New Financial Realities for U.S. Private Foundations

John E. Craig, Jr.The Commonwealth Fund

Grantmakers in Health2009 Art & Science of Health Grantmaking

June 10, 2009Baltimore, MD

2

The crash of 2008 devastated most financial markets, leaving few safe havens for endowment investors. Will the

post-March 9, 2009 rally last?

-43.4%

-53.2%

-44.6%

-35.7%

33.5%

41.9%

57.4%

26.0%

48.4%

16.4%

3.0%

-34.9%

-37.0%

-2.4%-3.1%

13.9%

-2.5%

4.0%

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

U.S. Equities

Int'l Developed Equities

Emerging Markets

Energy

REITsCommodities

High Grade US Corp Bonds

TIPSUS Gov't Bonds

Market Sector

Ret

urn

CY 2008

Mar. 9-May 28, 2009

3

The current bear market in stocks is the second most severe since 1926, but is close in scale to that of the tech

bust of 2000-02 and the oil crisis of 1973-74

-86.0%

-57.0% -55.0%

-49.0% -48.0%-46.0%

-100%

-90%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

Sep 1929-Jun 1932

Oct 2007-Mar 2009

Mar 1937-March 1938

Mar 2000-Oct 2002

Jan 1973-Oct 1974

Nov 1938-April 1942

Peak to trough market return. Source: Cambridge Associates

4

What Brought It On?

• Easy money– High leverage, risk taking across the board– Self-correcting market bubbles philosophy

• Market innovation outpacing market regulation—derivatives and securitization revolutions, based in Over-the-Counter markets, hedge funds– Opacity– Counterparty risk with cascading effects– Result: High Systemic Risk

• Breakdown in consumer and other lending standards

5

As a result of the 2008 market crash, total private foundation assets have likely declined by 28-33 percent

$115 $122 $138 $142$163 $177 $189 $196

$227

$268

$330

$385

$449$486

$467$435

$477$510

$551

$615

$670

$502

$561

$0

$100

$200

$300

$400

$500

$600

$700

$800

19871988

19891990

19911992

19931994

199519996

19971998

19992000

20012002

20032004

20052006

20072008?

2008 Low Est.

2008 High Est.

Total Foundation AssetsSource: Trend data, The Foundation Center; estimates, The Commonwealth

Fund, 12/31/08

Bil

lio

ns

6

In 2008, leading foundation endowments suffered severely negative returns, pulling down their long-term average annual returns to levels

insufficient to cover the 5% payout requirement as well as inflation

-25.3%

3.4% 4.2% 5.1%

-1.6%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

1 Year 3 Year 5 Year 7 Year 10 Year

Average Annual Returns for 89 Foundation Endowments, including the TIFF Multi-Asset Fund, periods ending 12-31-08

Av

era

ge

An

nu

al R

etu

rn

Source: Cambridge Associates

7

Endowment Performance Under Stress: The Commonwealth Fund’s Experience Through

March 31, 2009

-27.4%

-3.0%

3.5%5.2% 5.9%

-33.6%

-7.9%

0.6% 0.6%

-1.4%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

OneYear

3-Year

5-Year

7-Year

10-Year

Average Annual Compound Return

Commonwealth

Benchmark

8

Endowment Performance Under Stress: Sources of Satisfaction and Disappointment for The

Commonwealth Fund

• Satisfaction– Diversification strategy “worked”– TIFF pools (16% of endowment) delivered,

particularly in the Marketable Alternatives space– Most Fund-selected managers outperformed their

benchmarks– No disasters (hedge fund, securities lending, short-

term vehicles with liquidity/solvency issues)

• Dissatisfaction– Fixed Income strategy—unanticipated and major risk

exposure– Adherence to policy asset allocation targets in a

dramatically changing world

9

Cambridge Associates’ Assessment of Fair Market Valuation of Asset Classes (selected), July 2008

Very Overvalued

Overvalued Fairly Valued Undervalued Very Undervalued

Emerging Markets Debt

Global Ex-U.S. Developed Equities

U.S. High Quality Equities

Japanese Equities

U.S. Equities Commodities

Emerging Markets

U.S. Corporate Bonds

U.S. High Yield Bonds

Oil & Gas

U.S. Real Estate

U.S. $

U.S. Buyout Funds

U.S. Venture Capital

10

Looking Ahead: The Commonwealth Fund’s Strategy

• Revise Fixed Income strategy• Pay more attention to assessments of fair market values

of asset classes—more flexibility in adherence to asset class allocation targets in unusual circumstances

• Seize opportunities: non-marketable alternatives, distressed debt

11

Cambridge Associates’ Assessment of Fair Market Valuation of Asset Classes (selected), April 9,

2009Very

OvervaluedOvervalued Fairly Valued Undervalued Very

Undervalued

U.S. Treasuries U.S. Equities Emerging Markets Equities

U.S. High Yield Bonds

U.S. Venture Cap.

