F Y 2 3 E N D OW M E N T R E P O R T
Don Bielinski, chair of the UIF Board's Budget and Finance Committee, interviewed UIF Chief Investment Officer Travis Shore and UIF COO Christy Devocelle about the FY23 financial and endowment report.
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FY23 ENDOWMENT REORT
E N D OW M E N T R E P O R T
Opportunity Abounds TRAVIS W. SHORE CHIEF INVESTMENT OFFICER
After a challenging fiscal year in 2022, fiscal year 2023 provided some relief. The endowment portfolio generated an investment return of 9.0%.
Fiscal year 2023 marked my first full year with the Foundation. In last year’s letter, I mentioned four key early priorities: engagement, recruiting, portfolio assessment and planning, investment sourcing and diligence. During the year, the investment office made significant progress on each of these priorities. Our senior leadership team is fully staffed thanks to the addition of Jeremy Heer, who is excited to support his alma mater (BS ’93, UIUC). Jeremy joined us after 12 years at the University of Chicago’s investment office and leads our research and engagement efforts. He has been very active in the campus and alumni communities. We also added two investment analysts who joined in July 2023. The team was very active this year, as we positioned the portfolio for a world with higher global interest rates, inflationary pressures, tight labor markets, and stubbornly strong economic growth in the United States while most other global economies struggled to generate desired levels of economic growth. With the support of the Foundation Board of Directors, Investment Policy Committee, and Foundation leadership, I could not be more excited about the opportunities ahead.
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MARKETS Capital markets are still sorting through post-pandemic effects of extraordinary monetary and fiscal policy. University endowment returns will likely be disparate this year. Institutions with outsized private equity and/or venture capital exposure have generally been among the best performers over the last decade, but this was not the case in 2023. Public equity markets found their lows in October 2022 and rebounded astonishingly, while private investment markets continued to the search for normalization after the bonanza from late 2020 through 2021. Despite a volatile start to the fiscal year, the S&P 500 Index returned 19.6%, NASDAQ returned 26.1%, and the MSCI ACWI returned 16.5%. Aside from inflation sensitive assets (primarily commodities), there were few places to hide in 2022. When markets experience inflation concerns, the correlation between equity markets and bond markets is normally positive. As the Federal Reserve embarked on its most aggressive interest rate hiking cycle in history, a traditional 70/30 (stocks/bonds) portfolio would have generated historically poor results. This fiscal year, there was some return to normalcy as government bonds exhibited a slightly negative return while equities rallied. Despite this apparent return to normalcy, uncertainty remains. Given recent strength, it is fair to say there is a hint of optimism in markets, which was not the case for the full fiscal year. Optimism began to form when markets began to discount the idea the Federal Reserve was near its terminal rate and would start cutting interest rates in mid-2023. In fact, on June 30th, 2022, the market hypothesized that the terminal rate would be 3.9% in March 2023 and steadily decline from there. There was only one point during the fiscal year when market-implied forward interest rates were higher than what was eventually realized. This occurred in November 2022 when the market priced the
February 2023 forward rate at 4.8%, which eclipsed the eventual spot rate of 4.75%. In all other instances, the market has been underestimating the Federal Reserve’s resolve to tackle inflation. Forward inflation expectations can be attributed to the narrative around the Federal Reserve’s future decisions. Going into fiscal 2023, the five-year breakeven, or the future inflation level expected in five years, was well over 3%,
With the support of the Foundation Board of Directors, the Investment Policy Committee, and Foundation leadership, I could not be more excited about the opportunities ahead. —TRAVIS SHORE UIF CHIEF INVESTMENT OFFICER
peaking at roughly 3.73% in March 2022. As of this writing, this measure sits at 2.25%, only a quarter of a percentage point above the Federal Reserve’s stated mandate. The two-year breakeven tells a similar, and surprisingly more optimistic story at 2.09%. As of this writing, core inflation (as measured by CPI) stands at 4.3% and recent readings have softened. Despite the progress, inflationary pressures have not been fully resolved and have a long way to go to return to the stated mandate of 2%.
