To mark the eight-year anniversary of this site, EndowmentInvestor updates our examination of the fundamental question:. We think it a reasonable and useful question, even if the Endowment Model is taking its slings and arrows.

Primary attributes of the endowment investment model include:.

Basically margined naked [i. Foundations and endowments thinking their hedge funds are generating alpha should look to this article and ask themselves if they're really just being paid for providing disaster insurance. Unlike our post last weekEndowmentInvestor does not think this encourages actually writing puts as a replicating strategy; rather, it encourages thinking about the risks.

This articlefrom Harvard's Erik Stafford, contends that private equity is an admixture of:. Basically margined value investing without opening the monthly statements gets you private equity returns without the high feesfees that average 6 percent per year, according to Stafford.

Foundations and endowments incurring year lockups should decide if the anticipated premium is sufficient compensation for the illiquidity and complexityparticularly when then can accomplish much the same. That is, we believe passive investing should be the default in particular asset classes until the staff and investment committee believe they have sound reason to go active.

And, we're pretty skeptical about those sound reasons. Recently, a particular investment in the small cap value space passed its 5th anniversary. The Vanguard Explorer Value fund [ VEVFX ] is a multi-manager small-cap value fund. EarlierEndowmentInvestor looked at another Vanguard product in the Endowment Model space. Why examine this actively managed small cap fund?

Small value is an interesting equity tilt that seems to be rewarded at endowment-length horizons. Further, it makes an interesting case study. The fund has three subadvisors, all in the small value space.

Further, the risk profile is good. Critically, the expense ratio is 0. That's cheap, even for institutional pricing. We estimate 57 basis points is in line with what the biggest and most-advantaged foundation and endowments pay and is meaningfully lower than the basis points smaller endowments face. It's really cheap considering there is mutual fund overhead that commingled products and separate accounts don't bear.

This article from Vanguard explains their approach to active management, focusing on fees and manager selection. EndowmentInvestor's conclusions are similar: Manager selection is hard.

We aren't endorsing an investment in this fund. Rather, we're endorsing looking at it [and the links above] to decide if your staff and investment committee thinks they can do better than the well-resourced Vanguard team.

If not, your conclusion might be to stay passive. Some recent and recently-discovered links worthy of your consideration from around the web:. CalPERS recently announced its intention to divest from hedge funds.

EndowmentInvestor has long been interested in the Vanguard Managed Payout funds as mini-endowments. See herehereand here. However, Vanguard just announced changes to the funds concurrently with other major consolidations in their fund lineup. EndowmentInvestor lauds the changes.

Their justification [see here ] focuses on 4 percent being more sustainable over a retirement. If that's true over a year retirement, it is even more valid for a perpetual endowment. While the breaking news compelled earlier publication of this, our more-general observations scheduled for November 5 still apply:. He contends that fees should be measured, not as a percent of assets, but rather as a percent of returns.

CIO recruiter Charles Skorina has a quarterly newsletter with a heavy focus on endowment management. His two most recent issues examine performance [and CIO pay-for-performance] at the Ivy League, Ivy-Plus and Global-Caliber Public endowments. See here and here. A blog at the CFA Institute recently included a post by Tom Brakke on "Cash as Trash, Cash as King, and Cash as a Weapon. The cash-as-king viewpoint highlights its utility. The cash-as-weapon viewpoint is as a tool in the portfolio management arsenal.

The post goes on to consider "cash is a sector," Warren Buffet's view of cash as a call option, and whether consultants' distaste for managers holding cash is justified.

EndowmentInvestor commends reading it in full. Brakke makes the case from an investment point of view. Some arguments for holding cash include:. Cash is certainly not costless today. Low nominal returns make it a negative real-return asset. Nonetheless, many nonprofits scarred [or scared] by illiquidity over the era are making strategic decisions to hold cash. This might be in the investment portfolio or might be by having meaningful operational cash buffers.

