This paper surveys the practice of asset allocation for larger U.S.
university endowments focusing on asset category definitions.
Wide diversity today reflects the broad shift to alternative investments and the blurring of boundaries by investment funds and
managers. A prominent example involves hedge funds. Numerous
and divergent subcategories depict the current wide-ranging
opportunities available. We point out the movement to define asset
categories with reference to their target performance or underlying
return drivers rather than traditional investment vehicle-types, and
we speculate on future directions and implications for the role of
strategic asset allocation for institutional investors.
Asset allocation generally is accepted as a central tenet of sound
money management for institutional investors. However, the role of
strategic asset allocation and its implementation have been evolving
over the past decade and longer. This evolution is exemplified in the
way that larger U.S. university endowments manage their capital.
College and university endowments have been heralded as innovators. Noticeably, these investors have made a significant shift to
alternative assets, especially private equity and hedge funds
(Swensen 2000, 2009). In 2014, the average endowment portfolio
was 51 percent alternatives, up from 23 percent in 2000; table 1
shows that endowments with more than $1 billion in assets have
even higher allocations to alternatives, which average 57 percent
(Griswold 2015). Many endowments have enviable historical performance records. Accordingly, other institutional investors have
gained interest in the so-called endowment model. In conjunction
with this trend to alternative investments, U.S. university endowments have been on the forefront of modifications to the definitions of the underlying asset categories. At one time, there were
three or four major categories: equities, bonds, cash, and (
sometimes) real estate. Today, the situation has changed dramatically.
In this paper, we survey the asset categories and allocations
employed by the larger U.S. endowments as reported in publicly
available reports. The survey reveals a great diversity in the definition of asset categories. This diversity reflects the need to develop
workable solutions for addressing the blurring of traditional
boundaries by investment funds, such as liquid alternatives products, and by an increasing focus on underlying return drivers.
Likewise, many endowments frame asset category choices in terms
of their own teams and investment processes as they seek to generate returns in a competitive landscape with scrutiny from broad
and sophisticated constituencies.
The endowment model, especially for investors outside the university domain, has attracted criticism about governance, fees, and
incentives, concerns that have been cited in policy discussions on
public pension funds and helped motivate the U.S. Department of
Labor’s Fiduciary Rule (OECD 2015, Pew 2014, Parisian and Bhatti
2015). Practical problems include evaluating the efficiency of active
management fees for portfolios highly correlated to liquid indexes
and understanding exposures to underlying factors such as oil prices
that can affect portfolios through multiple channels, including direct
exposures to futures or physical assets, public equity, and private
equity. It is natural to look to the universities that led the trend into
alternatives for insights into navigating the resulting complexities.
The endowment model emphasizes manager selection and opportunistic investing over the top-down decision-making incorporated
into asset allocations (Monk 2014). Common reasons include the
high dispersion of returns among alternative investment funds, the
stickier nature of manager relationships in partnership structures,
and less-liquid longer-term underlying investments. In a study of
endowment returns from 1984 to 2005, Brown et al. (2010) find
evidence that endowments overweight asset categories wherein
they can source stronger managers. Endowments themselves often
make this point in self-reports.
In contrast, asset categories play a central role for many investors.
They provide the framework for governance and oversight through
THE EVOLUTION OF ASSET CLASSES
Lessons from University Endowments
By John M. Mulvey, PhD, and Margaret Holen, PhD
Table 1: Asset Allocation for U.S. Colleges and Universities (2014)
over $1 billion
Equities 36% 31%
Domestic equities 17% 13%
International equities 19% 18%
Fixed income 9% 8%
Alternatives 51% 57%
Short-term securities/cash/other 4% 4%
Source: NACUBO (2015)