Hear from Tanya Suba-Tang and Bahman Mirzaee as they discuss the current challenges and opportunities facing endowments and foundations within the investment landscape. Mirzaee, in his capacity as a principal at Mercer, delineates the various types of organizations that fall under the purview of endowment and foundation management, including educational institutions, private and corporate foundations, and cultural organizations such as museums. He emphasizes the fiduciary responsibilities these entities hold regarding the management of assets derived from donations, grants, and other financial contributions, elucidating the critical role they play in ensuring the sustainability of their respective missions.

As the conversation unfolds, Mirzaee introduces the three primary ways in which Mercer supports its clients: through Outsourced Chief Investment Officer (OCIO) services, advisory roles, and direct investment assistance. The OCIO model, in particular, stands out as a rapidly expanding service that allows organizations to share fiduciary duties with Mercer, thereby enhancing their investment capacity while benefiting from the expertise and resources that Mercer brings to the table. Mirzaee articulates how this collaborative approach not only alleviates the burden on organizations with limited internal investment capabilities but also fosters a deeper understanding of their unique investment needs, particularly in a landscape characterized by increasing market volatility.

Transitioning to the contemporary challenges that endowments and foundations face, Mirzaee provides a thorough analysis of the macroeconomic factors influencing investment strategies. He discusses the repercussions of shifting interest rates, demographic trends, and legislative changes that affect funding structures for educational institutions and other nonprofits. Notably, Mirzaee highlights the impending demographic cliff, projecting a significant decline in the number of graduating high school seniors, which poses a substantial risk to the enrollment and funding stability of many educational organizations. Furthermore, he addresses the impact of recent tax reforms on charitable giving, noting that changes to the deductibility of donations could influence donor behavior and subsequently alter the financial landscape for nonprofits. Through this comprehensive discourse, Mirzaee underscores the complexities of navigating the investment landscape for endowments and foundations, ultimately providing valuable insights into the strategies that may be employed to mitigate these challenges and capitalize on emerging opportunities.

Hello and welcome to Financial Perspectives, a CFA Society San Francisco podcast where we interview and discuss trends with leaders from across the investment and finance industry.

This month, our host, Tanya Suba-Tang, membership director with CFA Society San Francisco, had the pleasure of speaking with Bahman Mirzaee, principal and Endowments and Foundation segment leader at Mercer. Listen in as they discuss trends and challenges in the Endowment and Foundation space.

Bahman, it's so great to see you today. Thank you so much for joining me.

Great to be here. Tanya, thanks for hosting. Appreciate seeing me.

Absolutely. And I just wanted to say that you are my lucky first feature episode on season six. So you are our star opener this season.

Okay. That's a lot of pressure. Do my best to deliver so the rest of the season can get better from here.

Oh, well, I, I think you're just fine.

And we're going to be talking something so interesting and I don't think we actually really talked about this topic in our podcast in our whole five seasons. So I'm really thrilled to have you and kind of diving into this. So for all our listeners.

Faman is a principal, endowment and foundation at Mercer, so I would love for you to kind of set the tone for our listeners. Can you kind of share a little of what are some types of organizations that work with in your position?

Sure.

I think the "who" is probably the most interesting part of what my team does and we support a wide range of organizations and to meet their investment needs.

So in the educational segment alone, think about educational services, K through 12 schools, community colleges, higher education, and the list just compounds from there. There are private foundations, corporate foundations, religious organizations are a major part of our client set. Then there's community found.

Another fun segment is museums. Membership organizations. I think about like law groups or affiliation groups, like geologists or something to that sort.

There are way too many to name, but I would wager that nobody listening today has not interacted or at least benefited from the services of some nonprofit in their ecosystem.

That's a very great description. I think a lot of the times our listeners might hear endowments of foundations and not necessarily know what that entails.

So how does Mercer and your team specifically work with these specific endowments and foundations?

Sure, in its simplest form, endowments, foundations have assets that they have fiduciary responsibility over. So these things come from donations, grants, gifts, anything that's been given to them to support their mission, whatever that mission might be.

And what generally happens is this takes the form of like a long term pool. And my team is dedicated solely to just Servicing and helping these types of clients.

And we work with endowments and foundations in primarily three ways. One is ocio, which is outsourced chief investment officer services.

One is advisory, and the last one is kind of investments or like direct investments, help with them.

You mentioned OCIO for me and of course for our listeners. What is that exactly and how does that work?

Oh sure, yeah, we love acronyms and financial services. I'm sure the podcast listeners are very familiar with that. But let me go through all three services. So one I mentioned was investments.

So imagine if you're an organization and you have this long term pool and you have a very specific need and you come to us and say, you know, we'd love your help in identifying a large cap value manager, or we'd love for you to set up and build out our private equity sleeve for us. So that's one specific silo.

The next one is we have, you know, our internal investment staff and we'd love for you to come in and give us advice, set up advisory and we come in and give you our best advice and you either implement it or don't. But the responsibility is on the client.

Now the fastest growing segment and by far the most interesting is what we call outsource chief investment officer services. This is where us and the client share the fiduciary responsibility and the investments are delegated to Mercer.

