Our Investment Theory

The endowment theory of investing refers to an asset allocation methodology which seeks to generate high risk-adjusted returns with lower volatility by increasing the number of asset classes and strategies used to create a portfolio. These asset classes and strategies normally include alternative investments such as hedge funds, private equity, and real estate assets, in addition to traditional stocks and bonds. This investment strategy was adopted by the major university endowments such as Yale and Harvard and, therefore, is often referred to as endowment-style investing.

Large endowments, which have substantial allocations to alternative investments, typically outperformed traditional investments such as stocks and bonds over the past 10 years. The figure below compares 10-year investment returns for endowments against the S&P 500 and an investment grade bond index. Notice how the larger endowments held a considerably higher portion of alternative assets and achieved higher returns.*

Two factors help to explain the performance gap between endowments and traditional investment: By investing in less liquid alternatives, endowments are typically able to construct a higher yielding portfolio with less correlation to the broader markets. Also the quality of the manager plays a key role. Illiquid alternative investments are more difficult to evaluate than publicly traded securities. Skilled managers that are adept at taking advantage of pricing inefficiencies in illiquid securities will have a greater impact on returns than skilled managers operating in the public markets, where price inefficiencies are fewer in number and there is generally less return potential.

While many institutions invest heavily in alternatives to build diversification and generate better returns, most individual investors have historically lacked access to alternatives due to, among other things, high investment minimums. In the recent years access to alternative investments for main street investors has increased and we are now able to build diversified portfolios based on the endowment theory of investing.