Broker Check

Our Investment Theory

The Endowment Theory of Investing:

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.

How do endowments invest?

Over half of the typical endowment portfolio is invested in alternative investment strategies. As of June 30, 2014, the average endowment allocated 51% of its total portfolio to alternative investments.* Yale University’s endowment, widely considered the pioneer in alternative investing, has allocated more than 65% of its portfolio to alternative investments.**

Typical endowment portfolio

Source: National Association of College and University Business Officers and Commonfund Institute. Data includes asset allocations for U.S. Higher Education Endowments and Affiliated Foundations with assets under management of at least $1 billion in fiscal year 2014. Alternative strategies includes private equity (LBOs, mezzanine, M&A funds and international private equity); marketable alternative strategies (hedge funds: absolute return, market neutral, long/short, 130/30, event?driven and derivatives); venture capital; energy and natural resources (oil, gas, timber, commodities and managed futures); and distressed debt.

How have endowments performed versus traditional investments?

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.*

Average 10-year net returns June 2004–June 2014

Why endowments do outperformed traditional investments?

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.

Is the Endowment Theory of Investing available to main-street investors?

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.

*2014 NACUBO (National Association of College and University Business Officers)-Commonfund Study of Endowment

**As of June 30, 2012. Investments include allocations to Natural Resources, Private Equity and Real Estate.
Past performance is not indicative of future results. An investment cannot be made directly in an index.