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CHAPTER 3
The Endowment Model
Investors allocating assets to alternative investments need a framework on which to build their portfolios. What should the size of the allocation to traditional investments be, relative to alternative investments? Within alternative investments, how should the portfolio be diversified across asset classes, styles, and managers? For many, the answers come from a study of the investment practices of the managers of the largest endowment and foundation portfolios.
3.1 Defining Endowments and Foundations
Endowments refer to the permanent pools of capital owned by institutions such as colleges, universities, hospitals, museums, and religious organizations. When well funded and well managed, an endowment can provide a permanent annual income to the organization, while maintaining the real value of its assets in perpetuity. The idea of perpetuity is not a theoretical concept. The two largest U.S. university endowments are owned by Harvard University and Yale University, which were founded in 1636 and 1701, respectively. Universities that are more than 310 years old with assets of over $23 billion each can operate under the assumption that their assets will exist in perpetuity. The assets held by an endowment can generate income that offsets the impact of economic fluctuations over the course of the business cycle.
Most endowments are run by a single organization but may be funded by thousands of donors. In the United States, each organization is typically organized as a tax-free charity, in which individuals receive a tax deduction for making charitable donations. The investment income of the organization may also be tax exempt. Donations to the organization can be made in many forms, including cash, real estate, or equity securities, as well as art and other collectibles. Noncash donations are frequently sold and the proceeds reinvested according to the strategic asset allocation of the endowment manager. The endowment fund of a single university may be composed of thousands of smaller gifts, many of which are segregated to fund specific scholarships, professorships, or the maintenance of specific buildings or academic programs. These restricted gifts may require that the university maintain the corpus, the nominal value of the initial gift, while spending the income generated by the gift to benefit the stated purpose.
Exhibit 3.1 shows the significant asset size of the U.S. and Canadian college and university endowment community. As of June 2014, the National Association of College and University Business Officers (NACUBO) reported that endowment assets totaled $516 billion, with $140 billion held by the six universities with the largest endowment funds. The total value of endowments likely exceeded $516 billion as of June 2014, as this figure includes only those assets of the 832 endowments that responded to the survey. Should nonsurveyed colleges and universities also have endowments, then the total assets would exceed the amount reported in Exhibit 3.1.
EXHIBIT 3.1 Assets of the Largest North American University Endowments
Source: 2015 NACUBO-Commonfund Study of Endowments.
The wealth of college and university endowments is highly concentrated at a small number of institutions. As of June 2014, 91 of the 832 colleges and universities reporting to the NACUBO survey had assets exceeding $1 billion. These largest endowments controlled 74 % of the total endowment and foundation assets under management (AUM) held
