Building an optimized investment infrastructure begins with clearly defined goals and identifying who, both inside and outside the family, will play a role in the wealth management process. Some families choose to build a family office to oversee some, or all of the functions related to managing their wealth in-house. However, for many families, the best approach is to build a team of advisors who are experts in their fields and who can work together to meet the family’s investment needs. This paper serves as a guide for families who have decided to outsource the investment function of their portfolio by partnering with an investment advisor. Its aim is to help families understand the different structural components to consider as they work to create an institutional-caliber portfolio (Figure 1). These structural components include investment management, banking, lifestyle services, legal representation, tax accounting/reporting, and philanthropy.

But First, a Word on Governance and Controls

For a family who has experienced a liquidity event, governance may not be top of mind. However, reflecting on how investment decisions will be made can often provide valuable direction on what type of partners they need. An honest assessment of a family’s desire to be involved in day-to-day investment decisions, oversight, and implementation—and their experience in making such decisions—will guide families to solutions that make the most sense for them. In some families, a primary wealth owner may prefer to make and approve all investment decisions, while in others a delegate or investment committee may be preferable. Considering these complex foundational questions up front can help determine optimal partners.

Investment Management

Working with an Advisor

Investment advisors provide a range of services to help manage a family’s wealth. First, they help the family create an investment strategy that aligns with their financial goals and risk tolerance. This includes due diligence, strategic asset allocation, risk management, investment selection, and regular monitoring of investments. Investment advisors can also provide investment education and retirement planning, estate planning, and tax planning. The role that an investment advisor takes on within an investment infrastructure differs from family to family. For this reason, they often operate in close coordination with lawyers, accountants, and tax specialists to ensure a comprehensive approach to wealth management.

Fiduciary Versus Advisory

When selecting an investment advisor, families should first consider the difference between a fiduciary and advisory relationship (Figure 2). They should consider a fiduciary relationship if they seek a partner who is legally bound to act in their best interests, especially if they prefer not to be deeply involved in day-to-day investment decisions. On the other hand, an advisory relationship might be suitable for families who desire more control over their investment choices and are comfortable with a more collaborative approach.

Portfolio Administration

Handling day-to-day portfolio operations is no small task. Families should note that the amount of time required to source and evaluate investments often goes well beyond what an individual alone can handle, even if they have a strong investment background. Meeting a portfolio’s oversight requirements also involves significant work. An outside investment manager can help family investors sort through the universe of available funds and strategies to identify which investments may best suit their goals. Whether a family creates a single, “one-stop shop” office to support its needs or elects to build a broader team of experts, a strong team is needed to oversee the execution of the playbook. From there, the focus should be on working with reputable and experienced service providers with strong references and a track record of success.

The work of portfolio administration also includes placing and signing off on trades, completing subscription documents, paying capital calls, cash monitoring, approving consent documents, and tracking performance. Cash management—for example, uncovering opportunities to achieve better cash yields than a custodian bank might be offering—is another key administrative task. Considerable work with selected banks is required to set up accounts and services, which we discuss in more detail below.

Many wealth owners try in earnest to take on all this work themselves, but find it becomes too challenging to manage in conjunction with other day-to-day obligations. In most cases, families should have someone readily available to undertake these responsibilities. Some investment advisors, including Cambridge Associates, can manage operational activities for clients—in either a fiduciary or advisory capacity. Alternatively, families who have opted to build a family office often handle portfolio operations with an in-house team.

Banking

Another key infrastructure choice that families need to make involves selecting a bank and the type of investment account they will use to operate and oversee their portfolio. There are two main options to choose from: a brokerage or custodian account (Figure 3).

A brokerage account is typically lower cost, as assets are held in a large general account on behalf of families. Because securities in a brokerage account are tied to a broader pool of assets, they may become encumbered or put in jeopardy in the event of a bank failure. By contrast, a custodian account is considered a more secure method of holding assets, with all securities held in the name of the account holder. Custodian accounts allow for assets to remain freely transferable providing an additional layer of capital protection in the event a bank or broker comes under financial pressure. For these reasons, custodial accounts are often referred to as “safekeeping” accounts. The landscape of brokerage account providers is fairly broad. However, when it comes to custodians, choices are more limited. When deciding between brokerage and custodial platforms, families should also consider the related costs. As service utility varies by preference and goals, families should know what they are signing up for (Figure 4).

Large custodians target families with assets of $200 million or more. These banks generally have better online portals, more service options, investment capabilities, and superior customer service teams. However, they also have revenue targets to consider when taking on new business, so they prefer larger clients and typically charge around 5 basis points (bps) on market value. Mid-size custodians generally charge a higher fee of around 10 bps, but don’t have defined revenue targets by relationship. In some cases, these banks may want to maintain an existing relationship with the family if a third-party manager is brought in. Alternatively, families with smaller mandates can seek out smaller custodial account providers, which offer no-frills services with fees starting at around $12,000. Figure 5 approximates what percent of assets are custodied once a portfolio is built out and fully allocated to its asset class targets.

