategies can result in a more robust total equity allocation.

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Build more opportunistic illiquid portfolios

Despite the challenging environment for some alternatives in recent years, we believe that private assets continue to have a critical role to play and that there are several steps E&Fs can take to build private markets portfolios that are positioned for the new regime. These include using co-investments and secondaries in PE, as well as private credit and infrastructure.

Endowments look forward

By taking a dynamic approach to the overall portfolio, rethinking diversification in liquid and semi-liquid assets, selectively embracing active management where it is most beneficial, and opportunistically investing in illiquid assets, we believe that E&Fs can meet the challenges confronting them today, and in the years ahead.
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Authors

Edward Ng, CFA
Edward Ng, CFA
Client CIO for Endowments, Foundations and Healthcare
Ned Rosenman
Ned Rosenman
Head of Client Engagement, Endowments and Foundations Custom Solutions
Vinitha Kaushik, CFA
Vinitha Kaushik, CFA
Client CIO for Endowments, Foundations and Healthcare
William Jafari, CFA
William Jafari, CFA
Client CIO for Endowments, Foundations and Family Offices

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