U.S. FOUNDATIONS REPORT LOWER AVERAGE ANNUAL RETURN OF 8.1% IN FY 2005; BENCHMARK LEADERS REPORT RETURN OF 15.5%
Commonfund Benchmarks Study - Foundations and Operating Charities 2006 shows allocation decreases in Domestic Equities and Fixed Income; increases in Alternative Strategies, International and Index Equities; Spending Rate declines to 5.5%
WILTON, CT, June 8, 2006 – U.S. foundations reported an average annual return of 8.1% in Fiscal Year 2005 according to the Commonfund Benchmarks Study® - Foundations and Operating Charities 2006. These findings compare with an average annual return of 11.4% for the previous year and 17.8% in FY 2003. Average returns ranged from 7.4% to 8.4% for all size groups. Benchmark Leaders in the Top Decile reported an annual return of 15.5%, and in the Top Quartile a return of 12.4%. Average 3-year and 5-year returns for all institutions were 13.9% and 5.2% respectively. Benchmark Leaders in the Top Decile and Top Quartile reported 3-year returns of 17.3% and 16.1% respectively; and 5-year returns of 7.5% and 6.7% respectively.
Average returns were 8.9% for operating charities; 8.2% for independent/private institutions and 6.9% for community foundations. The average reported return assumption for the next three to five years is 8.0%. The annual study surveyed 334 independent/private, community and operating charities including social service, cultural and religious organizations whose fiscal year ended December 31, 2005.
“Foundation investment performance was better than expected given the challenging, low-growth environment last year” said John S. Griswold, Jr., Executive Director, Commonfund Institute. “Foundations increased allocations to alternative strategies, international equities and cash/short term investments, and should continue to achieve respectable returns with proper diversification, due diligence and good corporate governance.”
* Net of fees
· FY2003/Based on 242 institutions that provided return data
· FY2004/Based on 317 institutions that provided return data
· FY2005/Based on 334 institutions that provided return data
Average asset allocations for total institutions reported for FY 2005 showed some significant changes from the previous year. Domestic equities declined to 37% vs. 45% percent the previous year. Within domestic equities, large cap allocations dropped to 50% vs. 59%; Index equities rose to 24% vs. 17%; mid cap were 10% vs. 9%; small cap remained unchanged at 15%.
Fixed income average allocation was 19% vs. 20% the previous year. Alternative strategies increased to 20% vs. 18%, international equities rose to 18% vs. 14%, and cash/short term investments were 6% vs. 3%.
Total foundations reported significant increases in allocations to domestic bonds (86% vs. 82% the previous year), and reductions in global bonds (6% vs. 8%), high yield bonds (4% vs. 6%), and international bonds (3% vs. 4%). Community foundations and operating charities reduced allocations to domestic bonds and increased global bonds. Among total institutions, there were reductions in international equity allocations to Active MSCI (72% vs. 76%), and modest increases in Passive MSCI (6% vs. 5%) and Emerging Markets (21% vs. 19%).
Benchmark Leaders in the Top Decile reported higher allocations to alternatives (29%) and international equities (22%) compared with total institutions; and lower allocations to domestic equities (27%) and fixed income (14%). Top Quartile institutions also reported higher allocations to alternatives (26%) and international equities (22%) than total institutions and lower allocations to domestic equities (30%) and fixed income (16%). Top Decile institutions reduced large cap allocations to 52% vs. 68% the previous year; mid cap to 5% vs. 12%; and small cap to 13% vs. 19%. Index equities rose sharply to 30% of domestic equity allocations vs. 1% the previous year. Top Quartile institutions made similar changes in asset allocations.
More foundations reported rebalancing their portfolios: 87% vs. 78% the previous year. This trend was consistent for all size and types of institutions. Of these respondents, 52% reported using tactically flexible rebalancing and just under one-half used a fixed mechanism approach. The most common method reported by 58% was rebalancing “as needed.” Eight percent of institutions reported the use of portable alpha strategies; and 4% said they planned to begin using this approach. Ninety-four percent of respondents report having policy portfolios and use them as targets for rebalancing and/or to develop performance benchmarks.
Foundations and operating charities expect to continue the trend of decreasing domestic equities and fixed income, and increasing international equities, alternative strategies and cash/short term investments. For 2006, 37% of foundations reported they expect to decrease domestic equity allocations; and 18% expect to decrease fixed income allocations. About one-quarter (24%) of foundations expect to increase international equities, and 43% expect to increase alternative strategies.
