Tough Times: Foundation Finances and Investments - John Craig


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Tough Times: Foundation Finances and Investments - John Craig

  1. 1. New Financial Realities for U.S. Private Foundations John E. Craig, Jr. The Commonwealth Fund Grantmakers in Health 2009 Art & Science of Health Grantmaking June 10, 2009 Baltimore, MD
  2. 2. The crash of 2008 devastated most financial markets, leaving few safe havens for endowment investors. Will the post-March 9, 2009 rally last?
  3. 3. The current bear market in stocks is the second most severe since 1926, but is close in scale to that of the tech bust of 2000-02 and the oil crisis of 1973-74 Peak to trough market return. Source: Cambridge Associates
  4. 4. What Brought It On? <ul><li>Easy money </li></ul><ul><ul><li>High leverage, risk taking across the board </li></ul></ul><ul><ul><li>Self-correcting market bubbles philosophy </li></ul></ul><ul><li>Market innovation outpacing market regulation—derivatives and securitization revolutions, based in Over-the-Counter markets, hedge funds </li></ul><ul><ul><li>Opacity </li></ul></ul><ul><ul><li>Counterparty risk with cascading effects </li></ul></ul><ul><ul><li>Result: High Systemic Risk </li></ul></ul><ul><li>Breakdown in consumer and other lending standards </li></ul>
  5. 5. As a result of the 2008 market crash, total private foundation assets have likely declined by 28-33 percent Total Foundation Assets Source: Trend data, The Foundation Center; estimates, The Commonwealth Fund, 12/31/08 Billions
  6. 6. In 2008, leading foundation endowments suffered severely negative returns, pulling down their long-term average annual returns to levels insufficient to cover the 5% payout requirement as well as inflation Source: Cambridge Associates
  7. 7. Endowment Performance Under Stress: The Commonwealth Fund’s Experience Through March 31, 2009
  8. 8. Endowment Performance Under Stress: Sources of Satisfaction and Disappointment for The Commonwealth Fund <ul><li>Satisfaction </li></ul><ul><ul><li>Diversification strategy “worked” </li></ul></ul><ul><ul><li>TIFF pools (16% of endowment) delivered, particularly in the Marketable Alternatives space </li></ul></ul><ul><ul><li>Most Fund-selected managers outperformed their benchmarks </li></ul></ul><ul><ul><li>No disasters (hedge fund, securities lending, short-term vehicles with liquidity/solvency issues) </li></ul></ul><ul><li>Dissatisfaction </li></ul><ul><ul><li>Fixed Income strategy—unanticipated and major risk exposure </li></ul></ul><ul><ul><li>Adherence to policy asset allocation targets in a dramatically changing world </li></ul></ul>
  9. 9. Cambridge Associates’ Assessment of Fair Market Valuation of Asset Classes (selected), July 2008 U.S. Venture Capital U.S. Buyout Funds U.S. $ U.S. Real Estate Oil & Gas U.S. High Yield Bonds U.S. Corporate Bonds Emerging Markets Commodities U.S. Equities Japanese Equities U.S. High Quality Equities Global Ex-U.S. Developed Equities Emerging Markets Debt Very Undervalued Undervalued Fairly Valued Overvalued Very Overvalued
  10. 10. Looking Ahead: The Commonwealth Fund’s Strategy <ul><li>Revise Fixed Income strategy </li></ul><ul><li>Pay more attention to assessments of fair market values of asset classes—more flexibility in adherence to asset class allocation targets in unusual circumstances </li></ul><ul><li>Seize opportunities: non-marketable alternatives, distressed debt </li></ul>
  11. 11. Cambridge Associates’ Assessment of Fair Market Valuation of Asset Classes (selected), April 9, 2009 U.S. $ Oil & Gas Mortgage Securities U.S. Real Estate U.S. Corp. Bonds Commodities Buyout Funds Bank Debt Global Ex-U.S. Developed Equities Emerging Markets Debt U.S. Venture Cap. U.S. High Yield Bonds Emerging Markets Equities U.S. Equities U.S. Treasuries Very Undervalued Undervalued Fairly Valued Overvalued Very Overvalued
  12. 12. Lessons from the Ongoing Financial Crisis for Foundation Management
