Available Now

Order now and be among the first to learn from Alternative Investing expert Bob Rice. Begin building your alternatives portfolio today! Order from Amazon.com, Barnes & Noble or 800-CEO-Reads

This episode aired on Bloomberg TV on Nov 13, 2012

Endowment Model

The endowment model is a form of the strategic asset allocation model of portfolio construction that involves diversifying investments across strategies, asset classes and investment horizons, as opposed to the standard long-only stock and bond model. This is the investment model that has allowed such superstars as the Harvard Endowment to consistently produce stellar returns while other investors have faltered.

Q. We spoke about this briefly with our guest earlier today, but what are the important elements of the so-called endowment model of investing?

A. This is really a version of something that’s also called “strategic asset allocation”. The first and most important point, as you might guess, is a method of investing that focuses on what percentages of your assets you have in specific strategies … not which super star managers you want to invest in. Strategy allocation has been shown to be more statistically important than individual fund manager selection over time.

Q. So, what kinds of strategies are the focus, then?

A. Really, the whole idea is kind of uber-diversification: across strategies, assets, and time, rather than traditional long only stock and bonds. Here’ a pie chart of where Harvard is this year [show image]

You’ll see that only 12% is in US equities and only 4% in domestic bonds… pretty dramatically different than the typical investors. Almost a quarter is in real assets, 16% is in hedge fund strategies, and another 12% is in private equity. That shows you the kind of diversification the “endowment model” is looking for.

Q. So what’s in that real assets category? I assume they don’t invest in fake ones.

A. This is where they hold their real estate, natural resources, and commodities.
One of the more interesting things about Harvard is how aggressive they have been in timber. This is an ultra interesting asset class because it self-renews, generates inflation protected yield, is a great play on developing economies. They were a huge player in the US, then went to New Zealand, and are now stomping around in Brazil.

Q. What’s all this mean for individuals?

A. Basically, its a really important lesson. This approach has greatly outperformed 60/40 portfolios over the long haul (and that is what they are meant to do; short term performance is just not that important) **with less risk**. Obviously, individuals can’t exactly emulate these allocations, especially because they have different liquidity needs. But still, with all the new liquid alternatives, and changes in the private placement rules, individuals should pay attention to the lessons of the endowment model.