Resi­li­ence and adap­ta­bi­lity in endow­ment capital

Resi­li­ence in endow­ment capi­tal is worth stri­ving for, despite the risks. Risks can have any number of causes: from the economy or the finan­cial market itself to govern­ment inter­ven­tion, poli­ti­cal chan­ges and geopo­li­ti­cal events such as the war in Ukraine. 

It is important to diffe­ren­tiate between two key types of risk:

Default risks  

Default risks relate to the irre­trie­va­ble loss of capi­tal employed. Defaults – up to and inclu­ding total loss – come to pass when compa­nies or count­ries go bank­rupt, but they can also occur with opti­ons trading or struc­tu­red products. These risks are mini­mi­sed by spre­a­ding the port­fo­lio across secu­ri­ties from a wide array of compa­nies and issuers, ther­eby diver­si­fy­ing it. Should an indi­vi­dual company default, the impact is almost imper­cep­ti­ble because indi­vi­dual, speci­fic default risks are ‘diver­si­fied away’.

Market risks

The valua­tions of secu­ri­ties can change without a default being immi­nent. Values fluc­tuate as the ‘market’ goes up and down. Market risks affect all secu­ri­ties in a given segment – be it a region, a sector, a coun­try or an asset class – to a grea­ter or lesser extent. They cannot be diver­si­fied away. Distri­bu­ting invest­ments across multi­ple segments can, howe­ver, create a diver­si­fi­ca­tion effect because not all segments bear the same burden if, for exam­ple, inte­rest rates spike or commo­di­ties suddenly become more expen­sive as a result of a trade conflict. 

What can be done about this? No stocks, no stock market risk. The easiest way to get assets out of the danger zone is to mini­mise invest­ment risk. This approach falls short, howe­ver, because it negle­cts the fact that not only the nomi­nal value of the capi­tal but also its earnings poten­tial should be main­tai­ned in the long term. Rather than avoi­ding or mini­mi­sing risks, the point is to iden­tify them correctly, distin­gu­ish them from others and set about addres­sing them.

The importance of diver­si­fi­ca­tion for resi­li­ence in endow­ment capi­tal cannot be over­sta­ted. You won’t find many concepts in the invest­ment world as uncon­tro­ver­sial as this: diver­si­fi­ca­tion is the first means of redu­cing risk. 

Endu­ring fluctuation

A nonpro­fit orga­ni­sa­tion must be posi­tio­ned to weather certain fluc­tua­tions in the finan­cial market, because they can’t be avoided. Depen­ding on an organisation’s reli­ance on current income, grea­ter or lesser fluc­tua­tions can be tole­ra­ted. It is not enough for an orga­ni­sa­tion to be able to do this – it has to want to do it. It must be prepared to bear these invest­ment risks, in other words, risk tole­rance must be present among the decis­ion-makers. Such willing­ness is not always a given, espe­ci­ally in the case of opera­tio­nal foun­da­ti­ons that coll­ect dona­ti­ons. There are often grea­ter concerns about having to explain ones­elf to lenders.

Adap­ta­bi­lity is criti­cal in respon­ding to unfo­re­seeable risks. To a certain degree, default and market risks are ‘normal’ and predic­ta­ble. Howe­ver, a resi­li­ent invest­ment port­fo­lio must also be prepared for unfo­re­seeable deve­lo­p­ments. Take COVID-19, for exam­ple: the pande­mic itself was unpre­dic­ta­ble, at least in terms of when and how severe it would be, and certainly no one could say what its short and long-term impact on markets would be. The stag­ge­ring issues in global supply chains and the diffe­rent reac­tions on the part of count­ries and compa­nies are just one exam­ple of how a crisis chan­ges struc­tures in the long term. In such cases, resi­li­ence – in the sense of adap­ta­bi­lity – is required. 

Flexi­ble liquidity 

If an organisation’s board reco­g­ni­ses the need to adjust its invest­ment stra­tegy, imple­men­ta­tion will depend on the liqui­dity of the asset clas­ses concer­ned. The more invest­ments are made in illi­quid clas­ses like direct property invest­ments or private equity, the more complex and time-consum­ing imple­men­ta­tion beco­mes. If the adjus­t­ment only rela­tes to liquid asset clas­ses – for exam­ple, if you want to invest in sustainable tech­no­logy stocks instead of commo­dity stocks – this can usually be done imme­dia­tely and without major real­lo­ca­tion costs. 

In short: just as diver­si­fi­ca­tion is essen­tial for resi­li­ence, liqui­dity is essen­tial for adaptability.

Exam­ple: How should a typi­cal invest­ment port­fo­lio of a Swiss foun­da­tion be asses­sed in terms of resi­li­ence? Of the 79 port­fo­lios we use to calcu­late the Swiss Phil­an­thropy Perfor­mance Index (SwiPhiX), let’s take a closer look at the ‘middle’ portfolio.

Outcome: The middle foun­da­tion port­fo­lio (SwiPhiX portfolio)

• is well diver­si­fied and resi­li­ent. Foun­da­ti­ons that imple­men­ted this port­fo­lio reco­vered rela­tively quickly from the COVID crisis (and other surpri­ses) and did not expe­ri­ence any defi­ni­tive defaults. 
• is adap­ta­ble, as it is open to chan­ges within asset clas­ses. Alter­na­tive invest­ments, which tend to be less liquid than the other asset clas­ses, play a very minor role.