  13. 13. Organizing for Successful Endowment Management: Achieving Expected Returns while Controlling Risk <ul><li>Guidelines; Benchmarks </li></ul><ul><li>Investment Policy Statement </li></ul><ul><li>Membership Criteria </li></ul><ul><li>Committee Mandate Statement </li></ul><ul><li>Conflict of Interest Policy </li></ul><ul><li>Performance Reporting System </li></ul>Securities Selection Investment Manager Selection Asset Class Allocation Investment Committee/ Investment Consultant/ Staffing
  14. 14. Over the last 25 years, larger private foundations have increasingly diversified their endowment portfolios, substantially increasing allocations to a variety of equity markets and reducing fixed income allocations Median % allocation of 106 endowments with median assets of $266 million, June 30, 2008 (Source: Cambridge Associates)
  15. 15. Very large foundations and endowment pools are better equipped to execute sophisticated endowment management strategies than are smaller ones Returns are for the five years ending September 30, 2008, for 106 foundations. Source: Cambridge Associates
  16. 16. Performance of TIFF Multi-Asset Fund
  17. 17. Lessons from the Recent Experience for Foundation Endowment Management: a Basic Checklist <ul><li>Is our Investment Committee populated with real investment experts? </li></ul><ul><ul><li>Do we have and enforce a Conflict of Interest policy? </li></ul></ul><ul><ul><li>Do we perform adequate due diligence on all investment vehicles? </li></ul></ul><ul><ul><li>Do we use a top-rate investment consultant? </li></ul></ul><ul><ul><li>Is our Investment Committee adequately staffed? </li></ul></ul><ul><ul><li>Do we track performance over the long term and do attribution analysis? </li></ul></ul><ul><li>Do we have an Investment Policy Statement? </li></ul><ul><ul><li>In highly unusual circumstances, are we adhering to our Investment Policy Statement rigidly? </li></ul></ul><ul><li>Do we understand all of the vehicles in which our endowment is invested? </li></ul><ul><ul><li>Do we reach for yield in “safe” short-term strategies? </li></ul></ul><ul><li>Why are we not using TIFF or the Common Fund, nonprofit cooperatives run for the benefit of the sector and overseen by the best endowment managers in the country? </li></ul>
  18. 18. Is There a Light at the End of the Tunnel? <ul><li>Financial Bailouts </li></ul><ul><li>Fiscal Stimulus </li></ul><ul><li>New Regulatory Structure for the Financial Sector </li></ul><ul><ul><li>Derivatives and securitized markets—shift from Other-the-Counter to Exchange-traded markets; from opacity and counterparty risk to public, market-clearing pricing; capital and collateral requirements for all market participants, not just banks </li></ul></ul><ul><ul><li>Consolidated Regulation of Banks and Shadow Banks </li></ul></ul><ul><ul><li>Strengthened regulation and tightening of standards on consumer loans </li></ul></ul>
  19. 19. Distinguishing Features of the Foundation Sector; How the Grantmakers in Health Universe Differs
  20. 20. 270 private foundations with assets of $250 million or more in 2006 controlled 50 percent of the sector’s resources; the vast majority of the 72,479 foundations are very small organizations, with assets under $10 million. Mega foundations have assets of $15 billion or more; Very large , from $1 billion to $14.99 billion; Large , from $250 million to $999.99 million ; Mid-size , from $50 million to $249.99 million ; Small , from $10 million to $49.99 million ; Very Small , from $1 million to $9.99 million ; Micro foundations, less than $1 million . Source: The Foundation Center, data for 2004-07.
  21. 21. Assets of the Grantmakers in Health universe are more concentrated in very large and large foundations, with much less representation of small, very small, and micro foundations. Mega foundations have assets of $15 billion or more; Very large , from $1 billion to $14.99 billion; Large , from $250 million to $999.99 million ; Mid-size , from $50 million to $249.99 million ; Small , from $10 million to $49.99 million ; Very Small , from $1 million to $9.99 million ; Micro foundations, less than $1 million . Source: Foundation Center and Grantmakers in Health (data are for 2004-early 2008 period). Very small, .1%, 9 fdns .
