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Top 7 Trends for Endowments, Foundations, and Sovereign Wealth Funds Right Now


TOP 7 TRENDS FOR ENDOWMENTS, FOUNDATIONS, AND SOVEREIGN WEALTH FUNDS RIGHT NOW

Blog post Zachary Jarvinen 2022-06-13



Institutional investors buy, sell, and manage large quantities of investment
securities on behalf of their clients, customers, and shareholders. Considering
their broad reach, expertise, and the fact that they hold trillions of dollars
in assets under management (AUM), these investors are often considered the “big
fish.”

Three of the biggest and most high-profile big fish are sovereign wealth funds
(SWFs) and endowments and foundations (E&Fs).

SWFs are state-owned investment funds with a long-term investment horizon and an
investable asset base derived from a country’s reserves. Currently, global SWFs
manage close to $10 trillion in assets, which indicates how influential they are
on the global allocator stage.

E&Fs are also part of the institutional investors’ “big fish club,” although
they have a different mandate than SWFs: to benefit specific
charitable/non-profit causes such as educational institutions. Every year, E&Fs
pay 4%–5% of AUM to their cause.

The COVID-19 pandemic and the resultant economic shutdowns impacted many SWFs
and E&Fs, forcing them to pursue a balance between operating budgets,
predictable distributions, and maintaining a long-term investment horizon.

Nonetheless, these investors remain at the center of financial markets and will
do so for many years. Currently, they operate in an environment characterized by
high inflation, rich equity valuations, and ESG (Environmental, Social,
Governance) concerns.

Keep reading for more detailed insights into these and other key trends that
will affect SWFs and E&Fs in 2022 and beyond.


TREND #1: MOVEMENT TOWARDS DIGITAL SYSTEMS AND ASSETS

More SWFs and E&Fs are embracing digitally-powered systems and processes. They
will continue to invest in the digital economy in 2022. Many will embark on
full-scale digital transformation to digitize and automate fund due diligence
across multiple asset classes. They will also adopt digitization to streamline
screening and monitoring processes, improve information exchange, and boost
collaboration between different teams.

Some of these investors will also scale up their investments in digital assets
and the cryptocurrency ecosystem, including in non-fungible tokens (NFTs). SWFs
that prefer not to directly invest in these assets will do so indirectly by
purchasing stock in businesses such as cryptocurrency trading and investing
platforms and crypto payments enablers.

The indirect approach will enable them to get more involved in the
fast-expanding and highly lucrative digital assets market – safely and steadily.
It will also help them diversify and balance their investment portfolios and
better manage the risks involved in each investment vehicle.

SWFs – particularly development and multigenerational funds that don’t have a
liquidity imperative – will also invest in illiquid, alternative, or real
digital assets directly or indirectly through joint ventures (JVs) and private
equity (PE) limited partnerships.


TREND #2: EXPECT AN INCREASE IN CAPITAL FOR PRIVATE ASSETS

Following the 2008 financial crisis, many SWFs changed their capital allocation
strategy by moving away from investments in traditional government bonds to
alternative investments and unlisted assets like private equity, real estate,
and infrastructure.

One 2016 survey by the International Forum of Sovereign Wealth Funds (IFSWF)
bears out this post-crisis trend. At the time, most survey respondents (54%)
favored fixed-income assets. Equities were the next popular asset type for 34%
of respondents.

The other high-profile crisis of recent times, the COVID-19 pandemic, has
accelerated this trend. According to one whitepaper, between 2018 and 2022,
equities continued to be the largest exposure for SWFs, holding a 5.4% share of
global public equities. Further, over 50% of the alternative asset allocation of
SWFs is concentrated in PE and real estate. SWFs also own about 16% of global
AUM in the PE industry.

In 2022, SWFs will increase their allocations to PE and real estate both via
direct investment and co-investments. Some will also aim for marginal de-risking
by increasing their allocations to cash and fixed income vehicles.

These investment vehicles require different risk management strategies, robust
governance procedures around investment decision-making, and continual
third-party monitoring. Moreover, regulatory scrutiny on SWFs is also
increasing. SWFs will make a concerted effort to implement strong controls and
monitoring tools to deal with these requirements.


TREND #3: COMMODITIES WILL CONTINUE TO SEE AN INCREASE IN CAPITAL TO COUNTER
INFLATIONARY EFFECTS

The traditional portfolios of SWFs and E&Fs are often heavy in assets that
perform well in stable, low-inflation environments. But recent inflation
increases in many global markets are forcing these investors to modify their
investment strategy and add more inflation-sensitive assets to their portfolios,
such as property, infrastructure, and commodities.

The average annual inflation is expected to rise in 2022, mainly due to higher
food and oil prices resulting from Russia’s invasion of Ukraine. According to a
Bloomberg survey of economists, inflation (measured by the Consumer Price Index
or CPI) could rise by 5.1%, which would be the country’s highest annual level
since 1981.

Commodities are an indicator of future inflation, so investing in them can
enable SWFs and E&Fs to hedge against inflation and improve the robustness of
their forward-looking portfolios. This is especially true of commodities like
real estate, gold, and copper.


