CAPTRUST, a US-based Registered Investment Advisor (RIA) recently released the results of its first annual endowment and foundation survey.  The results make for interesting reading. CAPTRUST explains:

While we are still in the early stages of evaluating the responses, our initial scan revealed some clear and noteworthy trends to start with. Most notably, there seems to be a disconnect between the return objectives and asset allocations of respondents with their risk tolerance.

Key findings include the following:

  • Asset allocation is not universally aligned with return objectives. For example, not-for-profits with low return expectations (i.e. less than 5%) and high return expectations (i.e. greater than 8%) had similar asset allocations (60% growth and 40% defensive). Why would anyone hold a higher risk portfolio if returns weren’t any better? Either conservative investors are being over-optimistic or aggressive investors are being too pessimistic.
  • Willingness to experience portfolio loss is not universally aligned with asset allocation or return objective. The group with the highest return target was also the most risk sensitive. Even for those with more modest return targets, only half of investors were willing to accept a loss of only 5%. This is inconsistent with their almost 70% allocation to growth assets.
  • Given average asset allocations, the potential for future portfolio losses is greater than many investors have expressed they are willing to bear. More than 85% of respondents indicated a willingness to experience a maximum loss of less than -15%. But based on their average asset allocation, these investors would have experienced at least two -20% draw downs over the last twenty years.

Perhaps the most interest result was when survey participants were asked how they defined risk and set investment objectives. They were given three definitions of risk to choose from:

  • Volatility of spending
  • Not keeping up with inflation
  • The impact on spending as their definition of risk

Most not-for-profits chose the impact on spending as their definition of risk.

They were next asked to choose how they set their investment objectives from the following options:

  • Benchmark relative
  • Absolute return
  • Inflation plus spending and expenses

Benchmark relative was the most common answer.

It seems that the not-for-profits surveyed measured risk with reference to their needs, but they set their objectives with reference to the market. CAPTRUST observes:

As we see it, most investors view success on a benchmark-relative basis over the long-term, but very often they view risk of loss on a short-term basis. The key to finding a middle ground between risk and return is a clear and defined objective-setting process. This process should start with identifying return goals, evaluating both ability and willingness to take risk, spending needs, and any other unique factors such as laws, tax constraints, cash flows, and others.