Why the Endowment Model Is Taking Over the Wealth Management Sector

Definition and Origin

The endowment investment models are usually characterized by high allocations to hedge funds, private capital, and dynamic management across other less traditional asset classes, accompanied with low allocations to core fixed income. It is a collective term for a class of portfolio management concepts, named after it was first adopted by some university endowments in the United States.

Endowment funds of well-known universities such as Yale, Harvard and Stanford are all early endowment model users. For example, Yale endowment fund has generated an average return of 13.1% a year through June 30, 2020, outpacing the 8.8% average annual return of a traditional portfolio with 60% in stocks and 40% in bonds over the same 35%-year period. [1] Although some endowments are suffering from lower returns in the past few years, the long-term value investing feature of the model helps the investors to generate outstanding returns over the long run.

These unique investment models have become exceedingly popular among domestic institutional investors in recent years. Many high-net-worth individuals and family offices have also studied and utilized it to manage their family assets. We here at Bridge Point Capital attempt to analyze the investment mechanism behind the model and provide outstanding returns for our investors.

Characteristics and Performances

David Swensen, the chief investment officer at Yale University, revolutionized how institutions manage their money through endowment model. When he took over Yale’s endowment fund in 1985, the endowment was worth $1.3 billion. Since then it has grown to $31.2 billion and generates an average return of 13.1% a year through June 30, 2020.

The foundational principles of the endowment model are thought to include leveraging investment expertise and a long-term perspective to add value by dynamically managing the portfolio through market dislocations and investing in more complex and less competitive areas of the market.

This results in an investment philosophy that aims for higher returns and places a greater emphasis on skill and the illiquidity premium than you would see from a typical institutional investor.[2] Figure 1 & 2 show the value of total asset under management of Yale’s endowment fund and the asset allocation of the fund.

Figure 1: Value of Yale Endowment Fund

Figure 2: Yale endowment’s asset allocation[3]

Some Advantages

Helping investors to realize time arbitrage

  • Asset classes with the highest long-term returns often lack liquidity in the short-term. Yale’s fund has allocated roughly 35% of its capital to VC and PE, which is actually a clever use of the characteristics of its capital to earn a liquidity premium.

  • Due to the long-term nature of endowment funds, they have a higher tolerance for short-term volatility and thus are able to reach higher returns.

Diversifying performance-oriented assets

  • Modern portfolio theory implies that through diversification, investors can reduce risk while keeping the return of the investment portfolio unchanged. Through the allocation of non-traditional assets such as hedge funds, PE, VC, private real estate, and private energy (compared to traditional assets stocks and bonds), the Endowment Model has achieved diversification at the asset class level.

  • The Endowment Model also involves global asset allocation. Since the 1980s, some leading US endowment funds have begun to allocate overseas assets. Through global allocation, investors have expanded their sources of return from a single domestic market to the rest of world, allowing them to take a share of the rapid development of other economies and the rise of capital markets in other countries.

Emphasizing the use of professional investment managers to manage assets in order to obtain Alpha

  • Most large endowment funds are professionally managed by investment managers that have clear investment goals and allocate the money into a variety of investments. Similarly, most family offices in Europe and the United States also entrust most of their assets.

The Endowment Model provides great insight on wealth management with asset allocation across the global becomes a major trend. BPC’s professional and internationalized investment network enables us to create long term value and deliver outstanding returns to all our investors.

[1] https://www.wsj.com/articles/david-swensen-yale-endowment-chief-who-changed-the-course-of-institutional-investing-dies-at-67-11620305438

[2] https://russellinvestments.com/-/media/files/us/insights/institutions/non-profit/how-non-profits-can-improve-upon-the-endowment-model.pdf?la=en&hash=4D3CD065D9E57FBE7640F6D5B5E9D7C9615AFA9F

[3] https://www.ft.com/content/e43825e7-7824-4355-881b-cb11629cd070