Integrate Endowment Model Principles in Your Own Portfolio - dummies

Integrate Endowment Model Principles in Your Own Portfolio

By David Stevenson

The recent return to form for large endowment funds in the UK and around the world tells you an important fact — over the long term, the endowment model delivers exceptional returns in a relatively stable manner. They do so by using the following techniques:

  • Use alternatives: Think out of the box and don’t stick just to the standard 60/40 per cent equity/bond mix.

  • Get the best managers: Make sure that you hunt down the very best managers if you’re going to pay for expert advice; otherwise keep things simple, cut costs and use index-tracking funds.

  • Be adventurous and think global: For example, if you’re based in the UK don’t be overly focused on your home country and sterling.

  • Think real assets: Ensure that you have some inflation proofing inside your portfolio by investing in hard assets, like metals, land, and energy sources — assets that tend to be negatively correlated to stocks and bonds.

Although in theory you can apply these principles to any portfolio, no matter how big or small, the truth is that large endowments have huge advantages over mere mortals. For this reason many experts concede that the big endowment funds run strategies that average private investors can’t easily copy.

For instance, many successful fund managers only accept money from outfits such as super-big endowments, because those funds are large, stable and for the long term. Some successful fund managers, especially in the private equity space, have also closed their offerings to new money, effectively locking out all but a tiny part of the market. But endowment enthusiasts don’t think that you should give up.

David Swenson and Yale

David Swenson of Yale endowment fame reckons that if you don’t have access to his amazing panel of top return-producing fund managers, you shouldn’t try to pick individual stocks or pay anyone to do it for you. He’s a tireless critic of the mainstream for-profit mutual-fund industry.

Instead, he advocates that private investors should use low-cost index funds as one way of building a diversified portfolio. Swenson maps out a ‘well-diversified, equity-oriented portfolio’ for private investors.

His current advice is that you create a single portfolio consisting of passive, index-tracking funds that invest in the following:

  • Domestic (US/UK) stock funds: 30 per cent

  • Real estate investment trusts: 15 per cent

  • US (or UK) Treasury bonds: 15 per cent

  • US (or UK) Treasury inflation-protected securities: 15 per cent

  • Foreign developed-market stock funds (such as the EU, Japan, Australia): 15 per cent

  • Emerging-market stock funds (Brazil, Russia, India, China, Taiwan, South Korea and the rest of the developing world): 10 per cent

Mike Azlen and Frontier

Other experts have their own endowment-based portfolio mixes. For instance, UK investor Mike Azlen, based at fund manager Frontier, runs low-cost multi-asset class portfolios that draw on the best ideas of university endowments (see the table).

These varying-risk-based portfolios comprise passively managed funds at a cost of less than 1 per cent per year. In particular Azlen’s funds mirror many of the same asset allocations used by Harvard and Yale universities.

Endowment Index Portfolio: 2011 Asset Allocation
Asset Class Proportion of Fund (%)
Private equity 27
Commodities 13
Global equities 13
Global bonds 10
Real estate 13
Hedge funds 8
Managed futures or CTA hedge funds 8
Emerging-markets equities 6
Emerging-markets bonds Under 2

Source: Frontier Investment Management

Mebane Faber and Cambrian IM

US-based fund manager and investment writer Mebane Faber — chief investment officer at Cambrian IM — is a fan of the diversified endowment model.

In a recent book with Eric Richardson, The Ivy Portfolio (as in the Ivy League of top US universities), Faber outlines what he thinks a private investor’s portfolio may look like, with all the building blocks comprised of cheap, low-cost passive tracking funds, such as ETFs:

  • Domestic (US/UK) stocks: 20 per cent

  • Foreign (non US or UK) stocks: 20 per cent

  • Bonds: 20 per cent

  • Real estate: 20 per cent

  • Commodities: 20 per cent