Emerging Markets Debt

Global Ex-U.S. Developed Equities

Bank Debt

Buyout Funds Commodities U.S. Corp. Bonds

U.S. Real Estate

Mortgage Securities

Oil & Gas

U.S. $

Lessons from the Ongoing Financial Crisis for Foundation

Management

13

Organizing for Successful Endowment Management: Achieving Expected Returns while

Controlling Risk

• Guidelines; Benchmarks

• Investment Policy Statement

• Membership Criteria• Committee Mandate Statement• Conflict of Interest Policy• Performance Reporting System

Securities Selection

Investment Manager Selection

Asset Class Allocation

Investment Committee/ Investment Consultant/

Staffing

14

Over the last 25 years, larger private foundations have increasingly diversified their endowment portfolios, substantially increasing allocations to a variety of equity markets and reducing fixed income allocations

U.S. Stocks23%

Foreign Stocks (developed)

17%

Emerging Markets5%

Bonds17%

Hedge Funds19%

Commodities2%

Real Estate4%

Oil & Gas1%

Other4%

Cash Equivalents3%

Venture Capital2%

Private Equity3%

Median % allocation of 106 endowments with median assets of $266 million, June 30, 2008 (Source: Cambridge Associates)

15

Very large foundations and endowment pools are better equipped to execute sophisticated endowment management strategies than are smaller ones

6.4%7.0%

8.0%8.4%

9.6%

5.4%

0%

2%

4%

6%

8%

10%

12%

Under $20 mil. $20 mil. - $99 mil. $100 mil. - $499 mil. $500 mil. - $1 bil. $1 bil +

Foundation Endowment Size

5-Y

ear

Ave

. A

nn

ual

Ret

urn

Fdn. Category

Weighted Benchmark

Returns are for the five years ending September 30, 2008, for 106 foundations. Source: Cambridge Associates

16

Performance of TIFF Multi-Asset Fund

-28.9%

-4.9%

2.3%

5.1%

-31.2%

0.5%2.9%

-6.7%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

One-Year

3-Year

5-Year

10-Year

Average Annual Compound Return for Periods Ending March 31, 2009

Multi-Asset

MA Benchmark

17

Lessons from the Recent Experience for Foundation Endowment Management: a Basic

Checklist• Is our Investment Committee populated with real investment experts?

– Do we have and enforce a Conflict of Interest policy?– Do we perform adequate due diligence on all investment vehicles?– Do we use a top-rate investment consultant?– Is our Investment Committee adequately staffed?– Do we track performance over the long term and do attribution analysis?

• Do we have an Investment Policy Statement?– In highly unusual circumstances, are we adhering to our Investment

Policy Statement rigidly?

• Do we understand all of the vehicles in which our endowment is invested?– Do we reach for yield in “safe” short-term strategies?

• Why are we not using TIFF or the Common Fund, nonprofit cooperatives run for the benefit of the sector and overseen by the best endowment managers in the country?

18

Is There a Light at the End of the Tunnel?

• Financial Bailouts• Fiscal Stimulus• New Regulatory Structure for the Financial

Sector– Derivatives and securitized markets—shift from

Other-the-Counter to Exchange-traded markets; from opacity and counterparty risk to public, market-clearing pricing; capital and collateral requirements for all market participants, not just banks

– Consolidated Regulation of Banks and Shadow Banks– Strengthened regulation and tightening of standards

on consumer loans

Distinguishing Features of the Foundation Sector; How the

Grantmakers in Health Universe Differs

20

270 private foundations with assets of $250 million or more in 2006 controlled 50 percent of the sector’s resources; the vast majority of the 72,479 foundations are very small organizations, with assets under $10 million.

Very Large--61, with 29% of sector assets

Large--208, with 16% of sector assets

Mid-size--1,245, with 21% of sector assets

Micro Foundation--44,597, with 2% of

sector assets

Small--4,632, with 16% of sector assets

Very Small--21,733, with 11% of sector

assets

Mega Foundations--1, with 5% of sector

assets

Mega foundations have assets of $15 billion or more; Very large, from $1 billion to $14.99 billion; Large, from $250 million to $999.99 million; Mid-size, from $50 million to $249.99 million; Small, from $10 million to $49.99 million; Very Small, from $1 million to $9.99 million; Micro foundations, less than $1 million. Source: The Foundation Center, data for 2004-07.

21

Assets of the Grantmakers in Health universe are more concentrated in very large and large foundations, with much less representation of small, very small, and micro foundations.

Mega Fdns, 5%

Very Large, 29%

Very Large, 68% of assets,20 fdns

Large, 16%

Large, 17%, 35 fdns.

Mid-size, 21%

Mid-size, 13%, 111 fdns.

Small, 2%, 56 fdns.

Small, 16%

Very small, 11%

Micro Fdns, 2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

All Fdns GIH FdnsMega foundations have assets of $15 billion or more; Very large, from $1 billion to $14.99 billion; Large, from $250 million to $999.99 million; Mid-size, from $50 million to $249.99 million; Small, from $10 million to $49.99 million; Very Small, from $1 million to $9.99 million; Micro foundations, less than $1 million. Source: Foundation Center and Grantmakers in Health (data are for 2004-early 2008 period).