Their report usefully points out the wide difference between typical small- and mid-sized endowments and the large endowments that get the headlines. Accordingly, our analysis shows that the majority of endowments would have been better off had they simply invested in low-cost, diversified, transparent public funds. Depending on the period, the typical medium and small endowment underperforms. EndowmentInvestor notes Vanguard's characterization of the differentiators that the largest endowments enjoyed:.

The largest endowments have over time developed a distinct depth of expertise, particularly regarding alternatives. The average large endowment has a staff size of ten investment professionals. The ten largest endowments have made an even bigger commitment to expertise, with an average staff size of 25 investment professionals. Larger endowments are able to commit significant capital to an investment manager.

In combination with their long- developed expertise, this gives them a strong position in negotiating fees. Indeed, some of the top endowment managers say that high fees alone are a reason to avoid some funds, implying that if an investment cannot be obtained at a reasonable price, it is not worth investing in.

The largest endowments are twice as likely as small ones to invest in alternative strategies directly. The cost lessons [the last 2 points] are to be expected of Vanguard, but are instructive. It is somewhat striking that Vanguard makes the staffing point without discussing cost. EndowmentInvestor has just read Simon Lack's Hedge Fund Miragean indictment of the hedge fund industry. The book builds on hedge-professional Lack's AR article [ here ], which in turn cites academic research from Dichev and Yu [see here ].

The basic premise of the book, the article, and the academic research is that investors have been ill-served by hedge funds. All rely on the IRR, Internal Rate of Return, which penalizes badly-timed investments.

Since massive inflows to hedge funds occurred leading intothe answer is a foregone conclusion. This comes from the generous 2-and fee structure and is augmented by the ability to sell the successful hedge fund business. This realization led him to question the basic premise of hedge fund investing. Lack highlights the self-serving nature of hedge funds.

Of how successful managers are prone to return capital and have their own [fee-derived] wealth become a greater and greater portion of the money invested. His background is in hedge fund seeding. There are many anecdotes from his experience that don't necessarily support his thesis but are nonetheless interesting. In this, he's basically prescribing his own experience.

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For many, it's impractical advice. Indeed, meaningfully staffed foundations and endowments may be amongst the few who can actually take his advice. Nonetheless, in highlighting the problems and false promises of hedge funds, Simon Lack's Hedge Fund Mirage performs a useful service for foundation and endowment investors. EndowmentInvestor has generally thought of founder's stock as a problem. Founder's stocktypically low-basis stock donated to a private foundationis antithetical to diversification.

No sane CIO would concentrate 90 percent of the portfolio in one stock if starting the portfolio from cash. They only "park" the money there pending diversificaiton. Holding on to founder's stock is incredibly risky. If we consider foundations and endowments as a wholehowever, we might draw a different conclusion. If every nonprofit kept its founder's stock and remained undiversified, the nonprofit community as a whole would be diversified.

Individual nonprofits would have "non-diversification" risk, but as Charlie Munger told the foundation community:. There are worse things than some foundation's [sic] losing relative clout in the world. This is good practice. Another good practice is to juxtapose the fees against the excess returns calculated by the investment consultant.

Oftentimes, consultant-generated data is gross of fees, so showing the fees and [purported] outperformance side-by-side is a revelation. Lastly, have an exhibit prepared for the investment committee that shows fees in dollars instead of percentages or basis points. Too often, endowment and foundation trustees scrutinize operating budgets at a high level of granularity yet let significantly larger investment management expenses go unexamined.

The laws governing endowments and foundations typically include notions of "prudence," "Incurring only reasonable costs," and "acting in good faith. This week's Buttonwood column in the Economist [ here ], claims in its title that "Yale may not have the key.

Buttonwood's key points include:. After the cheap gimmick of our blank post on What many endowments learned from the financial crisisit's time to reflect on lessons EndowmentInvestor learned:. Ettore's Observation is a variation of Murphy's Law The other line always moves faster. If you change lines, the one you just left will start to move faster than the one you are in now.