TREND #4: SWFS AND E&FS EDGE TOWARDS TRANSPARENCY

Following concerns about unethical agendas, many regulators and the public are
calling for larger, opaque funds to show their intentions more clearly via
disclosures. The Linaburg-Maduell Transparency Index (LMTI) was developed in
2008 in response to the financial crisis.

The LMTI rates the transparency of SWFs and government-owned investment
vehicles. It thus enables these funds to benchmark themselves and prove their
transparency to the public. A rating of 8 indicates that the fund is adequately
transparent.

The highest possible achievable rating is 10. According to the SWFI, only 15
SWFs have a rating of 10. In 2022, more funds will aim for this rating. In
tandem, the demand for investment solutions that offer greater visibility into
portfolios and easier portfolio management will also increase.

More regulators will look for solutions with custom reports, analytics, and data
visualization capabilities to assess the transparency of SWFs, better understand
their agendas, and determine if they are involved in unethical practices.


TREND #5: ENDOWMENTS AND FOUNDATIONS WILL SCALE UP THEIR “IMPACT INVESTING”
STRATEGY

Endowments and foundations already have a very specific mandate – to benefit a
specific cause. Most endowments serve educational institutions, while
foundations provide grants for many types of causes depending on their mission
and vision.

Foundations such as the Bill & Melinda Gates Foundation and endowments held by
non-profits like Harvard University hold billions in assets and pay out a
healthy percentage of their AUM to their cause every year.

In 2022, E&Fs will scale up their impact-oriented approach to achieve two goals:
generate healthy financial returns for their cause and make a positive and
tangible impact on society. Some E&Fs may willingly sacrifice returns if they
can generate a highly specific impact, say in environmental or social terms.

To generate this impact, more E&Fs will scale up their investments in private
markets like venture capital (VC). These investments will allow them to provide
new financing to worthy causes to initiate new projects or scale-up existing
projects.

Through such investments, E&F investors will also be able to influence and guide
companies’ practices to create tangible outcomes in terms of improved diversity,
equity, and inclusion (DE&I), more robust decision-making, and more ethical (and
less fraudulent) practices.


TREND #6: INVESTMENTS IN FIXED INCOME VEHICLES WILL INCREASE TO DIVERSIFY RATE
AND CREDIT EXPOSURE

In the current investment environment, interest rate risks and tight credit
spreads offered by many bonds leave the portfolios of SWFs and E&Fs exposed to
inflationary volatility. Many bonds also result in negative real yields for
these investors.

Moreover, bonds are no longer a “natural” diversifier for more volatile
equities. One reason is that following the pandemic, market volatilities led to
a sharp fall in bond prices. Even if prices recover, SWFs and E&Fs will no
longer fall back on bonds as the default portfolio diversification strategy.

Instead, more institutional investors will invest in private debt and other
lower-beta strategies to diversify their portfolios’ rate and credit exposure.
These real assets will also provide higher total returns than traditional public
fixed-income vehicles.


TREND #7: THE FOCUS ON “SUSTAINABLE” ESG INVESTING WILL INCREASE

Environmental, social, and governance (ESG) criteria have evolved into a key
focal point for institutional investors, including E&Fs and SWFs. This is why
investments in ESG funds and equities grew more than 3x from $7.2 billion in
2020 to $22.7 billion in 2021.

These investors adopt several ESG investment strategies such as negative
screening, DE&I, ESG indexation, ESG integration, and active ownership. In
future years, more SWFs and E&Fs will focus more on ESG and sustainable
investing.

Many investors will also embrace climate-change-related metrics and
sophisticated models to assess the impact of various emission scenarios on their
portfolios. Others will adopt new standards and standardized frameworks such as
the One Planet Framework to promote longer-term sustainability with ESG
investing and to drive the transition to a low carbon economy.

In 2022, more investors will adopt climate change metrics and frameworks. As the
popularity and prominence of ESG investing rises, they will also implement tools
to measure ESG and DE&I metrics, leverage new investment opportunities, and
guide their sustainability investment goals.


DD360: A PURPOSE-BUILT PLATFORM TO SIMPLIFY DUE DILIGENCE FOR SWFS AND E&FS

To keep up with the trends explored in this article – particularly around new
investments in private credit assets and ESG funds – sovereign wealth funds and
endowments and foundations will have to step up their due diligence efforts.

As they assess various potential investments and their risk profiles,
institutional investors will need a way to adapt and streamline operational due
diligence (ODD). Old-fashioned, spreadsheet-based ODD processes that require
manual labor are too inefficient and too cumbersome to meet these needs. DD360
from CENTRL provides a solution to these challenges.

DD360 is a powerful, feature-rich automation platform that’s purpose-built for
operational due diligence. All kinds of SWFs and E&Fs can leverage DD360 to
digitize their due diligence workflows, reduce risk and improve response rates.
With this platform, asset owners and managers can identify risks in future
investments and make better-quality investment decisions.

The platform seamlessly manages every aspect of the due diligence process with
automated DDQ and RFI workflows, a single document repository, and automatic
report generation. Moreover, due diligence practitioners at SWFs and E&Fs can
scale due diligence to more funds and monitor the progress of several
investments simultaneously.

To know more about DD360 and why SWFs and E&Fs love its intuitive interface and
a single source of truth, book a demo.

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