After electing whether to use a brokerage or custodian account, account-specific add-on services can be determined. If a custodian relationship is selected, families can opt to add accounting services, including alternative asset pricing, so they have an official book of record. This service is useful for tax purposes, as transaction records and tax document collection can be shared with the tax provider.

Performance reporting is another add-on service that many families use to compare data against that of investment service providers. However, if a family’s investment consultant provides performance reporting, they will want to confirm whether two sources of performance data are useful to them or if this is an unnecessary cost. Some custodians offer nominee services to investors, whereby assets are purchased in the name of the bank. This is done for specific reasons, such as maintaining privacy of holdings and managing administrative complexities between clients and their banks. As families determine what kind of accounts they need, they should consult their existing tax service providers to be sure they are meeting all the bank’s documentation and regulatory requirements. An investment manager can next review the final account structure and domicile information and help recommended which investment vehicles may be best suited.

Beyond selecting where assets will be housed, families often need to negotiate terms related to borrowing and lending. For example, they may have an interest in taking a line of credit against their assets or becoming involved in private lending. In such cases, it’s important to consider both the existing banking relationship and the service offerings of other banks to determine an optimal approach.

Lifestyle Services

Services such as property management, bill pay, and support personnel can serve as additional components of an investment infrastructure that are not related to the portfolio. In many cases, support personnel include individuals who are responsible for cash and balance sheet management and tax coordination. The time and convenience provided by such services can allow family members to focus on other priorities such as business ventures and philanthropic work. Other benefits of lifestyle services include additional risk management and enhanced privacy. Finding the right service level starts by defining the scope and objective of the work, be it office staffing, property management, or household and travel administration. It is important to partner with service providers that align with the family’s specific preferences.

Legal Representation and Structuring

In addition to choosing an investment account type or entity, families need to consider their legal representation and structuring needs. Investors need legal support to determine optimal investment structuring strategies and to review investment agreements as new ideas are evaluated. Asset protection is another key component of legal representation—including the use of trusts and limited liability entities. Families should work with legal professionals who have expertise in wealth management and understand their unique needs.

Likewise, determining a clear legal structure is essential for ensuring a smooth transfer of wealth to future generations. A comprehensive succession plan that addresses issues, such as leadership transition, governance structures, and other family dynamics, will help ensure continuity of the investment strategy and an enduring focus on the family’s key values. For these reasons, a family’s legal representation should also be well-versed in wills, trusts, power of attorney, and healthcare directives.

Tax Accounting and Reporting

Tax accounting and reporting is a crucial component of a family’s investment operations. Beyond ensuring compliance with tax laws and regulations—including income reporting, deductions, and capital gains rules—effective tax accounting can also help maximize an investor’s tax efficiency and preserve wealth. Tax laws and regulations are complex and change frequently. Tax advisors who specialize in working with family investors can help with meeting requirements and identify tax planning opportunities. They can also assist investment transaction record keeping, make it easier to prepare tax returns, and respond to any tax inquiries. In some cases, investment managers can work with custodian banks to help streamline the flow of tax documents to maximize efficiency.

Philanthropy

Many families choose to set up a family foundation as part of their wealth planning. This type of capital pool requires a distinct kind of portfolio management, one that adheres to a unique set of spending requirements and liability needs. It can be beneficial to work with a partner that has experience in managing the fund disbursement process and tracking ongoing commitments. Families can also work with a philanthropy advisor to help them define and implement their giving strategy. Philanthropy advisors specialize in helping families clarify their values, mission, and priorities. Having a well-defined philanthropic plan in place can give families greater confidence in their giving strategy.

Complexity Considerations

For families of significant wealth, complexity is a natural byproduct of a well-managed portfolio. Generally speaking, the infrastructure needed to properly support the daily, weekly, monthly, and annual operations of an institutional-caliber portfolio will parallel the portfolio’s size and scale. A relatively straightforward investment structure with few family partnerships can allow for easier implementation and support. By contrast, more complex investment structures—such as unique pooling vehicles to support the needs of many beneficiaries—require additional flexibility. These structures also usually require enhanced tax management and accounting services. Families should conduct a thorough assessment of their internal resources, including time, expertise, and willingness to engage in investment management. If the complexity outweighs the family’s capacity for effective management, simplifying the investment structure or seeking external expertise may be prudent. On balance, an investment framework’s multidimensionality should help—not hinder—the work of serving the family’s long-term financial goals.

Building Toward Success

If or when a family’s wealth picture changes, it may be time to take a step back and determine the right partners and processes for moving ahead. Building the right investment infrastructure will play a crucial role in helping to preserve and maintain wealth over the long term. Families should take care not to underestimate the amount of work that effective investment management and wealth governance involves. Identifying their unique areas of expertise will help to clarify the areas where collaboration and partnership can be best used. In all instances, costs should be commensurate to the value delivered.

As families navigate the complexities of wealth management, it is crucial to remain proactive in building and adjusting their investment infrastructure. We encourage families to regularly review their investment goals, governance structures, and service provider relationships to ensure they align with their evolving needs. Ultimately, family investors should feel safe in the knowledge that they are operating an institutional-caliber portfolio—confident that their capital is not only protected from undue risk but being put to work in the service of their unique ambitions and values.

