Endowment and foundation managers allocated the most to venture capital, growth and high-beta public equities during the post-COVID market run-up, but now some of these execs are facing a “hangover effect” as their ability to reposition portfolios is being hampered by the slowdown in realizations in many of these investments, KKR’s Henry McVey said in a recently released report.
KKR surveyed and spoke with 30 CIOs of endowments and foundations representing hundreds of billions in assets under management. The $491 billion private markets firm found that even as investment assets soared at these non-profits, the rising cost of compensation levels is leading more CIOs to consolidate relationships and concentrate assets with their best managers while holding off on staff build-outs despite the rise in assets in recent years.
One solution proposed by McVey is that CIOs should consider adding more top-down guardrails to ensure that their teams are sizing positions properly, creating the right sector and thematic tilts, and tightening up risk management practices, including factor analyses, as manager selection has been a greater source of returns than asset allocation lately.
“Finally, our research shows that only a select group of E&F managers are typically getting access to the best managers at the right time in the cycle,” wrote McVey. “This somewhat subtle reality, which calls into question whether VC is a scalable asset, is leading to sub-optimal outcomes: our work shows that only the top handful of VC managers outperform so meaningfully that the increase in volatility is warranted.”
In McVey’s view, CIOs will need to boost diversification across investment products, including real assets, as growth-oriented investments remain challenged in the current market environment.
Roughly 80% of KKR survey participants actually think that inflation will become embedded, creating a regime change for investing (shifting to a high inflation, lower real growth environment). According to the survey, many are now considering meaningfully growing their real assets portfolio, albeit from a historically low base.
Interestingly, KKR suggested that another layer of complexity was added when many organizations recently swore off natural resources in their portfolios as part of their ESG initiatives and in response to internal/external constituency pressures. This has led CIOs to seek new, “cleaner” opportunities across infrastructure and real estate. KKR said that several CIOs have plans to use excess cash to buy higher yield core infrastructure as a substitute for energy’s inflation-hedging capabilities when liquidity is not a concern.
CIOs are increasingly focused on illiquid investments, and particularly those that provide more upfront yield, including real estate, private credit and select private equity. All told, surveyed CIOs planned to boost illiquid investments to 55% of total plan assets within three years, compared to just 34% for many of the benchmark E&F industry studies KKR reviewed.
KKR also asserts that endowment and foundation CIOs are leaning into alternatives at the expense of public equities. They predict that over the next three years that private equity will account for 16% of portfolio assets, which is up from 12% pre-pandemic. Private credit will double in size to 4% of assets from 2% of pre-pandemic and real estate will grow to 6% from 5% of overall assets.
The most important figures of all, however, are still performance-related. The majority (75%) of CIO’s KKR spoke with said that they could withstand an annualized loss of 20-25%. But for CIOs whose bonuses are tied to three-year performance figures it could spell trouble ahead as inflationary pressures remain a top concern going forward.
