Developed by a select group of university investors and later adopted by many nonprofits, the “endowment model” was often considered the gold standard for maximizing long-term returns. In recent years, many adherents have underperformed compared to simpler, lower-cost portfolios of index-like public bond and equity allocations.
We don’t believe the endowment model is broken. In our view, it excels at the “art” of asset allocation: emphasizing diversifying alternative investments, seeking alpha-generative skill, and leveraging a long investment horizon to capture risk and illiquidity premia. However, it has not placed as much emphasis on adopting the “science” of portfolio construction: technological and analytical tools that help detect and adapt to changes in market structure.
In this paper, we examine the challenges facing the endowment model and propose a more dynamic, holistic and scientific approach to modernize it.
Executive Summary
- The endowment model has been an important blueprint for many years, taking advantage of long investment time horizons to make large illiquid asset allocations.
- The model has been challenged by opportunity costs that arise from unexpected liquidity crunches.
- The model prioritized skills-oriented, return-seeking manager selection in alternative strategies, but this resulted in limited transparency, overlapping risks, operational complexity and cost inefficiency.
- We believe advances in portfolio management technology and analytics allow for a more adaptive playbook, which can better navigate evolving macroeconomic conditions:
- A holistic portfolio approach focused on true portfolio exposures, risks and diversification
- Streamlined manager relationships, with greater oversight and holdings-level transparency
- Better integration of private investments and their liquidity and cash-flow profiles - We summarize this playbook in five key “ABC” principles:
A. Attribute and Adjust
B. Balance Liquidity
C. Consolidate Manager Relationships
D. Directly Invest
E. Eliminate Silos
A Disappointing Decade
Trailing performance of the average endowment portfolio and a 70/30 portfolio
Fiscal-year performance of the average endowment portfolio and a 70/30 portfolio
Nothing herein constitutes a prediction or projection of future events or future market behavior. Past performance is no guarantee of future results.
Source: 2024 NACUBO-Commonfund Study of Endowments, Bloomberg. Endowment returns are net of costs. Returns for periods over one year are annualized. Indices used for the 70/30 Portfolio: MSCI World Index; Bloomberg U.S. Aggregate Index.
