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“At our endowment—at most endowments—what we’re trying to do is this: Generate a real return of at least 5% to maintain or increase the purchasing power of the endowment. Today’s challenge is to do this in an environment of very low interest rates that sets a floor from which all risk assets are valued. In a simple framework where the value of the endowment equals the starting value plus investment gains and contributions, less spending, if we can’t earn our required return, we either need to rely on increased gifts or decreased spending. If all of the focus is on return, then we are forced to look at assuming additional risk. With the financial crisis still top of mind, however, we need to realistically assess our risk profile and ask the question ‘Can we endure another 2008?’ Another outcome of 2008 is that we, and others, are getting away from traditional asset allocation models. We now focus more on risk factors. You’re seeing a lot of that across the industry—and not just with endowments and foundations. It’s part of a larger move to look inwards. Endowments in general think about risk more than they use to. We understand risk better, and we look at the entire enterprise’s risk more. You can’t just look at the portfolio—you have to look at how that portfolio will do when the university needs capital. We look at correlations between risks, so in a downturn, the university will likely need to give out more financial aid, while at the same time contributions to the endowment will fall. With those factors in mind, we need to balance our long-term time horizon with shorter-term liquidity. All the same, investors should be rewarded for taking on risk over the long term, or else the capital markets would not function. The endowment model is supposed to be one in which we are the early investors in an asset class. For us, right now, that has manifested itself in an increasing emphasis on real assets. It’s not new—but it is an area garnering increased attention and allocations. There’s no consensus around the definition, of course. We’re asking ourselves, “What do real assets actually mean? What’s the purpose? Is it an inflation hedge, a return source, or a diversifier?” We have a lot of equity-related beta, so we’re looking to diversify that. With real assets, we start by dividing them into liquid and non-liquid categories. We then look at sector—natural resources are something we really like. Energy investments, metals, and mining—this is where we want to be. We’re new to some of these, so we’re putting a lot of effort into learning about them. In terms of other diversifiers, we’re gradually moving more of our equities offshore. Our emerging market allocation (10%) almost matches our US equity allocation (12.5%) and our developed non-US allocation (11.5%). The private equity allocation is still dominated by US-based investments—but that’s not a statement about opposition to overseas private equity. There is just a higher hurdle there. And while we take a long-term view, we also seek to position the endowment opportunistically. The elephant in the financial market room, so to speak, is the recent volatility related to geopolitical turmoil and related market dislocations. As a result, we are looking at opportunities created by the European banking crisis and the provision of credit more broadly.”
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