Efficient Frontier Insights & The Endowment Model

Abstract

The success of the endowment model of investing has long been the envy of both Wall Street and Main Street investors. Despite all of the press on how to invest like an endowment, the strategy can still be a bit of a mystery for industry outsiders. To shed some light on how endowment performance compares to the risk-return spectrum of other random portfolios that use comparable beta sources, we used Modern Portfolio Theory as an analytical framework to demonstrate some well-known – and not so well-known – findings: “Efficient” frontier portfolios that maximize return versus risk may NOT be sufficiently diversified; Diversification improves the odds of owning an all-weather portfolio, but benefits eventually diminish from using too many assets, and may also constrain potential performance; Asset allocation drives the risk-return relationship, possibly more than other practices such as market timing and security selection, especially for large portfolios with 100 fund managers; Disciplined threshold rebalancing meaningfully improves the risk-return profile, and can be better than fixed period rebalancing; Simple, low-fee, liquid, and transparent beta-driven portfolios of index funds, much like the EndowBridge Legacy Strategy, can produce superior risk-adjusted returns that are comparable to those of modern endowment funds, without the use of illiquid, opaque, and higher fee alternative assets.There will always be a place for top-quartile alternative and active fund managers in a portfolio. The best endowment investment teams show that manager selection and active management add value.Diversification even across outsourced investment managers (OCIOs) makes fiduciary sense and can ensure liquidity in a financial crisis. Thus, it is wise to employ a low-fee, beta-driven strategy to complement any long-term investor’s existing asset allocation.