Howard Marks of Oaktree Capital saw this as a useful metaphor for investments. If I could switch to the faster lane while everything remained unchanged, doing so would cut my travel time. But everyone sees which lane is moving fastest, and if everyone switches into that lane, that will make it the slow lane. Thus the collective actions of drivers alter the environment.

In fact, they create the environment. There are a number of manifestations of Ettore's Observation and O'Brien's Variation:. Having recently enjoyed the benefit of the HOV-3 lanes in northern Virginia, EndowmentInvestor would like to extend Howard Mark's metaphor of driving on the highway:. EndowmentInvestor realizes this is not the definitive word on Ettore's Observation applied to investments, but does find the concept stimulating.

EndowmentInvestor marks this second anniversary of the Vanguard Managed Payout funds with a minor retrospective. These are Vanguard's "endowment funds. We considered the funds a year ago at their first anniversary [see here ]. Key observations then included:. As we said last year at this time, EndowmentInvestor finds these Vanguard funds instructive and will continue to watch them. Philosopher John Rawls advanced the "veil of ignorance" as a means of evaluating whether a society was just.

Under his thought experiment, relationships among groups are ordered without knowing which group you will be part of. Here, EndowmentInvestor tries to use the veil of ignorance with respect to endowment investment stakeholders:. Others attempting this exercise might bring different biases to the veil of ignorance, but EndowmentInvestor thinks advantages of cftc regulated binary options brokers be comfortable on either side of these relationships.

While this is our utopian speculation, the veil of ignorance thought experiment does highlight directions that endowment investors could follow. Much of what passes for alpha is exotic beta.

As an example, consider the EAFE-mandate international manager that invests outside EAFE in emerging markets. Should an endowment reward this manager for doing something it could do itself? So-called hedge fund replication strategies offer less-expensive access to exotic beta.

Combinations of ETFs can do so as well. However, astute use of either requires some effort and sophistication from the endowment. The fact that much pseudo-alpha is actually exotic beta su ggests it is overpriced. Accessing exotic beta may require them to pay up for hedge funds. Again, it's a tradeoff for individual foundations and endowments to decide.

The advisor has appointed an investment committee for the Funds. The investment committee makes three key asset allocation decisions for the Funds. The investment committee's decisions are also based on the collective professional judgment of its members.

The Funds are managed in accordance with a variety of statistical and compliance-based risk management controls and procedures. Hedge fund redemptions and the current crisis are highlighting the importance of permanent capital. Permanent capital gives traders the ammunition to adapt to the rapidly-morphing situation. One response from hedge funds to the need for permanent capital has been to exchange lock ups for fee reductions.

In return for agreeing to provide more-permanent taxability of restricted stock options, LP investors get a fee break. While EndowmentInvestor is all for lower fees, this can be a fool's bargin! Instead, they have committed to being last to any future bank run.

Only if all investors are locked up does the lower-fees for lock-ups exchange make sense. Endowment Investor To advance endowment and foundation investing. Worth Linking Abnormal Returns Skorina Newsletter Earn money from clicking ads Siegel's Blog Yale MBA course Endowment Institute Cambridge UK Training.

Subscribe to this blog's feed. Disclaimer This site is made available for educational go make money runescape f2p 2016 only. Nothing on this site is intended to serve as investment, financial, accounting or legal advice.

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The visitor is urged to seek his or her own investment, financial, accounting or legal advice from a qualified professional. We the site and author specifically disclaim any and all liability related to the subject matter of this blog. Blog powered by Typepad. The endowment investment model: The perspective To mark the eight-year anniversary of this site, EndowmentInvestor updates our examination of the fundamental question: What is the endowment investment model?

Primary attributes veolia stock buy or sell the endowment investment model include: EQUITY BIASED and RETURN SEEKING: Equities and high-return alternatives are favored. EndowmentInvestor believes that characterizations of the endowment investment model as "favoring alternatives" misses the point that high-return alternatives are preferred stock market investment weblog that significant equity beta how to make money zombie cafe in the portfolio.