Very small, .1%, 9 fdns.

22

Other Distinguishing Characteristics of

Grantmakers in Health Universe • Origins often not private philanthropy: results of

conversions or offshoots of health care organizations, insurers, class action legal settlements—75% originate from non-traditional sources

• Significantly “younger” overall• More focused programmatically—on health and

on specific communities, regions• Unique features of Health Sector in which

foundations operate– For-profit focus– Major government funding and regulation roles– Health Care Reform environment

Consequences of the Recent Experience—Mission, Strategy, Spending Policy,

Organization

24

As a result of the crash, the number of GIH foundations with assets above $100 million has fallen from about 141 to

about 112; the number with assets below $50 million has risen from about 62 to about 81.

1113

16

22

50

62

1917

21

14

2420

23

60

43

21

1115

0

10

20

30

40

50

60

70

<$10 mm $10 mm-$19.99

mm

$20 mm-$29.99

mm

$30 mm-$49.99

mm

$50 mm-$99.99

mm

$100 mm-$249.99

mm

$250 mm-$499.99

mm

$500 mm-$999.99

mm

$1 bb+

Pre-CrashPost-Crash

Source: Estimates by The Commonwealth Fund, as of 12/31/08

25

Consequences of the Recent Experience—Addressing Challenges, Seizing Opportunities

• Are we large enough to maintain institutional vitality over the long term?– Governance—ability to recruit and maintain an

engaged and attentive board– Leadership—ability to attract and retain talented CEO– If in doubt, what are our options?

• Spend-down• Merger with another foundation• Question particularly acute for smaller foundations,

depending on mission, business model, program strategy

26

Consequences of the Recent Experience—Addressing Challenges, Seizing Opportunities

• Are we large enough to maintain our pre-crash program strategy? If in doubt, what are our options?– Number of programs—critical mass necessary for vitality issue– Staffing– Co-venturing

• Should we engage in counter-cyclical spending?– Need– A sensible policy: spend at higher rate when investment returns are low

and at lower rate when investment returns are high, i.e., accumulate reserves in fat years and spend them in lean

• Is this a time to make big bets on promoting health care reform/ helping assure effective implementation of health care reform?– Assisting state health reform efforts– Building local and regional capacity for reformed system covering all

and focused on quality, patient-centeredness, reduced costs

27

The annual average giving rate of foundations, mainly based on lagging three-year average assets, typically rises

in bear markets and falls in bull markets

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

An

nu

al T

ot.

Fo

un

dat

ion

Giv

ing

(b

il.)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

3-yr

. L

agg

ed G

ivin

g R

ate

(% A

sset

s)

Fdn. Giving

3-yr Giving rate

Source: The Foundation Center

28

A Case Study: Commonwealth Fund’s Programmatic Response– Challenge

• Budget reductions of 15%, 10%, 8%, 2.5% over next 4 years (barring a market rebound)

• Continue to spur momentum for national health care reform

– Response: SWOT analysis of programs and mission-driven strategic reallocation of funds

29

The Commonwealth Fund Revised Five-Year Budget Plan

$27.4$28.9

$37.7

$40.9$41.9

$34.7

$31.3$28.8 $28.0 $28.0

$17.4$18.5

$26.0$27.2 $27.7

$23.0

$19.4$16.9 $16.4 $16.4

$10.0 $10.4$11.6

$13.6 $14.2$11.7 $11.8 $11.9 $11.7 $11.7

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

2006 2007 2008 2009 2010 cur. 2010 rev. 2011 2012 2013 2014

FY ending June 30

FY

Sp

en

din

g (

mill

ion

s)

Total

Extramural

Intramural

30

The Commonwealth Fund’s spending rate will rise temporarily to just over 7 percent, and will be worked down to 5.4 percent over

next five years.

4.7%

5.4%

7.1% 7.0%6.6%

6.1%5.7%

5.4%5.3%5.1%

4.9%5.3%

5.7%

6.2%6.4% 6.5%

6.2%

4.4%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014

FY Ending

Sp

en

din

g R

ate

FY Rate

5-Yr. Ave. Rate

31

Commonwealth Fund Program Strategy, 2009-14

• Affordable Health Insurance• Payment System Reform• Patient-Centered Coordinated Care

– Health Care Disparities

• Meeting and Raising Performance Benchmarks• Health Care Reform Leadership

– Commission on a High Performance Health System– State High Performance Health Systems– International Health Policy & Practice– Fellowship in Minority Health Policy

32

Discussion Questions

• Endowment Management

• Program Strategy in a Still Threatening Financial, but Dynamic Health Care, Reform Environment

33

DisclosuresJohn E. Craig, Jr.

• Employment: The Commonwealth Fund, Executive Vice President & COO

• Board Memberships– TIFF Education Foundation– The Greenwall Foundation – Nonprofit Coordinating Committee of New York– International Women’s Health Coalition– National Center on Philanthropy and the Law– Investment Committee of Social Science Research

Council