Checking up on the Endowment Model

2015 performance results for U.S. Higher Education endowments have been released by the NACUBO. While returns were not stellar, the average endowment beat the S&P 500 for the second year in a row. This is welcome news for the so-called “endowment model” of investing which relies to a significant extent on alternative investments to provide alpha and dampen portfolio volatility.

The financial crisis and its aftermath severely tested the endowment model. The chart below shows the average yearly returns of endowments versus the S&P 500 since 2006. The roads for both the long-only index and the endowment portfolio, with an average exposure to alternatives of 52%, have been rocky to say the least.

Over the 10-year period ending last year, endowments posted average annual returns of 6.3%, with the more sophisticated larger endowments (AUM over $1B) gaining an average 7.2%. These returns lagged both the S&P 500 at 7.9% and the broader market Russell 3000 at 8.2%. On the positive side, however, the volatility of the endowment returns has been about two-thirds that of the S&P 500 for the period reinforcing the role of alternatives in managing risk.

Post-crisis, the use of alternative investments in retail wealth management portfolios has grown substantially. Reviewing the experience of endowments and the effectiveness of the endowment model in this environment has added relevance for the HNW and UHNW marketplaces, particularly given recent and anticipated future market volatility.

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