While endowments have always had a perpetual horizon, the endowment investment model actually attempts to take advantage of this. It is, perhaps, a self-referential definition but the attributes listed here make those following the endowment investment model "leading edge" investors. More than that, though, is the conscious attempt to embrace investments and approaches that are ahead of the mainstreamthey seek first-mover advantage. Other characteristics of the endowment investment model include: This is a corollary of diversification, but the endowment investment model was more global earlier than other investors.

Today's manifestation of this approach is to overweight emerging markets, particularly China. This is the corollary to the perpetual investment horizon, but merits separate mention. EndowmentInvestor believe successful endowment management requires a long term view in evaluating managers and fantasy market simulation sports stock. After building some institutional goodwill from past successes, practitioners of the endowment investment model "spend" that goodwill by establishing idiosyncratic investmentsones that differ from other endowments and the survey benchmarks.

Most endowments imf forex active investment management heavily. The endowment investment model embraces the language how to send money order to usaa risk. Stress tests and risk budgets are part of that vocabulary.

More so than even foundations, university investment offices have embraced the CIO title and its supporting structure. The importance of a first-class investment committee has received growing emphasis. The roles of the committee and the staff are clearly demarcated. Selling out-of-the money put options "portfolio insurance" Leverage High fees Basically margined naked [i. How to make homemade private equitywhich reminds us that what passes for alpha may be beta Why some learn how to trade stocks for beginners the private equity premium is not really about illiquidity The value of an illiquidity scheduleshowing private equity as illiquid and uncalled commitments as leverage What is called "illiquidity" is actually "irreversibility" The denominator effect How private equity provides " illiquidity services " Taking time, in an annual work planto focus on the asset class Larry Siegel on illiquidity at the Ford Foundation Once, private equity was free Homemade private equity This articlefrom Harvard's Erik Stafford, contends that private equity is an admixture of: Value investing Leverage Hold-to-maturity accounting High fees Basically margined value investing without opening the monthly statements gets you private equity returns without the high feesfees that average 6 percent per year, according to Stafford.

Around the web Some recent and recently-discovered links worthy of your consideration from around the web: Ian Toner of consultant Wurts on the importance of the board's time here Charles Skorina on the folly of divestment CIO magazine on the fee-versus-diversification tradeoff [and the related academic article ] This year's less best way to make money in stronghold kingdoms than usual Yale Endowment Update.

Should your endowment or foundation follow suit? There are a number of reasons to be skeptical: Fees matter crucially Simple investing is a virtue and HFs are complex Many hedge funds are merely mid-beta products that don't offer a great deal of diversification when it's really needed What, then, to do?

Scrutinize your hedge funds for banal, yet expensive, mid-beta productsthen cut them Scrutinize your all-in hedge fund costs A huge portion of the anticipated hedge fund alpha may nifty binary trading tips free and forex to fees Consultant costs are real Each layer of fees, base or carry, is real and worth counting Consultant, staff, and board time is a cost Seek out truly diversifying hedge funds Be open to recent ho-hum performance from hedge funds that do offer true diversification Assure your hedge fund allocation at the end of this analysis is large enough to be meaningful.

Concentrating with fewer managers Negotiating lower base fees and higher incentive fees Private equity co-investments Separate accounts instead of fund-of-funds Arriving early at the first close [with a big commitment]. Vanguard Managed Payout funds at age five and a half EndowmentInvestor has long been interested in the Vanguard Managed Payout funds as mini-endowments.

The key changes to the managed payout funds include: The three funds, with targeted payouts of 3 percent, 5 percent and 7 percent, are being merged into one. The consolidated fund will have a payout of 4 percent.

While the breaking news compelled earlier publication of this, our more-general observations scheduled for November 5 still apply: The funds have evolved over time. More recently, we note: They are up-weighting corporate bonds. This is in lieu of using Vanguard's total bond market fund exclusively. This is consistent with Vanguard Asset Management Service's advice to a small nonprofit EndowmentInvestor knows. Adding international bonds in a small dosage. Most Vanguard balanced mandates are doing this.