Sean Sullivan, Senior Investment Director, Private Client Practice

Heather Jablow, Head of the Private Client Practice, North America

Kara Paluch and Garrett Walsh also contributed to this publication.

The post Optimizing Wealth Infrastructure for Families appeared first on Cambridge Associates.

Read the full article. 

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This paper frames a decision-making process to enable an institution to achieve something that feels untenable—a roadmap for action (or not). The result may feel unsatisfactory, perhaps for all stakeholders on some level, but a divisive climate demands a clear perspective and an explicable institutional response. Fiduciaries have a responsibility to determine a course of action that considers the future of the institution given its mission and mandate.

A return to first principles and an orderly decision-making process can enable an institution to move forward and feel confident about how and why the outcome was achieved. The resulting position and/or action around divestment is an outcome of the process.

In summary, our experience suggests a decision-making process as follows:

1. Define the exclusion. Each institution needs a well-defined process to evaluate divestment proposals and determine the specific investments that would be excluded from the portfolio. Included in the exclusion definition are the reasons for divestment, expected outcomes, and how they would be measured. Following a consistent process and criteria are especially important to address fervent opinions equitably and to communicate clearly.
2. Navigate complex issues with good governance. Good governance is a roadmap that can provide structure, processes, and policies to respond to and communicate with stakeholders while upholding fiduciary responsibilities.
3. Weigh other considerations. There are several related considerations that need to be included in the evaluation, namely costs, timing, legal requirements, and the relationship to a bigger picture.

Define the Exclusion

What is Divested and Why

What set of investments should be excluded from the investment portfolio? Divestment proposals usually start with a sentiment or concern. Recommendations for divestment may be as broad as a demand to avoid affiliation with perceived unacceptable behavior or more specific recommendations for exclusion of economic sectors, regions, nations, or companies associated with or involved in conflict, human rights violations, and other harms. To implement a divestment effort, the investment management team needs clarity about the investments that should be excluded from the investment portfolio. This is often quite difficult, as investments that fail an aspect of the exclusion criteria may have other qualities that are additive to the portfolio in other ways.

Closely related to the recommendation of what should be excluded is the answer to why should it be excluded. Is the reason for the divestment decisions a moral statement or an effort to influence policy through economic impact? Some divestment policies require an economic reason if endowment resources are going to be redeployed because the endowment is an asset with economic value. Would the institution divest to avoid economic risk and stranded assets, or is the intention to influence geopolitical strife—such as compelling a company to stop supplying equipment to an aggressor nation—through withholding capital? If change is the goal, investor engagement as a shareholder may provide a more direct path to influence a company’s decisions.

Values

Many calls for divestment ask an institution to express its values or exercise power to change the course of a conflict or to support a specific movement. Organizational values can be more specific for a private foundation, but shared values are harder to define for a university. By their very nature, universities are designed to explore and cultivate different perspectives. For example, students may weigh values differently or may have different values entirely, especially in today’s divisive political and cultural environment. Faculty and alumni stakeholders bring their values and expectations as well. As a result, it is difficult to eliminate a particular type of investment based on shared institutional values. It is up to those with fiduciary responsibilities to determine whether these divestment requests reflect the mission and commitments of the entire institution.

Goals and Outcomes

What will be the outcome of eliminating a sector or set of companies? How will the impact of the divestment decision be measured over time? Before embarking on a divestment journey, it is important to understand the destination. What is the ultimate goal of the call to action? Are outcomes measurable within the institution or beyond?

Decision makers must determine if the goal is achievable and aligns with institutional and investment principles and policies. This includes weighing fiduciary responsibility, investment implications, and institutional and societal implications.

Navigate Complex Issues with Good Governance

Stakeholder concerns are a form of engagement, and each endowment program needs effective governance to acknowledge and respond to inquiries and requests clearly and effectively. Endowment governance shapes the structure, policies, and processes that direct endowment investments. Good governance is the framework for engagement and communication.

Structure

The first step is to develop a governance structure to consider requests, so that a group is prepared to do the work on behalf of the institution if a divestment issue is presented. Who is eligible to make a divestment recommendation? Who decides whether to implement the request? A decision that involves an interpretation or amendment to existing policy is the responsibility of the Board of Trustees. However, an institutional governance structure can identify the group of people that will receive the divestment proposal. That body may be the Board, the investment committee, a sub-committee of the Board, or a separate group designated to evaluate resources in light of institutional policies. ² Policies and guidelines provide a framework for the group to assess the considerations of the proposal and to determine the best course of action. While one viewpoint may be expressed in the divestment proposal, it is important for the group to consider different sides of the issue within the institutional community.

