7 lessons to learn from university endowment investing | Invest
Forget hedge funds and family offices. When it comes to assets under management, or AUM, few institutions rival the size of the endowments of America’s leading private post-secondary institutions.
Harvard University manages an endowment of approximately $53.2 billion. Yale University comes in second with an endowment of $42.9 billion, and Stanford University follows in third place with $37.8 billion in AUM.
These endowments provide schools with a stream of investment returns that fund operating expenses, research, and scholarships for students. Their investment strategies are designed to maximize risk-adjusted returns, achieve resilience in most market conditions, and provide a perpetual stream of income.
Here are seven lessons retail investors can learn from how college endowments invest their capital:
- Consider private equity.
- Match the duration of fixed income assets to expected liabilities.
- Try absolute return strategies.
- Do not over-allocate to equities.
- Don’t neglect international equities.
- Keep contributions consistent and high.
- Have an investment policy statement.
Consider private equity
Private equity refers to common stock of unlisted companies. Access to private equity is often locked behind private equity and venture capital firms, which only open funds to high net worth or institutional investors.
Most college endowments are eligible for both and therefore can utilize this asset class. As an investment, private stocks can potentially offer higher returns than public stocks as well as lower market correlation.
The downside here is illiquidity, as many private equity funds subject their investors to lock-up periods. However, this is not a problem for endowments, which generally have a long time horizon. Retail investors can copy this with funds that offer private equity exposure or own publicly traded private equity firms.
Match the duration of fixed income assets to expected liabilities
Endowments often have planned liabilities that are expected to become due within a certain period of time. Examples could include the construction of a new library building or a sports stadium, which should be fully funded and completed within 25 years.
The endowment can buy a zero-coupon fixed-income asset like a STRIP treasury bill with a maturity of 25 years. In this case, the interest rate and reinvestment risks are cancelled. Even if rates go up and the price of the bond goes down, the endowment is unaffected as long as it holds the bond to maturity.
At maturity, the endowment can redeem the bond at face value and receive the original investment plus interest. Retail investors can copy that. For example, if you retire in 10 years, buying a 10-year Treasury bond guarantees you a refund plus interest at maturity and protects you from rising interest rates.
Try Absolute Return Strategies
Most stock and bond investors try to match or beat a benchmark. For example, fund managers picking stocks might attempt to outperform the S&P 500 Index. However, some funds do not attempt to compete with a benchmark. These funds seek positive returns regardless of market conditions.
In many ways they resemble hedge funds, using exotic strategies like global macro, long/short and systematic trend following across a variety of asset classes to achieve a positive return regardless of how the market moves. market. During periods of volatility when stocks and bonds fall in tandem, like this year, absolute return strategies shine. Notably, Yale’s endowment devotes about 22% of its asset allocation to an assortment of absolute return strategies. Investors can access absolute return strategies through various managed futures funds.
Do not over-allocate to equities
Many retail investors, especially younger ones, hold a 100% stock portfolio. While this approach can maximize long-term returns, it does so with excessive risk.
With 100% equities, high volatility and steep declines are likely. In comparison, most endowments hold a small equity allocation, both domestic and international.
For example, the Yale endowment only holds about 4% domestic stock and 14% foreign stock. Instead, endowments seek returns through other assets, including real estate, commodities, venture capital and private equity. Retail investors can mimic this by buying shares of real estate investment trusts or REITs, business development companies or BDCs, and commodity funds.
Don’t overlook international equities
Many retail investors allocate their portfolios heavily to domestic equities. This is called a country of origin bias. While beneficial for tax efficiency and currency risk, this can lead to long-term underperformance.
College endowments realize this and often allocate their equity holdings heavily to international equities. The goal is to offset the risk of the U.S. market performing poorly for an extended period, which can be disastrous for a school that relies on its endowment income to fund its operations.
While US equities have outperformed over rolling 20-year periods, much of their returns came from various upsides from 2009 to 2021. Previously, international equities, especially those in emerging markets, were much higher. Markets are cyclical and winners revert to the mean. So, holding international stocks makes sense for long-term investors, whether for an endowment or as a retail investor.
Maintain consistent and high contributions
Many university endowments rely on a generous stream of donor contributions to grow their AUM. While investment returns play a role in ensuring strong long-term returns, maximizing contributions can provide an equally, if not more, boost.
Having consistent cash flow helps endowment portfolios accumulate faster and aids in portfolio rebalancing. Retail investors can apply this lesson by maximizing their own savings rate. This means investing money consistently no matter how the market moves.
Most endowments do not keep a high cash allocation, as they prefer to invest it as early as possible while leveraging their high diversification to reduce risk. Retail investors can do the same by putting money to work as soon as it hits their brokerage accounts.
Have an investment policy statement
College endowments are governed quite effectively. This often consists of an investment committee, an investment manager and various advisers. There may also be a charter or statement of investment policy that defines the objectives of the endowment and imposes constraints on the selection and allocation of assets.
Retail investors can do the same via a Written Investment Policy Statement, or IPS. It is a document that outlines the investor’s time horizon, risk tolerance and desired investment results. It can also indicate which assets the investor can or cannot buy, rebalancing timeframes and frequency of contributions. Having an IPS helps investors stay calm, rational, and methodical when it comes to managing their portfolio, much like an endowment.