Don’t Give Up the Ship: The Future of the Endowment Model

Abstract

The endowment model, long thought to be superior, has recently come under criticism because of poor returns relative to stock and bond benchmarks in the past decade. The author argues that the long-run prospects for the endowment model are favorable because (1) the model relaxes many of the constraints that keep other types of investors from achieving maximal risk-adjusted return, (2) the model is focused on the very long run, and (3) the current prospects for stocks and bonds, at least in the United States but potentially elsewhere, are problematic. The author concludes that, although it is subject to agency costs such as the temptation to take risk now and allow someone else to deal with the consequences later, the endowment model is sound and can continue to be pursued by skilled investors.

TOPICS: Foundations & endowments, portfolio theory, risk management, performance measurement

Key Findings

• ▪ Endowment funds have structural advantages that should allow them to earn above-market risk-adjusted returns in the long run.

• ▪ The last decade’s poor relative performance of endowment funds was caused as much by high returns on public US equities and bonds as it was by poor performance of the alternatives held by endowments.

• ▪ The near future for stocks and bonds looks problematic, so endowments with their historical commitment to alternatives should be able to outperform again.