The program reinforced my knowledge about economic indicators, the general state of the U.S. economy and provided fundamental lessons in risk and portfolio management. As an economics major interested in a future career in finance, I found this fascinating, and thanks to ISA, I feel years ahead in terms of real-world knowledge.
Here are my five key insights from ISA 2023:
On the minds of many senior staff and board members is the banking crisis caused by the collapse of several banks, most notably Silicon Valley Bank. Understanding how the crisis was both impacted by, and influences, the financial climate is critical. For context, the Federal Reserve’s hike in interest rates collapsed the value of long-term government bonds which, like all banks, SVB was heavily invested in, contributing to the bank’s collapse. This ushered investors towards treasury bonds and other safer bets and prompted institutions to consider diversifying their banking relationships and revisit their cash management strategies. Finally, the shock on the financial system has further contributed to the slowdown in lending caused by recent interest rate hikes, which will not only impact the investment space, but will likely also have tangible impacts across the real economy.
ISA 2023 included ample discussions on negative economic indicators in today’s economy. Seeing as many of these indicators, such as an inverted yield curve, typically signal a recession, it is best that stewards of endowments take measures to hedge against the risk of an economic downturn, even if it never comes. The Covid crisis has created a rare and unpredictable set of economic outcomes, so forward-thinking institutional investors should create plans of action in the case of an economic downturn by assessing what has worked well or poorly in prior downturns, in terms of investments and governance. Lastly, it is important for investors in the endowment space to avoid being overcome by short-term thinking, as most endowments are invested on a perpetual time horizon. Therefore, even in the case of a drawdown, endowments’ mission goals should be mostly unaffected so long as their portfolio construction accounts for ample liquidity needs and stabilizing yearly spending policies are in place.
Many conversations at ISA revolved around risk, considering several economic, investment, and mission related factors. There was, for example, talk about the Sharpe Ratio, a measure of performance relative to how much risk a portfolio takes on. Nevertheless, the main and most relevant discussion on risk was in a session entitled “Balancing Risk and Return”, which explored the three primary considerations for endowments developing their risk profile: mission risk, market risk, and liquidity risk.
Institutions that set explicit definitions for their mission goals make mission risk, and consequently market and liquidity risk, easier to quantify. Multi-faceted risk management frameworks help ensure that mission-oriented organizations are poised to fulfill their mission today and preserve and carry forward resources for future generations.
Another topic at ISA was the impact of inflation on endowment and foundation investment portfolios. In the past, Commonfund has written about the importance of looking beyond CPI + 5 percent when calculating the returns needed to achieve intergenerational equity, instead recommending that higher education institutions replace CPI with the HEPI (Higher Education Price Index®). The HEPI, an inflation index calculated annually by Commonfund, reflects the inflation of goods and services needed to run a higher education institution. By using HEPI, institutions can more accurately keep track of the rate of inflation that will be part of their budget, ensuring they maintain the same purchasing power over time.
HEPI tends to be higher than CPI over time1, so the reality is that most educational institutions using the CPI + 5 percent growth objective are gradually falling behind inflation. To counteract this, endowments could consider decreasing their yearly endowment withdrawal percentage or increasing risk to bring higher returns. It is recommended that institutions outside of higher ed take on a similar perspective by investigating if CPI inflation is truly representative of their cost structure and spending needs. If this is not the case, it may be necessary to adjust return objectives to keep pace with inflation.
Spending policy is a key component in managing the severity of potential drawdowns, “smoothing” out returns and generating more consistent income for the endowment’s mission. In the session, “Reimagining Spending as a Tool for Mission-Oriented Endowment Management” we primarily covered three of these spending methodologies: moving average, banded inflation, and hybrid.
Ultimately, fiduciaries were encouraged to give their spending policy the attention it deserves, as it is the link between the endowment and the institution and helps to manage risk while ensuring appropriate spending toward mission year after year.
I was delighted to have had the opportunity to attend the Investment Stewardship Academy and learn more about the endowment space, especially as a current university student. Reports show that 49 percent of university endowment-based spending is used for scholarships and financial aid3, which I personally rely on for my education. I am grateful to have met so many wonderful fiduciaries at ISA who make opportunities like mine possible, and hope that the lessons distilled in this summary can be as useful for institutions’ successes as they will be for my own.