CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

CHAPTER 2

The Endowment Model

Investors allocating assets to alternative investments need a framework on which to build their portfolios. What should the size of the allocation to traditional investments be, relative to alternative investments? Within alternative investments, how should the portfolio be diversified across asset classes, styles, and managers? For many, the answers come from a study of the investment practices of the managers of the largest endowment and foundation portfolios.

2.1 DEFINING ENDOWMENTS AND FOUNDATIONS

Endowments refer to the permanent pools of capital owned by institutions such as colleges, universities, hospitals, museums, and religious institutions. When well-funded and well-managed, the endowment can provide a permanent annual income to the organization, while maintaining the real value of the assets in perpetuity. The idea of perpetuity is not a theoretical concept. The two largest U.S. university endowments are owned by Harvard University and Yale University, which were founded in the years 1636 and 1701, respectively. Universities that are over 310 years old with assets of over $16 billion each can operate under the assumption that their assets will exist in perpetuity. The assets held by the endowment can generate income that offsets the impact of economic fluctuations over the course of the business cycle.

Most endowments are run by a single organization, but may be funded by thousands of donors. In the United States, each organization is ...