This is consistent with Vanguard AMS's advice to a small nonprofit EndowmentInvestor knows. Direct investments in commodities. They are still underweight real how much does a yoga instructor make in ontario relative to leading endowments.

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Their market neutral investment is now managed in-house. Not many leading endowments would have a 10 percent allocation to a single hedge fund like Vanguard does. They are getting more traction. Morningstar semi-likes them, rating all Bronze. They're now appreciably ahead of their ill-timed May launch ufc stock market ticker. But that required reinvestment.

Interestingly, these funds' payout mechanisms are covered by two U. For the record, 5 minute demo binary options trading account is skeptical of whether most patented finance insights are truly novel and non-obvious. Examining the Ivy-Plus endowments CIO recruiter Charles Skorina has a tesco sunday opening times during olympics newsletter with a heavy focus on endowment management.

He rightly focuses on 5-year performance, not something more evanescent. Turnover in the CIO position is bad. As an executive recruiter, Skorina seems to like CIOs to become CIOs, which EndowmentInvestor finds a bit limiting, but is probably appropriate for these top-of-profession positions. These CIOs seem to all get incentive pay, even when lagging plausible external benchmarks.

Timber, as an asset class, buys topcover for being green. Like us, Skorina remembers the Jari Projector international timber gone bad. Strategic cash A blog at the CFA Institute recently included a post by Tom Brakke on "Cash as Trash, Cash as King, and Cash as a Weapon. Some arguments for holding cash include: As a really-cheap tail risk hedge. As prefunding for capital calls. As prefunding for grantmakingthat is, as an operational buffer. EndowmentInvestor notes Vanguard's characterization of the differentiators that the largest endowments enjoyed: EndowmentInvestor commends the report.

Hedge Fund Mirage EndowmentInvestor has just read Simon Lack's Hedge Fund Miragean indictment of the hedge fund industry. Lack's prescription for hedge fund investors comes early in the book: Keeping founder's stock EndowmentInvestor has generally thought of founder's stock as a problem. Individual nonprofits would have "non-diversification" risk, but as Charlie Munger told the foundation community: There is a certain beauty to everyone keeping their founder's stock: How much money do h&r block tax preparers make fees would be dramatically lower Committee meetings would be dramatically shorter Few investment consultants would have a claim on nonprofit assets.

Buttonwood on the endowment model This week's Buttonwood column in the Economist [ here ], claims in its title that "Yale may not have the key. Buttonwood's key points include: Illiquidity as a defining characteristic of the Yale model because endowments have long horizons. Yale benefited from a first-mover advantage into new asset classes. An allusion to Martin Leibowitz's "stress beta" analysis [see here ] where correlations go to 1 and the benefits of diversification are diluted.

High fees in alternatives dilute the benefit of the Yale example. Things we learned from the financial crisis After the cheap gimmick of our blank post on What many endowments learned from the financial crisisit's time to reflect on lessons EndowmentInvestor learned: Trustees cannot be trusted.

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Denominator effects distort decision making. Old-school asset allocations looked good during the crisis even as they are underdiversified in normal times. Investment horizons are shorter in practice than in theory. Perpetuity is a long time. Crises hide manager problems. When the house is on fire, the tatty chair in the corner is not your primary concern. Crises hide fee concerns. For the same reason. Spending during a downturn cannot be recouped.

A downturn, though, is when charities really need to spend. Ettore's observation Ettore's Observation is a variation of Murphy's Law There are a number of manifestations of Ettore's Observation and O'Brien's Variation: Properly-equipped nonprofits can take advantage of their distinctiveness [3 passengers perhaps the committee, staff and consultant?

