The Return on Governance

Good governance could deliver a higher return and more resilience in endowments and foundations portfolios.

Strong investment governance helps make a tangible contribution to portfolio outcomes, particularly over the long-term time horizons of endowments and foundations (E&F) portfolios.

The opening years of the 2020s have delivered a wave of interconnected challenges for investors, with the combined impact of COVID-19, the war in Ukraine, and rising interest rates driving widespread regime change across the global economy and financial markets. From high inflation and supply chain disruption to banking crises, the complexity of today’s backdrop has brought new tests for investors.

In this environment, investment committees and trustees managing portfolios on behalf of E&F organizations are focusing much of their energy on portfolio construction and the risk-adjusted returns expected from portfolio allocations. This “return on investment” is front of mind for many organizations.

In their bid to maximize returns, however, organizations risk overlooking the potential “return on governance”—namely, how good governance practices can potentially help enhance returns and better manage risk over the long term.

From our work with global investors—from endowments and foundations to sovereign wealth funds and pension schemes—we know that good governance enables portfolios to respond to changing circumstances and market movements. This flexibility mitigates the risk of being caught off guard by adverse events and supports organizations seeking to capitalize on investment opportunities through periods of market upheaval. We believe that generating a “return on governance” can be particularly effective for E&F portfolios—from charities and foundations to faith-based organizations—given the long-term time horizons that typically characterize the objectives of this group of investors.

We were interested in understanding—and quantifying—what a “return on governance” could potentially constitute in the context of a long-term E&F portfolio, and we explore the implications in this paper.

We believe that a robust governance model can contribute to annual performance by:

• Helping align liquidity decisions within portfolio allocations to a long-term horizon
• Expanding diversification of the portfolio across asset classes to manage risk
• Helping enable effective rebalancing

In combination, these three core components enhance organizations’ flexibility to navigate regime change and geopolitical events in markets.

During strong markets, good governance ensures the program does not leave “money on the table” in the form of portfolio returns. Through market downturns, good governance models can help to ensure market value protection and provide all parties with peace of mind that the program has the appropriate level of risk to weather storms.

Building good governance models into the investment process unlocks real value potential for your organization.

Ed Stahlhuth is investment director of endowments and foundations at Mercer.