Alternative Strategies Overall Gain; Hedge Funds and Private Equity Drop
Within alternatives, average allocations to hedge funds dropped slightly to 48% vs. 50%. Seventy-six percent of hedge fund assets were placed directly. An average 7.8 hedge fund managers were used. There was a wide range of marketable alternative strategies, particularly among the largest institutions. Fund of funds (67% of respondents) and long-short equity (52%) were the most common strategies reported. Concerns with hedge fund investments were relatively low; oversight, due diligence and return per unit of risk were most often cited.
Private equity allocations dropped to 14% vs. 18% the previous year; and there were increases in public equity real estate (7% vs. 5%); energy and natural resources (9% vs. 6%); and distressed debt (5% vs. 3%). These changes were evident in all size and types of institutions.
For Top Decile institutions, average allocations to hedge funds rose to 46% vs. 33% the previous year; and private equity declined significantly to 12% vs. 22%. Top Quartile institutions also increased hedge fund allocations to 44% vs. 40%; and reduced private equity to 16% vs. 19%.
Comparison of Alternative Strategies Asset Mix* for Fiscal Years 2004 and 2005
|
Numbers in percent (%)
Type of Investment
|
Total Foundations |
Over $1 Billion |
$501- Million- $1 Billion |
$101- $500 Million |
$50- $100 Million |
|
Base** |
215 |
260 |
22 |
27 |
28 |
39 |
132 |
152 |
33 |
42 |
|
|
‘04 |
‘05 |
‘04 |
‘05 |
‘04 |
‘05 |
‘04 |
‘05 |
‘04 |
‘05 |
|
Private equity (LBOs, mezzanine, M&A funds and international private capital) |
18 |
14 |
22 |
16 |
12 |
10 |
6 |
8 |
7 |
6 |
|
Marketable alternative strategies (hedge funds, absolute return, market neutral, long/short, event driven and derivatives) |
50 |
48 |
44 |
43 |
56 |
58 |
63 |
60 |
72 |
61 |
|
Venture capital |
9 |
9 |
11 |
11 |
7 |
7 |
5 |
5 |
4 |
2 |
|
Private equity real estate (excluding property used for charitable purposes) |
9 |
8 |
8 |
8 |
6 |
10 |
12 |
9 |
6 |
11 |
|
Public equity real estate (REITs) |
5 |
7 |
4 |
7 |
12 |
6 |
6 |
6 |
4 |
5 |
|
Energy and natural resources (oil, gas, timber, commodities, and managed futures) |
6 |
9 |
7 |
9 |
5 |
8 |
5 |
10 |
5 |
11 |
|
Distressed debt |
3 |
5 |
4 |
6 |
2 |
1 |
2 |
2 |
2 |
4 |
*
Dollar Weighted
** FY 2004/Based on 215 institutions that provided alternative strategies allocations
FY 2005/Based on 260 institutions that provided alternative strategies allocations
Overall, private equity allocations dropped to 14% vs. 18% the previous year, and venture capital remained unchanged at 9%. Private equity real estate was 8% vs. 9%, and public equity real estate rose to 7% vs. 5%. Energy/natural resources rose to 9% vs. 6%; and distressed debt to 4% vs. 3%.
Investment Restrictions
Fewer total institutions reported investment restrictions: 22% vs. 29% the previous year. However, more of the largest institutions (over $1 billion in assets) reported having investment restrictions. Few independent/private or community foundations reported restrictions, while 44% of operating charities cited them. Investment restrictions cited most frequently were tobacco (71% of respondents) and alcohol (33%). Community foundations most often reported investment restrictions concerning unfair labor practices; and operating charities reported gambling and pornography more frequently than other groups.
Donor Stock
Of the 202 Independent/Private foundations, donor stock was reported by 15% of respondents (30 institutions), down from 17% (33 institutions) the previous year. The average amount of donor stock dropped to 21% vs. 25%. 44% of 25 institutions with assets over $1 billion reported donor stock in their portfolios, compared with 10% of the 30 institutions with assets between $51 and $100 million. Twenty-seven percent of the 30 respondents reported restrictions on the disposition of their donor stock, and 67% of the 30 respondents reported that donors play a significant role in the foundation’s governance.
Institutions with donor stock reported an average 32% allocation to domestic equities; this compared with an average 36% allocation to domestic equities by institutions without donor stock.
Spending Rates Decline
The overall spending rate reported was 5.5%, down from an average 5.8% the previous year. This is the lowest level in four years covered by this study. Reductions were consistent across all size groups, and for independent/private foundations and operating charities. However, community foundations continue to spend at 6.4%, higher than all other groups. Seventy-eight percent of respondents reported no change in the spending rate over the past year. Fifty-five percent reported increased spending in dollar terms over the past year,
Budgeted payout for FY 2006 was lower than actual FY 2005 spending for all except the largest institutions, which reported a slight increase to 5.6% vs. 5.5%. By type, independent schools reported a higher average budgeted payout for FY 2006 of 5.3% vs. 5.2% the previous year; community foundations reported a lower budgeted payout of 5.4% vs. 6.4%; and operating charities a lower budgeted payout of 5.0% vs. 5.6%.