Process

What is the review and evaluation process? Process establishes the criteria for consideration and the steps for how a proposal may flow from consideration to potential adoption. Criteria for consideration will provide guidelines on specificity of the divestment request, rationale, and goals. Some institutions specifically ask that a proposal include how divestment will help achieve the desired goal. Criteria should also determine the financial and broader considerations for the institution, such as reputation and social or moral implications. Providing the basis and expectations for the divestment request will enable the governing groups to assess the institutional merit and determine how the proposal fits into the broader policy framework.

Policy

The investment policy ultimately must reflect all of the guidance for how endowment assets will be invested. Institutional leadership must base their decision in policy and have a firm understanding of both the short-term and long-term financial implications of divestment. How does the justification for divestment align with institutional bylaws and investment policy? Does the current investment policy outline ethical investment guidelines or environmental, social, and governance (ESG) guidelines? If current policies are insufficient, the Board may need to revise or augment them. Some institutions also have a specific divestment policy to manage proposals.

• Investment policy: The investment policy governs endowment investments. It outlines the goals of the investment program, investment strategy, and asset allocation guidelines, risk and liquidity parameters, and any ESG and impact investment guidelines. If the investment policy rules out divestment or outlines divestment consideration criteria, then no additional policy is needed to address divestment.
• Divestment policy: Some institutions also have a specific divestment policy or statement to outline how divestment considerations are managed. A divestment policy can be employed to outline criteria for consideration and the decision-making process. If a recommendation to divest is approved and requires a change in investment policy, the Board will need to refer to the divestment statement or revise the investment policy to accommodate the new approach.

Weigh Other Considerations

There are further considerations that fiduciaries need to weigh before making a divestment decision because endowment assets are part of a vast institutional ecosystem and must comply with laws and regulations. When responding to calls to divest, we believe institutions should assess financial and regulatory implications, and if the endowment is the appropriate mechanism to affect the issue at hand.

Costs

Divestment narrows the investment opportunity set and introduces new trade-offs. In addition to the elimination of certain direct investments, the divestment decision may steer the portfolio away from asset managers that do not screen for the excluded investments. The divested assets may ultimately become less favorable holdings because of growing pressure to move away from the goods and services involved in the conflict. Or they may be profitable endeavors, and, as a result of divestment, the institution chooses not to participate in financial gains. For example, firms with sales generated in aerospace and defense outperformed the broader index of stocks over the past five years.

Is the institution willing to trade off real, long-term dollars that could be used to provide impact in a different way? Higher endowment returns educate more students, hire more faculty, and invest in teaching and research that can influence policy through writing, legal work, and media. How should the institution balance current causes and views with future views, obligations, and priorities? The endowment is composed of long-term capital intended to support the institution in perpetuity. A change in investment policy can alter the long-term return potential of the portfolio.

Timeline

Very specific, short-term changes to investment policy are contrary to the long-term nature of a diversified investment strategy and the time horizon of the perpetual assets. It takes time to divest, especially if ownership is through external investment managers and private investments that involve longer-term lock-ups for limited partners. Does the timing of the cause inspiring divestment align with the long-term nature of an endowment? Are there other more immediate forms of expression that could affect change sooner?

Another element of timing is how often fiduciaries will review the divestment. How long will the institution withhold capital? If the offending company or industry changes its ways will positive change call for restored investment? At what frequency will circumstances be reviewed to evaluate outcomes? Are those responsibilities defined in the governance process? Questions of timing are connected to the desired outcomes and the nature of the concern.

Legal and Fiduciary Responsibilities

The endowment functions within the bylaws of the institution, as well as regional and national laws. It is important to understand whether the exclusionary action of divestment is permitted under those laws. The action may also be counter to government policy, so it is important to understand the potential impact on government contracts and oversight. Does the opposition impel the institution to extend its boycott to its own government?

Bigger Picture

Endowment policy fits into broader institutional strategy and actions. If the divestment issue is an institutional priority, are other elements of the institution also being employed or deployed to address the issue? How does the endowment’s divestment fit into a broader strategy? Is the endowment one piece of an activist strategy? Would the divestment action be amplified by other forms of activism and collective change? For example, if the endowment is divesting from a popular food chain that is operating in a contentious region, but members of the university community continue to eat at the local franchise, the endowment would be held to a different standard than the community and would be divesting in an isolated vacuum.

Concluding Thoughts

Divestment is a complex decision. The endowment portfolio is composed of a group of gifts entrusted to the institution in perpetuity. Endowment funds are invested with a shared mandate to withstand geopolitical and economic tumult and to equitably distribute funding to multiple generations of stakeholders. The endowment assets serve the entire institution, forever. Fiduciaries have a responsibility to determine a course of action that considers the future of the institution, given its mission and mandate.

This paper offers considerations for how to manage calls for divestment and raises questions that need to be answered to respond clearly and effectively to divestment requests. To navigate tumultuous times and passionate entreaties, we believe institutions need to lean into good governance. It is important that the decision-making process provides clarity, and by extension an opportunity for learning, listening, and engagement, especially when the outcome of the process will not satisfy all stakeholders. An orderly process and response can enable an institution to move forward and feel confident about how and why the outcome was achieved.

Tracy Abedon Filosa, Head of CA Institute
Margaret Chen, Global Head, Endowment and Foundation Practice

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.

