David Swensen’s model for the Yale endowment may not be suitable for all endowments and foundations, according to consulting firm NEPC, but they shouldn’t rush to a 60/40 portfolio either.
Instead, smaller and mid-sized endowments—with less than $500 million in assets—may be better suited to a hybrid investment program that falls somewhere between the “illiquid, complex endowment model and the liquid, traditional 60/40 portfolio,” the consultancy firm said in a paper.
“Higher returns generated by 60/40 portfolios over recent periods have led some endowment and foundation investment committee members to consider the endowment model’s long-term viability and whether the traditional allocation split is perhaps a better solution for meeting spending needs,” Scott Perry, partner and member of NEPC’s endowments and foundations team, said.
According to the 2013 NACUBO-Commonfund study of endowments, institutions saw an average one-year annualized return of 11.7% and a three-year return of 10.2%. A combination of the S&P 500 and Barclays Capital Aggregate indices returned 20.6% and 18.5% respectively.
The concern was greatest among smaller institutions with limited resources unable to take on significant illiquidity and complexity, NEPC said.
“The endowment model is not a ‘one size fits all’ solution,” Perry said. “A holistic approach that integrates the spending needs of the endowment with the operating budget is central to success.”
Along with understanding one’s budgetary needs, endowments and foundations should employ a multifaceted and dynamic asset allocation structure, take advantage of the illiquidity premium when possible, maintain an appropriate number of manager relationships, consider using passive management in certain areas to reduce fees, and think long-term, the paper said.
According to NEPC, a more diversified portfolio, with a balanced target asset allocation to equities, fixed income, multi-asset, and alternatives, had an expected return of 7.1%, slightly lower than the endowment model’s forecasted 7.6%. However, Perry noted that the custom model “has all the potential to satisfy the investment program’s return goals.”
The 60/40 portfolio, on the other hand, projected just over 5% expected return according to the consulting firm’s data.
“While a simple 60/40 portfolio has performed admirably over the past five years, the pendulum will likely swing back in favor of a more diversified approach,” Perry said. “Many asset classes that have performed well of late—domestic equities and fixed income—are now looking towards more subdued returns in the next five to seven years.”
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