Even when the HOV lanes are inaccessible for whatever reason [limited staff, weak committee, etc. But the lane strategy should be selected after reflecting on the nonprofit's unique circumstances. Further, and consistent with O'Brien's Variation, once selected, the lane strategy should not be altered after short-term setbacks.

Vanguard Managed Payout Funds at two EndowmentInvestor marks this second anniversary of the Vanguard Managed Payout funds with a minor retrospective. Key observations then included: The 5 percent payout fund [the one most relevant to typical foundation and endowment investors] specifies inflation-adjusted "capital preservation" not capital appreciation as its goal.

Including a long-short fund makes the asset mix much more typical of endowment best practice than other balanced mutual funds at Vanguard or elsewhere. But the Vanguard funds concentrate their long-short manager risk. Real assets that hedge inflation do not receive a particularly prominent role. EndowmentInvestor liked the way the asset allocation process was described. Their introduction was horribly timed.

In the intervening year, what has changed with these funds? They seem to have come to appreciate EndowmentInvestor's second point above to not put all of your absolute return eggs in one basket. They've opted to add Vanguard's Intermediate Investment Grade bond fund alongside the Total Bond Index fund. Effectively this means more credit risk this year. This, at a time when many endowments have decided to eschew credit risk altogether.

The growth-oriented 3 percent payout fund lagged its benchmark non-trivially in They are underweight REITs, relative to their benchmark. In hindsight, this was a mistake but a mistake that EndowmentInvestor commiserates with. Headlines were filled with real estate horror stories a year ago.

Like many endowment-style investment pools their drawdown was worse than a traditionalist balanced fund and their recovery stronger. They are still under water. Veil of ignorance Philosopher John Rawls advanced the "veil of ignorance" as a means of evaluating whether a society was just. Here, EndowmentInvestor tries to use the veil of ignorance with respect to endowment investment stakeholders: Investment Managers would have performance fees with appropriate benchmarks.

Investment managers are paid for investmentnot marketingsuccess. Investment managers would co-invest to a major degree. Consultants would be evaluated on their actual contribution. They would be fiduciaries. They would be paid better, but clients would expect more. Their incentives would be about more than merely perpetuating the relationship.

Endowment Staff would have incentive pay, but would not benchmark themselves against the private sector. Trustees would be paid, albeit nominally. Pay also entitles trustees to righteous indignation about poor colleagues.

Trustees would seek inter-generational equity. Investment Committees would be small.

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Grant Recipientsif any, could build cash reserves without triggering a response from the foundation. Scholarship Recipients, if any, would write thank you notes.

Donors should not have a say in investment management. This semi-annual study should be on every endowment and foundation investor's calendar. EndowmentInvestor is consistently suspicious of active management. Key points from the latest SPIVA study include:. This 5-year period [] can reasonably be called a full market cycle. The shocking amount of style drift.

Actively-managed funds don't stick to their knittingalmost half of all domestic funds don't exhibit style consistency over five years. Active management matters in bonds, tooperhaps more so than in the past. EndowmentInvestor is struck by the contrast between the SPIVA study and the data that investment consultants show.

Consultant databases generally cast a more-flattering light on active management. While consultants generally assert that their databases are free of look-back and survivorship biases, closer questioning reveals nuances to these claims. In contrast, the SPIVA research is based on the CRSP Survivor-Bias-Free Mutual Fund Database.

Given the scholarly scrutiny of all of the CRSP databases as well as consultant's incentives to encourage active management, EndowmentInvestor gives greater credence to the SPIVA study. It's possible that the difference lies in SPIVA's focus on mutual funds, instead of institutional accounts, but the SPIVA studies should cast doubts on active management's allure. Vanguard managed payout funds What can we learn? Vanguard's family of "managed payout" funds have been available for a year now.

EndowmentInvestor deconstructs them as well as their initial experience to see what lessons endowment and foundation investors can learn. The payout rate is applied to the average daily balance of a hypothetical account over the prior 3 years. This is the classical moving average approach, not the recently-popular "Standford-Yale method" for computing payouts that use both recent market values and prior year spending.

