Like most asset allocation strategies, the ‘endowment model’ for investing was challenged by the financial crisis and its practitioners have learnt lessons from the episode, according to Sandra Urie, CEO at Cambridge Associates, an asset consultant with deep experience in the field.
Endowment-style investors weren’t on their own as they came under pressure from the systemic breakdown of the financial crisis and the ensuing volatility and liquidity scarcity.
“Those weekend events” – Urie said, employing a euphemism to describe the 2008 Wall Street bank crises – “just kept coming.”
But not all endowment-style investors fared badly. About 80 per cent of Cambridge’s endowment clients did not experience liquidity problems during this period, Urie said, and like other investors, they learned some lessons.
They learnt the reality that absolute portfolios can decline – they don’t have a “floor” – and that investment risk should be viewed in dimensions other than volatility. It also takes the form of leverage, liquidity, equity beta, currency, inflation, interest rates, credit spreads and exposure to active management, Urie clarified.
“We’ve been doing modelling in trying to get at how you can deconstruct that overall volatility in a portfolio and assign it accordingly.”
She said investors had taken these lessons on board rather than becoming shy of risk.
“I don’t think the appetite for risk has been hurt. It’s more about understanding the risks you’re taking and why.”
The endowment model of investing became famous throughout the industry as the Yale and Harvard university endowments posted impressive returns that were, in large part, attributable to investments in hedge funds, venture capital, timberland and other alternatives. Observing this, some pension funds began eyeing these strategies – particularly as they sought to diversify away from equity beta after the dotcom crash. Talk of ‘endowment envy’ percolated throughout the industry.
But the financial crisis brought an end to the long stretch of outperformance enjoyed by many endowment-style investors as liquidity pressures and the market rout of 2008 unceremoniously grounded their consistent double-digit returns.
Too often, the endowment model was incorrectly viewed as just an alternatives-heavy approach to asset allocation, when it is purely a framework for thinking about institutional investment, Urie said.
“It is a form of investing with a long-term horizon. Each investor steps back and asks: ‘What is the role of this portfolio, and what is the financial structure of our organisation? How dependent are we on our portfolio for operating revenue?’ That can lead to an asset allocation that includes alternatives, because it’s consistent with what they’re trying to achieve.”