So in an OCR relationship, we act as an extension of your staff.

This includes revising and setting up an investment policy statement, figuring out your spending needs, building out a portfolio, trading management searches, rebalancing, building out private markets solution for you, and a massive amount of other services and support that we offer. So I should also note that in many of these cases, especially in OCIO capacities, an organization might retain their investment committee.

So let's say you're a big community foundation and you have your volunteers, and your volunteers, a subset of them will form an investment committee and that investment committee will then help us make decisions and be part of the solution going forward. So just because you engage in an OCIO is no means a reflection of the sophistication and talent of the organization.

We have various goals, specifically in the K through 12 segments that, you know, parents are involved, that are incredibly sophisticated buyers, I would say in this space. So, and then, then the delegation also varies slightly.

So for example, you can say, look, we are hiring you as an outsourced chief investment officer service. That is your job and our job is to hold you accountable.

And then this also evolve to say, look, we really like to collaborate and we like for this to be more of a partnership. So we meet you where you're at.

Generally, a story to kind of help illustrate how this works in practice is we had a client approach us in the Bay Area and this individual spent 20 years at this organization acting as their chief investment officer. And he did a wonderful job. However, after 20 years, it's time to retire and we're not immune to any of the demographic issues happening in the world.

So the committee went out and did a search and they weren't able to find anybody that fit the profile, the characteristics that they wanted. So they came to us and said, here is our investment thesis. Here's our pool of assets. Would you act as our ocio?

And obviously we said yes, and we helped them get set up.

And then the last thing I'll mention, I apologize for going on for a little bit too long on this, but it's really an important and growing part of the investment industry is an understated benefit of hiring an OCIO is a lot of these organizations are staffed by volunteers. So think about a parent or a CFO or somebody on a board of a museum.

They're really there to volunteer their time because they care about the mission or they care about the organization. But at some point they might peel off or retire or move on to another organization.

And what a lot of the folks on my team do, and they do it extremely well, is act as a pseudo historian for the organization. They come in and somebody, you onboard, a new board member, and they say, like, how do we get here? What's going on? What have we tried?

And you have that consistent relationship. And some of our clients have been with us for 15, 20 plus years and we're able to bring that perspective. Here's how you got here.

Here's what donations look like, here's what the growth of the portfolio has. Here's why the portfolio constructed in a certain manner. So a lot of fun stuff in our, in our space.

Wow, that's fantastic. Thank you so much for sharing that. Now I think everyone's probably very interested.

You know, things were said earlier this year and so would really love to kind of get your thoughts on some trends, challenges and investment themes in the endowments and foundation space.

Yeah, and I think this is the genesis of our entire conversation was I was mentioning some of the things happening earlier this year in our space and you said, let's, let's talk about it. And I will tell you, it has been fascinating.

We have never created and trashed so much research as we have in the last 12 months because of all the changes.

So on top of the other headline news that your listeners are I'm sure familiar with, our clients specifically had had to deal with a whole host of other issues and challenges. But let's start with investments because this is a CFA podcast. So let's, let's start with the fun stuff first.

One of the things that's come up consistently is the endowment model or the Yale model, which I'm sure your listeners are familiar with. And the way we describe the portfolios that we build are their perpetuity portfolios.

They are supposed to outlast all of us, anybody at the desk, anybody bored anywhere else.

Now, what Yale did very early on was they diversified out of common stocks and bonds and they started investing in asset classes like private equity, venture hedge funds. And the story is well told, so I won't repeat it here, but that success came a lot of imitation.

Now the question has become with the changing interest rate environment and all the changes and the growth in the private markets, is the, is the model still valid? Now, on the surface level, since these portfolios are meant to last forever, you could say absolutely.

You could take on a liquidity risk and you could reap some of the benefits. And that's how it should work. Most people thought they could just copy and paste a portfolio over.

And there was this wonderful article in the Financial Times recently where they talked about the Yale model, the endowment model, and they said what most people miss is there were two other factors in play and I tend to fall into this camp as well. One was access to investment talent and the other was access to long term relationships with your investment providers.

And that's essentially what we do here, is that investments aren't meant to be easy and you can't just copy and paste and diversify out. So that's what we at Mercer try to bring to our clients is we have these long standing relationship with asset managers.

We know what they do, we know what their pipeline looks like and where they excel.

And that's really what we try to bring to our clients now in regards to challenges and themes, this year has seen a whole host of macro challenges to nonprofits. So the one item was the passage of the big beautiful bill, which was in the news and this was pre our discussion.

So a lot of that has been resolved now. And the way to best describe it is imagine yourself as the CIO or the president of a major research university.

Right now you have grants that are potentially in hundreds of Millions of dollars that has either been funded, frozen, or canceled or held up in court. You have changes to visas and a crackdown. International student enrollment.

So the average student enrollment, by the way, international Enrollment is about 6% across the country. But at research universities, that could be as high as 20%.

Oh, wow.

So it's, it's quite a big number. So if those, if those numbers come down, it's a big deal for those large research universities.