The post The Divestment Question: Focus on Governance appeared first on Cambridge Associates.

This year we saw endowment strength in three of the four metrics.

• The endowment’s role grew slightly as it supported a higher portion of growing operating budgets compared to 2022. At the median of our data set, the endowment supported 16% of operating expenses.
• The endowment maintained the level of coverage of growing financial aid commitments. Endowment distributions represented 0.7x coverage of tuition discounts.
• Endowment market values and debt balances grew in sync in 2023 as the endowment continued to provide ballast on the balance sheet, measured by a 4.4x median endowment-to-debt ratio.
• Due to higher effective spending rates, the net flow rate (-3.1%) was weaker in 2023, but new gifts continued to provide an additional source of endowment growth and liquidity.

The Endowment Is Supporting a Growing Portion of Growing Costs

Levels of endowment dependence vary across the 80 colleges and universities in the 2023 Endowment Radar Study. Endowment support ranges from a small fraction of the university budget to supporting more than half (Figure 2).

The median level of endowment dependence was 16.3% in 2023, which was similar to 2021 and higher than 2022 (14.1%). This year’s growth in endowment dependence is notable, given the significant growth in operating budgets that the endowments are supporting. For the median institution, the growing level of endowment support was driven by a 10.5% increase in endowment distribution, which outpaced the significant 8.3% growth rate of expenses. For the colleges and universities in our study, expense growth outpaced broader inflation ⁴ in 2023, but kept pace with recent trends, as higher education costs caught up with broader inflation growth over the past three years (Figure 3).

Revenues also increased in 2023, but the 6.3% median revenue increase did not keep pace with the 8.3% growth in expenses. This dynamic is demonstrated in slightly narrower operating margins (Figure 4). On average, core operating margins before endowment and gift subsidies were more negative (-21.8% in 2023 versus -18.6% in 2022). The median overall margin finished positive but had less cushion (2.1% in 2023 versus 4.2% in 2022). The number of institutions completing the fiscal year with a negative margin more than doubled in 2023, indicating the challenging financial environment for many.

Putting all of these financial pieces together, we can see that the endowment is taking on a growing role in supporting growing costs that are outpacing other revenue sources for most colleges and universities in the Endowment Radar study.

Tuition Discounts Keep Pace With Tuition Prices

One of the pressure points for the operating margin is the growing “cost” of forgone revenue in the form of discounted tuition provided to students as financial aid and scholarships. Financial aid commitments have increased for the colleges and universities in our study every year. This trend continued in 2023 when the average growth rate in financial aid was 5.2%, keeping pace with the growth in tuition charges, which increased 5.1%. ⁵ The average tuition discount was 44%, meaning, on average, institutions collected 56% of the tuition charged to students. Net tuition revenue growth has been limited, as schools have increased financial and merit aid to respond to growing student needs and the competitive enrollment landscape.

The endowment distribution directly supports financial aid and scholarships via endowments restricted for those purposes and indirectly by subsidizing total costs, which increases the availability of other funds that can be used to support financial aid. Endowment support-to-financial aid is a coverage ratio that considers the direct and indirect roles the endowment plays in pricing strategy. ⁶ It measures the relationship between endowment distribution and tuition discounts to compare the endowment subsidy to the budget to the forgone revenue discounted to students. The coverage ratio of endowment distribution-to-financial aid ranged from 0.1x to 4.6x and the median was 0.7x (Figure 5).

The institutions that have endowment “coverage” for financial aid can offset forgone tuition revenue with endowment spending (Figure 6). This enables them to deliver their discounted price to students from a position of strength as shown in light blue shading in the upper-right quadrant. The colleges and universities in yellow shading on the lower-right side are offering high discount rates, but from a weaker financial position. Without a higher subsidy from the endowment to offset this forgone revenue, they will need to employ other financial levers—such as auxiliary revenue, annual fund gifts, and careful expense management—to fund these commitments and balance the budget.

Endowment Values Shifted the Balance Sheet

Balance sheets were strengthened for many institutions in 2023 as the median endowment market value grew (2.1%) and the median debt burden decreased (-1.5%). Growth in assets relative to liabilities resulted in the median endowment-to-debt ratio of 4.4x, an uptick from the 4.0x median in 2022. At the institutional level, we see a range of experiences (Figure 7). More than 75% of the institutions saw an increase in 2023 market value, and approximately 60% reduced their debt obligations. Nearly 40% of the institutions saw greater balance sheet strength with a combination of increased endowment market value and decreased outstanding debt obligations.

Net Flow Rate

In addition to long-term performance, net flow—the ratio that calculates the net rate of spending and inflows—is an indicator of whether the endowment will keep pace with the enterprise, lose purchasing power, or take on a greater role in the future. Most colleges and universities have negative net flow rates, but the degree that inflows offset spending from the endowment determine the liquidity profile and purchasing power of the portfolio.

