Endowment evolution

How new tax policy could reshape endowment investment strategies

The recent passage of the “One Big Beautiful Bill” marks a turning point in US tax policy—and it has significant implications for many colleges and universities. The sweeping legislation introduces new tax structures that will affect how some endowments manage, grow, and spend their assets. The institutions that face the most potential financial harm from the new tax hikes can take tangible steps to mitigate their impact, drawing on techniques other institutional investors have used for decades to minimize taxes’ impact on their results.

What the Big Beautiful Bill means for endowments

Under the new bill, private nonprofit institutions of higher education that enroll at least 3,000 students will be taxed at three different tiers. Endowments with between $500,000 and $750,000 in assets per student will be taxed at the current rate of 1.4%. Endowments with between $750,001 and $2 million per student face a 4% tax rate, and endowments above $2 million per student face an 8% tax rate.¹

Three key investment implications of the new tax policy

The new rules have wide-ranging implications for endowments. Here are three key investment considerations:

1. Lower expected returns, net of taxes, could call for changes to target asset allocations

The new taxes could take a sizable bite out of the returns that support endowment portfolios’ annual spending and long-term growth. The reduction in potential returns may require staff and boards to reduce annual spending, accept slower growth of their endowments, or assume greater risk in pursuit of similar after-tax returns. Many institutions may want to increase allocations to growth-oriented assets including equities, credit, and alternatives such as hedge funds, private equity, and private credit.

2. Liquidity needs may rise, affecting decisions related to alternatives

Many institutions of higher learning are struggling with reductions in federal government grants. A sudden increase in the tax rate could exacerbate these funding issues. Institutions might be forced to raise cash by selling assets from the more liquid segments of their portfolios. They also might choose to sell less-liquid assets if they can find buyers at the right price. For example, the Harvard and Yale endowments already have announced plans to sell portions of their private equity portfolios.

These liquidity needs may reduce endowments’ use of alternatives in the short run. That said, alternatives’ potential to improve portfolios’ diversification, growth, and income may prove especially valuable in a future in which endowments must overcome tax-related headwinds.

The new outlook also may call for adjustments within alternative asset allocations. For example, private credit and real estate generate a high percentage of their total returns in the form of income, which can create an annual tax liability. Endowments might prefer to allocate more to private equity and venture capital, as well as public equity, because taxation of gains on those asset classes is deferred—in which case they will need to ensure the other portions of their portfolios provide enough liquidity to meet spending needs, fund capital calls, and pay taxes.

3. Endowment investment strategies may need to become more tax-aware

Taxes have not been a major consideration for most endowments in the past, but that is about to change for large endowments. Tax-efficient investments such as municipal bonds may take on greater roles in endowment portfolios. Endowments may make greater use of tax-efficient, low-turnover vehicles such as exchange-traded funds, and they might explore greater use of segregated accounts to provide more control over the timing of realizing gains. Some also may employ sophisticated tax-loss harvesting and other tax-aware investment strategies, such as programs that use derivatives or structured products to manage exposure without triggering gains. By contrast, endowments may de-emphasize the use of high-turnover systematic and quantitative strategies, or managed futures programs run by Commodity Trading Advisors.

Insights from our experience in tax-aware investing

State Street Investment Management has been managing tax-aware portfolios for more than 30 years. We are intimately familiar with the range of strategies and tactics that institutional investors can use to mitigate tax drag. These strategies have become increasingly sophisticated and effective in recent years, as advanced portfolio management platforms, coupled with the voluminous market data available today, support tax-aware investing across a wide range of asset classes and investment styles.

For example, our Systematic Equity Beta team employs optimization techniques to manage tax considerations efficiently. Portfolio managers rebalance regularly, taking advantage of natural market volatility to recognize tax losses from securities that have declined. Harvested tax losses can be used to offset taxable capital gains, either within the equity portfolio or from other investments such as private equity or hedge funds, potentially helping improve the after-tax return of an overall portfolio.

The tax savings produced by harvesting losses can stay invested and potentially compound over time, adding considerable long-term value. A typical tax-managed portfolio harvests losses and defers gains over many years, so the net unrealized gains of the portfolio tend to grow over time.

The passage of the Big Beautiful Bill introduces new tax challenges for many colleges and universities. Government policies affecting endowments remain in flux, with potential implications not only for investment management but also for return expectations, spending, the choice of investment vehicles, and other considerations. We are monitoring this evolving landscape, and we will continue to work closely with our clients to navigate it.