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Foundations big on alternatives; PE posts top returns in asset class: study

  • Why this is important: Foundations rely on alternatives for higher returns, but sharp valuations could drive down returns.

Foundations have strong appetite for alternative strategies, including private equity, as their strongest-performing asset classes.

But strong returns could be coming to an end in the high-valuation environment in private and public markets.

Still, both private and community foundations remain bullish on alternative strategies, the 2017 Council on FoundationsCommonfund study of investment of endowments for private and community foundations shows.

Alts accounted for 43 percent of the asset allocation among private foundations and 27 percent among community foundations in 2017, the report, released Aug. 9, shows.

PE returns more than tripled for community foundations and rose almost 45 percent for private foundations. PE also generated the highest returns in alternative strategies for private and community foundations in 2017.

Private equity returned 11.1 percent in 2017 for community foundations, more than double the 4.8 percent in 2016. For private foundations it returned 10 percent in 2017, up from 6.9 percent in 2016, the study said.

Overall asset allocation remained stable, a reflection that foundations were “adhering to their policies” as long-term investors, said Cathleen Rittereiser, executive director at Commonfund Institute.

PE portfolios — including LBOs, mezzanine, M&A funds and non-U.S. private equity — accounted for 18 percent of the alternatives portfolio across both types of foundations.

For private foundations with assets over $500 million, however, PE allocation dropped 3 percentage points to 6 percent of the total portfolio. “The study does not speculate on the specific reasons for the drop,” Commonfund told Buyouts.

Overall, 2017 brought the strongest returns in four years for foundations, the report said. Private foundations reported an average return of 15.6 percent and community foundations reported an average return of 15.2 percent for 2017.

Compare those with 2016, when private-foundation returns averaged 6.4 percent and community foundations reported an average 7.3 percent return, the report said.

Alternative strategies including PE, marketable alternatives, venture capital, private real estate, energy and natural resources, commodities and managed futures, and distressed debt returned an average of 9.7 percent for private foundations and 8.6 percent for community foundations, the study said.

But strong results may not be possible in the coming months because of high valuations in the private markets, Rittereiser said.

That can be a cause of concern: 10-year annualized returns hovered at an average 5.5 percent for private foundations and 5.3 percent for community foundations.

“Even in the mid-5 percent range, returns are usually not sufficient to maintain the corpus of foundations’ endowments after spending, inflation and costs, but they offer some breathing room compared to last year,” said Gene Cochrane, interim president and CEO of the Council on Foundations, and Mark Anson, CEO and chief investment officer of Commonfund, in a news release.

To meet their obligations for administering the endowments, foundations must maintain returns of more than 5 percent plus inflation and a little more, Rittereiser said.

Energy and natural resources, the top alternative strategy in 2016, posted huge declines this year. The strategy declined to 6.7 percent from 12.9 percent for private foundations and to 1.9 percent from 10.4 percent for community foundations.

The report gathered data from 143 private foundations and 81 community foundations with $104.5 billion in total endowment assets.

The foundations were divided into three cohorts according to their sizes and ranged from under $101 million in assets to over $500 million in assets.

Correction: This report was updated to correct the alternatives strategies returns for private and community foundations. The numbers have been updated following a correction issued by Council on Foundation-Commonfund Study of Foundations (CCSF).

Action Item: Read more on the study here https://www.commonfund.org/