Net flow is a metric that tends to vary considerably by institution, and from year to year for some institutions, because it is sensitive to cash flow timing and the unanticipated event, such as the gift of a large bequest (Figure 8). The calculated rate is also sensitive to the beginning endowment market value, which is the ratio’s denominator. In 2023, there were more negative net flow rates, driven by higher rates of spending.

The 1.5% median inflow rate was the same as the prior year, but the median effective spending rate increased from -3.8% to -4.4%, resulting in a shift in the median net flow rate from -2.1% to -3.0%. This was a result of lower beginning endowment market values for many institutions, as well as higher spending volume. As noted in the endowment dependence discussion, distributions increased more than 10%, as more dollars were spent from the endowment in 2023.

Higher spending coincides with higher costs this year and puts more reliance on strong investment performance to maintain purchasing power of existing endowment funds. Purchasing power should be monitored over longer cycles that are in line with the long-term nature of endowment capital and policy goals.

Conclusion

Endowments provided an important ballast to the private college and university business model in 2023. For many the institutions, higher costs and financial aid commitments were accompanied by growing endowment market values. Greater endowment dependence was fueled by higher rates of spending. Balance sheet health improved for the majority of institutions.

Endowment Radar brings together analysis of several financial metrics that can and often do change from year to year. Reviewing these results helps to manage with an eye toward future risks that may impact investment markets and university operations, including inflation, interest rates, and demographics. Evaluating these metrics and the role of the endowment in supporting colleges and universities during these tumultuous times helps to support near-term and long-term decisions and strategies.

Tracy Abedon Filosa, Head of CA Institute

Cameryn Dera and Shreya Vajram also contributed to this publication.

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.
3. Endowment Radar is a methodology that Cambridge Associates developed to visually evaluate the endowment’s role in the college and university enterprise. Data as reported to Cambridge Associates LLC, or as reported in publicly available audited financial statements for 80 private colleges and universities.
4. Consumer inflation measured by Urban Consumer Price Index: CPI-U.
5. The 2022 to 2023 comparison is for a constant universe of 73 institutions. Financial aid commitment is measured as all scholarship aid provided to students as reported on financial statements, including aid for undergraduate and graduate students, and aid to tuition, fees, room, and board.
6. Note that the endowment distribution is not all designated for financial aid. We are simply comparing the subsidy from endowment to the forgone revenue of student aid. We are also using discount rate as a barometer of price, recognizing that it is an imperfect assumption.

The post Endowment Radar Study 2023: Endowment Dependence Grows with Higher Costs appeared first on Cambridge Associates.

We believe the most effective investors are those that have a clear understanding of risk. What’s more, they understand that effective risk management is not a checklist of one-off measures, but an ongoing, highly disciplined process. Heather Jablow, Head of Private Client Practice, North America, recently authored an article for Family Office Magazine that provides family offices with a framework for managing the three main components of risk.

Read the full article.

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.
3. Endowment Radar is a methodology that Cambridge Associates developed to visually evaluate the endowment’s role in the college and university enterprise. Data as reported to Cambridge Associates LLC, or as reported in publicly available audited financial statements for 80 private colleges and universities.
4. Consumer inflation measured by Urban Consumer Price Index: CPI-U.
5. The 2022 to 2023 comparison is for a constant universe of 73 institutions. Financial aid commitment is measured as all scholarship aid provided to students as reported on financial statements, including aid for undergraduate and graduate students, and aid to tuition, fees, room, and board.
6. Note that the endowment distribution is not all designated for financial aid. We are simply comparing the subsidy from endowment to the forgone revenue of student aid. We are also using discount rate as a barometer of price, recognizing that it is an imperfect assumption.

The post Risk and Liquidity Management for Family Offices appeared first on Cambridge Associates.

This paper explores the strategic and expanding role of the endowment in the public university business model. We analyze the components of endowment spending and endowment growth, and how spending can drive growth. We demonstrate how transparency about endowment net flows can deepen understanding of the current and future role of the endowment and strengthen communication with donors about the impact of their gifts.

The Role of the Public University Endowment

Public university endowments support the university through three types of spending:

• Funding the operating budget and directly support student scholarships, faculty positions, research, and service delivery. This level of spending is determined by the endowment spending policy, which is designed to keep pace with inflation and deliver consistent support every year.
• Funding for revenue enhancing activities, such as fundraising infrastructure and investment management. Public universities and foundations often source this additional funding via an administrative fee (also known as an admin fee), which is assessed on the endowment market values.
• If flexible funds are available, an additional draw from the endowment may support sporadic needs, such as capital campaign costs, capital project financing or other strategic priorities.

These three categories of spending add up to the total amount of withdrawals from the endowment. To maintain purchasing power, endowment return must equal the rate of total spending plus inflation over time.

Over the past ten years, the median experience of public university endowments has met that goal (Figure 1). After adjusting for inflation, investment returns, and spending, an endowment starting at $100 in 2013 grew to an adjusted value of $108 in 2023. The median real (adjusted for inflation) average annual compound return (AACR) of 5.3% slightly exceeded spending, and the median growth rate net of spending was 0.8%. This growth indicates that the endowment maintained purchasing power and delivered to donors and stakeholders who have consistently benefited from endowment spending.

