A Case For The Inclusion Of Alternatives In A Balanced Portfolio

The Endowment Model is an alternative theory for portfolio management. Unlike the modern portfolio theory – first applied in 1952 – which promotes a 60/40 stock/bond split, the endowment model advocates an allocation to alternative assets within a portfolio.

Most well-known endowments were established to continue the educational mission of our nation’s largest colleges and universities. Based on our research, we believe these university endowments invest in the alternative, equity, and fixed income markets, with a long term, future-oriented horizon.

Universities’ large capital pools allow them to diversify across many different asset classes and countries. We believe this ensures that assets within each portfolio have low correlations to each other. By investing in alternatives such as real estate, commodities, and private equity, the universities were able to perform well even when the markets suffered greatly during the recent economic downturn.   Alternatives’ low correlation to the markets provided a hedge against huge portfolio dropdowns during the financial crisis.

Figure 1 FINAL

Figure 1 – The Endowment Asset Allocation represents the make-up of the 20 largest university endowments in the United States, excluding Cornell University.


As such, we believe the endowment model invests in less volatile, less marketable assets in order to produce high, yet stable returns. As shown in Figure 1, alternative investments and strategies comprised the largest proportion (51.4%) of the top 20 largest endowments’ asset allocations in 2013.  The 36% allocation to equities and 13% allocation to fixed income are significantly lower than the traditional portfolio 60/40 stock/bond split.

Endowment Model Figure 2 FINAL

Figure 2

Endowment Model Figure 3 FINAL

Figure 3


Although portfolios that follow the endowment model may not outperform the S&P 500 and other benchmarks in the short-term, an analysis of the returns of the largest endowments shows that, on average, portfolios using the endowment model generate higher returns in the long run.

Of the 20 largest university endowments in the United States, 16 reported both short and long-term returns. As shown in Figure 2, the S&P (highlighted in orange) beat each of these endowments in the 2013 fiscal year. This can be attributed to the huge rally in equities markets as a result of the Fed’s continuation of quantitative easing, momentum investing, and a loss of fundamentals in the market.

As shown in Figure 3, 14 of these endowments had higher annualized returns than the S&P’s 8.08% annualized return over the previous 10 years, however.  By diversifying their portfolios with alternatives, we believe the universities were able to avoid major losses from the economic collapses that occurred in 2000 and 2008 and continue growing the schools’ investment portfolios.

The long-term success of the endowment model can be replicated by both institutions and individuals.  Although university endowments have enough capital to invest directly in alternative assets by purchasing real estate and other physical assets, individuals have typically found limited opportunities available. As investors have grown increasingly dissatisfied with public markets, there have evolved greater choices for investing in alternative assets that offer meet a wider range of capital requirements.

For example, certain funds that specialize in alternative assets or alternative strategies may pool smaller capital investments in order to make larger investments in assets, similar to those of endowments. Crowdfunding provides another option for the individual investor. Creatively structured private placements can also be a viable avenue for accredited and qualified investors. Through these varied opportunities, we believe individual investors and smaller institutions can lower their portfolios’ volatilities and enhance long-term returns — taking a page from the textbook of some of the most renowned academic institutions.

Assertions in this article are based on proprietary internal research analyzing endowment asset allocations and performance returns.

Either the current or target asset allocation of each of the largest 20 endowments (as determined by the 2013 NACUBO-Commonfund Study of Endowments) was found from the universities’ 2013 financial reports. Each university’s allocation groups were compiled into 3 broader categories: alternatives, equities, and fixed income and cash. The percentage of the endowment allocated to each asset class was then multiplied by the endowment size to give the dollar value invested in each category. The dollar value of each category was summed across all endowments and then divided by the total asset value of all endowments included in the study to find the percent allocation of each asset class amongst all endowments. Data from Cornell University was excluded from the analysis as its financial report did not provide enough detailed information.

Figures 2 and 3 depict the endowment returns of 16 of the 20 largest endowments. This sample represents only the endowments who reported both 1 year and 10 year annualized returns in 2013. University endowment returns were gathered from their year-end 2013 financial reports.  Morningstar was used to determine the returns of the S&P 500 for each period.  Other sources, including the Wall Street Journal, the Duke Chronicle, and Cornell Sun, were used to confirm endowment returns.