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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