To move beyond maintenance of current spending levels and expand the role of endowment assets, a university needs to raise new endowment funds. New inflows increase the purchasing power of the endowment, and the endowment spending that funds the mission. Inflows represent new commitments to funding more of the mission. A growing endowment relieves reliance on student revenues, state appropriations, and annual fundraising dollars. Inflows also provide an investment advantage, as they replenish endowment liquidity needed to fund spending. They offer more flexibility for the investment strategy to incorporate illiquidity that comes with long-term investment commitments in venture capital and private equity.

The combination of spending and fundraising is net flow. Inflows from successful fundraising efforts have been a significant driver of public university endowment growth over the past ten years. When we analyze endowment performance and factor in all elements of net flow (shown as the real return after net flow in Figure 2), we see that the median growth rate of public university endowments has grown 5.7% annually since 2013. Inflows augmented strong performance and provided a 67% bump to overall growth after spending over this ten-year period.

Sources of Growth

There is a delicate balance between spending, sustainability, and growth, especially when sourcing revenue enhancing funding from an administrative fee assessed on endowment assets. The implementation and disbursement of the administrative fee is a balancing act, with a goal to fund strategic investments and growth without eroding the purchasing power of existing endowment funds. For those that strike the right balance, the admin fee can support sustainability and growth. But if the admin fee is too high, it will erode purchasing power and ultimately divert resources away from the mission. It is the responsibility of the board, with direction from the investment committee and the finance committee, to strike this balance. The calibration of endowment uses and sources will affect investment performance, liquidity, spending, and sustainable growth. When applied strategically, the admin fee can be an investment in endowment growth (Figure 3). In 2023, we saw a correlation between levels of admin fees and endowment fundraising achievement; those with admin fees of 1% or higher experience gift flow rates of 3% and above.

How Attention to Net Flow Can Transform the Role of the Endowment

In the following case study, we consider the correlation between net flow and specifically how a higher administrative fee that yields higher gift flow can expand the endowment support delivered to the university. We model two public university endowments over the past ten years that both earn the average investment returns for their peer group (7.9% nominal AACR) and have the same spending policy rate (3.5% effective spending). University A assesses a lower admin fee of 0.8% and has a gift flow of 2.0%, while University B has a higher admin fee of 1.25% and a higher gift flow of 4.0% (Figure 4).

Net flow matters. University B’s net flow of -0.75% versus University A’s -2.3% results in higher market value, endowment spending, and administrative fee revenue (Figure 5). Both endowments grow over the ten-year period from 2013 to 2023, but stronger net flow contributed to an expanded role for the University B endowment. The University B endowment ends with $32.7 million more in endowment value and delivers $1 million more in annual budget funding by Year 10 and $1.2 million more in administrative fee revenue.

Net Flow Strategy

In 2023 we saw a range of net flow results for public colleges, universities, and affiliated foundations (Figure 6). The net flow rate is time-sensitive, and we expect it to fluctuate year to year because the ratio is a function of fiscal year spending and fundraising achievement (dollars in the door) and market values.

Institutions on the left side of Figure 6 had strong net flow that contributed to endowment growth in 2023. Institutions on the right side had limited fundraising and higher spending, which may have eroded purchasing power. The net flow metric measures the combination of inflows and outflows and communicates important information about the role of the endowment and the plan for the future role of the endowment. What-if analysis about net flows and the power of new endowment gifts can help donors understand the direct link to endowment assets and a sustainable financial model for important programs and purposes. Given that net flow tells us a great deal about portfolio liquidity and the current and future role of the endowment in the university financial model, it makes sense for the Board, leadership team, advancement team, investment management team, and the investment committee to communicate about this metric every year.

Conclusion

The public university endowment can be much more than a static funding source. A strong investment program that is augmented by successful fundraising and disciplined spending can propel endowment growth. Moving beyond a balanced budget, forward-thinking public universities are considering how endowment growth can transform the revenue model and expand resources available to students and faculty. Net flow analysis can provide transparency about the current and future role of the endowment and strengthen communication with donors about the long-term impact of their endowment gifts. Endowment strategy that factors in net flow patterns and plans can achieve an investment edge and inspire fundraising.

Tracy Abedon Filosa, Head of CA Institute

Cameryn Dera also contributed to this publication.

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.
3. Endowment Radar is a methodology that Cambridge Associates developed to visually evaluate the endowment’s role in the college and university enterprise. Data as reported to Cambridge Associates LLC, or as reported in publicly available audited financial statements for 80 private colleges and universities.
4. Consumer inflation measured by Urban Consumer Price Index: CPI-U.
5. The 2022 to 2023 comparison is for a constant universe of 73 institutions. Financial aid commitment is measured as all scholarship aid provided to students as reported on financial statements, including aid for undergraduate and graduate students, and aid to tuition, fees, room, and board.
6. Note that the endowment distribution is not all designated for financial aid. We are simply comparing the subsidy from endowment to the forgone revenue of student aid. We are also using discount rate as a barometer of price, recognizing that it is an imperfect assumption.

