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10 Tips for Endowment and Foundation Managers to Keep Funds on Track

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As the recovery from the Great Recession continues and the bull market charges ever upward (until it slips again), those tasked with growing the funds of endowments and foundations are faced with difficult choices.

On the one hand, it has to be tempting to go heavily into equities. The returns have been incredible. And, well, that’s the point, isn’t it?

On the other hand, that may not be the point at all. In fac,t the best managers are looking past the short-term hot investments by making sure their funds can weather whatever economic storm comes their way.

A report this summer on the Endowment Index revealed that the largest college endowment fund, Yale’s, underperformed the market during the current run-up. But an examination shows that Yale and other similar funds outperformed the markets during the recession. The key to both circumstances is diversification. It’s a strategy investors would do well to remember when managing their portfolios.

And Northern Trust noted that  theendowments and foundations it tracks had a yearlong increase of 14.7% as of the end of 2014′s third quarter .

(For more, see Why Endowment Funds Like Yale’s are Doing Just Fine and Top 20 Richest Colleges for 2013: The Biggest Endowments.)

Mercer Capital’s experts on endowments and foundations released a Top 10 list of best practices for fund managers and boards to contemplate as they consider their investment strategies.

Check out 10 Tips for Endowment and Foundations Managers to Keep Funds on Track:

Tip 1. Currency Values Matter

The dollar has grown stronger this year and that means it’s important to take a close look at foreign investments. That’s because the strength of the dollar compared to other currencies makes them less lucrative.

Mercer’s Take: Foreign currencies are still a good bet, but this is a good time to move some of those holdings to domestic investments as a hedge.

Tip 2. Assess Private Equity

Stocks are an important component of the portfolios held by endowments and foundations. However, making sure they bring expected returns over the long haul takes work and planning.

Mercer’s Take: Board and committees need to review private equity holdings to ensure they are meeting long-term goals. Policies must be put in place so that equity holdings continue to generate targeted returns throughout multiple cycles.

Tip 3. Consider Emerging Markets

Once the hot ticket for investors, emerging markets have been less attractive compared to mature ones.

Mercer’s Take: Inexpensive compared to developed markets, this is an excellent time to invest in emerging market stocks. Still, such investments must be managed actively to ensure long-term gains.

Tip 4. Watch the Tail

After a strong beginning to the year, U.S. markets have been more volatile during the final quarter. Still, the Dow is consistently threatening to push ever higher (as it did on December 23, finishing over the 18,000 mark for the day).

Mercer’s Take: Tail risk insurance to protect the gains made during the bull market is under consideration by many boards and endowments. It’s important to weigh the cost of it against possible benefits. A long-term plan should help alleviate any short-term losses incurred in a market downturn.

Tip 5. Practice Good Governance

Making sure that the unique requirements proscribed by the board are followed is critical to keeping control of the portfolio.

Mercer’s Take: Asking the right questions along the way is the key. The board needs to make sure that its consensus of priorities is agreed to and that its components are spelled out clearly in the investment policy statement. The board must also ask itself if it has the ability to manage its portfolio and if any portion of its duties needs to be outsourced.

Tip 6. Watch the Central Banks

The period of quantitative easing in the U.S. is drawing to a close, though Japan has entered an even bigger round of its own QE while the Europeans are watching and waiting. The programs by central banks to keep interest rates low have obviously had effects throughout world economies.

Mercer’s Take: Boards must ensure that their long-term strategies take into account the ways the end of QE will affect economies and thus investment instruments.

Tip 7. Think Outside the Box

It’s easy for boards to fall into the trap of sticking to the traditional financial markets. The returns have been trending into record territory as economic recovery continues. Unfortunately that trap leads to short-term thinking.

Mercer’s Take: Finding niche and innovative ways to invest is critical to continuing to meet goals. Boards and committees must identify future innovative investment strategies to fulfill long-term goals.

Tip 8. Consider New Age Investing

Trends in investing matter and can affect long-term gains in markets. Impact investing and sustainable growth investing are two worth paying attention to as boards make their plans.

Mercer’s Take: Investing trends can affect short- and long-term portfolio growth. Endowment and foundations need to be aware of trends and factor their effects into their planning.

Tip 9. Use the Right Benchmarks

Often, the boards of endowments and foundations compare themselves to peers to decide whether they are doing a good job of managing their portfolios. This mentality of keeping up with the Joneses might not be the best way to evaluate success.

Mercer’s Take: Endowment and foundation managers should consider using a set of benchmarks that measure risk and return and allows them to see all sides of their complicated portfolios.

Tip 10. Practice Diversification

We mentioned it earlier, but the fantastic run-up of equities to record after record is making every stock-based portfolio look pretty good. But what if the bubble bursts?

Mercer’s Take: Like the title of the slide says, diversification is the answer. Allocations should be checked and monitored as a hedge against vulnerability to the vagaries of the markets.