Figure A. ENDOWMENT POOL COMPARISON TO BENCHMARK
As of June 30, 2023
PRESENTED IN YEARS AS OF JUNE 30, 2023
ONE
THREE
FIVE
TEN
Total Return (Net of Fees)
1
9.0%
10.5%
6.5%
7.0%
2
Total Portfolio Benchmark
11.2%
10.4%
7.3%
7.4%
Relative +/-
-2.2%
0.1%
-0.8%
-0.4%
5.1%
5.1%
5.1%
5.1%
Annualized Effective Total Spending Rate3
1 Performance is presented net of external investment management and incentive fees and includes legacy assets no longer relevant to the ongoing strategic management of the portfolio. 2 Effective July 1, 2022: 70% MSCI ACWI; 30% Bloomberg US Aggregate Bond Index. Prior to that, a composite of ten underlying indices in prior asset allocation. 3 Includes Administrative Fee. Spending is pursuant to the Foundation's policy and in consultation with the University. The policy is reviewed annually by the Foundation's Board of Directors. For 2023, the 5.1% total spending consists of a 3.8% "effective" spending rate and a 1.3% "effective" administrative fee. The Foundation currently distributes 4.0% of a six-year moving average of the corpus of most endowment accounts to the University.
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FY23 ENDOWMENT REPORT
$2.73 BILLION UI FOUNDATION ACTIVE ENDOWMENT
78.4%
16.0%
1.0%
4.6%
$2.14 Billion
$436.9 Million
$29.3 Million
$124.3 Million
URBANA-CHAMPAIGN
CHICAGO
SPRINGFIELD
UI SYSTEM
UI FOUNDATION ENDOWMENT POOL
94% $2.57 BILLION of the Active Endowment
DISTRIBUTED TO THE UNIVERSITY OF ILLINOIS SYSTEM
$83M+
79.4%
16.9%
$65,958,777
$13,987,140
1.1%
2.6%
$907,962
$2,192,955
URBANA-CHAMPAIGN
SPRINGFIELD
CHICAGO
OTHER
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In recent quarters, economist and market participant discussions centered around the potential “hard landing," “soft landing,” and “no landing” scenarios. Economists argue over the definitions for these terms but suffice to say “hard landing” means recession, “soft landing” means no recession as inflation recedes, and the recently concocted phrase “no landing” means the economy will not slow and inflation will not return to 2%. Despite all of this, the fiscal year began with consensus believing a recession would occur sometime during the following 12 months. Unfortunately, “consensus” included your chief investment officer. Consensus subsequently dissolved with a split forming between these camps. Equity markets are pricing lower rates, lower inflation and a strong economy, but will this happen? Of course, nobody knows what will happen. Leading economic indicators are trending negative, but the labor market remains resilient. This is where much of the optimism resides. The S&P 500 Index is trading at 18.4x forward price/earnings, representing nearly a two-turn increase from the prior year and above the historical 16.7x forward price/earnings. Earnings consensus for the calendar year is projected to be flat to slightly down, and while top-line growth is projected to see an increase, margins have been squeezed. Last year, I wrote, “What is clear is the 2014-2021 investing environment is over. “FAANG” stocks (Facebook, Apple, Amazon, Netflix, and Google), “TINA” (there is no alternative), and their more absurd COVID-era cousins (meme stocks, YOLO, HODL) are a thing of the past.” To this point, I comically will say we were accurate as they have been replaced by what is now called "The Magnificent Seven" (Apple, Amazon, Facebook, Google, Microsoft, Nvidia, and Tesla). According to Bianco Research, as of August 24th, the “Magnificent Seven" contributed 10.24% of the 11.94% of the S&P 500's return during the calendar year. The remaining 493 stocks contributed merely 1.69%. Nvidia has taken the market by
storm, as have other companies associated with generative artificial intelligence. The seven aforementioned stocks have generated average year-to-date returns of 112.5% and constitute roughly 25% of the S&P 500. As mentioned, private markets are lagging public markets in their search for price discovery. Investors remain wary of the valuations obtained during 2020 and 2021. Fundraising in private equity and venture capital has slowed significantly from prior years, as has transaction volume. Highlighting the overhang is that private equity
We are in a privileged role as we have the advantage of a long-time horizon in an increasingly short-term focused world. —TRAVIS SHORE UIF CHIEF INVESTMENT OFFICER
and venture capital are sitting on near-record levels of dry powder. In some circumstances, private equity may be afforded the luxury to wait as entry multiples could decline with time. Venture capital, however, may find price discovery earlier as many cash-burning companies will be forced to come to the market for additional capital in their growth phase. It is difficult to predict how long or the point in time in which price discovery arrives and deal activity increases.
