Don’t Give Up the Ship: The Future of the Endowment Model

Laurence Articles

Endowment funds have long been thought to be the best-managed asset pools in the institutional investment world, employing the most capable people and allocating assets to managers, conventional and alternative, who can and do truly focus on the long run? But, after a decade of subpar performance, documented by Richard Ennis in this issue of the JOURNAL OF PORTFOLIO MANAGEMENT, is this perception still valid? What inherent advantages do endowment funds have, and what special challenges do they face? What are the prospects for the endowment model of investing in the future?

This brief essay tries to answer these questions in the light of capital market theory and realities. But, first, what do we mean by the endowment model? It involves:

  • Defining the investment opportunity set to include every asset class in the world, as well as potential profit-generating situations that do not clearly belong to any established asset class
  • Treating the investment time horizon as very long or even perpetual, with attention paid to intergenerational equity while retaining the capacity to generate cash as needed by the endowed institution
  • Relaxing conventional institutional constraints on leverage, short selling, capital calls, and the ability to sell quickly or even mark to market
  • Being mindful of capacity limitations, transaction costs, and liquidity requirements–the “financial frictions” that do not occupy pride of place in the business-school version of investing but that are vitally important when one goes to implement the theories one has learned.

With all those advantages over other kinds of asset pools, endowments surely ought to be able to deliver superior returns! We’ll get to that shortly. But first, a look at the downside of such a structure.

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