An Integrated Model of University Endowments

Abstract

University endowments have attracted considerable recent attention as an important institutional investor class while developing a unique aspect to their investing policies ‐ often referred to as the “endowment model”. Our paper develops a formal theoretical endowment model within which to view the consistent application of asset allocation and spending policies. The innovation in this research is that we tie the donations process to the investment performance. An empirical analysis using recent endowment data validates our donations process assumptions. We investigate both substitution and wealth effects and find that conventional predictions can be reversed due to this form of donations endogeneity. Specifically risky asset allocations are higher for endowments with more donations despite the substitution effect and spending rates for smaller endowments are more volatile than for larger endowments due to the wealth effect of endowment size. Looking at empirical data on actual US endowment practices, we find that universities behave as though the substitution effect persists, although the size impact on endowment practices is more in line with our model.