Note that the 5 percent is after investment expenses since the percentage is applied to an after-expense account value, like that required of U.

The amount is adjusted annually, like many nonprofits and colleges do. What is the asset mix? The asset mix target is not explicitly laid out in the current prospectus, which EndowmentInvestor finds lamentable.

Instead, we must rely on the current actual asset mix as well as information from the potentially-outdated preliminary prospectus. That said, while endowment best practice might include an absolute return allocation of this magnitude, it would be spread across multiple managers. These funds concentrate their long-short manager risk. The absolute return allocation can be construed as substituting for fixed income.

International equities have a more prominent role than the toehold of some traditional asset mixes. For the 5 percent payout fund [marked "V5"], real assets that hedge inflation do not receive a particularly prominent role.

Despite the regrettable absence of asset asset allocation targets in the prospectus, EndowmentInvestor did appreciate two paragraphs about their asset allocation process, which we format for emphasis and clarity:. Although this is obviously lawyer-language, it is not a bad road map to good foundation and endowment asset allocation practice.

One beauty of the funds is the low expense ratio. This is fairly amazing. It is not clear whether Vanguard uses lower-cost Admiral or institutional shares. The funds' SAI indicates they can engage in securities lending. Their return in the first year has been ugly. The 5 percent payout fund is off The 3 percent payout fund is off This means the payout levels are significantly below the payouts percent to 18 percent lower.

This is one of the dangers of a pure moving average approach that a Yale-Stanford payout, which considers prior year spending, attempts to address.

All that aside, EndowmentInvestor finds them instructive and will continue to watch them. Morningstar examined the funds in detail on July 2, What is the reward?

Five Questions Trustees Should Ask This continues the series on " Five Questions Trustees Should Ask. Endowments and foundations should consider the following in evaluating "What is the Reward? What are the possible rewards? Is the upside limited? With bond-like investments, it is. Does the investment thesis require a "catalyst" to trigger the payoff? What are the related probabilities? Are the probable rewards consistent with an endowment's need to have an equity bias?

What are the basic determinants of investment value? The rewards are necessarily tempered by the investment costs. Are these costs reasonable? Do they create an alignment of incentives for investors and managers? What is the cost vs. Are there attributes of the potential rewards that are especially munificent for the endowment or foundation in particular? That is, are there unique benefits for our endowment? For example, inflation-linked bonds might be particularly attractive for perpetual-horizon charities interested in maintaining purchasing power.

Similarly, local real estate might be particularly interesting to a local grantmaking foundation, despite the non-diversification. Small cap alpha, or not. A spectrum of opportunity? An argument that EndowmentInvestor has frequently heard in investment committees is that a mix of active and passive strategies is appropriate because there is a spectrum of market efficiency.

This thinking asserts that less efficient domains like small cap or emerging market stocks should be actively managed while more efficient domains like large cap U. The accompanying graphic captures the essence of this thinking with respect to a 3x3 Morningstar-mode equity style box; beta, or index, strategies in large cap space with alpha, or active, strategies in small cap space.

Research on the existence of small cap alpha is mixed. Gregory Allen, now President of consultant Callan, made the case for small cap alpha in the Journal of Portfolio Management in [abstract here ]. This new version relies on a robust academic database, the CRSP Survivor-Bias-Free U. Mutual Fund Database, and isn't the most timely data but is well worth the wait. In the mid version, they report: Smaller-stock markets are more efficient, not less, over this period. Small cap appears more efficient than large cap at the 1- and 3-year horizons as well The 5-year horizon performance gap between the index and the average small cap funds is an shockingly-large annualized 2.

EndowmentInvestor encourages endowment and foundation fiduciaries to be cautious about accepting claims of small cap alpha and a sliding scale of market efficiency. The data above strongly suggest that seeking small cap alpha is a dangerous game. Lock in Hedge fund redemptions and the current crisis are highlighting the importance of permanent capital.