And then there was already a 1.4% tax on private institutions with at least 3,000 students with an endowment of 500 to 750k per student. Now, what's changed in the bill is that they've added tiers just like we, you and I, are subject to a progressive tax.

These institutions are going to be, I guess, opened up to a progressive tax of sorts now as your endowment increases. So let's say you're at the 750 to $1 million per student. Your tax increase to about 4%.

If you have over $2 million per student, your tax can go all the way up to 8%. Now, obviously there's only a handful of large institutions that are blessed with those types of numbers, but it is a change.

And then there's a whole host of other things in the education space.

So that includes reduction in federal student aid, reduction in the parent plus loans, elimination of the grad grad plus loans and limitations, and changes to the loan repayment options that people have.

Now, on top of all this, there is now a new requirement also for schools to pass on an earnings test that they have to even get access to the federal student loans.

And then there is the indirect effect which we have yet to feel, which is if there are cuts to Medicaid and SNAP programs at the state level, the state legislature might have to make some decisions on education, which means that if they choose to fund Medicare and snap, they might actually pull back from spending on the educational portions of their budgets. So if you are again ahead of a major university, it's been a very, very tough year for you.

One of the other topics that I kind of want to bring up was this other trend in education more broadly. There is what we call this demographic cliff happening across the US and we all have had discussions about this, right?

You've seen the birth rates around the world, and the US Is by no means immune to any of this. So what we're projecting is a decline of 13% in graduating high school seniors in the US over the next 15 years.

Now, that's, that's a big Pipeline for these universities. Obviously there's variation across the U.S. for example, in California, it could be as high as 29% fewer graduating high school seniors.

So if you are an educational institution, these are things that are incredibly top of mind for you.

And then the second order effects obviously is what if you're a college town, those students that come into school, they, they support your local ecosystem, they might stay and start companies and things of that nature. And then I know I've gone a little bit too deep on the education side, but just high level other items that we're keeping an eye on.

Obviously inflation is a big deal and everybody has been feeling it. We're getting the same feedback from our clients.

If you're a food bank, a homeless shelter, or you provide free medical clinic care, you're, you're being, you're being stretched a little bit then these days. And then charities that support causes overseas have been hit hard by the closure in usaid.

And then there's also challenges for any organizations that are providing any type of immigrant population with any type of support. Now I wanted to make sure you don't have any questions before.

There's a whole other host of other things that are challenging on the giving side, which is a big deal for our clients. So on the giving side, there's two things I'd like to really highlight.

And by giving, I mean you and I and everybody else in the US giving donations out to these organizations that we still care about. So now there was a change in the big beautiful bill about a permanent charitable deduction for non itemizers.

So around, you know, when we go to file our taxes, around tax time in February, March, April, time frame, you can either choose to itemize or take the standard deduction. If you took the standard deduction, your charitable giving wasn't impacted as much. But if you itemize, you can obviously deduct those.

So what's changed is around 85% of the population chooses their standard deduction, which might change with the SALT reforms that we also saw.

But the beauty of this is now for a standard deduction, you now get 1,000 for single and 2,000 for married filed jointly, where you can deduct that giving to your favorite organization, which could be a game changer for a lot of organizations that rely on smaller donations.

Yeah.

There's also a change on the corporate side.

There's now a 1% floor on corporate contributions to charity, meaning that you won't get a charitable deduction until donations exceed 1% of your taxable income. And we project that that might impact philanthropic giving by corporations by about 10%.

Now, on the positive side, America has a very rich and proud tradition of giving. I know that you have listeners all over the globe, but there's also this massive trend of baby boomers retiring.

The wealth transfer and charitable causes will get some tailwinds and support from those changes.

Additionally, you know, a strong economy, strong stock market, they really lend themselves to individuals making large donations to these types of organizations. So those are some of the positives, negatives, challenges and trends that are going on in our space.

Oh my gosh, Bahman, that's a lot to take in. But you know, a lot is happening.

And thank you so much for sharing this because a lot of positive, a little bit of negative, a lot of things that we got to look forward to. But you know, I don't think anybody else kind of really understood the extent of these changes and how they're impacting in so many things.

So thank you so much for sharing your insights. I think I've learned a lot and our listeners learned a lot.

Thank you Tanya for having us.

Like I said, we work closely with our clients to make sure they understand how these changes will impact them and we're happy to come back and talk to you as needed.

Oh, that would be fantastic. I'd love to have you back and see, you know, maybe in a year. Let's see where we are, right?

That sounds great. Thanks for hosting.

Thank you.

Thank you to this month's guest, Bahman Mirzaee for your thought provoking insights. I'm sure the many tips you've shared will have a lasting impact on not only mine, but our listeners perspective on endowments and foundations.

Join us next time for another Financial Perspectives episode airing on the last Tuesday of the month.

Make sure to send in a message to the show by emailing podcast@cfa-sf.org. we'd love to hear what you thought of this episode or any suggestions you have on future topics that you'd like for us to cover. Thank you for being a dedicated listener.

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