  22. 22. Other Distinguishing Characteristics of Grantmakers in Health Universe <ul><li>Origins often not private philanthropy: results of conversions or offshoots of health care organizations, insurers, class action legal settlements—75% originate from non-traditional sources </li></ul><ul><li>Significantly “younger” overall </li></ul><ul><li>More focused programmatically—on health and on specific communities, regions </li></ul><ul><li>Unique features of Health Sector in which foundations operate </li></ul><ul><ul><li>For-profit focus </li></ul></ul><ul><ul><li>Major government funding and regulation roles </li></ul></ul><ul><ul><li>Health Care Reform environment </li></ul></ul>
  23. 23. Consequences of the Recent Experience—Mission, Strategy, Spending Policy, Organization
  24. 24. As a result of the crash, the number of GIH foundations with assets above $100 million has fallen from about 141 to about 112; the number with assets below $50 million has risen from about 62 to about 81. Source: Estimates by The Commonwealth Fund, as of 12/31/08
  25. 25. Consequences of the Recent Experience—Addressing Challenges, Seizing Opportunities <ul><li>Are we large enough to maintain institutional vitality over the long term? </li></ul><ul><ul><li>Governance—ability to recruit and maintain an engaged and attentive board </li></ul></ul><ul><ul><li>Leadership—ability to attract and retain talented CEO </li></ul></ul><ul><ul><li>If in doubt, what are our options? </li></ul></ul><ul><ul><ul><li>Spend-down </li></ul></ul></ul><ul><ul><ul><li>Merger with another foundation </li></ul></ul></ul><ul><ul><ul><li>Question particularly acute for smaller foundations, depending on mission, business model, program strategy </li></ul></ul></ul>
  26. 26. Consequences of the Recent Experience—Addressing Challenges, Seizing Opportunities <ul><li>Are we large enough to maintain our pre-crash program strategy? If in doubt, what are our options? </li></ul><ul><ul><li>Number of programs—critical mass necessary for vitality issue </li></ul></ul><ul><ul><li>Staffing </li></ul></ul><ul><ul><li>Co-venturing </li></ul></ul><ul><li>Should we engage in counter-cyclical spending? </li></ul><ul><ul><li>Need </li></ul></ul><ul><ul><li>A sensible policy: spend at higher rate when investment returns are low and at lower rate when investment returns are high, i.e., accumulate reserves in fat years and spend them in lean </li></ul></ul><ul><li>Is this a time to make big bets on promoting health care reform/ helping assure effective implementation of health care reform? </li></ul><ul><ul><li>Assisting state health reform efforts </li></ul></ul><ul><ul><li>Building local and regional capacity for reformed system covering all and focused on quality, patient-centeredness, reduced costs </li></ul></ul>
  27. 27. The annual average giving rate of foundations, mainly based on lagging three-year average assets, typically rises in bear markets and falls in bull markets Source: The Foundation Center
  28. 28. A Case Study: Commonwealth Fund’s Programmatic Response <ul><ul><li>Challenge </li></ul></ul><ul><ul><ul><li>Budget reductions of 15%, 10%, 8%, 2.5% over next 4 years (barring a market rebound) </li></ul></ul></ul><ul><ul><ul><li>Continue to spur momentum for national health care reform </li></ul></ul></ul><ul><ul><li>Response: SWOT analysis of programs and mission-driven strategic reallocation of funds </li></ul></ul>
  29. 29. The Commonwealth Fund Revised Five-Year Budget Plan
  30. 30. The Commonwealth Fund’s spending rate will rise temporarily to just over 7 percent, and will be worked down to 5.4 percent over next five years.
  31. 31. Commonwealth Fund Program Strategy, 2009-14 <ul><li>Affordable Health Insurance </li></ul><ul><li>Payment System Reform </li></ul><ul><li>Patient-Centered Coordinated Care </li></ul><ul><ul><li>Health Care Disparities </li></ul></ul><ul><li>Meeting and Raising Performance Benchmarks </li></ul><ul><li>Health Care Reform Leadership </li></ul><ul><ul><li>Commission on a High Performance Health System </li></ul></ul><ul><ul><li>State High Performance Health Systems </li></ul></ul><ul><ul><li>International Health Policy & Practice </li></ul></ul><ul><ul><li>Fellowship in Minority Health Policy </li></ul></ul>
  32. 32. Discussion Questions <ul><li>Endowment Management </li></ul><ul><li>Program Strategy in a Still Threatening Financial, but Dynamic Health Care, Reform Environment </li></ul>
  33. 33. Disclosures John E. Craig, Jr. <ul><li>Employment: The Commonwealth Fund, Executive Vice President & COO </li></ul><ul><li>Board Memberships </li></ul><ul><ul><li>TIFF Education Foundation </li></ul></ul><ul><ul><li>The Greenwall Foundation </li></ul></ul><ul><ul><li>Nonprofit Coordinating Committee of New York </li></ul></ul><ul><ul><li>International Women’s Health Coalition </li></ul></ul><ul><ul><li>National Center on Philanthropy and the Law </li></ul></ul><ul><ul><li>Investment Committee of Social Science Research Council </li></ul></ul>