Analysis: Bottom of the class

The UK’s university endowments are an enticing investor pool for private debt managers. And with £10.9 billion ($14 billion; €12 billion) under the control of the country’s top 100 institutions, according the Sutton Trust charity’s latest figures, so they should be.

The interest, however, is not returned. Of the country’s top 10 university endowments by assets under management, only one confirmed – via documents on its website – an allocation to private debt. The University of Edinburgh lists M&G’s Illiquid Credit Opportunities Fund II as one of its investments. The university declined to comment further.
Other institutions approached about their appetite for private debt told PDI they either had no allocation to the asset class or declined to comment on specific investments.

However, they may be missing an opportunity. “[An endowment] is trying to generate an attractive income to pursue activities at the university,” says Jo Waldron, director for alternative credit at M&G Investments.

Like other institutional investors, endowments are long-term investors and can hold assets until maturity. They are also looking for income and yield, notes Philip Robson, president of Canada-based fund manager Integrated Asset Management’s private debt group. “Anybody who is investing in these types of vehicles is looking for the same kind of characteristics,” he says.

Where endowments differ, however, is in their need to preserve capital almost indefinitely. Unlike a pension fund, notes Waldron, endowments aren’t managing a pool of assets that pay out regularly.

“That preservation of capital is the crux of the difference between an endowment and a pension fund,” she says. “You want to generate income without putting that capital at risk.”

That’s a sentiment shared by Patrick Marshall, head of private debt for Hermes Investment Management. “Endowments are not so driven by regular cash income, but if it’s available they’ll take it,” he says. By this token, endowments are more likely to invest in senior debt than lower down the capital structure, Marshall adds.

Additionally, tackling inflation is another hurdle endowments look to overcome with their asset allocations. “Of course, the cost of everything they’re funding only goes in one direction,” says Robson.

According to research by UK-based educational charity the Sutton Trust, UK university endowments have not grown at the same rate as their US counterparts over the past decade.

“There’s a different culture of giving in the US,” Conor Ryan, head of research for the charity, tells PDI. He says differing tax laws make donations to an educational endowment fund more of a draw for larger donors.

In order for UK endowments to fundraise more effectively, they should make it clear how the money raised is going to be used, Ryan says. “It’s important that the purpose of the endowment is made public,” he notes.

The success of fundraising within UK university endowments matters because it’s unlikely these investors will be able to put significant money towards new types of investments – including private debt.

According to PDI data, several US universities have allocations of more than $100 million to private debt. Only two in Britain – Manchester and the University of London – have investments in the asset class. These investments are, however, through the institutions’ superannuation schemes rather than their endowments. The investments are also significantly smaller.

Large US-based university endowments are likely to have cash in hand to allocate to a private debt strategy. Growth in these funds means private debt managers can approach investors with more latitude to make allocations. “All of a sudden they’ve got a bit more money to do things with,” says Robson.

UK endowments are significantly smaller and might not have the same bandwidth to make allocations to new investment strategies. “They are miniscule compared to the Havards and Yales of this world,” adds Waldron.
Investing in alternatives is also something US endowments have more familiarity with. “US endowments also have a longer history of investing in private equity,” says Marshall.

Allocating to alternative asset classes isn’t new to endowments. Most have explored alternatives in some capacity, with real estate investments a popular choice for yield-producing assets.

Such allocations should mean endowments are already comfortable with some of the quirks of private debt, notably its liquidity profile. “They’ve got a lot of money in real estate, they’ve got bits and pieces in private equity,” says Waldron. “These are strategies doing the same thing in terms of liquidity.”

Distinction

In saying this, there is an important distinction between an endowment’s real estate holdings and any future allocation to alternatives like private debt. In some instances, real estate investments made by endowments represent legacy holdings – ownership of an asset that may stretch back several decades, if not centuries.

“From a tradition perspective you’re starting in a different place,” says Waldron. “You shouldn’t look at it as a current investment.”

According to Robson, it might not even be appropriate to assess real estate holdings in endowments as investments at all. “They tend to separate a bucket of assets from a bucket of investments,” he notes.

The legacy nature of real estate holdings in endowments means it’s unlikely funds will be swapping this alternative asset class in favour of a private debt allocation. More likely, an endowment would allocate away from fixed-income investments – searching for additional yield – or away from equities, in hope of preserving capital more securely.

How endowments are coming to allocation decisions is also something fund managers should be assessing.

According to Robson, endowments often work with investment consultants which act as gatekeepers to any potential investment. They may also, however, have sophisticated in-house investment teams already managing a university’s pension fund or similar institutional investment.