The post The Transformative Public University Endowment appeared first on Cambridge Associates.

Listen to the full episode.

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.
3. Endowment Radar is a methodology that Cambridge Associates developed to visually evaluate the endowment’s role in the college and university enterprise. Data as reported to Cambridge Associates LLC, or as reported in publicly available audited financial statements for 80 private colleges and universities.
4. Consumer inflation measured by Urban Consumer Price Index: CPI-U.
5. The 2022 to 2023 comparison is for a constant universe of 73 institutions. Financial aid commitment is measured as all scholarship aid provided to students as reported on financial statements, including aid for undergraduate and graduate students, and aid to tuition, fees, room, and board.
6. Note that the endowment distribution is not all designated for financial aid. We are simply comparing the subsidy from endowment to the forgone revenue of student aid. We are also using discount rate as a barometer of price, recognizing that it is an imperfect assumption.

The post Why Are Some Plan Sponsors Thinking About Unfreezing their DB Plans? appeared first on Cambridge Associates.

Although this exemption has been available for years, it has not been used extensively. With an increasing number of plans seeking to settle benefit obligations in the near term, this exemption offers a way for some plans to realize the potential return-generating benefits of a PI allocation without impeding de-risking activities. For plans at or near fully funded, the exemption allows for continued use of PI to enhance risk-adjusted returns.

How Does a QPAM Exemption Work?

A QPAM can facilitate the transfer of private assets under DOL exemption 84-14, where a separate QPAM acts as a fiduciary for each pool of assets (e.g., two unrelated QPAMs). Most asset owners already use a QPAM for discretionary or non-discretionary management of one or multiple asset pools. Employing a separate QPAM for one of the pools allows for the transfer of assets between the pools without running afoul of ERISA-prohibited transaction regulations.

The main area of concern with these sales is the fair market value of the private assets, which is negotiated between the separate QPAMs. Although this transfer can occur between any two pools of assets, it is most practical for a plan sponsor with multiple pools that are under the ownership of the sponsor. Here, the PI assets can be transferred out of the pension plan and into another pool of capital in a more streamlined manner.

In most cases, approval by an external entity is not necessary. Outside of the generally reasonable fees for this service to the QPAM and the time required to agree upon a price of the assets to be transferred, the sale can occur within a few months at a price that is sensible to both the purchaser and seller.

What Plans Qualify for the Exemption?

While the QPAM exemption is available to all organizations with an ERISA-governed DB plan, it is more practical for institutions with multiple pools of investment assets, given visibility within each pool. Assuming there is an adjacent capital pool—such as an endowment—that can add to its PI program, assets can be transferred dollar for dollar to the DB plan as long as the adjacent pool maintains sufficient liquidity for a cash transaction. For this reason, institutions such as universities, healthcare organizations, or other 501(c)(3) organizations—which often manage multiple large investment pools—are prime candidates for the QPAM exemption. Although corporations also qualify, additional approval from the DOL is required for the PI program to be transferred to a corporate balance sheet.

Transfer opportunities for non-related DB plan sponsors with private programs also exist. It is possible to find an unrelated party that is looking to obtain all or part of the PI program in question. If the right buyer can be found, a private transfer may be the best option.

Conclusion

Plan sponsors seeking enhanced risk-adjusted returns can achieve those returns through a PI program, knowing that if they ever have a liquidity need—such as a plan termination, pension risk transfer, or increasing fixed income assets—a QPAM facilitated transfer may be available. Determining whether to sell a private program to another pool is a decision a plan sponsor needs to make based upon their short-, mid-, and long-term pension plan goals.

Serge Agres, Managing Director, Pension Practice

Jacob Goldberg, Senior Investment Director, Pension Practice

Footnotes

1. There is a separate but related question that asks if an institution should take a political stance, from acknowledgement to action.
2. Relevant policies may include the investment policy, ethical investing guidelines, ESG guidelines, divestment criteria or policy, and university mission and values statements.
3. Endowment Radar is a methodology that Cambridge Associates developed to visually evaluate the endowment’s role in the college and university enterprise. Data as reported to Cambridge Associates LLC, or as reported in publicly available audited financial statements for 80 private colleges and universities.
4. Consumer inflation measured by Urban Consumer Price Index: CPI-U.
5. The 2022 to 2023 comparison is for a constant universe of 73 institutions. Financial aid commitment is measured as all scholarship aid provided to students as reported on financial statements, including aid for undergraduate and graduate students, and aid to tuition, fees, room, and board.
6. Note that the endowment distribution is not all designated for financial aid. We are simply comparing the subsidy from endowment to the forgone revenue of student aid. We are also using discount rate as a barometer of price, recognizing that it is an imperfect assumption.
7. This may include church plans and other plans defined by IRC 414(e), but applicability depends on specific state provisions.

The post Pool Hopping: ERISA-Regulated Defined Benefit Plans May Have More Private Investing Flexibility Than They Realize appeared first on Cambridge Associates.