Nearly one-half (48%) of institutions said they determine spending policy as a percentage of a moving average, with the average reported at 5.1%. 36% of private/independent foundations reported their policy is to meet the IRS minimum required spending rate of 5%.
Gifts and Donation
One-half (50%) of foundations reported increases in gifts, particularly at the larger institutions. This was down from 57% the previous year. Thirty-four percent reported no change in gifts. Midsize and smaller institutions more often indicated an increase or no change in gifts than did larger institutions.
Underwater Funds
Institutions holding underwater funds dropped significantly. Twenty-one percent of foundations reported underwater funds, down from 34% the previous year. The average portion of funds underwater was 1.9% (ranging from an average 0.5% at the largest foundations to 2.1% at the smallest) and compares to an average 7.6% the previous year. Community foundations reported underwater funds more frequently (33% of respondents) than operating charities (11%).
The most prevalent way of handling underwater funds are spending income only and continuing to spend. Underwater funds are restricted endowment funds whose market value has fallen below the historic dollar value as defined by the Uniform Management of Institutional Funds Act (UMIFA). The most frequent reasons cited for handling underwater funds in a particular manner are UMIFA and investment committee/board/policy decision.
Manager and Consultant Use
Manager use overall was up. Foundations overall reported using an average 17.8 managers vs. 15.3 the previous year. Eighty-two percent of respondents reported the use of consultants vs. 79% the previous year. Institutions with assets over $1 billion reported using the greatest numbers of investment management firms with an average 47.5 vs. 45.3 the previous year.
By type, independent/private institutions reported using the largest number of managers with an average 18.7 vs. 16.7 the previous year. Operating charities reported the greatest increase with average 17.8 vs. 13.4 the previous year. Overall, institutions added managers for domestic equities, international equities, fixed income and alternative strategies (both direct and fund-of-funds). All types of institutions added managers in virtually all asset classes over the past year. The one exception was the largest institutions (assets over $1 billion) which reduced the average managers in alternative strategies fund-of-fund investments to 4.0 vs. 4.7 the previous year.
Over the next three years, institutions reported they expect to reduce the number of domestic equity managers, and to increase the number of alternatives managers. The largest institutions expect to reduce the number of managers in all asset classes except alternative strategies. By type of institution, the area most often reporting expectations for additional managers is direct investment/alternative strategies investments. Only the smallest institutions (assets $51 – 100 million) expected to reduce the number of managers used for direct investment in alternative strategies.
Consultant use declined among the largest institutions (78% vs. 93%), while all other groups reported modest increases in consultant use. Eighty-eight percent of institutions that use consultants reported they have a conflict of interest policy for their consultants, compared with 77% the previous year. Conflict of interest policies for consultants are most prevalent at the largest institutions (93% of respondents), up from 59% the previous year. More institutions of all types reported having a conflict of interest policy for consultants.
Staffing and Investment Committees
Total institutions reported that professional staffing increased slightly to 1.2 FTEs reported vs. 1.1 FTEs the previous year. Institutions with assets over $1 billion reported the largest average staff with 4.2 FTEs, up from an average 4.1 FTEs the previous year. By type of institution, operating charities reported the largest staffs of 1.5 FTEs vs. an average 1.5 FTEs the previous year.
Overall, foundations reported the average size of the investment committee was 6.3 members vs. 6.6 members the previous year. Smaller institutions tend to report slightly larger investment committees with an average 6.9 members. All types of institutions saw a reduction in the average number of investment committee members.
Corporate Governance
More than one-half (54%) of foundations reported having a proxy voting policy, with 78% reporting they delegate proxy voting to outside managers. Twenty-two percent reported investment restrictions; among these respondents, 71% reported having restrictions on investments in tobacco, 33% on alcohol and less than 25% on all other restrictions.
The Commonfund Benchmarks Study® - Foundations and Operating Charities 2005, sponsored by the Commonfund Institute, surveyed 334 leading independent/private community foundations and operating charities throughout the U.S. with total assets of nearly $203 billion. The study was conducted through telephone interviews during the fourth quarter 2005 and first quarter 2006. It included 202 independent/private, 61 community foundations and 71 operating charities. All institutions were asked to report their data for the period ending December 31, 2005. The study is conducted annually.
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