Figure B. ACTUAL FY 2023 VS. POLICY PORTFOLIO BETA FACTOR
UIF ACTUAL
TARGET1
Equity
60.2%
62.5%
Credit
14.1%
15.0%
Interest Rates
5.1%
12.5%
Commodities
4.3%
5.0%
Real Estate
5.8%
5.0%
Cash
6.4%
0.0%
Hedged Exposure
4.1%
0.0%
100%
100%
Total 1 As affirmed by the Investment Policy Committee in June 2023.
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As of June 30, 2023
FY23 ENDOWMENT REPORT
Figure C. FY 2023 GEOGRAPHIC EXPOSURE
As of June 30, 2023
GEOGRAPHY
TOTAL UIF PORTFOLIO
North America
67.9%
Europe
12.4%
Asia Pacific
11.5%
Latin America
4.4%
Middle East and Africa
3.0%
Other
0.9%
Total
100.0%
Uncertainty does not necessarily mean bearishness, and the economy is not the stock market. We are in a privileged role as we have the advantage of a long-time horizon in an increasingly short-term focused world. We are not macroeconomists and do not profess to be traders or market timers. Uncertainty, in our case, warrants prudence and requires well-vetted theses and deep underwriting to gain high conviction.
PORTFOLIO AND PERFORMANCE The endowment returned 9.0% for the fiscal year. Given the narrow market environment and portfolio repositioning, we are pleased with this figure. Performance was driven by public equities and credit. Our core public equity portfolio returned approximately 15.6% versus the 16.5% return for the MSCI All Country World Index. The credit portfolio generated a 12.5% return which significantly exceeded market returns for high yield and investment grade corporate bonds. All other beta factors generated low- to mid-single digit returns for the year. We embarked upon a significant portfolio transition from April 2022 through fiscal year-end. During this time, executed and pending public market liquidations represented roughly 53% of the endowment. We have also been opportunistic in private markets, where we have committed $184 million and invested $57 million in co-investments and direct equity investments. During the year, the investment policy committee approved an updated investment policy statement. As part of this exercise, we migrated our asset allocation and risk measurement philosophy to a “beta factor” framework. Beta factors measure the dollar amount of risk we hold in each of the following asset classes: equity, credit, interest rates, commodities, real estate, and cash. Our beta factor exposure is shown in Figure B. We ended the fiscal year at approximately 60.2% equity, which is slightly underweight our long-term target of 62.5%. Given our aforementioned view on economic risk and inflation, we were biased toward cash and low duration government bonds, which combined for 11.5%
of the endowment at June 30. We were right on duration as rates moved higher, but we were wrong on equities. Subsequent to the end of the fiscal year, equities moved higher, before selling off in September. The portfolio sits roughly in-line with long-term targets in credit, commodities, and real estate. Our credit assets have performed well, beating equity returns in most categories. Credit is our most tactical beta factor, and we remain very excited about the return prospects in this area of the portfolio. We made no new investments in real estate or commodities during the fiscal year. The endowment continues to own predominantly U.S. assets, but with healthy exposure to equity investments in the rest of the world. Within equities, we have higher exposure (on a percentage basis) in the United States than the MSCI All-Country World Index, which primarily results from our private equity and venture capital portfolio. Within public markets, we are underweight U.S. equities and overweight other areas of the world including emerging markets in southeast Asia and Latin America. Our credit assets are predominantly U.S. instruments with some exposure to Europe. All other beta factors are predominantly U.S. domiciled instruments and properties. Our geographical exposure is shown in Figure C.
CLOSING REMARKS We ended fiscal year 2023 with a moderately conservative position relative to a 70/30 index of global stocks and domestic bonds. Interest rate volatility is high as inflation remains elevated, so we have limited interest rate risk within fixed income. We also carry more cash and liquidity than we would expect to maintain over time, but we are paid to wait for opportunities as money market instruments currently offer healthy nominal rates of return. The first quarter of fiscal year 2024 exhibited moderate volatility and offered the opportunity to further adjust the portfolio. We took advantage of these movements and turned over roughly 16% of the portfolio. Despite economic uncertainty, opportunity abounds, and we remain flexible when opportunities are presented.
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